-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VexpDvlrpjpQuslNRYq+bLGGcAgXQKnpa4GjL8jZ6hDbr+n7smeC+mIhY7bfV65o 6QFHX+7GLm0/0sJufdcXFw== 0000950131-99-001928.txt : 19990402 0000950131-99-001928.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950131-99-001928 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTH CENTRAL BANCSHARES INC CENTRAL INDEX KEY: 0001005188 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 421449849 STATE OF INCORPORATION: IA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-27672 FILM NUMBER: 99579443 BUSINESS ADDRESS: STREET 1: 825 CENTRAL AVE STREET 2: C/O FIRST FED SAVINGS BANK OF FT DODGE CITY: FORT DODGE STATE: I0 ZIP: 50501 BUSINESS PHONE: 5155767531 MAIL ADDRESS: STREET 1: 825 CENTRAL AVENUE CITY: FORT DODGE STATE: IA ZIP: 50501 10-K405 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------- ------------- 0-27672 (Commission File Number) NORTH CENTRAL BANCSHARES, INC. (Exact Name of Registrant as Specified in its Charter) Iowa 421449849 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) c/o First Federal Savings Bank of Iowa 825 Central Avenue, Fort Dodge, Iowa 50501 (Address of Principal Executive Offices) (Zip Code) (515) 576-7531 (Registrant's Telephone Number including area code) Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file reports) and (2) has been subject to such requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [X] As of March 19,1999, there were issued and outstanding 2,957,242 shares of the Registrant's Common Stock. The aggregate value of the voting stock held by non-affiliates of the Registrant, computed by reference to the average bid and asked prices of the Common Stock as of March 1, 1999 was $44,144,265. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Proxy Statement for the Registrant's 1999 Annual Meeting of Shareholders are incorporated by reference into Items 10, 11, 12 and 13 of Part III hereof. PART I ITEM 1. BUSINESS General North Central Bancshares, Inc. (the "Holding Company"), an Iowa corporation, is the holding company for First Federal Savings Bank of Iowa (the "Bank"), a federally chartered savings bank. Collectively, the Holding Company and the Bank are referred to herein as the "Company." The Holding Company was organized on December 5, 1995 at the direction of the Board of Directors of the Bank for the purpose of acquiring all of the capital stock to be issued by the Bank in connection with the conversion and reorganization of the Bank and North Central Bancshares, M.H.C. (the "MHC") from the mutual to the stock holding company structure (these transactions are collectively referred to as the "Conversion"). On March 20, 1996, upon completion of the Conversion, the Holding Company issued an aggregate of 4,011,057 shares of its Common Stock, par value $0.01 per share, of which 1,385,590 shares were issued in exchange for all of the Bank's issued and outstanding shares, except for shares owned by the MHC which were cancelled, and 2,625,467 shares of which were sold in Subscription and Community Offerings at a price of $10.00 per share, with gross proceeds amounting to $26,254,670. At this time, the Holding Company conducts business as a unitary savings and loan holding company and the principal business of the Holding Company consists of the operation of its wholly-owned subsidiary, the Bank. The Holding Company's executive offices are located at the home office of the Company at 825 Central Avenue, Fort Dodge, Iowa. The Holding Company's telephone number is (515) 576-7531. First Federal Savings Bank of Iowa The Bank is a federally chartered savings bank that conducts its operations from its main office located in Fort Dodge, Iowa and six branch offices located in Iowa. Three of the Bank's branches are located in north central Iowa, in the cities of Fort Dodge, Nevada and Ames. On January 30, 1998, the Bank completed the acquisition of Valley Financial Corp., an Iowa corporation, and the holding company for Valley Savings Bank, FSB (the "Acquisition"). See "Acquisition of Valley Financial Corp." As a result of the Acquisition, the Bank also has three branches in southeastern Iowa, in the cities of Burlington and Mount Pleasant. The Bank is the successor to First Federal Savings and Loan Association of Fort Dodge, which was chartered originally in 1954, and on May 7, 1987 became a federally chartered savings bank. The Bank adopted its present name on February 27, 1998. The Bank is a community-oriented savings institution that is primarily engaged in the business of attracting deposits from the general public in the Bank's market areas, and investing such deposits in one-to-four family residential real estate mortgages and multifamily mortgages and, to a lesser extent, secured and unsecured consumer loans, with emphasis on second mortgage loans. The Bank's deposits are insured by the FDIC under the SAIF. The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since 1954. At December 31, 1998, the Bank had total assets of $336.7 million, total deposits of $246.7 million, and total shareholders' equity of $48.2 million. The Bank's principal executive office is located at 825 Central Avenue, Fort Dodge, Iowa and its telephone number at that address is (515) 576-7531. Acquisition of Valley Financial Corp. As of the close of business on January 30, 1998, the Bank completed the Acquisition of Valley Financial Corp., ("Valley Financial"), pursuant to an Agreement and Plan of Merger, dated as of September 18, 1997, (the "Merger Agreement"). The Acquisition resulted in the merger of Valley Financial's wholly owned subsidiary, Valley Savings Bank, FSB ("Valley Savings") with and into the Bank, with the Bank as the 2 resulting financial institution (the "Bank Merger"). Valley Savings, formerly headquartered in Burlington, Iowa was a federally-chartered stock savings bank with three branch offices located in southeastern Iowa. The former offices of Valley Savings are being operated as a division of the Bank. In connection with the Acquisition, each share of Valley Financial's common stock, par value $1.00 per share, issued and outstanding (other than shares held as treasury stock of Valley Financial) was cancelled and converted automatically into the right to receive $525.00 per share in cash pursuant to the terms and conditions of the Merger Agreement. As a result of the Acquisition, shareholders of Valley Financial were paid a total of $14,726,250 in cash. The source of funds for the Acquisition consisted of the Bank's accumulation of its cash flow from the maturity of short-term liquid investments, principal and interest on loans, sale of other investment securities, other cash receipts, net of operating expenses and other projected disbursements. Market Area and Competition The Company is an independent savings and loan company serving its primary market area of Webster and Story Counties, which are located in the central and north central part of the State of Iowa. As a result of the Acquisition, the Company also operates branch locations in Burlington and Mount Pleasant, Iowa. The Company's market area is influenced by agriculture as well as gypsum mining, retail sales, professional services and public education. The Company is headquartered in Fort Dodge, the Webster County seat, where it operates two Company locations. The Company's Nevada branch operates in the city of Nevada, Iowa, the county seat for Story County. Nevada is located close to Ames, the location of Iowa State University, and is also located 35 miles from Des Moines, the state capital. The Company's Ames branch operates in the city of Ames, Iowa and is also located 30 miles from Des Moines. Fort Dodge has become a strong retail center for North Central Iowa and Nevada and Ames are significantly influenced by the proximity of Iowa State University and certain Iowa state government agencies. Burlington, the county seat of Des Moines County, is a strong retail center for southeastern Iowa. Mount Pleasant is the county seat of Henry County. The unemployment rate for Webster County as of December 1998 was 2.3%, compared to the national rate of 4.3% and the State of Iowa rate of 2.7%. The unemployment rate for Story County was 2.0%, for Des Moines County was 2.8% and Henry County was 3.2%. The Nevada, Iowa and Ames, Iowa markets have been a source of loan and depositor growth for the Company in recent periods, and the Company expects to continue to pursue lending and deposit growth opportunities in these markets, as well as the markets in Burlington and Mount Pleasant, Iowa. However, due to the loan demand in the Company's overall market area, increased competition, and the Company's decision to diversify its loan portfolio, the Company has originated and purchased loans (primarily multifamily loans) from out of state. The Company intends to continue such originations and purchases pursuant to its underwriting standards for Company-originated loans. The Company encounters strong competition both in attracting deposits and in originating real estate and other loans. Its most direct competition for deposits has historically come from commercial and savings banks, other savings associations, and credit unions in its market area. Competition for loans comes from such financial institutions as well as mortgage banking companies. The Company expects continued strong competition in the foreseeable future. Many such institutions have greater financial and marketing resources available to them than does the Company. The Company competes for savings deposits by offering depositors a high level of personal service and a wide range of competitively priced financial products. In recent years, additional strong competition has come from stock and bond dealers and brokers and, in particular, mutual funds. The Company competes for real estate loans primarily through the interest rates and loan fees it charges and advertising, as well as by offering high levels of personal service. 3 Lending Activities Loan Portfolio Composition. The principal components of the Company's loan portfolio are fixed- and adjustable-rate first mortgage loans secured by one-to-four family owner-occupied residential real estate, fixed-and adjustable-rate first mortgage loans secured by multifamily residential real estate and, to a lesser extent, secured and unsecured consumer loans, with emphasis on second mortgage loans. At December 31, 1998, the Company's loans receivable totalled $259.4 million, of which $149.0 million, or 57.5%, were one-to-four family residential real estate first mortgage loans, and $76.3 million, or 29.4%, were other first mortgage loans, primarily multifamily and commercial real estate loans purchased by the Company. Consumer loans, consisting primarily of automobile loans and second mortgage loans, totalled $34.1 million, or 13.1%, of the Company's loan portfolio. Savings associations, such as the Bank, are generally subject to the same limits on loans to one borrower as are imposed on national banks. Generally, under these limits, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the association's unimpaired capital and surplus. Additional amounts may be lent, in the aggregate not exceeding 10% of unimpaired capital and surplus, if any such loan or extension of credit is fully secured by readily-marketable collateral. Such collateral is defined to include certain debt and equity securities and bullion, but generally does not include real estate. For the year ended December 31, 1998, it was the Company's policy to limit loans to one borrower to $2.5 million. At December 31, 1998, the Company's largest aggregate outstanding loan to one borrower was $2.5 million and the second largest borrower had an aggregate balance of $2.1 million, both of which were first mortgage multifamily residential real estate loans and both were performing as of that date. 4 Analysis of Loan Portfolio. Set forth below are selected data relating to the composition of the Company's loan portfolio by type of loan as of the dates indicated:
At December 31, 1998 1997 1996 1995 1994 ----------------- ----------------- ----------------- ----------------- ----------------- Percent Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- (Dollars in thousands) First mortgage loans: One-to-four family residential(1)............. $148,992 57.46% $115,763 59.48% $107,168 63.44% $ 94,876 62.70% $ 84,203 65.48% Multifamily................. 64,895 25.02 51,345 26.38 34,488 20.42 31,622 20.90 21,474 16.70 Commercial.................. 11,396 4.39 3,800 1.95 5,225 3.09 5,825 3.85 6,163 4.79 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total first mortgage loans 225,283 86.87 170,908 87.81 146,881 86.95 132,323 87.45% 111,840 86.97 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Consumer loans: Automobiles................. $ 7,348 2.83% $ 4,696 2.41% $ 4,155 2.46% $ 2,967 1.96% $ 2,889 2.25% Second mortgage(2).......... 20,784 8.01 16,226 8.34 15,303 9.06 13,284 8.78 10,735 8.35 Other(3).................... 5,946 2.29 2,796 1.44 2,582 1.53 2,736 1.81 3,127 2.43 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans...... 34,078 13.13 23,718 12.19 22,040 13.05 18,987 12.55 16,751 13.03 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans receivable.... $259,361 100.00 $194,626 100.00 $168,921 100.00% $151,310 100.00% $128,591 100.00% Less: Undisbursed portion of construction loans........ $ 2,025 0.78$ 453 0.23% $ 371 0.22% $ 782 0.52% $ 1,048 0.81% Unearned loan discount...... 312 0.12 424 0.22 525 0.31 682 0.45 1,013 0.79 Net deferred loan origination fee 316 0.12 349 0.18 241 0.14 238 0.16 203 0.16 Allowance for loan losses... 2,676 1.03 2,151 1.11 1,953 1.16 1,736 1.14 1,543 1.20 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans receivable, net $254,032 97.95% $191,249 98.26% $165,831 98.17% $147,872 97.73% $124,784 97.04% ======== ====== ======== ====== ======== ===== ======== ====== ======== ======
- ----------------------- (1) Includes interest-only construction loans that convert to permanent loans. (2) Second mortgage loans included $1.4 million, $1.1 million, $862,000, $724,000,and $403,000 (in actual dollars) of nonowner-occupied residential first mortgage loans at December 31, 1998, 1997, 1996, 1995 and 1994, respectively. (3) Other consumer loans included $2.3 million, $269,000, $213,000, $299,000 and $499,000 (in actual dollars) of commercial mortgage loans at December 31, 1998, 1997, 1996, 1995 and 1994, respectively. 5 Loan Maturity Schedule. The following table sets forth the maturity or period to repricing of the Company's loan portfolio at December 31, 1998. Overdraft lines of credit are reported as due in one year or less. Adjustable-rate loans are included in the period in which interest rates are next scheduled to adjust rather than in which they contractually mature, and fixed rate loans are included in the period in which the final contractual repayment is due.
At December 31, 1998 --------------------------------------------------------------------------------- Within 1-3 3-5 5-10 10-20 Beyond 20 1 Year Years Years Years Years Years Total ------ ----- ----- ----- ----- --------- ----- (In thousands) First mortgage loans: One-to-four family residential(1)........ $29,084 $19,195 $36,173 $58,087 $ 5,867 $ 585 $148,991 Multifamily............. 22,127 22,680 11,305 6,165 2,618 -- 64,895 Commercial.............. 1,849 5,804 1,841 1,902 -- -- 11,396 Consumer loans (2).......... 5,562 10,200 17,117 1,179 20 -- 34,078 ------- ------- ------- ------- ------- ------- ------- Total ................ $58,622 $57,879 $66,436 $67,333 $ 8,505 $ 585 $259,360 ======= ======= ======= ======= ======= ======= ========
- ------------------------ (1) One-to-four family loans include $102.9 million of 7 year fixed rate loans that convert to adjustable rates at the beginning of the eighth year and are annually adjustable thereafter. $63.4 million of these loans with repricing periods greater than 5 years have been classified as fixed rate loans. $39.5 million of these loans with repricing periods less than 5 years have been classified as adjustable rate loans. (2) Includes second mortgage loans of $20.8 million at December 31, 1998. The following table sets forth the dollar amounts of all fixed rate and adjustable rate loans in each loan category at December 31, 1998 due after December 31, 1999.
Due After December 31, 1999 Fixed Adjustable Total ----- ---------- ----- (In thousands) First mortgage loans: One-to-four family residential(1)................... $ 81,150 $ 38,757 $119,907 Multifamily......................................... 9,294 33,474 42,768 Commercial.......................................... 4,468 5,079 9,547 Consumer loans (2)....................................... 28,004 512 28,516 -------- -------- -------- Total............................................. $122,917 $ 77,821 $200,738 ======== ======== ========
- ------------------------ (1) One-to-four family loans include $98.9 million of 7 year fixed rate loans that convert to adjustable rates at the beginning of the eighth year and are annually adjustable thereafter. $63.4 million of these loans with repricing periods greater than 5 years have been classified as fixed rate loans. $35.5 million of these loans with repricing periods less than 5 years have been classified as adjustable rate loans. (2) Includes second mortgage loans of $19.0 million at December 31, 1998. One-to-Four Family Residential Real Estate Loans. Traditionally, the Company's primary lending activity consists of the origination of fixed- and adjustable-rate one-to-four family owner-occupied residential first mortgage loans, substantially all of which are collateralized by properties located in the Company's market area. The Company also originates one-to-four family, interest only construction loans that convert to permanent loans after an initial construction period that generally does not exceed nine months. At December 1998, 54.9% of the Company's residential real estate loans had fixed rates, and 45.1% had adjustable rates. The Company originates loans for portfolio and sells loans in the secondary mortgage market. However, the Company's one-to-four family, fixed-rate, residential real estate loans originated for portfolio are generally originated and underwritten according to standards that qualify such loans to be included in Federal 6 Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") purchase and guarantee programs and that otherwise permit resale in the secondary mortgage market. The Bank has sold fixed-rate loans with maturities equal to or in excess of 15 years in the secondary mortgage market. For the year ended December 31, 1998, the Bank sold $4.5 million of mortgage loans consisting of seventy one-to-four family residential mortgage loans. One-to-four family loans are underwritten and originated according to policies approved by the Board of Directors. First Iowa Mortgage, Inc., the Bank's wholly owned mortgage banking subsidiary, sold $23.5 million of mortgage loans consisting of two hundred seventy nine one-to-four family residential mortgage loans. Originations of one-to-four family fixed-rate first mortgage loans are monitored on an ongoing basis and are affected significantly by the level of market interest rates, the Company's interest rate gap position, and loan products offered by the Company's competitors. The Company's one-to-four family fixed-rate first mortgage loans amortize on a monthly basis with principal and interest due each month. To make the Company's fixed-rate loan portfolio more interest rate sensitive, the Company currently emphasizes the origination of fixed-rate loans with terms of 15 years or less to be held in portfolio. The Company also offers 7-year fixed-rate first mortgage loans that convert to adjustable-rate loans that adjust on an annual basis after the initial fixed rate term. The overall maturity of these loans may be up to 30 years. The Company determines whether a customer qualifies for these loans based upon the initial fixed interest rate. The Company's adjustable rate mortgage loans, or "ARM loans", are generally originated for terms of up to 30 years, with interest rates that adjust annually. The Company establishes various annual and life-of-the-loan caps on ARM loan interest rate adjustments. Currently, the Company offers ARM loans with annual rate caps of 1.5% and maximum life-of-loan caps of 11.95%. Prior to 1995, the Company's ARM loans originated for retention in its portfolio generally were based on the 11th District Cost of Funds Index, a lagging market index. At present, the interest rate on its ARM loans is calculated by using the weekly average yield on United States Treasury Securities adjusted to a constant maturity of one year. The Company currently offers one-year ARM loans with initially discounted rates, often known as "teaser rates." The Company determines whether a borrower qualifies for an ARM loan based on the fully indexed rate of the ARM loan at the time the loan is originated, rather than the introductory or "teaser" rate or the maximum life-of-the rate to which the loan could adjust. In addition, the Company establishes floors for each loan originated below which the loan may not adjust. One-to- four family residential ARM loans totalled $67.2 million, or 26.5%, of the Company's total net loan portfolio at December 31, 1998. The primary purpose of offering ARM loans is to make the Company's loan portfolio more interest rate sensitive. ARM loans carry increased credit risk associated with potentially higher monthly payments by borrowers as general market interest rates increase. It is possible, therefore, that during periods of rising interest rates, the risk of default on ARM loans may increase due to the upward adjustment of interest costs to the borrower. Management believes that the Company's credit risk associated with its ARM loans is reduced because of the annual and lifetime interest rate adjustment limitations on such loans, although such limitations do create an element of interest rate risk. See Item 7A. "Discussion of Market Risk-- Interest Rate Sensitivity Analysis". The Company's one-to-four family residential first mortgage loans customarily include due-on-sale clauses, which are provisions giving the Company the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as security for the loan. Due-on-sale clauses are an important means of adjusting the rates on the Company's fixed rate mortgage loan portfolio, and the Company has generally exercised its rights under these clauses. Regulations limit the amount that a savings institution may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. See Item 1. 7 "Regulation-Regulation of Federal Savings Associations-Real Estate Lending Standards." The Company's lending policies limit the maximum loan-to-value ratio on mortgage loans without private mortgage insurance to 80% of the lesser of the appraised value or the purchase price of the property to serve as collateral for the loan. The Company generally makes one-to-four family first real estate loans with loan-to-value ratios of up to 90%; however, for one-to-four family real estate loans with loan-to-value ratios greater than 80%, the Company requires the loan amount to be covered by private mortgage insurance. The Company requires fire and casualty insurance, flood insurance, where applicable, an abstract of title, and a title opinion on all properties securing real estate loans originated by the Company. Multifamily Residential and Commercial Real Estate Loans. The Company's loan portfolio contains loans secured by multifamily residential and commercial real estate. Such loans constituted approximately $76.3 million, or 30.0%, of the Company's total net loan portfolio at December 31, 1998. Of such loans, $70.0 million, or 91.7%, were purchased or originated by the Company and were secured by properties outside the State of Iowa (the "out of state" properties). There was one commercial real estate loan more than 90 days past due at December 31, 1998. This loan was repaid in full subsequent to year end. These loans are primarily secured by multifamily residences such as apartment buildings and by commercial facilities such as office buildings and retail buildings. Multifamily residential real estate loans are offered with fixed and adjustable rates and are structured in a number of different ways depending upon the circumstances of the borrower and the type of multifamily project. Fixed rate loans generally amortize over 15 to 30 years, and generally contain call provisions permitting the Company to require that the entire principal balance be repaid at the end of five to fifteen years. Such loans are priced as five to fifteen year loans with maximum loan-to-value ratios of 80%. See " -- Purchased or Out of State Originated Loans". All purchased or out of state originated loans in excess of $200,000 are approved by the Chief Executive Officer, Chief Operating Officer and the Board of Directors and are subject to the same underwriting standards as for loans originated by the Company. All purchased or out of state originated loans less than $200,000 are approved by the Chief Executive Officer and Chief Operating Officer and ratified by the Board of Directors and are subject to the same underwriting standards as loans originated by the Company. Before a loan is purchased, the Company obtains a copy of the original loan application, certified rent rolls, the original title insurance policy and personal financial statements of any guarantors of the loan. An executive officer or director of the Company also makes a personal inspection of the property securing the loan. Such purchases are made without recourse to the seller. Generally, the originating financial institution or mortgage banker continues to service the loans, remitting principal and interest to the Company. The Company generally imposes a $2.5 million limit on the aggregate size of multifamily and commercial loans to any one borrower. Any exceptions to the limit must be specifically approved by the Board of Directors on a loan-by-loan basis within the Company's legal lending limit. See "Regulation -- Regulation of Federal Savings Associations -- Loans to One Borrower". Loans secured by multifamily and commercial real estate generally involve a greater degree of credit risk than single-family residential mortgage loans and typically, such loans also have larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multifamily and commercial real estate is typically dependent upon the successful operation of the related real estate property. If the cash flow from such real estate projects are reduced, the borrower's ability to repay the loan may be impaired. Consumer Loans, Including Second Mortgage Loans. The Company also originates consumer loans, which primarily include second mortgage loans. As of December 31, 1998, second mortgage loans totalled $20.8 million, or 8.0%, of the Company's net total loan portfolio. The Company's second mortgage loans have fixed interest rates and are generally for terms of 3 to 5 years. The Company's second mortgage loans are 8 secured by the borrower's principal residence generally with a maximum loan-to-value ratio, including the principal balances of both the first and second mortgage loans, of generally no more than 80%. The average principal amount of the Company's second mortgage loans is approximately $12,000. To a lesser extent, the Company also originates loans secured by automobiles, with fixed rates generally on a 80% loan-to-value basis for new cars. All of the Company's automobile loans were originated by the Company and generally, have terms of up to five years. In addition, the Company also makes other types of consumer loans, primarily unsecured signature loans for various purposes. The minimum loan amount for such loans is $1,000, the maximum loan amount for such loans is $7,500, and the average balance of such loans is approximately $1,800. The Company originates a limited number of commercial business loans, which the Company includes with its consumer loan portfolio for reporting purposes. Such loans may be unsecured and are originated for any business purpose, such as for the purchase of computers and business equipment. The maximum loan amount for such unsecured loans is $7,500. The Company's business plan calls for an increase in consumer lending for the foreseeable future, particularly second mortgage lending. The Company generally expects consumer loan demand will come from its mortgage loan customers. Consumer loans generally provide for shorter terms and higher yields as compared to residential first mortgage loans, but generally carry higher risks of default. At December 31, 1998, $189,000, or 0.55%, of the Company's consumer loan portfolio was on non-accrual status. Loan Originations, Solicitation, Processing, and Commitments. Loan originations are derived from a number of sources such as real estate agent referrals, existing customers, borrowers, builders, attorneys, and walk-in customers. Upon receiving a loan application, the Company obtains a credit report and employment verification to verify specific information relating to the applicant's employment, income, and credit standing. In the case of a real estate loan, an appraiser approved by the Company appraises the real estate intended to collateralize the proposed loan. An underwriter in the Company's loan department checks the loan application file for accuracy and completeness, and verifies the information provided. Pursuant to the Company's written loan policies, all first mortgage loans originated prior to 1998 were approved by the Chief Executive Officer. Beginning in 1998, senior management approve all first mortgage loans greater than $150,000. All first mortgage loans less than $150,000 are approved by two loan officers. The Loan Committee of the Board of Directors meets monthly to review a sampling of all loans originated in the month. After a loan is approved, a loan commitment letter is promptly issued to the borrower. The commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. Commitments are typically issued for 60-day periods in the case of loans to refinance, loans to purchase existing real estate, and construction loans. The borrower must provide proof of fire and casualty insurance on the property serving as collateral, which insurance must be maintained during the full term of the loan. An abstract of title along with an attorney's title opinion is required on all first mortgage loans secured by real property in Iowa. At December 31, 1998, the Company had outstanding commitments to originate $855,000 of loans. This amount does not include commitments to purchase loans, the undisbursed overdraft loan privileges or the unfunded portion of loans in process. Purchased or Out of State Originated Loans. The Company's loan portfolio contains $78.8 million of loans secured by out of state properties. These loans represented 30.4% of the Company's total loan portfolio at December 31, 1998. Substantially all of the multifamily residential and commercial real estate loans in the Company's loan portfolio are purchased or originated out of state by the Company without recourse to the seller. At December 31, 1998, approximately $11.2 million of these purchased loans represented loans secured 9 by real estate in the West Coast states of California, Oregon and Washington. At that date, the Company's investment in properties located in California totalled $5.6 million and was distributed among two dozen cities. Most of these loans were originated from 1973 through 1987 and were purchased by the Company between 1982 and 1988 generally under a 75% loan-to-value guideline. The Company's loans in California were purchased prior to December 31, 1988. Concentrations of California real estate loans exist in three areas, Los Angeles, Lodi/Stockton and San Diego. The downturn in California real estate markets has not adversely impacted the Company. The Company's investment in properties located in Wisconsin totalled $34.6 million and was primarily distributed between the Milwaukee and Madison areas. These loans were originated between 1985 and 1998 and were purchased by the Company between 1991 and 1998. The Company's investment in properties in Colorado totalled $19.3 million and was primarily distributed between the Colorado Springs and Denver areas. The remainder of the Company's purchased or out of state originated loans are distributed in various states. At December 31, 1998, the Company's multifamily residential and commercial real estate loans had an average balance of $380,000 and the largest loan had a principal balance of $2.5 million. As of December 31, 1998 there was one commercial real estate loan that was more than 90 days past due and was on a nonaccrual status. This loan was repaid in full subsequent to year end. To supplement its origination of one-to-four family first mortgage loans, the Company also purchases loans secured by one-to-four family residences out of state. At December 31, 1998, $8.5 million, or 3.3%, of the Company's total loan portfolio consisted of purchased one-to-four family loans, of which $2.8 million were secured by properties located in Missouri and $2.2 million were secured by properties in Wisconsin. As of December 31, 1998 there were no purchased one-to-four family first mortgage loans that were on a nonaccrual status. Loans purchased by the Company entail certain risks not necessarily associated with loans the Company originates. The Company's purchased loans are generally acquired without recourse with servicing retained by the seller or originator of the loans. Although the Company reviews each purchased loan using the Company's underwriting criteria for originations and a Company officer or director performs an on-site inspection of each purchased loan, the Company is dependent on the servicer of the loan for ongoing collection efforts and collateral review. In addition, the Company purchases loans with a variety of terms, including maturities, interest rate caps and indices for adjustment of interest rates that may differ from those offered at the time by the Company in connection with loans the Company originates. Finally, the market areas in which the properties which secure the purchased loans are located are subject to economic and real estate market conditions that may significantly differ from those experienced in the Company's market areas. If economic conditions continue to limit the Company's opportunities to originate loans in its market areas, the Company may increase its investment in out of state mortgage loans. There can be no assurance, however, that economic conditions in these out of state areas will not deteriorate in the future resulting in increased loan delinquencies and loan losses among the loans secured by property in these areas. In an effort to reduce the risk of loss on out of state purchased loans, the Company only purchases loans that meet the underwriting policies for loans originated by the Company although specific rates and terms may differ from the rates and terms offered by the Company. The Company also requires appropriate documentation, and personal inspections of the underlying real estate collateral by an executive officer or director prior to purchase. The servicers of the loans generally conduct annual inspections of the underlying real estate collateral and copies of the reports of such inspections are generally provided to the Company. 10 Set forth below is a table of the Company's purchased or out of state originated loans by state of origin (including multifamily residential, commercial real estate and one-to-four family first mortgage loans) as of December 31, 1998. Balance as of State December 31, 1998 ----- ----------------- (In thousands) Arizona $1,052 California 5,597 Colorado 19,302 Florida 301 Georgia 138 Indiana 1,590 Kansas 843 Minnesota 350 Missouri 3,499 Montana 169 Nebraska 570 Nevada 770 New Mexico 111 North Carolina 984 North Dakota 117 Ohio 668 Oregon 3,493 South Carolina 126 Tennessee 249 Texas 965 Utah 1,124 Washington 2,127 Wisconsin 34,557 Other 109 ------- Total $78,811 ======= 11 Origination, Purchase and Sale of Loans. The table below shows the Company's originations, purchases and sales of loans for the periods indicated.
For the Years Ended December 31, -------------------------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (In thousands) Total loans receivable at beginning of period......... $ 194,626 $ 168,921 $ 151,310 ----------- ----------- ----------- Originations: First mortgage loans: One-to-four family residential..................... 36,226 25,001 24,178 Multifamily........................................ -- -- 3,410 Commercial......................................... 1,100 50 235 Consumer loans: Automobile......................................... 6,349 3,698 3,962 Second mortgage ................................... 14,493 9,642 10,060 Other ............................................. 2,595 1,591 2,247 ----------- ----------- ----------- Total originations:.............................. 60,763 39,982 44,092 Effect of Valley Financial Acquisition............. 58,911 -- -- Loan Purchases: First mortgage-- one-to-four family................ 3,159 51 3,133 First mortgage-- multifamily....................... 21,315 22,313 4,813 Loan Sales: First mortgage-- one-to-four family................ 4,517 815 -- First mortgage-- multifamily....................... -- -- 380 Consumer loan...................................... -- -- 67 Transfer of mortgage loans to foreclosed real estate............................. 373 175 148 Repayments............................................ 75,523 35,651 33,832 ----------- ----------- ----------- Net loan activity..................................... 63,734 25,705 17,611 ----------- ----------- ----------- Total loans receivable at end of period.......... $ 258,361 $ 194,626 $ 168,921 =========== =========== ===========
Loan Origination Fees and Other Income. In addition to interest earned on loans, the Company generally receives fees in connection with loan originations. Such loan origination fees, net of costs to originate, are deferred and amortized using an interest method over the contractual life of the loan. Fees deferred are recognized into income immediately upon prepayment of the related loan. At December 31, 1998, the Company had $316,000 of deferred loan origination fees, net. Such fees vary with the type of loans and commitments made. The Company typically charges an origination fee on fixed- and adjustable-rate first mortgage loans. In addition to loan origination fees, the Company also receives other fees, service charges (such as overdraft fees), and other income that consist primarily of deposit transaction account service charges and late charges. The Company recognized fees and service charges of $1.2 million, $657,000 and $580,000 for the fiscal years ended December 31, 1998, 1997 and 1996 respectively. 12 Investment Activities At December 31, 1998, the Company's investment portfolio is comprised of United States Treasury securities, United States Government Agencies, Municipal Obligations, mortgage-backed securities, equity securities consisting of FHLMC preferred stocks, FNMA preferred stock, FHLB stock, other common and preferred stocks and interest-earning deposits. At December 31, 1998, $5.0 million, or 12.6%, of the Company's investment portfolio, excluding equity securities, was scheduled to mature in one year or less, and $16.8 million, or 41.8% was scheduled to mature within one to five years. The Company is required under federal regulations to maintain a minimum amount of liquid assets that may be invested in specified short term securities and certain other investments. The Company generally has maintained a portfolio of liquid assets that exceeds regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management's projections as to the short term demand for funds to be used in the Company's loan origination and other activities. In addition, the Company's liquidity levels are affected by the level and source of its borrowed funds. Investment Portfolio. The following table sets forth the carrying value of the Company's investment portfolio at the dates indicated.
At December 31, ---------------------------------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (In thousands) Investment securities: U.S. Treasury Notes........................ $ 9,410 $ 11,046 $ 16,518 U.S. Government agencies.................... 18,884 -- -- Mortgage-backed securities.................. 7,508 -- -- State and Local Obligations................. 4,378 -- -- FHLB stock.................................. 2,379 1,550 1,374 Equity securities........................... 7,323 7,220 8,711 ----------- ----------- ----------- Total investment securities............... 49,882 19,816 26,603 Interest-earning deposits................... 13,201 2,463 2,973 ----------- ----------- ----------- Total investments......................... $ 63,083 $ 22,279 $ 29,576 =========== =========== ===========
13 Investment Portfolio Maturities. The following table sets forth the scheduled maturities, carrying values, market values and weighted average yields for the Company's investment portfolio at December 31, 1998.
At December 31, 1998 ----------------------------------------------------------------------------- One Year or Less One to Five Years Over Five Years -------------------------- ------------------------ ------------------------ Annualized Annualized Annualized Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield -------- ---------- --------- ----------- --------- ----------- (Dollars in thousands) Investment securities: U.S. Treasury Notes....... $ 5,045 5.92% $ 3,843 5.34% $ 522 6.81% U.S. Government agencies(1) -- -- 10,488 5.95 8,396 6.30 Mortgage-backed securities -- -- 1,673 5.93 5,834 6.10 State and Local Obligations -- -- 802 4.01 3,576 4.49 FHLB Stock................ -- -- -- -- -- -- Common Stock. . . . . . . -- -- -- -- -- -- Preferred Stock-other . . . -- -- -- -- -- -- Preferred Stock-FNMA -- -- -- -- -- -- Preferred Stock-FHLMC..... -- -- -- -- -- -- ------- ------- ------- ------- ------- ------- Total................... $ 5,045 5.92% $16,806 5.73% $18,328 5.90% Interest-bearing deposits at the FHLB............... 13,201 4.42 -- -- -- -- ------- ------- ------- ------- ------- ------- Total investments....... $18,246 4.83% $16,806 5.73% $18,328 5.90% ======= ======= ======= ======== ======= =======
At December 31, 1998 ----------------------------------------------- Total ----------------------------------------------- Annualized Average Weighted Carrying Market Life in Average Value Value Years Yield ---------- --------- ------- ---------- Investment securities: U.S. Treasury Notes....... $ 9,410 $ 9,410 1 5.73% U.S. Government agencies(1 18,884 18,884 4 6.11 Mortgage-backed securities 7,508 7,508 10 6.06 State and Local Obligation 4,378 4,378 9 4.40 FHLB Stock................ 2,379 2,379 6.50 Common Stock. . . . . . . 652 652 2.33 Preferred Stock-other . . 273 273 7.01 Preferred Stock-FNMA 5,402 5,402 6.49 Preferred Stock-FHLMC..... 996 996 6.72 ------- ------- ------- Total................... $49,882 $49,882 5.91% Interest-bearing deposits at the FHLB............... 13,201 13,201 4.42 ------- ------- ------- Total investments....... $63,084 $63,084 5.59% ======= ======= =======
(1) Certain securities have call features which allows the issuer to call the security prior to maturity date. 14 Sources of Funds General. Deposits are the major source of the Company's funds for lending and other investment purposes. In addition to deposits, the Company derives funds from FHLB advances, the amortization and prepayment of loans, the maturity of investment securities and operations. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. The Company may use borrowings on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes. Deposits. During 1998, consumer and commercial deposits were attracted principally from within the Company's market area through the offering of a broad selection of deposit instruments including NOW accounts, savings accounts, money market savings, certificates of deposit and individual retirement accounts. The Company also offers these products in its new market area which it now serves as a result of the Acquisition. See "Acquisition of Valley Financial Corp." Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. The maximum rate of interest which the Company may pay is not established by regulatory authority. The Company regularly evaluates its internal cost of funds, surveys rates offered by competing institutions, reviews the Company's cash flow requirements for lending and liquidity, and executes rate changes when deemed appropriate. The Company has sought to decrease the risk associated with changes in interest rates by offering competitive rates on deposit accounts and by pricing certificates of deposit to provide customers with incentives to choose certificates of deposit with longer terms. The Company does not obtain funds through brokers through a solicitation of funds outside its market area, nor by offering negotiated rates on certificates of deposit in excess of $100,000. Deposit Portfolio. Deposits with the Company as of December 31, 1998, were represented by the various types of deposit programs described below.
Weighted Average Percentage Interest Checking and Minimum of Total Rate Original Term Savings Deposits Balance Balances Deposits -------- ------------- ---------------- ------- -------- ---------- (Dollars in thousands) 0.00% None Noninterest-bearing demand $ 50 $ 5,458 2.21% 1.50 None NOW accounts 50 30,909 12.53 2.25 None Savings accounts 25 26,099 10.58 3.90 None Money Market savings 2,500 19,828 8.04 Certificates of Deposit 4.23 1-3 months Fixed term, fixed rate $ 1,000 $ 564 0.23 4.55 4-6 months Fixed term, fixed rate 1,000 4,727 1.92 4.71 7-9 months Fixed term, fixed rate 1,000 1,013 0.41 5.38 10-12 months Fixed term, fixed rate 1,000 18,092 7.33 5.53 13-24 months Fixed term, fixed rate 1,000 64,712 26.23 5.64 25-36 months Fixed term, fixed rate 1,000 23,623 9.58 5.91 37-48 months Fixed term, fixed rate 1,000 1,333 0.54 6.24 49-60 months Fixed term, fixed rate 1,000 49,365 20.01 6.91 61 months or greater Fixed term, fixed rate 1,000 745 0.30 3.50 Various Variable rate 100 222 0.09 -------- ------- Total certificates of deposit $246,690 100.00% ======== =======
15 The following table sets forth the change in dollar amount of deposits in the various types of deposit accounts offered by the Company between the dates indicated.
Increase Increase Increase Increase Balance (Decrease) (Decrease) Balance (Decrease) (Decrease) Balance 12/31/98 % $ 12/31/97 % $ 12/31/96 ------------------------------------------------------------------------------------------------- (Dollars in thousands) Noninterest bearing demand........ $ 5,458 73.55% $ 2,313 $ 3,145 38.24% $ 870 $ 2,275 NOW............................... 30,909 113.80 16,452 14,457 22.27 2,633 11,824 Savings account .................. 26,099 52.45 8,979 17,120 (3.58) (636) 17,756 Money market savings.............. 19,828 121.34 10,870 8,958 23.05 1,678 7,280 Certificates of deposit that mature: within 12 months.............. 81,295 99.44 40,533 40,762 10.25 3,790 36,972 within 12-36 months........... 64,962 53.20 22,558 42,404 33.24 10,578 31,826 beyond 36 months.............. 18,139 27.04 3,861 14,278 (34.47) (7,511) 21,789 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total...................... $ 246,690 $ 74.80% $ 105,566 $ 141,124 8.79% $ 11,402 $ 129,722 ========== ========== ========== ========== ========== ========== ==========
Increase Increase Increase Increase Balance (Decrease) (Decrease) Balance (Decrease) (Decrease) Balance 12/31/96 % $ 12/31/95 % $ 12/31/94 --------------------------------------------------------------------------------------------- (Dollars in thousands) Noninterest bearing demand............. $ 2,275 0.04% $ 8 $ 2,267 1.93% $ 43 $ 2,224 NOW.................................... 11,824 3.39 388 11,436 6.20 668 10,768 Passbook savings....................... 17,756 (5.85) (1,104) 18,860 (14.17) (3,114) 21,974 Money market savings................... 7,280 29.38 1,653 5,627 169.62 3,540 2,087 Certificates of deposit that mature: within 12 months................... 36,972 22.37 6,759 30,213 (21.32) (8,185) 38,398 within 12-36 months................ 31,826 (6.77) (2,311) 34,137 19.54 5,580 28,557 beyond 36 months................... 21,789 (9.71) (2,343) 24,132 19.58 3,951 20,181 ---------- ----------- ----------- ---------- ---------- ---------- ---------- Total........................... $ 129,722 2.41% $ 3,050 $ 126,672 2.00% $ 2,483 $ 124,189 ========== ========== ========== ========== ========== ========== ==========
16 The following table sets forth the certificates of deposit in the Company classified by rates as of the dates indicated:
At December 31, ------------------------------------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (In thousands) Rate - ---- 3.99% or less...................... $ 232 $ 91 $ 140 4.00-5.99%......................... 110,152 45,749 45,481 6.00-7.99%......................... 53,829 51,585 44,913 8.00 or greater.................... 183 19 53 ----------- ----------- ----------- $ 164,396 $ 97,444 $ 90,587 =========== =========== ===========
The following table sets forth the amount and maturities of certificates of deposit at December 31, 1998.
Amount Due --------------------------------------------------------------------------------------- Less Than 1 1-2 2-3 3-4 4-5 After 5 Year Years Years Years Years Years Total ------ ----- ----- ----- ----- ------- ----- (In thousands) Rate 3.99% or less........... $ 232 $ -- $ -- $ -- $ -- $ -- $ 232 4.00-5.99%.............. 57,320 37,218 6,462 297 8,849 6 110,152 6.00-7.99%.............. 23,572 15,332 5,947 7,044 1,737 197 53,829 8.00% or greater........ 173 -- -- 10 -- -- 183 ------- -------- ---------- -------- -------- -------- ---------- $81,297 $ 52,550 $ 12,409 $ 7,351 $ 10,586 $ 203 $ 164,396 ======= ======== ========== ======== ======== ======== ==========
The following table indicates the amount of the Company's certificates of deposit of $100,000 or more by time remaining until maturity at December 31, 1998. This amount does not include savings accounts of greater than $100,000, which totalled approximately $1.4 million at December 31, 1998.
Certificates of Deposit over Remaining Maturity $100,000 ------------------ --------------- (In thousands) Three months or less................................. $ 1,126 Three through six months............................. 1,837 Six through twelve months............................ 1,935 Over twelve months................................... 5,001 --------- Total.............................................. $ 9,899 =========
-17- The following table sets forth the savings activities of the Company for the periods indicated:
Year Ended December 31, ----------------------------------------------------- 1998 1997 1996 --------- --------- --------- (In thousands) Net increase (decrease) before interest credited and deposits acquired.................. $ (2,943) $ 6,132 $ (1,751) Effect of Valley Financial Acquisition.............. 99,269 -- -- Interest credited................................... 9,240 5,270 4,801 --------- --------- --------- Net increase in deposits........................ $ 105,566 $ 11,402 $ 3,050 ========= ========= =========
Borrowings Deposits are the Company's primary source of funds. The Company may also obtain funds from the FHLB. FHLB advances are collateralized by selected assets of the Company. Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB will advance to member institutions, including the Bank, for purposes other than meeting withdrawals, fluctuates from time to time in accordance with the policies of the OTS and the FHLB. The maximum amount of FHLB advances to a member institution generally is reduced by borrowings from any other source. In conjunction with the Bank's conversion from mutual to stock form in 1994, the Bank established an Employee Stock Ownership Plan (the "ESOP") for eligible employees. The ESOP borrowed $960,000 from an unrelated third party lender to finance the purchase of 104,075 shares of the Bank's common stock. Collateral for such loan consisted of the common stock held by the ESOP, as well as $100,000 in cash pledged by North Central Bancshares, MHC. The term of the loan was 10 years. The ESOP also borrowed funds in the amount of $840,000 from the Holding Company to purchase 84,000 shares of the Holding Company's Common Stock issued in the reorganization of the Bank and the MHC to the stock holding company form in 1996. In September 1996, these two loans were consolidated into a single loan from the Holding Company to the ESOP.
For the Year Ended December 31, ------------------------------------- 1998 1997 1996 -------- ------- -------- (Dollars in thousands) Weighted average rate paid on: (1) FHLB advances............................. 5.81% 5.94% 5.76% FHLB advances: Maximum balance........................... $42,550 $29,800 $24,300 Average balance........................... 33,980 23,672 11,503 Weighted average rate paid on: ESOP advances............................. N/A N/A 8.03% ESOP advances: Maximum balance........................... N/A N/A 790 Average balance........................... N/A N/A 513 Weighted average rate paid on: Other borrowings.......................... 1.00% 9.00% 7.00% Other borrowings: Maximum balance........................... $42 $35 $130 Average balance........................... 40 7 98
- ------------------------ (1) Calculated using monthly weighted average interest rates. -18- Title Abstract Business A component of the Company's operating strategy is to increase non-interest income, primarily through the expansion of the abstract company business conducted through a wholly owned subsidiary, First Iowa Title Services Inc. ("First Iowa"). On December 28, 1996, First Iowa purchased the assets of two abstract companies located in Webster and Calhoun Counties in Iowa. The abstract company in Calhoun County was subsequently sold on March 30, 1997. First Iowa currently provides real estate title abstracting services in Webster, Boone and Jasper counties. These services include researching recorded documents at the county courthouse and providing a history of those documents as they pertain to specific parcels of real estate. This information is used to determine who owns specific parcels of real estate and what encumbrances are on those specific parcels. The abstract business performed by First Iowa replaces a significant portion of the function of a title insurance company. Iowa law prohibits Iowa insurance companies or companies authorized to do business in Iowa from issuing title insurance or insurance against loss or damage by reason of defective title, encumbrance or otherwise. Institutions can purchase title insurance, for their own protection or to sell loans on the secondary market, but the cost of this insurance may not be passed on to the borrower. First Iowa had 17 employees as of December 31, 1998. Insurance and Annuity Business The Company has another wholly-owned subsidiary, First Financial Service Corporation ("First Financial"), which the Company began in 1971. First Financial's activities include the sale of life insurance on mortgage loans, and credit life and accident and health insurance on consumer loans made by the Company. In addition, First Financial sells life insurance annuity products. In connection with the Acquisition, the Bank acquired Valley Services, Inc., which was merged into First Financial. First Financial also originates leases for equipment such as computers, office equipment, light industrial equipment and commercial cleaning equipment. First Financial has no employees. The subsidiary has executed a management agreement with the Company which provides its management and staff. Mortgage Company Business First Iowa Mortgage, Inc. (formerly known as Hearthstone Mortgage Company, Inc.) was acquired as a part of the Acquisition of Valley Financial and is a wholly-owned subsidiary of the Bank. First Iowa Mortgage, Inc. originates first mortgage loans and subsequently sells these loans and the mortgage servicing rights to investors. First Iowa Mortgage, Inc. currently operates in Ames, Iowa First Iowa Mortgage, Inc. has 3 employees at December 31, 1998. Multifamily Apartment Building On July 13, 1995, the Company formed the Northridge Apartments Limited Partnership with the Fort Dodge Housing Corporation ("FDHC"), a non-profit Iowa corporation formed to acquire, develop and manage low-and moderate-income housing for residents of the Fort Dodge area. The FDHC is controlled by the Fort Dodge Municipal Housing Agency, an agency chartered by the City of Fort Dodge. The Northridge Partnership is a low-income housing tax credit project for certain federal tax purposes. A 44-unit apartment complex was completed on February 1, 1997. The tax credits for the year ended December 31, 1998 are approximately $149,000. The tax credits will amount to approximately $153,000 for each year during the eight-year period commencing with the year ended December 31, 1999. Personnel At December 31, 1998, the Company had 108 full-time and 27 part-time employees (including the 17 employees of First Iowa and the 3 employees at First Iowa Mortgage, Inc.). None of the Company's employees is represented by a collective bargaining group. The Company believes its relationship with its employees to be good. -19- FEDERAL AND STATE TAXATION Federal Taxation General. The following is a general discussion of material tax matters and does not purport to be a comprehensive description of the tax rules applicable to the Holding Company or the Bank. The Bank has not been audited in the last five years. For federal income tax purposes, the Holding Company and the Bank will be eligible to file consolidated income tax returns and report their income on a calendar year basis using the accrual method of accounting and will be subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's tax reserve for bad debts, discussed below. Bad Debt Reserves. The Bank, as a "small bank" (one with assets having an adjusted tax basis of $500 million or less) is permitted to maintain a reserve for bad debts with respect to "qualifying loans," which, in general, are loans secured by certain interests in real property, and to make, within specified formula limits, annual additions to the reserve which are deductible for purposes of computing the Bank's taxable income. Pursuant to the Small Business Job Protection Act of 1996, the Bank is now recapturing (taking into income) over a multi-year period a portion of the balance of its bad debt reserve as of December 31, 1995. Distributions. To the extent that the Company makes "nondividend distributions" to shareholders, such distributions will be considered to result in distributions from the Company's "base year reserve", i.e. its reserve as of December 31, 1987, to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in the Company's taxable income. Nondividend distributions include distributions in excess of the Company's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Company's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not constitute nondividend distributions and, therefore, will not be included in the Company's income. The amount of additional taxable income created from a nondividend distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, approximately one and one-half times the nondividend distribution would be includable in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate. Corporate Alternative Maximum Tax. The Internal Revenue Code (the "Code") imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net operating losses. AMTI is also adjusted by determining the tax treatment of certain items in a manner that negates the deferral of income resulting from the regular tax treatment of those items. Thus, the Company's AMTI is increased by an amount equal to 75% of the amount by which the Company's adjusted current earnings exceeds its AMTI (determined without regard to this adjustment and prior to reduction for net operating losses). Although the corporate environmental tax of 0.12% of the excess of AMTI (with certain modifications) over $2.0 million has expired, under current Administration proposals, such tax will be retroactively reinstated for taxable years beginning after December 31, 1998 and before January 2010. The Company does not expect to be subject to the AMT, but would be subject to the environmental tax liability. Dividends-Received Deduction. The Holding Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Holding Company and the Bank will not file a consolidated tax return, except that if the Holding Company or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. -20- State and Local Taxation Iowa Taxation. The Holding Company and the Bank's subsidiaries will file Iowa corporation tax returns and the Bank will file an Iowa franchise tax return. The Bank currently files an Iowa franchise tax return, and the Holding Company and the Bank's subsidiaries file an Iowa corporation tax return, on a calendar year basis. The State of Iowa imposes a tax on the Iowa franchise taxable income of thrift institutions at the rate of 5%. Iowa franchise taxable income is generally similar to federal taxable income except that interest from state and municipal obligations is taxable, and no deduction is allowed for state franchise taxes. The net operating loss carryback and carryforward rules are similar to the federal rules. The state corporation income tax rate ranges from 6% to 12% depending upon Iowa corporation taxable income. Interest from federal securities is not deductible for purposes of the Iowa corporation income tax. REGULATION General The Bank is a federal savings bank subject to the regulation, examination and supervision by the OTS and is subject to the examination and supervision of the Federal Deposit Insurance Corporation ("FDIC") as its deposit insurer. The Bank is a member of the SAIF, and its deposit accounts are insured up to applicable limits by the FDIC. All of the deposit premiums paid by the Bank to the FDIC for deposit insurance are currently paid to the SAIF. The Bank is also a member of the FHLB of Des Moines, which is one of the 12 regional FHLBs. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition, and it must obtain regulatory approvals prior to entering into certain transactions, such as mergers with, or acquisitions of, other depository institutions. The OTS and the FDIC conduct periodic examinations to assess the Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which a savings association can engage and is intended primarily for the protection of the insurance fund and depositors. The Holding Company, as a savings and loan holding company, files certain reports with, and otherwise complies with, the rules and regulations of the OTS and of the Commission under the federal securities laws. The OTS and the FDIC have significant discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank, and the operations of both. The following discussion is intended to be a summary of the material statutes and regulations applicable to savings associations and their holding companies, and it does not purport to be a comprehensive description of all such statutes and regulations. Regulation of Savings and Loan Holding Companies The Holding Company is a savings and loan holding company and is subject to OTS regulations, examinations, supervision and reporting requirements. In addition, the OTS has enforcement authority over the Holding Company and any of its non-savings association subsidiaries. Among other things, this authority permits the OTS 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. The Home Owner and Loan Act ("HOLA"), as amended, prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring another savings association or holding company thereof, without prior written approval of the OTS; acquiring or retaining, with certain exceptions, more than 5.0% of a non-subsidiary savings association, a non-subsidiary holding company or a non-subsidiary company engaged -21- in activities other than those permitted by HOLA; or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating an application by a holding company to acquire a savings association, the OTS must consider the financial and managerial resources and future prospects of the company and savings association involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors. As a unitary savings and loan holding company, the Holding Company generally is not restricted under existing laws as to the types of business activities in which it may engage, provided that the Bank continues to satisfy the QTL test. See "-- Regulation of Federal Savings Associations -- QTL Test" for a discussion of the QTL requirements. Upon any nonsupervisory acquisition by the Company of another savings association or savings bank that meets the QTL test and is deemed to be a savings association by the OTS and that will be held as a separate subsidiary, the Holding Company would become a multiple savings and loan holding company and would be subject to limitations on the types of business activities in which it could engage. HOLA limits the activities of a multiple savings and loan holding company and its non-insured association subsidiaries primarily to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act (the "BHC Act"), subject to the prior approval of the OTS, and to other activities authorized by OTS regulation. The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, subject to two exceptions: an acquisition of a savings association in another state (i) in a supervisory transaction, and (ii) pursuant to authority under the laws of the state of the association to be acquired that specifically permit such acquisitions. The conditions imposed upon interstate acquisitions by those states that have enacted authorizing legislation vary. Some states impose conditions of reciprocity, which have the effect of requiring that the laws of both the state in which the acquiring holding company is located (as determined by the location of its subsidiary savings association) and the state in which the association to be acquired is located, have each enacted legislation allowing its savings associations to be acquired by out-of-state holding companies on the condition that the laws of the other state authorize such transactions on terms no more restrictive than those imposed on the acquiror by the state of the target association. Some of these states also impose regional limitations, which restrict such acquisitions to states within a defined geographic region. Other states allow full nationwide banking without any condition of reciprocity. Some states do not authorize interstate acquisitions of savings associations. Transactions between the Bank and the Holding Company and its other subsidiaries are subject to various conditions and limitations. See "-- Regulation of Federal Savings Associations -- Transactions with Related Parties." The Bank must give 30-days written notice to the OTS prior to any declaration of the payment of any dividends or other capital distributions to the Holding Company. See "-- Regulation of Federal Savings Associations -- Limitation on Capital Distributions." Regulation of Federal Savings Associations Business Activities. The Bank derives its lending and investment powers from the HOLA and the regulations of the OTS thereunder. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities, and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage. These investment powers are subject to various limitations, including: (i) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories; (ii) a limit of 400% of an association's capital on the aggregate amount of loans secured by nonresidential real estate property; (iii) a limit of 20% of an association's assets on commercial loans with the amount of commercial loans in excess of 10% of assets being limited to small business loans; (iv) a limit of 35% of an association's assets on the aggregate amount of consumer loans and acquisitions of certain debt securities; (v) a limit of 5.0% of assets on non-conforming loans (loans in excess of the specific limitations of HOLA); and (vi) a limit of the greater of 5.0% of assets or an association's capital on certain construction loans made for the purpose of financing what is or is expected to become residential property. -22- Loans to One Borrower. Under HOLA, savings associations are generally subject to the same limits on loans to one borrower as are imposed on national banks. Generally, under these limits, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the association's unimpaired capital and surplus. Additional amounts may be lent, in the aggregate not exceeding 10% of unimpaired capital and surplus, if any such loan or extension of credit is fully secured by readily-marketable collateral. Such collateral is defined to include certain debt and equity securities and bullion, but generally does not include real estate. For the year ended December 31, 1998, the Bank generally imposed a $2.5 million limit on the aggregate size of loans to any one borrower. Any exception to the limit must be specifically approved by the Board of Directors on a loan-by-loan basis within the Bank's legal lending limit. At December 31, 1998, the Bank's largest aggregate amount of loans to one borrower was $2.5 million, and the second largest borrower had an aggregate balance of $2.1 million. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." QTL Test. HOLA requires a savings association to meet a QTL test. Under the QTL test, a savings association is required to maintain at least 65% of its "portfolio assets" in certain "qualified thrift investments" in at least 9 months of the most recent 12-month period. "Portfolio assets" means, in general, an association's total assets less the sum of (i) specified liquid assets up to 20% of total assets, (ii) goodwill and other intangible assets, and (iii) the value of property used to conduct the association's business. "Qualified thrift investments" includes various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of an association's portfolio assets. Recent legislation broadened the scope of "qualified thrift investments" to include 100% of an institution's credit card loans, education loans, and small business loans. 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. At December 31, 1998, the Bank maintained 92.7% of its portfolio assets in qualified thrift investments, and it had more than 65% of its portfolio assets in qualified thrift investments in the requisite number of the prior 12 months. A savings association that fails the QTL test must either operate under certain restrictions on its activities or convert to a bank charter. The initial restrictions include prohibitions against (i) engaging in any new activity not permissible for a national bank, (ii) paying dividends not permissible under national bank regulations, (iii) obtaining new advances from any FHLB, and (iv) establishing any new branch office in a location not permissible for a national bank in the association's home state. In addition, within one year of the date a savings association ceases to meet the QTL test, any company controlling the association would have to register under, and become subject to the requirements of, the BHC Act. If the savings association does not requalify under the QTL test within the three-year period after it failed the QTL test, it would be required to terminate any activity and to dispose of any investment not permissible for a national bank and would have to repay as promptly as possible any outstanding advances from an FHLB. A savings association that has failed the QTL test may requalify under the QTL test and be free of such limitations, but it may do so only once. Capital Requirements. The OTS regulations require savings associations to meet three minimum capital standards: a tangible capital ratio requirement of 1.5% of total assets as adjusted under the OTS regulations, a leverage ratio requirement of 3.0% of core capital to such adjusted total assets, and a risk-based capital ratio requirement of 8.0% of core and supplementary capital to total risk-based assets. The 3.0% core capital requirement has been effectively superseded by the OTS' prompt corrective action regulations, which impose a 4.0% core capital leverage requirement for "adequately capitalized" thrifts and a 5.0% core capital leverage requirement for "well capitalized" thrifts. See "-- Prompt Corrective Regulatory Action." The OTS and the federal banking regulators have proposed amendments to their minimum capital regulations to provide that the minimum leverage capital ratio for a depository institution that has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Ratings System will be 3% and that the minimum leverage capital ratio for any other depository institution will be 4%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. In determining the amount of risk-weighted assets for purposes of the risk-based capital requirement, a savings association must compute its risk-based assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the United States Government or its agencies -23- to 100% for consumer and commercial loans, as assigned by the OTS capital regulation based on the risks found by the OTS to be inherent in the type of asset. Tangible capital is defined, generally, as common stockholder's equity (including retained earnings), certain noncumulative perpetual preferred stock and related earnings, minority interests in equity accounts of fully consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and investments in and loans to subsidiaries engaged in activities not permissible for a national bank. Core capital is defined similarly to tangible capital, but core capital also includes certain qualifying supervisory goodwill and certain purchased credit card relationships. Supplementary capital currently includes cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses. The allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets, and the amount of supplementary capital that may be included as total capital cannot exceed the amount of core capital. The OTS and the other federal banking agencies are required to take into account interest rate risk ("IRR") in their risk-based capital standards. The OTS adopted regulations, effective January 1, 1994, that set forth the methodology for calculating an IRR component to be incorporated into the OTS risk-based capital regulations. The OTS has indefinitely deferred the implementation of the IRR component in the computation of an institution's risk-based capital requirement. The OTS continues to monitor the IRR of individual institutions and retains the right to impose additional capital on individual institutions. At December 31, 1998, the Bank was not required to maintain any additional risk-based capital under this regulation. At December 31, 1998, the Bank met each of its capital requirements, in each case on a fully phased-in basis. The table below presents the Bank's regulatory capital as compared to the OTS regulatory capital requirements at December 31, 1998:
Bank Capital Excess Capital ---- Requirements -------------- ------------ (In thousands) Tangible capital................................. $ 38,245 $ 4,917 $ 33,328 Core capital..................................... 38,245 9,834 28,411 Risk-based capital............................... 40,509 13,614 26,895
A reconciliation between regulatory capital and GAAP capital at December 31, 1998 in the accompanying financial statements is presented below:
Tangible Capital Core Capital Risk-based Capital ---------------- ------------ ------------------ (In thousands) GAAP capital..................................... $45,876 $45,876 $45,876 Intangible assets................................ (7,313) (7,313) (7,313) Unrealized (gain) on certain available for sale assets......................................... (318) (318) (188) Allowance for loan losses includable in supplementary capital....................... -- -- 2,134 ------- ------- ------- Regulatory capital............................... $38,245 $38,245 $40,509 ======= ======= =======
Limitation on Capital Distributions. OTS regulations impose limitations upon capital distributions by savings associations, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders of another institution in a cash-out merger, and other distributions charged against capital. Effective April 1, 1999, the OTS amended its capital distribution regulations to reduce regulatory burdens on savings associations. The prior regulations, which were effective throughout 1998, required that at least 30-days written notice must be given to the OTS of a proposed capital distribution by a savings association, and capital distributions in excess of specified earnings -24- or by certain institutions are subject to approval by the OTS. An association that has capital in excess of all fully phased-in regulatory capital requirements before and after a proposed capital distribution and that is not otherwise restricted in making capital distributions, could, after prior notice but without the approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year, or (ii) 75% of its net earnings for the previous four quarters. Any additional capital distributions would require prior OTS approval. In addition, the OTS can prohibit a proposed capital distribution, otherwise permissible under the regulation, if the OTS has determined that the association is in need of more than normal supervision or if it determines that a proposed distribution by an association would constitute an unsafe or unsound practice. Furthermore, under the OTS prompt corrective action regulations, the Bank would be prohibited from making any capital distribution if, after the distribution, the Bank failed to meet its minimum capital requirements, as described above. See "-- Prompt Corrective Regulatory Action." Under the amendments adopted by the OTS, certain savings associations will be permitted to pay capital distributions during a calendar year that do not exceed the association's net income for that year plus its retained net income for the prior two years, or the approval of, the OTS. However, a savings association subsidiary of a savings and loan holding company, such as the Bank, will continue to have to file a notice unless the specific capital distribution requires an application. Liquidity. The Bank is required to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, specified United States Government, state or federal agency obligations, shares of certain mutual funds and certain corporate debt securities and commercial paper) equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement may be changed from time to time by the OTS to any amount within the range of 4.0% to 10% depending upon economic conditions and the savings flows of member institutions, and is currently 4.0%. Monetary penalties may be imposed for failure to meet these liquidity requirements. At December 31, 1998, the Bank's liquidity position was $45.7 million or 17.58% of liquid assets, compared to $14.0 million or 9.28% at December 31, 1997. Assessments. Savings associations are required by OTS regulation to pay assessments to the OTS to fund the operations of the OTS. The general assessment, paid on a semi-annual basis, is computed upon the savings association's total assets, including consolidated subsidiaries, as reported in the association's latest quarterly Thrift Financial Report. The OTS adopted amendments to its regulations, effective January 1, 1999, that are intended to assess savings associations on a more equitable basis. The new regulations will base the assessment for an individual savings association on three components: the size of the association, on which the basic assessment would be based; the association's supervisory condition, which would result in an additional assessment based of a percentage of the basic assessment for any savings institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination; and the complexity of the association's operations, which would result in an additional assessment based of a percentage of the basic assessment for any savings association that managed over $1 billion in trust assets, serviced for others loans aggregating more than $1 billion, or had certain off-balance sheet assets aggregating more than $1 billion. In order to avoid a disproportionate impact on the smaller savings institutions, which are those whose total assets never exceeded $100 million, the new regulations provide that the portion of the assessment based on assets size will be lesser of the assessment under the amended regulations or the regulations before the amendment. Management believes that any change in its rate of OTS assessments under the amended regulations will not be material. Branching. Subject to certain limitations, HOLA and the OTS regulations permit federally chartered savings associations to establish branches in any state of the United States. The authority to establish such a branch is available (i) in states that expressly authorize branches of savings associations located in another state and (ii) to an association that qualifies as a "domestic building and loan association" under the Code, which imposes qualification requirements similar to those for a "qualified thrift lender" under HOLA. See "-- QTL Test." The authority for a federal savings association to establish an interstate branch network would facilitate a geographic diversification of the association's activities. This authority under HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings associations. Community Reinvestment. Under the Community Reinvestment Act ("CRA"), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation -25- to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings association, to assess the association's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received an "Outstanding" CRA rating in its most recent examination. In April 1995, the OTS and the other federal banking agencies adopted amendments revising their CRA regulations. Among other things, the amended CRA regulations substitute for the prior process-based assessment factors a new evaluation system that would rate an institution based on its actual performance in meeting community needs. In particular, the proposed system would focus on three tests: (i) a lending test, to evaluate the institution's record of making loans in its service areas; (ii) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing and programs benefitting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices. Small savings associations are to be assessed pursuant to a streamlined approach focusing on a lesser range of information and performance standards. The term "small savings association" is defined as including associations with less than $250 million in assets or an affiliate of a holding company with banking and thrift assets of less than $1.0 billion, which would include the Bank. The amended CRA regulations also clarify how an institution's CRA performance would be considered in the application process. Transactions with Related Parties. The Bank's authority to engage in transactions with its "affiliates" is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act ("FRA"). In general, an affiliate of the Bank is any company that controls the Bank or any other company that is controlled by a company that controls the Bank, excluding the Bank's subsidiaries other than those that are insured depository institutions. The OTS regulations prohibit a savings association (i) from lending to any of its affiliates that is engaged in activities that are not permissible for bank holding companies under Section 4(c) of the BHC Act and (ii) from purchasing the securities of any affiliate other than a subsidiary. Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings association and also limits the aggregate amount of transactions with all affiliates to 20% of the savings association's capital and surplus. Extensions of credit to affiliates are required to be secured by collateral in an amount and of a type described in Section 23A, and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the association as those prevailing at the time for comparable transactions with nonaffiliated companies. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards, that in good faith would be offered to or would apply to nonaffiliated companies. The Bank's authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board (the "FRB") thereunder. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) 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 association's capital. In addition, extensions of credit in excess of certain limits must be approved by the association's board of directors. Enforcement. Under the Federal Deposit Insurance Act (the "FDI Act"), the OTS has primary enforcement responsibility over savings associations and has the authority to bring enforcement action against all "institution-affiliated parties," including any controlling stockholder or any stockholder, attorney, appraiser and accountant who knowingly or recklessly participates in any violation of applicable law or regulation or breach of fiduciary duty or certain other wrongful actions that causes or is likely to cause a more than a minimal loss or other -26- significant adverse effect on an insured savings association. Civil penalties cover a wide range of violations and actions and range from $5,000 for each day during which violations of law, regulations, orders and certain written agreements and conditions continue, up to $1,000,000 per day for such violations if the person obtained a substantial pecuniary gain as a result of such violation or knowingly or recklessly caused a substantial loss to the institution. Criminal penalties for certain financial institution crimes include fines of up to $10 million and imprisonment for up to 30 years. In addition, regulators have substantial discretion to take enforcement action against an institution that fails to comply with its regulatory requirements, particularly with respect to its capital requirements. Possible enforcement actions range from the imposition of a capital plan and capital directive to receivership, conservatorship or the termination of deposit insurance. Under the FDI Act, the FDIC has the authority to recommend to the Director of OTS that enforcement action be taken with respect to a particular savings association. If action is not taken by the Director of the OTS, the FDIC has authority to take such action under certain circumstances. Standards for Safety and Soundness. Pursuant to the FDI Act, as amended by Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and the Riegle Community Development and Regulatory Improvement Act of 1994 (the "Community Development Act"), the OTS and the federal bank regulatory agencies adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice by the OTS that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of FDICIA. See "-- Prompt Corrective Regulatory Action." If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties. Real Estate Lending Standards. The OTS 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 OTS regulations require each savings association to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying OTS guidelines, which include loan-to-value ratios for the different types of real estate loans. Associations are also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending situations in which exceptions to the loan-to-value standards are justified. Prompt Corrective Regulatory Action. FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the banking regulators are required to take certain supervisory actions against undercapitalized institutions, based upon the five categories of institutions established by FDICIA: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized," which are categories defined by the institution's regulatory capital ratios. Generally, a capital restoration plan must be filed with the OTS within 45 days of the date an association receives notice that it is "undercapitalized," "significantly undercapitalized," or "critically undercapitalized." In addition, various mandatory supervisory actions become immediately applicable to any undercapitalized institution, including restrictions on growth of assets and other forms of expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Generally, subject to a narrow exception, FDICIA requires the applicable banking regulator to appoint a receiver or conservator for an institution that is critically undercapitalized. Under the OTS regulations, generally, a federally -27- chartered savings association is 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, and its leverage ratio is 5% or greater, and it is not subject to any order or directive by the OTS to meet a specific capital level. As of December 31, 1998, the Association met the criteria for being considered "well capitalized" by the OTS. Where appropriate, the OTS can impose corrective action by a savings and loan holding company under the "prompt corrective action" provisions of FDICIA. Insurance of Deposit Accounts. Pursuant to FDICIA, the FDIC established a new risk-based assessment system for determining the deposit insurance assessments to be paid by insured depositary institutions. Under the new assessment system, which began in 1993, the FDIC assigns an institution to one of three capital categories based on the institution's financial information as of the reporting period ending seven months before the assessment period. The three capital categories consist of (i) well capitalized, (ii) adequately capitalized, or (iii) undercapitalized. The FDIC also assigns an institution to one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution's primary federal regulator and information that the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. An institution's assessment rate depends on the capital category and supervisory category to which it is assigned. Under the regulation, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates currently range from 0.0% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.27% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concern). The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%. As a result of the Deposit Insurance Funds Act of 1996 (the "1996 Funds Act"), both the BIF and the SAIF currently satisfy the reserve ratio requirement. If the FDIC determines that assessment rates should be increased, institutions in all risk categories could be affected. The FDIC has exercised this authority several times in the past and could raise insurance assessment rates in the future. If such action is taken by the FDIC, it could have an adverse effect on the earnings of the Bank. In addition, the 1996 Funds Act expanded the assessment base for the payments on the FICO bonds. Beginning January 1, 1997, the deposits of both BIF- and SAIF-insured institutions were assessed for the payments on the FICO bonds. Until December 31, 1999, or such earlier date on which the last savings association ceases to exist, the rate of assessment for BIF-assessable deposits shall be one-fifth of the rate imposed on SAIF-assessable deposits. The annual rate of assessments for the payments on the FICO bonds for the quarterly period beginning on January 1, 1998 was set at 0.01256 % for BIF-assessable deposits and 0.0628% for SAIF-assessable deposits. For the quarterly period beginning on July 1, 1998 the rates of assessment for the FICO bonds was 0.0122% for BIF-assessable deposits and 0.0610% for SAIF-assessable deposits. Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. Federal Home Loan Bank System. The Bank is a member of the FHLB of Des Moines, which is one of the regional FHLBs composing the FHLB System. Each FHLB provides a central credit facility primarily for its member institutions. 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 in an amount at least equal to the greater of 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year or 1/20 of its advances (borrowings) from the FHLB of Des Moines. The Bank was in compliance with this requirement with an investment in FHLB of Des Moines stock at December 31, 1998 of $2.4 million. Any advances from a FHLB must be secured by specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for residential housing finance. -28- The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of earnings that the FHLBs can pay as dividends to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB advances increased, the Bank's net interest income would likely also be reduced. Federal Reserve System. The Bank is subject to provisions of the FRA and the FRB's regulations pursuant to which depositary institutions may be required to maintain non-interest-earning reserves against their deposit accounts and certain other liabilities. Currently, reserves must be maintained against transaction accounts (primarily NOW and regular checking accounts). The FRB regulations generally require that reserves be maintained in the amount of 3.0% of the aggregate of transaction accounts up to $46.5 million. The amount of aggregate transaction accounts in excess of $46.5 million are currently subject to a reserve ratio of 10.0%, which ratio the FRB may adjust between 8.0% and 12%. The FRB regulations currently exempt $4.9 million of otherwise reservable balances from the reserve requirements, which exemption is adjusted by the FRB at the end of each year. The Bank is in compliance with the foregoing reserve requirements. Because required reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a Federal Reserve Bank, or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce the Bank's interest-earning assets. The balances maintained to meet the reserve requirements imposed by the FRB may be used to satisfy liquidity requirements imposed by the OTS. FHLB System members are also authorized to borrow from the Federal Reserve discount window, but FRB regulations require such institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank. -29- EXECUTIVE OFFICERS OF THE HOLDING COMPANY The name, age, position, term of office as officer and period during which he or she has served as an officer is provided below for each executive officer of the Holding Company. David M. Bradley, Jean L. Lake, C. Thomas Chalstrom and John L. Pierschbacher are executive officers of the Holding Company and the Bank. Kirk A. Yung is an executive officer of the Bank, and as such, is deemed to be executive officer of the Holding Company pursuant to SEC regulations. David M. Bradley, CPA has been President of the Bank since 1990, Chief Executive Officer of the Bank since 1992 and was named Chairman of the Board in January 1997. He has been affiliated with the Bank for 16 years. Mr. Bradley is 46 years of age. Jean L. Lake has been employed with the Bank since 1972 and was named Secretary in 1987. Ms. Lake serves as Board Secretary and is in charge of marketing. Ms. Lake is 56 years of age. John L. Pierschbacher, CPA has been employed with the Bank since 1992. Mr. Pierschbacher was named Treasurer in January 1994. He is the Bank's chief financial officer and is in charge of the accounting functions of the Bank. Mr. Pierschbacher was employed in public accounting for nine years at the public accounting firm of McGladrey & Pullen, LLP prior to joining the Bank. Mr. Pierschbacher is 39 years of age. C. Thomas Chalstrom has been employed with the Bank since 1985, was named Executive Vice President of the Bank in January 1995, Executive Vice President of the Holding Company in January, 1998 and Chief Operating Officer of the Bank in January, 1999. Mr. Chalstrom is 34 years of age. Kirk A. Yung has been employed with the Bank since 1990, was named Senior Vice President in January 1995, and is in charge of consumer lending. Mr. Yung had five years of prior experience in various positions in financial institutions before joining the Bank. Mr. Yung is 36 years of age. ITEM 2. PROPERTIES The Company conducts its business through its main office located in Fort Dodge, Iowa and six full-service offices located in Fort Dodge, Nevada, Ames, Burlington and Mount Pleasant, Iowa. The following table sets forth certain information concerning the main office and each branch office of the Company and the offices of First Iowa Title Services and First Iowa Mortgage, Inc. at December 31, 1998. All of the offices of the Company are owned. In addition to the properties listed below, First Financial owns land in Fort Dodge, Iowa with a net book value of $99,000 and Northridge Apartments Limited Partnership owns a multifamily apartment building with a net book value of $1.9 million at December 31, 1998. The aggregate net book value of the Company's premises and equipment, on a consolidated basis was $3.6 million at December 31, 1998. -30-
Lease Location Opening Date Expiration Date Net Book Value -------- ------------ --------------- -------------- Main Office: 825 Central Avenue 1973 N/A $ 952,986 Fort Dodge, Iowa Branch Offices: 201 South 25th Street 1977 N/A $ 219,422 Fort Dodge, Iowa 404 Lincolnway 1977 N/A $ 548,019 Nevada, Iowa 107 Main Street 1977 N/A $ 360,413 Ames, Iowa 321 North Third Street 1953 N/A $ 608,298 Burlington, Iowa 1010 North Roosevelt 1975 N/A $ 351,925 Burlington, Iowa 102 South Main 1991 N/A $ 254,472 Mount Pleasant, Iowa First Iowa Offices: 805 Central Avenue 1982 2001 (1) $ 10,831 Fort Dodge, Iowa 814 8th Street 1996 2003 (2) $ 11,646 Boone, Iowa 200 1st Street South 1996 2003 (2) $ 13,616 Newton, Iowa First Iowa Mortgage Office: 1998 2003 $ 42,790 415 South Duff Ames, Iowa Construction in Process: 1st Avenue and Hwy 141 N/A N/A $ 242,020 Perry, Iowa -------------------------
(1) Does not include option to renew for an additional 3 years. (2) Does not include option to renew for an additional 5 years. ITEM 3. LEGAL PROCEEDINGS The Registrant is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Registrant's financial condition and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1998. -31- PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Price Range of the Company's Common Stock The Company's Common Stock trades on The Nasdaq National Market System under the symbol "FFFD." The following table shows the high and low per share sales prices of the Company's Common Stock as reported by Nasdaq and the dividends declared per share during the periods indicated. Such quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not necessarily represent actual transactions.
Price Range ----------- Dividends Declared Quarter Ended High Low Per Share ------------- ---- --- ------------------ 1997 First Quarter.............................. 16.750 13.375 0.0625 Second Quarter............................. 16.125 15.000 0.0625 Third Quarter.............................. 18.250 15.625 0.0625 Fourth Quarter ............................ 20.125 17.188 0.0625 1998 First Quarter.............................. 22.875 18.750 0.0800 Second Quarter............................. 24.875 21.188 0.0800 Third Quarter.............................. 21.250 15.000 0.0800 Fourth Quarter............................. 18.313 15.406 0.0800
The Company's Common Stock was traded at $16.50 as of March 12, 1999. Information Relating to the Company's Common Stock As of March 11, 1999, the Company had 2,120 shareholders of record, which does reflect the number of persons or entities who hold their Common Stock in nominee or "street" name through various brokerage firms. As of such date 2,957,242 shares of the Common Stock were outstanding. The Company's current quarterly dividend is $0.10 per share. The Board of Directors of the Company plans to maintain a regular quarterly dividend in the future and will continue to review the dividend payment amount in relation to the Company's earnings, financial condition and other relevant factors (such as regulatory requirements). The Bank will not be permitted to pay dividends to the Holding Company on its capital stock if its shareholders' equity would be reduced below the amount required for the liquidation account. For information concerning federal regulations which apply to the Bank in determining the amount of proceeds which may be retained by the Company and regarding a savings institution's ability to make capital distributions including payment of dividends to its holding company, see Note 12 to the Consolidated Financial Statements. Unlike the Bank, the Holding Company is not subject to OTS regulatory restrictions on the payment of dividends to its shareholders, although the source of such dividends will be dependent on the net proceeds retained by the Holding Company and earnings thereon and may be dependent, in part, upon dividends from the Bank. The Holding Company is subject to the requirements of Iowa law, which prohibit the Holding Company from paying a dividend if, after giving it effect, either of the following would result: (a) the Holding Company would not be able to pay its debts as they become due in the usual course of business; or (b) the Holding Company's total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the Holding Company were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. -32- ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial and other data of the Company set forth below is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere in this Annual Report on Form 10-K.
At December 31, (11) ------------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (In thousands) Selected Consolidated Financial Condition Data: Total assets............................ $ 336,690 $ 221,954 $ 203,093 $ 179,930 $ 157,153 Cash (noninterest bearing).............. 2,435 982 963 709 719 Loans receivable, net:(1) First mortgage loans secured by one-to-four family residences.......................... 145,967 114,286 106,053 93,438 82,523 First mortgage loans secured by multifamily properties........... 63,285 49,895 33,015 30,070 19,815 First mortgage loans secured by commercial properties............ 11,168 3,724 5,068 5,650 5,974 Consumer loans........................ 33,612 23,344 21,695 18,714 16,472 --------- --------- --------- --------- --------- Total loans receivable, net......... 254,032 191,249 165,831 147,872 124,784 Investment securities(2)................ 63,084 22,279 29,577 26,156 28,389 Deposits................................ 246,690 141,124 129,722 126,672 124,189 Borrowed funds.......................... 38,832 28,550 22,335 21,940 3,886 Total shareholders' equity.............. 48,207 50,417 49,235 29,900 27,813
For the Year Ended December 31, 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (In thousands) Selected Operating Data: Interest income......................... $ 23,602 $ 16,205 $15,090 $ 13,148 $ 11,592 Interest expense........................ 12,869 7,900 6,929 7,079 6,048 --------- --------- --------- --------- --------- Net interest income before provision for loan losses.......... 10,733 8,305 8,161 6,069 5,544 Provision for loan losses............... 210 240 240 250 242 --------- --------- --------- --------- --------- Net interest income after provision for loan losses.......... 10,523 8,065 7,921 5,819 5,302 --------- --------- --------- --------- --------- Noninterest income: Fees and service charges........... 1,243 657 580 445 430 Abstract fees...................... 1,584 1,222 931 794 332 Other income....................... 1,088 658 382 463 286 --------- --------- --------- --------- --------- Total noninterest income......... 3,915 2,537 1,893 1,702 1,048 --------- --------- --------- --------- --------- Noninterest expense: Salaries and employee benefits..... 3,482 2,209 2,004 1,681 1,282 Premises and equipment............. 812 444 421 382 326 Data processing.................... 553 258 244 236 248 One-time SAIF special assessment... -- -- 817 -- -- SAIF deposit insurance premiums......................... 143 85 279 287 306 Goodwill 436 28 29 30 -- Other expenses..................... 2,146 1,553 1,144 1,042 761 --------- --------- --------- --------- --------- Total noninterest expense........ 7,572 4,577 4,938 3,658 2,923 --------- --------- --------- --------- --------- Income before income taxes.............. 6,866 6,025 4,876 3,863 3,427 Income tax expense...................... 2,481 2,108 1,744 1,403 1,247 --------- --------- --------- --------- --------- Net income........................... $ 4,385 $ 3,917 $ 3,132 $ 2,460 $ 2,180 ========= ========= ========= ========= =========
-33-
At or for the Year Ended December 31, -------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Key Financial Ratios and Other Data: Performance Ratios: (%) Net interest rate spread (difference between average yield on interest-earning assets and average cost of interest- bearing liabilities)...................... 2.81% 2.87% 3.01% 2.75% 3.02% Net interest margin (net interest income as a percentage of average interest- earning assets)........................... 3.50 4.06 4.33 3.66 3.70 Return on average assets (net income divided by average total assets).......... 1.35 1.86 1.62 1.45 1.43 Return on average equity (net income divided by average equity)................ 8.73 7.94 6.30 8.54 11.19 Noninterest income to average assets........ 1.21 1.20 0.98 1.00 0.69 Efficiency ratio(3)......................... 51.69 42.21 49.11 47.07 44.35 Noninterest expense to average assets....... 2.34 2.17 2.56 2.16 1.92 Net interest income after provision for loan losses to noninterest expenses....... 138.97 176.22 160.40 159.07 181.41 Financial Condition Ratios: (%) Equity to assets at period end.............. 14.32 22.72 24.24 16.62 17.70 Tangible equity to tangible assets at period end (5) (6)..................... 12.42 22.32 23.80 16.09 17.10 Average shareholders' equity divided by average total assets...................... 15.52 23.38 25.73 16.99 12.82 Average tangible shareholders equity divided by average tangible total assets (5) (6).. 13.71 22.96 25.29 16.42 12.17 Average interest-earning assets to average interest-bearing liabilities.............. 116.28 130.97 136.02 121.37 116.87 Asset Quality Ratios: (%)(4) Nonaccrual loans to total net loans......... 0.38 0.08 0.11 0.12 0.26 Nonperforming assets to total assets(7)..... 0.34 0.10 0.15 0.23 0.21 Allowance for loan losses as a percent of total loans receivable at end of period... 1.03 1.10 1.16 1.15 1.20 Allowance for loan losses to nonaccrual loans..................................... 279.72 1,468.33 1,059.35 960.20 476.23 Per Share Data: Book value per share........................ $16.26 $15.43 $14.36 $8.72 $8.11 Tangible book value per share (5)........... 13.79 15.09 14.01 8.39 7.78 Basic earnings per share (8)................ 1.44 1.23 0.82 0.63 0.21 Diluted earnings per share (9).............. 1.40 1.21 0.82 0.63 0.21 Dividends declared per share................ 0.32 0.25 0.28 0.60 0.12 Dividend payout ratio....................... 0.22 0.20 0.34 0.95 0.57 Key Financial Ratios Excluding SAIF Assessment: (%) (10) Return on average assets (net income divided by average total assets).................. 1.35% 1.86% 1.89% 1.45% 1.43% Return on average equity (net income divided by average equity)................ 8.73 7.94 7.34 8.54 11.19 Efficiency ratio (3)........................ 51.69 42.21 40.99 47.07 44.35 Noninterest expense to average assets ...... 2.34 2.17 2.13 2.16 1.92 Net interest income after provision for loan losses to noninterest expenses....... 138.97 176.22 192.21 159.07 181.41 - ----------------------- (Notes on following page)
-34- (1) Loans receivable, net represents total loans less discounts, loans in process, net deferred loan fees and allowance for loan losses. The allowance for loan losses at December 31, 1998, 1997, 1996, 1995 and 1994 was $2.7 million, $2.2 million, $2.0 million, $1.7 million and $1.5 million, respectively. (2) Includes interest-bearing deposits with the Federal Home Loan Bank of Des Moines (the "FHLB"). (3) Efficiency ratio represents noninterest expense divided by the sum of net interest income before provision for loan losses plus noninterest income. (4) Asset Quality Ratios are end of period ratios. With the exception of end of period ratios, all ratios are based on average monthly balances during the indicated periods and are annualized where appropriate. (5) Tangible equity consists of stockholders' equity less goodwill and title plant. Goodwill and title plant at December 31, 1998, 1997, 1996, 1995 and 1994 was $7.3 million, $1.1 million, $1.2 million, $1.1 million and $1.1 million, respectively. (6) Tangible assets consists of total assets less goodwill and title plant. Goodwill and title plant at December 31, 1998, 1997, 1996, 1995 and 1994 was $7.3 million, $1.1 million, $1.2 million, $1.1 million and $1.1 million, respectively. (7) Nonperforming assets consists of nonaccrual loans, foreclosed real estate and other nonperforming assets. (8) Basic earnings per share information is calculated by dividing net income by the weighted average number of shares outstanding. Basic earnings per share information for the year ended December 31, 1994 is calculated by dividing net income subsequent to the conversion of the Bank from mutual to stock form in 1994 by the weighted average number of shares outstanding. The weighted average number of shares outstanding for basic earnings per share computation for 1998, 1997, 1996, 1995 and 1994 were 3,048,148, 3,184,269, 3,818,273, 3,919,488 and 3,906,980, respectively. Net income subsequent to such conversion was $810,000 for the period ended December 31, 1994. (9) Diluted earnings per share information is calculated by dividing net income by the weighted average number of shares outstanding, adjusted for the effect of dilutive potential common shares outstanding which consists of stock options granted. Diluted earnings per share information for the year ended December 31, 1994 is calculated by dividing net income subsequent to the conversion of the Bank from mutual to stock form in 1994 by the weighted average number of shares outstanding. The weighted average number of shares outstanding for diluted earnings per share computation for 1998, 1997, 1996, 1995 and 1994 were 3,132,833, 3,241,069, 3,818,273, 3,919,488 and 3,906,980, respectively. Net income subsequent to such conversion was $810,000 for the period ended December 31, 1994. (10) For 1996, excludes the one-time $817,000 (pre-tax) special assessment for the recapitalization of the Savings Association Insurance Fund ("SAIF"). (11) As of the close of business on January 30, 1998, the Company completed the Acquisition of Valley Financial Corp. Subsequent to January 30, 1998, the information contained in the Financial Selected Data tables reflect the effect of the Acquisition. Financial data prior to January 30, 1998, does not reflect the Acquisition and is based upon historical figures. See discussion regarding Pro Forma Financial information, page 51 through 53. -35- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General North Central Bancshares, Inc. (the "Holding Company"), an Iowa corporation, is the holding company for First Federal Savings Bank of Iowa (the "Bank"), a federally chartered savings bank. Collectively, the Holding Company and the Bank are referred to herein as the "Company." The Holding Company was organized on December 5, 1995 at the direction of the Board of Directors of the Bank for the purpose of acquiring all of the capital stock to be issued by the Bank in connection with the conversion and reorganization of the Bank and North Central Bancshares, M.H.C. (the "MHC") from the mutual to the stock holding company structure (these transactions are collectively referred to as the "Conversion"). On March 20, 1996, upon completion of the Conversion, the Holding Company issued an aggregate of 4,011,057 shares of its common stock, par value $0.01 per share ("Common Stock"), of which 1,385,590 shares were issued in exchange for all of the Bank's issued and outstanding shares, except for shares owned by the MHC which were cancelled, and 2,625,467 shares of which were sold in Subscription and Community Offerings at a price of $10.00 per share, with gross proceeds amounting to $26,254,670. At this time, the Holding Company conducts business as a unitary savings and loan holding company and the principal business of the Holding Company consists of the operation of its wholly-owned subsidiary, the Bank. The profitability of the Company depends primarily on its level of net interest income, which is the difference between interest earned on the Company's interest-earning assets, consisting primarily of loans and investment securities, and the interest paid on interest-bearing liabilities, which primarily consist of deposits and advances from the FHLB. Net interest income is a function of the Company's interest rate spread, which is the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to interest-bearing liabilities. The Company's net income is affected by its level of noninterest income which primarily consists of service fees and charges and abstract fees, and noninterest expense, which primarily consists of compensation and employee benefit expenses, premises and equipment and data processing. Net income also is affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities, which events are beyond the control of the Company. Acquisition of Valley Financial Corp. As of the close of business on January 30, 1998 (the "Effective Time"), the Company completed the acquisition of (the "Acquisition") Valley Financial Corp., ("Valley Financial"), pursuant to an Agreement and Plan of Merger, dated as of September 18, 1997, (the "Merger Agreement"). The Acquisition resulted in the merger of Valley Financial's wholly owned subsidiary, Valley Savings Bank, FSB ("Valley Savings") with and into the Bank, with the Bank as the resulting financial institution. Valley Savings, headquartered in Burlington, Iowa, was a federally-chartered stock savings bank with three branch offices located in southeastern Iowa. The former offices of Valley Savings are being operated as a division of the Bank. In connection with the Acquisition, each share of Valley Financial's common stock, par value $1.00 per share, issued and outstanding (other than shares held as treasury stock of Valley Financial) was cancelled and converted automatically into the right to receive $525.00 per share in cash pursuant to the terms and conditions of the Merger Agreement. As a result of the Acquisition, shareholders of Valley Financial were paid $14,726,250 in cash. SAIF Recapitalization In response to the disparity in deposit insurance assessment rates that existed between banks insured by the Bank Insurance Fund ("BIF") and thrifts insured by the SAIF, the Deposits Funds Insurance Act of 1996 (the "Funds Act") was enacted on September 30, 1996. The Funds Act authorized the Federal Deposit Insurance Corporation ("FDIC") to impose a special assessment on all institutions with SAIF-assessable deposits in the amount necessary to -36- recapitalize the SAIF. The Company's special SAIF assessment of $817,000 before taxes (and $512,000 net of taxes) was charged against income in the third quarter of 1996 and paid in November 1996 (the "SAIF Assessment"). In view of the recapitalization of the SAIF, the FDIC reduced the assessment rates for SAIF-assessable deposits. For the fiscal years ended December 31, 1998 and 1997, the Bank incurred $143,000 and $85,000, respectively, in deposit insurance premiums and for the interest payments on the FICO bonds issued by the Financing Corporation to recapitalize the now defunct Federal Savings and Loan Insurance Corporation. Business Strategy The Company's current business strategy is to operate the Bank as a well-capitalized, profitable and independent community-oriented savings bank dedicated to providing quality customer service. Generally, the Company has sought to implement this strategy primarily by using deposits and advances from the FHLB as its source of funds and maintaining a substantial part of its assets in loans secured by one- to four-family residential real estate, multi-family loans and commercial real estate located both inside and outside the Company's market area, consumer and other loans and in other liquid investment securities. Specifically, the Company's business strategy incorporates the following elements: (1) operating as a community-oriented financial institution, maintaining a strong core customer base by providing quality service and offering customers the access to senior management and services that a locally-headquartered institution can offer; (2) maintaining high asset quality by emphasizing investment in residential mortgage loans (including the purchase of qualifying multifamily loans) and securities issued or guaranteed by the United States Government or agencies thereof and mortgage-backed securities; (3) maintaining capital in excess of regulatory requirements and growing only to the extent that adequate capital levels can be maintained; (4) controlling noninterest expenses; (5) managing interest rate risk exposure while achieving desirable levels of profitability; and (6) increasing noninterest income through (i) the expansion of the abstract company business conducted through a wholly owned subsidiary, (ii) the acquisition of First Iowa Mortgage, Inc., a mortgage banking company and (iii) other increases in fees and service charges. Highlights of the Company's business strategy are as follows: Community-Oriented Institution. The Company is committed to meeting the financial needs of the communities in which it operates. Based in part on its participation in several different programs designed to facilitate residential lending to low- and moderate-income households, the Bank has received an "Outstanding" Community Reinvestment Act rating. The Company believes it is large enough to provide a full range of personal and business financial services and yet is small enough to be able to provide such services on a personalized and efficient basis. Management believes that the Company can be more effective in servicing its customers than many of its competitors which are not headquartered locally. Such proximity allows senior management of the Bank to quickly and personally respond to customer needs and inquiries. Strong Retail Deposit Base. In 1998, the Company had a relatively strong and stable retail deposit base drawn from its offices located in Fort Dodge, Ames, Nevada, Burlington and Mount Pleasant, Iowa. The stability of the Company's deposit base has been enhanced by the Company's offering of 5-year certificates of deposit (which comprises $50.1 million, or 20.3%, of total deposits at December 31, 1998) at attractive interest rates, and programs tying low-cost checking account services to the maintenance of specified certificate of deposit balances or loan balances. At December 31, 1998, 33.4% of the deposit base, or $82.3 million, consisted of core deposits, which included money market accounts, savings accounts, NOW accounts, and noninterest-bearing demand accounts. Core deposits are considered to be a more stable and lower cost source of funds than certificates of deposit or outside borrowings. The Company will continue to emphasize retail deposits by providing quality customer service, offering competitive rates on deposit accounts, and providing depositors with a full range of accounts. -37- Asset Quality and Emphasis on Residential Mortgage Lending. The Company has historically emphasized residential real estate financing, and has been primarily a portfolio lender. The Company expects to continue its commitment to financing the purchase or improvement of residential real estate in its market area. At December 31, 1998, 43.4% of the Company's total assets consisted of one-to-four family residential first mortgage loans. To supplement local mortgage loan originations and to diversify its mortgage loan portfolio geographically, the Company has purchased loans in the secondary mortgage market, with an emphasis on multifamily loans secured by properties outside the State of Iowa (the "out of state properties"). At December 31, 1998, the Company's portfolio of loans which were either originated or purchased by the Company and secured by out of state properties consisted of $8.8 million of one-to-four family residential mortgage loans, or 3.4% of the Company's total loan portfolio, and $70.0 million of multifamily and commercial loans, or 27.0% of the Company's total loan portfolio. At December 31, 1998, the Company's ratio of nonperforming assets to total assets was 0.34%. The Company also invests in United States Treasury securities, United States Government agencies, State and Local Obligations, mortgage-backed securities, interest-earning deposits, equity securities and FHLB stock. Generally, the yield on mortgage loans originated and purchased by the Company is greater than that of securities purchased by the Company. Future economic conditions and continued strong banking competition could result in diminished lending opportunities. If new loan originations are reduced in the future, the Company may increase its investment in securities and in purchased mortgage loans outside its market area. Capital Strength and Controlled Internal Growth. Total equity increased from $27.8 million at December 31, 1994 to $48.2 million at December 31, 1998, an increase of 73.3%. Total assets have increased by $179.5 million, or 114.2%, since December 31, 1994. As a result, the ratio of total equity to total assets has decreased from 17.7% at December 31, 1994 to 14.3% at December 31, 1998. The Company's growth can be attributed to the Acquisition and emphasis on the origination and purchase of residential mortgage loans and the purchase of multifamily mortgage loans. The Company's growth has been funded through a combination of the use of proceeds from the stock offerings held in 1994 and 1996, FHLB advances and deposit growth. The Company intends to maintain strong levels of total equity and capital ratios by controlling growth to the extent that adequate capital levels can be maintained. Acquisition Strategy. With the consummation of the Acquisition in 1998, the Company has grown through the purchase of another financial institution. The Acquisition resulted in an increase in total assets of approximately 42%, making effective use of the Company's excess capital. The Company intends to continue evaluating the possibility of acquiring branch offices and other financial institutions, which involves executing confidentiality agreements and conducting due diligence. Such evaluations by the Company provide no indication of the likelihood that the Company will enter into any agreement to engage in an acquisition transaction as, in many instances, such transactions are subject to competitive bidding and, in every instance, are subject to extensive arm's length negotiations once by the Company's evaluation is complete. Increasing Noninterest Income. The Company has attempted to increase its level of noninterest income from both new and traditional lines of business to supplement net interest income. The Company currently owns abstract companies in Webster, Boone and Jasper counties in Iowa, First Iowa Title Services, Inc. ("First Iowa"), the Bank's wholly owned subsidiary. The abstract business performed by First Iowa replaces the function of a title insurance company. The Company believes that First Iowa can continue to be an excellent source of fee income. Noninterest income from such business for the year ended December 31, 1998 was $1.6 million, offset by noninterest expense attributable to First Iowa. The Company also owns a mortgage banking company in Ames, Iowa, First Iowa Mortgage, Inc. ("First Iowa Mortgage"), the Bank's wholly owned subsidiary. On January 30, 1998, the Company acquired First Iowa Mortgage as a part of the Acquisition of Valley Financial. Non-interest income for such business for the year ended December 31, 1998 was $339,000, offset by non-interest expense attributable to First Iowa Mortgage. -38- Liquidity and Interest Rate Risk Management. Management seeks to manage the Company's interest rate risk exposure by monitoring the levels of interest rate sensitive assets and liabilities while maintaining an acceptable interest rate spread. At December 31, 1998, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same period by $ 41.4 million, representing a one-year gap to total assets ratio of negative 12.3% as compared to a positive 0.28% at December 31, 1997. This change is due in part to the Acquisition of Valley Financial. To reduce the potential volatility of the Company's earnings in a changing interest rate environment, the Company has emphasized the origination of 7-year fixed rate mortgage loans that convert to adjustable rates at the conclusion of their initial terms and have overall maturities of up to 30 years, adjustable-rate loans, investment in short to medium term United States Treasury notes, U. S. Government agencies, mortgage-backed securities and has sought to lengthen the terms of its deposits through its pricing strategies with respect to longer term certificates of deposit. See "-- Discussion of Market Risk -- Interest Rate Sensitivity Analysis". Liquidity and Capital Resources OTS regulations require that thrift institutions such as the Bank maintain an average daily balance of liquid assets (cash, certain time deposits, banker's acceptances and specified United States Government, state or federal agency obligations) equal to a monthly average of not less than 4% of its net withdrawable deposits plus short-term borrowings. At December 31, 1998, the amount of the Bank's liquid assets were $45.7 million, resulting in a liquidity ratio of 17.6%. The Company's primary sources of funds are deposits, amortization and prepayment of loans, maturities of securities and other investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Company manages the pricing of its deposits to maintain a desired deposit balance. In addition, the Company invests in short-to-medium term interest-earning assets, which provide liquidity to meet lending requirements. At December 31, 1998, $5.0 million, or 12.6%, of the Company's investment portfolio, excluding equity securities, was scheduled to mature in one year or less and $16.8 million, or 41.8%, was scheduled to mature in one to five years and $18.3 million, or 45.6%, was scheduled to mature in more than five years. Certificates of deposit scheduled to mature in less than one year, at December 31, 1998, totalled $81.3 million. Based on prior experience, management believes that a significant portion of such deposits will remain with the Company. If the Company requires funds beyond its ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. The amount of eligible collateral for blanket lien pledges from the FHLB is $139.3 million as of December 31, 1998. For additional information about cash flows from the Company's operating, financing and investing activities, see the Statements of Cash Flows included in the Consolidated Financial Statements. At December 31, 1998, the Company had outstanding loan commitments of $2.8 million. This amount does not include undisbursed overdraft loan privileges and the unfunded portion of loans in process. The main sources of liquidity for the Holding Company are net proceeds from the sale of stock and payments from the Bank in the form of dividends and loan repayments. The main cash outflows are payments of dividends to shareholders and funds used to repurchase the Common Stock. During 1998, the Holding Company repurchased 311,324 shares of its Common Stock, pursuant to repurchase programs which were approved by the OTS. The Holding Company's ability to pay dividends to shareholders depends substantially on dividends and loan payments received from the Bank. The Bank may not declare or pay cash dividends on or repurchase any of its shares of common stock if the effect thereof would cause equity to be reduced below applicable regulatory capital requirements or the amount required to be maintained for the liquidation account. For a description of the liquidation account, see Notes 17 and 18 to the Consolidated Financial Statements. Unlike the Bank, the Holding Company is not subject to OTS regulatory restrictions on the payment of dividends to its shareholders, however, it is subject to the requirements of Iowa law. Iowa law generally prohibits the Holding Company from paying a dividend if, after giving it effect, either of the following would result: (a) the Holding Company would not be able to pay its debts as they become due in the usual course of business; or (b) the Holding Company's total assets would be less than the sum of its total liabilities, plus the amount that would -39- be needed, if the Holding Company were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. The primary investing activities of the Company are the origination and purchase of mortgage and other loans and the purchase of securities. During the years ended December 31, 1998, 1997 and 1996, the Company's disbursements for loan originations and purchases totaled $85.2 million, $62.3 million and $52.0 million, respectively. These activities were funded primarily by net deposit inflows, principal repayments on loans, proceeds from the sale of securities and FHLB advances. Net cash flows used in investing activities amounted to $2.2 million, $19.1 million and $21.3 million for the years ended December 31, 1998, 1997 and 1996, respectively. Net cash flows provided by financing activities amounted to $9.4 million, $14.3 million and $19.8 million for the years ended December 31, 1998, 1997 and 1996, respectively. The OTS regulations require savings associations, such as the Bank, to meet three minimum capital standards: a tangible capital ratio requirement of 1.5% of total assets as adjusted under the OTS regulations; a leverage ratio requirement of 3% of core capital to such adjusted total assets; and a risk-based capital ratio requirement of 8% of core and supplementary capital to total risk-based assets. The Bank satisfied these minimum capital standards at December 31, 1998 with tangible and leverage capital ratios of 11.7% and a total risk-based capital ratio of 23.8%. In determining the amount of risk-weighted assets for purposes of the risk-based capital requirement, a savings association must compute its risk-based assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the United States Government or its agencies to 100% for consumer and commercial loans, as assigned by the OTS capital regulations. These capital requirements, which are applicable to the Bank only, do not consider additional capital held at the Holding Company level, and require certain adjustments to shareholder's equity to arrive at the various regulatory capital amounts. The table below presents the Bank's regulatory capital amounts as compared to the OTS regulatory capital requirements at December 31, 1998:
Capital Excess Amount Requirements Capital ------- ------------ ------- (In thousands) Tangible capital..................................... $ 38,245 $ 4,917 $ 33,328 Core capital......................................... 38,245 9,834 28,411 Risk-based capital................................... 40,509 13,614 26,895
-40- Discussion of Market Risk--Interest Rate Sensitivity Analysis As a financial institution, the Company's primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Bank's assets and liabilities, and the market value of all interest-earning assets, other than those which possess a short term to maturity. Since all of the Company's interest-bearing liabilities and virtually all of the Company's interest-earning assets are located at the Bank, virtually all of the Company's interest rate risk management procedures are performed at the Bank level. Based upon the Bank's nature of operations, the Bank is not subject to foreign currency exchange or commodity price risk. The Bank's real estate loan portfolio, within Iowa, is subject to risks associated with the local economy. The Company has sought to diversify its loan portfolio by purchasing loans secured by properties outside of Iowa. At December 31, 1998, 30.4% of the Company's loan portfolio was secured by properties outside the State of Iowa, located in twenty-six states. See "Asset Quality." The Bank does not own any trading assets. At December 31, 1998, neither the Company nor the Bank had any hedging transactions in place, such as interest rate swaps and caps. The Company seeks to manage its interest risk by monitoring and controlling the variation in repricing intervals between its assets and liabilities. To a lesser extent, the Company also monitors its interest rate sensitivity by analyzing the estimated changes in market value of its assets and liabilities assuming various interest rate scenarios. As discussed more fully below, there are a variety of factors which influence the repricing characteristics of any given asset or liability. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The "interest rate sensitivity gap" is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income. The Company's policy in recent years has been to manage its exposure to interest rate risk generally by focusing on the maturities of its interest rate sensitive assets and by emphasizing adjustable-rate mortgage loans, and maintaining a level of liquidity by investing in short to medium term United States Treasury notes, U. S. Government agencies, mortgage-backed securities and short-term interest-earning deposits. The Company generally offers competitive rates on deposit accounts and prices certificates of deposit to provide customers with incentives to choose certificates of deposit with longer terms. At December 31, 1998, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same period by $41.4 million, representing a one-year gap ratio of negative 12.3%, compared to a one-year gap ratio of positive 0.28% at December 31, 1997. To manage the potential volatility of the Company's earnings in a changing interest rate environment, the Company has emphasized the origination of 7-year fixed rate mortgage loans that convert to adjustable rates at the conclusion of their initial terms and have overall maturities of up to 30 years, adjustable-rate loans and has sought to lengthen the terms of its deposits through its pricing strategies with respect to longer term certificates of deposit. The Chief Executive Officer regularly meets with the Bank's senior executive officers to review trends in deposits as well as mortgage and consumer lending. The Chief Executive Officer also regularly meets with the investment committee to review the investment portfolio. The Chief Executive Officer reports quarterly to the Board of Directors on interest rate risks and trends, as well as liquidity and capital ratios and requirements. -41- Gap Table. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1998 which are expected to reprice or mature, based upon certain assumptions, in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown that reprice or mature during a particular period were determined in accordance with the earlier of term of repricing or the contractual terms of the asset or liability. Certain assumptions used in preparing the table are set forth in the following table. Management believes that these assumptions approximate actual experience and considers them appropriate and reasonable.
At December 31, 1998 (1) --------------------------------------------------------------------------------------------- Within 1-3 3-5 5-10 10-20 Over 20 1 Year Years Years Years Years Years Total -------------- ------------- ------------ -------------- ----------- ----------- ----------- (Dollars in thousands) Interest-earning assets: First mortgage loans Adjustable (4)................ $ 51,059 $74,259 $ 9,113 $ -- $ -- $ -- $134,431 Fixed (4)..................... 26,966 33,893 19,535 19,045 591 10 100,040 Consumer and other loans......... 11,811 19,146 3,015 106 -- -- 34,078 Investment securities(3)......... 35,421 11,410 3,769 4,976 -- -- 55,576 -------- -------- -------- -------- -------- -------- -------- Total interest-earning assets. $125,257 $138,708 $ 35,432 $ 24,127 $ 591 $ 10 $324,125 ======== ======== ======== ======== ======== ======== ======== Rate sensitive liabilities: Savings accounts................. $ 26,099 $ -- $ -- $ -- $ -- $ -- $ 26,099 NOW accounts..................... 30,909 -- -- -- -- -- 30,909 Money market accounts............ 19,828 -- -- -- -- -- 19,828 Certificate accounts............. 81,283 64,973 18,140 -- -- -- 164,396 Non-interest-bearing deposits.... 5,458 -- -- -- -- -- 5,458 FHLB advances and other liabilities. 3,068 13,447 19,701 491 2,125 -- 38,832 -------- -------- -------- -------- -------- -------- -------- Total interest-bearing liabilities $166,645 $ 78,420 $ 37,841 $ 491 $ 2,125 $ -- $285,522 ======== ======== ======== ======== ======== ======== ======== Interest sensitivity gap............ $(41,388) $ 60,288 $ (2,409) $ 23,636 $ (1,534) $ 10 Cumulative interest-sensitivity gap. $(41,388) $ 18,900 $ 16,491 $ 40,127 $ 38,593 $ 38,603 Interest sensitivity gap to total assets -12.29% 17.91% -0.72% 7.02% -0.46% -- Cumulative interest-sensitivity gap total assets..................... -12.29% 5.61% 4.90% 11.92% 11.46% 11.47% Ratio of interest-earning assets to interest-bearing liabilities..... 75.16% 176.88% 93.63% 100.00% 100.00% -- 113.52% Cumulative ratio of interest-earning assets to interest-bearing liabilities 75.16% 107.71% 105.83% 114.16% 113.52% 113.52% 113.52% Total assets........................ $336,690 $336,690 $336,690 $336,690 $336,690 $336,690 $336,690 Cumulative interest bearing assets.. $125,257 $263,965 $299,397 $323,524 $324,115 $324,125 $324,125 Cumulative interest sensitive liabilities $166,645 $245,065 $282,906 $283,397 $285,522 $285,522 $285,522
- --------------------------------- (1) The Company prepared the above table using December 31, 1998 composite interest rate sensitivity assumptions of the Eighth District of the FHLB where such assumptions were available. Where such information was not available, the assumptions were made based on December 1998 OTS assumptions or the Company's actual experience. These assumptions are as follows: (i) fixed-rate first mortgage loans on one-to-four family residential properties with interest rates less than 8%, 8% to 9%, 9% to 10%, 10% to 11%, and 11% and over, and the remaining terms to maturity of over 15 years will prepay annually at 9%, 22%, 22%, 19% and 16%, respectively; (ii) adjustable-rate first mortgage loans on one-to-four family residential properties will prepay at 8% to 9% per year; (iii) fixed- and adjustable-rate mortgage loans on multifamily and commercial properties will repay at 8% per year; (iv) second mortgage consumer loans will prepay at 9% per year; (v) fixed-rate deposits will not be withdrawn prior to maturity; and (vi) passbook savings accounts, NOW accounts, money market accounts and noninterest-bearing deposit accounts are assumed to reprice within one year due to the possibility that such deposits will reprice in the event of significant changes in the overall level of interest rates. These assumptions are annual percentages based on remaining balances and should not be regarded as indicative of the actual prepayments and withdrawals that may be experienced by the Company. Certain shortcomings are inherent in the analysis presented by the foregoing table. (2) Fixed rate first mortgage loans include $44.0 million of one-to-four family seven year fixed rate loans than convert to adjustable rates at the beginning of the eighth year and are adjustable thereafter. (3) Includes FHLMC preferred stock, FNMA preferred stock, other equity securities, interest-bearing deposits and FHLB stock, all of which are shown in the within-one-year category. Components include interest-bearing deposits of $13.2 million and securities available for sale of $42.4 million. (4) Includes $629,000 and $6.9 million in mortgage-backed securities in the adjustable and fixed first mortgage loans, respectively. Certain shortcomings are inherent in the method of analysis presented in the Gap Table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different -42- degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of changes in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase. NPV Analysis. As part of its efforts to maximize net interest income and manage the risks associated with changing interest rates, management uses the "market value of portfolio equity" ("NPV") methodology which the OTS has adopted as part of its capital regulations. Under this methodology, interest rate risk exposure is assessed by reviewing the estimated changes in Net Interest Income ("NII") and NPV which would hypothetically occur if interest rates rapidly rise or fall along the yield curve. Projected values of NII and NPV at both higher and lower regulatory defined rate scenarios are compared to base case values (no change in rates) to determine the sensitivity to changing interest rates. Presented below, as of December 31, 1998, is an analysis of the Company's interest rate risk ("IRR") as measured by changes in NPV and NII for instantaneous and sustained parallel shifts of 100 basis points in market interest rates. Such limits have been established with consideration of the impact of various rate changes and the Company's current capital position.
Interest Rate Sensitivity of Net Portfolio Value (NPV)(1) Net Portfolio Value NPV as % of PV of Assets --------------------------------------------------- ------------------------------ Change in Rates $ Amount $ Change % Change NPV Ratio Change - -------------------- ---------- ----------------------- -------------- ---------------- ------------- (Dollars in thousands) +400 bp $39,231 -5,002 -11% 12.28% -88bp +300 bp 41,304 -2,929 -7 12.73 -43bp +200 bp 42,957 -1,275 -3 13.06 -10bp +100 bp 43,937 -295 -1 13.20 4bp 0 bp 44,232 -- -- 13.16 -- -100 bp 44,149 -84 -- 13.02 -14bp -200 bp 44,237 4 -- 12.92 -24bp -300 bp 45,007 775 2 12.99 -17bp -400 bp 45,273 1,040 2 12.93 -23bp
- --------------------------------- (1) Denotes rate shock used to compute interest rate risk capital component. As is the case with the Gap Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV Table presented assumes that the composition of the Company's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV Table provides an indication of the Company's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Company's net interest income and will differ from actual results. Asset Quality Delinquencies. The Company's collection procedures provide that when a loan is 15 days past due, a computer-generated late charge notice is sent to the borrower requesting payment, plus a late charge for mortgage loans. If delinquency continues, on the 20th day past due, a telephone call is made to the borrower seeking payment. If the loan is 30 days past due, a delinquent notice is mailed along with a letter advising that the mortgagors are in violation of the terms of their mortgage contract. If a loan becomes 60 days past due, the loan becomes subject to possible legal action. -43- After 90 days, if satisfactory payment terms are not reached with the borrower, foreclosure proceedings are initiated. To the extent required by the Department of Housing and Urban Development ("HUD") regulations, generally within 45 days of delinquency, a Section 160 HUD notice is given to the borrower which provides access to consumer counseling services. It is sometimes necessary and desirable to arrange special repayment schedules with mortgagors to prevent foreclosure or filing for bankruptcy. The mortgagors are required to submit a written repayment schedule which is closely monitored for compliance. Under these terms, the account is brought to date, usually within a few months. Nonperforming Assets. Loans are reviewed on a regular basis and are placed on nonaccrual status when, in the opinion of management, the collection of additional interest is doubtful. Mortgage loans and consumer loans are placed on nonaccrual status generally when either principal or interest is more than 90 days past due. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is charged against interest income. Real estate acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure is deemed foreclosed real estate until such time as it is sold. In general, the Company considers collateral for a loan to be in substance foreclosed if: (i) the borrower has little or no equity in the collateral; (ii) proceeds for repayment of the loan can be expected to come only from the operation or sale of the collateral; and (iii) the borrower has either formally or effectively abandoned control of the collateral to the Company, or retained control of the collateral but is unlikely to be able to rebuild equity in the collateral or otherwise repay the loan in the foreseeable future. When foreclosed real estate is acquired or otherwise deemed foreclosed real estate, it is recorded at the lower of the unpaid principal balance of the related loan or its estimated fair value, less estimated selling expenses. Valuations are periodically performed by management, and any subsequent decline in fair value is charged to operations. At December 31, 1998, the Company's foreclosed real estate consisted of four properties with an aggregate value of $187,000. Delinquent Loans, Nonaccrual Loans and Nonperforming Assets. The following table sets forth information regarding loans on nonaccrual status and foreclosed real estate of the Company at the dates indicated. At the dates indicated, the Company did not have any material restructured loans within the meaning of SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, and did not have any loans that were ninety days past due and still accruing interest.
At December 31, ------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 -------------- --------------- --------------- --------------- -------------- (Dollars in thousands) Nonaccrual loans and nonperforming assets: First mortgage loans: One-to-four family residential........... $ 403 $ 122 $ 149 $ 137 $ 299 Multifamily and commercial properties (2)......................... 423 -- -- -- -- Consumer loans:............................. 130 25 35 44 25 ------- ------- ------- ------- ------- Total nonaccrual loans................... 956 147 184 181 324 Total foreclosed real estate(1)............. 187 67 128 128 -- Other nonperforming assets.................. 1 -- 2 109 -- ------- ------- ------- ------- ------- Total nonperforming assets............... $ 1,144 $ 214 $ 314 $ 418 $ 324 ======= ======= ======= ======= ======= Total nonaccrual loans to net loans receivable............................... 0.38% 0.08% 0.11% 0.12% 0.26% Total nonaccrual loans to total assets...... 0.28 0.07 0.09 0.10 0.21 Total nonperforming assets to total assets................................... 0.34 0.10 0.15 0.23 0.21 (Notes on following page)
- ----------------- (1) Represents the net book value of property acquired by the Company through foreclosure or deed in lieu of foreclosure. Upon acquisition, this property is recorded at the lower of cost or fair value less estimated selling expenses. -44- (2) Includes a purchased loan which was secured by a commercial property that was 90 days past due in the amount of $364,636 (in actual dollars). This loan was repaid in March, 1999. The following table sets forth information with respect to loans delinquent 60-89 days in the Company's portfolio at the dates indicated.
At December 31, ---------------------------------------------------------------------- 1998 1997 1996 1995 1994 -------------- -------------- ------------- ------------ ------------- (In thousands) Loans past due 60-89 days: First mortgage loans: One-to-four family residential................ $ 1,070 $ 275 $ 323 $ 311 $ 288 Multifamily and commercial properties......... 22 -- -- -- -- Consumer loans................................... 270 135 51 28 62 ------- ------- ------- ------- ------- Total past due 60-89 days................... $ 1,362 $ 410 $ 374 $ 339 $ 350 ======= ======= ======= ======= =======
The following table sets forth information with respect to the Company's delinquent loans and other problem assets at December 31, 1998.
At December 31, 1998 ------------------------------------------- Balance Number ----------- ---------- (Dollars in thousands) One-to-four family first mortgage loans: Loans 60 to 89 days delinquent.................................. $ 1,070 25 Loans 90 days or more delinquent................................ 403 11 Multifamily and commercial first mortgage loans: Loans 60 to 89 days delinquent.................................. 22 1 Loans 90 days or more delinquent (1)............................ 423 2 Consumer Loans: Loans 60 to 89 days delinquent.................................. 270 29 Loans 90 days or more delinquent................................ 130 13 Foreclosed real estate............................................ 187 4 Other nonperforming assets........................................ 1 1 Loans to facilitate sale of foreclosed real estate................ 206 6 Special mention loans............................................. 654 24
(1) Includes a purchase loan which was secured by a commercial property that was 90 days past due in the amount of $364,636 (in actual dollars). This loan was repaid in March, 1999. Classification of Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by the OTS to be of lesser quality as "substandard," "doubtful," or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the savings institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management. Loans designated as special mention are generally loans that, while current in required payments, have exhibited some potential weaknesses that, if not corrected, could increase the level of risk in the future. At December 31, 1998, the Company -45- had $654,000 of special mention loans, consisting of eleven loans secured by one-to-four family residences, one commercial property and twelve consumer loans. The following table sets forth the aggregate amount of the Company's classified assets at the dates indicated.
At December 31, ------------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (In thousands) Substandard assets...................... $ 745(2) $ 208 $ 311 $ 1,134(1) $ 357 Doubtful assets......................... -- -- -- -- -- Loss assets............................. 35 18 9 -- 10 --------- --------- --------- --------- --------- Total classified assets............... $ 780 $ 226 $ 320 $ 1,134 $ 367 ========= ========= ========= ========= ========= - ------------
(1) Includes one purchased loan which was secured by a multifamily property that was 30 days past due in the amount of $791,000 (in actual dollars). This loan was repaid in January 1996. (2) Includes one purchase loan which was secured by a commercial property that was 90 days past due in the amount of $364,636 (in actual dollars). This loan was repaid in March, 1999. Allowance for Loan Losses. It is management's policy to provide an allowance for estimated losses on the Company's loan portfolio based on management's evaluation of the prior loss experience, industry standards, past due loans, economic conditions, the volume and type of loans in the Company's portfolio, which includes a significant amount of multifamily loans, substantially all of which are purchased and are collateralized by properties located outside of the Company's market area, and other factors related to the collectibility of the Company's loan portfolio. The Company regularly reviews its loan portfolio, including problem loans, to determine whether any loans require classification or the establishment of appropriate reserves or allowances for losses. Such evaluation, which includes a review of all loans of which full collectibility of interest and principal may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral. During the years ended December 31, 1998, 1997 and 1996 the Company's provision for loan losses were $210,000, $240,000 and $240,000, respectively. The Company's allowance for loan losses totalled $2.7 million, $2.2 million and $2.0 million at December 31, 1998, 1997 and 1996, respectively. Management believes that the allowances for losses on loans and foreclosed real estate are adequate. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowances for loan losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. -46- Analysis of the Allowance for Loan Losses. The following table sets forth the analysis of the allowance for loan losses for the periods indicated.
For the Year Ended December 31, ------------------------------------------------------------------------------ 1998 1997 1996 1995 1994 --------------- --------------- --------------- --------------- -------------- (Dollars in thousands) Total loans outstanding................. $ 259,360 $ 194,626 $ 168,921 $ 151,310 $ 128,951 Average net loans outstanding........... 246,510 175,284 156,708 137,068 118,997 Allowance balances (at beginning of period............................... 2,151 1,953 1,736 1,543 1,306 --------- --------- --------- --------- --------- Provisions for losses: First mortgage loans.................. 135 190 150 200 165 Consumer loans........................ 75 50 90 50 77 Effect of- Valley Financial Corporation........ 343 -- -- -- -- Charge-Offs: First mortgage loans.................. 6 21 5 2 -- Consumer loans........................ 23 31 19 56 7 Recoveries: First mortgage loans.................. -- -- -- -- -- Consumer loans........................ 1 10 1 1 2 --------- --------- --------- --------- --------- Net charge-offs....................... 28 42 23 57 5 --------- --------- --------- --------- --------- Allowance balance (at end of period).... $ 2,676 $ 2,151 $ 1,953 $ 1,736 $ 1,543 ========= ========= ========= ========= ========= Allowance for loan losses as a percent of total loans receivable at end of period................................ 1.03% 1.10% 1.16% 1.15% 1.20% Net loans charged off as a percent of average net loans outstanding......... 0.01 0.02 0.01 0.04 -- Ratio of allowance for loan losses to total nonaccrual loans at end of period................................ 279.96 1,468.33 1,059.35 960.20 476.23 Ratio of allowance for loan losses to total nonaccrual loans and foreclosed real estate at end of period.......... 233.95 1,006.96 621.31 562.15 476.23
-47- Allocation of Allowance for Loan Losses. The following table sets forth the allocation for loan losses by loan category for the periods indicated:
At December 31, ------------------------------------------------------------------ 1998 1997 1996 --------------------- -------------------- --------------------- % of Loans % of Loans % of Loans In Each In Each In Each Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- ------ ------------ (Dollars in thousands) Balance at end of period applicable to: One-to-four family residential mortgage loans........................ $ 684 57.46% $ 675 59.48% $ 503 63.44% Multifamily residential mortgage loans.. 1,298 25.02 1,026 26.38 948 20.42 Commercial mortgage loans............... 228 4.39 76 1.95 157 3.09 Consumer loans.......................... 466 13.13 374 12.19 345 13.05 ------- ------- ------- ------ ------- ------ Total allowance for loan losses....... $ 2,676 100.00% $ 2,151 100.00% $ 1,953 100.00% ======= ====== ======= ====== ======= ======
At December 31, ------------------------------------------ 1995 1994 -------------------- -------------------- % of Loans % of Loans In Each In Each Category to Category to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (Dollars in thousands) Balance at end of period applicable to: One-to-four family residential mortgage loans........................ $ 418 62.70% $ 429 65.48% Multifamily residential mortgage loans.. 870 20.90 646 16.70 Commercial mortgage loans............... 175 3.85 189 4.79 Consumer loans.......................... 273 12.55 279 13.03 ------- ------ ------- ------ Total allowance for loan losses....... $ 1,736 100.00% $ 1,543 100.00% ======= ====== ======= ======
Average Balance Sheet The following table sets forth certain information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. For purposes of this tables, average balances were computed on a monthly basis. -48-
For the Year Ended December 31, --------------------------------------------------------------- At December 31, 1998 1998 1997 ---------------------- ------------------------------- ------------------------------ Average Average Yield/ Average Yield/ Average Yield/ Balance Cost Balance Interest Cost Balance Interest Cost ------- ---- ------- -------- ------- ------- -------- -------- (Dollars in thousands) Assets: Interest-earning assets: First mortgage loans(1)..... $ 222,621 7.88% $216,914 $17,318(8) 7.98% $154,227 $12,433(8) 8.06% Consumer loans(1)........... 34,076 9.18 32,173 3,014 9.37 23,138 2,201 9.51 Investment securities....... 62,513(4) 5.59 57,826(5) 3,270 5.65 27,102(6) 1,571 5.79 ---------- ---- -------- ------- ----- -------- ------- ---- Total interest-earning assets 319,210 7.57% 306,913 23,602 7.69% $204,467 $16,205 7.93 ======= ======= Noninterest-earning assets.... 17,480 16,847 6,645 ---------- -------- -------- Total assets.............. $ 336,690 $323,760 $211,112 ========== ======== ======== Liabilities and Equity: Interest-bearing liabilities: NOW and money market savings................... $ 50,735 2.20% $ 44,622 $ 1,351 3.03% $ 21,777 $ 632 2.90% Passbook savings............ 26,098 2.24 25,591 594 2.32 17,425 392 2.25 Certificates of Deposit..... 164,396 5.63 159,701 8,948 5.60 93,239 5,470 5.87 38,832 5.61 34,020 1,976 5.81 23,679 1,406 5.94 Borrowed funds.............. ---------- ---- -------- ------- ----- -------- ------- Total interest-bearing liabilities............. $ 280,061 4.69% $263,934 $12,869 4.88% $156,120 $ 7,900 5.06% ======= Noninterest-bearing liabilities 8,422 9,587 5,634 ---------- -------- -------- Total liabilities......... $ 288,483 $273,521 $161,754 Equity......................... 48,207 50,239 49,358 ---------- -------- -------- Total liabilities and equity $ 336,690 323,760 $211,112 ========== ======== ======== Net interest income........... $10,733 $ 8,305 ======= ======= Net interest rate spread(2)... 2.88% 2.81% 2.87% Net interest margin (3)....... 3.45 3.50 4.06 Ratio of average interest-earning assets to average interest- bearing liabilities......... 113.98 116.28 130.97
For the Year Ended December 31, ------------------------------- 1996 ------------------------------- Average Average Yield/ Balance Interest Cost ------- -------- -------- Assets: Interest-earning assets: First mortgage loans(1)..... $137,668 $ 11,174(8) 8.12% Consumer loans(1)........... 20,900 2,007 9.60 Investment securities....... 29,827(7) 1,909 6.40 -------- -------- ---- Total interest-earning assets $188,395 $ 15,090 8.01 ======== Noninterest-earning assets.... 4,721 -------- Total assets.............. $193,116 ======== Liabilities and Equity: Interest-bearing liabilities: NOW and money market savings................... $ 18,704 $ 530 2.83% Passbook savings............ 18,997 432 2.27 Certificates of Deposit..... 88,688 5,256 5.93 Borrowed funds.............. 12,114 711 5.87 Total interest-bearing -------- -------- liabilities............. $138,503 $ 6,929 5.00% ======== Noninterest-bearing liabilities 4,920 -------- Total liabilities......... $143,423 Equity......................... 49,693 -------- Total liabilities and equity $193,116 ======== Net interest income........... $ 8,161 ======== Net interest rate spread(2)... 3.01% Net interest margin (3)....... 4.33 Ratio of average interest-earning assets to average interest- bearing liabilities......... 136.02
- -------------------- (1) Balance is net of deferred loan fees, loan discounts and loans in process. Nonaccrual loans are included in the balances. (2) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities. (3) Net interest margin represents net interest income divided by average total interest-earning assets. (4) Includes interest-bearing deposits of $13,201,000 and securities available for sale of $49,312,000. (5) Includes interest-bearing deposits of $8,235,000 and securities available for sale of $49,590,000. (6) Includes interest-bearing deposits of $3,912,000, securities available for sale of $22,440,000 and securities held to maturity of $750,000. (7) Includes interest-bearing deposits of $3,323,000, securities available for sale of $16,298,000 and securities held to maturity of $10,206,000. (8) Includes loan fee amortization of $(29,000), $(35,000) and $(33,000) for the years ended December 31, 1998, 1997 and 1996. -49- Rate/Volume Analysis The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in average volume (changes in average volume multiplied by old rate); (ii) changes in rates (changes in rate multiplied by old average volume); (iii) changes in rate-volume (changes in rate multiplied by the changes in average volume); and (iv) the net change.
Year Ended Year Ended December 31, 1998 December 31, 1997 Compared to Compared to Year Ended Year Ended December 31, 1997 December 31, 1996 ----------------------------------------- --------------------------------------- Increase/(Decrease) Increase/(Decrease) Due to Due to ----------------------------- Total -------------------------- Total Rate/ Increase Rate/ Increase Volume Rate Volume (Decrease) Volume Rate Volume (Decrease) --------- --------- -------- ---------- -------- -------- -------- ---------- (In thousands) Interest income: First mortgage loans.................... $ 5,054 $ (120) $ (49) $ 4,885 $ 1,344 $ (76) $ (9) $ 1,259 Consumer loans.......................... 859 (33) (13) 813 215 (19) (2) 194 Investment securities................... 1,770 (83) 12 1,699 (216) (109) (13) (338) ------- ------- ------ ------- ------- ------ ------ ------- Total interest-earning assets........ $ 7,683 $ (236) $ (50) $ 7,397 $ 1,343 $ (204) $ (24) $ 1,115 ======= ======= ====== ======= ======= ====== ====== ======= Interest expense: NOW and money market savings............ $ 663 $ 27 $ 29 $ 719 $ 87 $ 13 $ 2 $ 102 Passbook savings........................ 184 13 6 203 (36) (4) -- (40) Certificate of deposits................. 3,897 (246) (175) 3,476 271 (53) (3) 215 Borrowed funds.......................... 614 (30) (13) 571 679 8 7 694 ------- ------- ------ ------- ------- ------ ------ ------- Total interest-bearing liabilities... $ 5,358 $ (236) $ (153) $ 4,969 $ 1,001 $ (36) $ 6 $ 971 ======= ======= ====== ======= ======= ====== ====== ======= Net change in net interest income........... $ 2,325 $ -- $ 103 $ 2,428 $ 342 $ (168) $ (30) $ 144 ======= ======= ====== ======= ======= ====== ====== =======
-50- PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) The unaudited pro forma consolidated financial statements presented on the following pages are based on the historical financial statements of the Company and Valley Financial. The unaudited pro forma consolidated statements of income for the year ended December 31, 1998 and 1997 were prepared as if the Acquisition had occurred as of the beginning of the respective periods for purposes of the combined consolidated statements of income and as if such an acquisition had occurred at December 31, 1997 for purposes of the combined consolidated statement of financial condition. The income statement for the year ended December 31, 1998 would therefore include the month ended January 31, 1998 for Valley Financial. These pro forma financial statements are not necessarily indicative of the results of operations that might have occurred had the Acquisition taken place at the beginning of the period, or to project the Company's results of operations at any future date or for any future period. -51- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES ACTUAL AND PRO FORMA CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL CONDITION (Unaudited)
Actual Pro Forma December 31, December 31, ASSETS 1998 1997 ------------ ------------ Cash: Interest-bearing $ 13,201,437 $ 6,481,514 Noninterest-bearing 2,435,439 2,035,108 Securities available for sale 49,882,544 58,739,131 Loans receivable, net 254,032,497 250,722,118 Loans held for sale 1,681,017 331,746 Accrued interest receivable 1,933,237 2,273,563 Foreclosed real estate 186,931 74,240 Premises and equipment, net 3,616,438 3,229,924 Rental real estate 1,945,851 2,059,148 Title plant 925,256 925,256 Goodwill 6,387,671 6,795,123 Deferred taxes 13,490 -- Prepaid expenses and other assets 448,331 857,816 -------------- -------------- Total assets $ 336,690,139 $ 334,524,687 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits $ 246,690,313 $ 240,689,830 Other borrowed funds 38,832,239 40,250,984 Advances from borrowers for taxes and insurance 1,066,025 1,164,417 Dividend payable 237,133 204,155 Deferred income taxes -- 270,446 Income taxes payable 199,224 13,215 Accrued expenses and other liabilities 1,458,391 1,514,564 -------------- -------------- Total liabilities 288,483,325 284,107,611 -------------- -------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock ($.01 par value, authorized 3,000,000 shares, issued and outstanding none) -- -- Common Stock ($.01 par value, authorized 15,500,000 shares; issued and outstanding 4,011,057) 40,111 40,111 Additional paid-in capital 38,135,817 37,949,598 Retained earnings, substantially restricted 27,084,907 23,660,964 Unrealized gain on securities available for sale, net of income taxes 358,666 354,781 Treasury stock at cost (1,053,815 and 744,574 shares, respectively) (16,399,403) (10,377,937) Unearned shares, employee stock ownership plan (1,013,284) (1,210,441) --------------- --------------- Total stockholders' equity 48,206,814 50,417,076 -------------- -------------- Total liabilities and stockholders' equity $ 336,690,139 $ 334,524,687 ============== ==============
-52- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES PRO FORMA CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Unaudited)
Year Ended December 31, 1998 1997 ------------- ------------- Interest income............................... $ 24,223,861 $ 23,955,770 Interest expense.............................. 13,319,040 13,401,812 ------------- ------------- Net interest income..................... 10,904,821 10,553,958 Provision for loan losses..................... 210,000 140,000 ------------- ------------- Net interest income after provision for loan losses.......................... 10,694,821 10,413,958 ------------- ------------- Noninterest income: Fees and service charges................ 1,279,153 1,139,663 Abstract fees........................... 1,583,773 1,221,807 Gain on sale of securities available for sale, net.............. 51,362 263,870 Other income............................ 1,054,151 769,602 ------------- ------------- Total noninterest income............. 3,968,439 3,394,942 ------------- ------------- Noninterest expense: Salaries and employee benefits.......... 3,650,905 3,463,118 Premises and equipment.................. 846,223 739,524 Data processing......................... 583,111 429,843 SAIF deposit insurance premiums......... 148,226 135,206 Goodwill amortization................... 472,290 473,875 Other expenses.......................... 2,277,600 2,201,702 ------------- ------------- Total noninterest expense............ 7,978,355 7,443,268 ------------- ------------- Income before income taxes.................... 6,684,905 6,365,632 Provision for income taxes.................... 2,439,432 2,343,256 ------------- ------------- Net Income.................................... $ 4,245,473 $ 4,022,376 ============= =============
-53- Comparison of Financial Condition as of December 31, 1998, December 31, 1997 and December 31, 1996 The pro forma statement of financial condition as of December 31, 1997 was compared with the December 31, 1998 statement of financial condition in order to more clearly present the changes in financial condition. Total assets increased $2.2 million, or .6%, from $334.5 million at December 31, 1997 to $336.7 million at December 31, 1998. Interest bearing cash increased $6.7 million, or 103.7%, from $6.5 million at December 31, 1997 to $13.2 million at December 31, 1998. Securities available for sale decreased $8.9 million, or 15.1%, primarily due to the sales, calls, payments and maturities on U.S. Treasury notes, U.S. Government agencies and mortgage-backed securities, partially offset by the purchase of U.S. Government agencies and mortgage-backed securities. Total loans receivable, net, increased by $3.3 million, or 1.3%, from $250.7 million at December 31, 1997 to $254.0 million at December 31, 1998, primarily due to the origination of $36.2 million of first mortgage loans secured by one-to-four family residences, purchases and originations of first mortgage loans primarily secured by multifamily residences located out of state of $24.5 million, and originations of $14.5 million of second mortgage loans. These originations and purchases were offset in part by payments, prepayments and sales of loans during the year ended December 31, 1998. Deposits increased $6.0 million, or 2.5%, from $240.7 million at December 31, 1997 to $246.7 million at December 31, 1998, primarily reflecting increases in NOW accounts and money market accounts. Other borrowings, primarily FHLB advances, decreased $1.4 million, from $38.8 million at December 31, 1997 to $37.9 million at December 31, 1998. Total shareholders' equity decreased $2.2 million from $48.2 million at December 31, 1997 to $50.4 million at December 31, 1998, primarily due to dividends paid to shareholders and funds used for repurchases of Common Stock less, net income and increased unrealized gains. Total assets increased $18.9 million, or 9.3%, from $203.1 million at December 31, 1996 to $222.0 million at December 31, 1997. Securities available for sale decreased $3.3 million, or 14.2%, primarily due to the maturities of several U.S. Treasury notes and the call of certain equity securities, partially offset by the purchase of several U.S. Treasury notes and the purchase of certain equity securities. Securities held to maturity decreased $3.5 million, or 100.0%, due to the maturities of several U.S. Treasury notes and the Company's decision not to replace such securities at the present time, in order to allow the Company greater flexibility in managing its portfolio of investment securities. Total loans receivable, net, increased by $25.4 million, or 15.3%, from $165.8 million at December 31, 1996 to $191.3 million at December 31, 1997, primarily due to the origination of $25.0 million of first mortgage loans secured by one-to-four family residences, purchases and originations of first mortgage loans primarily secured by multifamily residences located out of state of $22.3 million, and originations of $9.6 million of second mortgage loans. These originations and purchases were offset in part by payments, prepayments and sales of loans during the year ended December 31, 1997. Deposits increased $11.4 million, or 8.8%, from $129.7 million at December 31, 1996 to $141.1 million at December 31, 1997, primarily reflecting increases in certificates of deposit. Other borrowings, primarily FHLB advances, increased $6.2 million, to $28.6 million at December 31, 1997 from $22.3 million at December 31, 1996. Total shareholders' equity increased $1.2 million from $49.2 million at December 31, 1996 to $50.4 million at December 31, 1997, primarily due to net income and increased unrealized gains, less dividends paid to shareholders and funds used for repurchases of Common Stock. Comparison of Results of Operations for the Years Ended December 31, 1998 and 1997 The pro forma statements of income for the years ended December 31, 1998 and 1997 were used for comparison purposes in order to more clearly present the changes in the results of operations. Interest Income. Interest income increased by $268,000 to $24.2 million for the year ended December 31, 1998 compared to $24.0 million for the year ended December 31, 1997. The increase in interest income was primarily due to a $5.4 million increase in average interest earning assets to $315.1 million for the year ended December 31, 1998, from $309.7 million for 1997. The increase in the average balances of interest earning assets primarily reflects increases in the average balances of first and second mortgage loans, partially offset by decreases in securities available for sale. These increases were primarily derived from originations of $36.2 -54- million of first mortgage loans secured by one-to-four family residences, purchases and originations of first mortgage loans secured by multifamily residences located outside of the State of Iowa of $24.5 million and originations of $14.5 million of second mortgage loans, which originations and purchases were offset in part by payments, prepayments and sales of loans during the year ended December 31, 1998. The increase in average interest-earning assets reflects the Company's continued emphasis on residential lending. See "-Business Strategy." The decreases in available for sale securities were primarily due to the sales, calls, payments and maturities on U.S. Treasury Notes, U.S. Government agencies and mortgage-backed securities, partially offset by the purchase of U.S. Government agencies and mortgage-backed securities. The average yield on interest earning assets decreased to 7.69% for the year ended December 31, 1998 from 7.74% for the year ended December 31, 1997, primarily due to a general decrease in market interest rates. Interest Expense. Interest expense decreased by $83,000 to $13.3 million for the year ended December 31, 1998 compared to $13.4 million for the year ended December 31, 1997. The decrease in interest expense was primarily due to a decrease in the average cost of NOW and money market accounts, savings accounts and borrowed funds and a decrease in the average balance of borrowed funds. The decrease in the average cost of funds is due to the general decrease in market interest rates. The decrease in the average balance of borrowed funds was partially due to the utilization of excess cash funds to repay certain borrowings. This decrease was partially offset by an increase in the average balances of interest bearing-liabilities of $3.1 million, from $270.2 million for the year ended December 31, 1997, compared to $273.3 million for the year ended December 31, 1998. The increase in the average balances of interest bearing liabilities reflects an increase in the average balances of NOW accounts and money market accounts and certificates of deposit, consistent with the Company's strategy of controlled internal growth. The average cost of interest bearing liabilities decreased from 4.96% for the year ended December 31, 1997 to 4.87% for the year ended December 31, 1998, reflecting changes in the distribution of NOW and money market savings accounts and borrowing of funds with longer maturities and, to a lesser extent, decreases in the average cost of NOW and money market savings accounts and borrowed funds. Net Interest Income. Net interest income before provision for loan losses increased by $351,000 to $10.9 million for the year ended December 31, 1998 from $10.6 million for the year ended December 31, 1997. The increase is primarily due to the increases in the average interest earning assets and decreases in the cost of interest bearing liabilities, offset in part by decreases in the average interest bearing liabilities and decreases in the average yield on interest bearing assets. The interest rate spread (i.e., the difference in the average yield on assets and average cost of liabilities) increased from 2.78% for the year ended December 31, 1997 to 2.82% for the year ended December 31, 1998. The increase in the spread reflects the general decline in the overall costs on interest bearing liabilities in excess of the decline in yields on the interest-earning assets combined with the increase in the average interest bearing assets in excess of the increase in the interest bearing liabilities. -55- The following table sets forth certain information relating to the Company's pro forma average balance sheets and reflects the pro forma average yield on assets and pro forma average cost of liabilities for the years ended December 31, 1998 and 1997.
For Years Ended December 31, ------------------------------------------------------------------------- 1998 1997 ----------------------------------- ----------------------------------- Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost ------- -------- ---------- ------- -------- ---------- (Dollars in thousands) Assets: Interest-earning assets: Loans..................................... $ 253,863 $ 20,737 8.17% $ 238,973 $ 19,768 8.27% Securities available for sale............. 53,138 3,106 5.85 65,556 3,914 5.97 Interest bearing cash..................... 8,103 381 4.70 5,167 274 5.31 --------- --------- --------- --------- --------- --------- Total interest-earning assets........... 315,104 $ 24,224 7.69% 309,696 $ 23,956 7.74% --------- --------- --------- --------- Noninterest-earning assets.................. 18,299 18,215 --------- --------- Total assets............................ $ 333,403 $ 327,911 ========= ========= Liabilities and Equity: Interest-bearing liabilities: NOW and money market savings.............. $ 46,457 $ 1,416 3.05% $ 42,295 $ 1,325 3.13% Savings................................... 26,329 616 2.34 26,465 650 2.46 Certificates of deposit................... 165,207 9,236 5.59 161,888 9,070 5.60 Borrowed funds............................ 35,275 2,051 5.81 39,512 2,357 5.96 --------- --------- --------- --------- --------- --------- Total interest-bearing liabilities.......... 273,268 $ 13,319 4.87% 270,160 $ 13,402 4.96% --------- --------- --------- --------- Noninterest-bearing liabilities............. 9,896 8,394 --------- --------- Total liabilities....................... 283,164 278,554 Equity...................................... 50,239 49,357 --------- --------- Total liabilities and equity ........... $ 333,403 $ 327,911 ========= ========= Net interest income.......................... $ 10,905 $ 10,554 ========= ========= Net interest rate spread..................... 2.82% 2.78% ========= ========= Net interest margin.......................... 3.46% 3.41% ========= ========= Ratio of average interest-earning assets to average interest-bearing liabilities........ 115.31% 114.63% ========= =========
Provision for Loan Losses. The Company's provision for loan losses was $210,000 and $140,000 for years ended December 31, 1998 and December 31, 1997, respectively. The Company establishes provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level which is deemed to be appropriate based upon an assessment of prior loss experience, industry standards, past due loans, economic conditions, the volume and type of loans in the Company's portfolio, which includes a significant amount of multifamily loans, substantially all of which are purchased and are secured by properties located out of state, and other factors related to the collectibility of the Company's loan portfolio. The net charge offs were $28,000 for the year ended December 31, 1998 as compared to $124,000 for the year ended December 31, 1997. The resulting allowance for loan loss was $2.7 million at December 31, 1998 as compared to $2.5 million at December 31, 1997. The increase in the allowance is primarily due to the increase in total loans from $253.8 million at December 31, 1997 to $259.4 million at December 31, 1998. The allowance for loan losses as a percentage of total loans receivable increased to 1.03% at December 31, 1998 from 0.99% at December 31, 1997. The level of nonperforming loans has increased to $956,000 at December 31, 1998 from $317,000 at December 31, 1997. See "Asset Quality". Management believes that the allowance for loan losses is adequate. While management estimates loan losses using the best available information, such as independent appraisals for significant collateral properties, no assurance can be made that future adjustments to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding no problem loans, identification of additional problem loans, and other factors, both within and outside of management's control. -56- Noninterest income. Total noninterest income increased by $573,000, or 16.9%, to $4.0 million for the year ended December 31, 1998 from $3.4 million for the year ended December 31, 1997. The increase is due to increases in fees and service charges, abstract fees and other income, partially offset by a decrease in the gain on the sale of investments. Fees and service charges increased $139,000 due to increases in overdraft fees on NOW accounts, service charges on NOW and savings accounts and loan prepayment fees. Abstract fees increased $362,000 due to increased sales volume. Sales volume increased in part due to a general decline in market interest rates. Other income increased by $285,000, primarily due to an increase in loan origination and commitment fees from First Iowa Mortgage, an increase in insurance sales, the rental income from the Bank's investment in the Northridge Apartment Limited Partnership, offset in part by a decrease in annuity sales. Non interest income for the year ended December 31, 1998 also reflects gains on the sales of securities available for sale of $51,000, as compared to gains on the sale of such securities of $264,000 for the 1997 comparable period due to a substantial portion of the Holding Company's available for sale securities being sold in 1997. See "-Business Strategy-Increased Noninterest Income". Noninterest Expense. Total non-interest expense increased by $535,000 to $8.0 million for the year ended December 31, 1998 from $7.4 million for the year ended December 31, 1997. The increase is primarily due to an increase in the employee salaries and benefits, premises and equipment, data processing and SAIF deposit insurance premiums. The increase in salaries and benefits was primarily a result of the expenses associated with the ESOP, normal salary increases, an increase in the number of employees and one time costs associated with the acquisition of Valley Financial. The increase in premises and equipment was primarily a result of purchases of computer equipment for the Bank and one time costs associated with the acquisition of Valley Financial. The increase in data processing is due to normal annual increases and one time costs associated with the acquisition of Valley Financial. The increase in SAIF deposit insurance premiums were due to a corresponding increase in the deposits at the Bank. The Company's efficiency ratio for the year ended December 31, 1998 and 1997 were 53.64% and 53.36%, respectively. The Company's ratio of noninterest expense to average assets for the year ended December 31, 1998 and 1997 were 2.39% and 2.27%, respectively. Income Taxes. Income taxes increased by $96,000 to $2.4 million for the year ended December 31, 1998 as compared to $2.3 million for the year ended December 31, 1997. The increase was principally due to an increase in pre-tax earnings during the 1998 period as compared to the 1997 period, offset in part by an increase in the tax credits recognized from the Bank's investment in the Northridge Apartments Limited Partnership in 1998 as compared to 1997. Net Income. Net income totalled $4.2 million for the year ended December 31, 1998 compared to $4.0 million for the same period in 1997. Comparison of Results of Operations for the Years Ended December 31, 1997 and 1996 The actual statements of income for the years ended December 31, 1997 and 1996 were used for comparison purposes. Interest Income. Interest income increased by $1.1 million to $16.2 million for the year ended December 31, 1997 compared to $15.1 million for the year ended December 31, 1996. The increase in interest income was primarily due to a $16.1 million increase in average interest earning assets to $204.5 million for the year ended December 31, 1997, from $188.4 million for 1996. The increase in the average balances of interest earning assets primarily reflects increases in the average balances of first and second mortgage loans. These increases were primarily derived from originations of $25.0 million of first mortgage loans secured by one-to-four family residences, purchases and originations of first mortgage loans secured by multifamily residences located outside of the State of Iowa of $22.3 million and originations of $9.6 million of second mortgage loans, which originations and purchases were offset in part by payments, prepayments and sales of loans during the year ended December 31, 1997. The increase in average interest-earning assets reflects the Company's continued emphasis on residential lending. See "-Business Strategy." The average balance of securities held to maturity decreased $9.5 million, or 92.7%, and such securities were in part, replaced by lower yielding securities available for sale. The average yield on interest earning assets decreased to 7.93% for the year ended December -57- 31, 1997 from 8.01% for the year ended December 31, 1996, primarily due to a general decrease in market interest rates. Interest Expense. Interest expense increased by $971,000 to $7.9 million for the year ended December 31, 1997 compared to $6.9 million for the year ended December 31, 1996. The increase in interest expense was primarily due to a $17.6 million increase in the average balances of interest bearing liabilities to $156.1 million for the year ended December 31, 1997 compared to $138.5 million for comparable 1996 period. The increase in the average balances of interest bearing liabilities reflects an increase in the average balances of certificates of deposit and borrowed funds, consistent with the Company's strategy of controlled internal growth. The increase of $11.6 million, or 95.5%, of the average balance of borrowed funds from 1996 reflects the repayment of borrowed funds with the proceeds of the Conversion in 1996 and the increase of borrowed funds subsequent to the Conversion to fund asset growth. The average cost of interest bearing liabilities increased to 5.06% for the year ended December 31, 1997 from 5.00% for the year ended December 31, 1996, reflecting changes in the distribution of NOW and money market savings accounts and borrowing of funds with longer maturities and to a lesser extent increases in the average cost of NOW and money market savings accounts and borrowed funds. This was offset in part by a decline in the average cost of certificates of deposit, primarily reflecting maturities of certificates of deposit at a rate of higher than the current market rate. Net Interest Income. Net interest income before provision for loan losses increased by $144,000 to $8.3 million for the year ended December 31, 1997 from $8.2 million for the year ended December 31, 1996. The increase is primarily due to the increases in the average interest earning assets, and increases in the average interest bearing liabilities. This increase was offset in part by the decrease in the interest rate spread (i.e., the difference in the average yield on assets and average cost of liabilities) from 3.01% for the year ended December 31, 1996 to 2.87% for the year ended December 31, 1997. The decline in the spread reflects the general decline in the overall yields on interest-earning assets combined with the increase in the average balance of borrowed funds and certificates of deposit which have higher costs than other interest-bearing liabilities. Provision for Loan Losses. The Company's provision for loan losses was $240,000 for years ended December 31, 1997 and December 31, 1996. The Company establishes provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level which is deemed to be appropriate based upon an assessment of prior loss experience, industry standards, past due loans, economic conditions, the volume and type of loans in the Company's portfolio, which includes a significant amount of multifamily loans, substantially all of which are purchased and are secured by properties located out of state, and other factors related to the collectibility of the Company's loan portfolio. The net charge offs were $42,000 for the year ended December 31, 1997 as compared to $23,000 for the year ended December 31, 1996. The resulting allowance for loan loss was $2.2 million at December 31, 1997 as compared to $2.0 million at December 31, 1996. The increase in the allowance is primarily due to the increase in total loans from $168.9 million at December 31, 1996 to $194.6 million at December 31, 1997 as well as the increase in multifamily loans both on an aggregate basis and a percentage of the total loan portfolio. The allowance for loan losses as a percentage of total loans receivable decreased to 1.10% at December 31, 1997 from 1.16% at December 31, 1996. The level of nonperforming loans has decreased to $147,000 at December 31, 1997 from $184,000 at December 31, 1996. See "Asset Quality". Management believes that the allowance for loan losses is adequate. While management estimates loan losses using the best available information, such as independent appraisals for significant collateral properties, no assurance can be made that future adjustments to the allowance will not be necessary based on changes in economic and real estate market conditions, further information obtained regarding no problem loans, identification of additional problem loans, and other factors, both within and outside of management's control. Noninterest income. Total noninterest income increased by $644,000, or 34.0%, to $2.5 million for the year ended December 31, 1997 from $1.9 million for the year ended December 31, 1996. The increase is -58- due to increases in abstract fees, other income and gain on the sale of investments. Abstract fees increased $291,000 due to increased sales volume, which is in part attributable to the purchase of the assets of an abstract company in December, 1996. Other income increased by $41,000, primarily due to the rental income from the Bank's investment in the Northridge Apartment Limited Partnership, offset in part by decreases in annuity sales. Non interest income for the year ended December 31, 1997 also reflects gains on the sales of securities available for sale of $249,000, as compared to gains on the sale of such securities of $14,000 for the 1996 comparable period due to a substantial portion of the Holding Company's available for sale securities being sold in 1997. See "-Business Strategy-Increasing Noninterest Income". Noninterest Expense. Total non-interest expense decreased by $362,000 million to $4.6 million for the year ended December 31, 1997 from $4.9 million for the year ended December 31, 1996. The decrease is primarily due to the $817,000 one-time assessment to recapitalize the SAIF in 1996. Absent the one-time SAIF special assessment, the noninterest expense for the year ended December 31, 1997 increased $455,000 over the corresponding period in 1996. The increase in 1997 is primarily due to increases in salaries and employee benefits and other expenses, offset in part by decreases in SAIF deposit insurance premiums. The increase in salaries and benefits was primarily a result of the expenses associated with the ESOP, normal salary increases and increase in the number of employees at the Ames office and at First Iowa, offset in part by the costs incurred in 1996 related to the adoption of a retirement plan for the benefit of the former Chairman of the Board. The increase in other expenses is primarily due to higher expenditures for advertising, employee expenses, professional fees and expenses associated with the Bank's investment in the Northridge Apartments Limited Partnership. The decrease in SAIF deposit insurance, excluding the one-time assessment, was primarily due to the enactment of legislation which decrease assessment rates for institutions such as the Bank. See "SAIF Recapitalization." The Company's efficiency ratio, excluding the one-time SAIF assessment, for the year ended December 31, 1997 and 1996 were 42.21% and 40.99%, respectively. The Company's ratio of noninterest expense to average assets, excluding the one-time SAIF assessment, for the year ended December 31, 1997 and 1997 were 2.17% and 2.13%, respectively. Income Taxes. Income taxes increased by $365,000 to $2.1 million for the year ended December 31, 1997 as compared to $1.7 million for the year ended December 31, 1996. The increase was principally due to an increase in pre-tax earnings during the 1997 period as compared to the 1996 period, offset in part by the tax credits recognized from the Bank's investment in the Northridge Apartments Limited Partnership in 1997. Net Income. Net income totalled $3.9 million for the year ended December 31, 1997 compared to $3.1 million for the same period in 1996. Impact of Inflation and Changing Prices The consolidated financial statements of the Company and notes thereto, presented elsewhere herein, have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, nearly all the assets and liabilities are monetary. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Impact of New Accounting Standards In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 establishes accounting and reporting standards for derivatives instruments, including certain derivative instruments embedded in other contracts, and for hedging contracts. It requires that an entity recognize all derivatives as either assets or liabilities, and measures those instruments at fair value. It also sets forth the -59- proper accounting for hedging activities, which is determined by the intended use of the derivative and how that use is designated by the entity. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. Earlier application is permitted and should not be applied retroactively to financial statements of prior periods. Since the Company is not currently holding any derivative instruments (as defined) and is not engaged in hedging activities, the adoption of SFAS No. 133 is expected to have no effect on the Company's financial condition or results of operations. In October 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." (SFAS No. 134). SFAS No. 134 amends FASB Statement No. 65 and conforms the subsequent accounting for securities retained after the securitization of mortgage loans held for sale by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a nonmortgage banking enterprise. Therefore, after the securitization of a mortgage loan held for sale, any retained mortgage-backed securities shall by classified in accordance with the provisions of FASB Statement No. 115. The adoption of SFAS No. 134 is expected to have no effect on a company's financial condition or results of operations. Year 2000 Compliance The Year 2000 ("Y2K") issue is a serious operational problem that is widespread and complex, affecting all industries. The problem consists essentially of the risk that programming code in existing computer systems will fail to properly recognize the new millennium when it occurs in the Year 2000. Many computer programs and related hard-printed memory circuits were developed with six-digit date fields. These programs and memory circuits were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or at the Year 2000. Because banks rely heavily on their computer systems, the Federal Financial Institutions Examination council ("FFIEC") has placed significant emphasis on the problems surrounding the Year 2000 issues and has required financial institutions to document the assessment, testing and corrections made to ready their computer systems and programs for the Year 2000 date change. The FFIEC and the OTS have strict regulations, guidelines and milestones in place that each FDIC insured financial institution must follow in order to remain operational. The Company's board of directors has remained informed of the Company's position and progress in its Year 2000 project. In addition, noninformation technology systems, such as telephones, copiers and elevators, may also contain embedded technology which controls its operation and which may be effected by the Y2K problem. When the Year 2000 arrives, systems, including some of those with embedded chips, may not work properly because of the way they store date information. They may not be able to deal with the date 01/01/00, and may not be able to deal with operational 'cycles' such as 'do X every 100 days'. Thus, even noninformation technology systems may affect the normal operations of the Company upon arrival of the Year 2000. In order to address the Y2K issue and to minimize its potential adverse impact, management has begun a process to identify areas that will be affected by the Y2K Problem, assess its potential impact on the operations of the Company, monitor the progress of FIserv, Inc. of Milwaukee ("FIserv") and other third party software vendors in addressing the matter, test changes provided by these vendors, and develop contingency plans for all critical systems. An internal committee of the Company has been formed to address the potential risks that Y2K poses for the Company. The Company's Y2K committee has completed the awareness, inventory and assessment phases of Y2K. The testing of the Company's internal computer system and software should be completed by the first part of the second quarter of 1999. The Company's most critical exposure to Y2K system problems is with its data processing provider, FIserv. FIserv's Vision system has been reported as being Y2K ready as of February, 1999. During the first and early second quarter of 1999, the Company intends to complete the testing phase of Y2K. Management anticipates that the enhancements necessary to prepare its mission critical systems for Y2K will be completed during the second quarter of 1999. Although the effort to prepare for Y2K is intended to address all Y2K issues, the Company has developed a contingency plan to address potential Y2K issues that -60- arise from noncompliance. Contingency plans have been developed on a department-by-department basis in anticipation of the possibility of unplanned system difficulties or failure of third parties to successfully prepare for Y2K. It is expected that most of these plans will provide for some types of manual record keeping and reporting procedures. The testing phase on the Company's contingency plan will begin in the second quarter of 1999. The Company anticipates that it has and will incur internal staff costs, consulting costs, data processing costs, additional purchase of equipment and other expenses related to the enhancements necessary to prepare its systems for Y2K. The Company has replaced some equipment, software and incurred consulting fees at a cost of approximately $40,000. Management anticipates the additional costs associated with Year 2000 compliance will not exceed $100,000. Any personnel and consulting costs have been and will continue to be expensed as incurred. -61- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES See Item 7. Management Discussion and Analysis. "Discussion of Market Risk - Interest Rate Sensitivity Analysis." ITEM 8. FINANCIAL STATEMENTS NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS --------------------------------------------------------- INDEPENDENT AUDITOR'S REPORT.......................................63 --------------------------------------------------------- FINANCIAL STATEMENTS Consolidated statements of financial condition....................64 Consolidated statements of income.................................65 Consolidated statements of shareholders' equity...................66 Consolidated statements of cash flows.............................67 Notes to consolidated financial statements........................69 --------------------------------------------------------- -62- [LETTERHEAD OF MC GLADREY & PULLEN, LLP] Independent Auditor's Report To the Board of Directors North Central Bancshares, Inc. Fort Dodge, Iowa We have audited the accompanying consolidated statements of financial condition of North Central Bancshares, Inc., and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for the three years ended December 31, 1998, 1997 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require 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 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 North Central Bancshares, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the three years ended December 31, 1998, 1997 and 1996, in conformity with generally accepted accounting principles. /s/ MC GLADREY & PULLEN, LLP Des Moines, Iowa February 10, 1999 NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 1998 and 1997
ASSETS 1998 1997 - ------------------------------------------------------------------------------------------------------------------- CASH: Interest-bearing $ 13,201,437 $ 2,462,809 Noninterest-bearing 2,435,439 982,354 Securities available-for-sale (Notes 3 and 9) 49,882,544 19,815,913 Loans receivable, net (Notes 4, 5, 9 and 15) 254,032,497 191,248,830 Loans held for sale 1,681,017 Accrued interest receivable (Note 6) 1,933,237 1,300,495 Foreclosed real estate 186,931 67,107 Premises and equipment, net (Note 7) 3,616,438 2,143,016 Rental real estate 1,945,851 2,059,148 Title plant 925,256 925,256 Goodwill 6,387,671 195,628 Deferred taxes (Note 10) 13,490 105,139 Prepaid expenses and other assets 448,331 647,913 -------------------------------------- Total assets $ 336,690,139 $ 221,953,608 ====================================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits (Note 8) $ 246,690,313 $ 141,123,707 Borrowed funds (Note 9) 38,832,239 28,550,000 Advances from borrowers for taxes and insurance (Note 5) 1,066,025 918,369 Dividend payable 237,133 204,155 Income taxes payable 199,224 194,325 Accrued expenses and other liabilities 1,458,391 545,976 -------------------------------------- Total liabilities 288,483,325 171,536,532 -------------------------------------- COMMITMENTS AND CONTINGENCIES (Notes 14 and 17) STOCKHOLDERS' EQUITY (Notes 12 and 18) Common stock, $.01 par value, authorized 15,500,000 shares; issued and outstanding 1998 and 1997 4,011,057 shares 40,111 40,111 Preferred stock, $.01 par value, authorized 3,000,000 shares; issued and outstanding 1998 and 1997 none Additional paid-in capital 38,135,817 37,949,598 Retained earnings, substantially restricted (Note 10) 27,084,907 23,660,964 Unearned shares, employee stock ownership plan (Note 11) (1,013,284) (1,210,441) Accumulated other comprehensive income 358,666 354,781 Less cost of treasury stock, 1998 1,046,608 shares; 1997 744,574 shares (16,399,403) (10,377,937) -------------------------------------- Total stockholders' equity 48,206,814 50,417,076 -------------------------------------- Total liabilities and stockholders' equity $ 336,690,139 $ 221,953,608 ======================================
See Notes to Consolidated financial Statements. -64- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Interest income: Loans receivable: First mortgage loans $ 17,317,988 $ 12,432,797 $ 11,173,567 Consumer loans 3,013,947 2,200,965 2,007,185 Securities and cash deposits 3,269,617 1,570,932 1,909,267 -------------------------------------------------- 23,601,552 16,204,694 15,090,019 -------------------------------------------------- Interest expense: Deposits (Note 8) 10,893,081 6,493,931 6,217,234 Other borrowed funds 1,975,879 1,405,679 711,418 -------------------------------------------------- 12,868,960 7,899,610 6,928,652 -------------------------------------------------- Net interest income 10,732,592 8,305,084 8,161,367 Provision for loan losses (Note 4) 210,000 240,000 240,000 -------------------------------------------------- Net interest income after provision for loan losses 10,522,592 8,065,084 7,921,367 -------------------------------------------------- Noninterest income: Fees and service charges 1,243,248 656,695 579,999 Abstract fees 1,583,773 1,221,807 931,031 Mortgage banking fees 339,397 Gain on sale of securities available-for-sale, net 51,362 248,526 13,774 Other income 696,919 409,968 368,691 -------------------------------------------------- Total noninterest income 3,914,699 2,536,996 1,893,495 -------------------------------------------------- Noninterest expense: Salaries and employee benefits (Note 11) 3,482,210 2,208,807 2,003,701 Premises and equipment 811,725 444,231 420,633 Data processing 553,288 258,250 243,762 SAIF special assessment 817,275 SAIF deposit insurance premiums 142,932 84,742 278,563 Goodwill amortization 435,817 27,947 28,973 Other expenses (Note 13) 2,145,854 1,552,675 1,145,477 -------------------------------------------------- Total noninterest expense 7,571,826 4,576,652 4,938,384 -------------------------------------------------- Income before income taxes 6,865,465 6,025,428 4,876,478 Provision for income taxes (Note 10) 2,480,620 2,108,304 1,743,557 -------------------------------------------------- Net income $ 4,384,845 $ 3,917,124 $ 3,132,921 ================================================== Basic earnings per common share (Note 19) $ 1.44 $ 1.23 $ 0.82 Earnings per common share - assuming dilution (Note 19) 1.40 1.21 0.82 Dividends declared per common share (Note 12) 0.32 0.25 0.28
See Notes to Consolidated Financial Statements. -65- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EQUITY Years Ended December 31, 1998 and 1997
Employee Additional Stock Comprehensive Common Paid-In Retained Ownership Income Stock Capital Earnings Plan - --------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 Comprehensive income: Net income $3,132,921 $37,000 $12,350,840 $18,220,626 $ (768,790) Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 12,445 - - 3,132,921 - ---------- Total comprehensive income $3,145,366 - - - - ========== Reorganization and conversion to stock form and proceeds from issuance of common stock 3,111 26,249,048 - - in connection therewith Purchase of treasury stock - - - - Dividends on common stock - - (821,943) - Expenses incurred relating to conversion to stock form - (844,469) - - Unearned ESOP shares - - - (840,000) Effect of contribution to employees stock ownership plan - 41,192 - 191,835 ------------------------------------------------ Balance, December 31, 1997 40,111 37,796,611 20,531,604 (1,416,955) Comprehensive income: Net income $3,917,124 - - 3,917,124 - Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 281,684 - - - - ---------- Total comprehensive income $4,198,808 ========== Purchase of treasury stock - - - - Dividends on common stock - - (787,764) - Effect of contribution to employees stock ownership plan - 147,968 - (206,514) Effect of stock options exercised - 5,019 - - ------------------------------------------------ Balance, December 31, 1996 40,111 37,949,598 23,660,964 (1,210,441) Comprehensive income: Net income $4,384,845 - - 4,384,845 - Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 3,885 - - - - ---------- Total comprehensive income $4,388,730 ========== Purchase of treasury stock - - - - Dividends on common stock - - (960,902) - Effect of contribution to employees stock ownership plan - 206,636 - 191,157 Effect of stock options exercise - (20,417) - - ------------------------------------------------ Balance, December 31, 1998 $40,111 $38,135,817 $27,084,907 $(1,013,284) ================================================
Accumulated Other Total Comprehensive Treasury Stockholders' Income Stock Equity - --------------------------------------------------------------------------------------- Balance, December 31, 1995 Comprehensive income: Net income $ 60,652 $ - $29,900,328 Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) - - 3,132,921 Total comprehensive income 12,445 - 12,445 Reorganization and conversion to stock form and proceeds from issuance of common stock - - 26,252,159 in connection therewith Purchase of treasury stock - (7,789,661) (7,789,661) Dividends on common stock - - (821,943) Expenses incurred relating to conversion to stock form - - (844,469) Unearned ESOP shares - - (840,000) Effect of contribution to employees stock ownership plan - - 233,027 --------------------------------------- Balance, December 31, 1996 73,097 (7,789,661) 49,234,807 Comprehensive income: Net income - - 3,917,124 Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 281,684 - 281,684 Total comprehensive income Purchase of treasury stock - (2,706,750) (2,706,750) Dividends on common stock - - (787,764) Effect of contribution to employees stock ownership plan - - 354,482 Effect of stock options exercise - 118,474 123,493 --------------------------------------- Balance, December 31, 1997 354,781 (10,377,937) 50,417,076 Comprehensive income: Net income - - 4,384,845 Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 3,885 - 3,885 Total comprehensive income Purchase of treasury stock - (6,164,419) (6,164,419) Dividends on common stock - - (960,902) Effect of contribution to employees stock ownership plan - - 403,793 Effect of stock options exercised - 142,953 122,536 --------------------------------------- Balance, December 31, 1998 $358,666 $(16,399,403) $48,206,814 =======================================
See Notes to Consolidated Financial Statements. -66- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 4,384,845 $ 3,917,124 $ 3,132,921 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 210,000 240,000 240,000 Depreciation 488,989 298,927 202,911 Amortization and accretion 539,878 74,219 (163,796) Deferred taxes (164,846) (80,591) (143,069) Effect of contribution to employee stock ownership plan 403,793 354,482 185,027 (Gain) on sale of foreclosed real estate and loans, net (4,726) (7,499) (16,924) (Gain) on sale of securities available-for-sale (51,362) (248,526) (13,774) Loss on disposal of equipment 9,191 3,321 19,781 Net (increase) in loans held for sale (1,681,017) Change in assets and liabilities: Decrease in accrued interest receivable 386,631 27,238 87,378 Decrease in income taxes receivable 31,766 (Increase) decrease in prepaid expenses and other assets 453,985 (301,190) (1,449,942) Increase in income taxes payable 25,036 29,211 182,826 Increase (decrease) in accrued expenses and other liabilities (41,121) 3,950 34,345 -------------------------------------------------------- Net cash provided by operating activities 4,959,276 4,310,666 2,329,450 -------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in loans 20,168,334 (3,298,056) (10,546,067) Purchase of loans (24,644,011) (22,363,597) (7,499,489) Proceeds from sale of securities available-for-sale 4,445,868 3,204,196 53,891 Purchase of securities available-for-sale (18,371,558) (2,777,723) (15,314,175) Proceeds from maturities of securities available-for-sale 25,460,742 3,500,000 Proceeds from maturities of securities held-to-maturity 3,500,000 12,500,000 Purchase of premises, equipment and rental real estate (776,473) (981,010) (381,450) Proceeds from sale of equipment 58 31,325 100 Purchase of title plant (110,947) Proceeds from sale of title plant 45,000 Cash paid in connection with acquisition of Valley Financial Corporation net of cash received (8,568,743) Other 69,974 62,925 16,442 -------------------------------------------------------- Net cash (used in) investing activities (2,215,809) (19,076,940) (21,281,695) -------------------------------------------------------- (Continued)
-67- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits $ 6,297,514 $ 11,401,663 $ 3,049,731 Net increase (decrease) in advances from borrowers for taxes and insurance (154,127) 72,881 63,943 Net change in short-term borrowings (3,000,000) (7,965,000) Proceeds from other borrowed funds 16,542,000 21,250,000 9,300,000 Payments of other borrowed funds (6,259,761) (12,035,000) (892,000) Proceeds from conversion to stock form 25,412,159 Payments for expenses incurred relating to conversion to stock form (642,326) Purchase of treasury stock (6,164,419) (2,706,750) (7,789,661) Proceeds from issuance of treasury stock 114,963 105,781 Dividends paid (927,924) (813,953) (719,428) -------------------------------------------------------- Net cash provided by financing activities 9,448,246 14,274,622 19,817,418 -------------------------------------------------------- Net increase (decrease) in cash 12,191,713 (14,766,274) (18,952,245) CASH Beginning 3,445,163 3,936,815 3,071,642 -------------------------------------------------------- Ending $ 15,636,876 $ (10,829,459) $ (15,880,603) ======================================================== SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION Cash payments for: Interest paid to depositors $ 10,989,646 $ 6,479,044 $ 6,236,351 Interest paid on borrowings 1,975,691 1,477,850 684,894 Income taxes 2,628,003 2,180,268 1,656,411
See Notes to Consolidated Financial Statements. -68- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 1. Significant Accounting Policies Organization, nature of business and basis of presentation: North Central Bancshares, Inc., (the Company), an Iowa corporation, is a unitary savings and loan holding company that owns 100% of the outstanding stock of First Federal Savings Bank of Iowa (the Bank), which is a federally chartered stock savings bank that conducts its operations from its main office located in Fort Dodge, Iowa, and six branch offices located in Fort Dodge, Nevada, Ames, Burlington and Mt. Pleasant, Iowa. The Company was created as part of a reorganization and conversion effected by the Bank and North Central Bancshares, M.H.C. (the MHC) which became effective on March 20, 1996. See Note 17 for a more complete description of the reorganization and conversion. Prior to March 20, 1996, the MHC owned approximately 65% of the Bank with the remaining 35% owned by members of the general public (including directors and officers of the Bank). The MHC became effective on August 31, 1994, when First Federal Savings Bank of Iowa (the mutual savings bank) converted to a federal mutual holding company and concurrently formed a new federally chartered stock savings bank subsidiary (the Bank). See Note 16 for a more complete description. The financial statements presented for the Company include, since March 20, 1996, the consolidated statements of the Company and the Bank and, for periods prior to the March 20, 1996 conversion, the consolidated statements of the MHC and the Bank as if the MHC owned 100% of the Bank. These financial statements were prepared as if the pooling-of-interests method of accounting were applied to the conversions. Effective January 1, 1998, the Bank adopted FASB Statement No. 130, which was issued in June 1997. Statement No. 130 establishes new rules for the reporting and display of comprehensive income and its components, but has no effect on the Bank's net income or total stockholders' equity. Statement No. 130 requires unrealized gains and losses on the Bank's available-for-sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement No. 130. Principles of consolidation: The consolidated financial statements, as described above, include the accounts of the Company and its wholly-owned subsidiary, the Bank and the Bank's wholly-owned subsidiaries, First Financial Service Corporation (which sells insurance and annuity products and originates equipment leases), First Iowa Title Services, Inc. (which provides real estate abstracting services), Northridge Apartments Limited Partnership (which owns a multifamily apartment building) and First Iowa Mortgage, Inc. (which originates and sells mortgage loans in the secondary market). All significant intercompany balances and transactions have been eliminated in consolidation. Accounting estimates and assumptions: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. -69- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Securities available-for-sale: Securities classified as available-for-sale are those debt and equity securities the Company intends to hold for an indefinite period of time, but not necessarily to maturity. 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 reported at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of the related deferred tax effect. The amortization of premiums and accretion of discounts is computed by the interest method over their contractual lives. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Loans held for sale: Loans held for sale are those loans held with the intent to sell in the foreseeable future. They are carried at the lower of aggregate cost or market value. Sales are made without recourse and any gain or loss is recognized at the settlement date. Loans receivable: Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, net deferred loan origination fees and unearned discounts. Discounts on first mortgage loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. The allowance for loan losses is increased by provisions charged to income and reduced by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and current economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. Uncollectible interest on loans that are contractually past due is charged-off or an allowance is established based on management's periodic evaluation, generally when loans become 90 days past due. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is no longer in doubt, in which case the loan is returned to accrual status. Loan origination fees and related costs: 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 estimated prepayments based on the Bank's historical prepayment experience. -70- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Foreclosed real estate: Real estate properties acquired through loan foreclosure are initially recorded at the lower of cost or fair value less selling costs at the date of foreclosure. Costs relating to development and improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management, and an allowance for losses is established by a charge to income if the carrying value of a property exceeds its market value less estimated selling costs. Premises and equipment: Premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed primarily by straight-line and double-declining balance methods over the estimated useful lives of the assets. Rental real estate: Rental real estate is comprised of a low-income housing, multifamily apartment building and equipment which is stated at cost, net of accumulated depreciation. Depreciation is computed primarily by the straight-line and double-declining balance methods over the estimated useful lives of the assets. Title plant: Title plant is carried at cost and, in accordance with FASB Statement No. 61, is not depreciated. Costs incurred to maintain and update the title plant are expensed as incurred. Goodwill: Goodwill is stated at cost, net of accumulated amortization and is being amortized over 10 - 15 years using the straight-line method. Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the difference between the reported amounts of assets and liabilities and their income tax bases. Income taxes are allocated to the Company and its subsidiaries based on each entity's income tax liability as if it filed a separate return. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all of the deferred tax assets, will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Earnings per share: Basic earnings per share and earnings per common share - assuming dilution were computed using the methodology prescribed by FASB Statement No. 128 Earnings per Share. The basic earnings per common share amounts were computed using the weighted average number of shares outstanding during the periods presented. The earnings per common share amounts - assuming dilution were computed using the weighted average number of shares outstanding during the periods presented, adjusted for the effect of dilutive potential common shares outstanding which consists of stock options granted. In accordance with Statement of Position 93-6, shares owned by the ESOP that have not been committed to be released are not considered to be outstanding for the purpose of computing earnings per share. -71- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Stock-option plan: SFAS No. 123, Accounting for Stock-Based Compensation, establishes a fair value based method for financial accounting and reporting for stock-based employee compensation plans and for transactions in which an entity issues its equity instruments to acquire goods and services from nonemployees. However, the standard allows compensation to continue to be measured by using the intrinsic value based method of accounting prescribed by APB No. 25, Accounting for Stock Issued to Employees, but requires expanded disclosures. The Company has elected to apply the intrinsic value based method of accounting for stock options issued to employees. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. Fair value of financial instruments: FASB Statement No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheets, for which it is practicable to estimate that value. 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. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: Cash: The carrying amount of cash represents the fair value. Securities: Fair values for all securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans: For variable-rate loans that reprice frequently and have experienced no significant change in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. Deposits: Fair values disclosed for demand, NOW, savings and money market savings deposits equal their carrying amounts, which represent the amount payable on demand. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected monthly maturities on time deposits. -72- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Borrowed funds: The fair value of borrowed funds is estimated based on discounted cash flows using currently available borrowing rates. Accrued interest receivable and payable: The fair values of both accrued interest receivable and payable are their carrying amounts. Commitments to extend credit: The fair values of commitments to extend credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and creditworthiness of the counterparties. At December 31, 1998 and 1997, the carrying amount and fair value of the commitments were not significant. Note 1. Business Combination As the close of business on January 30, 1998, the Bank completed the acquisition of Valley Financial Corp. ("Valley Financial") pursuant to an Agreement and Plan of Merger, dated as of September 19, 1997. The acquisition resulted in the merger of Valley Financial's wholly-owned subsidiary, Valley Savings Bank, FSB ("Valley Savings") with and into the Bank, with the Bank as the resulting financial institution. Valley Savings, headquartered in Burlington, Iowa, was a federally-charted stock savings bank with three branch offices located in southeastern Iowa. The former offices of Valley Savings are being operated as branches of the Bank. In connection with the acquisition, each share of Valley Financial's common stock, par value $1.00 per share, issued and outstanding (other than shares held as treasury stock of Valley Financial) was canceled and converted automatically into the right to receive $525 per share in cash pursuant to the terms and conditions of the Merger Agreement. As a result of the acquisition, shareholders of Valley Financial were paid a total of $14,726,250 in cash. The excess of the total acquisition cost over the fair value of the net assets acquired of $6,627,859 is being amortized over 15 years by the straight-line method. The acquisition was accounted for as a purchase transaction and therefore, the operating results of the former offices of Valley Savings Bank are included in the 1998 operating results of the Company only from the date of acquisition through December 31, 1998. -73- The following is a summary of the assets acquired and liabilities assumed in connection with the acquisition of Valley Financial Corporation: Cash $ 6,157,507 Securities 41,818,057 Loans 58,567,364 Accrued interest receivable 1,019,373 Premises and equipment 1,081,890 Goodwill 6,627,859 Prepaid expenses and other assets 228,785 Deposits (99,269,092) Advances from borrowers for taxes and insurance (301,783) Deferred income taxes (262,738) Accrued taxes payable 12,565 Accrued expenses and other liabilities (953,537) ------------- Cash paid 14,726,250 Less: cash received (6,157,507) ------------- Cash paid, net of cash received $ 8,568,743 ============= Unaudited pro forma consolidated results of operations for the years ended December 31, 1998 and 1997, as though Valley Savings Bank had been acquired as of January 1, 1997, follow: 1998 1997 ------------------------- Net interest income $ 10,904,821 $ 10,553,958 Net income 4,245,473 4,022,376 Basic earnings per common share 1.39 1.26 Earnings per common share - assuming dilution 1.36 1.24 -74- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 3. Securities Securities available-for-sale as of December 31, 1998, were as follows:
Gross Gross Amortized Cost Unrealized Unrealized Gains (Losses) Fair Value -------------------------------------------------------- Equity securities: Federal Home Loan Bank stock $ 2,379,400 $ $ $ 2,379,400 FHLMC preferred stock 975,000 20,748 995,748 FNMA preferred stock 5,134,375 268,661 5,403,036 Other 861,509 92,573 (29,376) 924,706 -------------------------------------------------------- 9,350,284 381,982 (29,376) 9,702,890 -------------------------------------------------------- Debt securities: U.S. Treasury notes 9,325,175 84,919 9,410,094 U.S. Government agencies 18,859,431 48,583 (23,939) 18,884,075 State and political subdivisions 4,282,940 95,195 (182) 4,377,953 Mortgage-backed securities 7,493,887 27,042 (13,397) 7,507,532 -------------------------------------------------------- 39,961,433 255,739 (37,518) 40,179,654 -------------------------------------------------------- $ 49,311,717 $ 637,721 $ (66,894) $ 49,882,544 ========================================================
-75- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Securities available-for-sale as of December 31, 1997, were as follows:
Gross Gross Amortized Cost Unrealized Unrealized Gains (Losses) Fair Value ------------------------------------------------------- Equity securities: Federal Home Loan Bank stock $ 1,549,700 $ - $ - $ 1,549,700 FHLMC preferred stock 1,005,810 - (3,978) 1,001,832 FNMA preferred stock 5,134,375 265,445 - 5,399,820 Other 557,078 261,858 - 818,936 Debt securities U.S. Treasury notes 10,995,766 50,994 (1,135) 11,045,625 ------------------------------------------------------- $ 19,242,729 $ 578,297 $ (5,113) $ 19,815,913 =======================================================
The amortized cost and fair value of debt securities as of December 31, 1998, by contractual maturity are shown below. Certain securities have call features which allow the issuer to call the security prior to maturity. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary: Securities Available-for-Sale ---------------------------------- Amortized Cost Fair Value ---------------------------------- Due in one year or less $ 5,011,439 $ 5,045,059 Due from one to five years 15,146,447 15,132,285 Due from five to ten years 10,747,060 10,851,721 Due after ten years 1,562,600 1,642,057 Mortgage-backed securities 7,493,887 7,508,532 ---------------------------------- $ 39,961,433 $ 40,179,654 ================================== Gross gains of $71,923, $248,526 and $13,774 were realized on the sale of available-for-sale securities in 1998, 1997 and 1996, respectively. Gross losses of $20,561, none and none were realized on the sale of available-for-sale securities in 1998, 1997 and 1996, respectively. At December 31, 1998, the Bank has pledged securities available-for-sale with a carrying amount of approximately $9,585,000 as collateral for certain deposits. -76- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- The components of other comprehensive income - unrealized gains on securities for the years ended December 31, 1998, 1997 and 1996, were as follows:
1998 1997 1996 ------------------------------------- Unrealized holding gains arising during the period $ 57,558 $ 697,783 $ 33,622 Less reclassification adjustment for net gains realized in net income 51,362 248,526 13,774 ------------------------------------- Net unrealized gains before tax (expense) 6,196 449,257 19,848 Tax (expense) (2,311) (167,573) (7,403) ------------------------------------- Other comprehensive income - net unrealized gains on securities $ 3,885 $ 281,684 $ 12,445 =====================================
Note 4. Loans Receivable Loans receivable at December 31, 1998 and 1997, are summarized as follows:
1998 1997 ------------------------------------- First mortgage loans (principally conventional) Principal balances: Secured by one-to-four family residences $ 144,777,159 $ 114,692,784 Secured by: Multifamily properties 64,895,056 51,345,391 Commercial properties 11,396,311 3,799,728 Construction loans 4,213,903 1,070,100 ------------------------------------- Total first mortgage loans 225,282,429 170,908,003 ------------------------------------- Consumer loans Principal balances: Automobile 7,348,369 4,696,339 Second mortgage 20,784,380 16,225,834 Other 5,946,051 2,794,877 ------------------------------------- Total consumer loans 34,078,800 23,717,050 ------------------------------------- Total loans 259,361,229 194,625,053 Less: Undisbursed portion of construction loans (2,023,859) (453,434) Unearned discounts (312,381) (423,640) Net deferred loan origination fees (316,054) (348,562) Allowance for loan losses (2,676,438) (2,150,587) ------------------------------------- $ 254,032,497 $ 191,248,830 =====================================
-77- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Activity in the allowance for loan losses is summarized as follows for the years ended December 31:
1998 1997 1996 ---------------------------------------------------- Balance, beginning $ 2,150,587 $ 1,952,887 $ 1,735,599 Provision charged to income 210,000 240,000 240,000 Effect of acquisition of Valley Financial Corporation 343,418 Loans charged-off (28,422) (52,724) (24,297) Recoveries 855 10,424 1,585 ---------------------------------------------------- Balance, ending $ 2,676,438 $ 2,150,587 $ 1,952,887 ====================================================
Nonaccrual loans totaled approximately $955,835 and $147,000, at December 31, 1998 and 1997, respectively. The amount of interest related to nonaccrual loans for 1998 and 1997, is insignificant. The Bank has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, executive officers and their immediate families (commonly referred to as related parties), all of which have been, in the opinion of management, on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Activity in loans receivable from certain executive officers and directors of the Bank consisted of the following:
Balance, December 31, 1995 $ 1,083,291 New loans 293,450 Repayments (173,128) ------------- Balance, December 31, 1996 1,203,613 New loans 221,983 Repayments (380,408) ------------- Balance, December 31, 1997 1,045,188 New loans 166,701 Repayments (135,925) ------------- Balance, December 31, 1998 $ 1,075,964 =============
Note 5. Loan Servicing Mortgage loans serviced for FHLMC and other banks are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of these loans at December 31, 1998 and 1997, are $7,742,415 and $2,963,396, respectively. Custodial escrow balances maintained in connection with the foregoing loan servicing were approximately $53,000 and $27,000, at December 31, 1998 and 1997, respectively. -78- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 6. Accrued Interest Receivable Accrued interest receivable at December 31, is summarized as follows:
1998 1997 -------------------------------------- Securities $ 515,681 $ 127,653 Loans receivable 1,449,004 1,177,763 -------------------------------------- 1,964,685 1,305,416 Less allowance for uncollectible interest 31,448 4,921 -------------------------------------- $ 1,933,237 $ 1,300,495 ======================================
Note 7. Premises and Equipment Premises and equipment consisted of the following at December 31:
1998 1997 ------------------------------------- Land $ 501,680 $ 255,744 Buildings and improvements 3,765,208 2,784,872 Leasehold improvements 15,546 15,546 Furniture, fixtures and equipment 1,639,447 1,218,608 Vehicles 65,956 48,723 ------------------------------------- 5,987,837 4,323,493 Less accumulated depreciation 2,371,399 2,180,477 ------------------------------------- $ 3,616,438 $ 2,143,016 =====================================
-79- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 8. Deposits Deposits at December 31, were as follows:
Weighted- Weighted- Average Average Rate at 1998 Rate at 1997 December 31, -------------------------- December 31, ----------------------------- Nature of Deposit 1998 Amount Percentage 1997 Amount Percentage - ------------------------------------------------------------------------------------------------------------------ Demand and NOW accounts: Noninterest bearing - % $ 5,458,374 2.2% - % $ 3,144,412 2.2% Interest-bearing 1.50 30,909,378 12.5 2.00 14,456,894 10.2 Savings accounts 2.25 26,098,591 10.6 2.25 17,119,633 12.1 Money market savings 3.90 19,828,064 8.0 4.35 8,958,483 6.4 -------------------------- ----------------------------- 82,294,407 33.3 43,679,422 30.9 -------------------------- ----------------------------- Certificates of deposit: Less than 4.0% 3.41 231,825 0.1 3.32 90,438 0.1 4.0% - 4.9% 4.68 15,922,939 6.5 4.68 5,403,762 3.8 5.0% - 5.9% 5.52 94,229,132 38.2 5.60 40,345,775 28.6 6.0% - 6.9% 6.22 46,652,259 18.9 6.23 44,707,179 31.7 7.0% - 7.9% 7.08 7,176,955 2.9 7.06 6,877,794 4.9 More than 8.0% 8.45 182,796 0.1 8.23 19,337 -------------------------- ----------------------------- 164,395,906 66.7 97,444,285 69.1 -------------------------- ----------------------------- 4.54% $ 246,690,313 100.0% 4.85% $ 141,123,707 100.0% ========================== =============================
At December 31, 1998, scheduled maturities of certificates of deposit were as follows:
One year One to Two to Three to Four to or less two years three years four years five years Thereafter --------------------------------------------------------------------------------------------- Less than 4.0% $ 231,825 $ $ $ $ $ 4.0 - 4.9% 12,716,765 2,788,183 376,748 19,656 21,587 5.0 - 5.9% 44,603,934 34,430,398 6,085,100 277,105 8,826,996 5,599 6.0 - 6.9% 22,164,122 9,820,493 5,899,267 7,036,826 1,725,947 5,604 7.0 - 7.9% 1,407,639 5,511,424 47,964 6,716 11,431 191,781 More than 8.0% 173,224 9,572 --------------------------------------------------------------------------------------------- $ 81,297,509 $ 52,550,498 $ 12,409,079 $ 7,349,875 $ 10,585,961 $ 202,984 =============================================================================================
-80- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Interest expense on deposits consisted of the following:
Years ended December 31, -------------------------------------------------------- 1998 1997 1996 -------------------------------------------------------- NOW accounts $ 554,031 $ 253,210 $ 223,567 Savings 594,276 392,064 431,724 Money market savings 797,372 378,981 306,005 Certificates of deposit 8,947,402 5,469,676 5,255,938 -------------------------------------------------------- $ 10,893,081 $ 6,493,931 $ 6,217,234 ========================================================
The aggregate amount of certificates of deposit of $100,000 or more was $9,899,375 and $5,782,000 as of December 31, 1998 and 1997, respectively. Note 9. Borrowed Funds Borrowed funds at December 31, 1998, included miscellaneous borrowings of $37,759 and borrowings from Federal Home Loan Bank of Des Moines (FHLB) as follows:
Weighted- Stated Average Maturity Interest Rate Amount Features ----------------------------------------------------------------------------------------- 1999 6.14% $ 3,000,000 2000 5.97 9,000,000 $4,000,000 callable February 1999 2001 6.02 4,300,000 2002 6.06 6,000,000 2003 5.13 1,000,000 2008 5.16 13,000,000 All callable, various dates 1999-2003 2013 5.25 2,494,480 15-year amortizing, repayable 2003 -------------------------------- 5.62% $ 38,794,480 ================================
The Bank has an open line of credit at the FHLB which matures on February 28, 1999. There were no advances on this line of credit at December 31, 1998. The term borrowings and open line of credit are collateralized by the FHLB stock and sufficient real estate loans to at least equal 150% of the total borrowings outstanding. -81- Note 10. Income Taxes and Retained Earnings Through 1995, the provisions of the IRS and similar sections of Iowa Law Code permitted the Bank to deduct from taxable income an allowance for bad debts based on 8% of taxable income before such deduction or actual loss experience. The Bank used the percentage of taxable income method to compute its deductions in 1995. Legislation passed in 1996 eliminated the percentage of taxable income method as an option for computing bad debt deductions for 1996, and in all future years. The Bank will still be permitted to take deductions for bad debts, but will be required to compute such deductions using an experience method. The Bank is recapturing its tax bad debt reserves which have accumulated since 1987, amounting to approximately $1,659,000. The tax associated with the recaptured reserves is approximately $615,000 and is being paid in years beginning in 1996, and ending in 2003. Deferred income taxes have been established for the taxes associated with the recaptured reserves. Deferred taxes have been provided for the difference between tax bad debt reserves and the loan loss allowances recorded in the financial statements subsequent to December 31, 1987. However, at December 31, 1998, retained earnings contain certain historical additions to bad debt reserves for income tax purposes of approximately $2,445,000 as of December 31, 1987, for which no deferred taxes have been provided because the Bank does not intend to use these reserves for purposes other than to absorb losses. If these amounts which qualified as bad debt deductions are used for purposes other than to absorb bad debt losses or adjustments arising from the carryback of net operating losses, income taxes may be imposed at the then existing rates. The approximate amount of unrecognized tax liability associated with these historical additions is $929,000. Income tax expense is summarized as follows:
Years ended December 31, ------------------------------------------- 1998 1997 1996 ------------------------------------------- Current $ 2,645,466 $ 2,188,895 $ 1,886,626 Deferred (164,846) (80,591) (143,069) ------------------------------------------- $ 2,480,620 $ 2,108,304 1,743,557 ===========================================
-82- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Deferred tax assets and liabilities consisted of the following components as of December 31, 1998 and 1997:
1998 1997 ------------------------------- Deferred tax assets: Unearned shares, employee stock ownership plan $ 30,000 $ 24,000 Allowance for loan losses 526,000 270,000 Deferred directors fees and compensation 57,000 62,000 Deposit acquired 23,000 Other 96,044 28,591 ------------------------------- Total gross deferred tax assets 732,044 384,591 ------------------------------- Deferred tax liabilities: Federal Home Loan Bank stock dividend 41,000 9,000 Unrealized gain on securities available-for-sale 214,000 218,452 Premises and equipment 76,000 10,000 Title plant 67,000 42,000 Loans acquired 188,000 Investments acquired 111,000 Other 21,554 ------------------------------- Total gross deferred tax liabilities 718,554 279,452 ------------------------------- Net deferred tax assets $ 13,490 $ 105,139 ===============================
Total income tax expense differed from the amounts computed by applying the U.S. Federal income tax rates of 34% to income before income taxes as a result of the following:
Years Ended December 31, -------------------------------------------------------------------------------------- 1998 1997 1996 -------------------------------------------------------------------------------------- Percent of Percent of Percent of Pretax Pretax Pretax Amount Income Amount Income Amount Income -------------------------------------------------------------------------------------- Income before income taxes $ 2,334,258 34.0% $ 2,048,646 34.0% $ 1,658,003 34.0% Nontaxable dividends (105,296) (1.5) (119,550) (2.0) (107,983) (2.2) State income taxes, net of federal income tax benefit 226,613 3.1 174,621 2.9 125,286 2.6 Low income housing tax credit (148,867) (2.1) (97,894) (1.6) Goodwill amortization 137,536 2.1 Other 36,376 0.5 102,481 1.7 68,251 1.4 -------------------------------------------------------------------------------------- $ 2,480,620 36.1% $ 2,108,304 35.0% $ 1,743,557 35.8% ======================================================================================
-83- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 11. Employee Benefit Plans Retirement plans: The Bank participates in a multiemployer defined benefit pension plan covering substantially all employees. This is a multiemployer plan and information as to actuarial valuations and net assets available for benefits by participating institutions is not available. There was no pension expense for the years ended December 31, 1998, 1997 and 1996. The Bank has a defined contribution plan covering substantially all employees. Contributions to the plan were approximately none, none and $19,000 for the years ended December 31, 1998, 1997 and 1996, respectively. As of July 31, 1996, the Bank no longer contributes to this plan. Employee Stock Ownership Plan (ESOP): In conjunction with the Bank's conversion to stock ownership, the Bank established an ESOP for eligible employees. All employees of the Bank as of January 1, 1994, were eligible to participate immediately and employees of the Bank hired after January 1, 1994, are eligible to participate after they attain age 21 and complete one year of service during which they work at least 1,000 hours. The ESOP borrowed funds in the amount of $960,000 to purchase 104,075 shares of common stock issued in the conversion in 1994 and $840,000 to purchase 84,000 shares of common stock issued in the reorganization and conversion in 1996. These funds are borrowed from the Company. The Bank makes contributions to the ESOP equal to the ESOP's debt service less dividends received by the ESOP. Dividends on unallocated ESOP shares are used to pay debt service. Contributions to the ESOP and shares released from the suspense account in an amount proportional to the repayment of the ESOP loan are allocated among ESOP participants on the basis of compensation in the year of allocation. Benefits generally become 100% vested after five years of credited service. Forfeitures will be reallocated among remaining participating employees, in the same proportion as contributions. Benefits may be payable in the form of stock or cash upon termination of employment. If the Bank's stock is not traded on an established market at the time of an ESOP participant's termination, the terminated ESOP participant has the right to require the Bank to purchase the stock at its current fair market value. Bank management believes there is an established market for the Bank's stock and therefore the Bank believes there is no potential repurchase obligation at December 31, 1998 and 1997. As shares are released, the Bank reports compensation expense equal to the current market price of the shares. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings. Dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest. ESOP compensation expense was $403,793, $354,482 and $233,027 for the years ended December 31, 1998, 1997 and 1996, respectively. -84- Shares of the Company's common stock held by the ESOP, at December 31, 1998 and 1997, are as follows:
1998 1997 ---------------------------- Allocated shares $ 80,254 $ 62,408 Unreleased (unearned) shares 105,098 125,667 ---------------------------- $ 185,352 $ 188,075 ============================ Fair market value of unreleased (unearned) shares $ 1,773,529 $ 2,497,632 ============================
Stock option plan: In 1996, the stockholders of the Company ratified the 1996 Incentive Option Plan (the Plan). The Plan provides for the grant of options at an exercise price equal to the fair market value on the date of grant. The Plan is intended to promote stock ownership by directors and selected officers and employees of the Company to increase their proprietary interest in the success of the Company and to encourage them to remain in the employment of the Company or its subsidiaries. Awards granted under the Plan may include incentive stock options, nonqualified stock options and limited rights which are exercisable only upon a change in control of the Bank or the Company. All awards to date are nonqualified stock options. The Plan authorizes the granting of stock options for a total of 401,105 shares of common stock or 10% of the shares issued in the 1996 conversion. All options are granted at an exercise price which was the market price of the common stock on the grant date. Options granted to officers and directors become exercisable in five equal annual installments commencing on the first anniversary of the grant date and continuing on each anniversary date thereafter. The options granted to officers expire ten years from the date of grant unless an earlier expiration date is triggered by death, disability, retirement or termination, as described in the Plan. A person who becomes a director after September 21, 1996, receives an annual grant of options to purchase 2,000 shares of common stock. Options granted to directors expire ten years from the date of grant, unless an earlier expiration date is triggered by removal for cause. -85- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- The table below reflects option activity for the period indicated:
Weighted- Average Exercise Number Price per Share of Shares ----------------------------------- Outstanding, December 31, 1995 - $ - Granted 237,000 12.38 Exercised ----------------------------------- Outstanding, December 31, 1996 237,000 12.38 Granted 3,500 15.44 Forfeited (1,000) 12.38 Exercised (8,500) 12.45 ----------------------------------- Outstanding, December 31, 1997 231,000 12.42 Granted 62,000 19.32 Forfeited Exercised (10,290) 12.38 ----------------------------------- Outstanding, December 31, 1998 282,710 $ 13.93 =================================== Options exercisable 80,810 $ 12.79 =================================== Remaining shares available for grant 98,605 ==================
As of December 31, 1998, the 282,710 options outstanding under the Plan have exercise prices between $12.375 and $20.00. The weighted average fair value per option of options granted during the years ended December 31, 1998, 1997 and 1996, were $5.96, $5.75 and $4.54, respectively. Had compensation cost for the Plan been determined based on the grant date fair values of awards (the method described in FASB Statement No. 123), the approximate 1998, 1997 and 1996, reported net income and earnings per common share would have been decreased to the pro forma amounts shown below:
1998 1997 1996 ---------------------------------------- Net income: As reported $ 4,384,845 $ 3,917,124 $ 3,132,921 Pro forma 4,202,056 3,780,710 3,098,600 Earnings per common share: As reported 1.44 1.23 0.82 Pro forma 1.38 1.19 0.81 Earnings per common share - assuming dilution: As reported 1.40 1.21 0.82 Pro forma 1.34 1.17 0.81
-86- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- The fair values of the grants are estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions: dividend rate of 1.30%, price volatility of 25%, risk-free interest rates of 5.49% to 6.62% and expected lives of eight years. Employment agreements: The Company and the Bank have entered into employment agreements with a key officer. Under the terms of the agreements, the officer is entitled to additional compensation in the event of certain conditions of involuntary termination. The agreements extend for up to 36 months. The Bank has entered into certain employment retention agreements with key officers. Under the terms of the agreements, the employees are entitled to additional compensation in the event of a change of control of the Bank or the Company and the employees are involuntarily terminated within the remaining unexpired employment period, up to 36 months. A change in control is generally triggered by the acquisition or control of 20% or more of the common stock. Note 12. Stockholders' Equity Regulatory capital requirements: The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible 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 table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), of Tier I capital (as defined) to average assets (as defined) and tangible capital to adjusted assets. Management believes, as of December 31, 1998, the Bank meets all capital adequacy requirements to which it is subject. -87- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- The Bank's actual capital amounts and ratios are also presented in the following table:
To Be Well Capitalized For Capital Under Prompt Corrective Actual Adequacy Purposes Action Provisions --------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio --------------------------------------------------------------------------------- (000's) (000's) (000's) As of December 31, 1998: Total Capital (to risk weighted assets) $ 40,509 23.8% $ 13,614 8.0% $ 17,018 10.0% Tier 1 Capital (to risk weighted assets) 38,245 22.5 6,807 4.0 10,211 6.0 Tier I (Core) Capital (to adjusted assets) 38,245 11.7 9,834 3.0 16,390 5.0 Tangible Capital (to adjusted assets) 38,245 11.7 4,917 1.5 As of December 31, 1997: Total Capital (to risk weighted assets) $ 39,478 32.1% $ 9,830 8.0% $ 12,288 10.0% Tier 1 Capital (to risk weighted assets) 37,935 30.9 4,915 4.0 7,373 6.0 Tier I (Core) Capital (to adjusted assets) 37,935 17.3 6,595 3.0 10,992 5.0 Tangible Capital (to adjusted assets) 37,935 17.3 3,298 1.5
Limitations on Dividends and Other Capital Distributions: OTS regulations impose limitations on dividends and other capital distributions by savings institutions. Capital distributions include cash dividends, payments to repurchase or otherwise acquire the savings association's shares, payments to stockholders of another institution in a cash out merger and other distributions charged against capital. The rule establishes three tiers of institutions. An institution such as the Bank that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Association") may, after prior notice but without the approval of the OTS, make capital distributions during a calendar year up to the higher of (i) 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its surplus capital at the beginning of the calendar year or (ii) 75% of its net income over the most recent four-quarter period, subject to certain limitations and restrictions as described in the regulations. Any additional capital distributions would require prior regulatory approval. A savings institution that does not meet its current regulatory capital requirement before or after payment of a proposed capital distribution may not make any capital distributions without the prior approval of the OTS. At December 31, 1998, the Bank was considered a Tier 1 Association. -88- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- The MHC, which owned 2,421,711 shares of common stock prior to the 1996 conversion, requested and received permission from the OTS to waive the receipt of dividends from the Bank for several quarterly periods. This waiver had the effect of reducing the actual amount of dividends paid in cash. The total amount of dividends waived totaled approximately $1,897,000. As a result of the 1996 reorganization and conversion, the waived dividends were added to the liquidation account (see Note 18). Note 13. Other Noninterest Expense Other noninterest expense amounts are summarized as follows for the years ended December 31:
1998 1997 1996 --------------------------------------------- Advertising and promotion $ 168,105 $ 147,605 $ 92,245 Professional fees 171,761 249,617 202,677 Printing, postage, stationery and supplies 369,877 215,332 182,134 Checking account charges 299,530 158,512 151,724 Insurance 85,987 81,056 72,236 OTS general assessment 80,337 49,326 54,825 Telephone 91,900 45,069 40,237 ATM costs 82,285 37,580 29,216 Other 796,072 596,525 349,156 --------------------------------------------- $ 2,145,854 $ 1,580,622 $ 1,174,450 =============================================
Note 14. Financial Instruments With Off-Statement of Financial Condition Risk The Bank is a party to financial instruments with off-statement of financial condition risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial condition. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-statement of financial condition instruments. The Bank does require collateral, or other security, to support financial instruments with credit risk. -89- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- A summary of the contract amount of the Bank's exposure to off-statement of financial condition risk for commitments to extend credit is as follows:
Contract or Notional Amount --------------------------- December 31, --------------------------- 1998 1997 --------------------------- Mortgage loans (including one-to-four family and multifamily loans) $ 4,788,000 $ 1,412,000 Undisbursed overdraft loan privileges and undisbursed home equity lines of credit 770,000 255,000
At December 31, 1998, the mortgage loan commitments above were comprised of variable-rate commitments carrying a weighted-average interest rate of 8.30% and fixed-rate commitments carrying a weighted-average interest rate of 7.28%. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts above do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but normally includes real estate and personal property. Note 15. Lending Activities and Concentrations of Credit Risk Most of the Bank's lending activity is with customers located within the state of Iowa. The Bank generally originates single family residential loans within its primary lending area of Webster, Story, Des Moines and Henry counties. The Bank's underwriting policies require such loans to be 80% loan to value based upon appraised values unless private mortgage insurance is obtained. Approximately 30% of the Bank's first mortgage loan portfolio at December 31, 1998, consisted of loans purchased or originated outside the state of Iowa, generally multifamily residential loans. Approximately $27,800,000 of loans purchased at December 31, 1998, were purchased from a bank in Wisconsin. These loans are secured by the underlying properties. The properties securing these loans are physically inspected. The loans are subject to the same underwriting guidelines as loans originated locally. The Bank is also active in originating secured consumer loans to its customers, primarily automobile and second mortgage loans. Collateral for substantially all consumer loans are security agreements and/or Uniform Commercial Code filings on the purchased asset. -90- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 16. Fair Values of Financial Instruments The carrying amount and fair value of the Company's financial instruments as of December 31, 1998 and 1997, were as follows:
1998 1997 ------------------------------------- ------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------------------------------------------------------------------------- (nearest 000) (nearest 000) Financial assets: Cash $ 15,636,876 $ 15,637,000 $ 3,445,163 $ 3,445,000 Securities 49,882,544 49,883,000 19,815,913 19,816,000 Loans, net 254,032,497 258,001,000 191,248,830 192,436,000 Accrued interest receivable 1,933,237 1,933,000 1,300,495 1,300,000 Financial liabilities: Deposits 246,690,313 249,040,000 141,123,707 142,850,000 Borrowed funds 38,832,239 39,183,000 28,550,000 28,620,000 Accrued interest payable 423,958 424,000 28,532 29,000
Note 17. 1994 Reorganization and Conversion to Stock Ownership On January 27, 1994, the Board of Directors of First Federal Savings Bank of Fort Dodge (a mutual savings bank), adopted a plan of reorganization whereby the Bank would reorganize from a federally chartered mutual savings bank into a federal mutual holding company and concurrently form a new federally chartered stock savings bank subsidiary. Pursuant to the reorganization, the Bank (a stock savings bank) was formed as a new federal stock savings bank subsidiary of the mutual savings bank. The mutual savings bank transferred substantially all of its assets and liabilities to the stock savings bank in exchange for 2,421,711 shares of newly issued common stock of the stock savings bank. The mutual savings bank then converted its mutual savings bank charter to a federal mutual holding company charter under the name of North Central Bancshares, Inc. (the mutual holding company). The reorganization was effective August 31, 1994, at which time 2,421,711 shares of stock were issued to the mutual holding company representing approximately 65.5% of the common stock of the Bank and the remaining 35%, or 1,278,289 shares, were sold in a public offering to persons other than the holding company at a price of $10 per share. The reorganization and stock offering were completed on August 31, 1994. The Bank received proceeds of $12,038,638, net of costs of $644,252 and net of $100,000 retained by the mutual holding company. Persons who had membership or liquidation rights with respect to the mutual savings bank as of the date of reorganization shall, as long as they remain depositors of the Bank, continue to have such rights solely with respect to the mutual holding company after the reorganization (see Note 18). -91- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 18. The 1996 Reorganization and Conversion On September 29, 1995, the Boards of Directors of the Bank and the Mutual Holding Company (MHC) adopted a Plan of Conversion and Agreement and Plan of Reorganization (the Plan). The reorganization became effective March 20, 1996. Pursuant to the Plan, (1) the MHC, which owned approximately 65.5% of the Bank, converted to an interim federal stock savings association and simultaneously merged into the Bank, with the Bank being the surviving entity. (2) The Bank then merged into an interim institution (Interim) formed as a wholly-owned subsidiary of the Company, a newly formed Iowa corporation formed in connection with the reorganization, with the Bank being the surviving entity. (3) The outstanding shares of the Bank's common stock (other than those held by the MHC, which were canceled) were converted into shares of common stock of the Company pursuant to a ratio that resulted in the holders of such shares owning in the aggregate approximately the same percentage of the Company as they owned of the Bank. The Company then offered for sale pursuant to the Plan additional shares equal to 65.5% of the common shares of the Company. The reorganization was effective on March 20, 1996, at which time the Company issued an aggregate of 4,011,057 shares of its common stock, 1,385,590 shares of which were issued in exchange for all of the Bank's issued and outstanding shares, except for shares owned by the MHC which were canceled, and 2,625,467 shares of which were sold in Subscription and Community Offerings at a price of $10.00 per share, with gross proceeds amounting to $26,252,159. The Plan provided that when the conversion was completed, a "Liquidation Account" would be established in an amount equal to the amount of any dividends waived by the MHC, plus 65.5% of the Bank's total stockholders' equity, as reflected in its latest statement of financial condition in the final prospectus utilized in the conversion. The Liquidation Account is established to provide a limited priority claim to the assets of the Bank to qualifying depositors as of specified dates (Eligible Account Holders and Supplemental Eligible Account Holders) who continue to maintain deposits in the Bank after the conversion. In the unlikely event of a complete liquidation of the Bank, and only in such an event, Eligible Account Holders and Supplemental Eligible Account Holders would receive from the Liquidation Account a liquidation distribution based on their proportionate share of the then total remaining qualifying deposits. -92- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 19. Earnings Per Common Share Presented below is the reconciliation of the numerators and denominators of the computations for earnings per common share and earnings per common share - diluted, for the years ended December 31:
1998 1997 1996 ---------------------------------------------------- Numerator, income available to common stockholders $ 4,384,845 $ 3,917,124 $ 3,132,921 ==================================================== Denominator: Weighted-average shares outstanding 3,166,041 3,323,346 3,960,394 Less unallocated ESOP 117,894 139,077 142,121 ---------------------------------------------------- Weighted-average shares outstanding-basic 3,048,147 3,184,269 3,818,273 Dilutive effect of stock options 84,684 56,800 ---------------------------------------------------- Weighted-averages shares outstanding-diluted 3,132,831 3,241,069 3,818,273 ==================================================== Basic earnings per common share 1.44 1.23 .82 Earnings per common share-assuming dilution 1.40 1.21 .82
Note 20. Pending Accounting Pronouncements and Regulations In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, Accounting for Derivatives Instruments and Hedging Activities (SFAS No. 133). SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging contracts. It requires an entity recognize all derivatives as either assets or liabilities, and measures those instruments at fair value. It also sets forth the proper accounting for hedging activities, which is determined by the intended use of the derivative and how that use is designated by the entity. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. Earlier application is permitted and should not be applied retroactively to financial statements of prior periods. Since the Company is not currently holding any derivative instruments (as defined) and is not engaged in hedging activities, the adoption of SFAS No. 133 is expected to have no effect on the Company's financial condition or results of operations. In October 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 134, Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. (SFAS No. 134). SFAS No. 134 amends FASB Statement No. 65 and conforms the subsequent accounting for securities retained after the securitization of mortgage loans held for sale by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a nonmortgage banking enterprise. Therefore, after the securitization of a mortgage loan held for sale, any retained mortgage-backed securities shall be classified in accordance with the provisions of FASB Statement No. 115. The adoption of SFAS No. 134 is expected to have no effect on a company's financial condition or results of operations. -93- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- Note 21. NORTH CENTRAL BANCSHARES, INC. (Parent Company Only) Financial Information STATEMENTS OF FINANCIAL CONDITION December 31, 1998 and 1997
1998 1997 ---------------------------- ASSETS Cash $ 409,397 $ 740,722 Securities available-for-sale 924,706 818,936 Loan receivables, net 1,261,000 9,941,000 Investment in First Federal Savings Bank of Iowa 45,876,022 39,250,882 Income taxes receivable 28,490 Prepaid expenses and other assets 10,586 12,777 ---------------------------- Total assets $ 48,510,201 $ 50,764,317 ============================ LIABILITIES AND EQUITY LIABILITIES Dividend payable $ 237,133 $ 204,155 Income taxes payable 2,723 Accrued expenses and other liabilities 47,129 41,293 Deferred taxes 19,125 99,070 ---------------------------- Total liabilities 303,387 347,241 ---------------------------- EQUITY Common stock 40,111 40,111 Additional paid-in capital 38,135,817 37,949,598 Retained earnings 27,084,907 23,660,964 Unearned shares, employee stock ownership plan (1,013,284) (1,210,441) Accumulated other comprehensive income 358,666 354,781 Treasury stock at cost (16,399,403) (10,377,937) ---------------------------- Total equity 48,206,814 50,417,076 ---------------------------- Total liabilities and equity $ 48,510,201 $ 50,764,317 ============================
-94- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -----------------------------------------------------------------------------
STATEMENTS OF INCOME Years Ended December 31, 1998 and 1997 and the Period From March 20, 1996 (Date of Inception), to December 31, 1996 1998 1997 1996 --------------------------------------- Operating income: Equity in net income of subsidiary $ 4,393,955 $ 3,802,303 $ 2,523,316 Interest income 200,055 334,775 418,948 Gain on sale of securities available-for-sale, net 71,923 248,526 --------------------------------------- 4,665,933 4,385,604 2,942,264 --------------------------------------- Operating expenses: Salaries and employee benefits 45,000 39,950 21,440 Other 265,088 351,480 272,933 --------------------------------------- 310,088 391,430 294,373 --------------------------------------- Income before income taxes 4,355,845 3,994,174 2,647,891 Provision for income taxes (29,000) 77,050 65,400 --------------------------------------- Net income $ 4,384,845 $ 3,917,124 2,582,491 =======================================
-95- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STATEMENTS OF EQUITY December 31, 1998 and 1997, and the Period From March 20, 1996 (Date of Inception) to December 31, 1996 Employee Additional Stock Comprehensive Common Paid-In Retained Ownership Income Stock Capital Earnings Plan ---------------------------------------------------------------- Balance, March 20, 1996 Comprehensive income: Net income $2,582,491 $ - $ - $ - $ - Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax 27,068 - - 2,582,491 - ---------- Total comprehensive income $2,582,491 - - - - ========== Issuance of common stock in the conversion 40,111 26,211,948 - - Expenses incurred realating conversion to stock loan - (844,469) - - Transfer of equity from First Federal Savings Bank - 12,387,940 18,659,843 (768,790) Purchase of treasury stock - - - - Unearned ESOP shares - - - (840,000) Dividends on common stock - - (710,808) - Effect of contribution to employees stock ownership plan - 41,192 - 191,835 ------------------------------------------------ Balance, December 31, 1996 40,111 37,796,611 20,531,604 (1,416,955) Comprehensive income: Net income $3,917,124 - - 3,917,124 - Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 281,684 - - - - ---------- Total comprehensive income $4,198,808 ========== Purchase of treasury stock - - - - Dividends on common stock - - (787,764) - Effect of contribution to employees stock ownership plan - 147,968 - 206,514 Effect of stock options exercised - 5,019 - - ------------------------------------------------ Balance, December 31, 1997 40,111 37,949,598 23,660,964 (1,210,441) Comprehensive income: Net income $4,384,845 - - 4,384,845 - Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax 3,885 - - - - ---------- Total comprehensive income $4,388,730 ========== Purchase of treasury stock - - - - Dividends on common stock - - (960,902) - Effect of contribution to employees stock ownership plan - 206,636 - 191,157 Effect of stock options exercised - (20,417) - - ------------------------------------------------ Balance, December 31, 1998 $40,111 $38,135,817 $27,084,907 $(1,013,284) ================================================
Accumulated Other Total Comprehensive Treasury Stockholders' Income Stock Equity ---------------------------------------- Balance, December 31, 1995 Comprehensive income: Net income $ - $ - $ - Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) - - 3,132,921 Total comprehensive income 27,068 - 12,445 Issuance of common stock in the conversion - - 26,252,059 Expenses incurred realating conversion to stock loan - - (844,469) Transfer of equity from First Federal Savings Bank 46,029 - 30,325,022 Purchase of treasury stock - (7,789,661) (7,789,661) Unearned ESOP shares - - (840,000) Dividends on common stock - - (710,808) Effect of contribution to employees stock ownership plan - - 233,027 --------------------------------------- Balance, December 31, 1996 73,097 (7,789,661) 49,234,729 Comprehensive income: Net income - - 3,917,124 Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 281,684 - 281,684 Total comprehensive income Purchase of treasury stock - (2,706,750) (2,706,750) Dividends on common stock - - (787,764) Effect of contribution to employees stock ownership plan - - 354,482 Effect of stock options exercised - 118,474 123,493 --------------------------------------- Balance, December 31, 1997 354,781 (10,377,937) 50,417,076 Comprehensive income: Net income - - 4,384,845 Other comprehensive income, unrealized gains on securities, net of reclassification adjustment, net of tax (Note 3) 3,885 - 3,885 Total comprehensive income Purchase of treasury stock - (6,164,419) (6,164,419) Dividends on common stock - - (960,902) Effect of contribution to employees stock ownership plan - - 403,793 Effect of stock options exercised - 142,953 122,536 --------------------------------------- Balance, December 31, 1998 $358,666 $(16,399,403) $48,206,814 =======================================
See Notes to Consolidated Financial Statements. -96- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ----------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS December 31, 1998 and 1997, and the Period From March 20, 1996 (Date of Inception) to December 31, 1996
1998 1997 1996 ----------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 4,384,845 $ 3,917,124 $ 2,582,491 Adjustments to reconcile net income to net cash provided by operating activities: Equity in net income of First Federal Savings Bank (4,393,955) (3,802,303) (2,523,316) Dividends received from First Federal Savings Bank 3,295,694 10,000,000 - (Gain) on sale of securities available-for-sale (71,923) (248,526) - Change in deferred income taxes (485) 4,021 (7,228) Change in assets and liabilities: (Increase) in income taxes receivable (20,917) - - Decrease in prepaid expenses and other assets 2,191 13,499 (26,276) Increase (decrease) in income taxes payable (2,723) 11,913 8,522 Increase in accrued expenses and other liabilities 5,836 8,297 32,996 ----------------------------------------------------- Net cash provided by operating activities 3,198,563 9,904,025 67,189 ----------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in loans 8,680,000 (6,120,000) (3,821,000) Proceeds from sale of securities available-for-sale 128,550 1,270,447 Purchase of securities available-for-sale (361,058) (1,103,749) (475,250) Capital contributions to First Federal Savings Bank (5,000,000) - - One-half of stock proceeds paid to First Federal Savings Bank - - (12,703,561) ----------------------------------------------------- Net cash provided by (used in) investing activities 3,447,492 (5,953,302) (16,999,811) -----------------------------------------------------
(Continued) -97- NORTH CENTRAL BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -----------------------------------------------------------------------------
(Continued) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock - - 26,252,059 Payments for expenses incurred relating to conversion to stock form - - (844,469) Purchase of treasury stock (6,164,419) (2,706,750) (7,789,661) Proceeds from issuance of treasury stock 114,963 105,781 Dividends paid (927,924) (813,875) (480,464) ----------------------------------------------------- Net cash provided by (used in) financing activities (6,977,380) (3,414,844) 17,137,465 ----------------------------------------------------- Net increase (decrease) in cash (331,325) 535,879 204,843 CASH Beginning 740,722 204,843 ----------------------------------------------------- Ending $ 409,397 $ 740,722 $ 204,843 ===================================================== SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION Cash payment for income taxes $ 82,158 $ 105,781 $ 56,000
-98- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY Information regarding Directors and Executive Officers of the Registrant is included under the headings "Information with respect to Nominees and Continuing Directors," "Nominees for Election as Directors," "Continuing Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held on April 23, 1999, which has been filed with the SEC and is incorporated herein by reference. Information regarding Executive Officers, who are not Directors, appears under the caption "Executive Officers" included in Item 1 of this Form 10-K. ITEM 11. EXECUTIVE COMPENSATION Information relating to executive compensation is included under the headings "Executive Compensation" (excluding the Stock Performance Graph and the Compensation Committee Report) and "Directors' Compensation" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held on April 23, 1999, which has been filed with the SEC and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information relating to security ownership of certain beneficial owners and management is included under the headings "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held on April 23, 1999, which has been filed with the SEC and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and related transactions is included under the heading "Certain Relationships and Related Transactions" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held on April 23, 1999, which has been filed with the SEC and is incorporated herein by reference. -99- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements The following are filed as part of this annual report on Form 10-K: - Independent Auditor's Report - Consolidated Statements of Financial Condition at December 31, 1998 and 1997 - Consolidated Statements of Income for each of the years in the three year period ended December 31, 1998 - Consolidated Statements of Shareholders' Equity for each of the years in the three year period ended December 31, 1998 - Consolidated Statements of Cash Flows for each of the years in the three year period ended December 31, 1998 - Notes to the Consolidated Financial Statements 2. Financial Statement Schedules Financial Statement Schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto. (b) Reports on Form 8-K filed during the last quarter of 1998: None. -100- (c) Exhibits Required by Item 601 of Securities and Exchange Commission Regulation S-K:
Exhibit No. Description Page No. - ----------- ----------- -------- 3.1 Articles of Incorporation of North Central Bancshares, Inc. * 3.2 Bylaws of North Central Bancshares, Inc. * 4.1 Federal Stock Charter of First Federal Savings Bank of Iowa (formerly * known as First Federal Savings Bank of Fort Dodge) 4.2 Bylaws of First Federal Savings Bank of Iowa (formerly known as First * Federal Savings Bank of Fort Dodge) 4.3 Specimen Stock Certificate of North Central Bancshares, Inc. * 10.1 Employee Stock Ownership Plan of First Federal Savings Bank of Iowa ***** (formerly known as First Federal Savings Bank of Fort Dodge) and ESOP Trust Agreement (incorporating Amendments 1 and 2) 10.2 ESOP Loan Documents, dated September 3, 1996 **** 10.3 Employee Retention Agreements between First Federal Savings Bank of ** Fort Dodge and certain executive officers 10.4 Employment Agreement between First Federal Savings Bank of Iowa * (formerly known as First Federal Savings Bank of Fort Dodge) and David M. Bradley, effective as of August 31, 1994 10.5 Form of Employment Agreement between First Federal Savings Bank of * Iowa (formerly known as First Federal Savings Bank of Fort Dodge) and David M. Bradley 10.6 Form of Employment Agreement between North Central Bancshares, Inc. * and David M. Bradley 10.8 North Central Bancshares, Inc. 1996 Stock Option Plan *** 10.9 Amendment No. 1 to the North Central Bancshares, Inc. 1996 Stock ***** Option Plan 11.1 Statement regarding computation of per share earnings 13.1 Annual Report to security holders 21.1 Subsidiaries of the Registrant 23.1 Consent of McGladrey & Pullen, LLP 27.1 Financial Data Schedule 99.1 Proxy Statement for Annual Meeting of Shareholders of North Central Bancshares, Inc. filed with the Securities and Exchange Commission is incorporated herein by reference.
-101- * Incorporated herein by reference to Registration Statement No. 33-80493 on Form S-1 of North Central Bancshares, Inc. (the "Registrant") filed with the Securities and Exchange Commission, (the "Commission") on December 18, 1995, as amended. ** Incorporated herein by reference to the Exhibits to the Annual Report on Form 10-K filed by Registrant for fiscal year 1995, filed with the Commission on March 29, 1996. *** Incorporated herein by reference to the Amended Schedule 14A of Registrant filed with the Commission on August 19, 1996. **** Incorporated herein by reference to the Annual Report on Form 10-K of the Registrant filed with the Commission on March 31, 1997. ***** Incorporated herein by reference to the Annual Report on Form 10-K of the Registrant filed with the Commission on March 31, 1998. -102- Conformed SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant and has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. North Central Bancshares, Inc. Date: March 26, 1999 /s/ David M. Bradley ----------------------------------- By: David M. Bradley Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Name Title Date ---- ----- ---- /s/ David M. Bradley President, Chief Executive Officer, March 26, 1999 - ---------------------------- Officer, Director, and Chairman of David M. Bradley the Board (principal executive officer) /s/ John L. Pierschbacher Treasurer March 26, 1999 - ---------------------------- (principal accounting and John L. Pierschbacher financial officer) /s/ Robert H. Singer, Jr. Director March 26, 1999 - ---------------------------- Robert H. Singer, Jr. /s/ KaRene Egemo Director March 26, 1999 - ---------------------------- KaRene Egemo /s/ Howard A. Hecht Director March 26, 1999 - ---------------------------- Howard A. Hecht /s/ John M. Peters Director March 26, 1999 - ---------------------------- John M. Peters /s/ Melvin R. Schroeder Director March 26, 1999 - ---------------------------- Melvin R. Schroeder -103- TABLE OF CONTENTS List of Exhibits (filed herewith unless otherwise noted)
Exhibit No. Description Page No. - ----------- ----------- -------- 3.1 Articles of Incorporation of North Central Bancshares, Inc. * 3.2 Bylaws of North Central Bancshares, Inc. * 4.1 Federal Stock Charter of First Federal Savings Bank of Iowa (formerly * known as First Federal Savings Bank of Fort Dodge) 4.2 Bylaws of First Federal Savings Bank of Iowa (formerly known as First * Federal Savings Bank of Fort Dodge) 4.3 Specimen Stock Certificate of North Central Bancshares, Inc. * 10.1 Employee Stock Ownership Plan of First Federal Savings Bank of Iowa ***** (formerly known as First Federal Savings Bank of Fort Dodge) and ESOP Trust Agreement (incorporating Amendments 1 and 2) 10.2 ESOP Loan Documents, dated September 3, 1996 **** 10.3 Employee Retention Agreements between First Federal Savings Bank of ** Fort Dodge and certain executive officers 10.4 Employment Agreement between First Federal Savings Bank of Iowa * (formerly known as First Federal Savings Bank of Fort Dodge) and David M. Bradley, effective as of August 31, 1994 10.5 Form of Employment Agreement between First Federal Savings Bank of * Iowa (formerly known as First Federal Savings Bank of Fort Dodge) and David M. Bradley 10.6 Form of Employment Agreement between North Central Bancshares, Inc. * and David M. Bradley 10.8 North Central Bancshares, Inc. 1996 Stock Option Plan *** 10.9 Amendment No. 1 to the North Central Bancshares, Inc. 1996 Stock ***** Option Plan 11.1 Statement regarding computation of per share earnings 13.1 Annual Report to security holders 21.1 Subsidiaries of the Registrant 23.1 Consent of McGladrey & Pullen, LLP 27.1 Financial Data Schedule 99.1 Proxy Statement for Annual Meeting of Shareholders of North Central Bancshares, Inc. filed with the Securities and Exchange Commission is incorporated herein by reference.
* Incorporated herein by reference to Registration Statement No. 33-80493 on Form S-1 of North Central Bancshares, Inc. (the "Registrant") filed with the Securities and Exchange Commission, (the "Commission") on December 18, 1995, as amended. ** Incorporated herein by reference to the Exhibits to the Annual Report on Form 10-K filed by Registrant for fiscal year 1995, filed with the Commission on March 29, 1996. *** Incorporated herein by reference to the Amended Schedule 14A of Registrant filed with the Commission on August 19, 1996. **** Incorporated herein by reference to the Annual Report on Form 10-K of the Registrant filed with the Commission on March 31, 1997. ***** Incorporated herein by reference to the Annual Report on Form 10-K of the Registrant filed with the Commission on March 31, 1998. EX-11.1 2 STATEMENT REGARDING COMPUTATION EXHIBIT 11.1 Exhibit 11.1 Statement regarding computation of per share earnings. Presented below is the reconciliation of the numerators and denominators of the computations for earnings per common share and earnings per common share - diluted.
1998 ------------------------------------ Income Shares Per Share (Numerator) (Denominator) Amount ------------------------------------ Income available to common stockholder $4,384,845 3,166,041 Less unallocated ESOP shares -- 117,894 ---------- ---------- Basic earnings per common share Income available to common stockholders 4,384,845 3,048,147 $ 1.44 Effective of dilutive securities - options -- 84,684 ---------- ---------- Earnings per common share - assuming dilution Income available to common stockholders + assumed conversions $4,384,845 $3,132,831 $ 1.40 ========== ========== 1997 ------------------------------------ Income Shares Per Share (Numerator) (Denominator) Amount ------------------------------------ Income available to common stockholder $3,917,124 3,323,346 Less unallocated ESOP shares -- 139,077 ---------- ---------- Basic earnings per common share Income available to common stockholders 3,917,124 3,184,269 $ 1.23 Effective of dilutive securities - options -- 56,800 ---------- ---------- Earnings per common share - assuming dilution Income available to common stockholders + assumed conversions $3,917,124 $3,241,069 $ 1.21 ========== ==========
Basic earnings per common share information for 1996 is calculated by dividing net income by the weighted number of shares outstanding (3,818,273). Earnings per common share - assuming dilution for 1996 did not include the effect of options to purchase 237,000 shares of common stock because the exercise price was greater than the average market price of the common shares. EX-13.1 3 ANNUAL REPORT TO SECURITY HOLDERS EXHIBIT 13.1 Exhibit 13.1 Annual Report to security holders. NORTH CENTRAL BANCSHARES, INC. Holding Company for First Federal Savings Bank of Iowa 1998 ANNUAL REPORT TABLE OF CONTENTS MESSAGE OF THE CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER.... 3 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA.................... 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................. 7 INDEX TO FINANCIAL STATEMENTS.....................................33 QUARTERLY RESULTS OF OPERATIONS (Unaudited).......................70 MANAGEMENT OF THE HOLDING COMPANY AND THE BANK....................71 SHAREHOLDER INFORMATION...........................................72 This Annual Report to Shareholders contains certain forward looking statements consisting of estimates with respect to the financial condition, results of operations (including noninterest expense and availability of potential tax credits) and business of Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include changes in general, economic and market conditions, the development of an adverse interest rate environment that adversely affects the interest rate spread or other income anticipated from the Company's operations and investments, and changes in depositor preferences for financial products. North Central Bancshares, Inc. 825 Central Avenue . PO Box 1237 Fort Dodge, Iowa 50501-1237 March 22, 1999 MESSAGE OF THE CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Dear Shareholders: We are pleased to report to you the operating results of North Central Bancshares, Inc. ("North Central Bancshares" or the "Company") for the year ended December 31, 1998. North Central Bancshares is the holding company for First Federal Savings Bank of Iowa (the "Bank"). For the year ended December 31, 1998, North Central Bancshares' net income was $4.4 million, or $1.40 diluted earnings per share, as compared to $3.9 million, or $1.21 diluted earnings per share, for the year ended December 31, 1997. We are pleased with this 12.8% increase in net income and 15.7% increase in diluted earnings per share during 1998, which occurred in a very challenging interest rate environment. North Central Bancshares continued its commitment to enhancing shareholder value during 1998. On January 30, 1998, the Company acquired Valley Financial Corp. and its wholly owned subsidiary, Valley Savings Bank, FSB. As a result of this acquisition, the Company now has $337 million in assets and $247 million in deposits. First Federal Savings Bank of Iowa now operates a total of seven branches in the communities of Fort Dodge, Burlington, Ames, Nevada and Mount Pleasant, Iowa. Also, during 1998, the Company completed a 5% stock repurchase plan on August 5, 1998 and began an additional 5% stock repurchase program on November 13, 1998 which was subsequently completed January 28, 1999. Both of these repurchase programs improved earnings and return on stockholders' equity. On October 20, 1998, the Bank announced that it will construct a new branch office in Perry, Iowa. This location will be the eighth office for First Federal Savings Bank of Iowa. This office is scheduled to open June 1, 1999. I personally want to thank our loyal and valued staff who helped make 1998 such a successful year. The additional workload of increasing our bank's assets by over 50% during the past 12 months was a daunting challenge, and I commend them for a job well done. John M. Peters will retire from the Board of Directors at this year's annual meeting of the Company. During his ten year tenure on the Board, the Company and the Bank faced many challenges and decisions. We thank him for his wise counsel and direction during these exciting times and wish him well in his retirement years. The directors, officers and staff of North Central Bancshares, Inc. and its subsidiary, First Federal Savings Bank of Iowa wish to thank you for your continued interest and support. We pledge to continue our efforts to increase the overall financial return to you, our shareholders. Sincerely, /s/ David M. Bradley David M. Bradley Chairman, President, and Chief Executive Officer SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA The selected consolidated financial and other data of North Central Bancshares, Inc. set forth below is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements and Notes thereto presented elsewhere in this Annual Report.
At December 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (In thousands) Selected Consolidated Financial Condition Data: Total assets $336,690 $221,954 $203,093 $179,930 $157,153 Cash (noninterest bearing) 2,435 982 963 709 719 Loans receivable, net:(1) 145,967 114,286 106,053 93,438 82,523 First mortgage loans secured by one-to-four family residences First mortgage loans secured 63,285 49,895 33,015 30,070 19,815 by multifamily properties First mortgage loans secured 11,168 3,724 5,068 5,650 5,974 by commercial properties Consumer loans 33,612 23,344 21,695 18,714 16,472 -------- -------- -------- -------- -------- Total loans receivable, net 254,032 191,249 165,831 147,872 124,784 Investment securities(2) 63,084 22,279 29,577 26,156 28,389 Deposits 246,690 141,124 129,722 126,672 124,189 Borrowed funds 38,832 28,550 22,335 21,940 3,886 Total shareholders' equity 48,207 50,417 49,235 29,900 27,813
For the Year Ended December 31, 1998 1997 1996 1995 1994 -------- -------- ------- -------- -------- (In thousands) Selected Operating Data: Interest income $23,602 $16,205 $15,090 $13,148 $11,592 Interest expense 12,869 7,900 6,929 7,079 6,048 ------- ------- ------- ------- ------- Net interest income before 10,733 8,305 8,161 6,069 5,544 provision for loan losses Provision for loan losses 210 240 240 250 242 ------- ------- ------- ------- ------- Net interest income after 10,523 8,065 7,921 5,819 5,302 provision for loan losses ------- ------- ------- ------- ------- Noninterest income: 1,243 657 580 445 430 Fees and service charges Abstract fees 1,584 1,222 931 794 332 Other income 1,088 658 382 463 286 ------- ------- ------- ------- ------- Total noninterest income 3,915 2,537 1,893 1,702 1,048 ------- ------- ------- ------- ------- Noninterest expense: 3,482 2,209 2,004 1,681 1,282 Salaries and employee benefits Premises and equipment 812 444 421 382 326 Data processing 553 258 244 236 248 One-time SAIF special assessment -- -- 817 -- -- SAIF deposit insurance 143 85 279 287 306 premiums Goodwill 436 28 29 30 -- Other expenses 2,146 1,553 1,144 1,042 761 ------- ------- ------- ------- ------- Total noninterest expense 7,572 4,577 4,938 3,658 2,923 ------- ------- ------- ------- ------- Income before income taxes 6,866 6,025 4,876 3,863 3,427 Income tax expense 2,481 2,108 1,744 1,403 1,247 ------- ------- ------- ------- ------- Net income $ 4,385 $ 3,917 $ 3,132 $ 2,460 $ 2,180 ======= ======= ======= ======= =======
-4-
At or for the Year Ended December 31, ---------------------------------------------------- 1998 1997 1996 1995 1994 -------- ---------- ---------- -------- -------- Key Financial Ratios and Other Data: Performance Ratios: (%) Net interest rate spread (difference between 2.81% 2.87% 3.01% 2.75% 3.02% average yield on interest-earning assets and average cost of interest- bearing liabilities) Net interest margin (net interest income 3.50 4.06 4.33 3.66 3.70 as a percentage of average interest- earning assets) Return on average assets (net income 1.35 1.86 1.62 1.45 1.43 divided by average total assets) Return on average equity (net income 8.73 7.94 6.30 8.54 11.19 divided by average equity) Noninterest income to average assets 1.21 1.20 0.98 1.00 0.69 Efficiency ratio(3) 51.69 42.21 49.11 47.07 44.35 Noninterest expense to average assets 2.34 2.17 2.56 2.16 1.92 Net interest income after provision for 138.97 176.22 160.40 159.07 181.41 loan losses to noninterest expenses Financial Condition Ratios: (%) (4) Equity to assets at period end 14.32 22.72 24.24 16.62 17.70 Tangible equity to tangible assets 12.42 22.32 23.80 16.09 17.10 at period end (5) (6) Average shareholders' equity divided by 15.52 23.38 25.73 16.99 12.82 average total assets Average tangible shareholders equity divided 13.71 22.96 25.29 16.42 12.17 by average tangible total assets (5) (6) Average interest-earning assets to average 116.28 130.97 136.02 121.37 116.87 interest-bearing liabilities Asset Quality Ratios: (%) (4) Nonaccrual loans to total net loans 0.38 0.08 0.11 0.12 0.26 Nonperforming assets to total assets(7) 0.34 0.10 0.15 0.23 0.21 Allowance for loan losses as a percent of 1.03 1.10 1.16 1.15 1.20 total loans receivable at end of period Allowance for loan losses to nonaccrual 279.72 1,468.33 1,059.35 960.20 476.23 loans Per Share Data: Book value per share $ 16.26 $ 15.43 $ 14.36 $ 8.72 $ 8.11 Tangible book value per share (5) 13.79 15.09 14.01 8.39 7.78 Basic earnings per share (8) 1.44 1.23 0.82 0.63 0.21 Diluted earnings per share (9) 1.40 1.21 0.82 0.63 0.21 Dividends declared per share 0.32 0.25 0.28 0.60 0.12 Dividend payout ratio 0.22 0.20 0.34 0.95 0.57 Key Financial Ratios Excluding SAIF Assessment: (%) (10) Return on average assets (net income divided by average total assets) 1.35% 1.86% 1.89% 1.45% 1.43% Return on average equity (net income divided by average equity) 8.73 7.94 7.34 8.54 11.19 Efficiency ratio (3) 51.69 42.21 40.99 47.07 44.35 Noninterest expense to average assets 2.34 2.17 2.13 2.16 1.92 Net interest income after provision for 138.97 loan losses to noninterest expenses 176.22 192.21 159.07 181.41 _______________________ (Notes on following page)
-5- (1) Loans receivable, net represents total loans less discounts, loans in process, net deferred loan fees and allowance for loan losses. The allowance for loan losses at December 31, 1998, 1997, 1996, 1995 and 1994 was $2.7 million, $2.2 million, $2.0 million, $1.7 million and $1.5 million, respectively. (2) Includes interest-bearing deposits with the Federal Home Loan Bank of Des Moines (the "FHLB"). (3) Efficiency ratio represents noninterest expense divided by the sum of net interest income before provision for loan losses plus noninterest income. (4) Asset Quality Ratios are end of period ratios. With the exception of end of period ratios, all ratios are based on average monthly balances during the indicated periods and are annualized where appropriate. (5) Tangible equity consists of stockholders' equity less goodwill and title plant. Goodwill and title plant at December 31, 1998, 1997, 1996, 1995 and 1994 was $7.3 million, $1.1 million, $1.2 million, $1.1 million and $1.1 million, respectively. (6) Tangible assets consists of total assets less goodwill and title plant. Goodwill and title plant at December 31, 1998, 1997, 1996, 1995 and 1994 was $7.3 million, $1.1 million, $1.2 million, $1.1 million and $1.1 million, respectively. (7) Nonperforming assets consists of nonaccrual loans, foreclosed real estate and other nonperforming assets. (8) Basic earnings per share information is calculated by dividing net income by the weighted average number of shares outstanding. Basic earnings per share information for the year ended December 31, 1994 is calculated by dividing net income subsequent to the conversion of the Bank from mutual to stock form in 1994 by the weighted average number of shares outstanding. The weighted average number of shares outstanding for basic earnings per share computation for 1998, 1997, 1996, 1995 and 1994 were 3,048,148, 3,184,269, 3,818,273, 3,919,488 and 3,906,980, respectively. Net income subsequent to such conversion was $810,000 for the period ended December 31, 1994. (9) Diluted earnings per share information is calculated by dividing net income by the weighted average number of shares outstanding, adjusted for the effect of dilutive potential common shares outstanding which consists of stock options granted. Diluted earnings per share information for the year ended December 31, 1994 is calculated by dividing net income subsequent to the conversion of the Bank from mutual to stock form in 1994 by the weighted average number of shares outstanding. The weighted average number of shares outstanding for diluted earnings per share computation for 1998, 1997, 1996, 1995 and 1994 were 3,132,833, 3,241,069, 3,818,273, 3,919,488 and 3,906,980, respectively. Net income subsequent to such conversion was $810,000 for the period ended December 31, 1994. (10) For 1996, excludes the one-time $817,000 (pre-tax) special assessment for the recapitalization of the Savings Association Insurance Fund ("SAIF"). -6- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General North Central Bancshares, Inc. (the "Holding Company"), an Iowa corporation, is the holding company for First Federal Savings Bank of Iowa (the "Bank"), a federally chartered savings bank. Collectively, the Holding Company and the Bank are referred to herein as the "Company." The Holding Company was organized on December 5, 1995 at the direction of the Board of Directors of the Bank for the purpose of acquiring all of the capital stock to be issued by the Bank in connection with the conversion and reorganization of the Bank and North Central Bancshares, M.H.C. (the "MHC") from the mutual to the stock holding company structure (these transactions are collectively referred to as the "Conversion"). On March 20, 1996, upon completion of the Conversion, the Holding Company issued an aggregate of 4,011,057 shares of its common stock, par value $0.01 per share ("Common Stock"), of which 1,385,590 shares were issued in exchange for all of the Bank's issued and outstanding shares, except for shares owned by the MHC which were cancelled, and 2,625,467 shares of which were sold in Subscription and Community Offerings at a price of $10.00 per share, with gross proceeds amounting to $26,254,670. At this time, the Holding Company conducts business as a unitary savings and loan holding company and the principal business of the Holding Company consists of the operation of its wholly-owned subsidiary, the Bank. The profitability of the Company depends primarily on its level of net interest income, which is the difference between interest earned on the Company's interest-earning assets, consisting primarily of loans and investment securities, and the interest paid on interest-bearing liabilities, which primarily consist of deposits and advances from the FHLB. Net interest income is a function of the Company's interest rate spread, which is the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to interest-bearing liabilities. The Company's net income is affected by its level of noninterest income which primarily consists of service fees and charges and abstract fees, and noninterest expense, which primarily consists of compensation and employee benefit expenses, premises and equipment and data processing. Net income also is affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities, which events are beyond the control of the Company. Acquisition of Valley Financial Corp. As of the close of business on January 30, 1998 (the "Effective Time"), the Company completed the acquisition ( the "Acquisition") of Valley Financial Corp., ("Valley Financial"), pursuant to an Agreement and Plan of Merger, dated as of September 18, 1997, (the "Merger Agreement"). The Acquisition resulted in the merger of Valley Financial's wholly owned subsidiary, Valley Savings Bank, ("Valley Savings") with and into the Bank, with the Bank as the resulting financial institution. Valley Savings, headquartered in Burlington, Iowa, was a federally-chartered stock savings bank with three branch offices located in southeastern Iowa. The former offices of Valley Savings are being operated as a division of the Bank. In connection with the Acquisition, each share of Valley Financial's common stock, par value $1.00 per share, issued and outstanding (other than shares held as treasury stock of Valley Financial) was cancelled and converted automatically into the right to receive $525.00 per share in cash pursuant to the terms and conditions of the Merger Agreement. As a result of the Acquisition, shareholders of Valley Financial were paid $14,726,250 in cash. SAIF Recapitalization In response to the disparity in deposit insurance assessment rates that existed between banks insured by the Bank Insurance Fund ("BIF") and thrifts insured by the SAIF, the Deposits Funds Insurance Act of 1996 (the "Funds Act") was enacted on September 30, 1996. The Funds Act authorized the Federal Deposit -7- Insurance Corporation ("FDIC") to impose a special assessment on all institutions with SAIF-assessable deposits in the amount necessary to recapitalize the SAIF. The Company's special SAIF assessment of $817,000 before taxes (and $512,000 net of taxes) was charged against income in the third quarter of 1996 and paid in November 1996 (the "SAIF Assessment"). In view of the recapitalization of the SAIF, the FDIC reduced the assessment rates for SAIF-assessable deposits. For the fiscal years ended December 31, 1998 and 1997, the Bank incurred $143,000 and $85,000, respectively, in deposit insurance premiums and for the interest payments on the FICO bonds issued by the Financing Corporation to recapitalize the now defunct Federal Savings and Loan Insurance Corporation. Business Strategy The Company's current business strategy is to operate the Bank as a well- capitalized, profitable and independent community-oriented savings bank dedicated to providing quality customer service. Generally, the Company has sought to implement this strategy primarily by using deposits and advances from the FHLB as its source of funds and maintaining a substantial part of its assets in loans secured by one- to four-family residential real estate, multi-family loans and commercial real estate located both inside and outside the Company's market area, consumer and other loans and in other liquid investment securities. Specifically, the Company's business strategy incorporates the following elements: (1) operating as a community-oriented financial institution, maintaining a strong core customer base by providing quality service and offering customers the access to senior management and services that a locally- headquartered institution can offer; (2) maintaining high asset quality by emphasizing investment in residential mortgage loans (including the purchase of qualifying multifamily loans) and securities issued or guaranteed by the United States Government or agencies thereof and mortgage-backed securities; (3) maintaining capital in excess of regulatory requirements and growing only to the extent that adequate capital levels can be maintained; (4) controlling noninterest expenses; (5) managing interest rate risk exposure while achieving desirable levels of profitability; and (6) increasing noninterest income through (i) the expansion of the abstract company business conducted through a wholly owned subsidiary, (ii) the acquisition of First Iowa Mortgage, Inc., a mortgage banking company and (iii) other increases in fees and service charges. Highlights of the Company's business strategy are as follows: Community-Oriented Institution. The Company is committed to meeting the financial needs of the communities in which it operates. Based in part on its participation in several different programs designed to facilitate residential lending to low- and moderate-income households, the Bank has received an "Outstanding" Community Reinvestment Act rating. The Company believes it is large enough to provide a full range of personal and business financial services and yet is small enough to be able to provide such services on a personalized and efficient basis. Management believes that the Company can be more effective in servicing its customers than many of its competitors which are not headquartered locally. Such proximity allows senior management of the Bank to quickly and personally respond to customer needs and inquiries. Strong Retail Deposit Base. In 1998, the Company had a relatively strong and stable retail deposit base drawn from its offices located in Fort Dodge, Ames, Nevada, Burlington and Mount Pleasant, Iowa. The stability of the Company's deposit base has been enhanced by the Company's offering of 5-year certificates of deposit (which comprise $50.1 million, or 20.3%, of total deposits at December 31, 1998) at attractive interest rates, and programs tying low-cost checking account services to the maintenance of specified certificate of deposit balances or loan balances. At December 31, 1998, 33.4% of the deposit base, or $82.3 million, consisted of core deposits, which included money market accounts, savings accounts, NOW accounts, and noninterest-bearing demand accounts. Core deposits are considered to be a more stable and lower cost source of funds than certificates of deposit or outside borrowings. The Company will continue to emphasize retail deposits by providing quality customer service, offering competitive rates on deposit accounts, and providing depositors with a full range of accounts. -8- Asset Quality and Emphasis on Residential Mortgage Lending. The Company has historically emphasized residential real estate financing, and has been primarily a portfolio lender. The Company expects to continue its commitment to financing the purchase or improvement of residential real estate in its market area. At December 31, 1998, 43.4% of the Company's total assets consisted of one-to-four family residential first mortgage loans. To supplement local mortgage loan originations and to diversify its mortgage loan portfolio geographically, the Company has purchased loans in the secondary mortgage market, with an emphasis on multifamily loans secured by properties outside the State of Iowa (the "out of state properties"). At December 31, 1998, the Company's portfolio of loans which were either originated or purchased by the Company and secured by out of state properties consisted of $8.8 million of one- to-four family residential mortgage loans, or 3.4% of the Company's total loan portfolio, and $70.0 million of multifamily and commercial loans, or 27.0% of the Company's total loan portfolio. At December 31, 1998, the Company's ratio of nonperforming assets to total assets was 0.34%. The Company also invests in United States Treasury securities, United States Government agencies, State and Local Obligations, mortgage-backed securities, interest-earning deposits, equity securities and FHLB stock. Generally, the yield on mortgage loans originated and purchased by the Company is greater than that of securities purchased by the Company. Future economic conditions and continued strong banking competition could result in diminished lending opportunities. If new loan originations are reduced in the future, the Company may increase its investment in securities and in purchased mortgage loans outside its market area. Capital Strength and Controlled Internal Growth. Total equity increased from $27.8 million at December 31, 1994 to $48.2 million at December 31, 1998, an increase of 73.3%. Total assets have increased by $179.5 million, or 114.2%, since December 31, 1994. As a result, the ratio of total equity to total assets has decreased from 17.7% at December 31, 1994 to 14.3% at December 31, 1998. The Company's growth can be attributed to the Acquisition and the Company's emphasis on the origination and purchase of residential mortgage loans and the purchase of multifamily mortgage loans. The Company's growth has been funded through a combination of the use of proceeds from the stock offerings held in 1994 and 1996, FHLB advances and deposit growth. The Company intends to maintain strong levels of total equity and capital ratios by controlling growth to the extent that adequate capital levels can be maintained. Acquisition Strategy. With the consummation of the Acquisition in 1998, the Company has grown through the purchase of another financial institution. The Acquisition resulted in an increase in total assets of approximately 42%, making effective use of the Company's excess capital. The Company intends to continue evaluating the possibility of acquiring branch offices and other financial institutions, which involves executing confidentiality agreements and conducting due diligence. Such evaluations by the Company provide no indication of the likelihood that the Company will enter into any agreement to engage in an acquisition transaction as, in many instances, such transactions are subject to competitive bidding and, in every instance, are subject to extensive arm's length negotiations once the Company's evaluation is complete. Increasing Noninterest Income. The Company has attempted to increase its level of noninterest income from both new and traditional lines of business to supplement net interest income. The Company currently owns abstract companies in Webster, Boone and Jasper counties in Iowa, First Iowa Title Services, Inc. ("First Iowa"), the Bank's wholly owned subsidiary. The abstract business performed by First Iowa replaces the function of a title insurance company. The Company believes that First Iowa can continue to be an excellent source of fee income. Noninterest income from such business for the year ended December 31, 1998 was $1.6 million, offset by noninterest expense attributable to First Iowa. The Company also owns a mortgage banking company in Ames, Iowa, First Iowa Mortgage, Inc. ("First Iowa Mortgage"), the Bank's wholly owned subsidiary. On January 30, 1998, the Company acquired First Iowa Mortgage as a part of the Acquisition of Valley Financial. Non-interest income for such business for the year ended December 31, 1998 was $339,000, offset by non-interest expense attributable to First Iowa Mortgage. Liquidity and Interest Rate Risk Management. Management seeks to manage the Company's interest rate risk exposure by monitoring the levels of interest rate sensitive assets and liabilities while maintaining an -9- acceptable interest rate spread. At December 31, 1998, total interest-bearing liabilities maturing or repricing within one year exceeded total interest- earning assets maturing or repricing in the same period by $ 41.4 million, representing a one-year gap to total assets ratio of negative 12.3% as compared to a positive 0.28% at December 31, 1997. This change is due in part to the Acquisition of Valley Financial. To reduce the potential volatility of the Company's earnings in a changing interest rate environment, the Company has emphasized the origination of 7-year fixed rate mortgage loans that convert to adjustable rates at the conclusion of their initial terms and have overall maturities of up to 30 years, adjustable-rate loans, investment in short to medium term United States Treasury notes, U. S. Government agencies, mortgage- backed securities and has sought to lengthen the terms of its deposits through its pricing strategies with respect to longer term certificates of deposit. See "-- Discussion of Market Risk -- Interest Rate Sensitivity Analysis". Liquidity and Capital Resources OTS regulations require that thrift institutions such as the Bank maintain an average daily balance of liquid assets (cash, certain time deposits, banker's acceptances and specified United States Government, state or federal agency obligations) equal to a monthly average of not less than 4% of its net withdrawable deposits plus short-term borrowings. At December 31, 1998, the amount of the Bank's liquid assets were $45.7 million, resulting in a liquidity ratio of 17.6%. The Company's primary sources of funds are deposits, amortization and prepayment of loans, maturities of securities and other investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Company manages the pricing of its deposits to maintain a desired deposit balance. In addition, the Company invests in short- to-medium term interest-earning assets, which provide liquidity to meet lending requirements. At December 31, 1998, $5.0 million, or 12.6%, of the Company's investment portfolio, excluding equity securities, was scheduled to mature in one year or less and $16.8 million, or 41.8%, was scheduled to mature in one to five years and $18.3 million, or 45.6%, was scheduled to mature in more than five years. Certificates of deposit scheduled to mature in less than one year, at December 31, 1998, totalled $81.3 million. Based on prior experience, management believes that a significant portion of such deposits will remain with the Company. If the Company requires funds beyond its ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. The amount of eligible collateral for blanket lien pledges from the FHLB is $139.3 million as of December 31, 1998. For additional information about cash flows from the Company's operating, financing and investing activities, see the Statements of Cash Flows included in the Consolidated Financial Statements. At December 31, 1998, the Company had outstanding loan commitments of $2.8 million. This amount does not include undisbursed overdraft loan privileges and the unfunded portion of loans in process. The main sources of liquidity for the Holding Company are net proceeds from the sale of stock and payments from the Bank in the form of dividends and loan repayments. The main cash outflows are payments of dividends to shareholders and funds used to repurchase the Common Stock. During 1998, the Holding Company repurchased 311,324 shares of its Common Stock, pursuant to repurchase programs which were approved by the OTS. The Holding Company's ability to pay dividends to shareholders depends substantially on dividends and loan payments received from the Bank. The Bank may not declare or pay cash dividends on or repurchase any of its shares of common stock if the effect thereof would cause equity to be reduced below applicable regulatory capital requirements or the amount required to be maintained for the liquidation account. For a description of the liquidation account, see Notes 16 and 17 to the Consolidated Financial Statements. Unlike the Bank, the Holding Company is not subject to OTS regulatory restrictions on the payment of dividends to its shareholders, however, it is subject to the requirements of Iowa law. Iowa law generally prohibits the Holding Company from paying a dividend if, after giving it effect, either of the following would result: (a) the Holding Company would not be able to pay its debts as they become due in the usual course of business; or (b) the Holding Company's total assets would be less than the sum of its total liabilities, plus the -10- amount that would be needed, if the Holding Company were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. The primary investing activities of the Company are the origination and purchase of mortgage and other loans and the purchase of securities. During the years ended December 31, 1998, 1997 and 1996, the Company's disbursements for loan originations and purchases totaled $85.2 million, $62.3 million and $52.0 million, respectively. These activities were funded primarily by net deposit inflows, principal repayments on loans, proceeds from the sale of securities and FHLB advances. Net cash flows used in investing activities amounted to $2.2 million, $19.1 million and $21.3 million for the years ended December 31, 1998, 1997 and 1996, respectively. Net cash flows provided by financing activities amounted to $9.4 million, $14.3 million and $19.8 million for the years ended December 31, 1998, 1997 and 1996, respectively. The OTS regulations require savings associations, such as the Bank, to meet three minimum capital standards: a tangible capital ratio requirement of 1.5% of total assets as adjusted under the OTS regulations; a leverage ratio requirement of 3% of core capital to such adjusted total assets; and a risk-based capital ratio requirement of 8% of core and supplementary capital to total risk-based assets. The Bank satisfied these minimum capital standards at December 31, 1998 with tangible and leverage capital ratios of 11.7% and a total risk-based capital ratio of 23.8%. In determining the amount of risk-weighted assets for purposes of the risk-based capital requirement, a savings association must compute its risk-based assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the United States Government or its agencies to 100% for consumer and commercial loans, as assigned by the OTS capital regulations. These capital requirements, which are applicable to the Bank only, do not consider additional capital held at the Holding Company level, and require certain adjustments to shareholder's equity to arrive at the various regulatory capital amounts. The table below presents the Bank's regulatory capital amounts as compared to the OTS regulatory capital requirements at December 31, 1998:
Capital Excess Amount Requirements Capital -------- -------------- -------- (In thousands) Tangible capital $38,245 $ 4,917 $33,328 Core capital 38,245 9,834 28,411 Risk-based capital 40,509 13,614 26,895
-11- Discussion of Market Risk--Interest Rate Sensitivity Analysis As a financial institution, the Company's primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Bank's assets and liabilities, and the market value of all interest-earning assets, other than those which possess a short term to maturity. Since all of the Company's interest-bearing liabilities and virtually all of the Company's interest-earning assets are located at the Bank, virtually all of the Company's interest rate risk management procedures are performed at the Bank level. Based upon the Bank's nature of operations, the Bank is not subject to foreign currency exchange or commodity price risk. The Bank's real estate loan portfolio, within Iowa, is subject to risks associated with the local economy. The Company has sought to diversify its loan portfolio by purchasing loans secured by properties outside of Iowa. At December 31, 1998, 30.4% of the Company's loan portfolio was secured by properties outside the State of Iowa, located in twenty-six states. See "Asset Quality." The Bank does not own any trading assets. At December 31, 1998, neither the Company nor the Bank had any hedging transactions in place, such as interest rate swaps and caps. The Company seeks to manage its interest risk by monitoring and controlling the variation in repricing intervals between its assets and liabilities. To a lesser extent, the Company also monitors its interest rate sensitivity by analyzing the estimated changes in market value of its assets and liabilities assuming various interest rate scenarios. As discussed more fully below, there are a variety of factors which influence the repricing characteristics of any given asset or liability. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The "interest rate sensitivity gap" is defined as the difference between the amount of interest- earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income. The Company's policy in recent years has been to manage its exposure to interest rate risk generally by focusing on the maturities of its interest rate sensitive assets and by emphasizing adjustable-rate mortgage loans, and maintaining a level of liquidity by investing in short to medium term United States Treasury notes, U. S. Government agencies, mortgage-backed securities and short-term interest-earning deposits. The Company generally offers competitive rates on deposit accounts and prices certificates of deposit to provide customers with incentives to choose certificates of deposit with longer terms. At December 31, 1998, total interest-bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same period by $41.4 million, representing a one-year gap ratio of negative 12.3%, compared to a one-year gap ratio of positive 0.28% at December 31, 1997. To manage the potential volatility of the Company's earnings in a changing interest rate environment, the Company has emphasized the origination of 7-year fixed rate mortgage loans that convert to adjustable rates at the conclusion of their initial terms and have overall maturities of up to 30 years, adjustable-rate loans and has sought to lengthen the terms of its deposits through its pricing strategies with respect to longer term certificates of deposit. The Chief Executive Officer regularly meets with the Bank's senior executive officers to review trends in deposits as well as mortgage and consumer lending. The Chief Executive Officer also regularly meets with the investment committee to review the investment portfolio. The Chief Executive Officer reports quarterly to the Board of Directors on interest rate risks and trends, as well as liquidity and capital ratios and requirements. -12- Gap Table. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1998 which are expected to reprice or mature, based upon certain assumptions, in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown that reprice or mature during a particular period were determined in accordance with the earlier of term of repricing or the contractual terms of the asset or liability. Certain assumptions used in preparing the table are set forth in the following table. Management believes that these assumptions approximate actual experience and considers them appropriate and reasonable.
At December 31, 1998 (1) ---------------------------------------------------------------------------------- Within 1-3 3-5 5-10 10-20 Over 20 1 Year Years Years Years Years Years Total --------- --------- --------- --------- --------- --------- --------- (Dollars in thousands) Interest-earning assets: First mortgage loans Adjustable (4) $ 51,059 $ 74,259 $ 9,113 $ -- $ -- $ -- $134,431 Fixed (4) 26,966 33,893 19,535 19,045 591 10 100,040 Consumer and other loans 11,811 19,146 3,015 106 -- -- 34,078 Investment securities(3) 35,421 11,410 3,769 4,976 -- -- 55,576 -------- -------- -------- -------- -------- -------- -------- Total interest-earning assets $125,257 $138,708 $ 35,432 $ 24,127 $ 591 $ 10 $324,125 ======== ======== ======== ======== ======== ======== ======== Rate sensitive liabilities: Savings accounts $ 26,099 $ -- $ -- $ -- $ -- $ -- $ 26,099 NOW accounts 30,909 -- -- -- -- -- 30,909 Money market accounts 19,828 -- -- -- -- -- 19,828 Certificate accounts 81,283 64,973 18,140 -- -- -- 164,396 Non-interest-bearing deposits 5,458 -- -- -- -- -- 5,458 FHLB advances and other liabilities 3,068 13,447 19,701 491 2,125 -- 38,832 -------- -------- -------- -------- -------- -------- -------- Total interest-bearing liabilities $166,645 $ 78,420 $ 37,841 $ 491 $ 2,125 $ -- $285,522 ======== ======== ======== ======== ======== ========= ======== Interest sensitivity gap $(41,388) $ 60,288 $ (2,409) $ 23,636 $ (1,534) $ 10 Cumulative interest-sensitivity gap $(41,388) $ 18,900 $ 16,491 $ 40,127 $ 38,593 $ 38,603 Interest sensitivity gap to total assets -12.29% 17.91% -0.72% 7.02% -0.46% -- Cumulative interest-sensitivity gap to -12.29% 5.61% 4.90% 11.92% 11.46% 11.47% total assets Ratio of interest-earning assets to 75.16% 176.88% 93.63% 100.00% 100.00% -- 113.52% interest-bearing liabilities Cumulative ratio of interest-earning 75.16% 107.71% 105.83% 114.16% 113.52% 113.52% 113.52% assets to interest-bearing liabilities Total assets $336,690 $336,690 $336,690 $336,690 $336,690 $336,690 $336,690 Cumulative interest bearing assets $125,257 $263,965 $299,397 $323,524 $324,115 $324,125 $324,125 Cumulative interest sensitive liabilities $166,645 $245,065 $282,906 $283,397 $285,522 $285,522 $285,522
_________________________________ (1) The Company prepared the above table using December 31, 1998 composite interest rate sensitivity assumptions of the Eighth District of the FHLB where such assumptions were available. Where such information was not available, the assumptions were made based on December 1998 OTS assumptions or the Company's actual experience. These assumptions are as follows: (i) fixed-rate first mortgage loans on one-to-four family residential properties with interest rates less than 8%, 8% to 9%, 9% to 10%, 10% to 11%, and 11% and over, and the remaining terms to maturity of over 15 years will prepay annually at 9%, 22%, 22%, 19% and 16%, respectively; (ii) adjustable-rate first mortgage loans on one-to-four family residential properties will prepay at 8% to 9% per year; (iii) fixed- and adjustable-rate mortgage loans on multifamily and commercial properties will repay at 8% per year; (iv) second mortgage consumer loans will prepay at 9% per year; (v) fixed-rate deposits will not be withdrawn prior to maturity; and (vi) passbook savings accounts, NOW accounts, money market accounts and noninterest-bearing deposit accounts are assumed to reprice within one year due to the possibility that such deposits will reprice in the event of significant changes in the overall level of interest rates. These assumptions are annual percentages based on remaining balances and should not be regarded as indicative of the actual prepayments and withdrawals that may be experienced by the Company. Certain shortcomings are inherent in the analysis presented by the foregoing table. (2) Fixed rate first mortgage loans include $44.0 million of one-to-four family seven year fixed rate loans that convert to adjustable rates at the beginning of the eighth year and are adjustable thereafter. (3) Includes FHLMC preferred stock, FNMA preferred stock, other equity securities, interest-bearing deposits and FHLB stock, all of which are shown in the within-one-year category. Components include interest-bearing deposits of $13.2 million and securities available for sale of $42.4 million. (4) Includes $629,000 and $6.9 million in mortgage-backed securities in the adjustable and fixed first mortgage loans, respectively. -13- Certain shortcomings are inherent in the method of analysis presented in the Gap Table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of changes in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase. NPV Analysis. As part of its efforts to maximize net interest income and manage the risks associated with changing interest rates, management uses the "market value of portfolio equity" ("NPV") methodology which the OTS has adopted as part of its capital regulations. Under this methodology, interest rate risk exposure is assessed by reviewing the estimated changes in Net Interest Income ("NII") and NPV which would hypothetically occur if interest rates rapidly rise or fall along the yield curve. Projected values of NII and NPV at both higher and lower regulatory defined rate scenarios are compared to base case values (no change in rates) to determine the sensitivity to changing interest rates. Presented below, as of December 31, 1998, is an analysis of the Company's interest rate risk ("IRR") as measured by changes in NPV and NII for instantaneous and sustained parallel shifts of 100 basis points in market interest rates. Such limits have been established with consideration of the impact of various rate changes and the Company's current capital position.
Interest Rate Sensitivity of Net Portfolio Value (NPV)(1) Net Portfolio Value NPV as % of PV of Assets ----------------------------- ------------------------ Change in Rates $ Amount $ Change % Change NPV Ratio Change - ----------------- -------- -------- --------- ---------- ---------- (Dollars in thousands) +400 bp $39,231 -5,002 -11% 12.28% -88bp +300 bp 41,304 -2,929 -7 12.73 -43bp +200 bp 42,957 -1,275 -3 13.06 -10bp +100 bp 43,937 -295 -1 13.20 4bp 0 bp 44,232 -- -- 13.16 -- -100 bp 44,149 -84 -- 13.02 -14bp -200 bp 44,237 4 -- 12.92 -24bp -300 bp 45,007 775 2 12.99 -17bp -400 bp 45,273 1,040 2 12.93 -23bp
_________________________________ (1) Denotes rate shock used to compute interest rate risk capital component. As is the case with the Gap Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV Table presented assumes that the composition of the Company's interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV Table provides an indication of the Company's interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on the Company's net interest income and will differ from actual results. Asset Quality Delinquencies. The Company's collection procedures provide that when a loan is 15 days past due, a computer-generated late charge notice is sent to the borrower requesting payment, plus a late charge for mortgage loans. If delinquency continues, on the 20th day past due, a telephone call is made to the borrower seeking payment. If the loan is 30 days past due, a delinquent notice is mailed along with a letter advising that the mortgagors are in violation of the terms of their mortgage contract. If a loan becomes 60 days past due, the loan becomes subject to possible legal action. After 90 days, if satisfactory payment terms are not reached with -14- the borrower, foreclosure proceedings are initiated. To the extent required by the Department of Housing and Urban Development ("HUD") regulations, generally within 45 days of delinquency, a Section 160 HUD notice is given to the borrower which provides access to consumer counseling services. It is sometimes necessary and desirable to arrange special repayment schedules with mortgagors to prevent foreclosure or filing for bankruptcy. The mortgagors are required to submit a written repayment schedule which is closely monitored for compliance. Under these terms, the account is brought to date, usually within a few months. Nonperforming Assets. Loans are reviewed on a regular basis and are placed on nonaccrual status when, in the opinion of management, the collection of additional interest is doubtful. Mortgage loans and consumer loans are placed on nonaccrual status generally when either principal or interest is more than 90 days past due. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is charged against interest income. Real estate acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure is deemed foreclosed real estate until such time as it is sold. In general, the Company considers collateral for a loan to be in substance foreclosed if: (i) the borrower has little or no equity in the collateral; (ii) proceeds for repayment of the loan can be expected to come only from the operation or sale of the collateral; and (iii) the borrower has either formally or effectively abandoned control of the collateral to the Company, or retained control of the collateral but is unlikely to be able to rebuild equity in the collateral or otherwise repay the loan in the foreseeable future. When foreclosed real estate is acquired or otherwise deemed foreclosed real estate, it is recorded at the lower of the unpaid principal balance of the related loan or its estimated fair value, less estimated selling expenses. Valuations are periodically performed by management, and any subsequent decline in fair value is charged to operations. At December 31, 1998, the Company's foreclosed real estate consisted of four properties with an aggregate value of $187,000. Delinquent Loans, Nonaccrual Loans and Nonperforming Assets. The following table sets forth information regarding loans on nonaccrual status and foreclosed real estate of the Company at the dates indicated. At the dates indicated, the Company did not have any material restructured loans within the meaning of SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, and did not have any loans that were ninety days past due and still accruing interest.
At December 31, ---------------------------------------- 1998 1997 1996 1995 1994 -------- ------ ------ ------ ------ (Dollars in thousands) Nonaccrual loans and nonperforming assets: First mortgage loans: One-to-four family residential $ 403 $ 122 $ 149 $ 137 $ 299 Multifamily and commercial properties (2) 423 -- -- -- -- Consumer loans: 130 25 35 44 25 ------ ----- ----- ----- ----- Total nonaccrual loans 956 147 184 181 324 Total foreclosed real estate(1) 187 67 128 128 -- Other nonperforming assets 1 -- 2 109 -- ------ ----- ----- ----- ----- Total nonperforming assets $1,144 $ 214 $ 314 $ 418 $ 324 ====== ===== ===== ===== ===== Total nonaccrual loans to net loans receivable 0.38% 0.08% 0.11% 0.12% 0.26% Total nonaccrual loans to total assets 0.28 0.07 0.09 0.10 0.21 Total nonperforming assets to total assets 0.34 0.10 0.15 0.23 0.21 (Notes on following page) - ------------------------
-15- (1) Represents the net book value of property acquired by the Company through foreclosure or deed in lieu of foreclosure. Upon acquisition, this property is recorded at the lower of cost or fair value less estimated selling expenses. (2) Includes a purchase loan which was secured by a commercial property that was 90 days past due in the amount of $364,636 (in actual dollars). This loan was repaid in March, 1999. The following table sets forth information with respect to loans delinquent 60-89 days in the Company's portfolio at the dates indicated.
At December 31, ----------------------------------- 1998 1997 1996 1995 1994 ------- ----- ----- ----- ----- (In thousands) Loans past due 60-89 days: First mortgage loans: One-to-four family residential $1,070 $ 275 $ 323 $ 311 $ 288 Multifamily and commercial properties 22 -- -- -- -- Consumer loans 270 135 51 28 62 ------ ----- ----- ----- ----- Total past due 60-89 days $1,362 $ 410 $ 374 $ 339 $ 350 ====== ===== ===== ===== =====
The following table sets forth information with respect to the Company's delinquent loans and other problem assets at December 31, 1998.
At December 31, 1998 ---------------------- Balance Number ----------- --------- (Dollars in thousands) One-to-four family first mortgage loans: Loans 60 to 89 days delinquent $1,070 25 Loans 90 days or more delinquent 403 11 Multifamily and commercial first mortgage loans: Loans 60 to 89 days delinquent 22 1 Loans 90 days or more delinquent (1) 423 2 Consumer Loans: Loans 60 to 89 days delinquent 270 29 Loans 90 days or more delinquent 130 13 Foreclosed real estate 187 4 Other nonperforming assets 1 1 Loans to facilitate sale of foreclosed real estate 206 6 Special mention loans 654 24
(1) Includes a purchase loan which was secured by a commercial property that was 90 days past due in the amount of $364,636 (in actual dollars). This loan was repaid in March, 1999. Classification of Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by the OTS to be of lesser quality as "substandard," "doubtful," or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the savings institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management. Loans designated as special mention are generally loans that, while current in required payments, have exhibited some potential weaknesses that, if not corrected, could increase the level of risk in the future. At December 31, 1998, the Company had $654,000 of special mention loans, consisting of eleven loans secured by one-to-four family residences, one commercial property and twelve consumer loans. -16- The following table sets forth the aggregate amount of the Company's classified assets at the dates indicated.
At December 31, ----------------------------------------- 1998 1997 1996 1995 1994 -------- ----- ----- ---------- ----- (In thousands) Substandard assets $ 745(2) $ 208 $ 311 $1,134(1) $ 357 Doubtful assets -- -- -- -- -- Loss assets 35 18 9 -- 10 ----- ----- ----- ------ ----- Total classified assets $ 780 $ 226 $ 320 $1,134 $ 367 ===== ===== ===== ====== =====
- --------------------- (1) Includes one purchased loan which was secured by a multifamily property that was 30 days past due in the amount of $791,000 (in actual dollars). This loan was repaid in January 1996. (2) Includes one purchased loan which was secured by a commercial property that was 90 days past due in the amount of $364,636 (in actual dollars). This loan was repaid in March, 1999. Allowance for Loan Losses. It is management's policy to provide an allowance for estimated losses on the Company's loan portfolio based on management's evaluation of the prior loss experience, industry standards, past due loans, economic conditions, the volume and type of loans in the Company's portfolio, which includes a significant amount of multifamily loans, substantially all of which are purchased and are collateralized by properties located outside of the Company's market area, and other factors related to the collectibility of the Company's loan portfolio. The Company regularly reviews its loan portfolio, including problem loans, to determine whether any loans require classification or the establishment of appropriate reserves or allowances for losses. Such evaluation, which includes a review of all loans of which full collectibility of interest and principal may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral. During the years ended December 31, 1998, 1997 and 1996 the Company's provision for loan losses were $210,000, $240,000 and $240,000, respectively. The Company's allowance for loan losses totalled $2.7 million, $2.2 million and $2.0 million at December 31, 1998, 1997 and 1996, respectively. Management believes that the allowances for losses on loans and foreclosed real estate are adequate. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowances for loan losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. -17- Analysis of the Allowance for Loan Losses. The following table sets forth the analysis of the allowance for loan losses for the periods indicated.
For the Year Ended December 31, ---------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (Dollars in thousands) Total loans outstanding $259,360 $ 194,626 $ 168,921 $151,310 $128,951 Average net loans outstanding 246,510 175,284 156,708 137,068 118,997 Allowance balances (at beginning of period 2,151 1,953 1,736 1,543 1,306 -------- --------- --------- -------- -------- Provisions for losses: First mortgage loans 135 190 150 200 165 Consumer loans 75 50 90 50 77 Effect of- 343 -- -- -- -- Valley Financial Corporation Charge-Offs: First mortgage loans 6 21 5 2 -- Consumer loans 23 31 19 56 7 Recoveries: First mortgage loans -- -- -- -- -- Consumer loans 1 10 1 1 2 -------- --------- --------- -------- -------- Net charge-offs 28 42 23 57 5 -------- --------- --------- -------- -------- Allowance balance (at end of period) $ 2,676 $ 2,151 $ 1,953 $ 1,736 $ 1,543 ======== ========= ========= ======== ======== Allowance for loan losses as a percent of total loans receivable at end of period 1.03% 1.10% 1.16% 1.15% 1.20% Net loans charged off as a percent of average net loans outstanding 0.01 0.02 0.01 0.04 -- Ratio of allowance for loan losses to total nonaccrual loans at end of period 279.72 1,468.33 1,059.35 960.20 476.23 Ratio of allowance for loan losses to total nonaccrual loans and foreclosed real estate at end of period 233.95 1,006.96 621.31 562.15 476.23
-18- Allocation of Allowance for Loan Losses. The following table sets forth the allocation for loan losses by loan category for the periods indicated:
At December 31, ------------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------------------------------------------------------------------------------------------------------- % of Loans % of Loans % of Loans % of Loans % of Loans In Each In Each In Each In Each In Each Category to Category to Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans -------- ------------- -------- ------------ -------- ------------ ------- ----------- ------- ----------- (Dollars in thousands) Balance at end of period applicable to: One-to-four family residential mortgage loans $ 684 57.45% $ 675 59.48% $ 503 63.44% $ 418 62.70% $ 429 65.48% Multifamily residential mortgage loans 1,298 25.02 1,026 26.38 948 20.42 870 20.90 646 16.70 Commercial mortgage loans 228 4.39 76 1.95 157 3.09 175 3.85 189 4.79 Consumer loans 466 13.14 374 12.19 345 13.05 273 12.55 279 13.03 -------- ------------- -------- ------------ -------- ------------ ------- ----------- ------- ----------- Total allowance for loan losses $ 2,676 100.00% $ 2,151 100.00% $ 1,953 100.00% $ 1,736 100.00% $ 1,543 100.00% ======== ============= ======== ============ ======== ============ ======= =========== ======= ==========
Average Balance Sheet The following table sets forth certain information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. For purposes of this table, average balances were computed on a monthly basis. -19-
For the Year Ended December 31, ----------------------------------------------------------------------- At December 31, 1998 1998 1997 ---------------------- ----------------------------------- ---------------------------------- Average Average Yield/ Average Yield/ Average Yield/ Balance Cost Balance Interest Cost Balance Interest Cost ------------- --------- ------------- ------------ --------- ------------- ------------ ------- (Dollars in thousands) Assets: Interest-earning assets: First mortgage loans(1).............. $ 222,621 7.88% $ 216,914 $17,318(8) 7.98% $ 154,227 $12,433(8) 8.06% Consumer loans(1)...... 34,076 9.18 32,173 3,014 9.37 23,138 2,201 9.51 Investment securities.. 62,513(4) 5.59 57,826(5) 3,270 5.65 27,102(6) 1,571 5.79 --------- ---- --------- ------- ---- --------- ------- ---- Total interest-earning assets.............. 319,210 7.57% 306,913 23,602 7.69% $ 204,467 $16,205 7.93 ======= ======= Noninterest-earning assets.................. 17,480 16,847 6,645 --------- --------- --------- Total assets......... $ 336,690 $ 323,760 $ 211,112 ========= ========= ========= Liabilities and Equity: Interest-bearing liabilities: NOW and money market savings.............. $ 50,735 2.20% $ 44,622 $ 1,351 3.03% $ 21,777 $ 632 2.90% Passbook savings....... 26,098 2.24 25,591 594 2.32 17,425 392 2.25 Certificates of Deposit............... 164,396 5.63 159,701 8,948 5.60 93,239 5,470 5.87 Borrowed funds......... 38,832 5.61 34,020 1,976 5.81 23,679 1,406 5.94 --------- ---- --------- ------- ---- --------- ------- ---- Total interest-bearing liabilities......... $ 280,061 4.69% $ 263,934 $12,869 4.88% $ 156,120 $ 7,900 5.06% ======= Noninterest-bearing liabilities............. 8,422 9,587 5,634 --------- --------- --------- Total liabilities.... $ 288,483 $ 273,522 $ 161,754 Equity...................... 48,207 50,239 49,358 --------- --------- --------- Total liabilities and equity.......... $ 336,690 323,760 $ 211,112 ========= ========= ========= Net interest income...... $10,733 $ 8,305 ======= ======= Net interest rate spread(2)............... 2.88% 2.81% 2.87% Net interest margin (3).. 3.45 3.50 4.06 Ratio of average interest-earning assets to average interest- bearing liabilities..... 113.98 116.28 130.97 For the Year Ended December 31, ------------------------------------- 1996 ------------------------------------- Average Average Yield/ Balance Interest Cost ------------- --------- ----------- (Dollars in thousands) Assets: Interest-earning assets: First mortgage loans(1).............. $ 137,668 $ 11,174(8) 8.12% Consumer loans(1)...... 20,900 2,007 9.60 Investment securities.. 29,827(7) 1,909 6.40 --------- --------- ---- Total interest-earning assets.............. $ 188,395 $ 15,090 8.01 ========= Noninterest-earning assets.................. 4,721 --------- Total assets......... $ 193,116 ========= Liabilities and Equity: Interest-bearing liabilities: NOW and money market savings.............. $ 18,704 $ 530 2.83% Passbook savings....... 18,997 432 2.27 Certificates of Deposit............... 88,688 5,256 5.93 Borrowed funds......... 12,114 711 5.87 --------- --------- Total interest-bearing liabilities......... $ 138,503 $ 6,929 5.00% ========= Noninterest-bearing liabilities............. 4,920 --------- Total liabilities.... $ 143,423 Equity...................... 49,693 --------- Total liabilities and equity.......... $ 193,116 ========= Net interest income...... $ 8,161 ========= Net interest rate spread(2)............... 3.01% Net interest margin (3).. 4.33 Ratio of average interest-earning assets to average interest- bearing liabilities..... 136.02
____________________ (1) Balance is net of deferred loan fees, loan discounts and loans in process. Nonaccrual loans are included in the balances. (2) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities. (3) Net interest margin represents net interest income divided by average total interest-earning assets. (4) Includes interest-bearing deposits of $13,201,000 and securities available for sale of $49,312,000. (5) Includes interest-bearing deposits of $8,235,000 and securities available for sale of $49,590,000. (6) Includes interest-bearing deposits of $3,912,000, securities available for sale of $22,440,000 and securities held to maturity of $750,000. (7) Includes interest-bearing deposits of $3,323,000, securities available for sale of $16,298,000 and securities held to maturity of $10,206,000. (8) Includes loan fee amortization of $(29,000), $(35,000) and $(33,000) for the years ended December 31, 1998, 1997 and 1996. -20- Rate/Volume Analysis The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in average volume (changes in average volume multiplied by old rate); (ii) changes in rates (changes in rate multiplied by old average volume); (iii) changes in rate-volume (changes in rate multiplied by the changes in average volume); and (iv) the net change.
Year Ended Year Ended December 31, 1998 December 31, 1997 Compared to Compared to Year Ended Year Ended December 31, 1997 December 31, 1996 ------------------------------------------------------------------------------------ Increase/(Decrease) Increase/(Decrease) Due to Due to ---------------------------- Total -------------------------------- Total Rate/ Increase Rate/ Increase Volume Rate Volume (Decrease) Volume Rate Volume (Decrease) -------- -------- -------- ---------- --------- -------- ---------- ------------ (In thousands) Interest income: First mortgage loans............$ 5,054 $ (120) $ (49) $ 4,885 $ 1,344 $ (76) $ (9) $ 1,259 Consumer loans.................. 859 (33) (13) 813 215 (19) (2) 194 Investment securities........... 1,770 (83) 12 1,699 (216) (109) (13) (338) -------- ------- -------- ---------- --------- -------- --------- ----------- Total interest-earning assets..$ 7,683 $ (236) $ (50) $ 7,397 $ 1,343 $ (204) $ (24) $ 1,115 ======== ======= ======== ========== ========= ======== ========= =========== Interest expense: NOW and money market savings....$ 663 $ 27 $ 29 $ 719 $ 87 $ 13 $ 2 $ 102 Passbook savings................ 184 13 6 203 (36) (4) -- (40) Certificate of deposits......... 3,897 (246) (175) 3,476 271 (53) (3) 215 Borrowed funds.................. 614 (30) (13) 571 679 8 7 694 -------- ------- -------- ---------- --------- -------- --------- ----------- Total interest-bearing liabilities...................$ 5,358 $ (236) $ (153) $ 4,969 $ 1,001 $ (36) $ 6 $ 971 ======== ======= ======== ========== ========= ======== ========= =========== Net change in net interest income..........................$ 2,325 $ -- $ 103 $ 2,428 $ 342 $ (168) $ (30) $ 144 ======== ======= ======== ========== ========= ======== ========= ===========
-21- PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) The unaudited pro forma consolidated financial statements presented on the following pages are based on the historical financial statements of the Company and Valley Financial. The unaudited pro forma consolidated statements of income for the year ended December 31, 1998 and 1997 were prepared as if the Acquisition had occurred as of the beginning of the respective periods for purposes of the combined consolidated statements of income and as if such an acquisition had occurred at December 31, 1997 for purposes of the combined consolidated statement of financial condition. The income statement for the year ended December 31, 1998 would therefore include the month ended January 31, 1998 for Valley Financial. These pro forma financial statements are not necessarily indicative of the results of operations that might have occurred had the Acquisition taken place at the beginning of the period, or to project the Company's results of operations at any future date or for any future period. -22- MANAGEMENT OF THE HOLDING COMPANY AND THE BANK The Board of Directors of the Holding Company is divided into three classes, each of which contains one-third of the Board. The Bylaws of the Holding Company currently authorize six directors. Currently, all directors of the Holding Company are also directors of the Bank. Directors David M. Bradley, CPA is Chairman of the Board, President and Chief Executive Officer. John M. Peters is a retired attorney. Howard A. Hecht is a retired insurance executive, who was a Vice President with Principal Mutual Life Insurance Company in Des Moines, Iowa. Melvin R. Schroeder is Vice President of Instruction at Iowa Central Community College in Fort Dodge, Iowa. KaRene Egemo is the owner of Egemo Realty, Inc. in Fort Dodge, Iowa. Robert H. Singer, Jr. is the co-owner of Calvert, Singer & Kelley Insurance Services, Inc., an insurance agency, in Fort Dodge, Iowa. Executive Officers Who are Not Directors C. Thomas Chalstrom is Chief Operating Officer of the Bank and Executive Vice President of the Holding Company and the Bank. Jean L. Lake is Secretary of the Holding Company and the Bank. John L. Pierschbacher, CPA is Treasurer of the Holding Company and the Bank. Kirk A. Yung is Senior Vice President of the Bank. -71- SHAREHOLDER INFORMATION Price Range of the Company's Common Stock The Company's Common Stock trades on The Nasdaq National Market System under the symbol "FFFD." The following table shows the high and low per share sales prices of the Company's Common Stock as reported by Nasdaq and the dividends declared per share during the periods indicated. Such quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not necessarily represent actual transactions. Price Range -------------- Dividends Declared Quarter Ended High Low Per Share - ------------------- ------ ------ ------------------ 1997 - ---- First Quarter 16.750 13.375 0.0625 Second Quarter 16.125 15.000 0.0625 Third Quarter 18.250 15.625 0.0625 Fourth Quarter 20.125 17.188 0.0625 1998 - ---- First Quarter 22.875 18.750 0.0800 Second Quarter 24.875 21.188 0.0800 Third Quarter 21.250 15.000 0.0800 Fourth Quarter 18.313 15.406 0.0800 - -------------------- The Company's Common Stock was traded at $16.50 as of March 12, 1999. Information Relating to the Company's Common Stock As of March 11, 1999, the Company had 2,120 shareholders of record, which does include the number of persons or entities who hold their Common Stock in nominee or "street" name through various brokerage firms. As of such date 2,957,242 shares of the Common Stock were outstanding. The Company's current quarterly dividend is $0.10 per share. The Board of Directors of the Company plans to maintain a regular quarterly dividend in the future and will continue to review the dividend payment amount in relation to the Company's earnings, financial condition and other relevant factors (such as regulatory requirements). The Bank will not be permitted to pay dividends to the Holding Company on its capital stock if its shareholders' equity would be reduced below the amount required for the liquidation account. For information concerning federal regulations which apply to the Bank in determining the amount of proceeds which may be retained by the Company and regarding a savings institution's ability to make capital distributions including payment of dividends to its holding company, see Note 11 to the Consolidated Financial Statements. Unlike the Bank, the Holding Company is not subject to OTS regulatory restrictions on the payment of dividends to its shareholders, although the source of such dividends will be dependent on the net proceeds retained by the Holding Company and earnings thereon and may be dependent, in part, upon dividends from the Bank. The Holding Company is subject to the requirements of Iowa law, which prohibit the Holding Company from paying a dividend if, after giving it effect, either of the following would result: (a) the Holding Company would not be able to pay its debts as they become due in the usual course of business; or (b) the Holding Company's total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the Holding Company were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. -72- Annual Meeting The Annual Meeting of Shareholders of the Company will be held at 10:00 a.m., Friday, April 23, 1999 at the Country Inn, 3259 5/th/ Avenue South, Fort Dodge, Iowa. Stockholders and General Inquiries David M. Bradley North Central Bancshares, Inc. c/o First Federal Savings Bank of Iowa 825 Central Avenue Fort Dodge, Iowa 50501 (515) 576-7531 General Counsel Independent Auditor Johnson, Erb, Bice, McGladrey & Pullen, LLP Kramer, Good & Mulholland, P.C. 640 Capital Square 809 Central Avenue Fourth & Locust Streets Fort Dodge, Iowa 50501 Des Moines, Iowa 50309 Special Counsel Transfer Agent Thacher Proffitt & Wood American Securities Transfer and 1700 Pennsylvania Avenue, N.W., Suite 800 Trust, Inc. Washington, D.C. 20006 1825 Lawrence Street, Suite 444 Denver, Colorado 80202-1817 (303) 234-5300 Annual Report on Form 10-K A copy of the Company's Form 10-K (without exhibits) for the fiscal year ended December 31, 1998 will be furnished without charge to shareholders as of March 11, 1999 upon written request to Jean L. Lake, Corporate Secretary, North Central Bancshares, Inc., c/o First Federal Savings Bank of Iowa, 825 Central Avenue, Fort Dodge, Iowa 50501. -73- EX-21.1 4 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 Exhibit 21.1 Subsidiaries of Registrant.
State of Subsidiary Incorporation Percentage Owned First Financial Service Corporation Iowa Wholly owned by the Bank First Iowa Title Services, Inc. Iowa Wholly owned by the Bank Northridge Apartments Limited Partnership Iowa 99% owned by the Bank First Iowa Mortgage, Inc. Iowa Wholly owned by the Bank First Federal Savings Bank of Iowa Federal Wholly owned by the Registrant
EX-23.1 5 CONSENT OF MCGLADREY & PULLEN, LLP EXHIBIT 23.1 Exhibit 23.1 Consent of McGladrey & Pullen, LLP To the Board of Directors North Central Bancshares, Inc. Fort Dodge, Iowa We consent to the incorporation by reference in the North Central Bancshares, Inc. Registration Statement on Form S-8 of North Central Bancshares, Inc., pertaining to the North Central Bancshares, Inc. 1996 Stock Option Plan, of our report dated February 10, 1999, which appears in the annual report on Form 10-K of North Central Bancshares, Inc. and subsidiaries for the year ended December 31, 1998. /s/ McGladrey & Pullen, LLP McGladrey & Pullen, LLP Des Moines, Iowa March 25, 1999 EX-27 6 FINANCIAL DATA SCHEDULE
9 This schedule contains summary financial information extracted from the consolidated condensed statement of financial condition and the consolidated condensed statement of income and is qualified in its entirety by reference to such financial statements. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 2,435,439 12,201,437 0 0 49,882,544 0 0 254,032,497 2,676,438 336,690,139 246,690,313 11,000,000 2,960,773 27,832,239 0 0 40,111 48,166,703 336,690,139 20,331,935 3,269,617 0 23,601,552 10,893,081 12,868,960 10,732,592 210,000 51,362 7,571,826 6,865,465 6,865,465 0 0 4,384,845 1.44 1.40 7.69 956,821 0 0 0 2,150,588 28,422 855 2,676,438 2,676,438 0 0
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