-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O7XXHZ9pFn9PQYf+Tm4VYoLH6bsPtaPNEv9cKt3T5mJndxE1E9qcNx2cnGFCtO12 SBZYdxxWHZESxeYPb8EHPg== 0000904280-02-000208.txt : 20020926 0000904280-02-000208.hdr.sgml : 20020926 20020926161800 ACCESSION NUMBER: 0000904280-02-000208 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020926 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-22423 FILM NUMBER: 02773362 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-K 1 fm10k2002-1843.txt 2002 FORM 10-K - HCB BANCSHARES, INC. 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, 2002 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: $17,943,227 (1,192,241 shares at the last sale price on August 31, 2002 ($15.05 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: 1,503,436 shares of common stock as of August 31, 2002. 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, 2002. (Parts II and IV) 2. Portions of Proxy Statement for the 2002 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, 2002, the Company had consolidated total assets of $276.4 million, deposits of $165.0 million and stockholders' equity of $26.7 million, or 9.7% 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. On March 7, 2002, the Company announced that its bank subsidiary, HEARTLAND Community Bank had entered into a definitive Branch Purchase and Assumption Agreement with Simmons First Bank of South Arkansas 2 ("SFB"), a subsidiary of Simmons First National Corporation. Pursuant to such agreement, the Bank would sell its Monticello, Arkansas branch office to SFB. The sale was completed on July 19, 2002, and included approximately $8.3 million in loans, $1.5 million in fixed assets, $0.2 million in other assets, and $13.2 million in deposits. The Bank recognized a premium on the deposits of approximately $0.9 million and the difference was paid in cash to the buyer. After the sale of the Monticello branch, the Bank operates through five full-service banking offices located in Camden (2), Fordyce, Sheridan, and Bryant, Arkansas. Historically, the principal business strategy of the Bank, like most 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, 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"). 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. 3 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. MARKET AREA Management considers the Bank's primary market area to comprise the following counties in Arkansas: Calhoun, Cleveland, Dallas, 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 indicated that the population experienced growth in Cleveland (10.2%), Grant (18.0%) and Saline (30.1%) Counties, while population 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 Ouachita and Calhoun Counties, and well below the Arkansas average in Dallas County, 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 Calhoun, Dallas, 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, and SAU Tech. 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. 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 State of Arkansas. The Bank also makes a variety of consumer and commercial business loans. 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 4 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, 2002, the maximum aggregate amount that the Bank could have lent to any one borrower under the 15% limit was approximately $3.5 million. At such date, the largest aggregate amount of loans that the Bank had outstanding to any one borrower was $3.8 million. Although the aggregate loan balance as of June 30, 2002 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, 2002, the Bank and Bancshares' loans to the borrower referred to above totaled approximately $4.5 million with Bancshares carrying $0.7 million of the loans. 5 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, 2002, the Bank had no concentrations of loans exceeding 10% of gross loans other than as disclosed below.
At June 30, ----------------------------------------------------------------------- 2002 2001 2000 --------------------- --------------------- -------------------- Amount % Amount % Amount % ----------- ------- ------------ ------ ------------ ----- Type of Loan - ------------ Real estate loans: One-to-four family residential $48,507,922 36.38% $ 57,001,679 38.97% $ 61,198,180 42.26% Multi-family loans 6,355,028 4.77 6,810,198 4.66 9,220,931 6.37 Non-residential 41,334,937 31.00 49,736,511 34.01 48,756,744 33.67 Loans to facilitate sale of foreclosed real estate -- -- -- -- -- -- Land and other mortgage loans 8,602,412 6.45 10,080,790 6.89 5,644,050 3.90 Consumer loans: Loans secured by savings deposits 2,469,033 1.85 2,488,948 1.70 2,320,915 1.60 Home improvement 35,310 0.03 23,611 0.02 40,851 0.03 Auto 6,836,399 5.13 6,779,218 4.64 6,589,480 4.55 Other consumer 4,771,908 3.58 2,050,039 1.40 2,260,697 1.56 Commercial 14,406,499 10.81 11,289,519 7.71 8,769,131 6.06 ------------ ------ ------------ ------ ------------ ------ Total $133,319,448 100.00% $146,260,513 100.00% $144,800,979 100.00% ------------ ------ ------------ ------ ------------ ------ Less: Loans in process $ 7,663,698 $ 13,294,723 $ 8,100,982 Deferred loan costs (fees), net (149,663) (131,745) (158,217) Allowance for loan losses 1,628,515 1,446,114 1,231,709 ------------ ------------ ------------ Total $124,176,898 $131,651,421 $135,626,505 ============ ============ ============ At June 30, ----------------------------------------------- 1999 1998 --------------------- ----------------------- Amount % Amount % ----------- ------- ------------ ------ Type of Loan - ------------ Real estate loans: One-to-four family residential $ 53,622,417 43.74% $ 49,267,399 44.75% Multi-family loans 9,226,426 7.53 12,577,034 11.43 Non-residential 41,907,368 34.18 35,321,040 32.08 Loans to facilitate sale of foreclosed real estate -- -- 473,476 0.43 Land and other mortgage loans 3,547,514 2.89 598,860 0.54 Consumer loans: Loans secured by savings deposits 2,021,141 1.65 2,215,441 2.01 Home improvement 125,990 0.10 1,291,174 1.17 Auto 4,269,898 3.48 4,070,750 3.70 Other consumer 2,517,190 2.05 1,569,076 1.43 Commercial 5,367,611 4.38 2,708,927 2.46 ------------ ------ ------------ ------ Total $122,605,555 100.00% $110,093,177 100.00% ============ ====== ============ ====== Less: Loans in process $ 6,150,810 $ 3,921,787 Deferred loan costs (fees), net (37,339) 122,679 Allowance for loan losses 1,329,201 1,468,546 ------------ ------------ Total $115,162,883 $104,580,165 ============ ============
6 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, 2002. 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......................... $ 9,611 $ 10,871 $ 28,026 $ 48,508 Other mortgage loans............ 12,614 17,528 26,150 56,292 Commercial loans.................. 5,813 3,692 4,901 14,406 Consumer loans: Loans secured by savings deposits...................... 1,764 670 35 2,469 Other.......................... 832 7,881 2,931 11,644 ------- -------- -------- -------- Total........................ $30,634 $ 40,642 $ 62,043 $133,319 ======= ======== ======== ========
The following table sets forth as of June 30, 2002, dollar amounts of loans due one year or more after June 30, 2002 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.... $ 34,571 $ 4,326 $ 38,897 Other mortgage loans................. 33,444 10,234 43,678 Commercial loans....................... 8,004 589 8,593 Consumer loans: Loans secured by savings deposits.... 705 -- 705 Other consumer loans................. 10,812 -- 10,812 --------- --------- --------- Total.............................. $ 87,536 $ 15,149 $ 102,685 ========= ========= =========
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. 7 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, ------------------------------------------------ 2002 2001 2000 ------------- ------------- ------------- Loans originated: Real estate loans: One-to-four family residential............................ $ 42,880,138 $ 28,443,919 $ 46,925,450 Other mortgage loans...................................... 10,737,552 22,007,354 29,145,079 Commercial loans............................................ 14,547,306 4,465,227 7,973,954 Consumer loans.............................................. 11,231,892 9,659,572 13,515,847 ------------- ------------- ------------- Total loans originated................................... $ 79,396,888 $ 64,576,072 $ 97,560,330 ============= ============= ============= Loans purchased: Real estate loans........................................... $ -- $ 40,000 $ 82,547 ============= ============= ============= Loans sold.................................................... $ 27,117,741 $ 12,732,692 $ 10,160,826 ============= ============= =============
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, lower interest rates in the fiscal year ended June 30, 2002, and increased competition resulted in the origination of fewer numbers and total amount of commercial and multi-family real estate 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, 2002, $48.5 million, or 36.4%, 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 $42.9 million with $27.1 million or 63.2% 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. 8 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, 2002, the Bank's loan portfolio included $3.7 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 and will continue to place 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, 2002, the Bank had 241 commercial real estate, construction commercial real estate, land, and multi-family loans, with an average loan balance of approximately $228,000. At that date, 25 of these loans totaling approximately $5.5 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 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 9 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, 2002. 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, 2002, the Bank's commercial business loans totaled $14.4 million and primarily consisted of recreational vehicle floor plan loans, inventory loans, and equipment loans. At that date, the Bank had one commercial business loan with outstanding commitments exceeding $500,000. This loan is collateralized by a floor plan of recreational vehicles. 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. 10 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 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 11 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, 2002, and December 31, 2001. As of June 30, 2002, the Bank had $38,012 of assets classified doubtful, $7,097,276 of assets classified substandard, and $4,563,625 of assets designated as special mention. The Bank's total adversely classified assets represented approximately 2.6% of the Bank's total assets and 31.0% of the Bank's tangible regulatory capital plus allowance for loan loss at June 30, 2002. At June 30, 2002, 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. 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, 12 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, 2002, 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, 2002, in light of the Bank's loan portfolio review and changes in the mix of loan types, the Bank made $330,000 in provisions for loan losses bringing the total reserve for losses after net charged-off loans to $1.6 million, or 1.22% of gross outstanding loans which compares to 0.99% as of June 30, 2001. The provision was made in consideration of reviews of individual loans and the fact that nonperforming loans as of June 30, 2002 as a percent of total loans increased to 1.44% from 0.81% as of June 30, 2001. In addition, total classified assets as a percent of the Bank's tangible capital plus allowance for loan loss was 31.0% as of June 30, 2002, which compares to 8.1% as of June 30, 2001. Part of this increase is due to an increase in classified assets and part is due to the Bank paying Bancshares $9.0 million in dividends, thus reducing capital at the Bank. As of June 30, 2002, the Bank had $7.1 million in assets classified substandard or doubtful as compared to $2.5 million as of June 30, 2001.The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated. 13
Year Ended June 30, -------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- Balance at beginning of period ... $1,446,114 $1,231,709 $1,329,201 $1,468,546 $1,492,473 ---------- ---------- ---------- ---------- ---------- Loans charged-off: Real estate mortgage: One-to-four family residential 2,407 19,982 4,960 26,883 5,466 Other mortgage loans ......... -- -- -- -- -- Commercial ....................... 77,500 25,811 50,047 37,742 -- Consumer ......................... 154,475 55,968 44,791 79,632 43,100 ---------- ---------- ---------- ---------- ---------- Total charge-offs ................ 234,382 101,761 99,798 144,257 48,566 ---------- ---------- ---------- ---------- ---------- Recoveries: Real estate mortgage: One-to-four family residential 6,407 1,617 -- 865 -- Other mortgage loans ......... -- -- -- -- -- Commercial ..................... 57,357 -- -- -- -- Consumer ....................... 23,019 18,549 2,306 4,047 639 ---------- ---------- ---------- ---------- ---------- Total recoveries ................. 86,783 20,166 2,306 4,912 639 ---------- ---------- ---------- ---------- ---------- Net loans charged-off ............ 147,599 81,595 97,492 139,345 47,927 ---------- ---------- ---------- ---------- ---------- Provision for loan losses ........ 330,000 296,000 -- -- 24,000 ---------- ---------- ---------- ---------- ---------- Balance at end of period ......... $1,628,515 $1,446,114 $1,231,709 $1,329,201 $1,468,546 ========== ========== ========== ========== ========== Ratio of net charge-offs to average loans outstanding during the period............... 0.11% 0.06% 0.08% 0.13% 0.05% ==== ==== ==== ==== ====
14 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, ---------------------------------------------------------------------- 2002 2001 2000 ---------------------- --------------------- --------------------- 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.... $ 321,538 36.4% $ 480,460 39.0% $ 440,709 42.3% Multi-family, non-residential, and land........................ 998,653 42.2 570,261 45.6 551,000 43.9 Consumer loans...................... 137,273 10.6 89,360 7.7 91,000 7.7 Commercial loans.................... 171,051 10.8 255,662 7.7 149,000 6.1 Unallocated......................... -- -- 50,371 -- -- -- ----------- ----- ----------- ----- ----------- ----- Total........................ $ 1,628,515 100.0% $ 1,446,114 100.0% $ 1,231,709 100.0% =========== ===== =========== ===== =========== ===== At June 30, --------------------------------------------- 1999 1998 --------------------- --------------------- 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.... $ 422,000 43.7% $ 504,000 45.2% Multi-family, non-residential, and land........................ 603,000 44.6 557,000 44.0 Consumer loans...................... 101,000 7.3 123,000 8.3 Commercial loans.................... 82,000 4.4 72,000 2.5 Unallocated......................... 121,201 -- 212,546 -- ----------- ----- ---------- ----- Total........................ $ 1,329,201 100.0% $1,468,546 100.0% =========== ===== ========== =====
15 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 ------------------------------------------------------------ 2002 2001 2000 1999 1998 ---------- ---------- -------- -------- -------- Loans accounted for on a nonaccrual basis:(1) Real estate: One-to-four family residential........... $1,176,095 $ 838,271 $655,988 $462,205 $648,012 Other mortgage loans..................... 3,838 -- -- 22,139 -- Consumer loans............................. 188,824 137,987 102,003 81,648 138,747 Commercial loans........................... 152,699 -- -- -- -- ---------- ---------- -------- -------- -------- Total.................................... $1,521,456 $ 976,258 $757,991 $565,992 $786,759 ========== ========== ======== ======== ======== Accruing loans which are contractually past due 90 days or more: Real estate: One-to-four family residential........... $ 109,209 $ 38,816 $140,000 $ -- $ 41,770 Other mortgage loans..................... 251,333 -- -- -- -- Commercial loans........................... -- 161,926 -- -- -- Consumer loans............................. 35,953 13,400 21,524 -- -- ---------- ---------- -------- -------- -------- Total.................................... $ 396,495 $ 214,142 $161,524 $ -- $ 41,770 ========== ========== ======== ======== ======== Total nonperforming loans................ $1,917,951 $1,190,400 $919,515 $565,992 $828,529 ========== ========== ======== ======== ======== Percentage of total loans.................... 1.44% 0.81% 0.64% 0.46% 0.75% ==== ==== ==== ==== ==== Other nonperforming assets (2)............... $ 623,114 $ 175,783 $ 52,919 $ 20,289 $ 17,001 ========== ========== ======== ======== ======== Loans modified in troubled debt restructurings............................. $4,678,247 $ -- $ -- $ -- $392,000 ========== ========== ======== ======== ======== _____________ (1) Designated nonaccrual loan payments received are applied first to contractual principal and interest income is recognized only when contractually current. (2) Other nonperforming assets includes foreclosed real estate.
During the years ended June 30, 2002 and 2001, gross interest income of $127,763 and $80,541, 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 $64,679 and $33,365, respectively. At June 30, 2002, management had identified approximately $3.5 million of loans which amount is not reflected in the preceding table but as to where known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in future disclosure of such loans in the table above. All of these loans were included in the Bank's adversely classified asset amounts as of June 30, 2002. Of this aggregate amount, approximately $429,000 was attributable to 15 one-to-four family residential loans, $1,198,000 was attributable to 13 commercial loans, $1,698,000 was attributable to 7 other mortgage loans, and $139,000 was attributable to 14 16 consumer loans. At June 30, 2002, 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 as required by regulatory authorities 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, 2002, no privately issued securities were rated below AA except as follows: 17 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, 2002, the Bank estimated the value of the security at approximately $29,000 less than its face value. The Bank's carrying value for this security at that date was approximately $145,000 after recognition of impairment loss. 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, 2002, the deterioration affected the credit support and not the principal or interest of the security itself. At June 30, 2002, 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 $166,000 after recognition of impairment loss. The Bank's privately issued securities consist of collateralized mortgage obligations (CMOs) and mortgage pass-through securities. At June 30, 2002, all of the privately issued securities had adjustable interest rates with a weighted average yield of 5.70% and a weighted contractual average term to maturity of 17.8 years. The carrying value of the privately issued securities was approximately $1,700,000 or 1.9% 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, ------------------------------------------------ 2002 2001 2000 ------------ ------------ ------------ Securities available for sale: U.S. government and agencies............................... $ 1,530,945 $ 1,900,448 $ 5,880,903 Municipal securities....................................... 25,689,191 30,197,186 28,201,198 Other securities........................................... 1,995,000 -- -- Collateralized mortgage obligations........................ 11,310,152 12,159,483 11,805,058 Other mortgage-backed securities........................... 77,603,036 75,784,260 86,602,281 Equity securities.......................................... 70,240 40,800 53,625 ------------ ------------ ------------ $118,198,564 $120,082,177 $132,543,065 ============ ============ ============
The following table sets forth information regarding scheduled maturities of the Company's investment portfolio at June 30, 2002. 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 $1,530,945 6.30% $ -- -- % $ -- -- % Municipal securities -- -- -- -- -- -- Other securities -- -- -- -- -- -- Collateralized mortgage obligations -- -- -- -- 525,260 7.22 Other mortgage-backed securities 5,903 9.50 3,573,506 6.58 8,833,926 5.60 ---------- ---- ---------- ---- ---------- ---- Total $1,536,848 6.31% $3,573,506 6.58% $9,359,186 5.69% ========== ==== ========== ==== ========== ==== Equity securities More than Ten Years Total Investment Portfolio -------------------- -------------------------------- Carrying Average Carrying Market Average Value Yield Value Value Yield -------- -------- -------- ------ ------- U.S. government and agencies $ -- -- % $ 1,530,945 $ 1,530,945 6.30% Municipal securities 25,689,191 5.01 25,689,191 25,689,191 5.01 Other securities 1,995,000 2.92 1,995,000 1,995,000 2.92 Collateralized mortgage obligations 10,784,892 6.00 11,310,152 11,310,152 6.06 Other mortgage-backed securities 65,189,701 6.07 77,603,036 77,603,036 6.04 ------------ ---- ------------ ------------ ---- Total $103,658,784 5.74% $118,128,324 $118,128,324 5.77% ============ ==== ==== Equity securities 70,240 70,240 ------------ ------------ $118,198,564 $118,198,564 ============ ============
19 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 NOW accounts, money market accounts, statement 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, ------------------------------------------------------------------------- 2002 2001 2000 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ------- ------- ------- -------- -------- -------- NOW accounts.......................... $ 30,164,006 1.87% $ 25,799,621 4.34% $ 8,824,013 2.77% Money market savings deposits......... 6,191,033 1.90 6,967,070 3.72 16,093,630 3.84 Savings deposits - statement.......... 7,211,717 1.54 6,774,023 2.43 7,955,898 2.58 Certificates of deposit............... 112,568,794 4.36 106,806,416 5.76 104,443,704 5.21 ------------- ---- ------------- ---- ------------- ---- Total............................. $ 156,135,550 3.65% $ 146,347,130 5.26% $ 137,317,245 4.74% ============= ==== ============= ==== ============= ====
20 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 2002 Deposits (Decrease) 2001 Deposits (Decrease) ---------- -------- ---------- ---------- -------- ---------- Noninterest bearing deposits............ $ 8,889,867 5.39% $1,509,975 $ 7,379,892 4.58% $ 1,729,137 NOW accounts............................ 30,202,544 18.30 (472,884) 30,675,428 19.02 12,772,717 Money market savings deposits........... 5,911,715 3.58 177,850 5,733,865 3.56 (3,626,326) Savings deposits - statement............ 8,010,973 4.85 1,107,937 6,903,036 4.28 (627,396) Certificates of deposit................ 111,990,085 67.88 1,397,127 110,592,956 8.56 6,163,976 ------------ ------ ---------- ------------ ------ ----------- $165,005,183 100.00% $3,720,004 $161,285,179 100.00% $16,412,108 ============ ====== ========== ============ ====== =========== Balance at June 30, % of 2000 Deposits ---------- -------- Noninterest bearing deposits............ $ 5,650,755 3.90% NOW accounts............................ 17,902,711 12.36 Money market savings deposits........... 9,360,191 6.46 Savings deposits - statement............ 7,530,432 5.20 Certificates of deposit................ 104,428,982 72.08 ------------ ------ $144,873,071 100.00% ============ ======
21 The following table sets forth information regarding certificates of deposits classified by rates at the dates indicated.
At June 30, ------------------------------------------------ 2002 2001 2000 ------------- ------------- ------------ 1.50 - 3.24%...................... $ 58,571,151 $ -- $ -- 3.25 - 5.99%...................... 44,465,650 77,451,889 68,258,761 6.00 - 7.99%...................... 8,953,284 33,141,069 36,170,221 ------------- ------------- ------------ $ 111,990,085 $ 110,592,958 $104,428,982 ============= ============= ============
The following table sets forth information regarding amounts and maturities of certificates of deposits at June 30, 2002.
Balance Maturing 12-Months Ending June 30, ------------------------------------------------------------------------------ Rate 2003 2004 2005 Thereafter Total - ---- ---- ---- ---- ---------- ----- 1.50 - 3.24%................. $ 51,240,236 $ 7,312,659 $ 18,256 $ -- $ 58,571,151 3.25 - 5.99%................. 29,329,797 9,997,826 5,054,413 83,614 44,465,650 6.00 - 7.99%................. 6,249,878 2,683,406 20,000 -- 8,953,284 ------------ ----------- ---------- -------- ------------ $ 86,819,911 $19,993,891 $5,092,669 $ 83,614 $111,990,085 ============ =========== ========== ======== ============
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, 2002. Certificates Maturity Period of Deposit --------------- ------------- Three months or less....................... $ 4,114,418 Over three through six months.............. 5,794,392 Over six through 12 months................. 6,267,803 Over 12 months............................. 3,172,581 ------------ Total.................................. $ 19,349,194 ============ The following table sets forth information regarding deposit activities of the Bank for the periods indicated.
Year Ended June 30, ---------------------------------------------- 2002 2001 2000 ------------ ------------ ------------ Net increase (decrease) before interest credited........................................ $ (831,186) $ 8,676,800 $ (8,032,919) Interest credited........................................... 4,551,190 7,735,308 6,609,392 ------------ ------------ ------------ Net increase (decrease) in deposits............................................... $ 3,720,004 $ 16,412,108 $ (1,423,527) ============ ============ ============
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 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. 22 The following table sets forth certain information regarding borrowings by the Bank for the periods indicated. Averages are based on monthly balances. See the Notes to Consolidated Financial Statements set forth in item 8 herein.
Year Ended June 30, ----------------------------------------------- 2002 2001 2000 ------------- ------------- ------------- Amounts outstanding at end of period: FHLB advances............................................... $ 82,263,936 $ 91,915,694 $ 115,609,029 Weighted average rate....................................... 5.93% 5.88% 6.07% Maximum amount of borrowings outstanding at any month end: FHLB advances............................................... $ 91,831,310 $ 114,694,903 $ 117,040,406 Approximate average borrowings during the year outstanding with respect to: FHLB advances............................................... $ 86,442,890 $ 105,619,861 $ 112,554,831 Weighted average rate....................................... 5.92% 6.03% 5.85%
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, 2002, on a consolidated basis the Bank was authorized to invest up to approximately $5.5 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, 2002, the Bank's aggregate investment in, and loans to, the subsidiary service corporation totaled $575,929. Subsequent to June 30, 2002, on July 19, 2002, the bank sold its Monticello branch and excess land held for sale, which was held in HCB Properties, Inc., to SFB, which reduced the bank's aggregate investment in, and loans to HCB Properties, Inc. to $261,740. 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. 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. 23 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, 2002, the Bank had $82.2 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. A savings institution that does not meet the Qualified Thrift Lender test must either convert to a bank charter or comply with the following restrictions on its operations: (i) the institution may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for a national bank; (ii) the branching powers of the institution shall be restricted to those of a national bank; and (iii) payment of dividends by the institution shall be subject to the rules regarding payment of dividends by a national bank. Upon the expiration of three years from the date the institution ceases to be a Qualified Thrift Lender, it must cease any activity, and not retain any investment not permissible for a national bank and savings association. 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 8.0% 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. 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, 2002, the Bank had $575,929 investments in, or extensions of credit to, non-includable subsidiaries. 24 Adjusted total assets are a savings institution's total assets as determined under accounting principles generally accepted in the United States of America, 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, 2002, the Bank has $575,929 in 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, 2002.
Percent of Amount Assets(1) ------ ---------- (Dollars in thousands) Tangible capital............................... $ 21,396 7.88% Tangible capital requirement................... 4,073 1.50 --------- ----- Excess...................................... $ 17,323 6.38% ========= ===== Core capital................................... $ 21,396 7.88% Core capital requirement....................... 10,861 4.00 --------- ----- Excess...................................... $ 10,535 3.88% ========= ===== Total capital.................................. $ 23,025 17.06% Risk-based capital requirement................. 10,798 8.00 --------- ----- Excess..................................... $ 12,227 9.06% ========= ===== _________ (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.
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 25 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. In addition, FDIC-insured institutions are required to pay assessments to the FDIC 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. Until December 31, 1999, SAIF-insured institutions were required to pay FICO assessments at five times the rate at which Bank Insurance Fund ("BIF") members were assessed. Since December 31, 1999, both BIF and SAIF members have been 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. 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 $41.3 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. 26 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 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 27 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 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 specified time periods. Under the regulations jointly adopted by the federal banking regulators, a savings institution's capital adequacy for purposes of the FDICIA prompt corrective action rules is determined on the basis of the institution's 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 Tier 1 or core capital to adjusted total assets). 28 The following table shows the capital ratio requirements for each prompt corrective action category:
Adequately Significantly Well Capitalized Capitalized Undercapitalized Undercapitalized ---------------- ----------- ---------------- ---------------- Total risk-based capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0% Tier 1 risk-based capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0% Leverage ratio 5.0% or more 4.0% or more* Less than 4.0%* Less than 3.0% ________________ * 3.0% if the institution has a composite 1 CAMELS rating.
A "critically undercapitalized" savings institution is defined as an institution that has a ratio of "tangible equity" to total assets of less than 2.0%. 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. For information regarding the position of the Bank with respect to the FDICIA prompt corrective action rules, see Note 16 of Notes to Consolidated Financial Statements included under Item 8 hereof. 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. Additionally, the federal banking agencies, including the OTS and Federal Reserve Board, have issued guidelines relating to asset quality and earnings. Under the 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 will not have a material effect on the Bank's operations. 29 FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, legislation was enacted 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. 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. However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial 30 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. Notwithstanding the above rules as to permissible business activities of unitary savings institution holding companies, 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 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). 31 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 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 of 1977 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 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 32 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. STATE INCOME TAXATION The Bank is subject to Arkansas corporation income tax which is approximately 6.5% of taxable earnings. 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, 2002, the Bank had 102 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. ITEM 2. PROPERTIES - ------------------- The following table sets forth information regarding the Bank's offices at June 30, 2002.
YEAR OWNED OR APPROXIMATE OPENED LEASED BOOK VALUE SQUARE FOOTAGE ------ -------- ---------- -------------- Main Office: 237 Jackson Street, SW 1933 Owned $ 234,467 12,000 Camden, Arkansas Corporate Office: 313 Jefferson Street SW 2000 Leased -- 1,000 Camden, Arkansas Branch Offices: 4937 Highway 5 North 2000 Owned $ 1,708,933 6,500 Bryant, Arkansas 1125 Fairview Road, SW Suite 208 1981 Owned $ 135,805 1,200 Camden, Arkansas 610 West 4th Street 1969 Owned $ 755,236 3,500 Fordyce, Arkansas 473 Highway 425 North 1996 Owned $ 1,191,699 7,400 Monticello, Arkansas 108 South Main 1996 Owned $ 1,027,320 5,500 Sheridan, Arkansas
In addition to the offices described above, at June 30, 2002, 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. At June 30, 2002, the aggregate net book value of these properties totaled $1.2 million of which approximately $300,000 was classified as held for resale. On July 19, 2002, the Bank sold its Monticello branch, including the $300,000 land held for sale. 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. 33 The book value of the Bank's aggregate investment in properties, premises and equipment totaled approximately $7.1 million at June 30, 2002. See Note 7 of the Notes to Consolidated Financial Statements in the Annual Report to Stockholders for June 30, 2002. ITEM 3. LEGAL PROCEEDINGS - -------------------------- From time to time, the Bank is a party to various legal proceedings incident to its business. At June 30, 2002, 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. 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, 2002. 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 - -------------------------------------------------------------------------------- The information required by this item was previously disclosed in the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission (the "Commission") on November 9, 2001 (the "Form 8-K") and the Company's Amendment No. 1 to the Form 8-K filed with the Commission on November 13, 2001. 34 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 2002 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) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS Information required by this item is incorporated herein by reference to the sections captioned "Proposal I - Election of Directors -- Executive Compensation -- Securities Authorized for Issuance Under Equity Compensation Plans" in the Proxy Statement. (b) 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. (c) SECURITY OWNERSHIP CERTAIN BENEFICIAL OWNERS Information required by this item is incorporated herein by reference to the sections captioned "Voting Securities and Beneficial Ownership" in the Proxy Statement. (d) 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. 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, 2002 and 2001 35 Consolidated Statements of Income and Comprehensive Income for the years ended June 30, 2002, 2001 and 2000 Consolidated Statements of Stockholders' Equity for the years ended June 30, 2002, 2001 and 2000 Consolidated Statements of Cash Flows for the years ended June 30, 2002, 2001 and 2000 Notes to Consolidated Financial Statements for the years ended June 30, 2002, 2001 and 2000 (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 Intentionally omitted. 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(a) Employment Agreement by and between Heartland Community Bank and Charles Black + 10.7(b) Employment Agreement by and between HCB Bancshares, Inc. and Charles Black + 10.8 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 Stockholders for the fiscal year ended June 30, 2002 36 21 Subsidiaries 23.1 Consent of BKD, LLP 23.2 Consent of Deloitte & Touche LLP 99 Certification ________________ * 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). **** Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001 (File No. 0-22423) *****Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2001 (File No. 0-22423) + Management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K. On April 26, 2002, the Registrant filed a Current ------------------- Report on Form 8-K under item 5 to report the commencement of a stock repurchase program. (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. 37 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 25, 2002 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 25, 2002 ------------------------------------------------ Cameron D. McKeel Director, President and Chief Executive Officer (Principal Executive Officer) By: /s/ Scott A. Swain September 25, 2002 ------------------------------------------------ Scott A. Swain Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) By: /s/ Vida H. Lampkin September 25, 2002 ------------------------------------------------ Vida H. Lampkin Chairman of the Board By: /s/ John G. Rich September 25, 2002 ------------------------------------------------- John G. Rich Director By: /s/ Bruce D. Murry September 25, 2002 ------------------------------------------------- Bruce D. Murry Director By: /s/ Carl E. Parker, Jr. September 25, 2002 ------------------------------------------------- Carl E. Parker, Jr. Director By: /s/ F. Michael Akin September 25, 2002 ------------------------------------------------- F. Michael Akin Director By: /s/ Clifford Steelman September 25, 2002 ------------------------------------------------- Clifford Steelman Director CERTIFICATION I, Cameron D. McKeel, President and Chief Executive Officer of HCB Bancshares, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of HCB Bancshares, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows on the registrant as of, and for, the periods presented in this annual report. Date: September 25, 2002 By: /s/ Cameron D. McKeel ---------------------------------- Cameron D. McKeel Chief Executive Officer (Principal Executive Officer) CERTIFICATION I, Scott A. Swain, Senior Vice President and Chief Financial Officer of HCB Bancshares, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of HCB Bancshares, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; and 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows on the registrant as of, and for, the periods presented in this annual report. Date: September 25, 2002 By: /s/ Scott A. Swain ------------------------------------------------- Scott A. Swain Senior Vice President and Chief Financial Officer (Principal Financial Officer) EX-10 3 exhibit107afm10k2002-1843.txt EXHIBIT 10.7(A) TO 2002 FORM 10-K EMPLOYMENT AGREEMENT THIS AGREEMENT entered into this 20th day of June 2002, by and between HEARTLAND Community Bank (the "Bank") and Charles T. Black (the "Employee"), effective on the date (the "Effective Date") this agreement is executed. WHEREAS, the Employee has heretofore been employed by the Bank as its Senior Vice President Chief Lending Officer and is experienced in all phases of the business of the Bank; and WHEREAS, the Board of Directors of the Bank believes it is in the best interests of the Bank to enter into this Agreement with the Employee in order to assure continuity of management of the Bank and to reinforce and encourage the continued attention and dedication of the Employee to his assigned duties; and WHEREAS, the parties desire by this writing to set forth the continuing employment relationship of the Bank and the Employee. NOW, THEREFORE, it is AGREED as follows: 1. Defined Terms ------------- When used anywhere in this Agreement, the following terms shall have the meaning set forth herein. (a) "Affiliate" shall mean any "parent corporation" or "subsidiary corporation" of the Bank, as the terms are defined in Section 424(e) and (f), respectively, of the Code. (b) When the Bank is in the "mutual" form of organization, a "Change in Control" shall be deemed to have occurred if: (i) as a result of, or in connection with, any exchange offer, merger or other business combination, sale of assets or contested election, any combination of the foregoing transactions, or any similar transaction, the persons who were non-employee directors of the Bank before such transaction cease to constitute a majority of the Board of Directors of the Bank or any successor to the Bank; (ii) the Bank transfers substantially all of its assets to another corporation which is not an Affiliate of the Bank; (iii) the Bank sells substantially all of the assets of an Affiliate which accounted for 50% or more of the controlled group's assets immediately prior to such sale; (iv) any "person" including a "group", exclusive of the Board of Directors of the Bank or any committee thereof, is or becomes the "beneficial owner", directly or indirectly, of proxies of the Bank representing twenty-five percent (25%) or more of the combined voting power of the Bank's members; or (v) the Bank is merged or consolidated with another corporation and, as a result of the merger or consolidation, less than seventy percent (70%) of the outstanding proxies relating to the surviving or resulting corporation are given, in the aggregate, by the former members of the Bank. (c) If the Bank is in the "stock" form of organization, a "Change in Control" shall be deemed to have occurred if: (i) as a result of, or in connection with, any initial public offering, tender offer or exchange offer, merger or other business combination, sale of assets or contested election, any combination of the foregoing transactions, or any similar transaction, the persons who were non-employee directors of the Bank before such transaction cease to constitute a majority of the Board of Directors of the Bank or any successor to the Bank; (ii) the Bank transfers substantially all of its assets to another corporation which is not an Affiliate of the Bank; (iii) the Bank sells substantially all of the assets of an Affiliate which accounted for 50% or more of the controlled group's assets immediately prior to such sale; (iv) any "person" including a "group" is or becomes the "beneficial owner", directly or indirectly, of securities of the Bank representing twenty-five percent (25%) or more of the combined voting power of the Bank's outstanding securities (with the terms in quotation marks having the meaning set forth under the federal securities laws); or (v) the Bank is merged or consolidated with another corporation and, as a result of the merger or consolidation, less than seventy percent (70%) of the outstanding voting securities of the surviving or resulting corporation is owned in the aggregate by the former stockholders of the Bank. Notwithstanding the foregoing, a "Change in Control" shall not be deemed to --- occur solely by reason of a transaction in which the Bank converts to the stock form of organization, or creates an independent holding company in connection therewith. (d) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time, and as interpreted through applicable rulings and regulations in effect from time to time. (e) "Codes Sec. 280G Maximum" shall mean product of 2.99 and his "base amount" as defined in Code ss.280G(b)(3). (f) "Good Reason" shall mean any of the following events, which has not been consented to in advance by the Employee in writing: (i) the requirement that the Employee move his personal residence, or perform his principal executive functions, more than thirty (30) miles from his primary office as of the later of the Effective Date and the most recent voluntary relocation by the Employee; (ii) a material reduction in the Employee's base compensation under this Agreement as the same may be increased from time to time; (iii) the failure by the Bank to continue to provide the Employee with compensation and benefits provided under this Agreement as the same may be increased from time to time, or with benefits substantially similar to those provided to him under any of the employee benefit plans in which the Employee now or hereafter becomes a participant, or the taking of any action by the Bank which would directly or indirectly reduce any of such benefits or deprive the Employee of any material fringe benefit enjoyed by him under this Agreement; (iv) the assignment to the Employee of duties and responsibilities materially different from those normally associated with his position; (v) a failure to reelect the Employee to the Board of Directors of the Bank, if the Employee has served on such Board at any time during the term of the Agreement; (vi) a material diminution or reduction in the Employee's responsibilities or authority (including reporting responsibilities) in connection with his employment with the Bank; or (vii) a material reduction in the secretarial or other administrative support of the Employee. In addition, "Good Reason" shall mean an impairment of the Employee's health to an extent that it makes continued performance of his duties hereunder hazardous to his physical or mental health. (g) "Just Cause" shall mean, in the good faith determination of the Bank's Board of Directors, the Employee's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. The Employee shall have no right to receive compensation or other benefits for any period after termination for Just Cause. No act, or failure to act, on the Employee's part shall be considered "willful" unless he has acted, or failed to act, with an absence of good faith and without a reasonable belief that his action or failure to act was in the best interest of the Bank. (h) "Protected Period" shall mean the period that begins on the date one year before the Change in Control and ends on the closing date of the Change in Control. (i) "Trust" shall mean a grantor trust that is designed in accordance with Revenue Procedure 92-64 and has a trustee independent of the Bank. 2. Employment. The Employee is employed as the Senior Vice President Chief ---------- Lending Officer of the Bank. The Employee shall render such administrative and management services for the Bank as are currently rendered and as are customarily performed by persons situated in a similar executive capacity. The Employee shall also promote, by entertainment or otherwise, as and to the extent permitted by law, the business of the Bank. The Employee's other duties shall be such as the Board of Directors (the "Board") of the Bank may from time to time reasonably direct, including normal duties as an officer of the Bank. 3. Base Compensation. The Bank agrees to pay the Employee during the term ------------------ of this Agreement a salary at the rate of $95,000 per annum, payable in cash not less frequently than monthly. The Board shall review, not less often than annually, the rate of the Employee's salary, and in its sole discretion may decide to increase his salary. Notwithstanding the foregoing, following a Change in Control, the Board of Directors of the Bank shall continue to annually review the rate of the Employee's salary, and shall increase said rate of salary by a percentage which is not less than the average annual percentage increase in salary that the Employee received over the three calendar years immediately preceding the year in which the Change in Control occurs. 4. Discretionary Bonuses. The Employee shall participate in an equitable ---------------------- manner with all other senior management employees of the Bank in discretionary bonuses that the Board may award from time to time to the Bank's senior management employees. No other compensation provided for in this Agreement shall be deemed a substitute for the Employee's right to participate in such discretionary bonuses. Notwithstanding the foregoing, following a Change in Control, the Employee shall receive discretionary bonuses that are made no less frequently than, and in annual amounts not less than, the average annual discretionary bonuses paid to the Employee during each of the three calendar years immediately preceding the year in which such Change in Control occurs. 5. (a) Participation in Retirement, Medical and Other Plans. During the ------------------------------------------------------ term of this Agreement, the Employee shall be eligible to participate in the following benefit plans: group hospitalization, disability, health, dental, sick leave, life insurance, travel and/or accident insurance, auto allowance/auto lease, retirement, pension, and/or other present or future qualified plans provided by the Bank, generally which benefits, taken as a whole, must be at least as favorable as those in effect on the Effective Date. (b) Employee Benefits; Expenses. The Employee shall be eligible to ----------------------------- participate in any fringe benefits which are or may become available to the Bank's senior management employees, including for example: any stock option or incentive compensation plans, and any other benefits which are commensurate with the responsibilities and functions to be performed by the Employee under this Agreement. The Employee shall be reimbursed for all reasonable out-of-pocket business expenses which he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with the policies of the Bank. 6. Term. The Bank hereby employs the Employee, and the Employee hereby ---- accepts such employment under this Agreement, for the period commencing on the Effective Date and ending 36 months thereafter (or such earlier date as is determined in accordance with Section 9). Additionally, on each annual anniversary date from the Effective Date, the Employee's term of employment shall be extended for an additional one-year period beyond the then effective expiration date provided the Board determines in a duly adopted resolution that the performance of the Employee has met the Board's requirements and standards, and that this Agreement shall be extended. Only those members of the Board of Directors who have no personal interest in this Employment Agreement shall discuss and vote on the approval and subsequent review of this Agreement. 7. Loyalty; Noncompetition. ----------------------- (a) During the period of his employment hereunder and except for illnesses, reasonable vacation periods, and reasonable leaves of absence, the Employee shall devote all his full business time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, from time to time, Employee may serve on the boards of directors of, and hold any other offices or positions in, companies or organizations, which will not present any conflict of interest with the Bank or any of its subsidiaries or affiliates, or unfavorably affect the performance of Employee's duties pursuant to this Agreement, or will not violate any applicable statute or regulation. "Full business time" is hereby defined as that amount of time usually devoted to like companies by similarly situated executive officers. During the term of his employment under this Agreement, the Employee shall not engage in any business or activity contrary to the business affairs or interests of the Bank, or be gainfully employed in any other position or job other than as provided above. (b) Permissible Investments. Nothing contained in this Section shall ------------------------ be deemed to prevent or limit the Employee's right to invest in the capital stock or other securities of any business dissimilar from that of the Bank, or, solely as a passive or minority investor, in any business. 8. Standards. The Employee shall perform his duties under this Agreement in --------- accordance with such reasonable standards as the Board may establish from time to time. The Bank will provide Employee with the working facilities and staff customary for similar executives and necessary for him to perform his duties. 9. Vacation and Sick Leave. At such reasonable times as the Board shall in ----------------------- its discretion permit, the Employee shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment under this Agreement, all such voluntary absences to count as vacation time, provided that: (a) The Employee shall be entitled to an annual vacation in accordance with the policies that the Board periodically establishes for senior management employees of the Bank. (b) The Employee shall not receive any additional compensation from the Bank on account of his failure to take a vacation or sick leave, and the Employee shall not accumulate unused vacation or sick leave from one fiscal year to the next, except in either case to the extent authorized by the Board. (c) In addition to the aforesaid paid vacations, the Employee shall be entitled without loss of pay, to absent himself voluntarily from the performance of his employment with the Bank for such additional periods of time and for such valid and legitimate reasons as the Board may in its discretion determine. Further, the Board may grant to the Employee a leave or leaves of absence, with or without pay, at such time or times and upon such terms and conditions as such Board in its discretion may determine. (d) In addition, the Employee shall be entitled to an annual sick leave benefit as established by the Board. 10. Termination and Termination Pay. Subject to Section 12 hereof, the --------------------------------- Employee's employment hereunder may be terminated under the following circumstances: (a) Death. The Employee's employment under this Agreement shall ----- terminate upon his death during the term of this Agreement, in which event the Employee's estate shall be entitled to receive the compensation due the Employee through the last day of the calendar month in which his death occurred. (b) Disability. (1) The Bank may terminate the Employee's employment ---------- after having established the Employee's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity which impairs the Employee's ability to substantially perform his duties under this Agreement and which results in the Employee becoming eligible for long-term disability benefits under the Bank's long-term disability plan (or, if the Bank has no such plan in effect, which impairs the Employee's ability to substantially perform his duties under this Agreement for a period of one hundred eighty (180) consecutive days). The Employee shall be entitled to the compensation and benefits provided for under this Agreement for (i) any period during the term of this Agreement and prior to the establishment of the Employee's Disability during which the Employee is unable to work due to the physical or mental infirmity, or (ii) any period of Disability which is prior to the Employee's termination of employment pursuant to this Section 10(b); provided that any benefits paid pursuant to the Bank's long term disability plan will continue as provided in such plan. (2) During any period that the Employee shall receive disability benefits and to the extent that the Employee shall be physically and mentally able to do so, he shall furnish such information, assistance and documents so as to assist in the continued ongoing business of the Bank and, if able, shall make himself available to the Bank to undertake reasonable assignments consistent with his prior position and his physical and mental health. The Bank shall pay all reasonable expenses incident to the performance of any assignment given to the Employee during the disability period. (c) Just Cause. The Board may, by written notice to the Employee, ----------- immediately terminate his employment at any time, for Just Cause. The Employee shall have no right to receive compensation or other benefits for any period after termination for Just Cause. (d) Without Just Cause; Constructive Discharge. (1) The Board may, by ------------------------------------------- written notice to the Employee, immediately terminate his employment at any time for a reason other than Just Cause, in which event the Employee shall be entitled to receive the following compensation and benefits (unless such termination occurs during the Protected Period in which event the benefits and compensation provided for in Section 12 shall apply): (i) the salary provided pursuant to Section 3 hereof, up to the expiration date of this Agreement including any renewal term (the "Expiration Date"), plus said salary for an additional 12-month period, (ii) a put option meeting the requirements set forth in subsection 3 hereof, provided that the Employee shall not be entitled to such put option if on the date the Employee terminates employment, either the Employee does not own any common stock of the Bank or an affiliated company, or such common stock is "readily tradeable" within the meaning of Cod ss. 401(a)(28)(C); and (iii) at the Employee's election either (A) cash in an amount equal to the cost to the Employee of obtaining all health, life, disability and other benefits which the Employee would have been eligible to participate in through the Expiration Date based upon the benefit levels substantially equal to those that the Bank provided for the Employee at the date of termination of employment or (B) continued participation under such Bank benefit plans through the Expiration Date, but only to the extent the Employee continues to qualify for participation therein. All amounts payable to the Employee shall be paid, at the option of the Employee, either (I) in periodic payments through the Expiration Date, or (II) in one lump sum within ten (10) days of such termination. (2) The Employee shall be entitled to receive the compensation and benefits payable under subsection 10(d)(1) hereof in the event that the Employee voluntarily terminates employment within 90 days of an event that constitutes Good Reason, (unless such voluntary termination occurs during the Protected Period, in which event the benefits and compensation provided for in Section 12 shall apply). (3) A put option deliverable to the Employee pursuant to this Section 10(d) shall, at a minimum, obligate the Bank and any successor to purchase any shares of its common stock are the common stock of any affiliated company that the Employee owns on the date of terminating employment. The terms of such purchase shall be set forth in a written instrument prepared and executed by the Bank, and shall require that (i) the purchase price be no less than the appraised value of such stock, determined in accordance with Code Sec. 401(a)(28)(C), by an appraiser mutually agreed upon by the Employee and the Bank, as of the last day of the fiscal year in which the Employee's employment terminates, and (ii) the Bank make such payment as soon as practicable after the Bank receives said appraisal. (e) Termination or Suspension Under Federal Law. (1) If the Employee -------------------------------------------- is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate, as of the effective date of the order, but vested rights of the parties shall not be affected. (1) If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all obligations under this Agreement shall terminate as of the date of default; however, this Paragraph shall not affect the vested rights of the parties. (2) All obligations under this Agreement shall terminate, except to the extent that continuation of this Agreement is necessary for the continued operation of the Bank: (i) by the Director of the Office of Thrift Supervision ("Director of OTS"), or his or her designee, at the time that the Federal Deposit Insurance Corporation ("FDIC") or the Resolution Trust Corporation enters into an agreement to provide assistance to or on behalf of the Bank under the authority contained in Section 13(c) of FDIA; or (ii) by the Director of the OTS, or his or her designee, at the time that the Director of the OTS, or his or her designee approves a supervisory merger to resolve problems related to operation of the Bank or when the Bank is determined by the Director of the OTS to be in an unsafe or unsound condition. Such action shall not affect any vested rights of the parties. (3) If a notice served under Section 8(e)(3) or (g)(1) of the FDIA (12 U.S.C. 1818(e)(3) or (g)(1)) suspends and/or temporarily prohibits the Employee from participating in the conduct of the Bank's affairs, the Bank's obligations under this Agreement shall be suspended as of the date of such service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank may in its discretion (i) pay the Employee all or part of the compensation withheld while its contract obligations were suspended, and (ii) reinstate (in whole or in part) any of its obligations which were suspended. (4) Any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with 12 U.S.C. Section 1828(k) and any regulations promulgated thereunder. (f) Voluntary Termination by Employee. Subject to Section 12 hereof, ---------------------------------- the Employee may voluntarily terminate employment with the Bank during the term of this Agreement, upon at least ninety (90) days' prior written notice to the Board of Directors, in which case the Employee shall receive only his compensation, vested rights and employee benefits up to the date of his termination (unless such termination occurs pursuant to Section 10(d)(2) hereof or within the Protected Period in Section 12(a) hereof in which event the benefits and compensation provided for in Sections 10(d) or 12, as applicable, shall apply). 11. No Mitigation. The Employee shall not be required to mitigate the ------------- amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Employee in any subsequent employment. 12. Change in Control. ----------------- (a) Trigger Events. The Employee shall be entitled to collect the severance benefits set forth in Subsection (b) hereof in lieu of any benefits under Section 10 hereof in the event that (i) a Change in Control occurs, or (ii) the Bank or its successor(s) in interest terminate the Employee's employment without his written consent and for any reason other than Just Cause during the Protected Period. (b) Amount of Severance Benefit. If the Employee becomes entitled to collect severance benefits pursuant to Section 12(a) hereof, the Bank shall: (i) pay the Employee a severance benefit equal to the difference between the Code Sec. 280G Maximum and the sum of any other "parachute payments" as defined under Code Sec. 280G(b)(2) that the Employee receives on account of the Change in Control, and (ii) pay for long-term disability and provide such medical benefits as are available to the Employee under the provisions of COBRA, for eighteen (18) months (or such longer period, up to 24 months, if COBRA is amended). Said sum shall be paid in one lump sum within ten (10) days of the later of the date of the Change in Control and the Employee's last day of employment with the Bank, provided that the Employee may elect at any time on or before becoming entitled to collect benefits hereunder, to have such benefits be paid in substantially equal installments over a period of up to 10 years. In the event that the Employee and the Bank jointly agree that the Employee has collected an amount exceeding the Code 280G Maximum, the parties may agree in writing that such excess shall be treated as a loan ab initio which the Employee shall repay -- ------ to the Bank, on terms and conditions mutually agreeable to the parties, together with interest at the applicable federal rate provided for in Section 7872(f)(2)(B) of the Code. (c) Funding of Grantor Trust upon Change in Control. Not later than ten business days after a Change in Control, the Bank shall (i) deposit in a Trust an amount equal to the Code ss.280G Maximum, unless the Employee has previously provided a written release of any claims under this Agreement, and (ii) provide the trustee of the Trust with a written direction to hold said amount and any investment return thereon in a segregated account for the benefit of the Employee, and to follow the procedures set forth in the next paragraph as to the payment of such amounts from the Trust. Upon the later of the Trust's final payment of all amounts due under the following paragraph or the date twelve months after the Change in Control, the trustee of the Trust shall pay to the Bank the entire balance remaining in the segregated account maintained for the benefit of the Employee. The Employee shall thereafter have no further interest in the Trust. During the 12-consecutive month period after a Change in Control, the Employee may provide the trustee of the Trust with a written notice requesting that the trustee pay to the Employee an amount designated in the notice as being payable pursuant to this Agreement. Within three business days after receiving said notice, the trustee of the Trust shall send a copy of the notice to the Bank via overnight and registered mail return receipt requested. On the tenth (10th) business day after mailing said notice to the Bank, the trustee of the Trust shall pay the Employee the amount designated therein in immediately available funds, unless prior thereto the Bank provides the trustee with a written notice directing the trustee to withhold such payment. In the latter event, the trustee shall submit the dispute to non-appealable binding arbitration for a determination of the amount payable to the Employee pursuant to this Agreement, and the costs of such arbitration shall be paid by the Bank. The trustee shall choose the arbitrator to settle the dispute, and such arbitrator shall be bound by the rules of the American Arbitration Bank in making his determination. The parties and the trustee shall be bound by the results of the arbitration and, within 3 days of the determination by the arbitrator, the trustee shall pay from the Trust the amounts required to be paid to the Employee and/or the Bank, and in no event shall the trustee be liable to either party for making the payments as determined by the arbitrator. 13. Indemnification. The Bank agrees that its Bylaws shall continue to --------------- provide for indemnification of directors, officers, employees and agents of the Bank, including the Employee during the full term of this Agreement, and to at all times provide adequate insurance for such purposes. 14. Reimbursement of Employee for Enforcement Proceedings. In the event ------------------------------------------------------- that any dispute arises between the Employee and the Bank as to the terms or interpretation of this Agreement, whether instituted by formal legal proceedings or otherwise, including any action that the Employee takes to defend against any action taken by the Bank, the Employee shall be reimbursed for all costs and expenses, including reasonable attorneys' fees, arising from such dispute, proceedings or actions, provided that the Employee obtains either a written settlement or a final judgement by a court of competent jurisdiction substantially in his favor. Such reimbursement shall be paid within ten (10) days of Employee's furnishing to the Bank written evidence, which may be in the form, among other things, of a cancelled check or receipt, of any costs or expenses incurred by the Employee. 15. Federal Income Tax Withholding. The Bank may withhold all federal and ------------------------------- state income or other taxes from any benefit payable under this Agreement as shall be required pursuant to any law or government regulation or ruling. 16. Successors and Assigns. ---------------------- (a) Bank. This Agreement shall not be assignable by the Bank, provided ---- that this Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets of the Bank. (b) Employee. Since the Bank is contracting for the unique and -------- personal skills of the Employee, the Employee shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank; provided, however, that nothing in this paragraph shall preclude (i) the Employee from designating a beneficiary to receive any benefit payable hereunder upon his death, or (ii) the executors, administrators, or other legal representatives of the Employee or his estate from assigning any rights hereunder to the person or persons entitled thereunto. (c) Attachment. Except as required by law, no right to receive ---------- payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation or to exclusion, attachment, levy or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to effect any such action shall be null, void and of no effect. 17. Amendments. No amendments or additions to this Agreement shall be ---------- binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 18. Applicable Law. Except to the extent preempted by federal law, the laws -------------- of the State of Arkansas shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 19. Severability. The provisions of this Agreement shall be deemed ------------ severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 20. Entire Agreement. This Agreement, together with any understanding or ----------------- modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement between the parties hereto and shall supersede any prior agreement between the parties. IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first hereinabove written. ATTEST: HEARTLAND Community Bank /s/ Paula J. Bergstrom By: /s/ Vida H. Lampkin - ----------------------------- -------------------------------------- Paula J. Bergstrom, Secretary Vida H. Lampkin, Chairman of the Board WITNESS: /s/ Lisa B. Weaver /s/ Charles T. Black - ----------------------------- -------------------------------------- Lisa B. Weaver Charles T. Black EX-10 4 exhibit107bfm10k2002-1843.txt EXHIBIT 10.7(B) TO 2002 FORM 10-K EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT is entered into this 20th day of June, 2002, by and between HCB Bancshares, Inc. (the "Company") and Charles T. Black (the "Employee"), effective on the date (the "Effective Date") this agreement is executed. WHEREAS, the Employee has heretofore been employed by HEARTLAND Community Bank (the "Bank") as its Senior Vice President Chief Lending Officer, is experienced in all phases of the business of the Bank, and has become the Senior Vice President Chief Lending Officer of the Company; and WHEREAS, the Board of Directors (the "Board") of the Company believes it is in the best interests of the Company to enter into this Agreement with the Employee in order to assure continuity of management of the Bank and the Company, and to reinforce and encourage the continued attention and dedication of the Employee to his assigned duties; and WHEREAS, the parties desire by this writing to set forth the continuing employment relationship between the Company and the Employee. NOW, THEREFORE, it is AGREED as follows: 1. Defined Terms. ------------- When used anywhere in this Agreement, the following terms shall have the meaning set forth herein. (a) "Affiliate" shall mean any "parent corporation" or "subsidiary corporation" of the Bank, as the terms are defined in Section 424(e) and (f), respectively, of the Code. (b) A "Change in Control" shall be deemed to have occurred if: (i) as a result of, or in connection with, any initial public offering, tender offer or exchange offer, merger or other business combination, sale of assets or contested election, any combination of the foregoing transactions, or any similar transaction, the persons who were non-employee directors of the Company or the Bank before such transaction cease to constitute a majority of the Board of Directors of the Company or the Bank or any successor to the Company or the Bank; (ii) the Company or the Bank transfers substantially all of its assets to another corporation which is not an Affiliate of the Company; (iii) the Company sells substantially all of the assets an Affiliate which accounted for 50% or more of the controlled group's assets immediately prior to such sale; (iv) any "person" including a "group" is or becomes the "beneficial owner", directly or indirectly, of securities of the Company or the Bank representing twenty-five percent (25%) or more of the combined voting power of the Company or the Bank's outstanding securities (with the terms in quotation marks having the meaning set forth under the federal securities laws); or (v) the Company or the Bank is merged or consolidated with another corporation and, as a result of the merger or consolidation, less than seventy percent (70%) of the outstanding voting securities of the surviving or resulting corporation is owned in the aggregate by the former stockholders of the Company or the Bank. Notwithstanding the foregoing, a "Change in Control" shall not be deemed to occur solely by reason of a transaction in which the Bank converts to the stock form of organization, or creates an independent holding company in connection therewith. (c) "Code " shall mean the Internal Revenue Code of 1986, as amended from time to time, and as interpreted through applicable rulings and regulations in effect from time to time. (d) "Code Sec. 280G Maximum" shall mean product of 2.99 and the Employee's "base amount" as defined in Code ss.280G(b)(3). (e) "Good Reason" shall mean any of the following events, which has not been consented to in advance by the Employee in writing: (i) the requirement that the Employee move his personal residence, or perform his principal executive functions, more than 30 miles from his primary office as of the later of the Effective Date and the most recent voluntary relocation by the Employee; (ii) a material reduction in the Employee's base compensation under this Agreement as the same may be increased from time to time; (iii) the failure by the Bank or the Company to continue to provide the Employee with compensation and benefits provided under this Agreement as the same may be increased from time to time, or with benefits substantially similar to those provided to him under any of the employee benefit plans in which the Employee now or hereafter becomes a participant, or the taking of any action by the Bank or the Company which would directly or indirectly reduce any of such benefits or deprive the Employee of any material fringe benefit enjoyed by him under this Agreement; (iv) the assignment to the Employee of duties and responsibilities materially different from those normally associated with his position; (v) a failure to reelect the Employee to the Board of Directors of the Bank or the Company, if the Employee has served on such Board at any time during the term of the Agreement; (vi) a material diminution or reduction in the Employee's responsibilities or authority (including reporting responsibilities) in connection with his employment with the Bank or the Company; or (vii) a material reduction in the secretarial or other administrative support of the Employee. In addition, "Good Reason" shall mean an impairment of the Employee's health to the extent that it makes continued performance of his duties hereunder hazardous to his physical or mental health. -2- (f) "Just Cause " shall mean, in the good faith determination of the Company's Board of Directors, the Employee's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease-and-desist order, or material breach of any provision of this Agreement. The Employee shall have no right to receive compensation or other benefits for any period after termination for Just Cause. No act, or failure to act, on the Employee's part shall be considered "willful" unless he has acted, or failed to act, with an absence of good faith and without a reasonable belief that his action or failure to act was in the best interest of the Bank and the Company. (g) "Protected Period " shall mean the period that begins on the date one year before the Change in Control and ends on the closing date of the Change in Control. (h) "Trust" shall mean a grantor trust that is designed in accordance with Revenue Procedure 92-64 and has a trustee independent of the Bank and the Company. 2. Employment. The Employee is employed as the Senior Vice President Chief ---------- Lending Officer of the Company. The Employee shall render such administrative and management services for the Company as are currently rendered and as are customarily performed by persons situated in a similar executive capacity. The Employee shall also promote, by entertainment or otherwise, as and to the extent permitted by law, the business of the Company. The Employee's other duties shall be such as the Board may from time to time reasonably direct, including normal duties as an officer of the Company. 3. Consideration from Company: Joint and Several Liability. In lieu of ---------------------------------------------------------- paying the Employee a base salary during the term of this Agreement, the Company hereby agrees that to the extent permitted by law, it shall be jointly and severally liable with the Bank for the payment of all amounts due under the employment agreement between the Bank and the Employee. Nevertheless, the Board may in its discretion at any time during the term of this Agreement agree to pay the Employee a base salary for the remaining term of this Agreement. If the Board agrees to pay such salary, the Board shall thereafter review, not less often than annually, the rate of the Employee's salary, and in its sole discretion may decide to increase his salary. 4. Discretionary Bonuses. The Employee shall participate in an equitable ---------------------- manner with all other senior management employees of the Company in discretionary bonuses that the Board may award from time to time to the Company's senior management employees. No other compensation provided for in this Agreement shall be deemed a substitute for the Employee's right to participate in such discretionary bonuses. Notwithstanding the foregoing, following a Change in Control, the Employee shall receive discretionary bonuses that are made no less frequently than, and in amounts not less than, the average annual discretionary bonuses paid to the Employee during each of the three calendar years immediately preceding the year in which such Change in Control occurs. -3- 5. Participation in Retirement, Medical and Other Plans. ---------------------------------------------------- (a) During the term of this Agreement, the Employee shall be eligible to participate in the following benefit plans: group hospitalization, disability, health, dental, sick leave, life insurance, travel and/or accident insurance, auto allowance/auto lease, retirement, pension, and/or other present or future qualified plans provided by the Company, generally which benefits, taken as a whole, must be at least as favorable as those in effect on the Effective Date. (b) The Employee shall be eligible to participate in any fringe benefits which are or may become available to the Company's senior management employees, including for example: any stock option or incentive compensation plans, and any other benefits which are commensurate with the responsibilities and functions to be performed by the Employee under this Agreement. The Employee shall be reimbursed for all reasonable out-of-pocket business expenses which he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with the policies of the Company. 6. Term. The Company hereby employs the Employee, and the Employee hereby ---- accepts such employment under this Agreement, for the period commencing on the Effective Date and ending 36 months thereafter (or such earlier date as is determined in accordance with Section 9). Additionally, on each annual anniversary date from the Effective Date, the Employee's term of employment shall be extended for an additional one-year period beyond the then effective expiration date, provided the Board determines in a duly adopted resolution that the performance of the Employee has met the Board's requirements and standards, and that this Agreement shall be extended. Only those members of the Board of Directors who have no personal interest in this Employment Agreement shall discuss and vote on the approval and subsequent review of this Agreement. 7. Loyalty; Noncompetition. ----------------------- (a) During the period of his employment hereunder and except for illnesses, reasonable vacation periods, and reasonable leaves of absence, the Employee shall devote all his full business time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, from time to time, the Employee may serve on the boards of directors of, and hold any other offices or positions in, companies or organizations, which will not present any conflict of interest with the Company or any of its subsidiaries or affiliates, or unfavorably affect the performance of the Employee's duties pursuant to this Agreement, or will not violate any applicable statute or regulation. "Full business time" is hereby defined as that amount of time usually devoted to like companies by similarly situated executive officers. During the term of his employment under this Agreement, the Employee shall not engage in any business or activity contrary to the business affairs or interests of the Company, or be gainfully employed in any other position or job other than as provided above. -4- (b) Nothing contained in this Paragraph 7 shall be deemed to prevent or limit the Employee's right to invest in the capital stock or other securities of any business dissimilar from that of the Company, or, solely as a passive or minority investor, in any business. 8. Standards. The Employee shall perform his duties under this Agreement in --------- accordance with such reasonable standards as the Board may establish from time to time. The Company will provide Employee with the working facilities and staff customary for similar executives and necessary for him to perform his duties. 9. Vacation and Sick Leave. At such reasonable times as the Board shall in ----------------------- its discretion permit, the Employee shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment under this Agreement, all such voluntary absences to count as vacation time, provided that: (a) The Employee shall be entitled to an annual vacation in accordance with the policies that the Board periodically establishes for senior management employees of the Company. (b) The Employee shall not receive any additional compensation from the Company on account of his failure to take a vacation or sick leave, and the Employee shall not accumulate unused vacation from one fiscal year to the next, except in either case to the extent authorized by the Board. (c) In addition to the aforesaid paid vacations, the Employee shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment with the Company for such additional periods of time and for such valid and legitimate reasons as the Board may in its discretion determine. Further, the Board may grant to the Employee a leave or leaves of absence, with or without pay, at such time or times and upon such terms and conditions as such Board in its discretion may determine. (d) In addition, the Employee shall be entitled to an annual sick leave benefit as established by the Board. 10. Termination and Termination Pay. Subject to Section 12 hereof, the --------------------------------- Employee's employment hereunder may be terminated under the following circumstances: (a) Death. The Employee's employment under this Agreement shall terminate upon his death during the term of this Agreement, in which event the Employee's estate shall be entitled to receive the compensation due the Employee through the last day of the calendar month in which his death occurred. (b) Disability. (1) The Company may terminate the Employee's employment after having established the Employee's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity which impairs the Employee's ability to substantially perform his -5- duties under this Agreement and which results in the Employee becoming eligible for long-term disability benefits under the Company's long-term disability plan (or, if the Company has no such plan in effect, which impairs the Employee's ability to substantially perform his duties under this Agreement for a period of 180 consecutive days). The Employee shall be entitled to the compensation and benefits provided for under this Agreement for (i) any period during the term of this Agreement and prior to the establishment of the Employee's Disability during which the Employee is unable to work due to the physical or mental infirmity, or (ii) any period of Disability which is prior to the Employee's termination of employment pursuant to this Section 10(b); provided that any benefits paid pursuant to the Company's long- term disability plan will continue as provided in such plan. (2) During any period that the Employee shall receive disability benefits and to the extent that the Employee shall be physically and mentally able to do so, he shall furnish such information, assistance and documents so as to assist in the continued ongoing business of the Company and, if able, shall make himself available to the Company to undertake reasonable assignments consistent with his prior position and his physical and mental health. The Company shall pay all reasonable expenses incident to the performance of any assignment given to the Employee during the disability period. (c) Just Cause. The Board may, by written notice to the Employee, immediately terminate his employment at any time, for Just Cause. The Employee shall have no right to receive compensation or other benefits for any period after termination for Just Cause. (d) Without Just Cause; Constructive Discharge. The Board may, by written notice to the Employee, immediately terminate his employment at any time for a reason other than Just Cause, in which event the Employee shall be entitled to receive the following compensation and benefits (unless such termination occurs during the Protected Period, in which event the benefits and compensation provided for in Section 12 shall apply): (i) the salary provided pursuant to Section 3 hereof, up to the expiration date of this Agreement including any renewal term (the "Expiration Date"), plus said salary for an additional 12-month period, (ii) a put option meeting the requirements set forth in subsection (f) hereof, provided that the Employee shall not be entitled to such put option if, on the date the Employee terminates employment, either the Employee does not own any common stock of the Bank or an affiliated company, or such common stock is "readily tradeable" within the meaning of Code Sec. 401(a)(28)(C); and (iii) at the Employee's election either (A) cash in an amount equal to the cost to the Employee of obtaining all health, life, disability and other benefits which the Employee would have been eligible to participate in through the Expiration Date, based upon the benefit levels substantially equal to those that the Company provided for the Employee at the date of termination of employment or (B) continued participation under -6- such Company benefit plans through the Expiration Date, but only to the extent the Employee continues to qualify for participation therein. All amounts payable to the Employee shall be paid, at the option of the Employee, either (I) in periodic payments through the Expiration Date, or (II) in one lump sum within ten days of such termination. (e) Good Reason. The Employee shall be entitled to receive the compensation and benefits payable under subsection 10(d) hereof in the event that the Employee voluntarily terminates employment within 90 days of an event that constitutes Good Reason, (unless such voluntary termination occurs during the Protected Period, in which event the benefits and compensation provided for in Section 12 shall apply). (f) A put option deliverable to the Employee pursuant to this Section 10(d) shall, at a minimum, obligate the Company and any successor to purchase any shares of its common stock and the common stock of any affiliated company that the Employee owns on the date of terminating employment. The terms of such purchase shall be set forth in a written instrument prepared and executed by the Company, and shall require that (i) the purchase price be no less than the appraised value of such stock, determined in accordance with Code Sec. 401(a)(28)(C) by an appraiser mutually agreed upon by the Employee and the Company, as of the last day of the fiscal year in which the Employee's employment terminates, and (ii) the Company make such payment as soon as practicable after the Company receives said appraisal. (g) Termination or Suspension Under Federal Law. Any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with 12 U.S.C. Section 1828(k) and any regulations promulgated thereunder. (h) Voluntary Termination by Employee. Subject to Section 12 hereof, the Employee may voluntarily terminate employment with the Company during the term of this Agreement, upon at least 90 days' prior written notice to the Board of Directors, in which case the Employee shall receive only his compensation, vested rights and employee benefits up to the date of his termination (unless such termination occurs pursuant to Section 10(d) hereof or within the Protected Period, in Section 12(a) hereof, in which event the benefits and compensation provided for in Sections 10(d) or 12, as applicable, shall apply). 11. No Mitigation. The Employee shall not be required to mitigate the -------------- amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Employee in any subsequent employment. 12. Change in Control. ----------------- (a) Trigger Events. The Employee shall be entitled to collect the severance benefits set forth in Subsection (b) hereof in lieu of any benefits under Section 10 hereof in the event that (i) a Change in Control occurs, or (ii) the Company or its successor(s) in interest terminate the -7- Employee's employment without his written consent and for any reason other than Just Cause during the Protected Period. (b) Amount of Severance Benefit. If the Employee becomes entitled to collect severance benefits pursuant to Section 12(a) hereof, the Company shall (if not paid by the Bank pursuant to the employment agreement between the Employee and the Bank): (i) pay the Employee a severance benefit equal to the difference between the Code Sec. 280G Maximum and the sum of any other "parachute payments" as defined under Code Sec. 280G(b)(2) that the Employee receives on account of the Change in Control. (ii) provide such long-term disability insurance and medical insurance benefits as are available to the Employee under the provisions of COBRA, for 18 months (or such longer period, as may be required thereunder). Said sum shall be paid in one lump sum within ten days of the later of the date of the Change in Control and the Employee's last day of employment with the Bank or the Company, provided that the Employee may elect at any time on or before becoming entitled to collect benefits hereunder, to have such benefits paid in substantially equal installments over a period of up to 10 years. In the event that the Employee, the Bank, and the Company jointly agree that the Employee has collected an amount exceeding the Code Sec. 280G Maximum, the parties may agree in writing that such excess shall be treated as a loan ab initio which the Employee shall repay to the Company, on terms and conditions mutually agreeable to the parties, together with interest at the applicable federal rate provided for in Section 7872(f)(2)(B) of the Code. 13. Indemnification. The Company agrees that its Bylaws shall continue to --------------- provide for indemnification of directors, officers, employees and agents of the Company, including the Employee, during the full term of this Agreement, and to at all times provide adequate insurance for such purposes. 14. Reimbursement of Employee for Enforcement Proceedings. In the event ------------------------------------------------------- that any dispute arises between the Employee and the Company as to the terms or interpretation of this Agreement, whether instituted by formal legal proceedings or otherwise, including any action that the Employee takes to defend against any action taken by the Company, the Employee shall be reimbursed for all costs and expenses, including reasonable attorneys' fees, arising from such dispute, proceedings or actions, provided that the Employee obtains either a written settlement or a final judgment by a court of competent jurisdiction substantially in his favor. Such reimbursement shall be paid within ten days of Employee's furnishing to the Company written evidence, which may be in the form, among other things, of a canceled check or receipt, of any costs or expenses incurred by the Employee. 15. Federal Income Tax Withholding. The Company may withhold all federal ------------------------------- and state income or other taxes from any benefit payable under this Agreement as shall be required pursuant to any law or government regulation or ruling. -8- 16. Successors and Assigns. ---------------------- (a) Company. This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Company which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Company. (b) Employee. Since the Company is contracting for the unique and personal skills of the Employee, the Employee shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Company; provided, however, that nothing in this paragraph shall preclude (i) the Employee from designating a beneficiary to receive any benefit payable hereunder upon his death, or (ii) the executors, administrators, or other legal representatives of the Employee or his estate from assigning any rights hereunder to the person or persons entitled thereunto. (c) Attachment. Except as required by law, no right to receive payments under this Agreement shall be subject to anticipation, commutation, alienation, sale, assignment, encumbrance, charge, pledge, or hypothecation or to exclusion, attachment, levy or similar process or assignment by operation of law, and any attempt, voluntary or involuntary, to effect any such action shall be null, void and of no effect. 17. Amendments. No amendments or additions to this Agreement shall be ---------- binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 18. Applicable Law. Except to the extent preempted by Federal law, the laws -------------- of the State of Arkansas shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 19. Severability. The provisions of this Agreement shall be deemed ------------ severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 20. Entire Agreement. This Agreement, together with any understanding or ----------------- modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement between the parties hereto. -9- IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first hereinabove written. ATTEST: HCB BANCSHARES, INC. /s/ Paula J. Bergsgtrom By:/s/ Vida H. Lampkin - ------------------------------ -------------------------------------- Paula J. Bergstrom, Secretary Vida H. Lampkin, Chairman of the Board WITNESS: /s/ Lisa B. Weaver /s/ Charles T. Black - -------------------------------- -------------------------------------- Lisa B. Weaver Charles T. Black -10- EX-13 5 exhibit13fm10k2002-1843.txt EXHIBIT 13 TO 2002 FORM 10-K HCB BANCSHARES, INC 2002 ANNUAL REPORT TO OUR SHAREHOLDERS: What an exciting year it's been! Your Company has reached several milestones this year, and the end is not in sight. For example, net interest income after provision for loan and investment losses reached an all-time high of $6,733,412. At the same time, non-interest income also set a new record high of $1,606,460, more than double the figure of only four years ago. Return on equity was the highest in seven years, and earnings per share were the highest in the history of the Company. But, there's more improvement to come. Our ratio of non-interest expense to average total assets is higher than we like, and we need to make improvement there. Our nonperforming assets also reached a new high, primarily due to the faltering economy, but fortunately, unusually high losses have not occurred. And non-interest income can still be improved. In short, we aren't satisfied. Satisfaction - what a variety of ways there are to achieve it. Sometimes satisfaction comes from mere improvement, such as a marginal student raising his grade from an F to a C. That's certainly a tremendous achievement, and yet there's more to be done. Earning that C is very, very satisfying, but it isn't over yet. Passing is far better than failing, and absolutely deserves favorable recognition, but shouldn't that C become a B? And shouldn't that B become an A? Isn't "excellence" more satisfying than "average"? Don't we want to be the best we can be? And how do we decide when our performance is satisfying enough? In our business, as in many others, it's never enough. We will always be disappointed at losing a customer, no matter how many "satisfied" customers we may have. We will always be thrilled by reaching new levels of success, but then we will set even higher goals in an effort to reach even higher levels of success. No matter how many objectives we meet, or how well we meet them, we will still strive for more. In short, as we review the criteria by which we measure our achievement, there is no such thing as "enough". We must not . . . ever! . . . be "satisfied". During this past fiscal year, your Company has achieved some impressive results. Net interest income has never been higher. Income from other sources (non-interest income) has never been higher. Earnings per share have never been higher. But . . . it is not enough. We want continued improvement. Increased net income. Tighter control of non-interest expense. New products providing new sources of non-interest income. Reductions in high-rate borrowings, partly through repayment and partly through replacement at lower rates. Continued repurchases of our stock. Negotiated reductions of non-performing assets. And, or course, increased return on equity. We want, and expect, to be your best investment. We want to exceed your expectations, and we want to do that year after year after year. We want the satisfaction of being a high-performance company. Even then, we won't be "satisfied"! /s/ Cameron D. McKeel President and Chief Executive Officer 2 TABLE OF CONTENTS HCB Bancshares, Inc......................................................... 3 Market for Common Stock and Related Stockholder Matters..................... 4 Selected Consolidated Financial and Other Data.............................. 5 Quarterly Financial Data.................................................... 7 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................. 8 Consolidated Financial Statement.............................................18 Consolidated Statements of Financial Condition............................ 20 Consolidated Statements of Income and Comprehensive Income................ 21 Consolidated Statements of Stockholders' Equity........................... 23 Consolidated Statements of Cash Flows..................................... 24 Notes to Consolidated Financial Statements................................ 26 Corporate Information....................................................... 44 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, 2002, the Company had total assets of $276.4 million, deposits of $165.0 million, and stockholders' equity of $26.7 million, or 9.7% of total assets. As of June 30, 2002, the Bank operated through six full service-banking offices located in Camden (2), Fordyce, Bryant, Sheridan, and Monticello, Arkansas. During July 2002 the Bank sold its Monticello branch and operated through five full service-banking offices. 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, 2002, there were 1,503,436 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, 2002, there were 557 stockholders of record according to the Company's transfer agent listing. Following are the high and low bid prices, by fiscal quarter, as reported on the Nasdaq Small-Cap Market July 1, 2000 to June 30, 2002, as well as the dividends paid during such quarters.
High Low Dividends Per Share ------- ------ ------------------- Fiscal 2002 First Quarter $ 13.00 $ 11.90 $ 0.06 Second Quarter 12.95 12.00 0.07 Third Quarter 15.00 12.61 0.07 Fourth Quarter 16.70 14.27 0.08 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
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 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. 4 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
AT JUNE 30, ---------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ----------- Total assets.............................. $ 276,425,294 $287,598,650 $291,192,175 $285,396,885 $250,953,770 Loans receivable, net..................... 124,176,898 131,651,421 135,626,505 115,162,883 104,580,165 Allowance for loan losses................. 1,628,515 1,446,114 1,231,709 1,329,201 1,468,546 Cash and due from banks................... 3,492,257 3,302,540 3,211,802 3,560,884 1,531,363 Interest-earning savings deposits......... 14,404,572 15,107,481 236,846 1,693,330 5,073,035 Investment securities: Available for sale..................... 29,285,376 32,138,434 34,135,726 33,132,916 40,775,807 Held to maturity....................... -- -- -- -- -- Mortgage-backed securities: Available for sale.................... 88,913,188 87,943,743 98,407,339 113,986,773 58,697,109 Held to maturity...................... -- -- -- -- 27,503,257 Deposits.................................. 165,005,183 161,285,179 144,873,071 146,296,598 141,931,330 FHLB advances............................. 82,263,936 91,915,694 115,609,029 104,523,419 68,121,068 Note payable.............................. -- 80,000 160,000 240,000 320,000 Stockholders' equity...................... 26,736,288 31,934,334 28,240,550 32,117,560 37,678,924 Number of: Real estate loans outstanding.......... 1,517 1,730 1,820 1,709 2,829 Deposit accounts....................... 18,090 18,538 17,980 18,526 17,158 Offices open........................... 6 6 6 6 6
YEAR ENDED JUNE 30, ------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ----------- Interest income........................... $ 17,916,113 $ 20,078,400 $19,808,899 $18,274,647 $15,027,677 Interest expense.......................... 10,823,701 14,079,466 13,099,656 12,093,603 8,942,149 ------------- ------------ ----------- ----------- ----------- Net interest income....................... 7,092,412 5,998,934 6,709,243 6,181,044 6,085,528 Provision for loan and investment losses.. 359,000 296,000 -- -- 24,000 ------------- ------------ ----------- ----------- ----------- Net interest income after provision for loan and investment losses.......... 6,733,412 5,702,934 6,709,243 6,181,044 6,061,528 Noninterest income........................ 1,606,460 1,378,612 1,039,622 1,018,654 710,856 Noninterest expense....................... 7,113,145 6,929,118 7,304,110 6,847,715 6,407,976 ------------- ------------ ----------- ----------- ----------- Income before income taxes................ 1,226,727 152,428 444,755 351,983 364,408 Income tax provision (benefit)............ 61,027 (467,888) (341,147) (63,658) (20,705) ------------- ------------- ------------ ------------ ------------ Net income................................ $ 1,165,700 $ 620,316 $ 785,902 $ 415,641 $ 385,113 ============ =========== ========== ========== ========== Earnings per share: Basic................................... $ 0.71 $ 0.33 $ 0.40 $ 0.18 $ 0.16 Diluted................................. 0.68 0.33 0.40 0.18 0.16 Cash dividends declared................... 0.28 0.24 0.24 0.24 0.20
5
YEAR ENDED JUNE 30, --------------------------------------------------------------- 2002 2001 2000 1999 1998 -------- -------- -------- -------- -------- PERFORMANCE RATIOS: Return on assets (net income divided by average total assets) .................... 0.41% 0.21% 0.27% 0.15% 0.18% Return on average equity (net income divided by average equity) .................. 3.82 2.02 2.76 1.14 1.02 Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost)......... 2.25 1.72 2.12 1.81 2.11 Net interest margin (net interest income divided by average interest-earning assets).. 2.66 2.19 2.49 2.34 2.96 Ratio of average interest-earning assets to average interest-bearing liabilities...... 110.06 108.91 107.68 111.55 119.51 Ratio of noninterest expense to average total assets................................. 2.52 2.38 2.55 2.48 3.00 ASSET QUALITY RATIOS: Nonperforming assets to total assets at end of period............................. 0.92 0.48 0.33 0.21 0.34 Nonperforming loans to total loans at end of period............................. 1.44 0.81 0.64 0.46 0.75 Allowance for loan losses to total loans at end of period....................... 1.22 0.99 0.85 1.08 1.33 Allowance for loan losses to nonperforming loans at end of period....................... 84.91 121.48 133.95 234.84 177.25 Provision for loan losses to total loans at end of period ............................ 0.25 0.20 -- -- 0.02 Net charge-offs to average loans outstanding.... 0.11 0.06 0.08 0.13 0.05 CAPITAL RATIOS: Equity to total assets at end of period......... 9.67 11.10 9.70 11.25 15.01 Average equity to average assets................ 10.81 10.55 9.95 13.19 17.71 Dividend payout ratio (1)....................... 40.52 76.46 64.50 142.58 137.36 - -------------- (1) 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.
6 QUARTERLY FINANCIAL DATA The following tables represent summarized data for each of the four quarters in the years ended June 30, 2002 and June 30, 2001.
2002 (IN THOUSANDS, EXCEPT SHARE DATA) ----------------------------------------------------------- FOURTH THIRD SECOND FIRST QUARTER QUARTER QUARTER QUARTER Interest income $ 4,248 $ 4,458 $ 4,509 $ 4,701 Interest expense 2,430 2,559 2,796 3,039 ------ ----- ------ ----- Net interest income 1,818 1,899 1,713 1,662 Provision for loan and investment losses 140 60 99 60 ------ ----- ------ ----- Net interest income after provision for loan and investment losses 1,678 1,839 1,614 1,602 Noninterest income 401 402 429 375 Noninterest expenses 1,949 1,650 1,799 1,715 ------ ----- ------ ----- Income before income taxes 130 591 244 262 Income tax provision (benefit) (16) 110 (9) (24) ------ ----- ------ ----- Net income $ 146 $ 481 $ 253 $ 286 ====== ===== ====== ===== Basic earnings per common share $ 0.12 $ 0.28 $ 0.15 $ 0.16 Diluted earnings per common share 0.12 0.27 0.14 0.15 Cash dividends declared per common share 0.08 0.07 0.07 0.06 Weighted average common shares outstanding Basic 1,391,685 1,689,348 1,691,522 1,768,494 Diluted 1,489,017 1,774,003 1,762,565 1,843,429 2002 (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 Weighted average common shares outstanding Basic 1,842,259 1,840,580 1,863,269 1,918,473 Diluted 1,842,259 1,840,580 1,863,269 1,918,473
7 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' 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 the Bank will sell more of its long term loan originations and originate 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 interest rate risk exposure may decline somewhat. The matching of the Bank's assets and liabilities may be analyzed 8 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, 2002, the Bank's strategy was to continue to use cash flows from investment securities and deposit growth to fund loans and reduce 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 sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income. At June 30, 2002, 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 26.0%. 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 12.7%. 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. 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 in the event of an 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 4.66%, 4.33%, and 4.00% respectively. The following tables present the Bank's projected change in NPV as of June 30, 2002 and June 30, 2001, as calculated by OTS, based on information provided to the OTS by the Bank. Based on such information, from June 30, 2001 to June 30, 2002, the Bank's interest rate risk has become slightly more liability sensitive over the period. 9
June 30, 2002 ----------------------------------------------------------------------------------------------- CHANGE IN NPV INTEREST RATES NET PORTFOLIO VALUE RATIO (1) BP CHANGE IN NPV RATIO IN BP ----------------------------------- --------- ------------------------ (RATE SHOCK) AMOUNT $ CHANGE % CHANGE ------------ ------ -------- -------- +300 $16,344 $(9,884) (38)% 6.33 % (298) +200 19,671 (6,556) (25) 7.40 (191) +100 22,968 (3,260) (12) 8.39 (92) +0 26,228 9.31 -100 28,115 1,888 7 9.73 43 June 30, 2002 ----------------------------------------------------------------------------------------------- CHANGE IN NPV INTEREST RATES NET PORTFOLIO VALUE RATIO (1) 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 ___________ (1) NPV Ratio is defined as the NPV divided by the portfolio value of assets.
At June 30, 2002, it was estimated that the Bank's NPV could decrease 12%, 25%, and 38% in the event of 100 BP, 200 BP, and 300 BP respective increases in market interest rates, and could increase 7%, if market interest rates decreased by 100 BP. These calculations indicate that the Bank's NPV could be adversely affected by significant increases in interest rates. The Bank's interest-rate risk has increased moderately compared to June 30, 2001, primarily due to the Bank paying Bancshares $9.0 million in dividends during the period. 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, 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, 2002, 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. 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 daily 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 market value. 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, ----------------------------------------------------------------------------- 2002 2001 ---------------------------------- ------------------------------------ Average Average Average Interest Yield/ Average Interest Yield/ Balance Earned/Paid Rate Balance Earned/Paid Rate ------- ----------- ------- -------- ----------- ------ Interest-earning assets: Loans receivable......................... $131,434,245 $10,735,729 8.17% $136,107,616 $11,622,492 8.54% Investment and mortgage-backed securities Taxable................................ 91,762,885 5,418,567 5.90 99,455,695 6,401,378 6.44 Nontaxable............................. 26,709,166 1,344,478 5.03 29,246,420 1,529,550 5.23 FHLB stock............................... 4,680,945 148,101 3.16 6,138,292 355,715 5.80 FHLB DDA................................. 12,254,561 264,337 2.16 3,466,854 161,693 4.66 Other interest-earning assets.............. 153,854 4,901 3.19 115,486 7,572 6.56 ------------ ----------- ---- ------------ ----------- ---- Total interest-earning assets ......... 266,995,656 17,916,113 6.71 274,530,363 20,078,400 7.31 Noninterest-earning assets................. 15,411,663 16,144,665 ------------ ------------ Total assets........................... $282,407,319 $290,675,028 ============ ============ Interest-bearing liabilities: NOW, MMDA, statement savings............. $ 43,566,756 792,670 1.82 $ 39,540,714 1,543,181 3.90 Time deposits............................ 112,568,794 4,913,494 4.36 106,806,416 6,156,303 5.76 FHLB advances............................ 86,442,890 5,116,537 5.92 105,619,861 6,372,982 6.03 Note payable............................. 14,685 1,000 6.81 94,685 7,000 7.39 ------------ ----------- ---- ------------ ----------- ---- Total interest-bearing liabilities..... 242,593,125 10,823,701 4.46 252,061,676 14,079,466 5.59 Noninterest-bearing liabilities............ 9,290,121 7,948,247 ------------ ------------ Total liabilities...................... 251,883,246 260,009,923 Equity..................................... 30,524,073 30,665,105 ------------ ------------ Total liabilities and equity........... $282,407,319 $290,675,028 ============ ============ Net interest income........................ $ 7,092,412 $ 5,998,934 ========== =========== Net interest rate spread................... 2.25% 1.72% ==== ==== Net yield on interest-earning assets 2.66% 2.19% ==== ==== Ratio of average interest-earning assets to average interest-bearing liabilities 110.06% 108.91% ====== ====== Year Ended June 30, ------------------------------------- 2000 ------------------------------------- Average Average Interest Yield/ Balance Earned/Paid Rate -------- ----------- -------- Interest-earning assets: Loans receivable......................... $123,535,536 $10,491,741 8.49% Investment and mortgage-backed securities Taxable................................ 112,065,588 7,352,290 6.56 Nontaxable............................. 27,102,813 1,479,536 5.46 FHLB stock............................... 5,784,385 441,291 7.63 FHLB DDA................................. 543,475 28,729 5.29 Other interest-earning assets.............. 208,296 15,312 7.35 ------------ ----------- ---- Total interest-earning assets ......... 269,240,093 19,808,899 7.36 Noninterest-earning assets................. 16,659,326 ------------ Total assets........................... $285,899,419 ============ Interest-bearing liabilities: NOW, MMDA, statement savings............. $ 32,873,541 1,067,350 3.25 Time deposits............................ 104,443,704 5,439,824 5.21 FHLB advances............................ 112,554,831 6,579,482 5.85 Note payable............................. 175,082 13,000 7.43 ------------ ----------- ---- Total interest-bearing liabilities..... 250,047,158 13,099,656 5.24 Noninterest-bearing liabilities............ 7,392,828 ------------ Total liabilities...................... 257,439,986 Equity..................................... 28,459,433 ------------ Total liabilities and equity........... $285,899,419 ============ Net interest income........................ $ 6,709,243 =========== Net interest rate spread................... 2.12% ==== Net yield on interest-earning assets 2.49% ==== Ratio of average interest-earning assets to average interest-bearing liabilities 107.68% ======
11 RATE/VOLUME ANALYSIS The following table analyzes dollar amounts of changes in interest income and 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 -------------------------------------------------------------------------------------- 2002 vs. 2001 2001 vs 2001 --------------------------------------- ----------------------------------------- Increase (Decrease) Increase (Decrease) Due to Due to --------------------------------------- ----------------------------------------- Rate/ Rate/ Volume Rate Volume Total Volume Rate Volume Total ------ ---- ------ ----- ------ ---- ------ ----- (In thousands) Interest income: Loans receivable $ (399) $ (505) $ 17 $ (887) $ 1,068 $ 57 $ 6 $ 1,131 Investment and mortgage- backed securities Taxable (495) (529) 42 (982) (827) (139) 15 (951) Nontaxable (133) (57) 4 (186) 117 (62) (5) 50 FHLB stock (84) (162) 38 (208) 27 (106) (7) (86) FHLB DDA 410 (87) (220) 103 155 (3) (19) 133 Other interest-earning assets 3 (4) (1) (2) (7) (2) 2 (7) ------- ------- ------ ------- ------- ------- ------ ------- Total interest-earning assets (698) (1,344) (120) (2,162) 533 (255) (8) 270 ------- ------- ------ ------- ------- ------- ------ ------- Interest expense: NOW, MMDA, statement savings 157 (824) (84) (751) 216 216 44 476 Time deposits 332 (1,494) (81) (1,243) 123 580 13 716 FHLB advances (1,157) (121) 23 (1,255) (406) 212 (12) (206) Note payable (6) (1) 1 (6) (6) -- -- (6) ------- ------- ------ ------- ------- ------- ------ ------- Total interest-bearing liabilities (674) (2,440) (141) (3,255) (73) 1,008 45 980 ------- ------- ------ ------- ------- ------- ------ ------- Change in net interest income $ (24) $ 1,096 $ 21 $ 1,093 $ 606 $(1,263) $ (53) $ (710) ======= ======= ====== ======= ======= ======= ====== =======
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2002 AND 2001 The Company had consolidated total assets of $276.4 million and $287.6 million at June 30, 2002, and 2001, respectively. During the twelve-month period ended June 30, 2002 the Company experienced a decrease in its net consolidated loan portfolio from $131.7 million at June 30, 2001, to $124.2 million at June 30, 2002. During this same period, investments and mortgage-backed securities and other short-term interest-earning assets decreased slightly from $135.2 million at June 30, 2001 to $132.6 million at June 30, 2002. Deposits increased from $161.3 million at June 30, 2001, to $165.0 million at June 30, 2002. The outstanding balances of FHLB borrowings were $91.9 million and $82.3 million at June 30, 2001 and June 30, 2002, 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 $26.7 million at June 30, 2002, and $31.9 million at June 30, 2001. The decreases in equity were primarily due to the to the purchase of treasury stock, offset by a reduction of the unrealized 12 loss on investment securities available for sale and the Company's net income earned for the fiscal year ended June 30, 2002. During the year ended June 30, 2002, the Company purchased 510,389 shares (net of options exercised) of its common stock at a cost of approximately $7.6 million, or $14.82 per share. At June 30, 2002, the Bank's regulatory capital exceeded all applicable regulatory capital requirements and meets the definition of "well" capitalized under the Prompt Corrective Action provisions. COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 2002 AND 2001 Net Income. Net income for the year ended June 30, 2002, was approximately $1,166,000 compared to net income of $620,000 for the year ended June 30, 2001. The changes resulted primarily from an increase in net interest income of $1,093,000, an increase in noninterest income of $228,000, offset by an increase in the provision for loan and investment loss of $63,000, a decrease in the income tax benefit of $529,000, and a increase in noninterest expense of $184,000. Interest Income. Interest income for the year ended June 30, 2002, was $17.9 million, or $2.2 million less than interest income for the year ended June 30, 2001. The total average interest-earning assets decreased $7.5 million, while the yield decreased from 7.31% to 6.71%, due to rate and volume decreases on loans and investment securities. The average balance of loans receivable decreased $4.7 million, total loan interest income decreased $0.9 million, and the average yield on loans decreased 37 basis points. The average balance of investments and mortgage-backed securities receivable decreased $10.2 million, interest income decreased $1.2 million, and the average yield decreased 45 basis points. The average balance of other interest-earning assets (primarily FHLB DDA's and FHLB stock) increased $7.4 million, interest income decreased $108,000, and the average yield decreased 296 basis points. Interest Expense. Total average interest-bearing liabilities decreased $9.5 million, while the interest rate on such liabilities decreased from 5.59% to 4.46%. The average balance of interest-bearing deposits increased $9.8 million, deposit interest expense decreased $2.0 million, and the average cost decreased 161 basis points. The average balance of FHLB advances decreased $19.2 million, FHLB interest expense decreased $1.3 million, and the average cost decreased 11 basis points. Net Interest Income. Net interest income for the year ended June 30, 2002, was $7.1 million, or $1.1 million more than net interest income for the year ended June 30, 2001. The increase in net interest income from June 30, 2001 to 2002, was the result of an increase in our interest rate spread of 53 basis points. During the year ended June 30, 2002, the Federal Reserve dropped interest rates 5 times totaling 200 basis points, and the prime interest rate decreased 225 basis points from 7.00% on June 30, 2001 to 4.75% on June 30, 2002. These interest rate decreases caused a greater reduction in the average rates we paid on deposits and borrowed money than the average yield which we earned on loans, investments, and interest-bearing deposits. This trend reflects the liability sensitive nature of the Company which would, keeping all other things equal, typically show improved net interest income in a decreasing interest rate environment. Provision for Loan and Investment Losses. During the year ended June 30, 2002, the Bank's management continued its review of the appropriateness of the amount of the allowance for loan and investment losses. Based on these reviews, management made a $330,000 provision for loan losses and a $29,000 provision for investment losses for the year ended June 30, 2002. The allowance for loan losses of $1.6 million at June 30, 2002, represented 1.22% of gross outstanding loans which compares to 0.99% as of June 30, 2001. The provision was made in consideration of reviews of individual loans and the fact that nonperforming loans as of June 30, 2002 as a percent of total loans increased to 1.44% from 0.81% as of June 30, 2001. In addition, total classified assets as a percent of the Bank's tangible capital plus allowance for loan loss was 31.0% as of June 30, 2002, which compares to 8.1% as of June 30, 2001. Part of this increase is due to an increase in classified assets and part is due to the Bank paying Bancshares $9.0 million in dividends, thus reducing capital at the Bank. As of June 30, 2002, the Bank had $7.1 million in assets classified substandard or doubtful as compared to $2.5 million as of June 30, 2001. 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 13 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, 2002, was approximately $1,606,000 compared to approximately $1,378,000 for the year ended June 30, 2001. This increase of approximately $228,000 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, and data processing expenses. Total noninterest expense for the year ended June 30, 2002, was $7.1 million compared to $6.9 million for the year ended June 30, 2001. Significant components of the increase in noninterest expense are an $86,000 increase in salaries and employee benefits, a $52,000 increase in net occupancy expense, a $56,000 increase in data processing expense, a $146,000 increase in other expenses, offset with a $136,000 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, 2002 and 2001 were 5.0% and (307.0)%, respectively. The variance in the effective rate from the expected statutory rate is due primarily to tax exempt interest. The negative rate for fiscal year ended June 30, 2001, is a net tax benefit, and increases net income. The net tax benefit is primarily due to tax exempt income. The corresponding deferred tax asset totals approximately $1.7 million as of June 30, 2002, and $1.5 million as of June 30, 2001. 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 and interest-rate risk planning strategy of selling available for sale tax exempt securities and reinvesting the proceeds into taxable income producing securities. The strategy does not anticipate significant taxable gains on the sale of the tax-exempt securities, but rather a shift of nontaxable interest income to taxable interest income. See Note 10 to the Consolidated Financial Statements. 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 14 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 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. 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 noninterest 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 19 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 decreased 203 basis points. Interest Expense. Total average interest-bearing liabilities increased $2.0 million, while the interest rate on such liabilities increased from 5.24% to 5.59%. The average balance of interest-bearing deposits increased $9.0 million, deposit interest expense increased $1.2 million, and the average cost increased 35 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 15 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, 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 noninterest 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 benefits, 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. SUBSEQUENT EVENTS - BRANCH SALE On July 19, 2002, the bank sold its Monticello branch to Simmons First Bank of South Arkansas. The sale included approximately $8.3 million in loans, $1.5 million in fixed assets, $0.2 million in other assets, and $13.2 million in deposits. The Bank recognized a premium on the deposits of approximately $0.9 million and the difference was paid in cash to the buyer. The resulting after tax gain on the sale of the Monticello branch of approximately $440,000 translates into $0.29 in earnings per share. 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 customer 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 16 influenced by general interest rates, economic conditions, competition and other factors. The Bank does not solicit customer deposits outside of its market area through brokers or other financial institutions. At June 30, 2002, the Bank had designated securities with a fair value of approximately $118.2 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. At June 30, 2002, the Bank had outstanding approximately $6.1 million in commitments to originate loans (including unfunded portions of construction loans) and $1.6 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 $86.8 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. 17 INDEPENDENT AUDITORS' REPORT To the Board of Directors of HCB Bancshares, Inc. Camden, Arkansas We have audited the accompanying consolidated statement of financial condition of HCB Bancshares, Inc. and its subsidiary (the "Company") as of June 30, 2001, and the related consolidated statements of income and comprehensive income, stockholders' equity, and cash flows for the years ended June 30, 2001 and 2000. 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 accepted 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 the results of their operations and their cash flows for the years ended June 30, 2001 and 2000, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP September 21, 2001 18 INDEPENDENT AUDITORS' REPORT The Board of Directors HCB Bancshares, Inc. Camden, Arkansas We have audited the accompanying consolidated statement of financial condition of HCB Bancshares, Inc. as of June 30, 2002, and the related consolidated statements of income and comprehensive income, stockholders' equity, and cash flows for the year then ended. 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 audit. We conducted our audit in accordance with auditing standards generally accepted 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 audit provides a reasonable basis for our opinion. In our opinion, the 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position of HCB Bancshares, Inc. as of June 30, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. /s/ BKD, LLP Little Rock, Arkansas August 1, 2002 19 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, 2002 AND 2001 - --------------------------------------------------------------------------------
ASSETS 2002 2001 Cash and due from banks $ 3,492,257 $ 3,302,540 Interest-bearing deposits with banks 14,404,572 15,107,481 ------------ ------------ Cash and cash equivalents 17,896,829 18,410,021 Investment securities: Available for sale, at fair value (amortized cost at June 30, 2002 and 2001, of $115,796,195 and $120,222,942, respectively) 118,198,564 120,082,177 Loans receivable, net of allowance at June 30, 2002 and 2001, of $1,628,515 and $1,446,114, respectively 124,176,898 131,651,421 Accrued interest receivable 1,721,612 2,017,188 Federal Home Loan Bank stock 4,709,900 4,735,800 Premises and equipment, net 7,112,211 7,564,681 Goodwill, net 131,250 206,250 Real estate held for sale 910,587 398,132 Other assets 1,567,443 2,532,980 ------------ ------------ TOTAL $ 276,425,294 $ 287,598,650 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits $ 165,005,183 $ 161,285,179 Federal Home Loan Bank advances 82,263,936 91,915,694 Advance payments by borrowers for taxes and insurance 110,446 199,470 Accrued interest payable 740,008 972,900 Note payable -- 80,000 Other liabilities 1,569,433 1,211,073 ------------ ------------ Total liabilities 249,689,006 255,664,316 ------------ ----------- COMMITMENTS AND CONTINGENCIES (Notes 12 and 14) STOCKHOLDERS' EQUITY: Common stock, $.01 par value, 10,000,000 shares authorized, 2,645,000 shares issued, 1,425,056 and 1,935,445 shares outstanding at June 30, 2002 and 2001, respectively 26,450 26,450 Additional paid-in capital 25,832,641 25,914,132 Unearned ESOP shares (846,400) (1,058,000) Unearned MRP shares (116,169) (155,601) Accumulated other comprehensive income (loss) 1,441,942 (59,600) Retained earnings 14,950,088 14,256,684 ------------ ------------ 41,288,552 38,924,065 ------------ ------------ Treasury stock, at cost, 1,219,944 and 709,555 shares at June 30, 2002 and 2001, respectively (14,552,264) (6,989,731) ------------- ------------- Total stockholders' equity 26,736,288 31,934,334 ------------ ------------ TOTAL $ 276,425,294 $ 287,598,650 ============ ===========
See notes to consolidated financial statements. 20 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000 INTEREST INCOME: Interest and fees on loans $ 10,735,729 $ 11,622,492 $ 10,491,741 Investment securities: Taxable 5,418,567 6,401,378 7,352,290 Nontaxable 1,344,478 1,529,550 1,479,536 Other 417,339 524,980 485,332 ----------- ----------- ----------- Total interest income 17,916,113 20,078,400 19,808,899 INTEREST EXPENSE: Deposits 5,706,164 7,699,484 6,507,174 Federal Home Loan Bank advances 5,116,537 6,372,982 6,579,482 Note payable 1,000 7,000 13,000 ----------- ----------- ----------- Total interest expense 10,823,701 14,079,466 13,099,656 ----------- ----------- ---------- NET INTEREST INCOME 7,092,412 5,998,934 6,709,243 PROVISION FOR LOAN AND INVESTMENT LOSSES 359,000 296,000 -- ----------- ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN AND INVESTMENT LOSSES 6,733,412 5,702,934 6,709,243 ----------- ----------- ----------- NONINTEREST INCOME: Service charges on deposit accounts 984,089 765,532 555,292 Gain on sales of investment securities available for sale 1,518 -- -- Gain on sales of loans available for sale, net 381,733 223,906 276,841 Other 239,120 389,174 207,489 ----------- ----------- ----------- Net noninterest income 1,606,460 1,378,612 1,039,622 ----------- ----------- ----------- NONINTEREST EXPENSE: Salaries and employee benefits 3,961,413 3,875,094 3,904,807 Net occupancy expense 1,085,602 1,033,684 900,948 Federal insurance premiums 29,439 50,330 79,692 Data processing 368,176 312,551 326,528 Professional fees 489,360 624,622 1,050,873 Amortization of goodwill 75,000 75,000 75,000 Other 1,104,155 957,837 966,262 ----------- ----------- ----------- Total noninterest expenses 7,113,145 6,929,118 7,304,110 ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 1,226,727 152,428 444,755 INCOME TAX PROVISION (BENEFIT) 61,027 (467,888) (341,147) ----------- ------------ ------------ NET INCOME $ 1,165,700 $ 620,316 $ 785,902 ----------- ----------- ----------- (Continued)
21 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000 OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX Unrealized holding gain (loss) on securities arising during period $ 1,503,060 $ 4,342,068 $ (1,780,995) Reclassification adjustment for gains included in net income (1,518) -- -- ------------ ----------- ----------- Other comprehensive income (loss) 1,501,542 4,342,068 (1,780,995) ----------- ----------- ----------- COMPREHENSIVE INCOME (LOSS) $ 2,667,242 $ 4,962,384 $ (995,093) =========== =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING BASIC 1,635,669 1,866,387 1,988,984 =========== =========== =========== DILUTED 1,719,903 1,866,387 1,988,984 =========== =========== =========== EARNINGS PER SHARE: Basic $ 0.71 $ 0.33 $ 0.40 ==== ==== ==== Diluted $ 0.68 $ 0.33 $ 0.40 ==== ==== ==== DIVIDENDS PER SHARE $ 0.28 $ 0.24 $ 0.24 ==== ==== ==== (Concluded)
See notes to consolidated financial statements. 22 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED JUNE 30, 2002, 2001 AND 2000
- ----------------------------------------------------------------------------------------------------------------------------- ACCUMULATED ISSUED ADDITIONAL UNEARNED UNEARNED OTHER COMMON STOCK PAID-IN ESOP MRP COMPREHENSIVE RETAINED SHARES AMOUNT CAPITAL SHARES SHARES INCOME EARNINGS --------- -------- ------------ ------------ ----------- ---------- ------------- BALANCE, JULY 1, 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 Net income 1,165,700 Common stock committed to be released for ESOP 77,065 211,600 MRP shares earned 39,432 Net change in unrealized gain (loss) on securities available for sale, net of tax 1,501,542 Stock options exercised (158,556) Treasury stock purchased Dividends paid (472,296) --------- -------- ------------ ------------ ----------- ---------- ------------- BALANCE, JUNE 30, 2002 2,645,000 $ 26,450 $ 25,832,641 $ (846,400) $ (116,169) $1,441,942 $ 14,950,088 ========= ======== ============ ============ =========== ========== ============= TREASURY TREASURY TOTAL STOCK STOCK STOCKHOLDERS' SHARES AMOUNT EQUITY -------- ------------- ------------ BALANCE, JULY 1, 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 Net income 1,165,700 Common stock committed to be released for ESOP 288,665 MRP shares earned 34,432 Net change in unrealized gain (loss) on securities available for sale, net of tax 1,501,542 Stock options exercised (50,473) (619,821) 461,265 Treasury stock purchased 560,862 (8,182,354) (8,182,354) Dividends paid (472,296) --------- ------------- ------------ BALANCE, JUNE 30, 2002 1,219,944 $ (14,552,264) $ 26,736,288 ========= ============= ============
See notes to consolidated financial statements. 23 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000 OPERATING ACTIVITIES: Net income $ 1,165,700 $ 620,316 $ 785,902 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 743,412 730,212 649,779 Amortization (accretion) of: Deferred loan origination fees 117,153 116,232 (116,260) Goodwill 75,000 75,000 75,000 Premiums and discounts on loans, net (14,412) (4,487) (4,619) Premiums and discounts on investment securities, net 49,942 68,487 119,181 Provision for loan and investment loss 359,000 296,000 -- Deferred income taxes (269,037) (403,424) (477,356) Net gain on sale of investment securities available for sale (1,518) -- -- Origination of loans held for sale (26,675,718) (13,502,308) (9,239,668) Proceeds from sales of loans held for sale 27,117,741 12,732,692 10,160,826 Stock compensation expense 169,541 244,385 333,530 Change in accrued interest receivable 295,576 (164,301) (135,064) Change in accrued interest payable (232,892) 55,485 102,218 Change in other assets 192,983 (720,084) 826,402 Change in other liabilities 358,360 (41,483) (23,113) ------------ ------------ ------------ Net cash provided by operating activities 3,450,831 102,722 3,056,758 ------------ ------------ ------------ INVESTING ACTIVITIES: Purchases of investment securities available for sale (23,053,591) -- (3,302,892) Purchases of loans -- -- (82,547) Redemption (purchase) of Federal Home Loan Bank stock 25,900 1,487,700 (844,400) Proceeds from sales of investment securities - available for sale 4,995,347 -- -- Loan (originations), net of repayments 6,599,759 4,336,955 (21,181,354) Principal payments on investment securities 22,407,566 19,629,225 14,768,810 Proceeds from maturities of other interest-bearing deposits -- 99,000 619,000 Net (increase) decrease in real estate held for resale (512,455) (38,524) 103,870 Purchases of premises and equipment (290,942) (1,742,409) (701,559) ------------ ------------ ------------ Net cash provided (used) by investing activities 10,171,584 23,771,947 (10,621,072) ------------ ------------ ------------ (Continued)
24 HCB BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2002, 2001 AND 2000
2002 2001 2000 FINANCING ACTIVITIES: Net increase (decrease) in deposits $ 3,720,004 $ 16,412,108 $ (1,423,527) Advances from Federal Home Loan Bank 6,464,838 213,740,000 281,234,000 Repayment of Federal Home Loan Bank advances (16,116,596) (237,433,335) (270,148,390) Net increase (decrease) in advance payments by borrowers for taxes and insurance (89,024) 59,916 11,112 Purchase of treasury stock, net (7,562,533) (1,038,686) (2,708,518) Repayment of note payable (80,000) (80,000) (80,000) Dividends paid (472,296) (474,299) (506,929) ------------ ------------- ------------- Net cash provided (used) by financing activities (14,135,607) (8,814,296) 6,377,748 ------------ ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (513,192) 15,060,373 (1,186,566) CASH AND CASH EQUIVALENTS: Beginning of year 18,410,021 3,349,648 4,536,214 ------------ ------------- ------------- End of year $ 17,896,829 $ 18,410,021 $ 3,349,648 ============ ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for: Interest $ 11,056,593 $ 14,023,981 $ 12,997,438 ============ ============= ============= Income taxes paid (received) $ (94,698) $ 150,000 $ -- ============ ============= ============= (Concluded)
See notes to consolidated financial statements. 25 HCB BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JUNE 30, 2002, 2001 AND 2000 - -------------------------------------------------------------------------------- 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 accounting principles generally accepted in the United States of America 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. 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. 26 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, 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. 27 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. GOODWILL AND INTANGIBLE ASSETS - Goodwill and other long-lived assets are tested periodically for impairment and written down to their fair value as necessary. 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, and 1,988,984 weighted-average common shares outstanding for the years ended June 30, 2001, and 2000, respectively. Weighted-average common shares outstanding was the same for basic and diluted in those years. For the year ended June 30, 2002, basic earnings per share was calculated using 1,635,669 shares and dilutive earnings per share was calculated using 1,719,903 shares. 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, and 2000. However, for the year ended June 30, 2002, the Management Recognition Plan was antidilutive, but the Stock Option Plan was dilutive by 84,234 shares. STOCK PURCHASED FOR OPTION BENEFIT TRUST - As of June 30, 2002, the Company has a total of 78,380 shares of its common stock in its stock option plan trust. These shares are included in treasury stock on the accompanying 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 2001 and 2000 consolidated financial statements have been reclassified to conform to the classifications adopted for reporting in 2002. These reclassifications had no effect on net earnings. 28 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. The Company plans to adopt the provisions of this statement on July 1, 2002, and has determined that the effect on the Company's consolidated financial statements will not be material. 2. INVESTMENT SECURITIES Investment securities consisted of the following at June 30:
2002 -------------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR AVAILABLE FOR SALE COST GAINS LOSSES VALUE U.S. Government and agencies $ 1,500,000 $ 30,945 $ 1,530,945 Municipal securities 25,520,671 323,090 $ 154,570 25,689,191 Equity securities 39,750 30,490 70,240 Other securities 2,000,000 5,000 1,995,000 Mortgage-backed securities 75,820,993 1,820,096 38,053 77,603,036 Collateralized mortgage obligations 10,914,781 395,371 11,310,152 ------------ ---------- -------- ------------ Total $115,796,195 $2,599,992 $197,623 $118,198,564 ============ ========== ======== ============ 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 ============ ======== ======== ============
For the year ended June 30, 2002, the Company realized $11,659 in gains and $10,141 in losses on sales of investment securities available for sale. There were no realized gains or losses on sales of available for sale securities for the years ended June 30, 2001 and 2000. While at June 30, 2002, no securities were pledged to collateralize public deposits, as of June 30, 2001, municipal securities with a carrying value of approximately $2.1 million were pledged as collateral for public deposits. At June 30, 2002 and 2001, mortgage-backed securities with a carrying value of approximately $16.7 million and $20.7 million, respectively, were pledged as collateral for Federal Home Loan Bank advances. 29 The scheduled maturities of available for sale securities at June 30, 2002, 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.
AMORTIZED FAIR COST VALUE Due in one year or less $ 1,500,000 $ 1,530,945 Due from one year to five years -- -- Due from five years to ten years -- -- Due after ten years 27,520,671 27,684,191 ------------ ------------ 29,020,671 29,215,136 Equity securities 39,750 70,240 Mortgage-backed securities 75,820,993 77,603,036 Collateralized mortgage obligations 10,914,781 11,310,152 ------------ ------------ Total $115,796,195 $118,198,564 ============ ============
3. LOANS RECEIVABLE Loans receivable consisted of the following at June 30:
2002 2001 First mortgage loans: One- to four- family residences $ 41,724,098 $ 50,579,375 Multi-family and commercial 50,626,236 57,041,028 Real estate construction loans 12,449,965 16,008,775 Less undisbursed loan funds (5,945,029) (12,020,255) ------------ ------------ Total first mortgage loans 98,855,270 111,608,923 Consumer and other loans: Commercial loans 14,406,499 11,289,519 Automobile 6,836,399 6,779,218 Consumer and home improvement loans 4,807,218 2,073,650 Loans collateralized by deposits 2,469,033 2,488,948 Less undisbursed loan funds (1,718,669) (1,274,468) ------------ ------------ Total consumer and other loans 26,800,480 21,356,867 Allowance for loan losses (1,628,515) (1,446,114) Net deferred loan costs and discounts 149,663 131,745 ------------ ------------ Loans receivable, net $124,176,898 $131,651,421 ============ ============
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. At June 30, 2002, impaired loans totaled approximately $4,900,000. All impaired loans had designated reserves for possible loan losses. Reserves relative to impaired loans at June 30, 2002, was approximately $426,000. Approximately $173,000 in interest income was recognized on average impaired loans of approximately $2,200,000 for the year ended June 30, 2002. At June 30, 2001, loans identified by management as impaired were 30 not significant. Interest recognized on impaired loans on a cash basis during 2002 and 2001 was immaterial. The Company is not committed to lend additional funds to debtors whose loans have been modified. The subsidiary Bank had extensions of credit to executive officers, directors and to companies in which the Banks' directors were principal owners, in the amount of approximately $1.8 million as of June 30, 2002 and 2001. Balance, June 30, 2001 $1,833,111 New extensions of credit 119,100 Repayments (192,382) ---------- Balance, June 30, 2002 $1,759,829 ========== In management's opinion, such loans were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. Further, in management's opinion, these extensions of credit did not involve more than the normal risk of collectability or present other unfavorable features. 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. 4. ACCRUED INTEREST RECEIVABLE Accrued interest receivable consisted of the following at June 30:
2002 2001 Investment securities $ 839,287 $ 931,985 Loans 882,325 1,085,203 ---------- ---------- Total $1,721,612 $2,017,188 ========== ==========
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:
2002 2001 2000 Balance, beginning of year $ 1,446,114 $ 1,231,709 $ 1,329,201 Provision 330,000 296,000 -- Charge-offs (234,382) (101,761) (99,798) Recoveries 86,783 20,166 2,306 ------------ ------------ ------------ Balance, end of year $ 1,628,515 $ 1,446,114 $ 1,231,709 ============ ============ ============
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 1/20 of its advances (borrowings) from the FHLB. 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. 31 7. PREMISES AND EQUIPMENT Premises and equipment consisted of the following at June 30:
2002 2001 Land and buildings $ 7,153,233 $ 7,154,882 Furniture and equipment 3,667,962 3,404,811 ------------ ------------ Total 10,821,195 10,559,693 Accumulated depreciation (3,708,984) (2,995,012) ------------ ------------ Premises and equipment, net $ 7,112,211 $ 7,564,681 ============ ============
8. DEPOSITS Deposits are summarized as follows at June 30:
2002 2001 Demand and NOW accounts, including noninterest-bearing deposits of $8,889,867 and $7,379,892 in 2002 and 2001, respectively $ 39,092,410 $ 38,055,320 Money market 5,911,715 5,733,865 Statement savings 8,010,973 6,903,036 Certificates of deposit 111,990,085 110,592,958 ------------ ------------ Total $165,005,183 $161,285,179 ============ ============
The aggregate amount of short-term jumbo certificates of deposit with a minimum denomination of $100,000 was approximately $19.3 million and $13.6 million at June 30, 2002 and 2001, respectively. At June 30, 2002, scheduled maturities of certificates of deposit are as follows: Years ending June 30: 2003 $ 86,819,911 2004 19,993,891 2005 5,092,669 Thereafter 83,614 ------------ Total $111,990,085 ============ 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 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 $16.7 million at June 30, 2002, as additional collateral. Advances at June 30, 2002 and 2001, have maturity dates as follows: 32
2002 2001 WEIGHTED WEIGHTED AVERAGE AVERAGE RATE AMOUNT RATE AMOUNT Years ending June 30: 2002 -- % $ -- 5.82% $ 8,050,000 2003 5.70 12,007,051 5.70 12,030,126 2004 5.65 9,875,000 5.65 9,875,000 2005 5.95 7,141,929 5.42 9,721,318 2006 5.92 4,859,326 5.92 4,889,509 2007 5.91 6,477,709 6.14 8,400,629 Thereafter 6.06 41,902,921 6.05 38,949,112 ---- ----------- ---- ----------- Total 5.93% $82,263,936 5.88% $91,915,694 ==== =========== ==== ===========
10. INCOME TAXES Income tax provisions (benefits) are summarized as follows:
YEARS ENDED JUNE 30, ----------------------------------------------- 2002 2001 2000 Income tax provision (benefit): Current $ 330,065 $ (64,464) $ 136,209 Deferred (269,038) (403,424) (477,356) --------- --------- --------- Total $ 61,027 $(467,888) $(341,147) ========= ========= =========
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, ----------------------------------------------------------------------------- 2002 2001 2000 Taxes at statutory rate $ 417,087 34.0% $ 51,826 34.0% $ 151,217 34.0% Increase (decrease) resulting from: Tax exempt income (457,123) (37.26) (520,047) (341.18) (503,043) (113.11) Disallowed interest expense 66,972 5.46 85,650 56.19 67,735 15.23 Change in estimate 0 0.00 (67,000) (43.95) 0 0.00 Compensation (38,289) (3.12) (19,825) (13.01) (77,301) (17.38) Other, net 72,380 5.89 1,508 0.99 20,245 4.56 --------- ---- --------- ------- --------- ------ Total $ 61,027 4.97% $(467,888) (306.96)% $(341,147) (76.70)% ========= ==== ========= ======= ========= ======
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:
2002 2001 Deferred tax assets: Allowance for loan losses $ 543,084 $ 326,016 Unrealized loss on available for sale investments -- 81,165 Deferred compensation 388,868 312,942 Net operating loss carryforward 801,281 1,147,149 AMT credit carryforward 445,313 278,496 Other 140,367 13,425 ----------- ---------- 33 Total deferred tax assets 2,318,913 2,159,193 ----------- ---------- Deferred tax liabilities: Premises and equipment 106,624 262,610 Unrealized gains on available for sale investments 960,427 -- Investment premiums and discount -- 10,432 Loan fees 1,200 1,553 FHLB dividends 465,675 327,057 ----------- ---------- Total deferred tax liabilities 1,533,926 601,652 ----------- ---------- Net deferred tax asset $ 784,987 $1,557,541 =========== ==========
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, 2002, the amount of these reserves totaled approximately $3,462,590 with an unrecognized deferred tax liability of $1,177,281. 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 $2,300,832, of which $625,146, $1,120,698, and $554,988 expire in 2019, 2020, and 2021, respectively. The Company's AMT credit carryforward of $445,313 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 $1,246,594 as of June 30, 2002. 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 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. This tax strategy does not anticipate significant taxable gains on the sale of the tax exempt securities, but rather a shift of nontaxable interest income to taxable interest income. 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 $288,665, $179,882, and $163,578 was recognized during the years ended June 30, 2002, 2001 and 2000, 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, 2002 and 2001, 21,160 shares were committed to be released by the ESOP to participant accounts. At June 30, 2002, there were 126,960 shares allocated to participant accounts and 84,640 unallocated shares. The fair value of the unallocated shares amounted to approximately $1,265,368 (84,640 shares at $14.95 per share) at June 30, 2002. 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 34 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 years ended June 30, 2002, and 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. 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 of 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. No new options were granted during the years ended June 30, 2002, 2001, or 2000. A summary of the status of the Company's stock option plan as of June 30, 2002, and changes during the years ending June 30, 2001 and 2000, is presented below:
WEIGHTED AVERAGE EXERCISE OPTIONS SHARES PRICE 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 ------- ---- Granted -- -- Exercised 50,473 9.14 Forfeited 25,444 9.13 ------- ---- Outstanding at June 30, 2002 218,550 9.14 ------- ---- Options exercisable at June 30, 2002 (vested) 216,330 $ 9.13 ======= ====
Exercise prices for options outstanding at June 30, 2002, range from $9.125 to $9.375 per share. The weighted average remaining contractual life of such shares was 5.9 years at June 30, 2002. 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: 35
2002 AS REPORTED PRO FORMA Net income (in thousands) $ 1,166 $ 1,146 Earnings per share: Basic $ 0.71 $ 0.70 Diluted $ 0.68 $ 0.67 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
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:
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, 2002) 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, 2002) 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, 2002, 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 $40,000, $65,000 and $170,000 in compensation expense was recognized during the years ended June 30, 2002, 2001, and 2000, 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. 36 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. 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. 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, 2002, 2001 and 2000, contributions to the plan totaled approximately $124,000, $181,000, and $184,000, 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, 2002, 2001 or 2000. EMPLOYMENT AGREEMENTS - Certain executive officers of the Bank and the Company have employment agreements with one to three year renewable terms. Such agreements provide for termination pay and other benefits under certain circumstances. As of June 30, 2002, aggregate termination pay is approximately $0.90 million. CHANGE-IN-CONTROL AGREEMENTS - As of June 30, 2002, 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 a range of 25% to 299% of the officers' compensation. As of June 30, 2002, the aggregate benefits total approximately $0.70 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. 37 The Company had the following outstanding commitments at June 30, 2002: Undisbursed construction loans $4,614,879 Commitments to originate mortgage loans 1,330,150 Commitments to originate commercial loans 149,500 Unused lines of credit 1,569,169 ---------- Total $7,663,698 ========== 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, 2002, 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:
JUNE 30, 2002 JUNE 30, 2001 ESTIMATED ESTIMATED CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ASSETS: Cash and due from banks $ 3,492,257 $ 3,492,257 $ 3,302,540 $ 3,302,540 Interest bearing deposits with banks 14,404,572 14,404,572 15,107,481 15,107,481 Investment securities: Available for sale 118,198,564 118,198,564 120,082,177 120,082,177 Loans receivable, net 124,176,898 127,424,573 131,651,421 133,015,674 Accrued interest receivable 1,721,612 1,721,612 2,017,188 2,017,188 Federal Home Loan Bank stock 4,709,900 4,709,900 4,735,800 4,735,800 LIABILITIES: Deposits: Demand, NOW, money market and statement savings 53,015,098 53,015,098 50,692,221 50,692,221 Certificates of deposit 111,990,085 112,396,949 110,592,958 111,361,694 Federal Home Loan Bank advances 82,263,936 86,780,344 91,915,694 92,800,235 Advance payments by borrowers for taxes and insurance 110,446 110,446 199,470 199,470 Accrued interest payable 740,008 740,008 972,900 972,900 Note payable -- -- 80,000 80,019
For cash and due from banks, 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. 38 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, 2002 and 2001. 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. 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. 39 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, 2002 and 2001, 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. 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, 2002: Tier I (Core) Capital to Adjusted Total Assets $ 21,396 7.88 % $ 10,861 4.00 % $ 13,576 5.00 % Total Risk-Based Capital to Risk-weighted Assets 23,025 17.06 % 10,798 8.00 % 13,497 10.00 % Tier I (Core) Capital to Risk-weighted Assets 21,396 15.85 % N/A N/A 8,098 6.00 % Tangible Capital to Tangible Assets 21,396 7.88 % 4,073 1.50 % N/A N/A 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
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. 40 17. PARENT COMPANY ONLY FINANCIAL INFORMATION The following condensed statements of financial condition as of June 30, 2002 and 2001, and condensed statements of income and cash flows for the years ended June 30, 2002, 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, 2002 AND 2001
ASSETS 2002 2001 Deposit in Bank $ 1,221,185 $ 515,975 Cash equivalents 175,817 134,522 ----------- ----------- Cash and cash equivalents 1,397,002 650,497 Investment in Bank 21,927,797 29,861,612 Loans receivable 1,060,298 700,000 Investment securities 70,240 40,800 Other assets 821,076 909,850 ----------- ----------- TOTAL ASSETS $25,276,413 $32,162,759 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accrued expenses and other liabilities $ 143,058 $ 228,425 Stockholders' equity 25,133,354 31,934,334 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $25,276,413 $32,162,759 =========== ===========
CONDENSED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 2002, 2001 AND 2000
INCOME: 2002 2001 2000 Dividend from Bank $ 9,000,000 $ 1,000,000 $ -- Interest and dividend income 205,248 230,421 346,007 ----------- ----------- ----------- Total income 9,205,248 1,230,421 346,007 EXPENSES: Operating expenses 48,944 191,509 301,181 ----------- ----------- ----------- INCOME BEFORE INCOME TAXES AND DISTRIBUTIONS IN (EXCESS) LESS THAN BANK SUBSIDIARY INCOME 9,156,304 1,038,912 44,826 INCOME TAX PROVISION 59,849 13,000 15,242 ----------- ----------- ----------- INCOME BEFORE DISTRIBUTIONS IN (EXCESS) LESS THAN BANK SUBSIDIARY INCOME 9,096,455 1,025,912 29,584 DISTRIBUTIONS IN (EXCESS) LESS THAN BANK SUBSIDIARY INC (7,930,755) (405,596) 756,318 ----------- ----------- ----------- NET INCOME $ 1,165,700 $ 620,316 $ 785,902 =========== =========== ===========
41 HCB BANCSHARES, INC. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2002, 2001 AND 2000
OPERATING ACTIVITIES: 2002 2001 2000 Net income $ 1,165,700 $ 620,316 $ 785,902 Adjustments to reconcile net income to net cash provided (used) by operating activities: Distributions in excess (less) than bank subsidiary income 7,930,755 405,596 (756,318) Changes in operating assets and liabilities: Other assets 239,824 (259,752) 954,507 Accrued expenses and other liabilities (194,647) 228,425 (1,179,190) ------------- ------------ ------------ Net cash provided (used) by operating activities 9,141,632 994,585 (195,099) ------------- ------------ ------------ INVESTING ACTIVITIES: Purchase loan, net of repayments (360,298) -- 1,713,019 ------------- ------------ ------------ Net cash provided (used) by investing activities (360,298) -- 1,713,019 ------------- ------------ ------------ FINANCING ACTIVITIES: Dividends paid (472,296) (474,299) (506,929) Purchase of treasury stock, net (7,562,533) (1,038,686) (2,708,518) ------------- ------------ ------------ Net cash used by financing activities (8,034,829) (1,512,985) (3,215,447) ------------- ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 746,505 (518,400) (1,697,527) CASH AND CASH EQUIVALENTS: Beginning of period 650,497 1,168,897 2,866,424 ------------- ------------ ------------ End of period $ 1,397,002 $ 650,497 $ 1,168,897 ============= ============ ============
42 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, 2002 ----------------------------------------------------- BEFORE TAX TAX EXPENSE NET-OF-TAX AMOUNT (BENEFIT) AMOUNT AMOUNT UNREALIZED GAINS ON SECURITIES: Unrealized holding gain on securities arising during period $ 2,544,652 $ (1,041,592) $ 1,503,060 Less reclassification adjustment for (gains) losses included in net income (1,518) -- (1,518) ------------- ------------ ----------- Other comprehensive income $ 2,543,134 $ (1,041,592) $ 1,501,542 ============= ============ =========== 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 (BENEFIT) AMOUNT AMOUNT UNREALIZED LOSSES ON SECURITIES: Unrealized holding loss 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 loss $ (2,991,525) $ (1,210,530) $ (1,780,995) ============ ============ ============
19. SUBSEQUENT EVENTS On July 19, 2002, the bank sold its Monticello branch to Simmons First Bank of South Arkansas. The sale included approximately $8.3 million in loans, $1.5 million in fixed assets, $0.2 million in other assets, and $13.2 million in deposits. The bank recognized a premium on the deposits of approximately $0.9 million and the difference was paid in cash to the buyer. The resulting after tax gain on the sale of the Monticello branch of approximately $440,000 translates into $0.29 in earnings per share. 43 CORPORATE INFORMATION DIRECTORS MAIN OFFICE: Vida H. Lampkin 237 Jackson Street, S.W. Chairman of the Board Camden, Arkansas Cameron D. McKeel BRANCH OFFICES: President and Chief Executive Officer 4937 Highway 5 North Bryant, Arkansas Bruce D. Murry Retired Owner, Bruce's 1125 Fairview Road SW Camden, Arkansas Camden, Arkansas Carl E. Parker, Jr. 610 West 4th Street General Manager, Camden Monument Co. Fordyce, Arkansas Camden, Arkansas 473 Highway 425 North Clifford Steelman Monticello, Arkansas Retired Human Resource Administrator, Camden, Arkansas 108 South Main Street Sheridan, Arkansas F. Michael Akin President, CEO - Akin Industries INDEPENDENT AUDITOR: Monticello, Arkansas BKD, LLP John G. Rich 400 West Capital Of Counsel, Eppenstein & Eppenstein Suite 2500, P.O. Box 3667 New York, New York Little Rock, AR 72203-3667 EXECUTIVE OFFICERS: GENERAL COUNSEL: Charles T. Black Robert S. Laney Senior Vice President and Chief P.O. Box 777 Lending Officer Camden, Arkansas 71711-0777 Paula J. Bergstrom Senior Vice President Administration SECURITIES AND REGULATORY and Secretary COUNSEL: Scott A. Swain Senior Vice President and Chief Stradley Ronon Stevens & Young, LLP Financial Officer 1220 19th Street, N.W., Suite 700 ANNUAL STOCKHOLDERS MEETING: Washington, D.C. 20036 November 21, 2002 - 10:00 a.m. STOCK REGISTRAR & TRANSFER Camden Country Club AGENT: 1915 Washington Street SW Camden, Arkansas 71701 Registrar and Transfer Company Record Date - October 7, 2002 Cranford, New Jersey 07016-3572 ANNUAL REPORT ON FORM 10-K: A copy of the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2002, as filed with the Securities and Exchange Commission, will be furnished without charge to stockholders as of the record date for the 2002 Annual Meeting upon written request to: Corporate Secretary, HCB Bancshares, Inc., 237 Jackson Street, S.W, Camden, Arkansas 71701-3941. 44 EX-21 6 exhibit21fm10k2002-1843.txt EXHIBIT 21 TO 2002 FORM 10-K 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 7 exhibit231fm10k2002-1843.txt EXHIBIT 23.1 TO 2002 FORM 10-K EXHIBIT 23.1 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 August 1, 2002, incorporated by reference in the Annual Report on Form 10-K of HCB Bancshares, Inc. for the year ended June 30, 2002. /s/ BKD, LLP BKD, LLP Little Rock, Arkansas September 18, 2002 EX-23 8 exhibit232fm10k2002-1843.txt EXHIBIT 23.2 TO 2002 FORM 10-K EXHIBIT 23.2 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, on our audits of the consolidated statement of financial condition of HCB Bancshares, Inc. as of June 30, 2001 and the related consolidated statements of income and comprehensive income, stockholders' equity and cash flows for the years ended June 30, 2001 and 2000, incorporated by reference in the Annual Report on Form 10-K of HCB Bancshares, Inc. for the year ended June 30, 2002. /s/ Deloitte & Touche Little Rock, Arkansas September 18, 2002 EX-99 9 exhibit99fm10k2002-1843.txt EXHIBIT 99 TO 2002 FORM 10-K EXHIBIT 99 CERTIFICATION - ------------- To my knowledge, this Annual Report on Form 10-K for the year ended June 30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in this Annual Report fairly presents, in all material respects, the financial condition and results of operations of HCB Bancshares, Inc. By: /s/ Cameron D. McKeel ----------------------------------- Name: Cameron D. McKeel Title:Chief Executive Officer By: /s/ Scott A. Swain ----------------------------------- Name: Scott A. Swain Title:Chief Financial Officer Date: September 25, 2002 -----END PRIVACY-ENHANCED MESSAGE-----