0000904280-01-500110.txt : 20011009 0000904280-01-500110.hdr.sgml : 20011009 ACCESSION NUMBER: 0000904280-01-500110 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HCB BANCSHARES INC CENTRAL INDEX KEY: 0001029740 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 621670792 STATE OF INCORPORATION: OK FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-22423 FILM NUMBER: 1747841 BUSINESS ADDRESS: STREET 1: HEARTLAND COMMUNITY BANK STREET 2: 237 JACKSON ST CITY: CAMDEN STATE: AR ZIP: 71701 BUSINESS PHONE: 8708366841 MAIL ADDRESS: STREET 1: HEARTLAND COMMUNITY BANK STREET 2: 237 JACKSON STREET CITY: CAMDEN STATE: AR ZIP: 71701 10-K405 1 fm10k2001-1843.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________________ FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 2001 Commission File Number: 0-22423 HCB BANCSHARES, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in Its Charter) Oklahoma 62-1670792 --------------------------------------------- -------------------- (State or Other Jurisdiction of Incorporation (I.R.S. Employer or Organization) Identification No.) 237 Jackson Street, Camden, Arkansas 71701-3941 ---------------------------------------------- --------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (870) 836-6841 -------------- Securities registered pursuant to Section (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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing 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 amendment to this Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, as of a specified date within the past 60 days: $17,395,555 (1,386,100 shares at the last sale price on August 31, 2001 ($12.55 per share); for this purpose, directors, executive officers and 5% stockholders have been deemed to be affiliates). State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 2,118,223 shares of common stock as of August 31, 2001. DOCUMENTS INCORPORATED BY REFERENCE The following lists the documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated: 1. Portions of Annual Report to Stockholders for the Fiscal Year Ended June 30, 2001. (Parts II and IV) 2. Portions of Proxy Statement for the 2001 Annual Meeting of Stockholders. (Part III) PART I ITEM 1. DESCRIPTION OF BUSINESS -------------------------------- GENERAL HCB BANCSHARES, INC. HCB Bancshares, Inc. ("Bancshares") was incorporated under the laws of the State of Oklahoma in December 1996 at the direction of the Board of Directors of HEARTLAND Community Bank (the "Bank") for the purpose of serving as a savings institution holding company of the Bank, upon the acquisition of all of the capital stock issued by the Bank upon its conversion from mutual to stock form, which was completed on April 30, 1997 (the "Conversion"). The consolidated financial statements include the accounts of Bancshares and the Bank and are collectively referred to as the "Company". All significant intercompany balances and transactions have been eliminated in consolidation. Prior to the Conversion, Bancshares did not engage in any material operations. Since the Conversion, Bancshares has had no significant assets other than the outstanding capital stock of the Bank, a portion of the net proceeds of the Conversion and notes receivable, one of which is from the Employee Stock Ownership Plan ("ESOP"). Bancshares principal business is the business of the Bank. At June 30, 2001, the Company had consolidated total assets of $287.6 million, deposits of $161.3 million and stockholders' equity of $31.9 million, or 11.1% of total assets. The holding company structure permits Bancshares to expand the financial services currently offered through the Bank. As a holding company, Bancshares has greater flexibility than the Bank to diversify its business activities through existing or newly formed subsidiaries or through acquisition or merger with other financial institutions. Bancshares is classified as a unitary savings institution holding company and is subject to regulation by the Office of Thrift Supervision ("OTS"). As long as Bancshares remains a unitary savings institution holding company, under current law it can diversify its activities in such a manner as to include any activities allowed by law or regulation to a unitary savings institution holding company. See "Regulation -- Regulation of Bancshares -- Activities Restrictions." The Company's executive offices are located at 237 Jackson Street, Camden, Arkansas 71701-3941, and its telephone number is (870) 836-6841. HEARTLAND COMMUNITY BANK. HEARTLAND Community Bank was organized as a federally chartered mutual savings and loan association named "First Federal Savings and Loan Association of Camden" ("First Federal") in 1933, and in 1934 it became a member of the FHLB system and obtained federal deposit insurance. In May 1996, First Federal acquired the former Heritage Bank, FSB, which retained its separate federal savings bank charter and deposit insurance as a wholly owned subsidiary of First Federal (in order to facilitate possible future branch expansion, in the event the Bank ever becomes subject to Arkansas branching restrictions, which at that time were based on the home office location of each separately chartered banking institution), but whose business operations were fully integrated with those of First Federal. In September 1996, First Federal and Heritage changed their names to HEARTLAND Community Bank and HEARTLAND Community Bank, F.S.B., respectively. On February 23, 1998 the Bank sold all of the shares of stock of Heritage Banc Holding, Inc., parent of its subsidiary savings bank, HEARTLAND Community Bank, FSB ("FSB"), pursuant to an agreement between the Bank and the Bank of the Ozarks, Inc. ("BOO"). Upon completion of the transaction and pursuant to the terms of the agreement, the Bank acquired the loans and certain other assets and non-deposit liabilities of the Little Rock, Arkansas branch of FSB and all assets and liabilities of the Monticello, Arkansas branch and the Bryant, Arkansas loan production office of FSB and BOO acquired the savings deposits and premises and equipment of the Little Rock, Arkansas branch of FSB, as well as FSB's holding company charter and stock. This transaction was substantively a branch sale. Also at such time, Bancshares became a unitary rather than a multiple savings institution holding company. The Bank currently operates through six full-service banking offices located in Camden (2), Fordyce, Sheridan, Monticello, and Bryant, Arkansas. Historically, the principal business strategy of the Bank, like most 1 other savings institutions in Arkansas and elsewhere, has been to accept savings deposits from residents of the communities served by the Bank's branch offices and to invest those funds in single-family mortgage loans to those and other local residents. In this manner, the Bank and countless other independent community-oriented savings institutions operated safely and soundly for generations. In recent years, however, as the banking business nationwide and in the Bank's primary market area in particular has become more competitive, smaller savings institutions like the Bank have come under increasing market pressure either to grow and increase their profitability or to be acquired by a larger institution. Moreover, during this period the Bank's market area experienced only limited economic growth. The Bank's current business strategy, as developed and adopted by all of the Bank's directors, officers and employees, incorporates the following key elements: (i) remaining a community-oriented financial institution by continuing to provide the quality service that only a locally based institution and its dedicated staff can deliver, including the possible retention of additional executive officers in the future as the Bank's growth and other needs may warrant; (ii) strengthening the Bank's core deposit base and decreasing interest costs and increasing fee income by expanding the Bank's deposit facilities and products, including the addition and expansion of branch offices, the installation of ATMs, and an emphasis on attracting consumer demand deposits; (iii) increasing loan yields and fee income while maintaining asset quality by emphasizing the origination of higher yielding and shorter term loans, especially commercial and multi-family real estate loans and consumer and commercial business loans, for the Bank's portfolio while increasingly originating lower yielding longer term single-family residential loans principally for resale to investors; (iv) using the capital raised in the Conversion to support the Bank's future growth; and, (v) complementing the Bank's internally generated growth, by potentially acquiring one or more banking institutions or other financial companies if attractive opportunities arise. While it is expected that the Bank may experience especially high deposit and loan growth in the relatively high income and growth segments of the Bank's primary market area, particularly in the Sheridan, Monticello and Bryant areas, management expects to find significant deposit growth and lending opportunities throughout central and southern Arkansas. As a federally chartered savings institution, the Bank is subject to extensive regulation by the OTS. The Bank's lending activities and other investments must comply with various federal regulatory requirements, and the OTS periodically examines the Bank for compliance with various regulatory requirements. The Federal Deposit Insurance Corporation ("FDIC") also has the authority to conduct special examinations. The Bank must file reports with the OTS describing its activities and financial condition and is also subject to certain reserve requirements promulgated by the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). MARKET AREA Management considers the Bank's primary market area to comprise the following counties in Arkansas: Bradley, Calhoun, Cleveland, Dallas, Drew, Grant, Ouachita and Saline. To a lesser extent, the Bank accepts savings deposits and offers loans throughout the remainder of central and southern Arkansas. The year 2000 census data indicates that the population has experienced growth in Bradley (6.8%), Cleveland (10.2%), Drew (7.8%), Grant (18.0%) and Saline (30.1%) Counties, while population has declined somewhat in Calhoun (-1.4%), Dallas (-4.2%) and Ouachita (-5.8%) Counties over the past ten years. Median household income has been well above the Arkansas average in Saline, Grant and Cleveland Counties, slightly below the Arkansas average in Drew, Ouachita, and Calhoun Counties, and well below the Arkansas average in Dallas and Bradley Counties, though the Arkansas average is below the national average. With respect to unemployment rates, the Arkansas average has tended to rise slightly above the national average, and while unemployment rates have been well below the Arkansas average in Saline County, unemployment rates have been moderately above the Arkansas average in Grant and Cleveland Counties, and well above the Arkansas average in Bradley, Calhoun, Dallas, Drew and Ouachita Counties. The economies in the Bank's primary market area include a variety of industries, including manufacturing, government, services and retail trade. Important employers include Georgia Pacific in the timber industry and Lockheed Martin and Atlantic Research in the defense industry, SAU Tech and UA-Monticello. In addition, industries in the Bryant area include Bryant School District as the largest employer, with Alcoa as the largest industrial business, and United Auto Group as the second largest employer. 2 COMPETITION The Bank experiences substantial competition both in attracting and retaining savings deposits and in the originating of mortgage and other loans. Direct competition for savings deposits comes from other savings institutions, credit unions, and both regional and local commercial banks. Significant competition for the Bank's other deposit products and services comes from money market mutual funds and brokerage firms. The primary factors in competing for loans are loan products, interest rates and the quality of personal service. Competition for origination of real estate loans normally comes from other savings institutions, commercial banks, credit unions and mortgage companies. The Bank's primary competition comes from institutions located in the Bank's primary market area. Competing financial institutions offer a wide variety of deposit and loan products. Management's principal competitive strategy has been to emphasize quality customer service. LENDING ACTIVITIES The Bank's principal lending activity consists of the origination of loans collateralized by mortgages on existing and on construction of single-family residences in the Bank's primary market area, and commercial real estate and multifamily properties in the states of Arkansas and Tennessee. The Bank also makes a variety of consumer and commercial business loans. The Bank has for several years, made commercial real estate loans in the Memphis, Tennessee area through a long-standing broker relationship. Management expects to continue to expand on these types of lending. With certain limited exceptions, the maximum amount that a savings institution may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully collateralized by readily marketable collateral. Savings institutions are additionally authorized to make loans to one borrower, for any purpose, in an amount not to exceed $500,000 or, by order of the Director of the OTS, in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop residential housing, provided: (i) the purchase price of each single-family dwelling in the development does not exceed $500,000; (ii) the institution is in compliance with its regulatory capital requirements; (iii) the loans comply with applicable loan-to-value requirements, and; (iv) the aggregate amount of loans made under this authority does not exceed 150% of unimpaired capital and surplus. At June 30, 2001, the maximum aggregate amount that the Bank could have lent to any one borrower under the 15% limit was $4.6 million. At such date, the largest aggregate amount of loans that the Bank had outstanding to any one borrower was $4.7 million. Although the aggregate loan balance as of June 30, 2001 exceeded the Bank's lending limit at that date, the aggregate balance was within the lending limit on the dates the loans were approved by the board and booked. Bancshares may participate in loans to one borrower thereby permitting loans to one borrower to be made by the Bank and Bancshares lending together that exceed the Bank's regulatory loan limit. At June 30, 2001, the Bank and Bancshares' loans to the borrower referred to above totaled approximately $5.4 million with Bancshares carrying $0.7 million of the loans. 3 LOAN PORTFOLIO COMPOSITION. The following table sets forth information regarding the composition of the Bank's loan portfolio by type of loan at the dates indicated. At June 30, 2001, the Bank had no concentrations of loans exceeding 10% of gross loans other than as disclosed below.
At June 30, ---------------------------------------------------------------------- 2001 2000 1999 ------------------- --------------- ----------------- Amount % Amount % Amount % ------ ----- ------ ----- ------ ----- Type of Loan ------------ Real estate loans: One-to-four family residential $ 57,001,679 38.97% $ 61,198,180 42.26% $ 53,622,417 43.74% Multi-family loans 6,810,198 4.66 9,220,931 6.37 9,226,426 7.53 Non-residential 49,736,511 34.01 48,756,744 33.67 41,907,368 34.18 Loans to facilitate sale of foreclosed real estate -- -- -- -- -- -- Land and other mortgage loans 10,080,790 6.89 5,644,050 3.90 3,547,514 2.89 Consumer loans: Loans secured by savings deposits 2,488,948 1.70 2,320,915 1.60 2,021,141 1.65 Home improvement 23,611 0.02 40,851 0.03 125,990 0.10 Auto 6,779,218 4.64 6,589,480 4.55 4,269,898 3.48 Other consumer 2,050,039 1.40 2,260,697 1.56 2,517,190 2.05 Commercial 11,289,519 7.71 8,769,131 6.06 5,367,611 4.38 ------------ ------ ------------ ------ ------------ ------ Total $146,260,513 100.00% $144,800,979 100.00% $122,605,555 100.00% ------------ ------ ----------- ------ ------------ ------ Less: Loans in process $ 13,294,723 $ 8,100,982 $ 6,150,810 Deferred loan costs (fees), net (131,745) (158,217) (37,339) Allowance for loan losses 1,446,114 1,231,709 1,329,201 ------------ ------------ ------------ Total $131,651,421 $135,626,505 $115,162,883 ============ ============ ============ At June 30, ----------------------------------------- 1998 1997 ------------------ ----------------- Amount % Amount % ------ ----- ------ ----- Type of Loan ------------- Real estate loans: One-to-four family residential $ 49,267,399 44.75% $ 62,340,601 60.90% Multi-family loans 12,577,034 11.43 8,873,156 8.67 Non-residential 35,321,040 32.08 18,814,701 18.38 Loans to facilitate sale of foreclosed real estate 473,476 0.43 616,660 0.60 Land and other mortgage loans 598,860 0.54 483,236 0.47 Consumer loans: Loans secured by savings deposits 2,215,441 2.01 2,434,621 2.38 Home improvement 1,291,174 1.17 1,665,244 1.63 Auto 4,070,750 3.70 2,399,648 2.34 Other consumer 1,569,076 1.43 2,629,442 2.58 Commercial 2,708,927 2.46 2,101,963 2.05 ------------ ------ ------------ ------ Total $110,093,177 100.00% $102,359,272 100.00% ------------ ------ ------------ ------ Less: Loans in process $ 3,921,787 $ 2,057,095 Deferred loan costs (fees), net 122,679 167,069 Allowance for loan losses 1,468,546 1,492,473 ------------ ------------ Total $104,580,165 $ 98,642,635 ============ ============
4 LOAN MATURITY SCHEDULES. The following table sets forth information regarding dollar amounts of loans maturing in the Bank's portfolio based on their contractual terms to maturity, at June 30, 2001. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. The table does not include any estimate of prepayments, which significantly shorten the average life of all mortgage loans and may cause the Bank's repayment experience to differ from that shown below.
Due After Due Within One Through Due After One Year Five Years Five Years Total -------- ---------- ---------- ----- (In thousands) Real estate loans: One-to-four family mortgage loans......................... $12,169 $ 20,697 $ 24,136 $ 57,002 Other mortgage loans............ 18,673 18,996 28,958 66,627 Commercial loans.................. 5,826 4,174 1,290 11,290 Consumer loans: Loans secured by savings deposits 2,208 274 7 2,489 Other.......................... 3,189 5,148 516 8,853 ------- -------- -------- -------- Total........................ $42,065 $ 49,289 $ 54,907 $146,261 ======= ======== ======== ========
The following table sets forth as of June 30, 2001, dollar amounts of loans due one year or more after June 30, 2001 that had predetermined interest rates and that had adjustable interest rates at that date.
Predetermined Floating or Rates Adjustable Rates Total ------------- ---------------- -------- (In thousands) Real estate loans: One-to-four family mortgage loans.... $ 38,100 $ 6,733 $ 44,833 Other mortgage loans................. 37,044 10,910 47,954 Commercial loans....................... 4,106 1,358 5,464 Consumer loans: Loans secured by savings deposits.... 281 -- 281 Other consumer loans................. 5,664 -- 5,664 --------- --------- --------- Total.............................. $ 85,195 $ 19,001 $ 104,196 ========= ========= =========
Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan market rates are substantially lower than rates on existing mortgage loans. 5 LOAN ORIGINATIONS, PURCHASES AND SALES. The following table sets forth information regarding the Bank's loan originations, purchases and sales during the periods indicated.
Year Ended June 30, -------------------------------------------------- 2001 2000 1999 ----------- ------------ ------------- Loans originated: Real estate loans: One-to-four family residential............................ $ 28,443,919 $ 46,925,450 $ 24,486,365 Other mortgage loans...................................... 22,007,354 29,145,079 18,804,077 Commercial loans............................................ 4,465,227 7,973,954 7,350,903 Consumer loans.............................................. 9,659,572 13,515,847 5,380,714 ------------- ------------- ------------- Total loans originated................................... $ 64,576,072 $ 97,560,330 $ 56,022,059 ============= ============= ============= Loans purchased: Real estate loans........................................... $ 40,000 $ 82,547 $ -- ============= ============= ============= Loans sold.................................................... $ 12,732,692 $ 10,160,826 $ 13,140,464 ============= ============ =============
The Bank has increased both its scope of loan products offered and its loan origination efforts, including the addition of new consumer and commercial business loan offerings with an increased emphasis on the origination of such loans and commercial and multi-family real estate loans. However, higher interest rates in the first half of the fiscal year ended June 30, 2001, and increased competition resulted in the origination of fewer numbers and total amount of loans. The Bank has purchased loans from established and reputable loan originators from time to time to supplement the Bank's internally generated originations. Historically, substantially all of the Bank's loan purchases have been from one large homebuilder with which the Bank has a long-standing relationship. The Bank's experience with its purchased loans has been successful. The Bank originates long term, fixed-rate, single-family loans and sells them to investors in the secondary market. Management expects the Bank to increase its origination of selected types of loans that do not meet the Bank's loan portfolio needs, such as long-term fixed-rate residential mortgage loans for sale to investors. ONE-TO-FOUR FAMILY RESIDENTIAL LENDING. Historically, the Bank's principal lending activity has been the origination of fifteen-year fixed-rate first mortgage loans in the Bank's primary market area. The purchase price or appraised value of most of such residences generally has been between $50,000 and $200,000, with the Bank's loan amounts averaging approximately $75,000. At June 30, 2001, $57.0 million, or 39.0%, of the Bank's total loans were collateralized by one-to-four family residences, substantially all of which were existing, owner-occupied, single-family residences in the Bank's primary market area. While the Bank offers a variety of one-to-four family residential mortgage loans with fixed or adjustable interest rates and terms of up to 30 years, substantially all of the fixed-rate loans retained in the Bank's portfolio have terms of 15 years or less. Despite the relatively low credit risks associated with the Bank's 30-year one-to-four family portfolio loans, due to the interest rate risks associated with such longer term loans, management has approved shifting the Bank's one-to-four family residential lending emphasis in the future away from the origination of such loans for the Bank's portfolio and toward the origination of such loans for sale. Currently, it is the Bank's policy to originate all 30-year term one-to-four family residential loans in accordance with the investor's underwriting guidelines and to sell all such originations promptly to investors, servicing released. Such loan originations and sales have become significant. One-to-four-family residential loans originated during the year totaled $29.1 million with $12.7 million or 43.7% of originations sold or to be sold in the secondary market. The Bank will continue to make non-conforming loans to be held in the Bank's portfolio. Management expects to continue these policies in the future. 6 With respect to one-to-four family residential loans originated for retention in the Bank's portfolio, the Bank's lending policies generally limit the maximum loan-to-value ratio to 90% for owner-occupied properties and 80% for non-owner-occupied properties. Loans originated expressly for sale are originated in accordance with the lending policies and underwriting guidelines of the investor. From time to time, the Bank makes loans to individuals for construction of one-to-four family owner-occupied residences located in the Bank's primary market area, with such loans usually converting to permanent financing upon completion of construction. At June 30, 2001, the Bank's loan portfolio included $4.2 million of loans collateralized by one-to-four family properties under construction, some of which were construction/permanent loans structured to become permanent loans upon the completion of construction and some of which were interim construction loans structured to be repaid in full upon completion of construction and receipt of permanent financing. The Bank also offers loans to qualified builders for the construction of one-to-four family residences located in the Bank's primary market area. Because such homes are intended for resale, such loans are generally not covered by permanent financing commitments by the Bank. All construction loans are collateralized by a first lien on the property under construction. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. Construction/permanent loans are underwritten in accordance with the same requirements as the Bank's permanent mortgages, except the loans generally provide for disbursement in stages during a construction period of up to nine months, during which period the borrower may be required to make monthly interest payments. Borrowers must satisfy all credit requirements that would apply to the Bank's permanent mortgage loan financing prior to receiving construction financing for the subject property. Construction financing generally is considered to involve a higher degree of risk of loss than financing on existing properties. The Bank has sought to minimize this risk by limiting construction lending to qualified borrowers in the Bank's primary market area, and by requiring the involvement of qualified builders. COMMERCIAL AND MULTI-FAMILY REAL ESTATE LENDING. The Bank offers commercial and multi-family real estate loans in order to benefit from the higher interest rates than could be obtained from investment securities. The Bank has offered commercial and multi-family loans for years with many of such loans having been indirectly originated and underwritten by the Bank through a broker in the Memphis, Tennessee area with whom the Bank has had a long and successful relationship. It is anticipated that the Bank will continue to make loans through this method as opportunities arise, but management also has increased the Bank's emphasis on the direct origination of commercial and multi-family real estate loans, particularly in central Arkansas. Most of the Bank's commercial and multi-family real estate loans are collateralized by properties located in communities within Arkansas that have experienced significant growth in recent years. The Bank's emphasis on increasing this portfolio resulted in the addition to the Bank's staff of commercial and multi-family real estate loan originators who work closely with borrowers and various members of the commercial real estate industry throughout Arkansas. As opportunities for originations of such loans have increased, the Bank has been expanding its loan underwriting and servicing staff. All commercial and multi-family loans above loan officers' approved lending authorities are reviewed and approved by the Bank's lending committees at the headquarters in Camden prior to any funding or the issuance of any binding commitment by the Bank. The Bank's commercial real estate loans may be collateralized by offices, warehouses, shopping centers, land, nursing homes, single-family subdivision developments and other income-producing and commercial properties. Multi-family real estate loans are collateralized by greater than one-to-four family residential properties. At June 30, 2001, the Bank had 273 commercial real estate, construction commercial real estate, land, and multi-family loans, with an average loan balance of approximately $211,000. At that date, 50 of these loans totaling approximately $8.7 million were collateralized by properties outside Arkansas, and none of these out-of-market loans were classified by management as substandard, doubtful or loss or designated by management as special mention. Management expects the Bank to continue making these out-of-market loans from time to time as opportunities arise. The Bank's commercial and multi-family real estate loans generally are limited to loans not exceeding $3,500,000 on properties located either in Arkansas or other areas selected by management and approved by the Board of Directors, with terms of up to 20 years and loan-to-value ratios of up to 80%. Interest rates may be fixed 7 for up to 20 years. Under certain circumstances, these longer-term loans may be match funded with similar term FHLB advances to reduce interest rate risk. Commercial and multi-family real estate lending entails significant additional risks compared with one-to-four family residential lending. For example, commercial and multi-family real estate loans typically involve large loan balances to single borrowers or groups of related borrowers, the payment experience on such loans typically is dependent on the successful operation of the real estate project, and these risks can be significantly impacted by supply and demand conditions in the market for multi-family residential units and commercial office, retail and warehouse space. These risks may be higher with respect to loans collateralized by properties outside the Bank's primary market area or outside the Bank's most historically active lending areas. The Bank's recent and planned increases in commercial and multi-family lending also introduce additional risk as demands on the Bank's loan origination and administration increase and as the Bank's aggregate exposure to these types of loans increases. The aggregate amount of loans which federally chartered savings institutions may make on the security of liens on commercial real estate generally may not exceed 400% of the institution's capital. CONSUMER LENDING. The Bank's consumer loans primarily consist of loans collateralized by savings deposits at the Bank, and automobiles. These loans totaled $2.5 million and $6.8 million, respectively, at June 30, 2001. Management plans to continue the expansion of the Bank's consumer lending activities in the future as part of management's plan to provide a wider range of financial services while increasing the Bank's portfolio yields and improving its asset/liability management. The Bank makes certificate of deposit loans for up to 100% of the balance of the account. The interest rate on these loans typically is fixed at least three percentage points above the rate paid on a deposit at the Bank or four percentage points above the rate paid on a deposit at another institution, with the maturity and payment frequency matched to the terms of the deposit. The account must be pledged as collateral to secure the loan. The Bank makes home improvement loans collateralized by the borrower's residence. These loans, combined with any higher priority mortgage loan, which usually is from the Bank, generally are limited to 90% of the appraised value of the residence. Home improvement loans generally have fixed interest rates and terms of up to ten years. The Bank's new and used automobile loans generally are underwritten in amounts up to 90% of the purchase price, dealer cost or the loan value as published by the National Automobile Dealers Association. The terms of such loans generally do not exceed 60 months, with loans for older used cars underwritten for shorter terms. The Bank requires that the vehicles be insured and that the Bank be listed as loss payee on the insurance policy. Consumer loans generally involve more risk than first mortgage loans. Repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as a result of damage, loss or depreciation and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Further, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered. These loans may also give rise to claims and defenses by a borrower against the Bank, and a borrower may be able to assert against the Bank claims and defenses which it has against the seller of the underlying collateral. In underwriting consumer loans, the Bank considers the borrower's credit history, an analysis of the borrower's income, expenses and ability to repay the loan and the value of the collateral. The Bank's recent and planned increases in consumer lending also introduce additional risk as demands on the Bank's loan origination and administration increase and as the Bank's aggregate exposure to these types of loans increases. COMMERCIAL BUSINESS LENDING. The Bank currently offers working capital loans, floor plan loans to dealers of automobiles and recreational vehicles, and business equipment loans. At June 30, 2001, the Bank's commercial business loans totaled $11.3 million and primarily consisted of recreational vehicle floor plan loans, 8 inventory loans, and equipment loans. At that date, the Bank had two commercial business loans with outstanding commitments exceeding $500,000. One loan is collateralized by a floor plan of recreational vehicles, and the other is collateralized by inventory and accounts receivable of a furniture store. Commercial business loans generally involve more risk than single family residential loans. In underwriting commercial business loans, the Bank considers the obligor's credit history, an analysis of the obligor's income, expenses and ability to repay the obligation and the value of the collateral. LOAN SOLICITATION AND PROCESSING. The Bank's loan originations are derived from a number of sources, including referrals by realtors, builders, depositors, borrowers and mortgage brokers as well as walk-in customers. The Bank's solicitation programs consist of calls by the Bank's officers, branch presidents and other responsible employees to local realtors, builders, commercial businesses, and advertisements in local newspapers and billboards and radio broadcasts. The Bank's loan officers, including corporate lending staff, as well as branch presidents originate loans. Loan applications are accepted at each of the Bank's offices and, depending on the loan type and amount, may be processed and underwritten at the originating office or forwarded to the main office. Upon receipt of a loan application from a prospective borrower, the Bank's staff preliminarily reviews the information provided and makes an initial determination regarding the qualification of the borrower. If not disapproved, the application then is placed in processing, and a credit report and verifications are ordered to verify specific information relating to the loan applicant's employment, income and credit standing. It is the Bank's policy to obtain an appraisal of the real estate intended to secure a proposed mortgage loan from independent fee appraisers. It is the Bank's policy to obtain personal guarantees from the principals on all loans. Except when the Bank becomes aware of a particular risk of environmental contamination, the Bank generally does not obtain a formal environmental report on the real estate at the time a loan is made. It is the Bank's policy to record a lien on the real estate securing the loan and to obtain a title insurance policy that insures the property is free of prior encumbrances. Borrowers must also obtain hazard insurance policies prior to closing and, when the property is in a designated flood plain, paid flood insurance policies. The Board of Directors has the overall responsibility and authority for general supervision of the Bank's loan policies. The Board has established written lending policies for the Bank. The Bank's officers and loan committees approve loans up to specified limits above which the approval of the Board is required. Loan applicants are promptly notified of the decision of the Bank. It has been management's experience that substantially all approved loans are funded. INTEREST RATES AND LOAN FEES. Interest rates charged by the Bank on mortgage loans are primarily determined by competitive loan rates offered in its primary market area and the Bank's minimum yield requirements. Mortgage loan rates reflect factors such as prevailing market interest rate levels, the supply of money available to the savings industry and the demand for such loans. These factors are in turn affected by general economic conditions, the monetary policies of the federal government, including the Federal Reserve Board, the general supply of money in the economy, tax policies and governmental budget matters. The Bank receives fees in connection with loan commitments and originations, loan modifications, late payments and changes of property ownership and for miscellaneous services related to its loans. Loan origination fees are calculated as a percentage of the loan principal. The excess, if any, of loan origination fees over direct loan origination costs is deferred and accreted into income over the contractual life of the loan using the level yield method. If costs exceed fees, the excess is deferred and amortized to expense over the loan's contractual life using the level yield method. If a loan is prepaid, refinanced, or sold, all remaining deferred fees/costs with respect to such loan are taken into income or recognized in expense at such time. COLLECTION POLICIES. When a borrower fails to make a payment on a loan, the Bank generally takes prompt steps to have the delinquency cured and the loan restored to current status. Once the payment grace period has expired (in most instances 15 days after the due date), a late notice is mailed to the borrower, and a late charge is 9 imposed, if applicable. If payment is not promptly received, a second notice is sent 15 days after the expiration of the grace period. If the loan becomes 30 days delinquent, the borrower is contacted, and efforts are made to formulate an affirmative plan to cure the delinquency. If a loan becomes 60 days delinquent, the loan is reviewed by the Bank's management, and if payment is not made, management may pursue foreclosure, repossession, or other appropriate action. If a loan remains delinquent 90 days or more, the Bank generally initiates foreclosure proceedings. ASSET CLASSIFICATION; ALLOWANCES FOR LOSSES AND NONPERFORMING ASSETS. Federal regulations require savings institutions to classify their assets on the basis of quality on a regular basis. An asset is classified as substandard if it is determined to be inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. An asset is classified as doubtful if full collection is highly questionable or improbable. An asset is classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a special mention designation, described as assets which do not currently expose an institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets classified as substandard or doubtful require an institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, an institution must either establish a specific allowance for loss in the amount of the portion of the asset classified loss, or charge off such amount. Federal examiners may disagree with an institution's classifications. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the OTS Regional Director. Management regularly reviews the Bank's assets to determine whether assets require classification or re-classification, and the Board of Directors reviews and approves all classifications. The Bank contracts with a third-party professional to perform loan reviews generally on a semi-annual basis, including classification of assets and an assessment of the adequacy of the loan loss reserve. The most recent third party loan reviews were as of April 30, 2001, and June 30, 2000. As of June 30, 2001, the Bank had $50,573 of assets classified doubtful, $2,435,120 of assets classified substandard, and $1.4 million of assets designated as special mention. The Bank's total adversely classified assets represented approximately 0.9% of the Bank's total assets and 8.1% of the Bank's tangible regulatory capital plus allowance for loan loss at June 30, 2001. At that date, a majority of the Bank's adversely classified assets were one-to-four family residences in the Bank's primary market area. At June 30, 2001, management did not expect the Bank to incur any loss in excess of attributable existing allowances on any of the Bank's adversely classified or designated assets. Management also reviews the loss factors to determine whether they are current and relevant. Differences between estimated and actual losses have been insignificant for several years. However, if the losses experienced change significantly, a determination is made as to which factors utilized should be adjusted prospectively. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Company considers the characteristics of (1) one-to-four family residential first mortgage loans; (2) automobile loans; and (3) consumer and home improvement loans to permit consideration of the appropriateness of the allowance for losses of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the allowance for losses includes segregating certain specific, poorly performing loans based on their performance characteristics from the pools of loans as to type and then applying a loss factor to the remaining pool balance based on several factors including classification of the loans as to grade, past loss experience, inherent risks, economic conditions in the primary market areas and other factors which usually are beyond the control of the Company. Non-homogeneous loans are those loans that can be included in a particular loan type, such as commercial loans and multi-family and commercial first mortgage loans, but which differ in other characteristics to the extent that valuation on a pool basis is not valid. After segregating specific, poorly performing loans and applying the methodology as noted in the preceding paragraph for such specific loans, the remaining loans are evaluated based on payment experience, known difficulties in the borrower's business or geographic area, loss experience, inherent risks and other factors usually beyond the control of the Company. These loans are then graded and a factor, based on experience, is applied to estimate the probable loss. 10 In extending credit, the Bank recognizes that losses will occur and that the risk of loss will vary with, among other things, the type of credit being extended, the creditworthiness of the obligor over the term of the obligation, general economic conditions and, in the case of a collateralized obligation, the quality of the security. It is management's policy to maintain adequate allowances for losses based on management's assessment of the Bank's loan portfolio. The Bank increases its allowance for losses by charging provisions for losses against the Bank's income. Federal examiners may disagree with an institution's allowance for losses and may require adjustment. The Bank's methodology for establishing the allowance for losses takes into consideration probable losses that have been identified in connection with specific assets as well as losses that have not been identified but can be expected to occur. Management conducts regular reviews of the Bank's assets and evaluates the need to establish allowances on the basis of this review. Allowances are established by the Board of Directors on a regular basis based on an assessment of risk in the Bank's assets taking into consideration the composition and quality of the portfolio, delinquency trends, current charge-off and loss experience, the state of the real estate market, regulatory reviews conducted in the regulatory examination process and economic conditions generally. At the date of foreclosure or other repossession, the Bank records the property at fair value, less estimated costs to sell. Fair value is defined as the amount in cash or cash-equivalent value of other consideration that a property would yield in a current sale between a willing buyer and a willing seller. Fair value is measured by market transactions. If a market does not exist, fair value of the property is estimated based on selling prices of similar properties in active markets or, if there are no active markets for similar properties, by discounting a forecast of expected cash flows at a rate commensurate with the risk involved. Fair value generally is determined through an appraisal at the time of foreclosure. At June 30, 2001, the Bank held no properties acquired in settlement of loans for which estimated market values were unavailable. Any amount of cost in excess of fair value at foreclosure is charged-off against the allowance for loan losses. Subsequent to acquisition, the property is periodically evaluated by management and an allowance is established if the estimated fair value of the property, less estimated costs to sell, declines. If, upon ultimate disposition of the property, net sales proceeds differ from the net carrying value of the property, a gain or loss on sale of real estate is recorded. The banking regulatory agencies, including the OTS, have adopted a policy statement regarding maintenance of an adequate allowance for loan and lease losses and an effective loan review system. This policy includes an arithmetic formula for checking the reasonableness of an institution's allowance for loan loss estimate compared to the average loss experience of the industry as a whole. Management actively monitors the Bank's asset quality and charges off loans and properties acquired in settlement of loans against the allowances for losses on such loans and such properties when appropriate and provides specific loss allowances when necessary. Although management believes it uses the best information available to make determinations with respect to the allowances for losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used in making the determinations as to the appropriateness of the allowance. During the year ended June 30, 2001, in light of the Bank's loan portfolio review and changes in the mix of loan types, the Bank made $296,000 in provisions for loan losses bringing the total reserve for losses after net charged-off loans to $1.4 million, or 0.99% of gross loans. The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated. 11
Year Ended June 30, --------------------------------------------------------------------------- 2001 2000 1999 1998 1997 --------- -------- -------- -------- -------- Balance at beginning of period................. $ 1,231,709 $1,329,201 $1,468,546 $ 1,492,473 $ 1,283,234 ---------- ----------- ---------- ----------- ----------- Loans charged-off: Real estate mortgage: One-to-four family residential............. 19,982 4,960 26,883 5,466 11,317 Other mortgage loans....................... -- -- -- -- -- Commercial..................................... 25,811 50,047 37,742 -- -- Consumer....................................... 55,968 44,791 79,632 43,100 11,668 ----------- ----------- ---------- ----------- ----------- Total charge-offs.............................. 101,761 99,798 144,257 48,566 22,985 ----------- ----------- ---------- ----------- ----------- Recoveries: Real estate mortgage: One-to-four family residential............. 1,617 -- 865 -- 6,333 Other mortgage loans....................... -- -- -- -- -- Commercial................................... -- -- -- -- -- Consumer..................................... 18,549 2,306 4,047 639 4,220 ----------- ----------- ---------- ----------- ----------- Total recoveries............................... 20,166 2,306 4,912 639 10,553 ----------- ----------- ---------- ----------- ----------- Net loans charged-off.......................... 81,595 97,492 139,345 47,927 12,432 ----------- ----------- ---------- ----------- ----------- Acquisition of subsidiary...................... -- -- -- -- -- Provision for loan losses...................... 296,000 -- -- 24,000 221,671 ----------- ----------- ---------- ----------- ----------- Balance at end of period....................... $ 1,446,114 $ 1,231,709 $1,329,201 $ 1,468,546 $ 1,492,473 =========== =========== ========== =========== =========== Ratio of net charge-offs to average loans outstanding during the period.......... 0.06 % 0.08 % 0.13 % 0.05 % 0.01 % ====== ====== ====== ====== ======
12 The following table allocates the allowance for loan losses by asset category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
At June 30, ------------------------------------------------------------------------- 2001 2000 1999 ---------------------- ----------------------- ---------------------- Percent of Percent of Percent of Loans in Loans in Loans in Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans ------ ------------ ------ ----------- ------ ----------- Allocated to: Real estate loans: One-to-four family residential...... $ 480,460 39.0% $ 440,709 42.3% $ 422,000 43.7% Multi-family, non-residential, and land.............................. 570,261 45.6 551,000 43.9 603,000 44.6 Consumer loans........................ 89,360 7.7 91,000 7.7 101,000 7.3 Commercial loans...................... 255,662 7.7 149,000 6.1 82,000 4.4 Unallocated........................... 50,371 -- -- -- 121,201 -- ---------- ------ ---------- ----- --------- ----- Total.......................... $1,446,114 100.0% $1,231,709 100.0% $1,329,201 100.0% ========== ===== ========== ===== ========== ===== At June 30, ------------------------------------------------- 1998 1997 --------------------- ------------------------ Percent of Percent of Loans in Loans in Category to Category to Amount Total Loans Amount Total Loans ------ ----------- ------ ------------ Allocated to: Real estate loans: One-to-four family residential...... $ 504,000 45.18% $ 954,093 61.50% Multi-family, non-residential, and land.............................. 557,000 44.05 296,018 27.52 Consumer loans........................ 123,000 8.31 67,700 8.93 Commercial loans...................... 72,000 2.46 81,250 2.05 Unallocated........................... 212,546 -- 93,412 -- ---------- ------ ---------- ----- Total.......................... $1,468,546 100.00% $1,492,473 100.00% ========== ====== ========== ======
13 The Bank's increasing emphasis on the origination of commercial and multi-family real estate loans and consumer and commercial business loans may increase the Bank's risk of corresponding increases in loan loss provisions and charge-offs. While management believes the Bank has established its existing loss allowances in accordance with generally accepted accounting principles, there can be no guarantee or assurance that such allowances are, or in the future will be, adequate to absorb all loan losses or that regulators, in reviewing the Bank's assets, will not require the Bank to increase its loss allowance, thereby negatively affecting the Bank's reported financial condition and results of operations. The following table sets forth information with respect to the Bank's nonperforming assets at the dates indicated. For information regarding the Bank's interest accrual practices, see the Notes to Consolidated Financial Statements set forth in Item 8 herein.
At June 30 ------------------------------------------------------------ 2001 2000 1999 1998 1997 -------- -------- ------- -------- -------- Loans accounted for on a nonaccrual basis:(1) Real estate: One-to-four family residential........... $ 838,271 $ 655,988 $ 462,205 $ 648,012 $ 133,386 Other mortgage loans..................... -- -- 22,139 -- -- Consumer................................... 137,987 102,003 81,648 138,747 -- ---------- --------- ---------- --------- --------- Total.................................... $ 976,258 $ 757,991 $ 565,992 $ 786,759 $ 133,386 ========== ========= ========== ========= ========= Accruing loans which are contractually past due 90 days or more: Real estate: One-to-four family residential........... $ 38,816 $ 140,000 $ -- $ 41,770 $ 323,478 Commercial loans........................... 161,926 -- -- -- -- Consumer loans............................. 13,400 21,524 -- -- 56,904 ---------- --------- ---------- --------- --------- Total.................................... $ 214,142 $ 161,524 $ -- $ 41,770 $ 380,382 ========== ========= ========== ========= ========= Total nonperforming loans................ $1,190,400 $ 919,515 $ 565,992 $ 828,529 $ 513,768 ========== ========= ========== ========= ========= Percentage of total loans.................... 0.81% 0.64% 0.46% 0.75% 0.50% ==== ==== ==== ==== ==== Other nonperforming assets (2)............... $ 175,783 $ 52,919 $ 20,289 $ 17,001 $ 65,005 ========== ========= ========== ========= ========= Loans modified in troubled debt restructurings $ -- $ -- $ -- $ 392,000 $ 281,441 ========== ========= ========== ========= ========= ______________ (1) Designated nonaccrual loan payments received applied first to contractual principal; interest income recognized when contractually current. (2) Other nonperforming assets includes foreclosed real estate.
During the years ended June 30, 2001 and 2000, gross interest income of $80,541 and $70,933, respectively, would have been recorded on loans accounted for on a nonaccrual basis if the loans had been current throughout the respective periods. Interest on such loans included in income during such respective periods amounted to $33,365 and $20,045, respectively. At June 30, 2001, management had identified approximately $1.4 million of loans which amount is not reflected in the preceding table but as to which known information about possible credit problems of borrowers caused management to provide for increased monitoring of the ability of the borrowers to comply with present loan repayment terms, all of which was included in the Bank's adversely classified asset amounts at that date. Of this aggregate amount, approximately $859,000 was attributable to 21 one-to-four family residential loans, $389,000 was attributable to 8 commercial loans, $74,000 was attributable to two nonresidential real estate loans, and $107,000 14 was attributable to 17 consumer loans. At June 30, 2001, management did not expect the Bank to incur any loss in excess of attributable existing allowances on any of the Bank's assets. INVESTMENT ACTIVITIES GENERAL. The Bank is permitted under federal law to make certain investments, including investments in securities issued by various federal agencies and state and municipal governments, savings deposits at the FHLB of Dallas, certificates of deposit in federally insured institutions, certain bankers' acceptances and federal funds. It may also invest, subject to certain limitations, in commercial paper rated in one of the two highest investment-rating categories of a nationally recognized credit rating agency, and certain other types of corporate debt securities and mutual funds. Federal regulations require the Bank to maintain an investment in FHLB stock and to maintain a sufficient level of liquidity. The Bank has chosen to fulfill a portion of this requirement by investing in securities which provide liquidity. The Bank makes investments in order to maintain a sufficient level of liquid assets and manage cash flow, diversify its assets, obtain yield and, under prior federal income tax law, satisfy certain requirements for favorable tax treatment. The investment activities of the Bank consist primarily of investments in mortgage-backed securities and other investment securities, consisting primarily of securities issued or guaranteed by the U.S. government or agencies thereof and state and municipal securities. Typical investments include federally sponsored agency mortgage pass-through and federally sponsored agency and mortgage-related securities. Investment and aggregate investment limitations and credit quality parameters of each class of investment are prescribed in the Bank's investment policy. The Bank performs analyses on securities prior to purchase and on an ongoing basis to determine the impact on earnings and market value under various interest rate and prepayment conditions. Securities purchases are approved by the Bank's Investment Committee, and the Board of Directors reviews all securities transactions on a monthly basis. Securities designated as "held to maturity" are those assets which the Bank has the ability and intent to hold to maturity. The "held to maturity" investment portfolio is carried at amortized cost. Securities designated as "available for sale" are those assets which the Bank might not hold to maturity and thus are carried at market value with unrealized gains or losses, net of tax effect, recognized in stockholders' equity. Mortgage-backed securities typically represent an interest in a pool of fixed-rate or adjustable-rate mortgage loans, the principal and interest payments on which are passed from the mortgage borrowers to investors such as the Bank. Mortgage-backed security sponsors may be private companies or quasi-governmental agencies such as FHLMC, FNMA and GNMA, which guarantee the payment of principal and interest to investors. Mortgage-backed securities can represent a proportionate participation interest in a pool of loans or, alternatively, an obligation to repay a specified amount collateralized by a pool of loans (commonly referred to as a "collateralized mortgage obligation," or "CMO"). Mortgage-backed securities generally increase the quality of the Bank's assets by virtue of the credit enhancements that back them. They are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Bank. The Bank's mortgage-backed securities portfolio primarily consists of seasoned securities either issued by one of the quasi-governmental agencies or rated in one of the top two categories by a recognized rating organization. All of the Bank's privately issued securities were rated "AA" or higher by a nationally recognized credit rating agency at the time of purchase. Management regularly monitors the ratings of the Bank's privately issued holdings by reference to nationally published rating media and by communication with the issuer when necessary. At June 30, 2001, no privately issued securities were rated below AA except as follows: A Citicorp Mortgage, Inc. REMIC Pass-Through Class A Certificate was rated "CAA1" by Moody. The grade reflects deterioration in the performance of the mortgage pools underlying the security. At June 30, 2001, the Bank estimated the value of the security at approximately $54,000 less than its face value. The Bank's carrying value for this security at that date was approximately $192,709 after recognition of impairment loss. 15 A DLJ Mortgage Acceptance Corp. Pass-Through Class A-3 Certificate was rated "CAA2" by Moody. The grade reflects deterioration in the performance of the mortgage pools underlying the security. As of June 30, 2001, the deterioration affected the credit support and not the principal or interest of the security itself. Management had not identified any expected losses on principal or interest on the security as of that date. The Bank's carrying value for this security at that date was $352,158. The Bank's privately issued securities consist of collateralized mortgage obligations (CMOs) and mortgage pass-through securities. At June 30, 2001, all of the privately issued securities had adjustable interest rates with a weighted average yield of 6.88% and a weighted average term to maturity of 19.3 years. The carrying value of the privately issued securities was $3,058,540 or 3.5% of the mortgage-backed securities and CMOs at that date. None of the privately issued securities are insured or guaranteed by FHLMC or FNMA. The actual maturity of a mortgage-backed security varies, depending on when the mortgagors prepay or repay the underlying mortgages. Prepayments of the underlying mortgages may shorten the life of the investment, thereby adversely affecting its yield to maturity and the related market value of the mortgage-backed security. The yield is based upon the interest income and the amortization of the premium or accretion of the discount related to the mortgage-backed security. Premiums and discounts on mortgage-backed securities are amortized or accreted over the estimated term of the securities using a level yield method. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect the actual prepayment. The actual prepayments of the underlying mortgages depend on many factors, including the type of mortgage, the coupon rate, the age of the mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates. The difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is an important determinant in the rate of prepayments. During periods of falling mortgage interest rates, prepayments generally increase, and, conversely, during periods of rising mortgage interest rates, prepayments generally decrease. If the coupon rate of the underlying mortgage significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities. The following table sets forth information regarding carrying values of the Company's investment securities at the dates indicated. All securities are held as available for sale.
At June 30, --------------------------------------------------- 2001 2000 1999 ----------- ------------ ------------- Securities available for sale: U.S. government and agencies............................... $ 1,900,448 $ 5,880,903 $ 6,368,125 Municipal securities....................................... 30,197,186 28,201,198 26,704,416 Collateralized mortgage obligations........................ 12,159,483 11,805,058 12,346,191 Other mortgage-backed securities........................... 75,784,260 86,602,281 101,640,582 Equity securities.......................................... 40,800 53,625 60,375 -------------- --------------- --------------- $ 120,082,177 $ 132,543,065 $ 147,119,689 ============== =============== ===============
16 The following table sets forth information regarding scheduled maturities of the Company's investment portfolio at June 30, 2001. Yields on municipal securities are not tax-effected.
One Year or Less One to Five Years Five to Ten Years -------------------- ------------------ ------------------- Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield ------- ------- ------- ------- -------- ------- U.S. government and agencies $ -- -- % $1,900,448 6.28% $ -- --% Municipal securities -- -- -- -- 1,161,263 5.16 Collateralized mortgage obligations -- -- -- -- 515,835 7.11 Other mortgage-backed securities 8,742 9.36 2,260,401 6.66 6,198,695 6.51 ------ ---------- ---------- Total $ 8,742 9.36% $4,160,849 6.49% $7,875,793 6.35% ======= ==== ========== ==== ========== ==== Equity securities More than Ten Years Total Investment Portfolio ------------------- -------------------------------- Carrying Average Carrying Market Average Value Yield Value Value Yield -------- ------- ------- ----- ------- U.S. government and agencies $ -- --% $ 1,900,448 $ 1,900,448 6.28% Municipal securities 29,035,923 4.98 30,197,186 30,197,186 4.99 Collateralized mortgage obligations 11,643,648 6.47 12,159,483 12,159,483 6.50 Other mortgage-backed securities 67,316,422 6.40 75,784,260 75,784,260 6.42 ------------ ----------- Total $107,995,993 6.03% $120,041,377 $120,041,377 6.07% ============ ==== ============ ============ ==== Equity securities 40,800 40,800 ------------ ------------ $120,082,177 $120,082,177 ============ ============
17 DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS GENERAL. Deposits are the primary source of the Bank's funds for lending, investment activities and general operational purposes. While the Bank, like most independent savings institutions, historically has relied on certificates of deposit for a substantial portion of its deposit base, management has recently shifted the Bank's deposit gathering emphasis away from certificates of deposit and toward transaction accounts with more favorable interest costs, interest rate risk characteristics and opportunities for the Bank to perform valued customer services that generate additional fee income, and it is expected that management will continue this trend in the future. In addition to deposits, the Bank derives funds from loan principal and interest repayments, maturities of investment securities and interest payments thereon. Although loan repayments are a relatively stable source of funds, deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used to compensate for reductions in the availability of funds, or for general operational purposes. The Bank has access to advances from the FHLB of Dallas. DEPOSITS. The Bank attracts deposits principally from within its primary market area by offering competitive rates on its deposit instruments, including money market accounts, passbook savings accounts, Individual Retirement Accounts and certificates of deposit which range in maturity from 90 days to three years. Deposit terms vary according to the minimum balance required, the length of time the funds must remain on deposit and the interest rate. The Bank on a periodic basis establishes maturities, terms, service fees and withdrawal penalties for its deposit accounts. In determining the characteristics of its deposit accounts, the Bank considers the rates offered by competing institutions, lending and liquidity requirements, growth goals and federal regulations. The Bank does not typically accept brokered deposits or pay negotiated rates for jumbo certificates of deposits. The Bank attempts to compete for deposits with other institutions in its market area by offering competitively priced deposit instruments that are tailored to the needs of its customers. Additionally, the Bank seeks to meet customers' needs by providing convenient customer service to the community, efficient staff and convenient hours of service. Substantially all of the Bank's depositors are Arkansas residents who reside in the Bank's primary market area. The following table sets forth information regarding interest-bearing average deposit balances and rates during the periods presented.
Year Ended June 30, ----------------------------------------------------------------------- 2001 2000 1999 ------------------- ------------------ ------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ------- -------- ------- -------- ------- -------- NOW accounts.......................... $ 31,662,439 3.54% $ 14,170,075 1.73% $ 10,505,515 1.46% Money market savings deposits......... 6,967,070 3.72 16,093,630 3.84 20,474,110 3.57 Savings deposits - statement.......... 6,774,023 2.43 7,955,898 2.58 7,325,746 2.81 Certificates of deposit............... 106,806,416 5.76 104,443,704 5.21 103,414,235 5.35 ------------ ---- ------------ ---- ------------- ---- Total............................. $152,209,948 5.06% $142,663,307 4.56% $141,719,606 4.67% ============ ==== ============ ==== ============ ====
18 The following table sets forth information regarding changes in dollar amounts of deposits in various types of accounts offered by the Bank between the dates indicated.
Balance at Balance at June 30, % of Increase June 30, % of Increase 2001 Deposits (Decrease) 2000 Deposits (Decrease) ----------- -------- ---------- ----------- -------- ---------- NOW accounts ................ $ 38,055,320 23.60% $ 14,501,854 $ 23,553,466 16.26% $11,141,534 Money market savings deposits 5,733,865 3.56 (3,626,326) 9,360,191 6.46 (8,259,150) Savings deposits - statement 6,903,036 4.28 (627,396) 7,530,432 5.20 (441,015) Certificates of deposit ..... 110,592,958 68.56 6,163,976 104,428,982 72.08 (3,864,896) ------------- ------ ------------- ------------- ------ ----------- $ 161,285,179 100.00% $ 16,412,108 $ 144,873,071 100.00% $(1,423,527) ============= ====== ============= ============= ====== =========== Balance at June 30, % of 1999 Deposits ----------- -------- NOW accounts ................ $ 12,411,932 8.49% Money market savings deposits 17,619,341 12.04 Savings deposits - statement 7,971,447 5.45 Certificates of deposit ..... 108,293,878 74.02 ------------ ------ $146,296,598 100.00% ============ ======
19 The following table sets forth information regarding certificates of deposits classified by rates at the dates indicated.
At June 30, ------------------------------------------ 2001 2000 1999 -------- ------- ---------- 3.25 -5.99%................................................. $ 77,451,889 $ 68,258,761 $107,158,894 6.00 -7.99%................................................. 33,141,069 36,170,221 1,134,984 ------------ ------------ ------------ $110,592,958 $104,428,982 $108,293,878 ============ ============ ============
The following table sets forth information regarding amounts and maturities of certificates of deposits at June 30, 2001.
Amount Due ------------------------------------------------------- Less Than Rate One Year 1-2 Years 2-3 Years Total ---- ---------- --------- --------- ----- 3.25 - 5.99%.................. $62,900,440 $11,780,163 $2,771,286 $ 77,451,889 6.00 - 7.99%.................. 23,641,338 7,187,915 2,311,816 33,141,069 ----------- ----------- ---------- ------------ $86,541,778 $18,968,078 $5,083,102 $110,592,958 =========== =========== ========== ============
The following table sets forth information regarding amounts of certificates of deposit of $100,000 or more by time remaining until maturity at June 30, 2001. Certificates Maturity Period of Deposit --------------- ------------ Three months or less....................... $ 4,852,596 Over three through six months.............. 3,037,539 Over six through 12 months................. 5,715,876 Over 12 months............................. 3,027,079 ------------ Total.................................. $ 16,633,090 =========== The following table sets forth information regarding savings activities of the Bank for the periods indicated.
Year Ended June 30, ------------------------------------------------- 2001 2000 1999 -------- -------- ------ Net increase (decrease) before interest credited......................................... $ 8,676,800 $ (8,032,919) $ (2,521,766) Interest credited........................................... 7,735,308 6,609,392 6,887,034 -------------- -------------- -------------- Net increase (decrease) in savings deposits...................................... $ 16,412,108 $ (1,423,527) $ 4,365,268 ============= ============== ==============
BORROWINGS. Deposits historically have been the primary source of funds for the Bank's lending, investments and general operating activities. The Bank is authorized, however, to use advances from the FHLB of Dallas to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Dallas functions as a central reserve bank providing credit for savings institutions and certain other member financial institutions. As a member of the FHLB System, the Bank is required to own stock in the FHLB of Dallas and is 20 authorized to apply for advances. Advances are pursuant to several different programs, each with its own interest rate and range of maturities. Advances from the FHLB of Dallas are collateralized by the Bank's stock in the FHLB of Dallas, qualifying first mortgage loans and mortgage-backed investment securities. The following table sets forth certain information regarding borrowings by the Bank for the periods indicated. Averages are based on monthly balances.
Year Ended June 30, -------------------------------------------------- 2001 2000 1999 -------- -------- -------- Amounts outstanding at end of period: FHLB advances............................................... $ 91,915,694 $ 115,609,029 $104,523,419 Weighted average rate....................................... 5.88% 6.07% 5.63% Maximum amount of borrowings outstanding at any month end: FHLB advances............................................... $ 114,694,903 $ 117,040,406 $104,523,419 Approximate average borrowings during the year outstanding with respect to: FHLB advances............................................... $ 105,619,861 $ 112,554,831 $ 95,124,165 Weighted average rate....................................... 6.03% 5.85% 5.73%
SUBSIDIARY ACTIVITIES As a federally chartered savings bank, the Bank is permitted to invest an amount equal to 2% of its assets in non-savings institution service corporation subsidiaries, with an additional investment of 1% of assets where such investment serves primarily community, inner-city and community development purposes. Under such limitations, as of June 30, 2001 on a consolidated basis the Bank was authorized to invest up to approximately $5.7 million in the stock of or loans to such subsidiaries, including the additional 1% investment for community inner-city and community development purposes. The Bank has one subsidiary service corporation, HCB Properties, Inc., which was formed in August 1996 to hold certain properties acquired by the Bank for possible future expansion, because the properties are larger than the Bank's anticipated expansion needs, and it is expected that portions of the properties eventually will be sold. At June 30, 2001, the Bank's aggregate investment in, and loans to, the subsidiary service corporation totaled $580,928. REGULATION OF THE BANK GENERAL. As a federally chartered savings institution the Bank is subject to extensive regulation by the OTS and the FDIC and to OTS regulations governing such matters as capital standards, mergers, establishment of branch offices, subsidiary investments and activities and general investment authority. The OTS periodically examines the Bank for compliance with various regulatory requirements. The FDIC also has the authority to conduct special examinations of the Bank because its savings deposits are insured by the SAIF. The Bank must file reports with the OTS describing its activities and financial condition and also is subject to certain reserve requirements promulgated by the Federal Reserve Board. This supervision and regulation is intended primarily for the protection of depositors. FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System, which consists of 12 district FHLB's subject to supervision and regulation by the Federal Housing Finance Board ("FHFB"). The FHLB's provide a central credit facility primarily for member institutions. As a member of the FHLB of Dallas, the Bank is required to acquire and hold shares of capital stock in the FHLB of Dallas in an amount at least equal to 1% of the aggregate unpaid principal of its home mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB of Dallas, whichever is greater. 21 The FHLB of Dallas serves as a reserve or central bank for its member institutions within its assigned district. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHLB and the Board of Directors of the FHLB of Dallas. Long-term advances may only be made for the purpose of providing funds for residential housing finance and small businesses, small farms and small agri-businesses. At June 30, 2001, the Bank had $91.9 million in advances outstanding with the FHLB of Dallas. See " -- Deposit Activity and Other Sources of Funds -- Borrowings." QUALIFIED THRIFT LENDER TEST. The Bank is subject to OTS regulations that use the concept of a Qualified Thrift Lender to determine eligibility for Federal Home Loan Bank advances and for certain other purposes. To qualify as a Qualified Thrift Lender, a savings institution must either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments. Portfolio assets are defined to include total assets less intangibles, value of property used by a savings institution in its business and liquidity investments in an amount not exceeding 20% of assets. Qualified Thrift Investments consist of (i) loans, equity positions or securities related to domestic, residential real estate or manufactured housing, and educational, small business and credit card loans, (ii) 50% of the dollar amount of residential mortgage loans subject to sale under certain conditions, and (iii) stock issued by a Federal Home Loan Bank. Subject to a 20% of portfolio assets limit, savings institutions are able to treat as Qualified Thrift Investments 200% of their investments in loans to finance "starter homes" and loans for construction, development or improvement of housing and community service facilities or for financing small businesses in "credit-needy" areas. To be qualified as a Qualified Thrift Lender, a savings institution must maintain its status as a Qualified Thrift Lender for nine out of every 12 months. Failure to qualify as a Qualified Thrift Lender results in a number of sanctions, including the imposition of certain operating restrictions imposed on national banks. Upon failure to qualify as a Qualified Thrift Lender for two years, a savings institution must convert to a commercial bank. REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings institutions must maintain "tangible" capital equal to at least 1.5% of tangible assets, "core" capital equal to at least 4.0% (or 3.0% if the institution is rated CAMELS 1 under the OTS examination rating system) of adjusted total assets and "total" capital (a combination of core and "supplementary" capital) equal to at least 8% of "risk-weighted" assets. In addition, the OTS regulations impose certain restrictions on institutions that have a total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less than 4.0% (or 3.0% if the institution is rated CAMELS 1 under the OTS examination rating system). For purposes of these regulations, Tier 1 capital has the same definition as core capital. See " -- Prompt Corrective Regulatory Action." Core capital is defined as common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged savings deposits and "qualifying supervisory goodwill." Core capital is generally reduced by the amount of an institution's intangible assets for which no market exists. Limited exceptions to the deduction of intangible assets are provided for purchased mortgage servicing rights and qualifying supervisory goodwill. Tangible capital is given the same definition as core capital, but does not include an exception for qualifying supervisory goodwill and is reduced by the amount of all the savings institution's intangible assets with only a limited exception for purchased mortgage servicing rights. 22 Both core and tangible capital are further reduced by an amount equal to a savings institution's debt and equity investments in subsidiaries engaged in activities not permissible to national banks (other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and depository institutions or their holding companies). As of June 30, 2001, the Bank had $580,928 investments in, or extensions of credit to, non-includable subsidiaries. Adjusted total assets are a savings institution's total assets as determined under generally accepted accounting principles, increased by certain goodwill amounts and by a pro rated portion of the assets of unconsolidated includable subsidiaries in which the institution holds a minority interest. Adjusted total assets are reduced by the amount of assets that have been deducted from capital, the savings institution's investments in unconsolidated includable subsidiaries, and, for purposes of the core capital requirement, qualifying supervisory goodwill. In determining compliance with the risk-based capital requirement, a savings institution is allowed to use both core capital and supplementary capital provided the amount of supplementary capital used does not exceed the institution's core capital. Supplementary capital is defined to include certain preferred stock issues, nonwithdrawable accounts and pledged savings deposits that do not qualify as core capital, certain approved subordinated debt, certain other capital instruments, a portion of the institution's general loan loss allowances and up to 45% of unrealized gains on equity securities. Total core and supplementary capital are reduced by the amount of capital instruments held by other depository institutions pursuant to reciprocal arrangements and equity investments other than those deducted from core and tangible capital. At June 30, 2001, the Bank $580,928 equity investments for which OTS regulations require a deduction from total capital. The risk-based capital requirement is measured against risk-weighted assets, which equal the sum of each asset and the credit-equivalent amount of each off-balance sheet item after being multiplied by an assigned risk weight. Under the OTS risk-weighting system, one-to-four family first mortgages not more than 90 days past due with loan-to-value ratios under 80% and average annual occupancy rates of at least 80% and certain qualifying loans for the construction of one-to-four family residences pre-sold to home purchasers are assigned a risk weight of 50%. Consumer and residential construction loans are assigned a risk weight of 100%. Mortgage-backed securities issued or fully guaranteed as to principal and interest, by the FNMA or FHLMC are assigned a 20% risk weight. Cash and U.S. Government securities backed by the full faith and credit of the U.S. Government (such as mortgage-backed securities issued by GNMA) are given a 0% risk weight. The table below presents the capital position of the Bank relative to its various regulatory capital requirements at June 30, 2001.
Percent of Amount Assets(1) ------ --------- (Dollars in thousands) Tangible capital............................... $ 29,132 10.20% Tangible capital requirement................... 4,282 1.50 ------- ------ Excess...................................... $ 24,850 8.70% ======= ====== Core capital................................... $ 29,132 10.20% Core capital requirement....................... 11,420 4.00 ------- ------ Excess...................................... $ 17,712 6.20% ======= ====== Total capital.................................. $ 30,578 22.17% Risk-based capital requirement................. 11,032 8.00 ------- ------ Excess..................................... $ 19,546 14.17% ======= ===== (1) Based on adjusted total assets for purposes of the tangible capital and core capital requirements and risk-weighted assets for purpose of the risk-based capital requirement.
23 In addition to requiring generally applicable capital standards for savings institutions, the Director of the OTS is authorized to establish the minimum level of capital for a savings institution at such amount or at such ratio of capital-to-assets as the Director determines to be necessary or appropriate for such institution in light of the particular circumstances of the institution. Such circumstances would include a high degree of exposure of interest rate risk, prepayment risk, credit risk and concentration of credit risk and certain risks arising from non-traditional activities. The Director may treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings institution which fails to maintain capital at or above the minimum level required by the Director to submit and adhere to a plan for increasing capital. Such an order may be enforced in the same manner as an order issued by the FDIC. DEPOSIT INSURANCE. The Bank is required to pay assessments based on a percentage of its insured savings deposits to the FDIC for insurance of its savings deposits by the SAIF. Under the Federal Deposit Insurance Act, the FDIC is required to set semi-annual assessments for SAIF-insured institutions at a level necessary to maintain the designated reserve ratio of the SAIF at 1.25% of estimated insured savings deposits or at a higher percentage of estimated insured savings deposits that the FDIC determines to be justified for that year by circumstances indicating a significant risk of substantial future losses to the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, which is determined by the institution's capital level and supervisory evaluations. Based on the data reported to regulators for the date closest to the last day of the seventh month preceding the semi-annual assessment period, institutions are assigned to one of three capital groups -- well capitalized, adequately capitalized or undercapitalized -- using the same percentage criteria as in the prompt corrective action regulations. See "-- Prompt Corrective Regulatory Action." Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. Subgroup A consists of financially sound institutions with only a few minor weaknesses. Subgroup B consists of institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the deposit insurance fund. Subgroup C consists of institutions that pose a substantial probability of loss to the deposit insurance fund unless effective corrective action is taken. The SAIF deposit insurance assessment rates set by the FDIC range from zero for "well capitalized" institutions with the highest supervisory ratings to 0.27% of insured savings deposits for institutions in the highest risk-based premium category. Until December 31, 1999, SAIF-insured institutions were required to pay assessments to the FDIC at the rate of 6.5 basis points to help fund interest payments on certain bonds issued by the Financing Corporation ("FICO"), an agency of the federal government established to finance takeovers of insolvent thrifts. During this period, Bank Insurance Fund ("BIF") members were assessed for these obligations at the rate of 1.3 basis points. After December 31, 1999, both BIF and SAIF members are assessed at the same rate for FICO payments. The FDIC has adopted a regulation which provides that any insured depository institution with a ratio of Tier 1 capital to total assets of less than 2% will be deemed to be operating in an unsafe or unsound condition, which would constitute grounds for the initiation of termination of deposit insurance proceedings. The FDIC, however, would not initiate termination of insurance proceedings if the depository institution has entered into and is in compliance with a written agreement with its primary regulator, and the FDIC is a party to the agreement, to increase its Tier 1 capital to such level as the FDIC deems appropriate. Tier 1 capital is defined as the sum of common stockholders' equity, noncumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets other than mortgage servicing rights and qualifying supervisory goodwill eligible for inclusion in core capital under OTS regulations, and minus identified losses and investments in certain securities subsidiaries. Insured depository institutions with Tier 1 capital equal to or greater than 2% of total assets may also be deemed to be operating in an unsafe or unsound condition notwithstanding such capital level. The regulation further provides that in considering applications that must be submitted to it by savings institutions, the FDIC will take into account whether the institution is meeting with the Tier 1 capital requirement for state non-member banks of 4% of total assets for all but the most highly rated state non-member banks. 24 FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve Board, all FDIC-insured depository institutions must maintain average daily reserves equal to 3% on transaction accounts of up to $42.8 million plus 10% on the remainder. This percentage is subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. DIVIDEND RESTRICTIONS. Under OTS regulations, the Bank is not permitted to pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of the Bank at the time of the Conversion. In addition, the Bank is required by OTS regulations to give the OTS 30 days' prior notice of any proposed declaration of dividends. OTS regulations require that savings institutions submit notice to the OTS prior to making a capital distribution if (a) they would not be well-capitalized after the distribution, (b) the distribution would result in the retirement of any of the institution's common or preferred stock or debt counted as its regulatory capital, or (c) the institution is a subsidiary of a holding company. A savings institution must make application to the OTS to pay a capital distribution if (x) the institution would not be adequately capitalized following the distribution, (y) the institution's total distributions for the calendar year exceeds the institution's net income for the calendar year to date plus its net income (less distributions) for the preceding two years, or (z) the distribution would otherwise violate applicable law or regulation or an agreement with or condition imposed by the OTS. If neither the savings institution nor the proposed capital distribution meet any of the foregoing criteria, then no notice or application is required to be filed with the OTS before making a capital distribution. The OTS may disapprove or deny a capital distribution if in the view of the OTS, the capital distribution would constitute an unsafe or unsound practice. Under the OTS prompt corrective action regulations, the Bank would be prohibited from making any capital distributions if, after making the distribution, it would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a Tier 1 (core) capital ratio of less than 4.0%. See " -- Prompt Corrective Regulatory Action." The OTS, after consultation with the FDIC, however, may permit an otherwise prohibited stock repurchase if made in connection with the issuance of additional shares in an equivalent amount and the repurchase will reduce the institution's financial obligations or otherwise improve the institution's financial condition. In addition to the foregoing, earnings of the Bank appropriated to bad debt reserves and deducted for federal income tax purposes are not available for payment of cash dividends or other distributions to Bancshares without payment of taxes at the then current tax rate on the amount of earnings removed from the reserves for such distributions. See "Federal Income Taxation." Bancshares intends to make full use of this favorable tax treatment afforded to the Bank, and does not contemplate use of any post-Conversion earnings of the Bank in a manner which would limit the Bank's bad debt deduction or create federal tax liabilities. TRANSACTIONS WITH RELATED PARTIES. Transactions between savings institutions and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings institution is any company or entity which controls, is controlled by or is under common control with the institution. In a holding company context, the parent holding company of an institution (such as Bancshares) and any companies which are controlled by such parent holding company are affiliates of the savings institution. Generally, Sections 23A and 23B (i) limit the extent to which the savings institution or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. In addition to the restrictions imposed by Sections 23A and 23B, no savings institution may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any 25 stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings institution. Section 106 of the Bank Holding Company Act which applies to the Bank, prohibits the Bank from extending credit to or offering any other services, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or certain of its affiliates or not obtain services of a competitor of the institution, subject to certain exceptions. LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. Depository institutions like the Bank are also subject to the restrictions contained in Section 22(h) and Section 22(g) of the Federal Reserve Act on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, executive officer and to a greater than 10% stockholder of a depository institution and certain affiliated interests of such persons, may not exceed, together with all other outstanding loans to such person and affiliated interests, the institution's loans-to-one-borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus plus an additional 10% of such capital and surplus for loans fully collateralized by certain readily marketable capital). Section 22(h) also prohibits the making of loans above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and greater than 10% stockholders of an institution, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the institution with any "interested" director not participating in the voting. The Federal Reserve Board has prescribed the loan amount (which includes all other outstanding loans to such person) as to which such prior board of director approval is required as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, Section 22(h) requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons. Section 22(h) also generally prohibits a depository institution from paying the overdrafts of any of its executive officers or directors. Section 22(g) of the Federal Reserve Act requires that loans to executive officers of depository institutions not be made on terms more favorable than those afforded to other borrowers, requires approval for such extensions of credit by the board of directors of a the institution, and imposes reporting requirements for and additional restrictions on the type, amount and terms of credits to such officers. In addition, Section 106 of the Bank Holding Company Act prohibits extensions of credit to executive officers, directors, and greater than 10% stockholders of a depository institution by any other institution which has a correspondent banking relationship with the institution, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features. PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators are required to take prompt corrective action if an institution fails to satisfy certain minimum capital requirements. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees that would cause the institution to become undercapitalized. An institution that fails to meet the minimum level for any relevant capital measure (an "undercapitalized institution") generally is: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of businesses. The capital restoration plan must include a guarantee by the institution's holding company that the institution will comply with the plan until it has been adequately capitalized on average for four consecutive quarters, under which the holding company would be liable up to the lesser of 5% of the institution's total assets or the amount necessary to bring the institution into capital compliance as of the date it failed to comply with its capital restoration plan. A "significantly undercapitalized" institution, as well as any undercapitalized institution that does not submit an acceptable capital restoration plan, may be subject to regulatory demands for recapitalization, broader application of restrictions on transactions with affiliates, limitations on interest rates paid on savings deposits, asset growth and other activities, possible replacement of directors and officers, and restrictions on capital distributions by any bank holding company controlling the institution. Any company controlling the institution may also be required to divest the institution or the institution could be required to divest subsidiaries. The senior executive officers of a significantly undercapitalized institution may not receive bonuses or increases in compensation without prior approval and the institution is prohibited from making payments of principal or interest on its subordinated debt. In 26 their discretion, the federal banking regulators may also impose the foregoing sanctions on an undercapitalized institution if the regulators determine that such actions are necessary to carry out the purposes of the prompt corrective action provisions. If an institution's ratio of tangible capital to total assets falls below the "critical capital level," the institution will be subject to conservatorship or receivership within 90 days unless periodic determinations are made that forbearance from such action would better protect the deposit insurance fund. Unless appropriate findings and certifications are made by the appropriate federal bank regulatory agencies, a critically undercapitalized institution must be placed in receivership if it remains critically undercapitalized on average during the calendar quarter beginning 270 days after the date it became critically undercapitalized. Under the OTS regulation implementing the prompt corrective action provisions of FDICIA, the OTS measures an institution's capital adequacy for purposes of the prompt corrective action rules on the basis of its total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). An institution that is not subject to an order or written directive to meet or maintain a specific capital level is deemed "well capitalized" if it also has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6% or greater; and (iii) a leverage ratio of 5% or greater. An "adequately capitalized" savings institution is an institution that does not meet the definition of well capitalized and has: (i) a total risk-based capital ratio of 8% or greater; (ii) a Tier 1 capital risk-based ratio of 4% or greater; and (iii) a leverage ratio of 4% or greater (or 3% or greater if the savings institution has a composite 1 CAMELS rating). An "undercapitalized institution" is an institution that has (i) a total risk-based capital ratio less than 8%; or (ii) a Tier 1 risk-based capital ratio of less than 4%; or (iii) a leverage ratio of less than 4% (or 3% if the institution has a composite 1 CAMELS rating). A "significantly undercapitalized" institution is defined as an institution that has: (i) a total risk-based capital ratio of less than 6%; or (ii) a Tier 1 risk-based capital ratio of less than 3%; or (iii) a leverage ratio of less than 3%. A "critically undercapitalized" savings institution is defined as an institution that has " tangible equity" of less than 2%. Tangible equity is defined as core capital plus cumulative perpetual preferred stock (and related surplus) less all intangibles other than qualifying supervisory goodwill and certain purchased mortgage servicing rights. The OTS may reclassify a well capitalized savings institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically-undercapitalized) if the OTS determines, after notice and an opportunity for a hearing, that the savings institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any CAMELS rating category. As of June 30, 2001, the Bank was classified as "well capitalized" under the prompt corrective action regulations. SAFETY AND SOUNDNESS GUIDELINES. Under FDICIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"), each federal banking agency is required to establish safety and soundness standards for institutions under its authority. On July 10, 1995, the federal banking agencies, including the OTS and Federal Reserve Board, released Interagency Guidelines Establishing Standards for Safety and Soundness and published a final rule establishing deadlines for submission and review of safety and soundness compliance plans. The final rule and the guidelines went into effect on August 9, 1995. The guidelines require depository institutions to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution's business. The guidelines also establish certain basic standards for loan documentation, credit underwriting, interest rate risk exposure, and asset growth. The guidelines further provide that depository institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and should take into account factors such as comparable compensation practices at comparable institutions. If the appropriate federal banking agency determines that a depository institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines. A depository institution must submit an acceptable compliance plan to its primary federal regulator within 30 days of receipt of a request for such a plan. Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions. Management believes that the Bank already meets substantially all the standards adopted in the interagency guidelines, and therefore does not believe that implementation of these regulatory standards will materially affect the Bank's operations. 27 Additionally, the federal banking agencies, including the OTS and Federal Reserve Board, have issued guidelines relating to asset quality and earnings. Under the proposed guidelines, an FDIC-insured depository institution should maintain systems, commensurate with its size and the nature and scope of its operations, to identify problem assets and prevent deterioration in those assets as well as to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. Management believes that the asset quality and earnings standards would not have a material effect on the Bank's operations. FINANCIAL MODERNIZATION LEGISLATION. ON November 12, 1999, President Clinton signed legislation which could have a far-reaching impact on the financial services industry. The Gramm-Leach-Bliley ("G-L-B") Act authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and national banks to engage in a variety of new financial activities. Among the new activities that will be permitted to bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking. The Federal Reserve Board, in consultation with the Secretary of the Treasury, may approve additional financial activities. The G-L-B Act, however, prohibits future acquisitions of existing unitary savings and loan holding companies, like the Company, by firms which are engaged in commercial activities and limits the permissible activities of unitary holding companies formed after May 4, 1999. The G-L-B Act imposes new requirements on financial institutions with respect to customer privacy. The G-L-B Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, will be required to comply with state law if it is more protective of customer privacy than the G-L-B Act. The G-L-B Act directs the federal banking agencies, the National Credit Union Administration, the Secretary of the Treasury, the Securities and Exchange Commission and the Federal Trade Commission, after consultation with the National Association of Insurance Commissioners, to promulgate implementing regulations within six months of enactment. The privacy provisions became effective in July 2001. The G-L-B Act contains significant revisions to the FHLB System. The G-L-B Act imposes new capital requirements on the FHLBs and authorizes them to issue two classes of stock with differing dividend rates and redemption requirements. The G-L-B Act deletes the current requirement that the FHLBs annually contribute $300 million to pay interest on certain government obligations in favor of a 20% of net earnings formula. The G-L-B Act expands the permissible uses of FHLB advances by community financial institutions (under $500 million in assets) to include funding loans to small businesses, small farms and small agri-businesses. The G-L-B Act makes membership in the FHLB voluntary for federal savings associations. The G-L-B Act contains a variety of other provisions including a prohibition against ATM surcharges unless the customer has first been provided notice of the imposition and amount of the fee. The G-L-B Act reduces the frequency of Community Reinvestment Act examinations for smaller institutions and imposes certain reporting requirements on depository institutions that make payments to non-governmental entities in connection with the Community Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and authorizes a federal savings association that converts to a national or state bank charter to continue to use the term "federal" in its name and to retain any interstate branches. The Company is unable to predict the impact of the G-L-B Act on its operations at this time. Although the G-L-B Act reduces the range of companies with which may acquire control of the Company, it may facilitate affiliations with companies in the financial services industry. 28 REGULATION OF BANCSHARES GENERAL. Bancshares is a savings and loan holding company as defined by the Home Owners' Loan Act. As such, it is registered with the OTS and is subject to OTS regulation, examination, supervision and reporting requirements. As a subsidiary of a savings institution holding company, the Bank is subject to certain restrictions in its dealings with Bancshares and affiliates thereof. Bancshares also is required to file certain reports with, and otherwise comply with the rules and regulations of, the Securities and Exchange Commission ("SEC") under the federal securities laws. ACTIVITIES RESTRICTIONS. The Board of Directors of Bancshares presently intends to continue operating as a unitary savings and loan holding company. There are generally no restrictions on the activities of a unitary savings and loan holding company if the savings and loan holding company was formed prior to May 4, 1999. However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by such savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the Director of the OTS may impose such restrictions as deemed necessary to address such risk including limiting: (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. If the savings institution subsidiary of such a holding company fails to meet the QTL test, then such unitary holding company shall also presently become subject to the activities restrictions applicable to multiple holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, register as, and become subject to, the restrictions applicable to a bank holding company. See "Regulation of the Bank -- Qualified Thrift Lender Test." If Bancshares were to acquire control of another savings institution, other than through merger or other business combination with the Bank, Bancshares would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings institution meets the QTL test, the activities of Bancshares and any of its subsidiaries (other than the Bank or other subsidiary savings institutions) would thereafter be subject to further restrictions. Among other things, no multiple savings and loan holding company or subsidiary thereof which is not an institution shall commence or continue for a limited period of time after becoming a multiple savings institution holding company or subsidiary thereof, any business activity, upon prior notice to, and no objection by, the OTS, other than: (i) furnishing or performing management services for a subsidiary savings institution; (ii) conducting an insurance agency or escrow business; (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings institution; (iv) holding or managing properties used or occupied by a subsidiary savings institution; (v) acting as trustee under deeds of trust; (vi) those activities authorized by regulation as of March 5, 1987 to be engaged in by multiple holding companies; or (vii) unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies, those activities authorized by the Federal Reserve Board as permissible for bank holding companies. A multiple savings and loan holding company must obtain the approval of the OTS prior to engaging in the activities described in (vii) above. RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies may not acquire, without prior approval of the Director of the OTS, (i) control of any other savings institution or savings and loan holding company or substantially all the assets thereof, or (ii) more than 5% of the voting shares of an institution or holding company thereof which is not a subsidiary. Under certain circumstances, a registered savings and loan holding company is permitted to acquire, with the approval of the Director of the OTS, up to 15% of the voting shares of an under-capitalized savings institution pursuant to a "qualified stock issuance" without that savings institution being deemed controlled by the holding company. In order for the shares acquired to constitute a "qualified stock issuance," the shares must consist of previously unissued stock or treasury shares, the shares must be acquired for cash, the savings and loan holding company's other subsidiaries must have tangible capital of at least 6 1/2% of total assets, there must not be more than one common director or officer between the savings and loan holding company and the issuing savings institution, and transactions between the savings institution and the savings and loan holding company and any of its affiliates must conform to Sections 23A and 23B of the Federal Reserve Act. Except with the prior 29 approval of the Director of the OTS, no director or officer of an institution holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may also acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company. The Director of the OTS may only approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings institutions in more than one state if: (i) the multiple savings and loan holding company involved controls an institution which operated a home or branch office in the state of the institution to be acquired as of March 5, 1987; (ii) the acquiror is authorized to acquire control of the savings institution pursuant to the emergency acquisition provisions of the FDIC Act; or (iii) the statutes of the state in which the institution to be acquired is located specifically permit institutions to be acquired by state-chartered institutions or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions). OTS regulations permit federal savings institutions to branch in any state or states of the United States and its territories. Except in supervisory cases or when interstate branching is otherwise permitted by state law or other statutory provision, a federal institution may not establish an out-of-state branch unless (i) the federal institution qualifies as a QTL or as a "domestic building and loan association" under Section 7701(a)(19) of the Internal Revenue Code and the total assets attributable to all branches of the institution in the state would qualify such branches taken as a whole for treatment as a QTL or as a domestic building and loan association and (ii) such branch would not result in (a) formation of a prohibited multi-state multiple savings and loan holding company or (b) a violation of certain statutory restrictions on branching by savings institution subsidiaries of banking holding companies. Federal savings institutions generally may not establish new branches unless the institution meets or exceeds minimum regulatory capital requirements. The OTS will also consider the institution's record of compliance with the Community Reinvestment Act in connection with any branch application. FEDERAL SECURITIES LAW. Bancshares' Common Stock is registered with the SEC under the Securities Exchange Act of 1934, as amended ("Securities Exchange Act"). Bancshares is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities Exchange Act. FEDERAL INCOME TAXATION Savings institutions such as the Bank are subject to the provisions of the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code") in the same general manner as other corporations. Through tax years beginning before December 31, 1995, institutions such as the Bank which met certain definitional tests and other conditions prescribed by the Internal Revenue Code benefited from certain favorable provisions regarding their deductions from taxable income for annual additions to their bad debt reserve. For purposes of the bad debt reserve deduction, loans are separated into "qualifying real property loans," which generally are loans collateralized by interests in certain real property, and "nonqualifying loans," which are all other loans. The bad debt reserve deduction with respect to nonqualifying loans must be based on actual loss experience. The amount of the bad debt reserve deduction with respect to qualifying real property loans was based upon actual loss experience (the "experience method") or a percentage of taxable income determined without regard to such deduction (the "percentage of taxable income method"). Under the experience method, the bad debt deduction for an addition to the reserve for qualifying real property loans was an amount determined under a formula based generally on the bad debts actually sustained by a savings institution over a period of years. Under the percentage of taxable income method, the bad debt reserve deduction for qualifying real property loans was computed as 8% of a savings institution's taxable income, with certain adjustments. The Bank generally elected to use the method which has resulted in the greatest deductions for federal income tax purposes in any given year. Legislation that is effective for tax years beginning after December 31, 1995 requires institutions to recapture into taxable income over a six taxable year period the portion of the tax loan reserve that exceeds the pre-1988 tax loan loss reserve. The Bank will no longer be allowed to use the reserve method for tax loan loss provisions, but would be allowed to use the experience method of accounting for bad debts. There will be no future effect on net income from the recapture because the taxes on these bad debt reserves have already been accrued as a 30 deferred tax liability. The regulatory authorities have not examined the Bank's federal income tax returns in the past five years. For taxable years beginning after June 30, 1986, the Internal Revenue Code imposes an alternative minimum tax at a rate of 20%. The alternative minimum tax generally applies to a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI") and is payable to the extent such AMTI exceeds an exemption amount. The other items of tax preference that constitute AMTI include (a) tax-exempt interest on newly-issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) for taxable years including 1987 through 1989, 50% of the excess of (i) the taxpayer's pre-tax adjusted net book income over (ii) AMTI (determined without regard to this latter preference and prior to reduction by net operating losses). For taxable years beginning after 1989, this latter preference has been replaced by 75% of the excess (if any) of (i) adjusted current earnings as defined in the Internal Revenue Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). For any taxable year beginning after 1986, net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum taxes may be used as credits against regular tax liabilities in future years. In addition, for taxable years after 1986 and before 1992, corporations, including savings institutions, are also subject to an environmental tax equal to 0.12% of the excess of AMTI for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2.0 million. The Bank is not currently paying any amount of alternative minimum tax but may, depending on future results of operations, become subject to this tax. STATE INCOME TAXATION The Bank is subject to Arkansas corporation income tax which is 6.5% of all taxable earnings when income exceeds $100,000. Bancshares is incorporated under Oklahoma law and qualified to do business in Arkansas as a foreign corporation, and accordingly it incurs certain franchise and other taxes, which management believes are not material. EMPLOYEES As of June 30, 2001, the Bank had 99 full-time equivalent employees, none of whom was represented by a collective bargaining agreement. Management considers the Bank's relationships with its employees to be good. 31 ITEM 2. PROPERTIES The following table sets forth information regarding the Bank's offices at June 30, 2001.
YEAR OWNED OR APPROXIMATE OPENED LEASED BOOK VALUE SQUARE FOOTAGE ------ -------- ---------- -------------- Main Office: 237 Jackson Street, SW 1933 Owned $ 259,695 12,000 Camden, Arkansas Corporate Office: 313 Jefferson Street SW 2000 Leased -- 1,000 Camden, Arkansas Branch Offices: 4937 Highway 5 North 2000 Owned $ 1,748,463 6,500 Bryant, Arkansas 1125 Fairview Road, SW Suite 208 1981 Owned $ 148,184 1,200 Camden, Arkansas 610 West 4th Street 1969 Owned $ 781,673 3,500 Fordyce, Arkansas 473 Highway 425 North 1996 Owned $ 1,222,805 7,400 Monticello, Arkansas 108 South Main 1996 Owned $ 1,054,932 5,500 Sheridan, Arkansas
In addition to the offices described above, at June 30, 2001 the Bank held four other properties located in various communities within the Bank's primary market area. These properties were acquired for possible future construction of additional offices and related facilities. If certain of the properties are beyond the Bank's foreseeable needs for facilities usage, portions of those properties may be sold by the Bank, though such a sale is not currently planned. At June 30, 2001, the aggregate net book value of these properties totaled $1,258,077 of which $314,189 was classified as held for resale. It is anticipated that in the future management may determine to expand the Bank's network of banking facilities by installing ATMs in existing or new banking facilities, by building branches or other facilities on the properties held by the Bank, by acquiring other facilities or sites and/or by acquiring banks or other financial companies with their own facilities. The book value of the Bank's aggregate investment in properties, premises and equipment totaled approximately $7.6 million at June 30, 2001. See Note 7 of the Notes to Consolidated Financial Statements in the Annual Report to Stockholders for June 30, 2001. 32 ITEM 3. LEGAL PROCEEDINGS -------------------------- From time to time, the Bank is a party to various legal proceedings incident to its business. At June 30, 2001, except as set forth below, there were no legal proceedings to which the Company was a party, or to which any of its property was subject, which were expected by management to result in a material loss to the Company. In addition, there were no pending regulatory proceedings to which the Company or any of its properties was a party, which were expected to result in a material loss. In May, 1999, a shareholder filed a putative class action complaint against the Company and several current and former officers alleging that the defendants defrauded the plaintiff and other shareholder class members through various public statements and reports that had the supposed effect of artificially inflating the price the plaintiff and other putative class members paid to purchase the Company's common stock. The Company and the other defendants moved to dismiss the complaint. The federal district court granted the motion on March 31, 2001, but allowed plaintiffs 30 days from the date of the order to file an amended class action complaint. On August 28, 2001, the Company was informed by the federal district court that the case was dismissed with prejudice on August 27, 2001. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------------------------------------------------------------ There were no matters submitted to a vote of the security holders during the fourth quarter of the fiscal year ended June 30, 2001. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------------------------ The information contained under the section "Market for Common Stock and Related Stockholder Matters" in the Annual Report is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA -------------------------------- The information contained in the table captioned "Selected Consolidated Financial and Other Data" in the Annual Report is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ------------------------------------------------------------------- The information contained in the section captioned "Market Risk" in the Annual Report is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ---------------------------------------------------- The financial statements contained in the Annual Report, which are listed under Item 14 herein, are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE -------------------------------------------------------------------------------- None. 33 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------------------------------ For information concerning the Board of Directors and executive officers of the Company, the information contained under the section captioned "Proposal I -- Election of Directors" in the Company's definitive proxy statement for the Company's 2001 Annual Meeting of Stockholders (the "Proxy Statement") which will be filed within 120 days of the Company's fiscal year end and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION -------------------------------- The information contained under the sections captioned "Director Compensation" and "Executive Compensation" in the Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ------------------------------------------------------------------------ (a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Beneficial Ownership" in the Proxy Statement. (b) SECURITY OWNERSHIP OF MANAGEMENT Information required by this item is incorporated herein by reference to the sections captioned "Securities Ownership of Management" in the Proxy Statement. (c) CHANGES IN CONTROL Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------------- The information required by this item is incorporated herein by reference to the section captioned "Transactions with Management" in the Proxy Statement. 34 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ------------------------------------------------------------------------- (a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT ---------------------------------------------- (1) Financial Statements. The following consolidated financial statements are incorporated by reference from Item 8 hereof: Independent Auditors' Report Consolidated Statements of Financial Condition as of June 30, 2001 and 2000 Consolidated Statements of Income and Comprehensive Income for the years ended June 30, 2001, 2000 and 1999 Consolidated Statements of Stockholders' Equity for the years ended June 30, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the years ended June 30, 2001, 2000 and 1999 Notes to Consolidated Financial Statements for the years ended June 30, 2001, 2000 and 1999 (2) Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because of the absence of conditions under which they are required or because the required information is included in the Consolidated Financial Statements and related Notes thereto. (3) Exhibits. The following is a list of exhibits filed as part of this Annual Report on Form 10-K and is also the Exhibit Index. NO. DESCRIPTION --- ----------- 3.1 Articles of Incorporation of HCB Bancshares, Inc. * 3.2 Bylaws of HCB Bancshares, Inc. * 4 Form of Common Stock Certificate of HCB Bancshares, Inc. * 10.1 Form of HCB Bancshares, Inc. 1997 Stock Option and Incentive Plan *+ 10.2 Form of HCB Bancshares, Inc. Management Recognition Plan and Trust Agreement *+ 10.3(a) Employment Agreements by and between Heartland Community Bank and Vida H. Lampkin and Cameron D. McKeel *+ 10.3(b) Employment Agreements by and between HCB Bancshares, Inc. and Vida H. Lampkin and Cameron D. McKeel **+ 10.4(a) Change-in-Control Protective Agreement between Heartland Community Bank and William C. Lyon *+ 10.4(b) Change-in-Control Protective Agreement between HCB Bancshares, Inc. and William C. Lyon *+ 35 10.5 Heartland Community Bank Directors' Retirement Plan, as amended*+ 10.6(a) Change-in-Control Protective Agreement between Heartland Community Bank and Scott A. Swain *+ 10.6(b) Change-in-Control Protective Agreement between HCB Bancshares, Inc. and Scott A. Swain *+ 10.7*** Standstill Agreement, dated August 29, 2001, by and among HCB Bancshares, Inc. and Stilwell Value Partners IV, L.P., Stilwell Associates, L.P., Stilwell Value LLC and Joseph Stilwell 13 Annual Report to Security Holders 21 Subsidiaries 23 Consent of Deloitte & Touche LLP ___________ * Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 333-19093). ** Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 2000 (File No. 0-22423) *** Incorporated by reference to the Company's Current Report on Form 8-K filed on September 5, 2001 (File No. 0-22423) + Management contract or compensatory plan or arrangement. (b) REPORTS ON FORM 8-K. During the last quarter of the period covered by ------------------- this report, the Registrant did not file any Current Reports on Form 8-K (c) Exhibits. The exhibits required by Item 601 of Regulation S-K are -------- either filed as part of this Annual Report on Form 10-K or incorporated by reference herein. (d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. There --------------------------------------------------------------- are no other financial statements and financial statement schedules which were excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b) which are required to be included herein. 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HCB BANCSHARES, INC. Date: September 28, 2001 By: /s/ Cameron D. McKeel ------------------------------------- Cameron D. McKeel President and Chief Executive Officer (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. By: /s/ Cameron D. McKeel September 28, 2001 -------------------------------------------------------- Cameron D. McKeel Director, President and Chief Executive Officer (Principal Executive Officer) By: /s/ Scott A. Swain September 28, 2001 ---------------------------------------------------- Scott A. Swain Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) By: /s/ Vida H. Lampkin September 28, 2001 --------------------------------------------------- Vida H. Lampkin Chairman of the Board By: --------------------------------------------------- Ned Ray Purtle Director By: /s/ Bruce D. Murry September 28, 2001 --------------------------------------------------- Bruce D. Murry Director By: /s/ Carl E. Parker, Jr. September 28, 2001 ---------------------------------------------------- Carl E. Parker, Jr. Director By: --------------------------------------------------- F. Michael Akin Director By: /s/ Clifford Steelman September 28, 2001 ---------------------------------------------------- Clifford Steelman Director EX-13 3 ex13fm10k2001-1843.txt HCB BANCSHARES, INC. ANNUAL REPORT 2001 TO OUR SHAREHOLDERS: Our mission has been to ensure that Arkansas towns continue to have a local bank to help them meet their financial needs, and experience continues to tell us that our mission is sound, wanted, and well-received. During the fiscal year ending June 30, 2001, total customer deposits with HEARTLAND Community Bank grew by $16,412,108, or 11.3%, our largest growth ever in a single year. Our customer satisfaction surveys have included such comments as "Best bank I've ever had!", "You make banking a pleasure instead of a chore.", "The entire staff has provided wonderful service for our family.", "HCB is my inspiration and model for customer service!", and "I do not believe I have encountered this quality of banking experience." These comments, along with record growth in customer deposits (while interest rates were falling!), confirm that our mission is valid, that people still want to do their banking business with folks they know, folks who are involved in the community, local bankers who have the authority to make decisions . . . and who make those decisions based on local needs, rather than on the instructions issued from bank headquarters in some other state. Every HEARTLAND employee who has daily contact with customers receives special training in providing Excellent Customer Service. Our tellers receive special recognition for increasing their expertise as proven through professional tests, resulting in their earning designations as Teller II, Teller III, or Teller IV. Customer satisfaction is our goal, and the response from our customers and communities indicates that we're meeting that goal. With that infrastructure in place, we recognize that stockholder satisfaction is also crucial to the long-term success of our Company. During 2001 we joined forces with our largest outside stockholder to develop aggressive strategies for both short-term and long-term growth in the value of our common stock. That stockholder's designee has been added to our Board of Directors. Several strategies have been discussed, and we are currently researching the long-term and short-term pros and cons of those strategies. Our goal is to identify and execute those strategies that provide both short-term and long-term benefits for our shareholders and our Company, as we continue to provide sound community banking in South Arkansas. We expect steady improvement in our profitability, growth in both the book value and the market value of our common stock, an increase in the number of our banking offices, and a growing customer base. Our Board believes that this new relationship with our stockholder will be mutually beneficial, and we look forward to a long and prosperous association. FINANCIAL HIGHLIGHTS
2001 2000 1999 1998 1997 Total Assets (millions) $ 287.6 $ 291.2 $ 285.4 $ 251.0 $ 200.5 Net Interest Income (millions) $ 6.0 $ 6.7 $ 6.2 $ 6.1 $ 4.8 Ratio of Interest Earning Assets To Interest-Bearing Liabilities 106.44% 105.42% 111.55% 119.51% 108.76%
/s/ Cameron D. McKeel President and Chief Executive Officer HCB BANCSHARES, INC. HCB Bancshares, Inc. ("Bancshares") was incorporated under the laws of the State of Oklahoma in December 1996 at the direction of the Board of Directors of HEARTLAND Community Bank (the "Bank") for the purpose of serving as a savings institution holding company of the Bank, upon the conversion of the Bank from mutual to stock form, which was completed on April 30, 1997 (the "Conversion"). The accompanying consolidated financial statements include the accounts of Bancshares and the Bank and are collectively referred to as the "Company". All significant intercompany balances and transactions have been eliminated in consolidation. Prior to the Conversion, Bancshares did not engage in any material operations. Bancshares has no significant assets other than the outstanding capital stock of the Bank, a portion of the net proceeds of the Conversion and notes receivable, one of which is from the Employee Stock Ownership Plan ("ESOP"). Bancshares' principal business is the business of the Bank. At June 30, 2001, the Company had total assets of $287.6 million, deposits of $161.3 million, and stockholders' equity of $31.9 million, or 11.1% of total assets. The Bank currently operates through six full service-banking offices located in Camden (2), Fordyce, Bryant, Sheridan, and Monticello, Arkansas. As a federally chartered savings institution, the Bank is subject to extensive regulation by the OTS. The Bank's lending activities and other investments must comply with various federal regulatory requirements, and the OTS periodically examines the Bank for compliance. The Bank's deposits are insured up to the maximum limits by the Savings Association Insurance Fund ("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC"). The FDIC also has the authority to conduct special examinations. The Bank must file reports with OTS describing its activities and financial condition and is also subject to certain reserve requirements promulgated by the Federal Reserve Board. 3 MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS Bancshares common stock began trading on the Nasdaq National Market on May 7, 1997, under the symbol "HCBB." Effective February 2, 1999, the Bancshares common stock was delisted and ceased trading on the Nasdaq National Market. Bancshares common stock began trading on the OTC Bulletin Board effective September 16, 1999 and was listed on the Nasdaq Small-Cap Market effective November 22, 1999. At June 30, 2001, there were 2,158,989 shares of the common stock outstanding. For the purpose of this disclosure, shares held in the Stock Option Trust are considered to be outstanding, however, for financial reporting purposes, such shares are reported as treasury shares. At June 30, 2001, there were 689 stockholders of record according to the Company's transfer agent listings. Following are the high and low bid prices, by fiscal quarter, as reported on the Nasdaq National Market from July 1, 1997 to February 2, 1999 and on the Nasdaq Small-Cap Market November 22, 1999 to June 30, 2001, and through the initial underwriting brokerage firm of Trident Securities (McDonald Investments) from February 3, 1999 to November 21, 1999, as well as the dividends paid during such quarters. High Low Dividends Per Share ---- --- ------------------- Fiscal 2001 First Quarter $ 7.38 $ 6.00 $ 0.06 Second Quarter 9.25 7.19 0.06 Third Quarter 8.88 8.31 0.06 Fourth Quarter 13.20 8.94 0.06 Fiscal 2000: First Quarter $ 9.63 $ 8.00 $ 0.06 Second Quarter 9.63 7.00 0.06 Third Quarter 8.00 5.75 0.06 Fourth Quarter 7.25 5.63 0.06 The stated high and low bid prices reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not represent actual transactions. The payment of dividends on common stock is subject to determination and declaration by the Board of Directors of Bancshares. The payment of future dividends will be subject to the requirements of applicable law and the determination by the Board of Directors of Bancshares that the net income, capital and financial condition of Bancshares and the Bank, thrift industry trends and general economic conditions justify the payment of dividends, and there can be no assurance that dividends will continue to be paid in the future. Since Bancshares has no significant source of income other than dividends from the Bank, the payment of dividends by Bancshares can be dependent upon receipt of dividends from the Bank. Payment of cash dividends by the Bank is limited by certain federal regulations under which the Bank may not declare or pay a cash dividend on or repurchase any of its common stock if the effect thereof would cause its regulatory capital to be reduced below (1) the amount required for the liquidation account established in connection with the Bank's conversion to stock form or (2) the regulatory capital requirements imposed by the OTS. In certain circumstances earnings appropriated to bad debt reserves and deducted for federal income tax purposes may not be available to pay cash dividends without the payment of federal income taxes by the Bank on the amount of such earnings removed from the reserves for such purposes at the then current income tax rate. Federal regulations impose certain additional limitations on the payment of dividends and other capital distributions (including stock repurchases and cash mergers) by the Bank. Under OTS regulations, savings institutions must submit notice to the OTS prior to making a capital distribution if (a) they would not be well capitalized after the distribution, (b) the distribution would result in the retirement of any of the institution's common or preferred stock or debt counted as its regulatory capital, or (c) the institution is a subsidiary of a holding company. A savings institution must make application to the OTS to pay a capital distribution if (x) the institution 4 would not be adequately capitalized following the distribution, (y) the institution's total distributions for the calendar year exceeds the institution's net income for the calendar year to date plus its net income (less distributions) for the preceding two years, or (z) the distribution would otherwise violate applicable law or regulation or an agreement with or condition imposed by the OTS. 5 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
AT JUNE 30, -------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ---------- ---------- ---------- ---------- ------------- Total assets.............................. $287,598,650 $291,192,175 $285,396,885 $ 250,953,770 $200,498,516 Loans receivable, net..................... 131,651,421 135,626,505 115,162,883 104,580,165 98,642,635 Allowance for loan losses................. 1,446,114 1,231,709 1,329,201 1,468,546 1,492,473 Cash and due from banks................... 3,302,540 3,211,802 3,560,884 1,531,363 1,057,943 Interest-earning savings deposits......... 15,107,481 236,846 1,693,330 5,073,035 18,273,882 Investment securities: Available for sale..................... 32,138,434 34,135,726 33,132,916 40,775,807 -- Held to maturity....................... -- -- -- -- 17,260,383 Mortgage-backed securities: Available for sale.................... 87,943,743 98,407,339 113,986,773 58,697,109 18,361,987 Held to maturity...................... -- -- -- 27,503,257 36,493,086 Deposits.................................. 161,285,179 144,873,071 146,296,598 141,931,330 151,192,591 FHLB advances............................. 91,915,694 115,609,029 104,523,419 68,121,068 10,000,000 Note payable.............................. 80,000 160,000 240,000 320,000 400,000 Stockholders' equity...................... 31,934,334 28,240,550 32,117,560 37,678,924 37,430,852 Number of: Real estate loans outstanding.......... 1,710 1,820 1,709 2,829 2,093 Deposit accounts....................... 18,538 17,980 18,526 17,158 15,380 Offices open........................... 6 6 6 6 7
YEAR ENDED JUNE 30, ---------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ------------- ------------ ----------- ----------- ----------- Interest income........................... $ 20,078,400 $ 19,808,899 $18,274,647 $15,027,677 $12,987,848 Interest expense.......................... 14,079,466 13,099,656 12,093,603 8,942,149 8,195,782 ------------- ------------ ----------- ----------- ----------- Net interest income....................... 5,998,934 6,709,243 6,181,044 6,085,528 4,792,066 Provision for loan losses................. 296,000 -- -- 24,000 221,671 ------------- ------------ ----------- ----------- ----------- Net interest income after provision for loan losses......................... 5,702,934 6,709,243 6,181,044 6,061,528 4,570,395 Noninterest income........................ 1,378,612 1,039,622 1,018,654 710,856 305,067 Noninterest expense....................... 6,929,118 7,304,110 6,847,715 6,407,976 5,765,870 ------------- ------------ ----------- ----------- ----------- Income (loss) before income taxes......... 152,428 444,755 351,983 364,408 (890,408) Income tax benefit........................ (467,888) (341,147) (63,658) (20,705) (280,935) ------------- ------------ ----------- ----------- ----------- Net income (loss)......................... $ 620,316 $ 785,902 $ 415,641 $ 385,113 $ (609,473)(1) ============= ============ =========== =========== =========== Earnings per share: Basic................................... $ 0.33 $ 0.40 $ 0.18 $ 0.16 $ (.25) Diluted................................. 0.33 0.40 0.18 0.16 (.25) Cash dividends declared................... 0.24 0.24 0.24 0.20 --
--------------- (1) Noninterest expense and, therefore, net loss, for the year ended June 30, 1997 were adversely affected by the imposition of a special deposit insurance assessment in the second quarter of fiscal 1997 in connection with the recapitalization of the SAIF. Absent such assessment, management estimates that noninterest expense would have been approximately $4,876,859 and that net loss would have been approximately $58,286. 6
YEAR ENDED JUNE 30, ---------------------------------------------------------------- 2001 2000 1999 1998 1997 -------- -------- -------- -------- ---------- PERFORMANCE RATIOS: Return on assets (net income (loss) divided by average total assets) (1)................. 0.21% 0.27% 0.15% 0.18% (0.34)% Return on average equity (net income (loss) divided by average equity) (1)............... 2.02 2.76 1.14 1.02 (3.38) Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost)......... 1.85 2.23 1.81 2.11 2.35 Net interest margin (net interest income divided by average interest-earning assets).. 2.19 2.49 2.34 2.96 2.76 Ratio of average interest-earning assets to average interest-bearing liabilities...... 106.44 105.42 111.55 119.51 108.76 Ratio of noninterest expense to average total assets................................. 2.38 2.55 2.48 3.00 3.18 ASSET QUALITY RATIOS: Nonperforming assets to total assets at end of period............................. 0.48 0.33 0.21 0.34 0.29 Nonperforming loans to total loans at end of period............................. 0.81 0.64 0.46 0.75 0.50 Allowance for loan losses to total loans at end of period....................... 0.99 0.85 1.08 1.33 1.46 Allowance for loan losses to nonperforming loans at end of period....................... 121.48 133.95 234.84 177.25 290.50 Provision for loan losses to total loans at end of period ............................ 0.20 -- -- 0.02 0.22 Net charge-offs to average loans outstanding.... 0.06 0.08 0.13 0.05 0.01 CAPITAL RATIOS: Equity to total assets at end of period......... 11.10 9.70 11.25 15.01 18.92 Average equity to average assets................ 10.55 9.95 13.19 17.71 9.95 Dividend payout ratio (2)....................... 76.46 64.50 142.58 137.36 --
-------------- (1) Before cumulative effect adjustment. Returns on assets and equity for the year ended June 30, 1997 were adversely affected by the imposition of a special deposit insurance assessment in the second quarter of fiscal 1997 in connection with the recapitalization of the SAIF. Absent such assessment, management estimates that return on assets would have been approximately .07% and that return on average equity would have been approximately .70%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Item 7. (2) The fiscal year ended June 30, 1998, was the first full year that Bancshares was publicly traded. Dividend payout ratio is the total dividends declared divided by net income. 7 QUARTERLY FINANCIAL DATA The following tables represent summarized data for each of the four quarters in the years ended June 30, 2001 and June 30, 2000.
2001 (IN THOUSANDS, EXCEPT SHARE DATA) ----------------------------------------------------------- FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER Interest income $ 4,858 $ 4,990 $ 5,137 $ 5,093 Interest expense 3,222 3,519 3,712 3,626 ------ ------ --------- ------ Net interest income 1,636 1,471 1,425 1,467 Provision for loan losses 60 60 60 116 ------ ------ --------- ------ Net interest income after provision for loan losses 1,576 1,411 1,365 1,351 Noninterest income 460 264 331 323 Noninterest expenses 1,801 1,693 1,730 1,705 ------ ------ --------- ------ Income (loss) before income taxes 235 (18) (34) (31) Income tax provision (benefit) (103) (124) (134) (107) ------ ------ --------- ------ Net income 338 106 100 76 Basic earnings per common share 0.18 0.06 0.05 0.04 Diluted earnings per common share 0.18 0.06 0.05 0.04 Cash dividends declared per common share 0.06 0.06 0.06 0.06 Average common shares and common stock equivalents outstanding 1,842,259 1,840,580 1,863,269 1,918,473
2000 (IN THOUSANDS, EXCEPT SHARE DATA) ---------------------------------------------------------- FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER Interest income $ 5,046 $ 4,953 $ 4,912 $ 4,898 Interest expense 3,419 3,325 3,228 3,128 -------- -------- -------- -------- Net interest income 1,627 1,628 1,684 1,770 Provision for loan losses -- -- -- -- -------- -------- -------- -------- Net interest income after provision for loan losses 1,627 1,628 1,684 1,770 Noninterest income 316 240 257 227 Noninterest expenses 1,716 1,784 1,850 1,954 -------- -------- -------- -------- Income (loss) before income taxes 227 84 91 43 Income tax provision (benefit) (205) (152) 15 1 -------- -------- -------- -------- Net income 432 236 76 42 Basic earnings per common share 0.22 0.12 0.04 0.02 Diluted earnings per common share 0.22 0.12 0.04 0.02 Cash dividends declared per common share 0.06 0.06 0.06 0.06 Average common shares and common stock equivalents outstanding 1,922,356 1,918,618 1,953,898 2,161,695
8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS When used in this Annual Report, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area, and competition that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. GENERAL The Bank's principal business consists of attracting savings deposits from the general public and investing those funds in loans secured by first mortgages on existing owner-occupied single-family residences in the Bank's primary market area, commercial and multi-family real estate loans, and consumer and commercial business loans. The Bank also maintains a substantial investment portfolio of mortgage-related securities, nontaxable municipal securities, and U.S. government and agency securities. The Bank's net income is dependent primarily on its net interest income, which is the difference between interest income earned on its loans, mortgage-backed securities and securities portfolio and interest paid on customers' savings deposits and other borrowings. The Bank's net income is also affected by the level of noninterest income, such as service charges on customers' deposit accounts, net gains or losses on the sale of loans and securities and other fees. In addition, net income is affected by the level of noninterest expense, which primarily consists of employee compensation expenses, occupancy expenses, and other expenses. The financial condition and results of operations of the Bank and the thrift and banking industries as a whole are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by demand for and supply of credit, competition among lenders and the level of interest rates in the Bank's market area. The Bank's deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, as well as account maturities and the levels of personal income and savings in the Bank's market area. ASSET/LIABILITY MANAGEMENT Net interest income, the primary component of the Bank's net income, is determined by the difference or "spread" between the yield earned on the Bank's interest-earning assets and the rates paid on its interest-bearing liabilities and the relative amounts of such assets and liabilities. Key components of a successful asset/liability strategy are the monitoring and managing of interest rate sensitivity on both the interest-earning assets and interest-bearing liabilities. It has been the Bank's historical policy to mitigate the interest rate risk inherent in the historical savings institution business of originating long-term single-family mortgage loans funded by short-term savings deposits by maintaining substantial liquidity and capital levels to withstand unfavorable movements in market interest rates, by purchasing investment securities with adjustable-rates and/or short terms to maturity and by originating relatively shorter term consumer loans. In the future, however, it is anticipated that as the Bank sells more of its long term loan originations and originates for its portfolio more commercial and multi-family real estate loans and consumer and commercial business loans with relatively shorter terms to maturity or repricing, the Bank's 9 interest rate risk exposure may decline somewhat. The matching of the Bank's assets and liabilities may be analyzed by examining the extent to which its assets and liabilities are interest rate sensitive and by monitoring both its interest rate sensitivity "gap" and the expected effects of interest rate changes on its net portfolio value. For the fiscal year ending June 30, 2001, the Bank's strategy was to use cash flows from investment securities and deposit growth to fund loans and reduce short term Federal Home Loan Bank borrowings. Interest Rate Sensitivity Gap. An asset or liability is 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 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. At June 30, 2001, the Bank's total interest-bearing liabilities maturing or repricing within one year exceeded its total interest-earning assets maturing or repricing in the same period, and the Bank's cumulative one-year gap ratio totaled a negative 21.9%. In addition, the Bank's total interest-earning assets maturing or repricing within five years were slightly less than its total interest-bearing liabilities maturing or repricing in the same period, and the Bank's cumulative five-year gap ratio totaled a negative 11.3%. The Bank's gap measures indicate that net interest income would be exposed to increases in interest rates in the short term, but would be much less exposed to increases in interest rates over the longer term. 10 AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES The following table sets forth information regarding the Company's average interest-earning assets and interest-bearing liabilities and reflects the average yield of interest-earning assets and the average cost of interest-bearing liabilities for the periods indicated. Average balances are derived from monthly balances. The table also presents information for the periods indicated with respect to the difference between the weighted average yield earned on interest-earning assets and the weighted average rate paid on interest-bearing liabilities, or "interest rate spread," which savings institutions have traditionally used as an indicator of profitability. Another indicator of an institution's net interest income is its "net yield on interest-earning assets," which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. The yield on non-taxable securities has not been adjusted to a tax equivalent basis. Yield on available for sale securities is based on amortized cost. Loans on a nonaccrual basis are included in the computation of the average balance of loans receivable. Loan fees deferred and accreted into income are included in interest earned. Whenever interest-earning assets equal or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
Year Ended June 30, -------------------------------------------------------------------------------- 2001 2000 ------------------------------------- ------------------------------------- Average Average Average Interest Yield/ Average Interest Yield/ Balance Earned/Paid Rate Balance Earned/Paid Rate ------- ----------- ------ ------- ----------- ------ Interest-earning assets: Loans receivable ...........................$136,107,616 $ 11,622,492 8.54% $123,535,536 $ 10,491,741 8.49% Investment and mortgage-backed securities Taxable .................................. 99,455,695 6,401,378 6.44 112,065,588 7,352,290 6.56 Nontaxable ............................... 29,246,420 1,529,550 5.23 27,102,813 1,479,536 5.46 Other interest-earning assets .............. 9,720,632 524,980 5.40 6,536,156 485,332 7.43 ------------ ------------ ---- ----------- ------------ ---- Total interest-earning assets ............$274,530,363 20,078,400 7.31 $269,240,093 19,808,899 7.36 Non-interest-earning assets ................ 16,144,665 16,659,326 ------------ ------------ Total assets........................... $290,675,028 $285,899,419 ============ ============ Interest-bearing liabilities: Deposits................................. $152,209,948 7,699,484 5.06 $142,663,307 6,507,174 4.56 FHLB advances............................ 105,619,861 6,372,982 6.03 112,554,831 6,579,482 5.85 Notes payable............................ 94,685 7,000 7.39 175,082 13,000 7.43 ------------ ------------ ---- ----------- ------------ ---- Total interest-bearing liabilities..... 257,924,494 14,079,466 5.46 255,393,220 13,099,656 5.13 Non-interest-bearing liabilities........... 2,085,429 2,046,766 ------------ ------------ Total liabilities...................... 260,009,923 257,439,986 Equity..................................... 30,665,105 28,459,433 ------------ ------------ Total liabilities and equity........... $290,675,028 $285,899,419 ============ ============ Net interest income........................ $ 5,998,934 $ 6,709,243 ============ =========== Net interest rate spread................... 1.85% 2.23% ====== ====== Net yield on interest-earning assets 2.19% 2.49% ====== ====== Ratio of average interest-earning assets to average interest-bearing liabilities 106.44% 105.42% ====== ====== -------------------------------------- 1999 ------------------------------------- Average Interest Yield/ Balance Earned/Paid Rate ------- ----------- ------ Interest-earning assets: Loans receivable ..........................$108,211,367 $ 8,984,708 8.30% Investment and mortgage-backed securities Taxable ................................. 127,823,503 7,879,802 6.16 Nontaxable .............................. 18,542,595 906,755 4.89 Other interest-earning assets ............. 9,895,390 503,382 5.09 ------------ ------------ ---- Total interest-earning assets $264,472,855 18,274,647 6.91 Non-interest-earning assets............. .. 11,984,411 ------------ Total assets...........................$276,457,266 ============ Interest-bearing liabilities: Deposits.................................$141,719,606 6,620,808 4.67 FHLB advances............................ 95,124,165 5,453,795 5.73 Notes payable............................ 253,333 19,000 7.50 ------------ ------------ ---- Total interest-bearing liabilities..... 237,097,104 12,093,603 5.10 Non-interest-bearing liabilities........... 2,903,969 ------------ Total liabilities...................... 240,001,073 Equity..................................... 36,456,193 ------------ Total liabilities and equity...........$276,457,266 ============ Net interest income........................ $ 6,181,044 ============ Net interest rate spread................... 1.81% ====== Net yield on interest-earning assets 2.34% ====== Ratio of average interest-earning assets to average interest-bearing liabilities 111.55% ======
11 RATE/VOLUME ANALYSIS The following table analyzes dollar amounts of changes in interest income expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period's rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period's volume) and (iii) changes in rate/volume (changes in rate multiplied by changes in volume).
Year Ended June 30, ------------------------------------------------------------------------------------------- 2001 vs. 2000 2000 vs. 1999 ----------------------------------------------- ---------------------------------------- Increase (Decrease) Increase (Decrease) Due to Due to ----------------------------------------------- ---------------------------------------- Rate/ Rate/ Volume Rate Volume Total Volume Rate Volume Total ------- ------- ------- ------- ------- ------- ------ ------- (In thousands) Interest income: Loans receivable $ 1,068 $ 57 $ 6 $ 1,131 $ 1,272 $ 206 $ 29 $ 1,507 Investment securities and mortgage- backed securities (710) (201) 10 (901) (553) 612 (14) 45 Other interest-earning assets 236 (132) (64) 40 (171) 231 (78) (18) -------------------------------------------------------------------------------------- Total interest-earning assets 594 (276) (48) 270 548 1,049 (63) 1,534 ------- ------- ------- ------- ------- ------- ------- ------- Interest expense: Deposits 435 709 48 1,192 44 (157) (1) (114) FHLB advances (406) 212 (12) (206) 999 107 20 1,126 Note payable (6) -- -- (6) (6) -- -- (6) -------------------------------------------------------------------------------------- Total interest-bearing liabilities 23 921 36 980 1,037 (50) 19 1,006 ------- ------- ------- ------- ------- ------- ------- ------- Change in net interest income $ 571 $(1,197) $ (84) $ (710) $ (489) $ 1,099 $ (82) $ 528 ======= ======= ======= ======= ======= ======= ======= =======
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2001 AND 2000 The Company had consolidated total assets of $287.6 million and $291.2 million at June 30, 2001 and 2000, respectively. During the twelve-month period ended June 30, 2001 the Company experienced a decrease in its net consolidated loan portfolio from $135.6 million at June 30, 2000, to $131.7 million at June 30, 2001. During this same period, investments and mortgage-backed securities and other short-term interest-earning assets increased from $132.8 million at June 30, 2000 to $135.2 million at June 30, 2001, due to increases in the bank's FHLB DDA account and increases in the market value of investment securities. Deposits increased from $144.9 million at June 30, 2000 to $161.3 million at June 30, 2001. This represents an 11.3 percent increase in deposits. The outstanding balances of FHLB borrowings were $91.9 million and $115.6 million at June 30, 2001 and June 30, 2000, respectively. The decrease in FHLB borrowings was primarily due to slower loan demand combined with increases in deposits and investment securities paydowns. Stockholders' equity amounted to $31.9 million at June 30, 2001, and $28.2 million at June 30, 2000. The changes in equity were primarily due to the reduction of the unrealized loss on investment securities available for sale and the Company's net income earned for the fiscal year ended June 30, 2001, net of the decrease due to the purchase of 12 treasury stock. At June 30, 2001, the Bank's regulatory capital exceeded all applicable regulatory capital requirements and meets the definition of "well" capitalized under the Prompt Corrective Action provisions. 13 COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2001 AND 2000 Net Income. Net income for the year ended June 30, 2001 was approximately $620,000 compared to net income of $786,000 for the year ended June 30, 2000. The changes resulted primarily from a decrease in net interest income of $710,000, an increase in the provision for loan loss of $296,000, offset by an increase in the income tax benefit of $127,000, an increase in noninterest income of $339,000, and a decrease in non-interest expense of $375,000. Interest Income. Interest income for the year ended June 30, 2001 was $20.1 million, or $0.3 million more than interest income for the year ended June 30, 2000. The total average interest earning assets increased $5.3 million, while the yield decreased from 7.36% to 7.31%, primarily due to average yield decreases on investment securities and other interest earning assets. The average balance of loans receivable increased $12.6 million, total loan interest income increased $1.1 million, and the average yield on loans increased 5 basis points. The average balance of investments and mortgage-backed securities receivable decreased $10.5 million, interest income decreased $0.9 million, and the average yield decreased 13 basis points. The average balance of other interest-earning assets (primarily FHLB DDA's and FHLB stock) increased $3.2 million, interest income increased $40,000, and the average yield on decreased 2.03 percent. Interest Expense. Total average interest bearing liabilities increased $2.5 million, while the interest rate on such liabilities increased from 5.13% to 5.46%. The average balance of deposits increased $9.5 million, deposit interest expense increased $1.2 million, and the average cost increased 50 basis points. The average balance of FHLB advances decreased $6.9 million, FHLB interest expense decreased $0.2 million, and the average cost increased 18 basis points. Provision for Loan Losses. During the year ended June 30, 2001, the Bank's management continued its review of the appropriateness of the amount of the allowance for loan losses. Based on these reviews, management made a $296,000 provision for loan losses for the year ended June 30, 2001. The allowance for loan losses of $1.4 million at June 30, 2001 represented 0.99% of gross outstanding loans. The provision was made in consideration of reviews of individual loans and the fact that nonperforming loans as of June 30, 2001 as a percent of total loans increased to 0.81% from 0.64% as of June 30, 2000. Management evaluates the carrying value of the loan portfolio periodically and provisions are made if necessary. While management uses the best information available to make evaluations, future provisions to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize changes to the allowance based upon their judgments and the information available to them at the time of their examination. There were no significant changes in loan terms during the year, nor were there significant changes in the estimation methodologies employed or assumptions utilized. Nonperforming loan and loss trends did not indicate a need to substantially modify loss experience factors during the year. Noninterest Income. Noninterest income is comprised primarily of gains on the sales of loans and service charges on deposit accounts. Noninterest income for the year ended June 30, 2001 was approximately $1,379,000 compared to approximately $1,040,000 for the year ended June 30, 2000. This increase of approximately $339,000 is the result of loan fee income, growth of the Bank's checking and savings accounts resulting in increased service charges, and increases in the deposit account fee structure. Noninterest Expense. The major components of noninterest expense are salaries and employee benefits paid to or on behalf of the Company's employees and directors, professional fees paid to consultants, attorneys, and accountants, occupancy expense for ownership and maintenance of the Company's buildings, furniture, and equipment, 14 and data processing expenses. Total noninterest expense for the year ended June 30, 2001 was $6.9 million compared to $7.3 million for the year ended June 30, 2000. Significant components of the decrease in non-interest expense are a $133,000 increase in occupancy expense primarily resulting from a new full service branch in Bryant, Arkansas, and a $426,000 decrease in professional fees as a result of improved internal and accounting controls. In light of the substantial costs associated with the recent, pending and planned expansions of the Bank's activities, facilities and staff, including additional costs associated with adding staff, building or renovating branches, and introducing new deposit and loan products and services, it is expected that the Bank's noninterest expense levels may remain high relative to the historical levels for the Bank, as well as the prevailing levels for institutions that are not undertaking such expansions, for an indefinite period of time, as management implements the Bank's business strategy. Income Taxes. The effective income tax rates for the Company for the fiscal years ended June 30, 2001 and 2000 were (307.0)% and (76.7)%, respectively. The variance in the effective rate from the expected statutory rate is due primarily to tax exempt interest. These negative rates are a result of net tax benefit, which increases net income. These benefits are due primarily to increases in net operating loss carryforwards for income tax reporting purposes. The corresponding deferred tax asset totals approximately $1.5 million and $1.1 million as of June 30, 2001 and June 30, 2000, respectively. The recoverability of this asset is entirely contingent upon the production of taxable income for income tax reporting purposes. Management anticipates that the Company will produce such income in the near future based on management's current forecasts of earnings and management's tax planning strategy of selling certain available for sale tax exempt securities to generate taxable income. COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2000 AND 1999 Net Income. Net income for the year ended June 30, 2000 was approximately $786,000 compared to net income of $416,000 for the year ended June 30, 1999. The changes resulted primarily from an increase in net interest income of $528,000, an increase in the tax benefit of $277,000, less an increase in non-interest expense of $457,000. Net Interest Income. Net interest income for the year ended June 30, 2000 was $6.7 million, or $528,000 more than net interest income for the year ended June 30, 1999. This improvement is primarily due to rate increases on interest earning assets, offset by volume increases on interest bearing liabilities. The total average interest earning assets increased $4.8 million, and the yield increased from 6.91% to 7.36% primarily due to a 19 basis point increase in the average yield on loans while total average loans increased $15.3 million. Total average interest bearing liabilities increased $18.3 million, and the cost increased slightly from 5.10% to 5.13%. Provision for Loan Losses. During the year ended June 30, 2000, the Bank's management continued its review of loan files. Based on these reviews, management did not make any provisions for loan losses in the year ended June 30, 2000. The allowance for loan losses of $1.2 million at June 30, 2000 represented 0.85% of gross outstanding loans. Nonperforming loans as of June 30, 2000 as a percent of total loans increased to 0.64% from 0.46% as of June 30, 1999. Management evaluates the carrying value of the loan portfolio periodically and provisions are made if necessary. While management uses the best information available to make evaluations, future provisions to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize changes to the allowance based upon their judgments and the information available to them at the time of their examination. There were no significant changes in loan terms during the year, nor were there significant changes in the estimation methodologies employed or assumptions utilized. Nonperforming loan and loss trends did not indicate a need to modify loss experience factors during the year. 15 Noninterest Income. Noninterest income is comprised primarily of gains on the sales of loans and service charges on deposit accounts. Noninterest income for the year ended June 30, 2000 was approximately $1,040,000 compared to approximately $1,019,000 for the year ended June 30, 1999. This increase of approximately $21,000 is the result of gains on sales of loans and the growth of the Bank's checking and savings accounts, resulting in increased service charges, less a decrease in gains on sales of investment securities available for sale of $262,000. Noninterest Expense. The major components of noninterest expense are salaries and employee benefits paid to or on behalf of the Company's employees and directors, professional fees paid to consultants, attorneys, and accountants, occupancy expense for ownership and maintenance of the Company's buildings, furniture, and equipment, and data processing expenses. Total noninterest expense for the year ended June 30, 2000 was $7.3 million compared to $6.8 million for the year ended June 30, 1999. Significant components of the increase in non-interest expense are a $330,000 increase in salaries and benefits primarily resulting from increased staff, an increase of $93,000 in net occupancy expense, a $152,000 increase in other expenses, and a $30,000 decrease in professional fees. It is anticipated by management that future professional fees will continue to decline. In light of the substantial costs associated with the recent, pending and planned expansions of the Bank's activities, facilities and staff, including additional costs associated with adding staff, building or renovating branches, and introducing new deposit and loan products and services, it is expected that the Bank's noninterest expense levels may remain high relative to the historical levels for the Bank, as well as the prevailing levels for institutions that are not undertaking such expansions, for an indefinite period of time, as management implements the Bank's business strategy. Among the activities planned or in process are a full service branch in Bryant, Arkansas in place of the loan production office, and continued increased loan originations in the areas of multi-family residential, commercial business, and consumer loans. Income Taxes. The effective income tax rates for the Company for the fiscal years ended June 30, 2000 and 1999 were (76.7)% and (18.1)%, respectively. The variance in the effective rate from the expected statutory rate is due primarily to tax exempt interest. SOURCES OF CAPITAL AND LIQUIDITY The Company has no business other than that of the Bank. Bancshares' primary sources of liquidity are cash, dividends paid by the Bank and earnings on investments and loans. In addition, the Bank is subject to regulatory limitations with respect to the payment of dividends to Bancshares. The Bank has historically maintained substantial levels of capital. The assessment of capital adequacy is dependent on several factors including asset quality, earnings trends, liquidity and economic conditions. Maintenance of adequate capital levels is integral to provide stability to the Bank. The Bank seeks to maintain substantial levels of regulatory capital to give it maximum flexibility in the changing regulatory environment and to respond to changes in the market and economic conditions. The Bank's primary sources of funds are savings deposits, proceeds from principal and interest payments on loans and mortgage-backed securities, interest payments and maturities of investment securities, and earnings. While scheduled principal repayments on loans and mortgage-backed securities and interest payments on investment securities are a relatively predictable source of funds, deposit flows and loan and mortgage-backed prepayments are greatly influenced by general interest rates, economic conditions, competition and other factors. The Bank does not solicit savings deposits outside of its market area through brokers or other financial institutions. At June 30, 2001, the Bank had designated securities with a fair value of approximately $120.1 million as available for sale. In addition to internal sources of funding, the Bank as a member of the FHLB has substantial borrowing authority with the FHLB. The Bank's use of a particular source of funds is based on need, comparative total costs and availability. 16 At June 30, 2001, the Bank had outstanding approximately $12.0 million in commitments to originate loans (including unfunded portions of construction loans) and $1.3 million in unused lines of credit. At the same date, the total amount of certificates of deposit which were scheduled to mature in one year or less was $86.9 million. Management anticipates that the Bank will have adequate resources to meet its current commitments through internal funding sources described above. Historically, the Bank has been able to retain a significant amount of its savings deposits as they mature. Management is not aware of any current recommendations by its regulatory authorities, legislation, competition, trends in interest rate sensitivity, new accounting guidance or other material events and uncertainties that would have a material effect on the Bank's ability to meet its liquidity demands. MARKET RISK Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates. The risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. The Company's market risk arises primarily from interest rate risk inherent in lending and deposit-taking activities. The Company does not maintain a trading account for any class of financial instrument nor does it engage in hedging activities or purchase derivative instruments. Furthermore, the Company is not subject to foreign currency exchange rate risk or commodity price risk. The OTS currently requires savings institutions to measure and evaluate interest rate risk on a quarterly basis. A savings institution's interest rate risk is measured in terms of the sensitivity of its net portfolio value (NPV) to changes in interest rates. Net portfolio value is defined, generally, as the present value of expected cash inflows from existing assets and off-balance sheet contracts less the present value of expected cash outflows from existing liabilities and off-balance sheet contracts. The Bank presently monitors and evaluates the potential impact of interest rate changes upon the market value of the Bank's NPV on a quarterly basis. These computations estimate the effect on the Bank's NPV of sudden and sustained 100 Basis Points (BP) to 300 BP increases and decreases in market interest rates. The Bank's Board of Directors has adopted an interest rate risk policy which establishes maximum decreases in the Bank's estimated NPV of 20%, 35%, and 55% in the event of assumed immediate and sustained 100 BP to 300 BP, increases or decreases in market interest rates, respectively. In addition, in the event of the assumed immediate and sustained 100 BP, 200 BP, or 300 BP, increase or decrease in market interest rates, the board has set as minimum post shock NPV ratio of 6.00%, 6.50%, and 7.00% respectively. 17 The following tables present the Bank's projected change in NPV as of June 30, 2001 and 2000, as calculated by OTS, based on information provided to the OTS by the Bank. Based on such information, from June 30, 2000 to June 30, 2001, the Bank's interest rate risk has become less liability sensitive throughout the period.
2001 -------------------------------------------------------------------------------------------------- CHANGE IN NPV INTEREST RATES NET PORTFOLIO VALUE RATIO BP CHANGE IN NPV RATIO IN BP -------------------------------------- ----- ---------------------- (RATE SHOCK) AMOUNT $ CHANGE % CHANGE ------------ ------ -------- -------- +300 $24,498 $(10,785) (31)% 9.17 % (292) +200 28,096 (7,187) (20) 10.21 (188) +100 31,525 (3,758) (11) 11.13 (96) +0 35,283 12.09 -100 38,158 2,875 8 12.72 64 -200 39,912 4,629 13 12.98 89 -300 41,855 6,572 19 13.27 118
2000 -------------------------------------------------------------------------------------------------- CHANGE IN NPV INTEREST RATES NET PORTFOLIO VALUE RATIO BP CHANGE IN NPV RATIO IN BP -------------------------------------- ----- ---------------------- (RATE SHOCK) AMOUNT $ CHANGE % CHANGE ------------ ------ -------- -------- +300 $19,349 $(14,482) (43)% 7.31 % (428) +200 23,842 (9,989) (30) 8.73 (286) +100 28,693 (5,138) (15) 10.17 (142) +0 33,831 11.59 -100 38,838 5,007 15 12.87 128 -200 42,604 8,773 26 13.71 212 -300 45,416 11,585 34 14.23 264
At June 30, 2001, it was estimated that the Bank's NPV could decrease 11%, 20%, and 31% in the event of 100 BP, 200 BP, and 300 BP respective increases in market interest rates, and could increase 8%, 13%, and 19% in the event of equivalent decreases in market interest rates. These calculations indicate that the Bank's NPV could be adversely affected by significant increases in interest rates. The decrease in interest-rate risk compared to June 30, 2000 is primarily due to replacing maturing shorter-term FHLB advances with longer-term core deposits. This strategy is coupled with replacing shorter-term investment securities with longer-term loans. Changes in interest rates also may affect the Bank's net interest income. In a declining rate environment, more borrowers would be expected to refinance fixed rate loans at lower rates. This would have the effect of cutting the Bank's yield on fixed rate assets at a time when its liability costs would decline more slowly. In a rising rate environment fewer borrowers would be expected to refinance while more depositors would be expected to liquidate their certificates of deposit and reinvest them in higher rate certificates of deposit. Depositors would tend to exhibit this behavior once rates had increased sufficiently to offset early withdrawal penalties. This would have the effect of maintaining the asset yield at a time when liability costs would tend to rise. The Bank's Board of Directors is responsible for reviewing the Bank's asset and liability policies. On at least a quarterly basis, the Board reviews interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Bank's management is responsible for administering the policies and determinations of the Board of Directors with respect to the Bank's asset and liability goals and strategies. At June 30, 2001, the Bank's estimated changes in net interest income and NPV were within the targets established by the Board of Directors. Computations of prospective effects of hypothetical interest rate changes, such as the above computations, are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank may undertake in response to changes in interest rates. 18 [Letterhead of Deloitte & Touche] INDEPENDENT AUDITOR'S REPORT To the Board of Directors of HCB Bancshares, Inc. Camden, Arkansas We have audited the accompanying consolidated statements of financial condition of HCB Bancshares, Inc. and its subsidiary (the "Company") as of June 30, 2001 and 2000, and the related consolidated statements of income and comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of HCB Bancshares, Inc. and its subsidiary as of June 30, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2001, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP September 21, 2001 19 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, 2001 AND 2000 --------------------------------------------------------------------------------
ASSETS 2001 2000 Cash and due from banks $ 3,302,540 $ 3,211,802 Interest bearing deposits with banks 15,107,481 137,846 ------------- ------------- Cash and cash equivalents 18,410,021 3,349,648 Other interest bearing deposits with banks -- 99,000 Investment securities: Available for sale, at fair value (amortized cost at June 30, 2001 and 2000, of $120,222,942 and $139,920,654, respectively) 120,082,177 132,543,065 Loans receivable, net of allowance at June 30, 2001 and 2000, of $1,446,114 and $1,231,709, respectively 131,651,421 135,626,505 Accrued interest receivable 2,017,188 1,852,887 Federal Home Loan Bank stock 4,735,800 6,223,500 Premises and equipment, net 7,564,681 6,552,484 Goodwill, net 206,250 281,250 Real estate held for sale 398,132 359,608 Other assets 2,532,980 4,304,228 ------------- ------------- TOTAL $ 287,598,650 $ 291,192,175 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits $ 161,285,179 $ 144,873,071 Federal Home Loan Bank advances 91,915,694 115,609,029 Advance payments by borrowers for taxes and insurance 199,470 139,554 Accrued interest payable 972,900 917,415 Note payable 80,000 160,000 Other liabilities 1,211,073 1,252,556 ------------- ------------- Total liabilities 255,664,316 262,951,625 ------------- ------------- COMMITMENTS AND CONTINGENCIES (Notes 12 and 14) STOCKHOLDERS' EQUITY: Common stock, $.01 par value, 10,000,000 shares authorized, 2,645,000 shares issued, 1,935,445 and 2,046,580 shares outstanding at June 30, 2001 and 2000, respectively 26,450 26,450 Additional paid-in capital 25,914,132 25,945,850 Unearned ESOP shares (1,058,000) (1,269,600) Unearned MRP shares (155,601) (220,104) Accumulated other comprehensive loss (59,600) (4,401,668) Retained earnings 14,256,684 14,110,667 ------------- ------------- 38,924,065 34,191,595 ------------- ------------- Treasury stock, at cost, 709,555 and 598,420 shares June 30, 2001 and 2000 respectively (6,989,731) (5,951,045) ------------- ------------- Total stockholders' equity 31,934,334 28,240,550 ------------- ------------- TOTAL $ 287,598,650 $ 291,192,175 ============= =============
See notes to consolidated financial statements. 20 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME YEARS ENDED JUNE 30, 2001, 2000 AND 1999
2001 2000 1999 INTEREST INCOME: Interest and fees on loans $ 11,622,492 $ 10,491,741 $ 8,984,708 Investment securities: Taxable 6,401,378 7,352,290 7,879,802 Nontaxable 1,529,550 1,479,536 906,755 Other 524,980 485,332 503,382 ------------ ------------ ------------ Total interest income 20,078,400 19,808,899 18,274,647 INTEREST EXPENSE: Deposits 7,699,484 6,507,174 6,620,808 Federal Home Loan Bank advances 6,372,982 6,579,482 5,453,795 Note payable 7,000 13,000 19,000 ------------ ------------ ------------ Total interest expense 14,079,466 13,099,656 12,093,603 ------------ ------------ ------------ NET INTEREST INCOME 5,998,934 6,709,243 6,181,044 PROVISION FOR LOAN LOSSES 296,000 -- -- ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 5,702,934 6,709,243 6,181,044 NONINTEREST INCOME: Service charges on deposit accounts 765,532 555,292 328,958 Gain on sales of investment securities available for sale -- -- 261,996 Other 613,080 484,330 427,700 ------------ ------------ ------------ Net noninterest income 1,378,612 1,039,622 1,018,654 ------------ ------------ ------------ NONINTEREST EXPENSES: Salaries and employee benefits 3,875,094 3,904,807 3,574,562 Net occupancy expense 1,033,684 900,948 808,255 Federal insurance premiums 50,330 79,692 88,035 Data processing 312,551 326,528 397,585 Professional fees 624,622 1,050,873 1,080,916 Loss on impaired investment security -- -- 9,000 Amortization of goodwill 75,000 75,000 75,000 Other 957,837 966,262 814,362 ------------ ------------ ------------ Total noninterest expenses 6,929,118 7,304,110 6,847,715 ------------ ------------ ------------ INCOME BEFORE INCOME TAXES 152,428 444,755 351,983 INCOME TAX BENEFIT (467,888) (341,147) (63,658) ------------ ------------ ------------ NET INCOME $ 620,316 $ 785,902 $ 415,641 ------------ ------------ ------------
(Continued) 21 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME YEARS ENDED JUNE 30, 2001, 2000 AND 1999
2001 2000 1999 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX Unrealized holding gain (loss) on securities arising during period $ 4,342,068 $ (1,780,995) $(2,501,663) Reclassification adjustment for gains included in net income -- -- (172,917) ----------- ------------ ----------- Other comprehensive income (loss) 4,342,068 (1,780,995) (2,674,580) ----------- ------------ ----------- COMPREHENSIVE INCOME (LOSS) $ 4,962,384 $ (995,093) $(2,258,939) =========== ============ =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 1,866,387 1,988,984 2,344,083 =========== ============ =========== EARNINGS PER SHARE: Basic $ 0.33 $ 0.40 $ 0.18 =========== ============ =========== Diluted $ 0.33 $ 0.40 $ 0.18 =========== ============ =========== DIVIDENDS PER SHARE $ 0.24 $ 0.24 $ 0.24 =========== ============ ===========
(Concluded) See notes to consolidated financial statements. 22 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED JUNE 30, 2001, 2000 AND 1999
----------------------------------------------------------------------------------------------------------------------------- ISSUED ADDITIONAL ACCUMULATED COMMON STOCK PAID-IN UNEARNED UNEARNED OTHER SHARES AMOUNT CAPITAL ESOP MRP COMPREHENSIVE RETAINED SHARES SHARES INCOME EARNINGS --------- -------- ------------ ------------ ----------- ---------- ------------- BALANCE, JULY 1, 1998 2,645,000 $ 26,450 $ 25,861,230 $ (1,692,800) $ (578,528) $53,907 $ 14,008,665 Net income 415,641 Common stock committed to be released for ESOP 8,570 211,600 MRP shares earned 124,072 188,472 Net change in unrealized gain (loss) on securities available for sale, net of tax (2,674,580) Treasury stock purchased Dividends paid (592,612) --------- -------- ------------ ------------ ----------- ---------- ------------- BALANCE, JUNE 30, 1999 2,645,000 26,450 25,993,872 (1,481,200) (390,056) (2,620,673) 13,831,694 Net income 785,902 Common stock committed to be released for ESOP (48,022) 211,600 MRP shares earned 169,952 Net change in unrealized gain (loss) on securities available for sale, net of tax (1,780,995) Treasury stock purchased Dividends paid (506,929) --------- -------- ------------ ------------ ----------- ---------- ------------- BALANCE, JUNE 30, 2000 2,645,000 26,450 25,945,850 (1,269,600) (220,104) (4,401,668) 14,110,667 Net income 620,316 Common stock committed to be released for ESOP (31,718) 211,600 MRP shares earned 64,503 Net change in unrealized gain (loss) on securities available for sale, net of tax 4,342,068 Treasury stock purchased Dividends paid (474,299) --------- -------- ------------ ------------ ----------- ---------- ------------- BALANCE, JUNE 30, 2001 2,645,000 $ 26,450 $ 25,914,132 $ (1,058,000) $ (155,601) $ (59,600) $ 14,256,684 ========= ======== ============ ============ =========== ========== ============= TREASURY TREASURY TOTAL STOCK STOCK STOCKHOLDERS' SHARES AMOUNT EQUITY -------- ------------- ------------ BALANCE, JULY 1, 1998 -- -- $ 37,678,924 Net income 415,641 Common stock committed to be released for ESOP 220,170 MRP shares earned 312,544 Net change in unrealized gain (loss) on securities available for sale, net of tax (2,674,580) Treasury stock purchased 315,456 $(3,242,527) (3,242,527) Dividends paid (592,612) -------- ------------- ------------ BALANCE, JUNE 30, 1999 315,456 (3,242,527) 32,117,560 Net income 785,902 Common stock committed to be released for ESOP 163,578 MRP shares earned 169,952 Net change in unrealized gain (loss) on securities available for sale, net of tax (1,780,995) Treasury stock purchased 282,964 (2,708,518) (2,708,518) Dividends paid (506,929) -------- ------------- ------------ BALANCE, JUNE 30, 2000 598,420 (5,951,045) 28,240,550 Net income 620,316 Common stock committed to be released for ESOP 179,882 MRP shares earned 64,503 Net change in unrealized gain (loss) on securities available for sale, net of tax 4,342,068 Treasury stock purchased 111,135 (1,038,686) (1,038,686) Dividends paid (474,299) -------- ------------- ------------ BALANCE, JUNE 30, 2001 709,555 $ (6,989,731) $ 31,934,334 ======= ============= ============
See notes to consolidated financial statements. 23 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2001, 2000 AND 1999
2001 2000 1999 OPERATING ACTIVITIES: Net income $ 620,316 $ 785,902 $ 415,641 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation 730,212 649,779 544,142 Amortization (accretion) of: Deferred loan origination fees 116,232 (116,260) (2,729) Goodwill 75,000 75,000 75,000 Premiums and discounts on loans, net (4,487) (4,619) (510) Premiums and discounts on investment securities, net 68,487 119,181 323,110 Provision for loan loss 296,000 -- -- Deferred income taxes (403,424) (477,356) (311,921) Net gain on sale of investment securities available for sale -- -- (261,996) Loss on impaired investment security -- -- 9,000 Loss on disposal of assets, net -- -- 5,464 Origination of loans held for sale (13,502,308) (9,239,668) (14,751,445) Proceeds from sales of loans held for sale 12,732,692 10,160,826 13,140,464 Stock compensation expense 244,385 333,530 408,642 Change in accrued interest receivable (164,301) (135,064) 121,503 Change in accrued interest payable 55,485 102,218 171,310 Change in other assets (720,084) 826,402 (321,083) Change in other liabilities (41,483) (23,113) 72,750 ------------ ------------ ------------ Net cash provided (used) by operating activities 102,722 3,056,758 (362,658) INVESTING ACTIVITIES: Purchases of investment securities available for sale -- (3,302,892) (94,991,103) Purchases of loans -- (82,547) -- Redemption (purchase) of Federal Home Loan Bank stock 1,487,700 (844,400) (1,930,200) Proceeds from sales of investment securities - available for sale -- -- 48,024,577 Loan (originations), net of repayments 4,336,955 (21,181,354) (8,968,498) Principal payments on investment securities 19,629,225 14,768,810 22,279,177 Proceeds from maturities of other interest bearing deposits 99,000 619,000 2,064,000 Net (increase) decrease in land held for resale (38,524) 103,870 (2,288) Proceeds from sales of premises and equipment -- -- 14,426 Purchases of premises and equipment (1,742,409) (701,559) (1,462,969) ------------ ------------ ------------ Net cash provided (used) by investing activities 23,771,947 (10,621,072) (34,972,878)
24 (Continued) HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2001, 2000 AND 1999
2001 2000 1999 FINANCING ACTIVITIES: Net increase (decrease) in deposits $ 16,412,108 $ (1,423,527) $ 4,365,268 Advances from Federal Home Loan Bank 213,740,000 281,234,000 124,128,000 Repayment of Federal Home Loan Bank advances (237,433,335) (270,148,390) (87,725,649) Net increase (decrease) in advance payments by borrowers for taxes and insurance 59,916 11,112 (80,800) Purchase of treasury stock (1,038,686) (2,708,518) (3,242,527) Purchase of shares for the management retention plan -- -- (722,328) Repayment of note payable (80,000) (80,000) (80,000) Dividends paid (474,299) (506,929) (592,612) ------------- ------------- ------------- Net cash provided by financing activities (8,814,296) 6,377,748 36,049,352 ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,060,373 (1,186,566) 713,816 CASH AND CASH EQUIVALENTS: Beginning of year 3,349,648 4,536,214 3,822,398 ------------- ------------- ------------- End of year $ 18,410,021 $ 3,349,648 $ 4,536,214 ============= ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for: Interest $ 14,023,981 $ 12,997,438 $ 11,922,293 ============= ============= ============= Income taxes $ 150,000 $ -- $ 95,000 ============= ============= =============
(Concluded) See notes to consolidated financial statements. 25 HCB BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 2001, 2000 AND 1999 -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION - HCB Bancshares, Inc. ("Bancshares"), a bank holding company, owns 100 percent of Heartland Community Bank and its subsidiary (collectively the "Bank"). Bancshares' business is primarily that of owning the Bank and participating in the Bank's activities. The Bank provides a broad line of financial products to individuals and small to medium-sized businesses through banking offices located in Camden, Fordyce, Sheridan, Bryant, and Monticello, Arkansas. The accompanying consolidated financial statements include the accounts of Bancshares and the Bank and are collectively referred to as the "Company". All significant intercompany balances and transactions have been eliminated in consolidation. USE OF ESTIMATES - 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 and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of the deferred tax asset. CASH AND CASH EQUIVALENTS - For purposes of presentation in the consolidated statements of cash flows, "cash and cash equivalents" includes cash on hand and amounts due from depository institutions, which includes interest-bearing amounts available upon demand. OTHER INTEREST BEARING DEPOSITS WITH BANKS - Other interest bearing deposits with banks represents certificates of deposit in other banks held by the Company not meeting the definition of a cash equivalent. INVESTMENT SECURITIES - The Company classifies investment securities into one of two categories: held to maturity or available for sale. The Company does not engage in trading activities. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at cost, adjusted for the amortization of premiums and the accretion of discounts. Investment securities that the Company intends to hold for indefinite periods of time are classified as available for sale and are recorded at fair value. Unrealized holding gains and losses are excluded from earnings and reported net of tax as a separate component of stockholders' equity until realized. Investment securities in the available for sale portfolio may be used as part of the Company's asset and liability management practices and may be sold in response to changes in interest rate risk, prepayment risk or other economic factors. Premiums are amortized into interest income using the interest method to the earlier of maturity or call date. Discounts are accreted into interest income using the interest method over the period to maturity. The specific identification method of accounting is used to compute gains or losses on the sales of investment securities. If the fair value of an investment security declines for reasons other than temporary market conditions, the carrying value of such a security is written down to fair value by a charge to operations. LOANS RECEIVABLE - Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at unpaid principal balances adjusted for any charge-offs, the allowance for loan losses, deferred loan fees or costs, and unamortized premiums or discounts. Deferred loan fees or costs and premiums and discounts on loans are amortized or accreted to income using the level-yield method over the remaining period to contractual maturity. The accrual of interest on impaired loans is generally discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due or when the loan becomes ninety days past due, 26 whichever occurs first. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments in excess of principal due are received, until such time that in management's opinion, the borrower will be able to meet payments as they become due. ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is a valuation allowance to provide for incurred but not yet realized losses. The Bank reviews its loans for impairment on a quarterly basis. Impairment is determined by assessing the probability that the borrower will not be able to fulfill the contractual terms of the agreement. If a loan is determined to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or by use of the observable market price of the loan or fair value of collateral if the loan is collateral dependent. Throughout the year management estimates the level of probable losses to determine whether the allowance for loan losses is appropriate considering the estimated losses existing in the portfolio. Based on these estimates, an amount is charged to the provision for loan losses and credited to the allowance for loan losses in order to adjust the allowance to a level determined by management to be appropriate relative to losses. The allowance for loan losses is increased by charges to income (provisions) and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the appropriateness of the allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral and current economic conditions. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Company considers the characteristics of (1) one-to-four family residential first mortgage loans; (2) automobile loans and; (3) consumer and home improvement loans to permit consideration of the appropriateness of the allowance for losses of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the allowance for losses includes segregating certain specific, poorly performing loans based on their performance characteristics from the pools of loans as to type and then applying a loss factor to the remaining pool balance based on several factors including classification of the loans as to grade, past loss experience, inherent risks, economic conditions in the primary market areas and other factors which usually are beyond the control of the Company. Those segregated specific loans are evaluated using the present value of future cash flows, usually determined by estimating the fair value of the loan's collateral reduced by any cost of selling and discounted at the loan's effective interest rate if the estimated time to receipt of monies is more than three months. Non-homogeneous loans are those loans that can be included in a particular loan type, such as commercial loans and multi-family and commercial first mortgage loans, but which differ in other characteristics to the extent that valuation on a pool basis is not valid. After segregating specific, poorly performing loans and applying the methodology as noted in the preceding paragraph for such specific loans, the remaining loans are evaluated based on payment experience, known difficulties in the borrowers business or geographic area, loss experience, inherent risks and other factors usually beyond the control of the Company. These loans are then graded and a factor, based on experience, is applied to estimate the probable loss. Estimates of the probability of loan losses involve an exercise of judgment. While it is possible that in the near term the Company may sustain losses which are substantial in relation to the allowance for loan losses, it is the judgment of management that the allowance for loan losses reflected in the consolidated statements of financial condition is appropriate considering the estimated probable losses in the portfolio. REAL ESTATE HELD FOR SALE - Real estate acquired in settlement of loans is initially recorded at estimated fair value less estimated costs to sell and is subsequently carried at the lower of carrying amount or fair value less estimated disposal costs. Management periodically performs valuations, and an allowance for losses is established by a charge to operations to the extent that the carrying value of a property exceeds its estimated fair value. Costs relating to the development and improvement of the property are capitalized, whereas those relating to holding the property are expensed. Real estate acquired for sale is carried of the lower of cost or fair value less costs to sell. PREMISES AND EQUIPMENT - Office premises and equipment are stated at cost less accumulated depreciation and amortization. The Company computes depreciation of premises and equipment using the straight-line method over the estimated useful lives of the individual assets which range from 5 to 50 years for buildings and improvements and from 3 to 10 years for furniture and equipment. 27 GOODWILL AND LONG LIVED ASSETS - Goodwill is being amortized over six years using the straight-line method. Goodwill and other long lived assets are reviewed for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. LOAN ORIGINATION FEES - Loan origination 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 level-yield method over the contractual life of the loans. When a loan is fully repaid or sold, the amount of unamortized fee or cost is recorded in income. INCOME TAXES - The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Company considers the need for a valuation allowance if, based on available evidence, deferred tax assets are not expected to be realized. INTEREST RATE RISK - The Bank's asset base is exposed to risk including the risk resulting from changes in interest rates and changes in the timing of cash flows. The Bank monitors the effect of such risks by considering the mismatch of the maturities of its assets and liabilities in the current interest rate environment and the sensitivity of assets and liabilities to changes in interest rates. The Bank's management has considered the effect of significant increases and decreases in interest rates and believes such changes, if they occurred, would be manageable and would not affect the ability of the Bank to hold its assets as planned. However, the Bank is exposed to significant market risk in the event of significant and prolonged interest rate changes. EMPLOYEE STOCK OWNERSHIP PLAN - Compensation expense for the Employee Stock Ownership Plan ("ESOP") is determined based on the average fair value of shares committed to be released during the period and is recognized as the shares are committed to be released. For the purposes of earnings per share, ESOP shares are included in weighted-average common shares outstanding as the shares are committed to be released. MANAGEMENT RECOGNITION PLAN - Compensation for Management Recognition Plan shares granted is based on the fair value of the shares at the date of grant and is recognized ratably over the vesting period. EARNINGS PER SHARE - Earnings per share ("EPS") of common stock has been computed on the basis of the weighted-average number of shares of common stock outstanding, assuming the Company was a public company since July 1, 1996. Basic and diluted earnings per share were both calculated with 1,866,387, 1,988,984, and 2,344,083 weighted-average common shares outstanding for the years ended June 30, 2001, 2000, and 1999, respectively. Weighted-average common shares outstanding was the same for basic and diluted in those years. Potential dilutive common shares include the Stock Option Plan shares and the Management Recognition Plan shares, all of which were granted May 1, 1998. These potential common shares had no dilutive effect for the years ended June 30, 2001, 2000, and 1999. STOCK PURCHASED FOR OPTION BENEFIT TRUST - As of June 30, 2001, the Company has purchased a total of 223,544 shares of stock and placed them in its stock option plan trust. These shares are included in treasury stock on the accompanying condensed consolidated statement of financial condition, are available for sale, and are managed by the trustees specifically for funding stock option benefits provided to key employees. RECLASSIFICATIONS - Certain amounts in the 2000 and 1999 consolidated financial statements have been reclassified to conform to the classifications adopted for reporting in 2001. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations". The statement discontinues the use of the pooling of interest method of accounting for business combinations and is effective for all business combinations initiated after June 30, 2001. Management has completed an evaluation of the effects of this statement and does not believe that it will have a material effect on the Company's consolidated financial statements. In July 2001, the Financial Accounting Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets". The statement will require discontinuing the amortization of goodwill and other intangible assets with indefinite useful lives. Instead, these assets will be tested periodically for impairment and written down to their fair value as necessary. This statement is effective for fiscal years beginning after December 15, 2001, however, 28 early adoption is allowed for companies that have not issued first quarter financial statements as of July 1, 2001. The Company plans to adopt the provisions of this statement on July 1, 2002, and is currently evaluating the effect on the Company's consolidated financial statements. 29 2. INVESTMENT SECURITIES Investment securities consisted of the following at June 30:
2001 ------------------------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR AVAILABLE FOR SALE COST GAINS LOSSES VALUE U.S. Government and agencies $ 1,854,215 $ 46,233 $ 1,900,448 Municipal securities 30,488,774 159,481 $ 451,069 30,197,186 Equity securities 39,750 1,050 40,800 Mortgage-backed securities 75,714,645 424,709 355,094 75,784,260 Collateralized mortgage obligations 12,125,558 54,622 20,697 12,159,483 ---------- -------- --------- ----------- Total $ 120,222,942 $ 686,095 $ 826,860 $ 120,082,177 =========== ======== ========= ===========
2000 ------------------------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR AVAILABLE FOR SALE COST GAINS LOSSES VALUE U.S. Government and agencies $ 6,107,679 $ 226,776 $ 5,880,903 Municipal securities 30,459,285 $ 1,977 2,260,064 28,201,198 Equity securities 63,100 9,475 53,625 Mortgage-backed securities 90,635,969 17,825 4,051,513 86,602,281 Collateralized mortgage obligations 12,654,621 2,558 852,121 11,805,058 ---------- ------ ---------- ----------- Total $ 139,920,654 $ 22,360 $ 7,399,949 $ 132,543,065 =========== ====== ========== ===========
There were no significant gross realized gains or losses on sales of available for sale securities for the years ended June 30, 2001, and June 30, 2000 as compared to approximately $262,000 gross realized gains for the year ended June 30, 1999. At June 30, 2001, municipal securities with a carrying value of approximately $2.1 million were pledged to collateralize public deposits. At June 30, 2001 and 2000, mortgage-backed securities with a carrying value of approximately $20.7 million and $ 62.3 million, respectively, were pledged as collateral for Federal Home Loan Bank advances. The scheduled maturities of available for sale debt securities at June 30, 2001 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 30
AMORTIZED FAIR COST VALUE Due in one year or less $ -- $ -- Due from one year to five years 1,854,215 1,900,448 Due from five years to ten years 1,149,568 1,161,263 Due after ten years 29,339,206 29,035,923 ---------- ---------- 32,342,989 32,097,634 Equity securities 39,750 40,800 Mortgage-backed securities 75,714,645 75,784,260 Collateralized mortgage obligations 12,125,558 12,159,483 ---------- ---------- Total $ 120,222,942 $ 120,082,177 =========== ===========
3. LOANS RECEIVABLE Loans receivable consisted of the following at June 30:
2001 2000 First mortgage loans: One- to four- family residences $ 50,579,375 $ 53,789,291 Multi-family and commercial 57,041,028 56,765,619 Real estate construction loans 16,008,775 14,264,996 Less undisbursed loan funds (12,020,255) (7,386,539) ------------- ------------- Total first mortgage loans 111,608,923 117,433,367 Consumer and other loans: Commercial loans 11,289,519 8,769,131 Automobile 6,779,218 6,460,343 Consumer and home improvement loans 2,073,650 2,430,684 Loans collateralized by deposits 2,488,948 2,320,915 Less undisbursed loan funds (1,274,468) (714,443) ------------- ------------- Total consumer and other loans 21,356,867 19,266,630 Allowance for loan losses (1,446,114) (1,231,709) Net deferred loan costs and discounts 131,745 158,217 ------------- ------------- Loans receivable, net $ 131,651,421 $ 135,626,505 ============= =============
The Company originates and maintains loans receivable which are substantially concentrated in its lending territory (primarily Southern Arkansas) but also originates commercial real estate loans in other areas of Arkansas and in contiguous states. The Company's policy calls for collateral or other forms of repayment assurance to be received from the borrower at the time of loan origination. Such collateral or other form of repayment assurance is subject to changes in economic value due to various factors beyond the control of the Company. The Company has made loans to its directors, executive officers, and their related business interests. The aggregate dollar amount of loans outstanding to directors, officers and their related business interests totaled approximately $1.8 million and $0.8 million at June 30, 2001 and 2000, respectively. Loans identified by management as impaired at June 30, 2001 and 2000 were not significant. The Company is not committed to lend additional funds to debtors whose loans have been modified. Certain loans are originated for sale. These loans are typically held for sale only a short time, and do not represent a material amount in the aggregate prior to their sale. Normally the short time between origination and sale does not provide for significant differences between cost and market values. 31 4. ACCRUED INTEREST RECEIVABLE Accrued interest receivable consisted of the following at June 30: 2001 2000 Investment securities $ 931,985 $1,109,074 Loans 1,085,203 743,813 ---------- ---------- Total $2,017,188 $1,852,887 ========== ========== 5. ALLOWANCE FOR LOAN LOSSES A summary of the activity in the allowance for loan losses is as follows for the years ended June 30: 2001 2000 1999 Balance, beginning of year $ 1,231,709 $ 1,329,201 $ 1,468,546 Provision 296,000 -- -- Charge-offs, net of recoveries (81,595) (97,492) (139,345) ----------- ----------- ----------- Balance, end of year $ 1,446,114 $ 1,231,709 $ 1,329,201 =========== =========== =========== 6. FEDERAL HOME LOAN BANK STOCK The Bank is a member of the Federal Home Loan Bank System. As a member of this system, it is required to maintain an investment in capital stock of the Federal Home Loan Bank ("FHLB") in an amount equal to the greater of 1% of its outstanding home loans or .3% of its total assets. No ready market exists for such stock and it has no quoted market value but may be redeemed at par. The carrying value of the stock is its cost. 7. PREMISES AND EQUIPMENT Premises and equipment consisted of the following at June 30: 2001 2000 Land and buildings $ 7,154,882 $ 5,920,828 Furniture and equipment 3,404,811 2,896,456 ------------ ------------ Total 10,559,693 8,817,284 Accumulated depreciation (2,995,012) (2,264,800) ------------ ------------ Premises and equipment, net $ 7,564,681 $ 6,552,484 ============ ============ 8. DEPOSITS Deposits are summarized as follows at June 30:
2001 2000 Demand and NOW accounts, including noninterest-bearing deposits of $7,379,892 and $5,650,755 in 2001 and 2000, respectively $ 38,055,320 $ 23,553,466 Money market 5,733,865 9,360,191 Statement savings 6,903,036 7,530,432 Certificates of deposit 110,592,958 104,428,982 ------------ ------------ Total $161,285,179 $144,873,071 ============ ============
The aggregate amount of short-term jumbo certificates of deposit with a minimum denomination of $100,000 was approximately $13.6 million and $11.6 million at June 30, 2001 and 2000, respectively. 32 At June 30, 2001, scheduled maturities of certificates of deposit are as follows: Years ending June 30: 2002 $ 86,925,381 2003 18,584,475 2004 5,083,102 ----------- Total $ 110,592,958 =========== Eligible deposits of the Bank are insured up to $100,000 by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). 9. FEDERAL HOME LOAN BANK ADVANCES AND NOTE PAYABLE The Bank pledges as collateral for FHLB advances its FHLB stock and has entered into blanket collateral agreements with the FHLB whereby the Bank agrees to maintain, free of other encumbrances, qualifying single family first mortgage loans with unpaid principal balances, when discounted to 75% of such balances, of at least 100% of total outstanding advances. Additionally the Bank has pledged mortgage-backed securities with a carrying value of approximately $20.7 million at June 30, 2001, as additional collateral. Advances at June 30, 2001 and 2000, have maturity dates as follows:
2001 2000 WEIGHTED WEIGHTED AVERAGE AVERAGE RATE AMOUNT RATE AMOUNT Years ending June 30: 2001 -- % $ -- 6.46 % $ 35,045,000 2002 5.82 8,050,000 5.50 7,550,000 2003 5.70 12,030,126 5.70 12,047,991 2004 5.65 9,875,000 5.66 4,875,000 2005 5.42 9,721,317 5.73 7,000,000 2006 5.92 4,889,509 5.89 4,500,000 Thereafter 6.07 47,349,742 6.07 44,591,038 ---- ---------- ---- ---------- Total 5.88 % $ 91,915,694 6.07 % $ 115,609,029 ==== ========== ==== ===========
The note payable of $80,000 at June 30, 2001, is due in annual installments of $80,000 plus interest through September 2001. The note bears interest at 7.50% and is collateralized by real estate held for sale and office premises with a combined carrying value at June 30, 2001, of approximately $1.5 million. 10. INCOME TAXES Income tax provisions (benefits) are summarized as follows:
Years Ended June 30, ------------------------------------ 2001 2000 1999 Income tax provision (benefit): Current $ (64,464) $ 136,209 $ 248,263 Deferred (403,424) (477,356) (311,921) --------- --------- --------- Total $(467,888) $(341,147) $ (63,658) ========= ========= =========
33 The reasons for the differences between the statutory federal income tax rates and the effective tax rates are summarized as follows:
YEARS ENDED JUNE 30, ----------------------------------------------------------------------------------- 2001 2000 1999 Taxes at statutory rate $ 51,826 34.0% $ 151,217 34.0% $ 119,674 34.0% Increase (decrease) resulting from: Tax exempt income (520,047) (341.18) (503,043) (113.11) (304,193) (86.42) Disallowed interest expense 85,650 56.19 67,735 15.23 44,561 12.66 Change in estimate (67,000) (43.95) 0 0.00 64,915 18.44 Compensation (19,825) (13.01) (77,301) (17.38) (14,389) (4.09) Other, net 1,508 0.99 20,245 4.56 25,774 7.32 --------- ------ --------- ------ --------- ----- Total $(467,888) (306.96)% $(341,147) (76.70)%$ (63,658) (18.09)% ========= ====== ========= ====== ========= =====
During the year ended December 31, 1996, new legislation was enacted which provides for the recapture into taxable income of certain amounts previously deducted as additions to the bad debt reserves for income tax purposes. The Bank changed its method of determining bad debt reserves for tax purposes following the year ended June 30, 1997. The amounts to be recaptured for income tax reporting purposes are considered by the Bank in the determination of the net deferred tax liability. The Company's deferred tax asset account was comprised of the following at June 30: 2001 2000 Deferred tax assets: Allowance for loan losses $ 326,016 $ 275,866 Unrealized loss on investments 81,165 2,975,921 Deferred compensation 312,942 306,236 Net operating loss carryforward 1,147,149 661,092 AMT credit carryforward 278,496 278,496 Investment premiums and discount -- 18,360 Other 13,425 46,048 ---------- ---------- Total deferred tax assets 2,159,193 4,562,019 Deferred tax liabilities: Premises and equipment 262,610 222,683 Investment premiums and discount 10,432 -- Loan fees 1,553 -- FHLB dividends 327,057 290,462 ---------- ---------- Total deferred tax liabilities 601,652 513,145 ---------- ---------- Net deferred tax asset $1,557,541 $4,048,874 ========== ========== A deferred tax liability has not been recognized for the bad debt reserves of the Bank created in the tax years which began prior to December 31, 1987 (the base year). At June 30, 2001, the amount of these reserves totaled approximately $3,459,119 with an unrecognized deferred tax liability of $1,177,372. Such unrecognized deferred tax liability could be recognized in the future, in whole or in part, if (i) there is a change in federal tax law, (ii) the Bank fails to meet certain definitional tests and other conditions in the federal tax law, (iii) certain distributions are made with respect to the stock of the Bank, or (iv) the bad debt reserves are used for any purpose other than absorbing bad debt losses. The Company has a net operating loss carryforward of $3,373,968, which will begin expiring in 2019. The Company's AMT credit carryforward of $278,496 does not have an expiration date. The portion of the net deferred tax asset resulting from net operating loss carryforward and AMT credit carryforward totals $1,425,645. The Company has approved a tax-planning strategy intended to provide for the realization of these carryforwards. The success of this strategy is contingent on several factors including (1) the sale of a sufficient amount of tax-exempt investment securities and corresponding reduction in tax-exempt income and increase in taxable income and (2) sufficient taxable earnings from operations or other sources to provide aggregate net taxable income and permit utilization of the carryforwards prior to their expirations. Should this strategy not 34 result in a sufficient amount of net taxable income, the Company will determine the need for a valuation allowance for the portion of the net deferred tax asset resulting from the carryforwards. It is probable that without achievement of the intended results of the strategy, a valuation allowance would be necessary for the portion of the net deferred tax asset resulting from the carryforwards. 11. BENEFIT PLANS EMPLOYEE STOCK OWNERSHIP PLAN - The Company has established an employee stock ownership plan ("ESOP") to benefit substantially all employees. The ESOP has a note payable to Bancshares, the proceeds from which were used to purchase shares of common stock of Bancshares. The note receivable, presented in the statements of stockholders' equity as unearned ESOP shares, is to be repaid in installments of $211,600 on June 30th each year through 2006. Interest is based upon the prime rate, which is to be adjusted and paid annually. The note may be prepaid without penalty. The ESOP is funded by contributions made by the Bank in amounts sufficient to retire the debt. Compensation expense of $179,882, $163,578, and $220,171 was recognized during the years ended June 30, 2001, 2000, and 1999, respectively. Shares no longer required to be held to collateralize the debt and earnings from the common stock held by the ESOP are allocated among participants on the basis of compensation in the year of allocation. Benefits become 100% vested after three years of credited service. Forfeitures of nonvested benefits will be reallocated among remaining participating employees in the same proportion as contributions. At both June 30, 2001 and 2000, 21,160 shares were committed to be released by the ESOP to participant accounts. At June 30, 2001, there were 105,800 shares allocated to participant accounts and 105,800 unallocated shares. The fair value of the unallocated shares amounted to approximately $1,343,660 (105,800 shares at $12.70 per share) at June 30, 2001. Participants with vested account balances leaving employment, generally, may elect to have their allocated shares distributed. In the case of a distribution of shares, which at the time of distribution are not readily tradable on an established securities market, the Company is required to issue a put option to the participant. The put option is priced using the fair market value as determined as of the most recent valuation date (prior to the exercise of such right) by an independent appraiser. Any excess of the total purchase price at which the participant may put the shares to the Company over the fair value of the shares at the date of the issuance of the option is recognized as expense to the Company with the fair value of the shares recorded as treasury stock. During the year ended June 30, 2001, no put options were issued. During the year ended June 30, 2000, put options were issued to two employees but without any material expense to the Company. During the year ended June 30, 1999, put options were issued to two employees resulting in an expense to the Company totaling approximately $20,000. STOCK OPTION PLAN - The Stock Option Plan ("SOP"), approved by the Company's stockholders during the year ended June 30, 1998, provides for a committee of the Company's Board of Directors to award incentive or non-incentive stock options, representing up to 317,400 shares of Company stock. Options granted to executive officers and directors vest 25% immediately and 25% on each of the three subsequent anniversary dates on the grant. Options granted to employee's vest 20% immediately upon grant, with the balance vesting in equal amounts on the four subsequent anniversary dates of the grant. Options granted vest immediately in the event of disability or death. Outstanding stock options can be exercised over a ten-year period from the date of grant. Vested options of terminated participants expire one year after the participant's termination date. Under the SOP, options have been granted to directors and key employees to purchase common stock of the Company. The exercise price in each case equals the fair market value of the Company's stock at the date of grant. On October 29, 1998, the options committee of the Board of Directors lowered the option grant price on the existing 304,140 options granted to current employees and directors at that date to $9.125 per share, which was market value on that day. No new options were granted during the years ended June 30, 2001 or 2000. A summary of the status of the Company's stock option plan as of June 30, 2001, and changes during the years ending June 30, 2000 and 1999, is presented below: 35 WEIGHTED AVERAGE EXERCISE OPTIONS SHARES PRICE Outstanding at July 1, 1998 304,300 $ 16.00 Granted 20,100 9.35 Exercised -- -- Forfeited 9,104 9.22 ------- ------ Outstanding at June 30, 1999 315,296 $ 9.14 Granted -- -- Exercised -- -- Forfeited 2,316 9.22 ------- ------ Outstanding at June 30, 2000 312,980 9.14 Granted -- -- Exercised -- -- Forfeited 18,513 9.18 ------- ------ Outstanding at June 30, 2001 294,467 9.14 ------- ------ Options exercisable at June 30, 2001 (vested) 278,993 $ 9.13 ======= ====== Exercise prices for options outstanding at June 30, 2001, range from $9.125 to $9.375 per share. The weighted average remaining contractual life of such shares was 6.9 years at June 30, 2001. The Company applies the provisions of Accounting Principles Board Opinion No. 25 in accounting for its stock option plan, as allowed under SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, no compensation cost has been recognized for options granted to employees. Had compensation cost for these plans been determined based on the fair value at the grant dates or repricing date for awards under those plans consistent with the methods of SFAS No. 123, the Company's pro forma net income and pro forma earnings per share would have been as follows: 2001 AS REPORTED PRO FORMA Net income (in thousands) $ 620 $ 529 Earnings per share: Basic $ 0.33 $ 0.28 Diluted $ 0.33 $ 0.28 2000 AS REPORTED PRO FORMA Net income (in thousands) $ 786 $ 676 Earnings per share: Basic $ 0.40 $ 0.34 Diluted $ 0.40 $ 0.34 1999 AS REPORTED PRO FORMA Net income (in thousands) $ 416 $ 311 Earnings per share: Basic $ 0.18 $ 0.13 Diluted $ 0.18 $ 0.13 In determining the above pro forma disclosure, the fair value of options granted was estimated on the date of grant using the binomial option-pricing model with the following weighted average assumptions: 36 1999 1998 GRANTS GRANTS Volatility 54% 15% Life of options 7.5 years 7.5 years Risk-free interest rate 5.3% 5.7% Dividend rate 2.56% 2.63% The weighted average fair value of options granted during the fiscal year ended June 30, 1999, was $2.25 per share. MANAGEMENT RECOGNITION PLAN - The Management Recognition Plan ("MRP"), approved by the Company's stockholders during the year ended June 30, 1998, provides for a committee of the Company's Board of Directors to award restricted stock to key officers as well as non-employee directors. The MRP authorizes the Company to grant up to 52,900 shares of Company stock, all of which were granted during 1998. Compensation expense is recognized based on the fair market value of the shares on the grant date of $16.00 over the vesting period. Under the original plan, shares granted to directors (37,024, of which 1,322 were forfeited as of June 30, 2001) vest 25% at the grant date and 25% each May 1 afterward. Shares granted to non-directors (15,876, of which 1,908 were forfeited as of June 30, 2001) vest 20% at the grant date and 20% each May 1 afterward. Shares granted will be deemed vested in the event of disability, or death. At June 30, 2001, all shares have been acquired that are necessary to meet the Plan's award requirements. The difference between the price at the date of grant and the actual purchase price was recorded as an adjustment to stockholders' equity. Approximately $65,000, $170,000 and $188,000 in compensation expense was recognized during the years ended June 30, 2001, 2000, and 1999, respectively. On May 17, 2000, all directors voluntarily elected to extend their vesting period three additional years to May 1, 2004. In addition, certain officers also voluntarily elected to adopt the three-year extension of their vesting period. DEFINED BENEFIT PLAN - The Bank had a qualified, noncontributory defined benefit retirement plan (the "Plan") covering all of its eligible employees. Employees were eligible when they had attained at least twenty-one years of age and six months of service with the Bank. The Board of Directors initially adopted a resolution on July 1, 1996, to terminate the Plan as of September 16, 1996, and to freeze benefit accruals as of July 31, 1996. The Company experienced delays in terminating the Plan and on June 18, 1998, a resolution was adopted to terminate the Plan as of September 1, 1998, with benefit accruals remaining frozen as of July 31, 1996. Settlement of the related pension obligation occurred on August 30, 1999. 37 All active participants became fully vested for their accrued benefits. The Plan provides that any excess assets will be allocated to participants. As such, based on the funded status of the Plan, no gain or loss occurred upon settlement. JUNE 30, RECONCILIATION OF FUNDED STATUS: 1999 -------- Actuarial present value of accumulated benefit obligations: Vested portion $450,170 Vested part of excess assets 98,310 Non-vested portion -- -------- Accumulated benefit obligation 548,480 Effect of estimated future pay growth -- -------- Projected benefit obligation 548,480 Plan assets at fair value 548,480 -------- Funded status: Unrecognized net (gain) or loss -- Unrecognized prior service cost -- Unrecognized net transition obligation -- -------- (Accrued) prepaid pension cost -- ======== YEAR ENDED JUNE 30, 1999 ------------- Determination of pension cost: Service cost -- Interest cost $ 33,564 Actual return on assets 10,923 Net amortization and deferral (44,487) -------- Net periodic pension cost -- ========= The weighted average interest rate used in determining the projected benefit obligation was 6.0% in 1999. The expected long-term rate of return on assets was 6.0% for 1999. OFFICERS' AND DIRECTORS RETIREMENT PLAN - During the year ended June 30, 1996, the Bank adopted a "non-qualified" retirement plan for its officers and directors in recognition of their years of service to the Bank. The plan is an annuity contract plan whereby funds are to be set aside annually in a grantor trust, with the Bank acting as trustee of the Trust. Distributions are scheduled to be paid upon completion of six to ten years of service to the Bank. No tax deduction for the Plan is claimed until funds are paid to the beneficiaries. Future funding is dependent on continued service to the Bank and therefore is expensed as the plan is funded each year. For the years ended June 30, 2001, 2000 and 1999, contributions to the plan totaled approximately $181,000, $184,000, and $162,000, respectively. 401(K) PLAN - Effective July 1, 1993, employees of the Bank may participate in a 401(k) savings plan, whereby the employees may elect to make contributions pursuant to a salary reduction agreement upon reaching age 21 and completing one year of service. At its discretion, the Bank may make matching contributions to the plan. Employer contributions vest 20% each year beginning in the third year of service and become 100% vested in seven years. The Bank made no matching contribution during the years ended June 30, 2001, 2000 or 1999. EMPLOYMENT AGREEMENTS - Certain executive officers of the Bank and the Company have employment agreements with one-year renewable terms. Such agreements provide for termination pay and other benefits under certain circumstances. Aggregate termination pay is approximately $0.70 million. CHANGE-IN-CONTROL AGREEMENTS - As of June 30, 2001, certain officers of the Bank and the Company had change-in-control agreements with three-year renewable terms. Such agreements provide for benefits under circumstances of changes-in-control as defined in the agreements. The benefits provide for 299% of the officers' compensation. The aggregate benefits total approximately $0.50 million. Subsequent to June 30, 2001, additional 38 officers were provided with change-in-control agreements that provide for a range of 25% to 299% of the officers' compensation. The aggregate benefits total of these new agreements is approximately $0.48 million. 12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of financial condition. The Company does not use financial instruments with off-balance sheet risk as part of its asset/liability management program or for trading purposes. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. 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. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the credit applicant. Such collateral consists primarily of residential properties. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company had the following outstanding commitments at June 30, 2001: Undisbursed construction loans $ 6,817,867 Commitments to originate mortgage loans 5,202,388 Unused lines of credit 1,274,468 ---------- Total $ 13,294,723 ========== The funding period for construction loans is generally less than nine months and commitments to originate mortgage loans are generally outstanding for 60 days or less. At June 30, 2001, interest rates on commitments are believed by management to approximate market rates. 13. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair values of financial instruments are as follows: 39
JUNE 30, 2001 JUNE 30, 2000 ESTIMATED ESTIMATED CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ASSETS: Cash and due from banks $ 3,302,540 $ 3,302,540 $ 3,211,802 $ 3,211,802 Interest bearing deposits with banks 15,107,481 15,107,481 137,846 137,846 Other interest bearing deposits with banks -- -- 99,000 99,000 Investment securities: Available for sale 120,082,177 120,082,177 132,543,065 132,543,065 Loans receivable, net 131,651,421 133,015,674 135,626,505 132,485,000 Accrued interest receivable 2,017,188 2,017,188 1,852,887 1,852,887 Federal Home Loan Bank stock 4,735,800 4,735,800 6,223,500 6,223,500 LIABILITIES Deposits: Demand, NOW, money market and regular savings 50,692,221 50,692,221 40,444,089 40,444,089 Certificates of deposit 110,592,958 111,361,694 104,428,982 104,225,000 Federal Home Loan Bank advances 91,915,694 92,800,235 115,609,029 111,141,000 Advance payments by borrowers for taxes and insurance 199,470 199,470 139,554 139,554 Accrued interest payable 972,900 972,900 917,415 917,415 Note payable 80,000 80,019 160,000 161,000
For cash and due from banks, interest bearing deposits with banks, other interest bearing deposits with banks, Federal Home Loan Bank stock and accrued interest receivable, the carrying value is a reasonable estimate of fair value primarily because of the short-term nature of instruments or, as to Federal Home Loan Bank stock, the ability to sell the stock back to the Federal Home Loan Bank at cost. The fair value of investment securities is based on quoted market prices, dealer quotes and prices obtained from independent pricing services. The fair value of loans receivable is estimated based on present values using the rates currently offered for loans of similar remaining maturities at the reporting date. The fair value of demand deposit accounts, NOW accounts, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit, Federal Home Loan Bank advances, and note payable is estimated using the rates currently offered for deposits and borrowings of similar remaining maturities at the reporting date. For advance payments by borrowers for taxes and insurance and accrued interest payable the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of instruments. Commitments are generally made at prevailing interest rates at the time of funding and are relatively short term. Therefore, there is no difference between the contract amount and fair value. The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2001 and 2000. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since the reporting date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. 14. COMMITMENTS AND CONTINGENCIES In the ordinary course of business, the Company has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Company is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial statements of the Company. 40 In May, 1999, a shareholder filed a putative class action complaint against the Company and several current and former officers alleging that the defendants defrauded the plaintiff and other shareholder class members through various public statements and reports that had the supposed effect of artificially inflating the price the plaintiff and other putative class members paid to purchase the Company's common stock. The Company and the other defendants moved to dismiss the complaint. The federal district court granted the motion on March 31, 2001, but allowed plaintiffs 30 days from the date of the order to file an amended class action complaint. On August 28, 2001, the Company was informed by the federal district court that the case was dismissed with prejudice on August 27, 2001. 15. RETAINED EARNINGS Upon the Conversion, the Company established a special liquidation account for the benefit of eligible account holders and the supplemental eligible account holders in an amount equal to the net worth of the Bank as of the date of its latest statement of financial condition contained in the final offering circular used in connection with the Conversion. The liquidation account will be maintained for the benefit of eligible account holders and supplemental eligible account holders who continue to maintain their accounts in the Bank after Conversion. In the event of a complete liquidation (and only in such event), each eligible and supplemental eligible account holder will be entitled to receive a liquidation distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The Bank may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause the Bank's stockholders' equity to be reduced below applicable regulatory capital maintenance requirements for insured institutions or below the amount of the special liquidation account referred to above. This requirement effectively limits the dividend paying ability of the Company in that the Company must maintain an investment in equity of the Bank sufficient to enable the Bank to meet its requirements as noted above. Required capital amounts are shown in Note 16 to the consolidated financial statements. Liquidation account balances are not maintained because of the cost of maintenance and the remote likelihood of complete liquidation. Additionally, the Bank is limited to distributions it may make to Bancshares without OTS approval if the distribution would cause the total distributions to exceed the Bank's net income for the year to date plus the Bank's net income (less distributions) for the preceding two years. Bancshares may use assets other than its investment in the Bank as a source of dividends. 16. REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and 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 tangible capital (as defined in the regulations) to tangible assets (as defined) and core capital (as defined) to adjusted total assets (as defined), and of total risk-based capital (as defined) to risk-weighted assets (as defined). As of June 30, 2001 and 2000, the most recent notification from the Office of Thrift Supervision categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum core (Tier I core), Tier I risk-based, and total risk-based ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. 41 The Bank's actual capital amounts (in thousands) and ratios are also presented in the tables:
TO BE CATEGORIZED AS WELL CAPITALIZED UNDER PROMPT FOR CAPITAL CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------ ----- ------ ----- ------ ----- AS OF JUNE 30, 2001: Tier I (Core) Capital to Adjusted Total Assets $ 29,132 10.20 % $ 11,420 4.00 % $ 14,274 5.00 % Total Risk-Based Capital to Risk-weighted Assets 30,578 22.17 % 11,032 8.00 % 13,790 10.00 % Tier I (Core) Capital to Risk-weighted Assets 29,132 21.12 % N/A N/A 8,274 6.00 % Tangible Capital to Tangible Assets 29,132 10.20 % 4,282 1.50 % N/A N/A AS OF JUNE 30, 2000: Tier I (Core) Capital to Adjusted Total Assets $ 29,437 10.02 % $ 11,756 4.00 % $ 14,695 5.00 % Total Risk-Based Capital to Risk-weighted Assets 30,669 21.79 % 11,262 8.00 % 14,077 10.00 % Tier I (Core) Capital to Risk-weighted Assets 29,437 20.91 % N/A N/A 8,446 6.00 % Tangible Capital to Tangible Assets 29,437 10.02 % 4,408 1.50 % N/A N/A
Regulations require the Bank to maintain an amount equal to 4% of deposits (net of loans collateralized by deposits) plus short-term borrowings in cash and U.S. Government and other approved securities. 42 17. PARENT COMPANY ONLY FINANCIAL INFORMATION The following condensed statements of financial condition as of June 30, 2001 and 2000, and condensed statements of income and cash flows for the years ended June 30, 2001 and 2000, for HCB Bancshares, Inc. should be read in conjunction with the consolidated financial statements and the notes herein. HCB BANCSHARES, INC. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF FINANCIAL CONDITION JUNE 30, 2001 AND 2000 ASSETS 2001 2000 Deposit in Bank $ 515,975 $ 1,089,752 Cash equivalents 134,522 79,145 ----------- ----------- Cash and cash equivalents 650,497 1,168,897 Investment in Bank 29,861,612 25,898,664 Loans receivable 700,000 700,000 Investment securities 40,800 53,625 Other assets 909,850 419,364 ----------- ----------- TOTAL ASSETS $32,162,759 $28,240,550 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accrued expenses and other liabilities $ 228,425 $ -- Stockholders' equity 31,934,334 28,240,550 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $32,162,759 $28,240,550 =========== =========== CONDENSED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 2001 AND 2000 INCOME: 2001 2000 Dividend from Bank $ 1,000,000 $ -- Interest and dividend income 230,421 346,007 ----------- ----------- Total income 1,230,421 346,007 EXPENSES: Operating expenses 191,509 301,181 ----------- ----------- INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED EARNINGS OF BANK SUBSIDIARY 1,038,912 44,826 INCOME TAX PROVISION (BENEFIT) 13,000 15,242 ----------- ----------- INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS OF BANK SUBSIDARY 1,025,912 29,584 EQUITY IN UNDISTRIBUTED EARNINGS (LOSS) OF BANK SUBSIDIARY (405,596) 756,318 ----------- ----------- NET INCOME $ 620,316 $ 785,902 =========== =========== 43 HCB BANCSHARES, INC. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2001 AND 2000 OPERATING ACTIVITIES: 2001 2000 Net income $ 620,316 $ 785,902 Adjustments to reconcile net income to net cash provided (used) by operating activities: Equity in undistributed (earnings) loss of Bank subsidiary 405,596 (756,318) Changes in operating assets and liabilities: Other assets (259,752) 954,507 Accrued expenses and other liabilities 228,425 (1,179,190) ----------- ----------- Net cash provided (used) by operating activities 994,585 (195,099) ----------- ----------- INVESTING ACTIVITIES: Purchase of investments -- -- Purchase loan, net of repayments -- 1,713,019 ----------- ----------- Net cash provided by investing activities -- 1,713,019 ----------- ----------- FINANCING ACTIVITIES: Dividends paid (474,299) (506,929) Purchase of treasury stock (1,038,686) (2,708,518) ----------- ----------- Net cash used by financing activities (1,512,985) (3,215,447) ----------- ----------- NET DECREASE IN CASH AND CASH EQUIVALENTS (518,400) (1,697,527) CASH AND CASH EQUIVALENTS: Beginning of period 1,168,897 2,866,424 ----------- ----------- End of period $ 650,497 $ 1,168,897 =========== ===========
44 18. OTHER COMPREHENSIVE INCOME The amount of income tax expense or benefit allocated to each component of comprehensive income, including reclassification adjustments, are shown below: YEAR ENDED JUNE 30, 2001 ------------------------------------------ BEFORE TAX TAX EXPENSE NET-OF-TAX AMOUNT (BENEFIT) AMOUNT AMOUNT UNREALIZED GAINS ON SECURITIES: Unrealized holding gain on securities arising during period $7,236,824 $2,894,756 $4,342,068 Less reclassification adjustment for (gains) losses included in net income -- -- -- ---------- ---------- ---------- Other comprehensive income $7,236,824 $2,894,756 $4,342,068 ========== ========== ========== YEAR ENDED JUNE 30, 2000 ------------------------------------------ BEFORE TAX TAX EXPENSE NET-OF-TAX AMOUNT AMOUNT AMOUNT UNREALIZED GAINS ON SECURITIES: Unrealized holding gain on securities arising during period $(2,991,525) $(1,210,530) $(1,780,995) Less reclassification adjustment for (gains) losses included in net income -- -- -- ----------- ----------- ----------- Other comprehensive income $(2,991,525) $(1,210,530) $(1,780,995) =========== =========== =========== YEAR ENDED JUNE 30, 1999 ------------------------------------------ BEFORE TAX TAX EXPENSE NET-OF-TAX AMOUNT (BENEFIT) AMOUNT UNREALIZED GAINS ON SECURITIES: Unrealized holding gain on securities arising during period $(3,790,398) $(1,288,735) $(2,501,663) Less reclassification adjustment for (gains) losses included in net income (261,996) (89,079) (172,917) ----------- ----------- ----------- Other comprehensive income $(4,052,394) $(1,377,814) $(2,674,580) =========== =========== =========== 19. SUBSEQUENT EVENTS Subsequent to June 30, 2001, the Company purchased 77,803 shares for the stock option plan trust at a cost of approximately $985,000. In addition, from July 1, 2001 through September 17, 2001, 16,053 option shares were exercised at an average price of $9.125 per share. From July 1, 2001 through September 17, 2001, the Company also purchased 69,866 shares in treasury stock at an average cost of $12.58 per share for a total of approximately $879,000. In addition, subsequent to June 30, 2001, certain officers were provided with change-in-control agreements ranging from 25% to 299% of annual salary. Aggregate change-in-control pay for these new agreements is $0.48 million as of August 31, 2001. On September 5, 2001 the Company filed a Form 8-K Current Report with the SEC regarding a standstill agreement entered into with a major stockholder on August 29, 2001. Please refer to the Form 8-K Current Report for specifics regarding this agreement. 45 CORPORATE INFORMATION DIRECTORS Vida H. Lampkin Chairman of the Board Cameron D. McKeel President and Chief Executive Officer Bruce D. Murry Self-employed Camden, Arkansas Carl E. Parker, Jr. General Manager, Camden Monument Co. Camden, Arkansas Clifford Steelman Senior Human Resource Administrator, Atlantic Research Corporation Camden, Arkansas Ned Ray Purtle Self-employed Hope, Arkansas F. Michael Akin President, CEO - Akin Industries Monticello, Arkansas EXECUTIVE OFFICERS William C. Lyon Senior Vice President and Chief Lending Officer Paula J. Bergstrom Senior Vice President Administration and Secretary Scott A. Swain Senior Vice President and Chief Financial Officer ANNUAL STOCKHOLDERS MEETING: November 15, 2001 - 10:00 a.m. Charles O. Ross Center 746 California Avenue Camden, Arkansas Record Date - October 4, 2001 MAIN OFFICE: 237 Jackson Street, S.W. Camden, Arkansas 46 BRANCH OFFICES: 22461 Interstate 30, Suite 1100A Bryant, Arkansas 1125 Fairview Road SW Camden, Arkansas 610 West 4th Street Fordyce, Arkansas 473 Highway 425 North Monticello, Arkansas 108 South Main Street Sheridan, Arkansas INDEPENDENT AUDITORS: Deloitte & Touche, LLP 111 Center Street, Suite 1800 Little Rock, Arkansas 72201 GENERAL COUNSEL: Robert S. Laney, Esquire P.O. Box 777 Camden, Arkansas 71711-0777 SECURITIES AND REGULATORY COUNSEL: Stradley Ronon Housley Kantarian & Bronstein, LLP. 1220 19th Street, N.W., Suite 700 Washington, D.C. 20036 STOCK REGISTRAR & TRANSFER AGENT Registrar and Transfer Company Cranford, New Jersey 07016-3572 47 EX-21 4 ex21fm10k2001-1843.txt EXHIBIT 21 SUBSIDIARIES
STATE OR OTHER PERCENTAGE PARENT JURISDICTION OF INCORPORATION OWNERSHIP ------ ----------------------------- ---------- HCB Bancshares, Inc. Oklahoma Subsidiaries (1) ---------------- HEARTLAND Community Bank United States 100% Subsidiary of HEARTLAND Community Bank -------------------------------------- HCB Properties, Inc. Arkansas 100% --------- (1) The assets, liabilities and operations of the subsidiaries are included in the Consolidated Financial Statements contained in Item 8 hereof.
EX-23 5 ex23fm10k2001-1843.txt EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-51927 of HCB Bancshares, Inc. on Form S-8 of our report dated September 21, 2001, incorporated by reference in the Annual Report on Form 10-K of HCB Bancshares, Inc. for the year ended June 30, 2001. /s/ Deloitte & Touche LLP Little Rock, Arkansas September 27, 2001