-----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, VYgJhcxNG8nBx+ozDl6RPI/qigo9+dcJyHbrWSKf0CBg30T4EU9k0daTNYtodHqX Wqc6VO95ILVM2ZFEbFurrg== 0000928385-97-001594.txt : 19970930 0000928385-97-001594.hdr.sgml : 19970930 ACCESSION NUMBER: 0000928385-97-001594 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970929 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HCB BANCSHARES INC CENTRAL INDEX KEY: 0001029740 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 621670792 STATE OF INCORPORATION: OK FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-22423 FILM NUMBER: 97687254 BUSINESS ADDRESS: STREET 1: HEARTLAND COMMUNITY BANK STREET 2: 237 JACKSON STREET CITY: CAMDEN STATE: AK ZIP: 71701 BUSINESS PHONE: 5018366841 MAIL ADDRESS: STREET 1: HEARTLAND COMMUNITY BANK STREET 2: 237 JACKSON STREET CITY: CAMDEN STATE: AK ZIP: 71701 10-K405 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------- FORM 10-K [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1997 Commission File Number: 0-22423 HCB BANCSHARES, INC. ----------------------------------------------------------------- (Exact name of small business issuer 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 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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, or the average bid and asked prices of such stock, as of a specified date within the past 60 days: $31,942,638.75 (2,323,101 shares at the last sale price on September 23, 1997 ($13.75 per share); for this purpose, directors, executive officers and the employee stock ownership plan have not been deemed to be non-affiliates). State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 2,645,000 shares of common stock as of September 23, 1997. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the registrant's Annual Report to Stockholders for the Fiscal Year Ended June 30, 1997 (the "Annual Report"). (Part II) 2. Portions of the registrant's Proxy Statement for its 1997 Annual Meeting of Stockholders (the "Proxy Statement"). (Part III) PART I Item 1. Description of Business General HCB Bancshares, Inc. HCB Bancshares, Inc. (the "Company") 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, including its subsidiary savings bank, Heartland Community Bank, F.S.B., 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"). Prior to the Conversion, the Company did not engage in any material operations. Since the Conversion, the Company has had no significant assets other than the outstanding capital stock of the Bank, a portion of the net proceeds of the Conversion and a note receivable from the Employee Stock Ownership Plan ("ESOP"). The Company's principal business is the business of the Bank. The holding company structure permits the Company to expand the financial services currently offered through the Bank. As a holding company, the Company 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. The Company is classified as a multiple savings institution holding company and is subject to regulation by the Office of Thrift Supervision ("OTS"). As long as the Company remains a multiple savings institution holding company, the Company will be subject to regulatory restrictions on the activities in which it and its non-savings institution subsidiaries may engage. See "Regulation -- Regulation of the Company -- 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 are 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. The Bank itself currently operates through four full service banking offices located in Camden (2), Fordyce and Sheridan, Arkansas, and its subsidiary savings bank operates through two full service banking offices located in Little Rock and Monticello, Arkansas and a loan production office in Bryant, Arkansas. At June 30, 1997, the Bank had total assets of $200.3 million, deposits of $151.2 million and equity of $37.7 million, or 18.8% of total assets. Historically, the principal business strategy of the Bank, like most other savings institutions in Arkansas and elsewhere, has been to accept 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. 1 In September 1995, the Bank's Board of Directors carefully considered the Bank's historical results of operations, current financial condition and future business prospects and, in consultation with the Bank's executive officers, determined to strengthen the Bank's competitiveness and profitability by concentrating its business strategy as an independent community bank on expanding the Bank's products and services and growing its customer and asset base. Since then, the Bank has actively sought to implement this strategy by adding two new executive officers -- Cameron McKeel as Executive Vice President and William Lyon as Senior Vice President and Chief Lending Officer -and more than doubling the Bank's total employees, by acquiring the former Heritage Bank, FSB, which added to the Bank's branch network additional branches in the growing and potentially lucrative Little Rock and Monticello banking markets, by upgrading selected branch office facilities, by expanding the types of loans and deposit accounts offered by the Bank, by updating the Bank's name and corporate identity from First Federal Savings and Loan Association of Camden to HEARTLAND Community Bank and by completing the Conversion. Throughout this period, the Bank's executive officers have worked with the Bank's directors and with the Bank's entire staff to formulate and effectuate the Bank's current strategic plan. On a going forward basis, 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 an independent 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 planned installation of ATMs, the introduction of debit cards and a planned 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) to complement the Bank's internally generated growth, potentially acquiring one or more banking institutions or other financial companies if attractive opportunities arise. While it is expected that the Bank may experience especially high deposit and loan growth in the relatively high income and growth segments of the Bank's primary market area, particularly in the Sheridan, Monticello, Bryant and, possibly, Little Rock areas, management expects to find significant deposit growth and lending opportunities throughout central Arkansas. As federally chartered savings institutions, each of the Bank and its subsidiary savings bank is subject to extensive regulation by the OTS. The lending activities and other investments of each institution must comply with various federal regulatory requirements, and the OTS periodically examines each institution for compliance with various regulatory requirements. The Federal Deposit Insurance Corporation ("FDIC") also has the authority to conduct special examinations. Each institution must file reports with 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"). See "Proposed Legislative and Regulatory Changes" below. Proposed Legislative and Regulatory Changes Legislation proposed in the United States Congress could have a profound impact on the banking and thrift industries and the operations of commercial banks and thrift institutions, including the Bank. Such legislation includes proposals to eliminate regulatory distinctions between institutions chartered as banks and savings associations under federal law and would ease the merger of the Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF"), the two deposit insurance funds. The legislation also could require federally chartered savings associations to convert to federally chartered commercial banks or to state chartered institutions, probably by a specified date. The legislation under consideration is subject to continuing review and major revision and might not be adopted soon or ever. 2 Market Area Management considers the Bank's primary market area to comprise the following counties in Arkansas: Calhoun, Cleveland, Dallas, Drew, Grant, Ouachita and Pulaski. To a lesser extent, the Bank accepts deposits and offers loans throughout central and southern Arkansas. In recent years, population has experienced low to moderate growth in Drew, Grant and Pulaski Counties, while population has declined somewhat in Calhoun, Cleveland, Dallas and Ouachita Counties. Household income has increased substantially throughout the Bank's primary market area in recent years, and household income has been well above the Arkansas average in Grant and Pulaski Counties and somewhat above the Arkansas average in Ouachita County but somewhat below the Arkansas average in Calhoun, Cleveland and Drew Counties and well below the Arkansas average in Dallas County, though the Arkansas average is below the national average. With respect to unemployment rates, while the Arkansas average has tended to fall somewhat below the national average, and unemployment rates have been well below the Arkansas average in Grant and Pulaski Counties, unemployment rates have been well above the Arkansas and national averages in Calhoun, Cleveland, Dallas, Drew and Ouachita Counties. The economies in the Bank's primary market area include a variety of industries, including manufacturing, government, services and retail trade. Important employers include International Paper and Georgia Pacific in the timber industry and Lockheed Martin and Atlantic Research in the defense industry. Competition The Bank experiences substantial competition both in attracting and retaining savings deposits and in the making of mortgage and other loans. Direct competition for savings deposits comes from other savings institutions, credit unions, regional bank holding companies and 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 interest rates and loan origination fees and the quality and range of services offered by various financial institutions. Competition for origination or real estate loans normally comes from other savings institutions, commercial banks, credit unions, mortgage bankers and mortgage brokers. The Bank's primary competition comes from institutions headquartered in the Bank's primary market area and from various non-local commercial banks that have branch offices located in the Bank's primary market area. Many competing financial institutions have financial resources substantially greater than the Bank and offer a wider 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 secured by mortgages on existing single-family residences in the Bank's primary market area. The Bank also makes commercial and multi-family real estate loans and a variety of consumer and commercial business loans, and management expects to continue and expand the Bank's increased emphasis 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 secured 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 3 of each single-family dwelling in the development does not exceed $500,000; (ii) the institution is in compliance with its fully phased-in 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, 1997, the maximum aggregate amounts that the Bank and its subsidiary savings bank could have lent to any one borrower under the 15% limit were $4.4 million and $500,000, respectively. At such date, the largest aggregate amounts of loans that the Bank and its subsidiary savings bank had outstanding to any one borrower were $1,330,000 and $491,000, respectively. 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, 1997, the Bank had no concentrations of loans exceeding 10% of gross loans other than as disclosed below.
At June 30, --------------------------------------------------------- 1997 1996 ---------------------------- ---------------------------- Amount % Amount % -------------- ------ ------------- --------- Type of Loan Real estate loans: One- to four-family residential.................... $ 62,340,601 62.27% $ 61,650,286 70.79% Multi-family loans................................. 8,873,156 8.86 6,819,212 7.83 Non-residential.................................... 18,814,701 18.79 13,746,549 15.78 Loans to facilitate sale of foreclosed real estate........................... 616,660 0.62 720,749 0.83 Land and other mortgage loans...................... 483,236 0.48 36,944 0.04 Consumer loans: Loans secured by deposits.......................... 2,434,621 2.43 1,832,180 2.10 Home improvement................................... 1,665,244 1.66 204,776 0.24 Auto............................................... 2,399,648 2.40 786,656 0.90 Other consumer..................................... 2,629,442 2.63 418,027 0.48 Commercial........................................... 2,101,963 2.10 880,311 1.01 -------------- ------ ------------- ------- Total............................................ $ 102,359,272 100.00% $ 87,095,690 100.00% ------------ ====== ------------- ====== Less: Loans in process................................... $ 2,057,095 $ 1,544,097 Deferred loan fees and discounts................... 167,069 137,335 Allowance for loan losses.......................... 1,492,473 1,283,234 -------------- ------------- Total............................................ $ 98,642,635 $ 84,131,024 ============== =============
4 Loan Maturity Schedules. The following table sets forth information regarding dollar amounts of loans maturing in the Bank's portfolio based on their contractual terms to maturity, including scheduled repayments of principal, at June 30, 1997. 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 During the Year Ending Due After Due After Due After June 30, 3 Through 5 Through 10 Through ------------------------------ 5 Years After 10 Years After 15 Years After 1998 1999 2000 June 30, 1997 June 30, 1997 June 30, 1997 ------ ------ ------- ------------- ------------- ------------- Real estate loans: One- to four-family mortgage loans................... $ 2,765,998 $ 349,077 $ 3,246,769 $ 5,386,160 $ 9,452,683 $ 24,875,919 Other mortgage loans...... 1,590,551 530,544 4,046,463 3,402,878 3,627,432 2,984,246 Consumer loans: Loans secured by deposits 1,789,446 645,175 -- -- -- -- Home improvement and other................. 2,758,539 1,077,751 1,756,931 2,087,111 1,015,965 -- ----------- ---------- ----------- ----------- ------------ ------------ Total.................. $ 8,904,534 $2,602,547 $ 9,050,163 $10,876,149 $ 14,096,080 $ 27,860,165 =========== ========== =========== =========== ============ ============ Due After 15 Years After June 30, 1997 Total ------------- ------- Real estate loans: One- to four-family mortgage loans................... $ 16,880,655 $ 62,957,261 Other mortgage loans...... 11,988,979 28,171,043 Consumer loans: Loans secured by deposits -- 2,434,621 Home improvement and other................. -- 8,696,297 ------------ ------------ Total.................. $ 28,869,634 $102,359,272 ============ ============
The following table sets forth dollar amounts of loans due one year or more after June 30, 1997 that had predetermined interest rates and that had adjustable interest rates at that date.
Predetermined Rate Adjustable Rate ------------- --------------- Real estate loans: One- to four-family residential.................. $ 40,266,100 $15,821,994 Multi-family residential......................... 2,693,632 11,144,039 Consumer loans: Loans secured by deposits........................ 579,604 -- Home improvement and other....................... 7,740,680 -- ------------ ----------- Total.......................................... $ 51,280,016 $26,966,033 ============ ===========
5 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. 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, ------------------------- 1997 1996 ------ ------ Loans originated: Real estate loans: One- to four-family residential............... $ 9,175,000 $ 6,766,000 Other mortgage loans.......................... 11,579,200 3,928,000 Consumer loans.................................. 4,276,008 1,867,292 ------------- ------------ Total loans originated....................... $ 25,030,208 $ 12,561,292 ============= ============ Loans purchased: Real estate loans............................... $ 1,305,000 $ 4,555,000 ============= ============ Loans sold........................................ $ 1,804,100 $ 244,230 ============= ============
The Bank has increased both its range of loan products offered and its loan origination efforts, including the addition of new consumer and commercial business loan offerings and an increased emphasis on the origination of such loans and 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 large home builders, and a commercial and multi-family mortgage banker, with which the Bank has a long-standing relationship, and the Bank's experience with its purchased loans has been successful. In light of the expected continuation and expansion of the Bank's increased loan originations, management expects to reduce the Bank's loan purchasing activities in the future. The Bank has not sold substantial amounts of loans in the past. However, management expects the Bank to increase its origination of selected types of loans which do not meet the Bank's loan portfolio needs, such as long-term fixed-rate residential mortgage loans, for sale to investors, and it is expected that increases in such originations will result in increases in the Bank's loan sales. One- to Four-Family Residential Lending. Historically, the Bank's principal lending activity has been the origination of fifteen-year fixed-rate loans secured by first mortgages on existing single-family residences 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 $52,300. At June 30, 1997, $62.3 million, or 60.9%, of the Bank's total loans were secured 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 one- to four-family portfolio loans, due to the unfavorable yield and interest rate risks associated with such loans, management has shifted the Bank's 6 one- to four-family residential lending emphasis away from the origination of such loans for the Bank's portfolio and toward the origination of such loans for sale, and management has revised the Bank's underwriting guidelines specifically to facilitate the sale of such loans without undue delay or expense. Currently, it is the Bank's policy to originate all one- to four-family residential loans in accordance with the Bank's underwriting guidelines and to sell all such originations promptly to investors, servicing released, though it is recognized that the Bank will continue to occasionally make nonconforming loans to be held in the Bank's portfolio. It is expected that management will continue these policies in the future, though, in order to increase the Bank's fee income, management may determine to retain the servicing on loans sold in the future as the Bank's loan servicing capacity grows. 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% (with private mortgage insurance or other collateral for the amount over 80%) 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, 1997, the Bank's loan portfolio included $2,102,595 of loans secured by 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 secured 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 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, by requiring the involvement of qualified builders, and by limiting the aggregate amount of outstanding construction loans. Commercial and Multi-Family Real Estate Lending. The Bank offers commercial and multi-family real estate loans in order to benefit from the higher origination fees and interest rates, as well as shorter terms to maturity, than could be obtained from single-family mortgage loans. The Bank has offered commercial and multi-family loans for years with many of such loans having been indirectly originated and underwritten by the Bank through a broker in the Memphis, Tennessee area with whom the Bank has had a long and successful relationship. It is anticipated that the Bank will continue to make loans through the broker in Memphis as opportunities arise, but management also has increased the Bank's emphasis on the direct origination of commercial and multi-family real estate loans, particularly in Central Arkansas, and has continued to expand these activities. Most of the Bank's commercial and multi-family real estate loans are secured by properties located in communities within Central Arkansas that have experienced significant growth in recent years, particularly communities in or near the greater Little Rock area. The Bank's acquisition of the former Heritage Bank, FSB, which was headquartered in Little Rock, resulted in the addition to the Bank's staff of a commercial and multi-family real estate loan origination specialist who works closely with borrowers and various members of the commercial real estate industry throughout central Arkansas. As opportunities for increased originations of such loans have increased, the Bank has been expanding its loan underwriting and servicing staff. All commercial and multi-family loans are reviewed and approved by the Bank's staff at the headquarters office in Camden prior to any funding or the issuance of any binding commitment by the Bank. 7 The Bank's commercial and multi-family real estate loans may be secured by apartments, offices, warehouses, shopping centers and other income-producing multi-family and commercial properties. At June 30, 1997, the Bank had 163 of these loans, with an average loan balance of approximately $185,150. At that date, 65 of these loans totaling approximately $11.7 million were secured by properties outside central Arkansas, and none of these out-of-market loans was 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 following paragraphs set forth information regarding the Bank's commercial and multi-family real estate loans with outstanding balances exceeding $500,000 at June 30, 1997. None of these loans was classified by management as substandard, doubtful or loss or designated by management as special mention at that date. For information regarding the Bank's asset classification policies, see "Asset Classification, Allowances for Losses and Nonperforming Assets." Outpatient Surgery Center in Conway, Arkansas. In November 1996, the Bank made a $1,662,300 loan secured by a 6,375 square foot medical office building and outpatient surgery center. At that time, an appraisal indicated a loan-to-value ratio of approximately 79%. The loan is being amortized over 20 years for the purpose of monthly payments of principal and interest, maturing in November 2016. The interest rate is adjustable each five years. At June 30, 1997, the outstanding balance was $1,637,670, and the loan was fully performing in accordance with its terms. Shopping Center - Kiehl Plaza in Sherwood, Arkansas; Convenience Store - 1700 Airport Road in Hot Springs, Arkansas; BP Convenience Store in Conway, Arkansas. In November 1996, the Bank made a $1,300,000 loan secured by a shopping center and two convenience stores. At that time, the appraisals indicated a loan-to-value ratio of approximately 80%. The loan is being amortized over 20 years for the purpose of monthly payments of principal and interest, but the full balance of the loan will be due in November 2001. Shortly after origination, the Bank sold a 40% interest in this loan. At June 30, 1997, the outstanding balance of the Bank's 60% interest in this loan was $770,415, and the loan was fully performing in accordance with its terms. Apartments in El Dorado, Arkansas. In August 1994, the Bank made a $720,000 loan secured by a 44 unit apartment building. At that time, an appraisal indicated a loan-to-value ratio of approximately 80%. The loan is being amortized over 15 years for the purpose of monthly payments of principal and interest, but the full balance of the loan will be due in August 1997. At June 30, 1997, the outstanding balance was $638,834, and the loan was fully performing in accordance with its terms. Apartments in San Marcos, Texas. In February 1992, the Bank made a $750,000 loan secured by a 69 unit apartment building. This loan was made to facilitate the sale of the property, which had been acquired by the Bank following a default on a prior loan. At that time, an appraisal indicated a loan-to-value ratio of approximately 64%. The loan currently is being amortized over 15 years for the purpose of monthly payments of principal and interest, with the full balance of the loan due in March 2010. At June 30, 1997, the outstanding balance was $614,968, and the loan was fully performing in accordance with its terms. Retail Center in Memphis, Tennessee. In July 1996, the Bank made a $560,000 loan secured by a 118,000 square foot retail center. At that time, an appraisal indicated a loan-to-value ratio of approximately 26%. The loan is being amortized over 15 years for the purpose of monthly payments of principal and interest, and the full balance of the loan will be due in August 2011. At June 30, 1997, the outstanding balance was $541,949, and the loan was fully performing in accordance with its terms. 8 Office Building in Memphis, Tennessee. In September 1996, the Bank made a $625,000 loan secured by a 30,000 square foot office building. At that time, an appraisal indicated a loan-to-value ratio of approximately 69%. The loan is being amortized over 20 years for the purpose of monthly payments of principal and interest, and the full balance of the loan will be due in September 2016. At June 30, 1997, the outstanding balance was $614,276, and the loan was fully performing in accordance with its terms. Apartments in Conway, Arkansas. In July 1996, the Bank made a $600,000 loan secured by a 20 unit apartment building. At that time, an appraisal indicated a loan-to-value ratio of approximately 65%. The loan is being amortized over 20 years for the purpose of monthly payments of principal and interest, and the full balance of the loan will be due in September 2002. At June 30, 1997, the loan was fully performing in accordance with its terms. Apartments in Conway, Arkansas. In October 1996, the Bank made a $665,000 loan secured by another 20-unit apartment building in the above apartment project. At that time, an appraisal indicated a loan-to-value ratio of approximately 73%. The loan is being amortized over 20 years for the purpose of monthly payments of principal and interest, and the full balance of the loan will be due in September 2002. At June 30, 1997, the loan was fully performing in accordance with its terms. Retail Store in Fordyce, Arkansas. In January 1992, the Bank made a $650,000 loan secured by a 32,500 square foot retail store. At that time, an appraisal indicated a loan-to-value ratio of approximately 73%. The loan currently is being amortized over 5 years for the purpose of monthly payments of principal and interest, with the full balance of the loan due in February 2000. At June 30, 1997, the outstanding balance was $503,631, and the loan was fully performing in accordance with its terms. Nursing Home in Little Rock, Arkansas. In January 1997, the Bank made a $1,000,000 loan secured by a 105-bed nursing home. At that time, an appraisal indicated a loan-to-value ratio of approximately 50%. The loan is being amortized over 12 years for the purpose of monthly payments of principal and interest, and the full balance of the loan will be due in January 2000. Shortly after origination, the Bank sold a 50% interest in this loan. At June 30, 1997, the outstanding balance of the Bank's 50% interest in this loan was $489,856 and the loan was fully performing in accordance with its terms. Nursing Homes in Pine Bluff, Arkansas. In May 1997, the Bank made a $1,900,000 loan secured by two nursing homes with 167 total beds. At that time, an appraisal indicated a loan-to-value ratio of approximately 75%. The loan is being amortized over 10 years for the purpose of monthly payments of principal and interest, and the full balance of the loan will be due in June 2000. Shortly after origination, the Bank sold a 45% interest in this loan. At June 30, 1997, the outstanding balance of the Bank's 55% interest in this loan was $1,045,000, and the loan was fully performing in accordance with its terms. In addition, at June 30, 1997 the Bank had $21.7 million in 51 commercial and multi-family real estate loans with outstanding balances exceeding $200,000, only one of which was adversely classified or designated by management. For additional information, see "Asset Classification, Allowances for Losses and Nonperforming Assets" below. The Bank's commercial and multi-family real estate loans generally are limited to loans not exceeding $1,750,000 on properties located either in Central 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 five years, after which period the rate may adjust or the loan may become due. 9 Commercial and multi-family real estate lending entails significant additional risks compared with one- to four-family residential lending. For example, commercial and multi-family real estate loans typically involve large loan balances to single borrowers or groups of related borrowers, the payment experience on such loans typically is dependent on the successful operation of the real estate project, and these risks can be significantly impacted by supply and demand conditions in the market for multi-family residential units and commercial office, retail and warehouse space. These risks may be higher with respect to loans secured 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. Historically, the Bank's consumer loans have primarily consisted of loans secured by deposits at the Bank and home improvement loans secured by first or second mortgages on single-family residences in the Bank's primary market area. These loans totaled approximately $2.4 million and $4.1 million, respectively, at June 30, 1997. The Bank has recently expanded its consumer loan offerings to include a full variety of such loans, with a particular emphasis on loans secured by new and used automobiles and other vehicles, including boats. These vehicle loans increased from approximately $787,000 at June 30, 1996 to $2.4 million at June 30, 1997. 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 to the Bank's customers while increasing the Bank's portfolio yields and improving its asset/liability management. The Bank makes savings account loans for up to 100% of the balance of the account. The interest rate on these loans typically is fixed at least two 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 secured 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 or the "Black Book." 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. The Bank offers floor plan loans to selected dealers on a case by case basis. 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. 10 Commercial Business Lending. Before the acquisition of the former Heritage Bank, FSB, the Bank did not offer commercial business loans, except on a limited basis in modest amounts as an accommodation to customers of the Bank. Upon the acquisition, the Bank acquired approximately $768,000 of commercial business loans, and since then the Bank has been expanding its commercial business offerings and increasing its loan origination efforts. The Bank currently offers, or plans to offer, working capital loans, accounts receivable loans, floor plan loans to dealers of automobiles, and business equipment loans, and the Bank has recently added to its staff an additional loan officer with extensive experience originating and servicing indirect automobile loans. At June 30, 1997, the Bank's commercial business loans totaled $2.1 million and primarily consisted of automobile dealer floor plan loans and equipment loans. At that date, the Bank had one commercial business loan with an outstanding balance or loan commitment exceeding $300,000. The loan consisted of a floor plan lending arrangement dating back to August 1996 and begun by the former Heritage Bank, FSB. The loan is secured by used automobiles at a dealership in Monticello, Arkansas. The loan requires regular payments of interest, and the Bank requires principal paydowns as vehicles are sold and periodically in accordance with specified repayment schedules. At June 30, 1997, the Bank had committed to lend up to $500,000, the outstanding balance was $280,614, the loan was fully performing in accordance with its terms, and the loan was not adversely classified or designated by management. Commercial business loans generally involve more risk than single family residential loans. In underwriting commercial business loans, The Bank considers the obligor's credit history, an analysis of the obligor's income, expenses and ability to repay the obligation and the value of the collateral. Loan Solicitation and Processing. The Bank's loan originations are derived from a number of sources, including referrals by realtors, builders, depositors, borrowers and mortgage brokers, as well as walk in customers. The Bank's solicitation programs consist of calls by the Bank's officers, branch managers and other responsible employees to local realtors and builders and advertisements in local newspapers and billboards and radio broadcasts. Real estate loans are originated by the Bank's staff loan officers as well as the Bank's branch managers and executive officers, none of whom receives commissions for loan originations. 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 which insures that 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. Most borrowers are also required to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which the Bank makes disbursements for items such as real estate taxes. 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 committee approve loans up to specified limits above which the approval of the Board may be 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 11 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 Bank typically receives fees of up to one point (one point being equivalent to 1% of the principal amount of the loan) in connection with the origination of mortgage loans. The excess, if any, of loan origination fees over direct loan origination expenses is deferred and accreted into income over the contractual life of the loan using the interest method. If a loan is prepaid, refinanced or sold, all remaining deferred fees with respect to such loan are taken into income 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 or other appropriate action. If a loan remains delinquent 90 days or more, the Bank generally initiates foreclosure proceedings. Asset Classification, Allowances for Losses and Nonperforming Assets. Federal regulations require savings institutions to classify their assets on the basis of quality on a regular basis. An asset is classified as substandard if it is determined to be inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. An asset is classified as doubtful if full collection is highly questionable or improbable. An asset is classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a special mention designation, described as assets which do not currently expose an institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets classified as substandard or doubtful require an institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, an institution must either establish a specific allowance for loss in the amount of the portion of the asset classified loss, or charge off such amount. Federal examiners may disagree with an institution's classifications. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the OTS Regional Director. Management regularly reviews the Bank's assets to determine whether assets require classification or reclassification, and the Board of Directors reviews and approves all classifications. Following the Bank's acquisition of the former Heritage Bank, FSB, and in light of management's intention of increasing the Bank's emphasis on originating more commercial and multi-family real estate loans and consumer and commercial business loans, in August 1996 the Bank retained a consultant with extensive commercial banking experience in both executive and advisory capacities, both to perform a detailed initial evaluation of the Bank's loan portfolio and on an ongoing basis to assist management in planning and implementing these changes in the Bank's lending activities. The Bank also recently hired a staff loan analyst, whose responsibilities include assisting with monitoring the Bank's loan portfolio quality. The Bank also recently hired a staff loan analyst, whose responsibilities include assisting with monitoring the Bank's loan portfolio quality. As of June 30, 1997, the Bank had approximately $3,000 assets classified as loss, $41,000 of assets classified as doubtful, $3.5 million of assets classified as substandard and $678,000 of assets designated as special mention. The Bank's total adversely classified or designated assets represented approximately 2.1% of the Bank's total assets and 14.6% of the Bank's tangible regulatory capital at June 30, 1997. At that date, substantially all of the Bank's adversely classified or designated assets were one- to four-family residences in the Bank's primary market area, and none of such assets was in excess of $100,000, except for the following six loans totaling $1,263,830: - - Two of these loans were secured by interests in a partnership that owns and operates a strip shopping center in Little Rock, Arkansas, and were classified due to concerns about the borrowers' ability to repay the loan. - - Loan secured by commercial real estate in Camden, Arkansas classified due to insufficient cash flow and concerns about borrower's ability to repay the debt. - - Loan secured by a house built for speculative sale in Little Rock, Arkansas market: classified as a result of litigtion (Litigation has since been resolved and debt has been paid in full from sale proceeds of the house). - - Agriculture loan classified due to insufficient collateral and concerns about borrower's ability to repay the debt. - - Loan secured by a single family residence located out of market having a extraordinarily slow payment history. At June 30, 1997, management did not expect the Bank to incur any loss in excess of attributable existing reserves on any of the Bank's adversely classified or designated assets. 12 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 secured 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. The Bank's methodology for establishing the allowance for losses takes into consideration probable losses that have been identified in connection with specific assets as well as losses that have not been identified but can be expected to occur. Management conducts regular reviews of the Bank's assets and evaluates the need to establish allowances on the basis of this review. Allowances are established by the Board of Directors on a regular basis based on an assessment of risk in the Bank's assets taking into consideration the composition and quality of the portfolio, delinquency trends, current charge-off and loss experience, the state of the real estate market, regulatory reviews conducted in the regulatory examination process and economic conditions generally. Allowances are provided for individual assets, or portions of assets, when ultimate collection is considered improbable by management based on the current payment status of the assets and the fair value or net realizable value of the security. At the date of foreclosure or other repossession or at the date the Bank determines a property is an "in-substance foreclosed" property, the Bank transfers the property to real estate acquired in settlement of loans at the lower of cost or fair value. 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, 1997, the Bank held no properties acquired in settlement of loans for which market values were unavailable. Any amount of cost in excess of fair value is charged-off against the allowance for loan losses. The Bank records an allowance for estimated selling costs of the property immediately after foreclosure. 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 exceed the net carrying value of the property, a gain 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. Examiners will review an institution's allowance for loan losses and compare it against the sum of (i) 50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii) for the portions of the portfolio that have not been classified (including those loans designated as special mention), estimated credit losses over the upcoming twelve months given the facts and circumstances as of the evaluation date. This amount is considered neither a "floor" nor a "safe harbor" of the level of allowance for loan losses an institution should maintain, but examiners will view a shortfall relative to the amount as an indication that they should review management's policy on allocating these allowances to determine whether it is reasonable based on all relevant factors. 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 initial determinations. 13 During the year ended June 30, 1997, in light of the Bank's comprehensive loan portfolio review and reevaluation, the Bank made additional provisions for loan losses totalling $221,671, bringing the total reserve for losses on loans to $1.5 million, or 1.5% of gross loans. The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated.
Year Ended June 30, ------------------------- 1997 1996 ------- ------ Balance at beginning of period..................... $ 1,283,234 $ 728,491 ------------- ------------ Loans charged-off: Real estate mortgage: One- to four-family residential................ 11,317 12,130 Other mortgage loans........................... -- -- Consumer......................................... 11,668 -- ------------- ------------ Total charge-offs.................................. 22,985 12,130 ------------- ------------ Recoveries: Real estate mortgage: One- to four-family residential................ 6,333 250 Other mortgage loans........................... -- -- Consumer......................................... 4,220 -- ------------- ------------ Total recoveries................................... 10,553 250 ------------- ------------ Net loans charged-off.............................. 12,432 11,880 ------------- ------------ Acquisition of subsidiary.......................... -- 524,140 Provision for loan losses.......................... 221,671 42,483 ------------- ------------ Balance at end of period........................... $ 1,492,473 $ 1,283,234 ============= ============ Ratio of net charge-offs to average loans outstanding during the period.............. .024% 0.018% ============= ============
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.
June 30, ------------------------------------------------------ 1997 1996 -------------------------- -------------------------- Percent Percent of Loans of Loans in Category in Category to Total to Total Amount Loans Amount Loans -------- ------------ ------- ------------- Allocated to: Real estate loans: One- to four-family residential................ $ 954,093 60.90% $ 935,354 71.66% Multi-family and non-residential loans........................................ 296,018 27.05 278,650 23.61 Consumer loans:.................................. 67,700 10.00 17,635 3.72 Commercial..................................... 81,250 2.05 -- 1.01 Unallocated.................................... 93,412 -- 51,595 -- ----------- ------ ----------- ------- Total..................................... $ 1,492,473 100.00% $ 1,283,234 100.00% =========== ====== =========== ======
In addition to its allowance for loan losses, the Bank maintains an allowance for losses on real estate acquired in settlement of loans, including in-substance foreclosures. This allowance is established to cover losses on such properties. At June 30, 1997, the Bank had such an allowance in the amount of approximately $28,287. Numerous financial institutions throughout the United States have incurred losses due to significant increases in loss provisions and charge-offs resulting largely from higher levels of loan delinquencies and foreclosures. Depressed real estate market conditions have adversely affected the economies of various regions and have had a severe impact on the financial condition and businesses of many of the financial institutions doing business in these areas. Moreover, the Bank's increasing emphasis on the origination of commercial and multi-family loans and consumer and commercial business loans may increase the Bank's risk of corresponding increases in loan loss provisions and charge-offs. Finally, as a result of declines in real estate market values and significant losses experienced by many financial institutions, there has been a greater level of scrutiny by regulatory authorities of the loan portfolios of financial institutions undertaken as part of examinations of such institutions by the FDIC, OTS or other federal or state regulators. Results of examinations indicate that these regulators may be applying more conservative criteria in evaluating real estate market values, requiring significantly increased provisions for losses on loans and real estate acquired in settlement of such loans. While management believes the Bank has established its existing loss allowances in accordance with generally accepted accounting principles, there can be no guaranty or assurance that such reserves are, or in the future will be, adequate to absorb all loan losses or that regulators, in reviewing the Bank's assets, will not make the Bank increase its loss allowance, thereby negatively affecting the Bank's reported financial condition and results of operations. 15 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.
At June 30, ------------------------------ 1997 1996 ----------- ----------- Loans accounted for on a nonaccrual basis: /1/ Real estate: One- to four-family residential........................... $ 133,386 $ 166,228 Other mortgage loans...................................... -- -- Consumer.................................................... -- -- ----------- ----------- Total..................................................... $ 133,386 $ 166,228 =========== =========== Accruing loans which are contractually past due 90 days or more: Real estate: One- to four-family residential........................... $ 323,478 $ 725,487 Other mortgage loans...................................... -- -- Consumer loans.............................................. 56,904 127,142 ----------- ----------- Total..................................................... $ 380,382 $ 852,629 =========== =========== Total nonperforming loans................................. $ 513,768 $ 1,018,857 =========== =========== Percentage of total loans..................................... .50% 1.21% =========== =========== Other nonperforming assets /2/................................ $ 65,005 $ 168,206 =========== =========== Loans modified in troubled debt restructurings................ $ 281,441 $ 298,195 =========== ===========
/1/ Designated nonaccrual loan payments received applied first to contractual principal; interest income recognized when contractually current. /2/ Other nonperforming assets includes foreclosed real estate. During the years ended June 30, 1997 and 1996, gross interest income of $12,177 and $7,718, 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 $17,689 and $2,604, respectively. At June 30, 1997, management had identified approximately $4.22 million of loans which amount is not reflected in the preceding table but as to which known information about possible credit problems of borrowers caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms, all of which was included in the Bank's adversely classified or designated asset amounts at that date. Of this aggregate amount, $2.9 million was attributable to 126 one- to four-family residential loans, and $1.3 million was attributable to 11 commercial or multi-family real estate loans. At June 30, 1997, management did not expect the Bank to incur any loss in excess of attributable existing reserves 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, 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 a minimum amount of liquid assets which may be invested in cash and specified securities. From time to time, the OTS adjusts the percentage of liquid assets 16 which savings banks are required to maintain. See "Regulation -- Regulation of the Banks -- Liquidity Requirements" below. The Bank makes investments in order to maintain the levels of liquid assets 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. 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 mortgage-related 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 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 secured 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, 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 a 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 medium and by communication with the issuer where necessary. At June 30, 1997, no privately issued securities had been downgraded from their original rating, except during fiscal 1997 the Bank was notified of a downgrade in the rating of one of its private issue obligations. The security is a Citicorp Mortgage, Inc. REMIC pass-thru certificate. The downgrade reflected deterioration in the performance of the mortgage pools underlying the security. At June 30, 1997, the Class A Certificate holders had suffered no interest losses but had suffered $625,223 in principle losses. The Bank's balance of this security at that date was $871,312, which represented 1.36% of the total outstanding pool of $64,244,942. The credit enhancement available to Class A certificate holders was $2,901,490 at June 30, 1997. As long as this amount is positive, no significant loss to the Bank, if any, is anticipated. The Bank's privately issued securities have been primarily collateralized mortgage obligations (CMOs). At June 30, 1997, all of these securities had adjustable interest rates with a weighted average yield of 6.66% and a weighted average term to maturity of 24 years. The carrying value of the privately issued securities was $32.1 million, or 60.1% of mortgage-backed securities at that date. None of the privately issued securities is 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 17 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 accredited 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 Bank's investment securities at the dates indicated.
At June 30, ------------------------------ 1997 1996 ------------ ------------ Securities available for sale: U.S. government and agencies............................... $ 16,155,955 $ 5,279,625 Collateralized mortgage obligations........................ 6,171,341 9,034,604 Other mortgage-backed securities........................... 13,919,065 3,120,595 ------------ ------------ $ 36,246,161 $ 17,434,824 ============ ============ Securities held to maturity: U.S. government and agencies............................... $ -- $ -- Collateralized mortgage obligations........................ -- -- Other mortgage-backed securities........................... 35,869,295 45,212,891 ------------ ------------ Total................................................... $ 72,115,456 $ 62,647,715 ============ ============
18 The following table sets forth information in the scheduled maturities, amortized cost, market values and average yields for the Bank's investment portfolio at June 30, 1997.
One Year or Less One to Five Years Five to Ten Years More than Ten Years ------------------ ------------------- ------------------- --------------------- Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield ------- ------- ------- ------- ------- ------- ------ ------ Securities available for sale: U.S. government and agencies... $ 1,503,866 6.09% $12,647,279 6.78% $2,004,610 7.05% $ -- --% Collateralized mortgage obligations................. -- -- -- -- -- -- 6,270,999 6.43 Other mortgage-backed securities -- -- 2,197,535 7.54 5,483,501 7.07 6,238,029 7.30 ----------- ----------- ---------- ----------- 1,503,866 6.09 14,844,814 6.90 7,488,111 7.06 12,509,028 6.86 Securities held to maturity: U.S. government agencies........ -- -- -- -- -- -- -- -- Collateralized mortgage obligations................... -- -- -- -- -- -- -- -- Mortgage-backed securities...... -- -- 703,741 9.08 1,456,595 9.29 33,708,959 6.73 ----------- ----------- ---------- ----------- Total....................... $ 1,503,866 6.09 $15,548,555 7.00 $8,944,706 7.42 $46,217,987 6.77 =========== =========== ========== =========== Total Investment Portfolio --------------------------------- Carrying Market Average Value Value Yield ------- ----- ------ Securities available for sale: U.S. government and agencies... $16,155,755 $ 16,155,755 6.45% Collateralized mortgage obligations................. 6,270,999 6,270,999 6.43 Other mortgage-backed securities 13,919,065 13,919,065 7.20 ----------- ---------- 36,345,819 36,345,819 6.86 Securities held to maturity: U.S. government agencies........ -- -- -- Collateralized mortgage obligations................... -- -- -- Mortgage-backed securities..... 35,869,295 36,194,350 6.81 ----------- ---------- Total....................... $72,215,114 $72,540,169 6.84 =========== ===========
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 deposits, 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 mortgage-backed 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 on a short-term basis to compensate for reductions in the availability of funds, or on a longer term basis for general operational purposes. The Bank has access to borrow advances from the FHLB of Dallas, which the Bank uses from time to time. Deposits. The Bank attracts deposits principally from within its primary market area by offering competitive rates on its deposit instruments, including money market accounts, passbook savings accounts, Individual Retirement Accounts and certificates of deposit which range in maturity from 90 days to three years. Deposit terms vary according to the minimum balance required, the length of time the funds must remain on deposit and the interest rate. Maturities, terms, service fees and withdrawal penalties for its deposit accounts are established by the Bank on a periodic basis. 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 accept brokered deposits or pay negotiated rates for jumbo 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. Savings deposits in the Bank at June 30, 1997 were represented by the various types of savings programs listed below.
Interest Minimum Minimum Percentage of Rate /1/ Term Category Amount Balances Total Deposits - -------- -------- -------- -------- -------------- -------------- Demand Deposits 2.76% None NOW accounts $ 500 $ 9,406,397 6.22% 4.09 None Money market deposits 2,500 17,807,493 11.78 ------------ ------- Total Demand Deposits $ 27,213,890 18.00 3.04 None Savings deposits-passbook 8,441,845 5.50 Certificates of Deposit 4.13 3 months or less Fixed-term, fixed-rate 1,000 1,558,705 1.03 5.27 6 months Fixed-term, fixed-rate 1,000 33,602,568 22.22 5.39 12 months Fixed-term, fixed-rate 1,000 42,381,305 28.04 5.77 15-72 months Fixed-term, fixed-rate 1,000 38,010,450 25.13 ------------ ------- 5.63 Total certificates of deposit 115,553,028 76.42 ------------ ------- 5.12 Total deposits $151,208,763 100.00% ============ ======
- ------------- /1/ Represents weighted average interest rate. 20 The following table sets forth information regarding average deposit balances and rates during the periods presented.
June 30, ---------------------------------------------------- 1997 1996 ------------------------ ------------------------ Average Average Average Average Balance Rate Balance Rate ------------ --------- ------------- --------- NOW accounts...................................... $ 5,858,963 3.07% $ 4,387,731 2.92% Money market deposits............................. 18,333,058 4.23 13,777,197 3.94 Savings deposits - passbook....................... 7,792,066 3.02 6,632,913 3.71 Certificates of deposit........................... 116,980,504 5.42 95,231,454 5.66 ------------ ------------- Total......................................... $148,964,591 5.05 $ 120,029,295 5.26 ============ =============
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.
Increase Balance at (Decrease) Balance at June 30, % of from June 30, June 30, % of 1997 Deposits 1996 1996 Deposits ---------- -------- -------------- ---------- -------- NOW accounts........................ $ 9,406,397 6.22% $ 2,737,862 $ 6,668,535 4.57% Money market deposits............... 17,807,493 11.78 2,315,902 15,491,591 10.62 Savings deposits - passbook 8,441,845 5.58 413,690 8,028,155 5.50 Certificates of deposits............ 115,553,028 76.42 (177,942) 115,730,970 79.31 ------------ ------ ----------- ------------- ------ $151,208,763 100.00% $ 5,289,512 $ 145,919,251 100.00% ============ ====== =========== ============= ======
The following table sets forth information regarding time deposits classified by rates at the dates indicated.
At June 30, ------------------------------- 1997 1996 ------------- ------------- 2.00 - 3.99%............................................... $ -- $ -- 4.00 - 5.99%............................................... 99,606,159 75,847,271 6.00 - 7.99%............................................... 15,946,869 39,883,699 8.00 - 9.99%............................................... -- -- ------------- ------------- $ 115,553,028 $ 115,730,970 ============= =============
21 The following table sets forth information regarding amounts and maturities of time deposits at June 30, 1997.
Amount Due -------------------------------------------------------- Less Than After Rate One Year 1-2 Years 2-3 Years 3 Years Total - ---- -------- --------- --------- ------- ----- 4.00 - 5.99%................. $ 4,923,824 $48,797,581 $ 1,570,754 $ -- $ 99,606,519 6.00 - 7.99%................. 4,419,330 11,521,177 6,632 -- 15,947,139 ----------- ----------- ----------- ---------- ------------- $53,657,154 $60,318,758 $ 1,577,116 $ -- $ 115,553,658 =========== =========== =========== ========== =============
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, 1997.
Certificates Maturity Period of Deposit --------------- ------------ Three months or less....................... $ -- Over three through six months.............. 2,957,579 Over six through 12 months................. 3,929,943 Over 12 months............................. 2,486,229 ------------ Total.................................. $ 9,373,751 ============
The following table sets forth information regarding savings activities of the Bank for the periods indicated.
Year Ended June 30, --------------------------------- 1997 1996 -------------- ------------- Deposits.................................................... $ 142,004,936 $ 93,529,413 Withdrawals................................................. (144,249,869) (91,037,454) Net increase (decrease) before interest credited......................................... -- 2,491,959 Subsidiary acquisition...................................... -- 25,101,788 Interest credited........................................... 7,534,445 6,314,641 -------------- ------------- Net increase (decrease) in savings deposits.............................................. $ 5,289,512 $ 33,908,388 ============== =============
Borrowings. Savings 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 of which has its own interest rate and range of maturities. Advances from the FHLB of Dallas are secured by the Bank's stock in the FHLB of Dallas and first mortgage loans. 22 The following tables set forth certain information regarding short-term borrowings by the Bank for the periods indicated. Averages are based on monthly balances.
Year Ended June 30, ------------------------------- 1997 1996 ------------- ------------ Amounts outstanding at end of period: FHLB advances............................................... $ 10,000,000 $ 10,000,000 Maximum amount of borrowings outstanding at any month end: FHLB advances............................................... $ 12,500,000 $ 10,000,000 Approximate average short-term borrowings outstanding with respect to: FHLB advances............................................... $ 10,208,333 $ 7,500,000
Subsidiary Activities As federally chartered savings banks, the Bank and its separate subsidiary savings bank, are each 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, 1997 on a consolidated basis the Bank was authorized to invest up to approximately $6,010,973 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, 1997, the Bank's aggregate investment in, and loans to, the subsidiary service corporation totalled $1,307,000, all of which was subject to exclusion from the Bank's regulatory capital under applicable legal requirements (see "Regulation of the Banks -- Regulatory Capital Requirements"). Regulation of the Banks General. As federally chartered savings institutions, each of the Bank and its savings bank subsidiary (collectively, the "Banks") 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 Banks for compliance with various regulatory requirements. The FDIC also has the authority to conduct special examinations of the Banks because their deposits are insured by the SAIF. The Banks must file reports with the OTS describing their activities and financial condition and also are subject to certain reserve requirements promulgated by the Federal Reserve Board. This supervision and regulation is intended primarily for the protection of depositors. See also "Proposed Legislative and Regulatory Changes." Federal Home Loan Bank System. The Banks are members of the FHLB System, which consists of 12 district FHLBs subject to supervision and regulation by the Federal Housing Finance Board ("FHFB"). The FHLBs provide a central credit facility primarily for member institutions. As members of the FHLB of Dallas, the Banks are 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 their home mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 1/20 of their 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. It makes advances to members in accordance with policies and procedures established by the FHLB and the Board of Directors 23 of the FHLB of Dallas. Long-term advances may only be made for the purpose of providing funds for residential housing finance. At June 30, 1997, the Banks had $10 million in advances outstanding with the FHLB of Dallas. See " -- Deposit Activity and Other Sources of Funds -- Borrowings." Liquidity Requirements. The Banks are required to maintain average daily balances of liquid assets (cash, deposits maintained pursuant to Federal Reserve Board requirements, time and savings deposits in certain institutions, obligations of the United States and states and political subdivisions thereof, shares in mutual funds with certain restricted investment policies, highly rated corporate debt and mortgage loans and mortgage-related securities with less that one year to maturity or subject to pre-arranged sale within one year) equal to the monthly average of not less than a specified percentage (currently 5%) of their net withdrawable savings deposits plus short-term borrowings. The Banks are also required to maintain average daily balances of short-term liquid assets at a specified percentage (currently 1%) of the total of their net withdrawable savings accounts and borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet liquidity requirements. The average ratios of liquid assets and short-term liquid assets of the Banks for June 1997 were 68.11% and 26.23%, respectively. Qualified Thrift Lender Test. The Banks are subject to OTS regulations which 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, 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 and a restriction on obtaining additional advances from the Federal Home Loan Bank System. Upon failure to qualify as a Qualified Thrift Lender for two years, a savings institution must convert to a commercial bank in excess of the required percentage. At June 30, 1997, approximately 68.11% and 83.18% of the Banks' respective portfolio assets were invested in Qualified Thrift Investments. Regulatory Capital Requirements. Under OTS capital standards, savings institutions must maintain "tangible" capital equal to at least 1.5% of adjusted total assets, "core" capital equal to at least 3% of adjusted total assets and "total" capital (a combination of core and "supplementary" capital) equal to at least 8% of "risk-weighted" assets. In addition, the OTS has adopted regulations which 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 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. 24 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, 1997, the Banks had approximately $1,307,000 and zero, respectively, of investments in, or extensions of credit to, non-includible subsidiaries. Adjusted total assets are a savings institution's total assets as determined under generally accepted accounting principles, increased by certain goodwill amounts and by a pro rated portion of the assets of unconsolidated includible 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 includible 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 deposits that do not qualify as core capital, certain approved subordinated debt, certain other capital instruments and a portion of the institution's general loan loss allowances. Total core and supplementary capital are reduced by the amount of capital instruments held by other depository institutions pursuant to reciprocal arrangements and, by the amount of the savings institution's high loan-to-value ratio land loans, non-residential construction loans and equity investments other than those deducted from core and tangible capital. At June 30, 1997, the Banks had no high ratio land or non-residential construction loans and no 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 HEARTLAND Community Bank relative to its various regulatory capital requirements at June 30, 1997.
Percent of Amount Assets(1) --------- ------ (Dollars in thousands) Tangible capital............................... $ 29,058 16.92% Tangible capital requirement................... 2,576 1.50 --------- ------ Excess...................................... $ 26,482 15.42% ========= ===== Core capital................................... $ 29,058 16.92% Core capital requirement....................... 5,152 3.00 --------- ------ Excess...................................... $ 23,906 13.92% ========= ===== Total capital.................................. $ 29,819 41.31% Risk-based capital requirement................. 5,274 8.00 --------- ------- Excess..................................... $ 24,045 33.31% ========= =====
- ----------------- (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. 25 The table below presents the capital position of HEARTLAND Community Bank, F.S.B., relative to its various regulatory capital requirements at June 30, 1997.
Percent of Amount Assets(1) --------- ------ (Dollars in thousands) Tangible capital............................... $ 1,822 6.03% Tangible capital requirement................... 454 1.50 --------- ------ Excess...................................... $ 1,368 4.53% ========= ====== Core capital................................... $ 1,822 6.03% Core capital requirement....................... 907 3.00 --------- ------ Excess...................................... $ 915 3.03% ========= ====== Total capital.................................. $ 2,071 10.85% Risk-based capital requirement................. 1,526 8.00 --------- ------- Excess..................................... $ 545 2.85% ========= =======
- --------------------- (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. The OTS' risk-based capital requirements require savings institutions with more than a "normal" level of interest rate risk to maintain additional total capital. An institution's interest rate risk will be measured in terms of the sensitivity of its "net portfolio value" 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. A savings institution is considered to have a "normal" level of interest rate risk exposure if the decline in its net portfolio value after an immediate 200 basis point increase or decrease in market interest rates (whichever results in the greater decline) is less than two percent of the current estimated economic value of its assets. A savings institution with a greater than normal interest rate risk will be required to deduct from total capital, for purposes of calculating its risk-based capital requirement, an amount (the "interest rate risk component") equal to one-half the difference between the institution's measured interest rate risk and the normal level of interest rate risk, multiplied by the economic value of its total assets. Management does not believe the implementation of the interest rate risk requirement will have a material effect on the Banks. The OTS calculates the sensitivity of an institution's net portfolio value based on data submitted by the institution in a schedule to its quarterly Thrift Financial Report and using the interest rate risk measurement model adopted by the OTS. The amount of the interest rate risk component, if any, to be deducted from an institution's total capital will be based on the institution's Thrift Financial Report filed two quarters earlier. Savings institutions with less than $300 million in assets and a risk-based capital ratio above 12% are generally exempt from filing the interest rate risk schedule with their Thrift Financial Reports. However, the OTS will require any exempt institution that it determines may have a high level of interest rate risk exposure to file such schedule on a quarterly basis and may be subject to an additional capital requirement based upon its level of interest rate risk as compared to its peers. Due to their size and capital level, the Banks are exempt from the interest rate risk component. 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, 26 prepayment risk, credit risk and concentration of credit risk and certain risks arising from non-traditional activities. The Director may treat the failure of any savings institution to maintain capital at or above such level as an unsafe or unsound practice and may issue a directive requiring any savings institution which fails to maintain capital at or above the minimum level required by the Director to submit and adhere to a plan for increasing capital. Such an order may be enforced in the same manner as an order issued by the FDIC. Deposit Insurance. The Banks are required to pay assessments based on a percentage of its insured deposits to the FDIC for insurance of its 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 deposits or at a higher percentage of estimated insured 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. In recent years, institutions with SAIF-assessable deposits, like the Banks, were required to pay higher deposit insurance premiums than institutions with deposits insured by the Bank Insurance Fund ("BIF") administered by the FDIC. In order to recapitalize the SAIF and address the premium disparity, in November 1996 the FDIC imposed a one-time special assessment on institutions with SAIF-assessable deposits based on the amount determined by the FDIC to be necessary to increase the reserve levels of the SAIF to the designated reserve ratio of 1.25% of insured deposits. Institutions were assessed at the rate of 65.7 basis points based on the amount of their SAIF-assessable deposits as of March 31, 1995. As a result of the special assessment the Banks incurred a pre-tax expense totalling approximately $889,011 during the quarter ended September 30, 1996. The special assessment recapitalized the SAIF, and as a result the FDIC lowered the SAIF deposit insurance assessment rates through the end of 1997 to zero for well capitalized institutions with the highest supervisory ratings and 0.31% of insured deposits for institutions in the highest risk-based premium category. Since the BIF is above its designated reserve ratio of 1.25% of insured deposits, "well-capitalized" institutions in Subgroup A, numbering 95% of BIF-insured institutions, pay no federal deposit insurance premiums, with the remaining 5% of institutions paying a graduated range of rates up to 0.27% of insured deposits for the highest risk-based premium category. Until December 31, 1999, SAIF-insured institutions will be required to pay assessments to the FDIC at the rate of 6.5 basis points to help fund interest payments on certain bonds issued by the Financing Corporation ("FICO") an agency of the federal government established to finance takeovers of insolvent thrifts. During this period, BIF members will be assessed for these obligations at the rate of 1.3 basis points. After December 31, 1999, both BIF and SAIF members will be assessed at the same rate for FICO payments, or sooner if the two funds are merged. Since the SAIF now meets its designated reserve ratio as a result of the special assessment, SAIF members are now permitted to convert to the status of members of the BIF and may merge with or transfer assets to a BIF member. Although the Banks would qualify for insurance of deposits of the BIF, substantial entrance and exit fees apply to conversions from SAIF to BIF insurance and such fees may make a SAIF to BIF conversion prohibitively expensive. In the past, the substantial disparity existing between deposit insurance premiums paid by BIF and SAIF members gave 27 BIF-insured institutions a competitive advantage over SAIF-insured institutions like the Banks. The reduction of the SAIF deposit insurance premiums effectively eliminated this disparity and could have the effect of increasing the net income of the Banks and restoring the competitive equality between BIF-insured and SAIF-insured institutions. See also "Proposed Legislation and Regulatory Changes." 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% must be maintained on the first $49.3 million of transaction accounts, and a reserve of 10% must be maintained against all remaining transaction accounts. This percentage is subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. Dividend Restrictions. Under OTS regulations, the Bank is not permitted to pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of the Bank at the time of the Conversion. In addition, the Banks are required by OTS regulations to give the OTS 30 days' prior notice of any proposed declaration of dividends. OTS regulations impose additional limitations on the payment of dividends and other capital distributions (including stock repurchases and cash mergers) by the Banks. Under these regulations, an institution that, immediately prior to, and on a pro forma basis after giving effect to, a proposed capital distribution, has total capital (as defined by OTS regulations) that is equal to or greater than the amount of its fully phased-in capital requirements (a "Tier 1 Association") is generally permitted, after notice, to make capital distributions during a calendar year in the amount equal to the greater of: (i) 75% of its net income for the previous four quarters; or (ii) 100% of its net income to date during the calendar year plus an amount that would reduce by one-half the amount by which its ratio of total capital to assets exceeded regulatory requirements at the beginning of the calendar year. An institution with total capital in excess of current minimum capital ratio requirements but not in excess of the fully phased-in requirements (a "Tier 2 Association") is permitted, after notice, to make capital distributions without OTS approval of up to 75% of its net income for the previous four quarters, less dividends already paid for such period. An institution that fails to meet current minimum capital requirements (a "Tier 3 Association") is prohibited from making any capital distributions without the prior approval of the OTS. A Tier 1 Association that has been notified by the OTS that it is in need of more than normal supervision will be treated as either a Tier 2 or Tier 3 Association. The Banks are Tier 1 Associations. Despite the above authority, the OTS may prohibit any institution from making a capital distribution that would otherwise be permitted by the regulation, if the OTS were to determine that the distribution constituted an unsafe or unsound practice. 28 Under the OTS prompt corrective action regulations, the Banks 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 leverage ratio of less than 4.0%. See " -- Prompt Corrective Regulatory Action." Furthermore, during the first year following completion of the Conversion, the Bank will not pay dividends to the Company if, as a result of any such dividend, the Bank's tangible capital would be reduced below 10% of its adjusted total assets. In addition to the foregoing, earnings of the Banks appropriated to bad debt reserves and deducted for federal income tax purposes are not available for payment of cash dividends or other distributions to the Company without payment of taxes at the then current tax rate on the amount of earnings removed from the reserves for such distributions. See "Taxation." The Company intends to make full use of this favorable tax treatment afforded to the Banks, and the Company and does not contemplate use of any post-Conversion earnings of the Banks in a manner which would limit either 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 an institution is any company or entity which controls, is controlled by or is under common control with the savings institution. In a holding company context, the parent holding company of an institution (such as the Company) 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 Banks, prohibits the Banks 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 Banks are also subject to the restrictions contained in Section 22(h) and Section 22(g) of the Federal Reserve Act on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, executive officer and to a greater than 10% stockholder of a depository institution and certain affiliated interests of such persons, may not exceed, together with all other outstanding loans to such person and affiliated interests, the institution's loans-to-one- borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus plus an additional 10% of such capital and surplus for loans fully secured 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 29 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 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 90 days unless periodic determinations are made that forbearance from such action would better protect the deposit insurance fund. Unless appropriate findings and certifications are made by the appropriate federal bank regulatory agencies, a critically undercapitalized institution must be placed in receivership if it remains critically undercapitalized on average during the calendar quarter beginning 270 days after the date it became critically undercapitalized. Under the OTS regulation implementing the prompt corrective action provisions of FDICIA, the OTS measures an institution's capital adequacy for purposes of the prompt corrective action rules on the basis of its total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). An institution that is not subject to an order or written directive to meet or maintain a specific capital level is deemed "well capitalized" if it also has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6% or greater; and (iii) a leverage ratio of 5% or greater. An "adequately capitalized" savings institution is an institution that does not meet the definition of well capitalized and has: (i) a total risk-based capital ratio of 8% or greater; (ii) a Tier 1 capital risk-based ratio of 4% or greater; and (iii) a leverage ratio of 4% or greater (or 3% or greater if the savings institution has a composite 1 CAMELS rating). An "undercapitalized institution" is an institution that has (i) a total risk-based capital ratio less than 8%; or (ii) a Tier 1 risk-based capital ratio of less than 4%; or (iii) a leverage ratio of less than 4% (or 3% if the institution has a composite 1 CAMELS rating). A "significantly undercapitalized" institution is defined as an institution that has: (i) a total risk-based capital ratio of less than 6%; or (ii) a Tier 1 risk-based capital ratio of less than 3%; or (iii) a leverage ratio of less than 3%. A "critically undercapitalized" savings institution is defined as an institution that has "tangible equity" of less than 2%. Tangible equity is defined as core capital plus cumulative perpetual preferred stock (and related surplus) less all intangibles other than qualifying supervisory goodwill and certain purchased 30 mortgage servicing rights. The OTS may reclassify a well capitalized savings institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically-undercapitalized) if the OTS determines, after notice and an opportunity for a hearing, that the savings institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than- satisfactory rating for any CAMELS rating category. As of June 30, 1997, the Banks were classified as "well capitalized" under the prompt corrective action regulations. Safety and Soundness Guidelines. Under FDICIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"), each Federal banking agency is required to establish safety and soundness standards for institutions under its authority. On July 10, 1995, the federal banking agencies, including the OTS and Federal Reserve Board, released Interagency Guidelines Establishing Standards for Safety and Soundness and published a final rule establishing deadlines for submission and review of safety and soundness compliance plans. The final rule and the guidelines went into effect on August 9, 1995. The guidelines require depository institutions to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution's business. The guidelines also establish certain basic standards for loan documentation, credit underwriting, interest rate risk exposure, and asset growth. The guidelines further provide that depository institutions should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and should take into account factors such as comparable compensation practices at comparable institutions. If the appropriate federal banking agency determines that a depository institution is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines. A depository institution must submit an acceptable compliance plan to its primary federal regulator within 30 days of receipt of a request for such a plan. Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions. Management believes that the Banks already meet substantially all the standards adopted in the interagency guidelines, and therefore does not believe that implementation of these regulatory standards will materially affect the Banks' operations. Additionally under FDICIA, as amended by the CDRI Act, the federal banking agencies are required to establish standards relating to the asset quality and earnings that the agencies determine to be appropriate. On July 10, 1995, the federal banking agencies, including the OTS and Federal Reserve Board, issued proposed guidelines relating to asset quality and earnings. Under the proposed guidelines, an FDIC insured depository institution should maintain systems, commensurate with its size and the nature and scope of its operations, to identify problem assets and prevent deterioration in those assets as well as to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. Management believes that the asset quality and earnings standards, in the form proposed by the banking agencies, would not have a material effect on the Banks' operations. Regulation of the Company General. The Company is a savings institution holding company as defined by the Home Owners' Loan Act. As such, the Company is registered with the OTS and is subject to OTS regulation, examination, supervision and reporting requirements. As subsidiaries of a savings institution holding company, the Banks are subject to certain restrictions in their dealings with the Company and affiliates thereof. The Company also is required to file certain reports with, and otherwise comply with the rules and regulations of, the SEC under the federal securities laws. Activities Restrictions. The Board of Directors of the Company presently intends to continue operating the Company as a multiple savings institution holding company, in order to facilitate possible future branch expansion, in the event the Bank ever becomes subject to Arkansas branching restrictions, which are based on the home office location of each separately chartered banking institution. As a result, the activities of the Company and any of its subsidiaries (other than the Banks or other subsidiary savings institutions) will be subject to various restrictions. Among other things, no multiple savings institution 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 31 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 institution holding companies, those activities authorized by the Federal Reserve Board as permissible for bank holding companies. A multiple savings institution holding company must obtain the approval of the OTS prior to engaging in the activities described in (vii) above. In addition, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by an institution holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the Director of the OTS may impose such restrictions as deemed necessary to address such risk including limiting: (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Restrictions on Acquisitions. Savings institution holding companies may not acquire, without prior approval of the Director of the OTS, (i) control of any other savings institution or savings institution 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 institution 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 institution 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 institution holding company and the issuing savings institution, and transactions between the savings institution and the savings institution 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 institution holding company. The Director of the OTS may only approve acquisitions resulting in the formation of a multiple savings institution holding company which controls savings institutions in more than one state if: (i) the multiple savings institution 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 institution holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions). OTS regulations permit federal savings institutions to branch in any state or states of the United States and its territories. Except in supervisory cases or when interstate branching is otherwise permitted by state law or other statutory provision, a federal institution may not establish an out-of-state branch unless (i) the federal institution qualifies as a QTL or as a "domestic building and loan association" under ss.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 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 32 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. The Common Stock is registered with the SEC under the Securities Exchange Act of 1934, as amended ("Securities Exchange Act"), and, under OTS regulations, generally may not be deregistered for at least three years after the Conversion. The Company 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 Banks 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 Banks which met certain definitional tests and other conditions prescribed by the Internal Revenue Code benefitted 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 secured 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 may be 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 Banks 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 Banks 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 debts reserves has already been accrued as a deferred tax liability. The Banks' federal income tax returns have not been examined by the regulatory authorities in the past five years. For additional information, see Note 12 of the Notes to Consolidated Financial Statements contained elsewhere herein. 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 Internal Revenue Code provides that an item of tax preference is the excess of the bad debt deduction allowable for a taxable year pursuant to the percentage of taxable income method over the amount allowable under the experience method. The other items of tax preference that constitute AMTI include (a) tax-exempt interest on newly-issued (generally, issued on or after August 8, 1986) private activity bonds other than certain qualified bonds and (b) for taxable years including 1987 through 1989, 50% of the excess of (i) the taxpayer's pre-tax adjusted net book income over (ii) AMTI (determined without regard to this latter preference and prior to reduction by net operating losses). For taxable years beginning after 1989, this latter preference has been replaced by 75% of the excess (if any) of (i) adjusted current earnings as defined in the Internal Revenue Code, over (ii) AMTI (determined without regard to this preference and prior to reduction by net operating losses). For any taxable year beginning after 1986, net operating losses can offset no more than 90% of AMTI. Certain payments of alternative minimum taxes may be used as credits against regular tax liabilities in future years. In addition, for taxable years after 1986 and before 1992, corporations, 33 including savings institutions, are also subject to an environmental tax equal to 0.12% of the excess of AMTI for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2.0 million. The Banks are not currently paying any amount of alternative minimum tax but may, depending on future results of operations, become subject to this tax. State Income Taxation The Banks are subject to Arkansas corporation income tax which is 6.5% of all taxable earnings when income exceeds $100,000. The Company is incorporated under Oklahoma law and qualified to do business in Arkansas as a foreign corporation, and accordingly the Company incurs certain franchise and other taxes, which management does not expect to be material to the Company as a whole. Employees As of June 30, 1997, the Bank had 63 full-time and 4 part-time employees, none of whom was represented by a collective bargaining agreement. Management considers the Bank's relationships with its employees to be good. Executive Officers Who Are Not Directors The following table sets forth information regarding the executive officer of the Company who does not serve on the Board of Directors.
Age at June 30, Name 1997 Title ---- ------- ----- William C. Lyon 56 Vice President of the Company; Senior Vice President and Chief Lending Officer of the Bank
The following paragraph sets forth information regarding the principal occupation of the executive officer designated above. William C. Lyon has served as Vice President of the Company since December 1996 and has been Senior Vice President and Chief Lending Officer of the Bank since May 1996. Mr. Lyon also serves as a director and the Chief Lending Officer of the Bank's subsidiary savings bank. From January 1994 to May 1996, Mr. Lyon was a self-employed banking consultant and from 1991 to 1994 he served as Senior Vice President of American National Bank and Trust Co. in Shawnee, Oklahoma. Mr. Lyon is a member of the Lions Club and serves on various Chamber of Commerce committees. 34 Item 2. Properties The following table sets forth information regarding the Bank's offices at June 30, 1997.
Year Owned or Approximate Opened Leased Book Value Square Footage ------ -------- ---------- -------------- Main Office: 237 Jackson Street, S.W 1933 Owned $720,900 12,000 Camden, Arkansas Branch Offices: 23233 Interstate 30, No. 201 1996 Leased 18,300 1,000 Bryant, Arkansas 208 Cardinal Shopping Center 1981 Owned 156,000 1,200 Camden, Arkansas 610 West 4th Street 1969 Owned 724,000 3,500 Fordyce, Arkansas 109 North Chester 1993 Owned 610,000 1,800 Little Rock, Arkansas 207 North Church2 1993 Leased 26,000 2,200 Monticello, Arkansas 108 East Pine3 1996 Leased 120,900 900 Sheridan, Arkansas
- -------------- 1 Limited service loan production office opened in November 1996. 2 The Bank built a 7,400 square foot replacement branch at 473 Highway 425 North in Monticello, which opened in July 1997 at an aggregate building cost of approximately $1,250,000. 3 The Bank built a 5,500 square foot replacement branch at 108 South Main Street in Sheridan, which opened in August 1997 at an aggregate building cost of approximately $975,000. In addition to the offices described above, at June 30, 1997 the Bank held five 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, though certain of the properties are larger than the Bank's foreseeable needs, and therefore portions of those properties may be sold by the Bank. At that date, the aggregate net book value of these properties totaled $1.1 million, of which $480,000 was classified as held for resale. It is anticipated that in the future management may determine to expand the Bank's network of banking facilities by installing ATMs in existing or new banking facilities, by building branches or other facilities on the properties held by the Bank, by acquiring other facilities or sites and/or by acquiring banks or other financial companies with their own facilities. The book value of the Bank's aggregate investment in properties, premises and equipment totaled approximately $4.6 million at June 30, 1997. See Note 7 of the Notes to Consolidated Financial Statements. 35 Item 3. Legal Proceedings From time to time, the Bank is a party to various legal proceedings incident to its business. At June 30, 1997, there were no legal proceedings to which the Company or the Bank was a party, or to which any of their property was subject, which were expected by management to result in a material loss to the Company or the Bank, and there were no pending regulatory proceedings to which the Company, the Bank or its subsidiaries was a party, or to which any of their properties was subject, which were expected to result in a material loss. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of fiscal 1997. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The information required by this item is incorporated by reference to "Item 1. Business -- Regulation of the Banks -- Dividend Restrictions" herein and "Market Information," "Market Price of Common Stock and Dividend Information" and Note 21 of the Notes to Consolidated Financial Statements in the portions of the Annual Report filed as Exhibit 13 to this report. Item 6. Selected Financial Data The information required by this item is incorporated by reference to "Selected Consolidated Financial and Other Data" in the portions of the Annual Report filed as Exhibit 13 to this report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required by this item is incorporated by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the portions of the Annual Report filed as Exhibit 13 to this report. Item 8. Financial Statements and Supplementary Data The financial statements required by this item are incorporated by reference to the Consolidated Financial Statements, Notes to Consolidated Financial Statements and Independent Auditors' Reports in the portions of the Annual Report filed as Exhibit 13 to this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Effective June 25, 1997, the Company dismissed Gaunt & Co., Little Rock, Arkansas, and engaged Miller, England & Company, Little Rock, Arkansas, as the Company's independent certified public accountants. For additional information, see the Company's Current Report on Form 8-K dated June 25, 1997, which is incorporated herein by reference (File No. 0-22423). PART III Item 10. Directors and Executive Officers of the Registrant The information required by this item is incorporated by reference to "Election of Directors" in the Proxy Statement and "Item 1. Description of Business -- Executive Officers Who Are Not Directors" herein. 36 Item 11. Executive Compensation The information required by this item is incorporated by reference to "Executive Compensation" in the Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this item is incorporated by reference to "Voting Securities and Security Ownership" and "Election of Directors" in the Proxy Statement. Item 13. Certain Relationships and Related Transactions The information required by this item is incorporated by reference to "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' Reports Consolidated Statements of Financial Condition as of June 30, 1997 and 1996 Consolidated Statements of Income for the years ended June 30, 1997, 1996, and 1995 Consolidated Statements of Stockholders' Equity for the years ended June 30, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the years ended June 30, 1997, 1996 and 1995 Notes to Consolidated Financial Statements for the years ended June 30, 1997, 1996 and 1995 Consolidated Statements of Income of subsidiary for the period from July 1, 1994 to May 3, 1996 (uanudited) Consolidated Statements of Stockholders' Equity of subsidiary for the period from July 1, 1994 to May 3, 1996 (unaudited) Consolidated Statements of Cash Flows of subsidiary for the period from July 1, 1994 to May 3, 1996 (unaudited) Notes to Financial Statements of subsidiary (unaudited) (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. 37 (3) Exhibits. The following is a list of exhibits filed as part of this Annual Report on Form 10-K and is also the Exhibit Index.
No. Description --- ----------- 3.1 Articles of Incorporation of HCB Bancshares, Inc. * 3.2 Bylaws of HCB Bancshares, Inc. * 4 Form of Common Stock Certificate of HCB Bancshares, Inc. * 10.1 Form of HCB Bancshares, Inc. 1997 Stock Option and Incentive Plan *+ 10.2 Form of HCB Bancshares, Inc. Management Recognition Plan and Trust Agreement *+ 10.3(a) Employment Agreements by and between Heartland Community Bank and Vida H. Lampkin and Cameron D. McKeel *+ 10.3(b) Employment Agreements by and between HCB Bancshares, Inc. and Vida H. Lampkin and Cameron D. McKeel *+ 10.4(a) Change-in-Control Protective Agreement between Heartland Community Bank and William C. Lyon *+ 10.4(b) Change-in-Control Protective Agreement between HCB Bancshares, Inc. and William C. Lyon *+ 10.5 Heartland Community Bank Directors' Retirement Plan, as amended*+ 13 Portions of Annual Report to Stockholders for the Fiscal Year Ended June 30, 1997 21 Subsidiaries** 27 Financial Data Schedule
* Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 333-19093). ** Incorporated by reference to Item 1 herein. + Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K. The Company filed a Current Report on Form 8-K dated June 25, 1997 reporting under Item 4 thereof a change of the Company's independent certified public accountants. See Item 9 herein. (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. 38 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 29, 1997 By: /s/ Vida H. Lampkin ------------------- Vida H. Lampkin Chairman of the Board, 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/ Vida H. Lampkin ----------------------------------------------- Vida H. Lampkin Chairman of the Board, President and Chief Executive Officer (Principal Executive, Financial and Accounting Officer) By: /s/ Cameron D. McKeel ----------------------------------------------- Cameron D. McKeel Director and Vice President By: /s/ Roy Wayne Moseley ----------------------------------------------- Roy Wayne Moseley Director By: /s/ Bruce D. Murry ----------------------------------------------- Bruce D. Murry Director By: /s/ Carl E. Parker, Jr. ----------------------------------------------- Carl E. Parker, Jr. Director By: /s/ Lula Sue Silliman ----------------------------------------------- Lula Sue Silliman Director By: /s/ Clifford Steelman ----------------------------------------------- Clifford Steelman Director 39 EX-13 2 1997 ANNUAL REPORT Exhibit 13 Portions of 1997 Annual Report to Stockholders MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's common stock began trading on the Nasdaq National Market on May 7, 1997, under the symbol "HCBB." At August 31, 1997, there were 2,645,000 shares of the common stock outstanding and approximately 871 stockholders of record. Between May 7, 1997 and June 30, 1997, the low and high reported prices of the common stock on the Nasdaq National Market were between $12.50 and $14.12 per share, respectively. The payment of dividends on the Common Stock is subject to determination and declaration by the Board of Directors of the Company. Following fiscal 1997, the Board of Directors adopted a policy of paying regular quarterly cash dividends on the Common Stock. In addition, from time to time, the Board of Directors may determine to pay special cash dividends in addition to, or in lieu of, regular cash dividends. The payment of future dividends will be subject to the requirements of applicable law and the determination by the Board of Directors of the Company that the net income, capital and financial condition of the Company and the Association, thrift industry trends and general economic conditions justify the payment of dividends, and there can be no assurance that dividends will be paid or, if paid, will continue to be paid in the future. The Company did not pay dividends in fiscal 1997. Following fiscal 1997, the Company declared a cash dividend of $.05 per share payable on or about October 10, 1997 to stockholders of record as of September 30, 1997. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
At June 30, ------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 ------------ ------------ ------------ ------------ ------------ (In thousands) Total assets ............................. $200,365,778 $171,235,322 $126,987,168 $126,722,704 $123,748,431 Loans receivable, net .................... 98,642,635 84,131,024 55,112,980 53,247,142 50,000,592 Cash and cash equivalents ................ 19,456,092 17,291,882 3,125,599 3,054,978 3,527,284 Investment securities: Available for sale .................... 16,155,755 5,279,625 957,500 3,386,625 -- Held to maturity ...................... -- -- 2,000,000 -- 909,600 Mortgage-backed securities: Available for sale ................... 20,090,406 12,155,199 6,088,450 -- -- Held to maturity ..................... 35,869,295 45,212,891 57,144,915 64,084,120 66,773,893 Deposits ................................. 151,208,763 145,919,251 112,005,588 113,350,670 111,771,582 FHLB advances ............................ 10,000,000 10,000,000 -- -- -- Notes payable ............................ 400,000 -- -- -- -- Equity - substantially restricted ........ 37,739,513 14,228,436 14,270,972 12,860,593 11,472,231 Number of: Real estate loans outstanding ......... 2,093 1,993 1,507 1,537 1,602 Savings accounts ...................... 15,380 14,163 10,993 11,057 11,006 Offices open .......................... 7 6 3 3 3 Year Ended June 30, --------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------ ------------ ---------- ----------- ----------- (In thousands, except per share data) Interest income .................................... $ 13,101,676 $ 10,333,181 $8,844,782 $ 8,416,735 $ 8,492,889 Interest expense ................................... 8,195,782 6,766,598 5,112,481 4,645,404 4,920,251 ------------ ------------ ---------- ----------- ----------- Net interest income ................................ 4,905,894 3,566,583 3,732,301 3,771,331 3,572,638 Provision for loan losses .......................... (221,671) (42,483) -- (7,500) (120,000) ------------ ------------ ---------- ----------- ----------- Net interest income after provision for loan losses .................................. 4,684,223 3,524,100 3,732,301 3,763,831 3,452,638 Noninterest income ................................. 305,067 (733,652) 196,023 102,212 173,986 Noninterest expense ................................ 5,578,934 2,350,658 1,609,691 1,585,401 1,444,384 ------------ ------------ ---------- ----------- ----------- Income (loss) before income taxes and cumulative effect of change in method of accounting for income taxes and investment securities ....................................... (589,644) 399,790 2,318,363 2,280,642 2,182,240 Provision for income taxes (benefits) .............. (166,645) 174,801 966,763 869,756 847,869 ------------ ------------ ---------- ----------- ----------- Income (loss) before cumulative effect of change in method of accounting for income taxes and investment securities ....................................... (422,999) 224,989 1,351,600 1,410,886 1,334,371 Cumulative effect of change in method of accounting for income taxes ...................... -- -- -- (22,523) -- Cumulative effect of change in method of accounting for investment securities ............. -- -- 77,567 -- -- ------------ ------------ ---------- ----------- ----------- Net income (loss) .................................. $ (422,999) $ 224,989 $1,429,167 $ 1,388,363 $ 1,334,371 ============ ============ ========== =========== ===========
- --------------- 1 Noninterest expense and, therefore, net income (loss), for the year ended June 30, 1997 were adversely affected by the imposition of a special deposit insurance assessment in the second quarter of fiscal 1997 in connection with the recapitalization of the SAIF. Absent such assessment, management estimates that noninterest expense would have been approximately $4,689,923 and that net income would have been approximately $125,610. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" below.
Year Ended June 30, 1997 1996 1995 1994 1993 -------- -------- -------- -------- ------- Performance Ratios: Return on assets (net income (loss) divided by average total assets)(1)............... (0.23)% 0.16% 1.06% 1.11% 1.10% Return on average equity (net income (loss) divided by average equity)(1)............. (3.00) 1.53 9.82 11.52 12.24 Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost) 2.43 2.16 2.51 2.66 2.74 Net interest margin (net interest income divided by average interest-earning assets) 2.84 2.58 2.96 3.03 3.08 Ratio of average interest-earning assets to average interest-bearing liabilities 116.48 108.47 111.22 110.06 108.09 Ratio of noninterest expense to average total assets.............................. 3.08 1.64 1.26 1.25 1.19 Asset Quality Ratios: Nonperforming assets to total assets at end of period.......................... 0.24 0.14 0.23 0.37 0.35 Nonperforming loans to total loans at end of period.......................... 0.14 0.20 0.29 0.27 0.62 Allowance for loan losses to total loans at end of period.................... 1.51 1.53 1.33 1.37 1.45 Allowance for loan losses to nonperforming loans at end of period.................... 11.19x 7.69x 4.41x 5.08x 2.36x Provision for loan losses to total loans at end of period(2)....................... 0.22% 0.05% --% --% 0.24% Net charge-offs to average loans outstanding(2)............................ 0.01 0.02 -- 0.04 0.04 Capital Ratios: Equity to total assets at end of period...... 7.03 8.31 11.25 10.15 9.27 Average equity to average assets............. 7.78 10.25 10.76 9.66 9.02
- -------------- (1) Before cumulative effect adjustment. Returns on assets and equity for the year ended June 30, 1997 were adversely affected by the imposition of a special deposit insurance assessment in the second quarter of fiscal 1997 in connection with the recapitalization of the SAIF. Absent such assessment, management estimates that return on assets would have been approximately .07% and that return on average equity would have been approximately .89%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" below. (2) Annualized. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The Bank's principal business consists of attracting 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 and, to a lesser but growing extent, 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 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. 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 securities and other fees. In addition, net income is affected by the level of noninterest expense, which primarily consists of employee compensation expenses, deposit insurance premiums 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 deposits by maintaining substantial liquidity and capital levels to sustain unfavorable movements in market interest rates, by purchasing investment securities with adjustable-rates and/or short terms to maturity and by originating limited amounts of relatively shorter term consumer loans. In the future, however, it is anticipated that as the Bank sells more of its long term loan originations and originates for 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 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. Interest Rate Sensitivity Gap. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income. At June 30, 1997, the Bank's total interest-bearing liabilities maturing or repricing within one and five years exceeded its total interest-earning assets maturing or repricing in the same periods, and the Bank's cumulative one- and five-year gap ratios totaled negative 11.29% and 19.65%, respectively. The Bank's gap measures indicate that net interest income could be significantly exposed to increases in interest rates. In a rising interest rate environment, the Bank's net interest income could be adversely affected as liabilities would reprice to higher market rates more quickly than assets. This effect would be compounded, because the prepayment speeds of the Bank's long-term fixed-rate assets would decrease in a rising interest rate environment. The following table sets forth information regarding projected maturities and repricing of interest-earning assets and interest-bearing liabilities of the Bank at June 30, 1997. The computations were made without using assumptions for loan repayments or deposit decays. Except as stated below, the amounts of assets and liabilities shown to reprice or mature within a given period were determined in accordance with contractual terms of the assets or liabilities. In making the computations, all adjustable rate loans were considered to be due at the end of the next upcoming adjustment period. Fixed rate loans were considered to reprice at their contractual maturities with no consideration given to prepayments or scheduled payments. Liquid interest-earning investments with no contractual maturities are assumed to be subject to immediate repricing. Statement savings and money market accounts are subject to immediate availability and repricing and have been placed in the earliest gap category. In addition, fixed maturity deposits were assumed to reprice at their contractual maturities without consideration for early withdrawals. The interest rate sensitivity of the Bank's assets and liabilities illustrated in the following table could vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.
Over One Over Five Over Ten Over One Year Through Through Through Twenty or Less Five Years Ten Years Twenty Years Years Total ------------ ------------ ------------ ----------- ----------- ------------ Interest-earning assets: One- to four-family mortgage loans $ 14,801,331 $ 5,741,541 $ 13,206,278 $27,233,929 $ -- $60,983,079 Other mortgage loans.............. 688,317 12,238,050 7,616,522 5,985,749 -- 26,528,638 Consumer loans.................... 4,600,080 3,448,296 2,557,057 525,485 -- 11,130,918 Investment securities............. 1,503,910 12,651,845 2,000,000 -- -- 16,155,755 Mortgage-backed securities 38,044,501 1,316,850 4,868,741 3,584,991 6,898,118 54,713,201 FHLB of Dallas stock.............. 1,246,500 -- -- -- -- 1,246,500 Other interest-earning assets 18,273,882 -- -- -- -- 18,273,882 ------------ ------------ ------------ ----------- ----------- ------------ Total.......................... $ 79,465,379 $ 35,396,582 $ 30,248,598 $37,330,154 $ 6,898,118 $189,031,973 ------------ ------------ ------------ ----------- ----------- ------------ Interest-bearing liabilities: Deposits.......................... $101,698,450 $ 46,820,549 $ -- $ -- $ -- $148,518,999 FHLB advances..................... -- 5,000,000 5,000,000 -- -- 10,000,000 Notes payable..................... 80,000 320,000 -- -- -- 400,000 ------------ ------------ ------------ ----------- ----------- ------------ Total.......................... 101,778,450 52,140,549 5,000,000 -- -- 158,918,999 ------------ ------------ ------------ ----------- ----------- ------------ Interest sensitivity gap............. $(22,619,929) $(16,743,967) $ 25,248,598 $37,330,154 $ 6,898,118 $ 30,112,974 ============ ============ ============ =========== =========== ============ Cumulative interest sensitivity gap.................... $(22,619,929) $(39,363,896) $(14,115,298) $23,214,856 $30,112,974 $ 30,112,974 ============ ============ ============ =========== =========== ============ Ratio of interest-earning assets to interest-bearing liabilities... 77.78% 67.89% 604.97% --% --% 118.95% ============ ============ ============ =========== =========== ============ Ratio of cumulative gap to total assets....................... (11.29)% (19.65)% (7.04)% 11.59% 15.03% 15.03% ============ ============ ============ =========== =========== ============
Certain shortcomings are inherent in the method of analysis presented in the preceding table. Although certain assets and liabilities may have similar maturity or periods of repricing they may react in different degrees to changes in the market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, generally have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayments and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Additionally, an increased credit risk may result as the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. Virtually all of the adjustable-rate loans in the Bank's portfolio contain conditions which restrict the periodic change in interest rate. Net Portfolio Value. While the Bank historically has measured its interest rate sensitivity by computing the "gap" between the assets and liabilities which were expected to mature or reprice within certain periods, the OTS requires the Bank to measure its interest rate risk by computing estimated changes in the net present value of its cash flows from assets, liabilities and off-balance sheet items ("NPV") in the event of a range of assumed changes in market interest rates. These computations estimate the effect on the Bank's NPV of sudden and sustained 1% to 4% increases and decreases in market interest rates. The Bank's Board of Directors has adopted an interest rate risk policy which establishes maximum decreases in the Bank's estimated NPV of 30%, 50%, 75% and 100% in the event of assumed immediate and sustained 1%, 2%, 3% and 4% increases or decreases in market interest rates, respectively. At June 30, 1997, based on information provided by the OTS as of March 31, 1997, it was estimated that the Bank's consolidated NPV could decrease 15%, 33%, 52% and 71% in the event of 1%, 2%, 3% and 4% respective increases in market interest rates, and no decreases were estimated in the event of equivalent decreases in market interest rates. Like the "gap" calculations above, these calculations indicate that the Bank's net portfolio value could be adversely affected by increases in interest rates. Changes in interest rates also may affect the Bank's net interest income, with increases in rates expected to decrease income and decreases in rates expected to increase income, as the Bank's interest-bearing liabilities would be expected to mature or reprice more quickly than the Bank's interest-earning assets. The Bank's Board of Directors is responsible for reviewing the Bank's asset and liability policies. On at least a quarterly basis, the Board reviews interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Bank's management is responsible for administering the policies and determinations of the Board of Directors with respect to the Bank's asset and liability goals and strategies. Average Balances, Interest and Average Yields and Rates The following table sets forth information regarding the Bank'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 and at the date indicated. Average balances are derived from monthly balances, and loans receivable include nonaccrual loans. The table also presents information for the periods indicated and at June 30, 1997 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. Whenever interest-earning assets equal or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
Year Ended June 30, 1997 At June 30, 1997 --------------------------------- --------------------- Average Yield/ Average Yield/ Balance Cost Balance Interest Cost ------- ------ ------- -------- ------- (Dollars in thousands) Interest-earning assets: Loans receivable......................... $ 98,642,635 8.15% $ 95,084,828 $ 8,038,783 8.45% Investment and mortgage-backed securities 72,115,456 6.15 67,125,006 4,436,436 6.61 Other interest-earning assets............ 18,273,882 3.43 11,297,355 626,457 5.55 ------------ ------------ ----------- Total interest-earning assets.......... $189,031,973 6.93 $173,507,189 13,101,676 7.55 ----------- Non-interest-earning assets................ 11,333,805 7,914,134 ------------ ------------ Total assets........................... $200,365,778 $181,421,323 ============ ============ Interest-bearing liabilities: Deposits................................. $148,518,999 4.67% $148,964,591 7,534,445 5.06% FHLB advances............................ 10,000,000 6.21 10,208,333 636,637 6.24 Notes payable............................ 400,000 7.50 357,142 25,000 7.00 ------------ ------------ ----------- Total interest-bearing liabilities..... 158,918,999 5.12 159,530,066 8,196,082 5.12 ----------- Non-interest-bearing liabilities........... 3,707,266 7,780,215 ------------ ------------ Total liabilities...................... 162,626,265 167,310,281 Equity..................................... 37,739,513 14,111,042 ------------ ------------ Total liabilities and equity........... $200,365,778 $181,421,323 ============ ============ Net interest income........................ $ 4,905,594 =========== Interest rate spread....................... 2.43% ====== Net yield on interest-earning assets....... 2.84% ====== Ratio of average interest-earning assets to average interest-bearing liabilities.. 108.76% ====== Year Ended June 30, 1996 ------------------------------------ Average Average Yield/ Balance Interest Cost ------- -------- ------- (Dollars in thousands) Interest-earning assets: Loans receivable......................... $ 65,360,871 $ 5,352,338 8.19% Investment and mortgage-backed securities 66,253,218 4,467,685 6.74 Other interest-earning assets............ 6,719,134 513,217 7.64 ------------ ----------- Total interest-earning assets......... $138,333,223 10,333,240 7.47 ----------- Non-interest-earning assets................ 5,115,105 ------------ Total assets........................... $143,448,328 ============ Interest-bearing liabilities: Deposits................................. $120,029,295 $ 6,314,641 5.26 FHLB advances............................ 7,508,000 451,957 6.03 Notes payable............................ -- -- -- ------------ ----------- Total interest-bearing liabilities..... 127,529,295 6,766,598 5.31 ----------- Non-interest-bearing liabilities........... 1,216,329 ------------ Total liabilities...................... 128,745,149 Equity..................................... 14,702,704 ------------ Total liabilities and equity........... $143,448,328 ============ Net interest income........................ $ 3,566,642 =========== Interest rate spread....................... 2.16% ====== Net yield on interest-earning assets....... 2.58% ====== Ratio of average interest-earning assets to average interest-bearing liabilities.. 108.47% ======
Rate/Volume Analysis The following table analyzes dollar amounts of changes in interest income expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period's rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period's volume) and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.
Year Ended June 30, ----------------------------------------------- 1997 vs. 1996 ----------------------------------------------- Increase (Decrease) Due to ----------------------------------------------- Rate/ Volume Rate Volume Total ------- ------- -------- ------- (In thousands) Interest income: Loans receivable................................... $ 2,434 $ 169 $ 83 $ 2,686 Investment securities and mortgage- backed securities.............................. 59 (86) (4) (31) Other interest-earning assets..................... 254 (140) (7) 113 ------- ------- -------- ------- Total interest-earning assets................... 2,747 (57) 78 2,768 ------- ------- -------- ------- Interest expense: Deposits.......................................... 1,523 (240) (63) 1,220 FHLB advances..................................... 162 16 6 184 Note payable...................................... 25 -- -- 25 ------- ------- -------- ------- Total interest-bearing liabilities.................................. 1,710 (224) (57) 1,429 ------- ------- -------- ------- Change in net interest income....................... $ 1,037 $ 167 $ 135 $ 1,339 ======= ======= ======== =======
Comparison of Financial Condition at June 30, 1997 and 1996 The Bank had total assets of $200.3 million and $171.2 million at June 30, 1997 and 1996, respectively. The Bank's ability to expand its lending base and the size of its loan portfolio has been constrained by the lack of strong loan demand in its primary lending market based on its prior product offerings. The economic base in the Bank's primary lending area has not grown significantly over the last several years. Investments in loans totalled $98.6 million and $89.6 million at June 30, 1997 and 1996, respectively. During this same period, investment and mortgage-backed securities and other short-term interest-earning deposits fluctuated between$62.6 million at June 30, 1996 and $72.1 million at June 30, 1997. Due to the lack of strong loan demand, investment securities and other short-term interest-earning deposits tend to vary in conjunction with variations in savings activity. Additionally, the Bank expended $3.1 million to purchase land and construct and/or improve facilities during the year ended June 30, 1997 to consummate management's planned growth projections. Deposits increased from $145.9 million at June 30, 1996 to $151.2 million at June 30, 1997. The outstanding balances of FHLB advances at June 30, 1996 and 1997 were $10 million. These advances were utilized to reduce interest rate risk by better matching rates and maturities of existing interest-earning assets and interest-bearing liabilities. Equity amounted to $37.7 million at June 30, 1997, and to $14.2 million at June 30, 1996, respectively. The changes in equity were due primarily to the Bank's stock conversion during the fourth quarter. At June 30, 1997, the Bank's regulatory capital substantially exceeded all applicable regulatory capital requirements. Comparison of Results of Operations for the Years Ended June 30, 1997 and 1996 Net Income (Loss). Net loss for the year ended June 30, 1997 was $422,999 compared to net income of $224,889 for the year ended June 30, 1996. The changes were attributable to a special deposit insurance assessment of $889,011 and a provision for loan losses of $221,671, which were partially offset by an increase in net interest income of $1,339,311 and an increase in noninterest income of $1,079,719 for the year ended June 30, 1997, as compared to the year ended June 30, 1996. Income tax expense for the year ended June 30, 1997 compared to 1996 was a tax benefit of $166,645 compared to a tax expense of $174,801. Net Interest Income. Net interest income for the year ended June 30, 1997 was $4,905,894, an increase of 37.5% when compared to net interest income of $3,566,583 for the year ended June 30, 1996. This increase was attributable to an increase in total interest income of $2,768,495 and an increase in total interest expense of $1,429,184. The net interest margin for the year ended June 30, 1997 was 2.84% compared to 2.58% for the year ended June 30, 1996. This increase in net interest income and net interest margin is due to an increase in the average volume of interest-earning assets, combined with a decrease in the average rate paid on interest-bearing liabilities. One cause for the increase in average interest-earning assets when comparing the year ended June 30, 1997 to the year ended June 30, 1996 was the acquisition of the subsidiary, Heritage Bank, FSB in May of 1996. The average volume of interest-earning assets increased from $138.3 million for the year ended June 30, 1996 to $173.5 million for the year ended June 30, 1997 which had the effect of increasing total interest income by $2,843,000. The average rate paid on interest-bearing liabilities decreased during the year ended June 30, 1997 to 5.12% from 5.31% for the year ended June 30, 1996. The decrease in the average rate on interest-bearing liabilities had the effect of decreasing total interest expense between the year ended June 30, 1996 and the year ended June 30, 1997 by $224,000. The average yield on interest-earning assets remained relatively unchanged between the two periods, which is indicative of the fact that the Bank's interest-earning assets are not highly sensitive to the increases in market interest rates which occurred between the two periods. For the year ended June 30, 1997, the average yield on interest-earning assets was 7.55%, compared to 7.47% for the year ended June 30, 1996, which had the effect of increasing total interest income by $21,000. In addition, the average volume of interest-bearing liabilities increased by 24.1%, reflecting the acquisition of the Bank's subsidiary savings bank, when comparing June 30, 1997 to June 30, 1996. This volume increase attributed to an increase in total interest expense of $1,710,000. Provision for Loan Losses. During the year ended June 30, 1997, the Bank's management initiated an extensive internal loan review of all loan files both of the parent and subsidiary. The review resulted in the adoption of more conservative loan loss allowance standards than had been used in the past. This new policy on allowance for loan losses was deemed prudent in establishing credit underwriting standards for future expected lending areas, such as commercial real estate, business and consumer loans, which inherently have more risk. Management made provisions for loan losses in the year ended June 30, 1997 of $221,671. There was a provision of $42,483 made in the year ended June 30, 1996. The fiscal 1997 provisions were the result of the aforementioned extensive review of the allowance for loan losses of the Bank and management's estimates of conditions and circumstances that materialized in the year ended June 30, 1997 (See also Note 23 in Notes to Consolidated Financial Statements). The allowance for loan losses, after this provision, of $1,492,473, represented 1.49% of outstanding loans at June 30, 1997. Nonperforming loans as of June 30, 1997 and 1996, as a percent of total loans, remained below .20%. Management evaluates the carrying value of the loan portfolio periodically and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In particular, management recognizes that recent and planned changes in the amounts and types of lending by the Bank will result in further growth of the Bank's loan loss allowance and may justify further changes in the Bank's loan loss allowance policy in the future. 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. Noninterest Income. Noninterest income is comprised primarily of insurance commissions from sales of credit life insurance, fees for banking service charges and sales of investment and mortgage-backed securities. Noninterest income (loss) for the year ended June 30, 1997, was $305,067, compared to ($773,651) for the year ended June 30, 1996. This represents an increase of $1,078,718. This is partially due to losses of $926,947, that were realized on sales of investment securities which were classified as available-for-sale during the year ended June 30, 1996. The remaining increase of $151,771, is due to fluctuations in sales of credit life insurance policies and to an increase in new fee earning banking services offered by the Bank to its deposit customers. In light of the increasingly competitive markets for deposits and loans, management has recently shifted the Bank's deposit taking and loan origination activities to reflect, among other things, the importance of offering valued customer services that generate additional fee income, and it is expected that management will continue this trend after the Conversion. Noninterest Expense. The major components of noninterest expense are compensation and benefits paid to the Bank's employees and directors, occupancy expense for ownership and maintenance of the Bank's building and furniture and equipment, and insurance premiums paid to the FDIC for insurance of deposits. Total noninterest expense for the year ended June 30, 1997 was $5,578,934, compared to $2,350,658 for the year ended June 30, 1996. The increase was largely due to an increase in expense related to a one time assessment by the FDIC to the Bank to replenish the SAIF depleted by prior years losses in the thrift industry. During the years in which thrifts as an industry, suffered many publicized and non-publicized "bailouts" by the SAIF, and its predecessor, the Federal Savings and Loan Insurance Corporation, the deposit insurance fund for the thrift industry was severely depleted. After several years of debate Congress with the assistance of the FDIC, which administers the SAIF, consummated a plan of action to replenish the SAIF to a level of coverage required by statute (the designated reserve ratio of 1.25% of insured deposits) for the remaining covered deposits. The plan of remedy included a one time assessment to each thrift institution based on capital levels, and deposits among other factors. This one time assessment was recognized by the Bank in the year ended June 30, 1997, in the amount of $889,011 and was expensed in the same period. This assessment was paid November 27, 1996. The effective deposit insurance rate prior to the assessment was .23% compared to a rate of .065% after the assessment. The second largest component of noninterest expense for 1997 and 1996 was compensation expense, which totaled $2,029,428 in 1997 compared to $919,772 in 1996. This increase was attributable to increases in salary expense due to an increase in personnel for future growth, the acquisition of the subsidiary savings bank and increased directors fees due to additional time incurred by the Board in evaluating and working on various strategic plans for the Bank. Other noninterest expense incurred during the year ended June 30, 1997, included amounts incurred to facilitate the name change of the Bank to HEARTLAND Community Bank in September 1996. In addition, fees were incurred for personnel placement services to attract key personnel for hire, a computer consultant was engaged to evaluate operating systems and further growth needs, and marketing consultants were approached for market strategies and implementation. These expense categories increased $721,554 during the year ended June 30, 1997 compared with the same period in 1996. Noninterest expense increased for the year ended June 30, 1997, compared to the year ended June 30, 1996, by approximately $1,382,000 as a direct result of the acquisition of the subsidiary savings bank, exclusive of the FDIC one-time assessment. Included in noninterest expenses for the year ended June 30, 1997 was a charge for the amortization of goodwill of $160,073, which resulted from the acquisition of the subsidiary bank during the year ended June 30, 1996. The amortization will be $160,073 per year over a ten year period, subsequent to June 30, 1996, and is not expected to have a material effect on the future earnings of the Bank. 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, introducing new deposit and loan products and services and implementing planned stock benefit plans, it is expected that the Bank's noninterest expense levels may remain somewhat high relative to the historical levels for the Bank, as well as the prevailing levels for institutions that are not undertaking such expansions, for an indefinite period of time, as management implements the Bank's business strategy. Among the activities planned are increased loan originations in the areas of multi-family residential, commercial real estate, commercial business and consumer loans. Customer products being introduced include ATM and debit cards and an expanded deposit account mix. In addition, two new branch facilities were constructed, which were completed in July and August 1997. Other existing facilities are being renovated to attract and serve an increased customer base. Income Taxes. The effective income tax rates for the Bank for the years ended June 30, 1997 and 1996 were (28.26)% and 43.7%, respectively, which included federal and Arkansas tax components. A tax benefit of $166,645 for 1997 and an expense of $174,801 for 1996 was recognized. Sources of Capital and Liquidity The Company has no business other than that of the Bank. The Company's primary sources of liquidity are dividends paid by the Bank and repayment of the ESOP loan. The Bank is subject to regulatory limitations with respect to the payment of dividends to the Company. The Bank has historically maintained substantial levels of capital. The assessment of capital adequacy is dependent on several factors including assets 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. These levels of capital have been achieved through consistent earnings enhanced by low levels of noninterest expense and have been maintained at those high levels as a result of its historical policy of moderate growth. The Bank is required to maintain minimum levels of liquid assets as defined by the OTS regulations. This requirement which may be varied at the discretion of the OTS depending on economic conditions and deposit outflows, is based upon a percentage of deposits and short term borrowings. Current OTS regulations require that a savings institution maintain liquid assets of not less than 5% of its average daily balance of net withdrawal deposit accounts and borrowings payable in one year or less, of which short-term liquid assets must consist of not less than 1%. At June 30, 1997, the Bank's liquidity was in excess of the minimum OTS liquidity requirements. Management of the Bank seeks to maintain a relatively high level of liquidity in order to retain flexibility in terms of investment opportunities and deposit pricing and in order to meet funding needs of deposit outflows and loan commitments. Historically, the Bank has been able to meet its liquidity demands through internal sources of funding supplemented from time to time by advances from the FHLB of Dallas. The Bank's primary source of funds are deposits, proceeds from principal and interest payments on loans and mortgage-backed securities, interest payments and maturities of investment securities, and earnings. While scheduled principal repayments on loans and mortgage-backed securities and interest payments on investment securities are a relatively predictable source of funds, deposit flows and loan and mortgage-backed prepayments are greatly influenced by general interest rates, economic conditions, competition and other factors. The Bank does not solicit deposits outside of its market area through brokers or other financial institutions. The Bank has also designated certain securities as available for sale in order to meet liquidity demands. At June 30, 1997, the Bank had designated securities with a fair value of approximately $36.3 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. Another source of liquidity is the net proceeds of the Conversion. The Bank has received over half of the net proceeds of the Conversion. These funds have been used by the Bank for its business activities, including investment in interest-earning assets. At June 30, 1997, the Bank had outstanding $4,027,495 in commitments to originate loans (including unfunded portions of construction loans) and $78,000 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 $53.7 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 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. INDEPENDENT AUDITORS' REPORT Board of Directors HCB Bancshares, Inc. and Subsidiaries Camden, Arkansas We have audited the accompanying consolidated statements of financial condition of HCB Bancshares, Inc. and its subsidiaries as of June 30, 1997 and the related consolidated statements of income, stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements for the years ended June 30, 1996 and 1995 were audited by another auditor and their report is attached hereto. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. 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 in significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HCB Bancshares, Inc. and its subsidiaries as of June 30, 1997 and the results of their consolidated operations and cash flows for the years ended in conformity with generally accepted accounting principles. /s/ Miller, England & Co. Little Rock, Arkansas September 5, 1997 [LETTERHEAD OF GAUNT & COMPANY, LTD. APPEARS HERE] INDEPENDENT AUDITORS' REPORT Board of Directors Heartland Community Bank and Subsidiaries (formerly First Federal Savings and Loan Association of Camden) Camden, Arkansas We have audited the accompanying consolidated statements of financial condition of Heartland Community Bank (formerly First Federal Savings and Loan Association of Camden) and its subsidiary as of June 30, 1996 and 1995 and the related consolidated statements of income, equity and cash flows for the years then ended. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatements. 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 in significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Heartland Community Bank (formerly First Federal Savings and Loan Association of Camden) and its subsidiary as of June 30, 1996 and 1995 and the results of their consolidated operations and cash flows for the years ended in conformity with generally accepted accounting principles. As discussed in note 18, the financial statements for the year ended June 30, 1996, are consolidated as a result of the acquisition of the wholly owned-subsidiary on May 3, 1996. Also discussed in note 1c, as of July 1, 1994 the Bank changed its method of accounting for certain investments in debt and equity securities. /s/ Gaunt & Company, Ltd.* Little Rock, Arkansas August 28, 1996 (Except for Note [23], as to which the date is February 4, 1997) - ---------------- *This auditors' report was provided for use in the registrant's Registration Statement on Form SB-2 (No. 333-19093) declared effective March 21, 1997. The auditors did not provide this report for use in this Annual Report on Form 10-K. Changes to conform with the current financial statements and notes are in brackets. The changed reference to Note [23] was to Note 27 in the original auditors' report. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Financial Condition June 30, 1997 and 1996
ASSETS ------ June 30, ------------------------------ 1997 1996 ------------- --------------- Cash and cash equivalents $ 1,182,210 $ 422,509 Interest-bearing deposits in other financial institutions 18,273,882 16,869,373 Investment Securities (Note 2) Securities available for sale 16,155,755 5,279,625 Mortgage-backed securities (Note 2) Securities available for sale 20,090,406 12,155,199 Securities held-to-maturity (estimated market value of $36,194,353, and $44,934,075 respectively) 35,869,295 45,212,891 Loans, (net of allowance of $1,492,473 $1,283,234 respectively) (Note 3) 98,642,635 84,131,024 Accrued interest receivable 1,339,455 977,004 Foreclosed real estate, net 36,179 168,206 Premises and equipment (Note 7) 4,613,006 2,124,293 Land held for resale 480,000 -- Stock in Federal Home Loan Bank (at cost) 1,246,500 1,199,000 Income taxes receivable 648,398 556,959 Deferred tax asset 95,928 134,210 Goodwill, net of amortization (Note 16) 1,415,223 1,575,296 Other assets 276,906 429,733 ------------- ------------- TOTAL ASSETS $ 200,365,778 $ 171,235,322 ============= =============
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Financial Condition June 30, 1997 and 1996 LIABILITIES and EQUITY ----------------------
June 30, --------------------------------- LIABILITIES 1996 1996 --------------- --------------- Deposits (Note 8) $ 151,208,763 $ 145,919,251 Advances - Federal Home Loan Bank (Note 9) 10,000,000 10,000,000 Note payable (Note 10) 400,000 - - Accrued interest payable 410,477 395,939 Advances from borrowers for taxes and insurance 209,140 114,004 Accrued income taxes payable - - - - Other liabilities 397,885 577,692 --------------- --------------- Total Liabilities $ 162,626,265 $ 157,006,886 --------------- --------------- Commitments and Contingencies Note (6 and 14) STOCKHOLDERS' EQUITY Common stock, .01 par value, authorized 10,000,000 shares $ $ issued and outstanding 2,625,000 shares 2,645 - - Additional paid-in capital 25,794,471 - - Notes receivable, ESOP (Note 25) (2,116,000) - - Retained earnings, substantially restricted (Note 13 and 21) 14,091,750 14,514,749 Unrealized loss on securities available-for-sale, net of applicable deferred taxes (33,353) (286,313) --------------- --------------- Total Stockholders' Equity $ 37,739,513 $ 14,228,436 --------------- --------------- TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 200,365,778 $ 171,235,322 =============== ===============
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Income For the years ended June 30, 1997, 1996 and 1995
INTEREST INCOME 1997 1996 1995 ------------- ------------- ------------- Interest and fees on loans $ 8,038,783 $ 5,352,338 $ 4,526,621 Investment securities 849,541 252,560 202,942 Mortgage-backed and related securities 3,586,895 4,215,125 3,927,181 Other interest income 626,457 513,158 188,038 ------------- ------------- ------------- Total interest income $ 13,101,676 $ 10,333,181 $ 8,844,782 ------------- ------------- ------------- INTEREST EXPENSE Deposits (Note 8) $ 7,534,445 $ 6,314,641 $ 4,979,125 Borrowed funds 636,337 451,957 133,356 Notes payable 25,000 - - - - ------------- ------------- ------------- Total interest expense $ 8,195,782 $ 6,766,598 $ 5,112,481 ------------- ------------- ------------- Net interest income $ 4,905,894 $ 3,566,583 $ 3,732,301 Provision for loan losses (Note 3) $ 221,671 $ 42,483 $ - - ------------- ------------- ------------- Net interest income after provision for loan losses $ 4,684,223 $ 3,524,100 $ 3,732,301 ------------- ------------- ------------- NONINTEREST INCOME Net realized gain (loss) on sales of available for sale securities (Note 2) $ (21,215)$ (926,947) $ 101,994 Gain on sale of foreclosed real estate 18,911 - - - - Gain on sale of loans 3,261 Banking service charges 203,023 79,245 62,093 Other income 101,087 74,050 31,936 ------------- ------------- ------------- Total noninterest income (loss) $ 305,067 $ (773,652) $ 196,023 ------------- ------------- -------------
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Income For the years ended June 30, 1997, 1996 and 1995
NONINTEREST EXPENSE 1997 1996 1995 ------------- ------------- ------------- Salaries and compensation $ 2,029,428 $ 919,772 $ 789,685 Retirement and ESOP plan cost (Note 17 and 24) 427,617 319,997 45,569 Occupancy and equipment 366,596 172,278 117,467 Federal deposit insurance premiums (Note 22) 1,084,547 268,370 257,126 Loss on foreclosed real estate 32,857 43,439 19,127 Data processing expenses 269,067 114,171 97,984 Professional fees 411,984 109,986 47,376 Amortization of goodwill 160,073 25,436 - - Other expenses 796,765 377,209 235,627 ------------- ------------- ------------- Total noninterest expense $ 5,578,934 $ 2,350,658 $ 1,609,961 ------------- ------------- ------------- Income (loss) before income taxes and cumulative effect of change in accounting principle $ (589,644) $ 399,790 $ 2,318,363 Provision for income taxes (benefits) (166,645) 174,801 966,763 ------------- ------------- ------------- Income (loss) before cumulative effect of change in accounting principle $ (422,999) $ 224,989 $ 1,351,600 Change in accounting principle - cumulative effect of application of Statement on Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt Equity Securities" - - - - 77,567 ------------- ------------- ------------- Net income (loss) $ (422,999) $ 224,989 $ 1,429,167 ============= ============= ============= Earnings per share (Note 1 and 21) $ (0.17) $ - - $ - - ============= ============= ============= Cash dividends per share (Note 1 and 21) $ - - $ - - $ - - ============= ============= =============
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity For the years ended June 30, 1997, 1996 and 1995
Unrealized Common Additional Note Holding Stock Paid-in Receivable Retained Gain (Loss) (par) Capital ESOP Earnings Adjustment Total --------- ------------ ------------ ------------ ------------- --------------- Balance at June 30, 1994 $ -- -- $ -- $ 12,860,593 $ -- $ 12,860,593 Net income 1,429,167 1,429,167 Unrealized gain (loss) on securities available for sale, net of deferred taxes -- -- -- -- (18,788) (18,788) --------- ------------ ------------ ------------ ------------- --------------- Balance at June 30, 1995 14,289,760 (18,788) 14,270,972 Net income 224,989 224,989 Unrealized gain (loss) on securities available for sale, net of deferred taxes -- -- -- -- (267,525) (267,525) --------- ------------ ------------ ------------ ------------- --------------- Balance at June 30, 1996 -- -- -- 14,514,749 (286,313) 14,228,436 Net (loss) (422,999) (422,999) Net proceeds from issuance of common stock (Note 21) 2,645 23,642,341 23,644,986 Purchase of common stock by the ESOP 2,116,000 (2,116,000) -- ESOP contribution (Note 25) 36,130 36,130 Unrealized gain (loss) on securities available for sale, net of deferred taxes 252,960 252,960 --------- ------------ ------------ ------------ ------------- --------------- Balance at June 30, 1996 $ 2,645 25,794,471 $ (2,116,000) $ 14,091,750 $ (33,353) $ 37,739,513 ========= ============ ============ ============ ============= ===============
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flow For the years ended June 30, 1997, 1996 and 1995
June 30, -------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES 1997 1996 1995 ------------- ------------- ------------- Net Income (Loss) $ (422,999) $ 224,989 $ 1,429,167 ------------- ------------- ------------- Adjustments to reconcile net income to cash provided by operating activities: Depreciation $ 159,725 $ 66,005 $ 51,234 Amortization of: Deferred loan origination fees (26,698) 6,258 55,349 Goodwill 160,073 25,436 - - Premiums and discounts on loans (27,627) 309 (119) Premiums and discounts on investment securities (24,428) 125,952 106,296 Provision for loan loss 220,671 42,483 - - Provision for loss on foreclosed real estate 13,528 30,000 - - Deferred income taxes (110,574) (57,986) 147,239 Cumulative effect of FASB #115 adoption - - - - (77,567) Net (gain) loss on sale of investments: Available for sale 21,215 926,946 (99,093) Held-to-maturity - - - - (2,902) (Gain) loss on disposal of other assets 2,558 (5,732) 12,468 ESOP contribution credited to capital 36,130 - - - - Decrease (increase) in accrued interest receivable (363,939) 4,743 (60,723) Increase in accrued interest payable 14,538 29,818 35,718 (Increase) decrease in other assets 5,909 (174,649) (93,218) Increase (decrease) in other liabilities (127,957) 442,156 5,691 (Increase) in prepaid / payable income taxes (56,271) (567,831) 37,729 ------------- ------------- ------------- Total adjustments $ (103,147) $ 893,908 $ 118,102 ------------- ------------- ------------- Net cash flows provided (used) by operating activities $ (526,146) $ 1,118,897 $ 1,547,269 ------------- ------------- -------------
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flow For the years ended June 30, 1997, 1996 and 1995
June 30, -------------------------------------------------------- 1997 1996 1995 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES Loan originations and principal payments on loans $ (16,575,647) $ (5,283,509) $ 1,401,183 Proceeds from sale of loans 1,804,100 244,230 Purchase of loans (1,305,000) (4,555,000) (2,628,000) Proceeds from sale of investment securities: Available for sale 7,754,176 18,151,851 7,023,989 Held-to-maturity - - - - 406,779 Purchase of investment securities available for sale (28,986,589) (1,995,000) (9,780,348) Purchase of investment securities held-to-maturity - - (20,475,412) (5,094,695) Principal payments on investment securities 11,627,182 10,506,353 8,641,932 Investment in subsidiary - - (1,492,782) - - Investment in foreclosed real estate - - - - (2,378) Proceeds from sale of other assets 62,550 19,723 55,514 Purchases of premises and equipment (3,118,319) (762,178) (167,526) ------------- ------------- ------------ Net cash flows used by investing activities $ (28,737,547) $ (5,641,724) $ (143,550) ------------- ------------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in demand deposits, NOW accounts, passbook savings accounts and certificates of deposit $ 5,289,512 $ 8,806,600 $ (1,345,081) Net (decrease) increase in mortgage escrow funds (22,594) (117,491) 11,983 Proceeds from note payable 400,000 - - - - Net proceeds from issuance of common stock 25,760,985 - - - - Advances from FHLB - - 10,000,000 - - ------------- ------------- ------------- Net cash flows provided (used) by financing activities $ 31,427,903 $ 18,689,109 4 (1,333,098) ------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents $ 2,164,210 $ 14,166,283 $ 70,621 Cash and cash equivalents, beginning of year $ 17,291,882 $ 3,125,599 $ 3,054,978 ------------- ------------- ------------- Cash and cash equivalents, end of year $ 19,456,092 $ 17,291,882 $ 3,125,599 ============= ============= ============= Suplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 3,162,551 $ 6,775,124 $ 4,961,607 Income taxes $ 419,961 $ 786,845 $ 782,602 Loans transferred to foreclosed real estate $ 51,000 $ 126,307 $ 122,165 Suplemental disclosure of noncash investing and financing activities: Stock issued in exchange for note receivable from ESOP $ 2,116,000 $ - - $ - - ============= ============= =============
See accompanying notes to consolidated financial statements. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1 - Summary of Significant Accounting Policies - --------------------------------------------------- Conversion and Organization of Holding Corporation - -------------------------------------------------- On April 30, 1997, pursuant to a Plan of Conversion which was approved by its members and regulators, Heartland Community Bank ("Bank") converted from a federally chartered mutual savings and loan association to a federally chartered stock savings and loan association, and became a wholly-owned subsidiary of HCB Bancshares, Inc. (the "Corporation"). The Corporation was formed under Oklahoma Law in December 1996 to acquire all of the common stock of the Bank upon its conversion to stock form. The Corporation has no other operations and conducts no business of its own other than owning the Bank, investing its portion of the net proceeds received in the Conversion, and lending funds to the Employee Stock Ownership Plan (the "ESOP") which was formed in connection with the Conversion. Nature of Business - ------------------ The Bank and its subsidiary bank, are a federally chartered operating savings and loan association primarily engaged in the business of obtaining deposits and providing mortgage credit to the general public. The Association's primary regulator is the Office of Thrift Supervision (OTS) and its deposits are insured by the Savings Association Insurance Fund ("SAIF") of the FDIC. Basis of Financial Statement Presentation - ----------------------------------------- The accounting and reporting policies of the Corporation conform to generally accepted accounting principles and general practices within the financial services industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Outlined below are the accounting and reporting policies considered significant by the Corporation. Basis of Consolidation - ---------------------- The consolidated financial statements as of June 30, 1997 and 1996, include the accounts of HCB Bancshares, Inc., Heartland Community Bank (formerly First Federal Savings and Loan Association of Camden), (see also Note 18), and its wholly-owned subsidiaries, (Heartland Community Bank, FSB (formerly Heritage Banc Holding, Inc. and its wholly-owned subsidiary) and HCB Properties, Inc. (see also Note 16 and 20). All material intercompany balances and transactions have been eliminated in the consolidation. Cash Equivalents - ---------------- For purposes of the statements of cash flows, the Bank considers all highly liquid debt instruments with original maturities when purchased of three months or less to be cash equivalents. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1 - Summary of Significant Accounting Policies - Continued - --------------------------------------------------------------- Investment Securities and Mortgage-Backed Securities - ---------------------------------------------------- In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Bank adopted the provisions of the new standard for investments held as of July 1, 1994. Under the new rules, securities that the Bank has both the positive intent and ability to hold to maturity are carried at amortized cost. Securities that the Bank does not have the positive intent and ability to hold to maturity are classified as available-for-sale or trading and are carried at fair value. Unrealized holding gains and losses, net of tax, on securities classified as available - for-sale are carried as a separate component of equity. The Bank does not carry any trading securities. The cumulative effect as of July 1, 1994, of adopting Statement No. 115 included the reversal of $77,567 previously included in earnings that is to be excluded from earnings under this statement. Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by issuers of the securities. Mortgage-backed securities that are classified held-to-maturity are carried at unpaid principal balances, adjusted for unamortized premiums and unearned discounts. Premiums and discounts are amortized using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Gains and losses on the sale of securities are determined using the specific identification method. If the fair value of an investment security declines for reasons other than temporary market conditions, the carrying value of such security is written down to current value by a charge to operations. Securities Held to Maturity: Securities classified as held to maturity are those - --------------------------- debt securities the Corporation has both the intent and the ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premiums or accretion of discounts, computed by a method which approximates the interest method over their contractual lives. In the event of a permanent decline in market value, these securities may be adjusted to fair market value. The unrealized loss on write down of securities held to maturity is charged to current operations. Securities Available for Sale: Securities classified as available for sale are - ----------------------------- those debt securities that the Corporation intends to hold for an indefinite period of time but not necessarily to maturity and marketable equity securities not classified as held for trading. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of its securities, liquidity needs and other similar factors. Securities available for sale are carried at fair value. Unrealized gains and losses are reported as a separate component of equity, net of related tax effects. Realized gains and losses are included in earnings. Securities Held for Trading: Trading securities are held in anticipation of - --------------------------- short-term market gains. Such securities are carried at fair value with realized and unrealized gains and losses included in earnings. The Corporation currently has no securities which are classified as trading. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1 - Summary of Significant Accounting Policies - Continued - --------------------------------------------------------------- Loans Receivable - ---------------- Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, and net of deferred loan-origination fees and discounts. Discounts on first mortgage loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts on consumer loans are recognized over the lives of the loans using the interest method. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries.) Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. The Bank has adopted SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" which was amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures" on October 1, 1995. These statements prescribed the recognition criterion for loan impairment and the measurement methods for certain impaired loans and loans whose terms are modified in troubled debt restructuring. These measurement methods apply to all creditors and all loans, uncollateralized as well as collateralized, except for larger groups smaller-balanced homogeneous loans that are collectively evaluated for impairment, loans measured at fair market or lower of cost or fair value, leases and debt securities. The Bank considers all one-to-four family residential loans, construction loans, auto loans and other consumer loans, (as presented in Note 4), to be smaller homogenous loans. These statements apply to all restructured loans that involve a modification of terms. Loans within the scope of these statements are considered impaired when, based on current information and events, it is probable that all principal and interest will not be collected in accordance with the contractual terms of the loans. Management determines impairment of the loans based on knowledge of the borrower's repayment history. Pursuant to SFAS No. 114, paragraph 8, management has determined that a delay less than 90 days will be considered an insignificant delay and that an amount less than $25,000 will be considered an insignificant shortfall. The Bank does not apply SFAS No. 114 using major risk classifications, but applies SFAS No.114 on a loan by loan basis. All nonaccrual loans are considered to be impaired. Nonaccrual loans are specifically designated and segregated within the loan portfolio by management. Loans are charged off when management determines that principal and interest are not collectible. At June 30, 1997 and 1996, only nonaccrual loans were considered to be impaired. (See Note 4) Uncollectible interest on loans, all categories, that are contractually past due over ninety (90) days is charged off, or an allowance is established based on management's periodic evaluation. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is back to normal, in which case the loan is returned to accrual status. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1 - Summary of Significant Accounting Policies - Continued - --------------------------------------------------------------- Loan-Origination Fees, Commitment Fees, and Related Costs - --------------------------------------------------------- Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for estimated prepayments based on the Bank's historical prepayment experience. Commitment fees and costs relating to commitments, the likelihood of exercise of which is remote, are recognized over the commitment period on a straight-line basis. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment to yield. Foreclosed Real Estate - ---------------------- Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value (less selling costs) at the date of foreclosure. Costs relating to development and improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management, and an allowance for losses is established by a charge to operations if the carrying value of a property exceeds its estimated net realizable value. Income Taxes - ------------ The Bank records income tax expense based on the amount of taxes currently due on its tax return plus deferred taxes computed based on the expected future tax consequences of temporary differences between the financial statement amounts and tax basis of assets and liabilities, using existing tax rates. Premises and Equipment - ---------------------- Land is carried at cost. Buildings and furniture, fixtures, and equipment are carried at cost, less accumulated depreciation and amortization. Buildings and furniture, fixtures and equipment are depreciated using the straight-line method over the estimated useful lives of the assets which range from 15 to 40 years for buildings and improvements and 3 to 10 years for equipment. Fair Values of Financial Instruments - ------------------------------------ During the year ended June 30, 1996, the Bank adopted Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments", requires disclosure of fair value information about financial instruments, whether or not recognized in the statement of financial condition. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1 - Summary of Significant Accounting Policies - Continued - --------------------------------------------------------------- Fair Values of Financial Instruments - Continued - ------------------------------------------------ The following methods and assumptions were used by the Bank in estimating its fair value disclosures for consolidated financial instruments at June 30, 1997: Cash and cash equivalents: The carrying amounts reported in the statement of - ------------------------- financial condition for cash and cash equivalents approximate those assets' fair values. Time deposits: Fair values for time deposits are estimated using a discounted - ------------- cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. Investment securities: Fair values for investment securities are based on quoted - --------------------- market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans: For variable-rate loans that reprice frequently and with no significant - ----- change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The carrying amount of accrued interest receivable approximates its fair value. Deposits: The fair values disclosed for demand deposits (for example, - -------- interest-bearing checking accounts and passbook accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts.) The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value. Short-term borrowings and notes payable: The carrying amounts of short-term - --------------------------------------- borrowings and notes payable approximate their fair values. Other liabilities: Commitments to extend credit were evaluated and fair value - ----------------- was estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter-parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. NOTE 2 - Investment and Mortgage-Backed Securities - -------------------------------------------------- Investment Securities: The amortized cost and estimated market values of - --------------------- investment securities at June 30, 1997, are summarized as follows:
Available for Sale ------------------------------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Gains Unrealized Market Values Cost Losses ----------------- ----------------- ---------------- ----------------- U.S. Government and Federal Agencies $16,178,740 $ 9,646 $ 32,631 $ 16,155,755 ========== ====== ======= ===========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 2 - Investment and Mortgage-Backed Securities - Continued - -------------------------------------------------------------- The amortized cost and estimated market values of investment securities at June 30, 1996, are summarized as follows:
Available for Sale ------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Market Values ----------------- ----------------- ---------------- ----------------- U.S. Government and Federal Agencies $ 5,306,383 $ -- $ 26,758 $ 5,279,625 ========== ===== ======= ==========
The scheduled maturities of investment securities were as follows:
June 30, 1997 June 30, 1996 ----------------------------------- --------------------------------- Amortized Amortized Available for Sale Cost Market Value Cost Market Value - ------------------ ---------------- --------------- --------------- -------------- Due in one year or less $ 1,499,413 $ 1,503,866 $ 1,398,728 $ 3,387,887 Due after one year through five years 12,769,327 12,647,279 3,353,836 3,340,631 Due after five through ten years 2,000,000 2,004,610 554,819 551,107 ----------- ----------- ---------- ---------- $ 16,178,740 $ 16,155,755 $ 5,306,383 $ 5,279,625 =========== =========== ========== ==========
Proceeds from sales of securities available-for-sale during the year ended June 30, 1997 and 1996 were $7,571,924 and $1,006,875, respectfully. Gross losses of $21,215 were realized on those sales for the year ended June 30, 1997 and gross gains of $10,358 were realized on those sales recorded in the year ended June 30, 1996. Mortgage-Backed Securities: Mortgage-backed securities consist of the following - -------------------------- at June 30, 1997:
Available-for-Sale ----------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Market Values ----------------- ----------------- ----------------- ---------------- Mortgage-backed securities $ 13,854,553 $ 111,663 $ 33,399 $ 13,919,065 Collateralized Mortgage Obligations 6,270,999 15,723 114,173 6,171,341 ----------- -------- -------- ----------- $ 20,125,552 $ 127,286 $ 147,572 $ 20,090,406 =========== ======== ======== =========== Held-to-Maturity ---------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Market Values ----------------- ----------------- ----------------- ---------------- Mortgage-backed securities $ 35,869,295 $ 584,890 $ 259,832 $ 36,194,353 =========== ======== ======== ===========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 2 - Investment and Mortgage-Backed Securities - Continued - -------------------------------------------------------------- Mortgage-Backed Securities - Continued - -------------------------------------- Mortgage-backed securities consist of the following at June 30, 1996:
Available-for-Sale ----------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Market Values ----------------- ----------------- ----------------- ----------------- Mortgage-backed securities $ 3,135,911 $ 8,612 $ 23,928 $ 3,120,595 Collateralized Mortgage Obligations 9,455,472 1,043 421,911 9,034,604 ----------- ------ -------- ----------- $ 12,591,383 $ 9,655 $ 445,839 $ 12,155,199 =========== ====== ======== =========== Held-to-Maturity ----------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Market Values ----------------- ----------------- ----------------- ----------------- Mortgage-backed securities $ 45,212,891 $ 470,641 $ 749,458 $ 44,934,074 =========== ======== ======== ===========
The amortized cost and fair value of mortgage-backed securities by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
June 30, 1997 June 30, 1996 ---------------------------------- ----------------------------------- Amortized Market Amortized Market Value Available-For-Sale Cost Value Cost ------------------ --------------- -------------- --------------- ---------------- Due in one year or less $ $ $ 995,571 $ 991,951 - - - - Due after one through five years 2,194,753 2,197,535 771,337 777,371 Due after five through ten years 5,431,474 5,483,501 2,578,400 2,341,674 Due after ten years 12,499,325 12,409,370 8,246,075 8,044,202 ----------- ----------- ----------- ----------- $ 20,125,552 $ 20,090,406 $ 12,591,383 $ 12,155,198 =========== =========== =========== =========== June 30, 1997 June 30, 1996 ----------------------------------- ---------------------------------- Amortized Market Amortized Market Held-To-Maturity Cost Value Cost Value ---------------- ---------------- --------------- ---------------- -------------- Due after one through five years $ 703,741 $ 700,000 $ 285,348 $ 297,587 Due after five through ten years 1,456,595 1,500,000 2,485,383 2,597,545 Due after ten years 33,708,959 33,994,350 42,445,160 42,038,942 ----------- ----------- ----------- ----------- $ 33,869,295 $ 36,194,350 $ 45,212,891 $ 44,934,074 =========== =========== =========== ===========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 2 - Investment and Mortgage-Backed Securities - Continued - -------------------------------------------------------------- Mortgage-Backed Securities - Continued - -------------------------------------- All mortgage-backed securities were issued by either U.S. government agencies (Government National Mortgage Association, Federal National Mortgage Association), government-sponsored enterprises (Federal Home Mortgage Corporation or Resolution Trust Corporation) or private issuer mortgage-backed securities. As of June 30, 1997 and 1996, the carrying value of privately issued mortgage-backed securities included in the above schedules are presented below:
June 30, 1997 June 30, 1996 ------------- ------------- Available-for-sale $ 6,271,822 $ 8,637,067 Held-to-maturity 5,794,156 32,896,294 ----------- ----------- $ 32,065,978 $ 41,533,361 =========== ===========
During the year ended June 30, 1996, the Bank sold mortgage-backed securities available-for-sale for total proceeds of $17,144,976 and realized gross gains of $3,839 and gross losses of $941,324. In the year ended June 30, 1996, proceeds from sale of mortgage-backed securities held-to-maturity, of which greater than 85% of he principal had already been collected, were $406,779. Gross gains of $4,512 and gross losses of $1,610 were realized on those sales. On December 11, 1995, securities with an amortized cost of $26,270,667 were transferred from held-to-maturity to available-for-sale because of a one time reassessment in accordance with the implementation guidance of Statement No 115 on "Accounting for Certain Investments in Debt and Equity Securities". The securities had an unrealized loss of approximately $898,756. During the fiscal year 1997, the Bank was notified of a downgrade in the rating of one of its private issue obligations. The security is Citicorp Mortgage, Inc. - REMIC pass-thru certificates. The downgrade reflected deterioration in the performance of the mortgage pools underlying the certificates. Though the Class A Certificate holders have suffered no interest losses and suffered $625,223 in principle losses to date. The Bank's par balance of this security as of June 30, 1997 was $871,312 which represented 1.36% of the total outstanding pool of $64,244,942. The Class A credit enhancement available to certificate holders was $2,901,490 at June 30, 1997. As long as this amount is positive no significant loss to the bank, if any, is anticipated. Gains are summarized as follows for the years ended June 30, 1996 and 1995:
June 30, ----------------------------------- Realized gain on sales of: 1997 1996 --------------- ---------------- Mortgage-backed securities $ - - $ 3,839 Investment securities - - 10,538 ----------- - - 14,377 Realized losses on sales of - - Mortgaged-back securities - - (941,324) Investment Securities $ (21,215) - - -------- ---------- Net income (loss) $ (21,215) $ (926,947) ======== ==========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 3 - Loans Receivable - ------------------------- Loans receivable at June 30, 1997 and 1996 are summarized as follows:
Loans secured by first mortgages on real estate: June 30, 1997 June 30, 1996 ------------- ------------- Conventional 1-4 family residences $ 76,327,453 $ 61,650,286 Conventional Other 14,184,241 20,602,705 Loans to facilitate sales of foreclosed real estate 616,660 720,749 ------------ ----------- Total first mortgage loans 91,128,354 82,973,740 ------------ ----------- Loans secured by deposits 2,434,621 1,832,180 Auto 2,399,648 786,656 Home improvement and consumer loans 4,194,686 622,803 ------------ ----------- Total installment loans 9,028,955 3,241,639 ------------ ----------- Commercial loans 2,101,963 880,311 ------------ ----------- 102,359,272 87,095,690 ------------ ----------- Less: Allowance for loan losses 1,492,473 1,283,234 Net deferred loan fees, premiums and discounts 167,069 135,335 Loans in process 2,057,095 1,544,097 ------------ ----------- $ 98,642,635 $ 84,131,024 ============ ===========
Activity in the allowance for loan losses is summarized as follows for the years ended June 30, 1997 and 1996:
June 30, 1997 June 30, 1996 ------------- ------------- Balance at beginning of period $ 1,283,234 $ 728,491 Acquisition of subsidiary - - 524,140 Provision charged to income 221,671 42,483 Charge-offs (22,985) (12,130) Recoveries 10,553 250 ---------- ---------- Balance at end of period $ 1,492,473 $ 1,283,234 ========== ==========
At June 30, 1997 and 1996, the Bank had loans totaling $133,386 and $166,228 respectively on which interest had ceased to be recognized. The interest income not recorded on these loans totaled $12,177 and $7,718 respectively. At June 30, 1997 and 1996, the Bank had the following loans recognized as impaired loans under the criteria established by SFAS No.114 and SFAS No. 118:
June 30, 1997 June 30, 1996 ------------- ------------- Investment in loans - nonaccruals $ 133,386 $ 166,228 Related allowance for loan loss $ 33,346 $ 41,557
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 3 - Loans Receivable - Continued - ------------------------------------- Renegotiated loans for which interest has been reduced totaled $281,441 and $298,195 at June 30, 1997 and 1996. Interest income that would have been recorded under the original terms of such loans and the interest income actually recognized for the years ended June 30, 1997 and 1996 are summarized below:
June 30, 1997 June 30, 1996 ------------- ------------- Interest income that would have been recorded $ 29,729 $ 35,311 Interest income recognized 20,343 21,383 ------ ------ Interest income foregone $ 9,386 $ 13,927 ======= =======
The Bank is not committed to lend additional funds to debtors whose loans have been modified. NOTE 4 - Accrued Interest Receivable - ------------------------------------ Accrued interest receivable at June 30, 1997 and 1996 is summarized below:
June 30, 1997 June 30, 1996 ------------- ------------- Investment securities $ 348,044 $ 51,842 Mortgage-backed securities 309,440 332,064 Loans receivable 648,467 593,098 ESOP Plan 33,503 - - ---------- -------- $ 1,339,454 $ 772,620 ========== ========
NOTE 5 - Foreclosed Real Estate - ------------------------------- Activity in the allowance for losses for real estate foreclosed for the years ended June 30, 1997 and 1996 are presented below:
June 30, 1997 June 30, 1996 ------------- ------------- Balance at beginning of year $ 58,587 $ 28,587 Provision charged to income 13,527 30,000 Recoveries through sales (43,289) -- -------- -------- Balance at end of year $ 28,287 $ 58,587 ======== ========
NOTE 6 - Commitments and Contingencies - -------------------------------------- In the ordinary course of business, the Bank has various outstanding commitments and contingent liabilities that are not reflected in the accompanying financial statements. In addition, the Bank 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 financial position of the Bank. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 6 - Commitments and Contingencies - Continued - -------------------------------------------------- The principal commitments of the Bank and its subsidiary are as follows:
June 30, ----------------------------------- 1997 1996 ----------------- -------------- Fixed Rate - ---------- First mortgage loans $ 4,027,495 $ 1,127,500 Consumer loan - - 23,800 ---------- ---------- 4,027,495 1,151,300 Adjustable Rate - --------------- First mortgage loans - - 2,000,000 ---------- ---------- $ 4,027,495 $ 3,151,000 ========== ==========
In addition, the Bank had outstanding letter of credit to customers in the amount of $78,000 which were unfunded at year end June 30, 1997. NOTE 7 - Premises and Equipment - ------------------------------- Premises and equipment at June 30, 1997 and 1996 are summarized as follows:
Cost: June 30, 1997 June 30, 1996 - ----- ------------- ------------- Land and buildings $ 4,252,598 $ 2,207,867 Leasehold improvements 32,548 34,549 Equipment 1,074,130 545,293 ---------- ---------- 5,359,276 2,785,709 Accumulated depreciation (746,270) (661,416) ---------- ---------- $ 4,613,006 $ 2,124,293 ========== ==========
Depreciation expense amounted to $159,725 and $66,005 for the years ended June 30, 1997 and 1996 respectively. NOTE 8 - Deposits - ----------------- Deposits at June 30, 1997 and 1996 are presented below:
June 30, 1997 June 30, 1996 --------------------------------------------- ------------------------------------------ Weighted Weighted Demand and NOW Average Average Accounts: Rate Amount % Rate Amount % ----------- ---------------- ---------- ----------- ---------------- ------- Non-interest bearing $ 2,689,637 1.78 $ 215,162 .14 Interest bearing 2.76% 6,716,760 4.44 2.65% 6,453,373 4.42 Money market 4.09% 17,807,493 11.78 4.14% 15,491,591 10.62 Passbook savings 3.04% 8,441,845 5.58 3.06% 8,028.15 5.50 ---------- ----- ---------- ----- 35,655,735 23.58 30,188,281 20.68 ---------- ----- ---------- -----
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 8 - Deposits - Continued - -----------------------------
Certificates of Deposit - ------------------------- 4.00% to 4.99% 4.84% 17,784,816 11.76 4.83% 13,614,170 9.26 5.00% to 5.99% 5.44% 81,821,344 54.11 5.39% 62,333,102 42.71 6.00% to 6.99% 6.30% 15,730,506 10.40 6.17% 39,600,698 27.16 7.00% to 7.99% 7.15% 216,362 .14 7.73% 283,000 .19 8.00% to 8.99% -- -- 8.00% 63,352 .06 ------------ ------ ------------ ------ 115,553,028 76.42 115,730,970 79.32 ------------ ------ ------------ ------ $151,208,763 100.00 $145,919,251 100.00 ============ ====== ============ ======
The aggregate amount of short-term jumbo certificates of deposit with a minimum denomination of $100,000 was approximately $49,373,751 and $8,924,677 at June 30, 1997 and 1996 respectively. Deposit accounts with balances in excess of $100,000 are not federally insured. At June 30, 1997 the scheduled maturities of consolidated certificates of deposit are as follows:
1998 1999 2000 2001 TOTAL -------------- -------------- -------------- -------------- -------------- 4.00% to 4.99% $17,784,816 $ 17,784,816 5.00% to 5.99% 31,453,008 $40,399,490 $ 8,398,091 $ 1,570,754 81,821,343 6.00% to 6.99% 4,319,330 9,810,321 1,600,856 -- 15,730,507 7.00% to 7.99% 100,000 10,000 100,000 6,632 216,362 ---------- ---------- ---------- ---------- ----------- $53,657,154 $50,309,811 $10,008,947 $ 1,577,116 $115,553,028 ========== ========== ========== ========== ===========
Interest expense on deposits for the years ended June 30, 1997 and 1996, is summarized as follows:
June 30, --------------------------------- 1997 1996 -------------- -------------- Money Market $ 775,882 $ 562,528 Passbook savings 235,320 194,014 NOW 179,721 128,322 Certificate of Deposit 6,343,522 5,429,775 --------- --------- $7,534,445 $6,314,641 ========= =========
NOTE 9 - Federal Home Loan Bank Advances - ---------------------------------------- Pursuant to collateral agreements with the Federal Home Loan Bank (FHLB), advances are secured by qualifying single family first mortgage loans. Advances at June 30, 1997 and 1996 have the following maturities:
Fixed Maturity Interest Rate -------- ------------- 2001 6.407% $ 5,000,000 2003 6.000% 5,000,000 ---------- $10,000,000 ==========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 10 - Note Payable - ---------------------- As of June 30, 1997, the Bank had a note payable outstanding to an unrelated Trust entity for the purchase of a banking facility site in the amount of $400,000. The note is payable in five annual installments of $80,000, plus interest at, seven and one-half percent (71/2%) per anum. NOTE 11 - Pension and Profit-Sharing Plans - ------------------------------------------ The Bank had a qualified, noncontributory defined benefit retirement plan covering all of its eligible employees. Employees are eligible when they have attained at least twenty-one years of age and six months of service with the Bank. The Bank adopted a resolution on July 1, 1996 to terminate the defined-benefit pension plan as of September 16, 1996 and to freeze benefit accruals under the plan as of July 31, 1996. The anticipates settlement of the related pension obligation within the next plan year. It is expected that the plan will qualify for a standard termination under the Internal Revenue Code for plans deemed "not in distress", meaning that plan assets are sufficient to provide all plan liabilities under the plan. All active participants will become fully vested in their accrued benefits. The following table sets forth the plan's funded status and amounts recognized in the Bank's consolidated statements of financial condition at June 30,1997 and 1996:
June 30 ----------------------------- 1997 1996 ------------- ------------ Actuarial present value of benefit obligations: Accumulated benefit obligation: Vested ($441,321) ($297,024) Nonvested - - (5,159) ---------- ---------- (441,321) (302,183) Effect of projected compensation - - (108,348) ---------- ---------- Projected benefit obligation for service rendered to date (441,321) (410,531) Plan assets at fair value 483,583 422,572 ---------- ---------- Funded Status 42,262 12,041 Unrecognized net (gain) or loss from past experience different from that assumed and effects of changes in assumptions 15,555 15,555 Unrecognized gain on curtailment of benefit obligation 108,348 - - Unrecognized net transition obligation (from adoption of FASB statement No. 87) being amortized over 26.35 years 14,968 14,968 ---------- ---------- Prepaid (accrued) pension cost $ 181,133 $ 42,564 ========== ==========
The components of net pension expense for the year ended June 30, 1997 and 1996 is as follows:
June 30 ----------------------- 1997 1996 ----------- ---------- Service cost-benefits earned during the period $ -- $ 23,874 Interest cost on projected benefit obligation 30,790 27,179 Actual return on plan assets (60,011) (54,544) Net amortization and deferral 30,221 29,059 -------- --------- Net pension expense $ -- $ 25,568 ======== =========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 11 - Pension and Profit-Sharing Plans - Continued - ------------------------------------------------------ Assumptions used to develop the net periodic pension cost were: Discount rate 7.5% 7.5% Expected long-term rate of return on assets 7.5% 7.5% Rate of increase in compensation levels 3.5% 3.5%
The actuarial values and tables were not available for the years ended June 30, 1997. The Bank had a profit-sharing (cash bonus) program. The year end of the plan coincides with the Bank's year end. Contributions to the profit-sharing (cash bonus) plan are based on five percent (5%) of the net profit after taxes for the period July 1 to May 31, of each year as the figures are available. All employees share equally in dollar amount based on employment for the entire plan year. Employees hired after July 1 and before June 30 of each year will participate on a pro-rated basis. Since contributions are not guaranteed from year to year and the computation is not determined by the board until the calculation period of July 1 to May 31 each year, no contribution is recorded for the profit-sharing plan for the year end June 30, 1997. Contributions for the plan years ended June 30, 1997 and June 30, 1996 were $ 6,818 and $37,512 respectively. 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 meeting the age requirement of twenty-one and the length-of-service to the Bank requirement of one year. The Bank makes a matching contribution of twenty percent (20%) of the first eight percent (8%) of employee contributions. Matching contributions to the plan were $ 25,997 and $1,188 for the year ended June 30, 1997 and 1996, respectively. NOTE 12 - Income Taxes - ---------------------- The Bank filed consolidated federal income tax returns on a fiscal year basis for the years ended June 30, 1997 and 1996. If certain conditions are met in determining taxable income, the Bank is allowed a special bad-debt deduction based on a Percentage of taxable income (presently eight (8) percent) or on specific experience formulas. The Bank used the percentage-of -taxable income method in the years June 30, 1997 and 1996. During the year end June 30, 1997 the Small Business Job Protection Act of 1996 (the 1996 Act) became effective for tax years beginning after December 31, 1995 and effected tax related deductions pertaining to reserves for bad debt. The 1996 Act repealed the internal revenue code section which in prior years allowed using a percentage of taxable income or actual loss. In addition to the repeal of the Code, the Bank is subject to a recapture of previously deducted provisions to bad debt reserves for tax purposes, since 1988, which exceed the calculations which would have been applicable using the historical "experience method", compared to a base reserve at the end of 1988. The estimated amount to be recaptured is approximately $738,887 with an applicable tax component of $251,222. The 1996 Act provided for a delay in the recapture tax payment for up to two years, if certain real estate lending conditions are met and at the point of recapture allows the tax to be repaid over a six year period. This potential recapture has been considered in recent years in calculating the deferred tax liability components by a valuation allowance of the bad debt reserves. The future calculation of the recapture tax due to the 1996 Act, as it relates to bad debt reserves, is not expected to have a significant effect on any future earnings. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 12 - Income Taxes - Continued - ---------------------------------- Effective July 1, 1993 the Bank adopted Statement No. 109 of the Financial Accounting Standards Board in accounting for income taxes. Deferred tax components include timing differences related to depreciation, allowance for loan loss reserves and premium and discounts on loans and investments. These are highlighted below: Retained earnings at June 30, 1997 and 1996, include approximately $3,462,860 for which no deferred federal income tax liability has been recognized. This amount represents an allocation of income to bad-debt deductions for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad-debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which would be subject to the then current corporate income tax rate. The unrecorded deferred income tax liability in the above amounts was approximately $1,326,200 at June 30, 1997 and 1996. The components of the deferred tax assets and liabilities at year end June 30, 1997, 1996 and 1995 are presented below:
June 30, ------------------------------------------------------------ 1997 1996 1995 ----------------- --------------- ---------------- Deferred Tax Assets - ------------------- Unrealized losses on securities available for sale $ 22,259 $ 184,332 $ 11,718 Deferred compensation 181,808 93,342 -- Deferred loan origination fees 45,475 41,696 43,915 Investment securities -- 13,153 1,191 Other 14,803 -- -- ------- ------- ------- Total 264,345 332,523 $ 56,824 ------- ------- ------- Deferred Tax Liabilities - ------------------------ Property and equipment 88,134 71,897 70,382 Allowance for loan losses, net of valuation adjustment 2,653 101,359 161,104 Discounts on loans purchased 38,783 23,351 -- Investments 36,769 -- -- Other 2,078 -- -- --------- -------- ------- Total 168,417 198,313 231,486 --------- -------- ------- Net deferred tax assets $ 95,928 $ 134,210 $ 174,662 ========= ======== -------
Total income tax expense (benefits) for the years ended June 30, 1997, 1996 and 1995 differed from the amounts computed by applying the federal income tax rate of 34% and the Arkansas income tax rates of 6.5% to pretax income as a result of the following:
June 30, ------------------------------------------------------ Income Tax Expense (Benefit) 1997 1996 1995 ---------------------------- --------------- ------------ --------------- Current $ (56,271) $ 230,791 $ 819,524 Deferred (110,374) (55,990) 147,239 --------- -------- --------- Income tax expense (benefit) $ (166,645) $ 174,801 $ 966,763 ========= ======== =========
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 12 - Income Taxes - Continued - ----------------------------------
June 30, --------------------------------------------------------- 1997 1996 1995 ------------------ ----------------- --------------- Expected income tax expense (benefits) $(225,774) $ 153,879 $892,537 Goodwill amortization 61,291 9,790 -- Tax bad-debt deduction, 2,662 5,681 55,231 Other, net (4,824) 5,451 18,995 --------- -------- ------- Total income tax expense (benefits) $(166,645) $ 174,801 $966,763 ========= ======== ======= Effective tax expense (benefit) rate (28,26)% 43.7% 41.7% ====== ==== =====
The difference between federal and state taxable income is generally attributable to interest income on U.S. Obligations that is tax exempt for state taxation purposes. NOTE 13 - Capital Requirements - ------------------------------ FIRREA was signed into law on August 9, 1989; regulations for savings institutions' minimum-capital requirements went into effect on December 7, 1989. In addition to the capital requirements, FIRREA includes provisions for changes in the federal regulatory structure for institutions, including a new deposit insurance system, increased deposit insurance premiums, and restricted investment activities with respect to non-investment grade corporate debt and certain other investments. FIRREA also increases the required ratio of housing-related assets needed to qualify as a savings institution. Regulations require institutions to have minimum regulatory tangible capital equal to 1.5 percent of total assets a core capital ratio of 3% of adjusted assets, and a risk-based capital ratio equal to 8% of risk adjusted assets as defined by regulation. FIRREA also includes restrictions on loans to one borrower, certain types of investment and loans, loans to officers, directors' and principal stockholders, brokered deposits, and transactions with affiliates. Federal regulations require the Bank to comply with a Qualified Thrift Lender (QTL) test which requires that 65% of assets be maintained in housing-related finance and other specified assets. If the QTL test is not met, limits are placed on growth, branching, new investments, FHLB advances, and dividends, or the Bank must convert to a commercial bank charter. Management considers the QTL test to have been met. Regulations of the Office of Thrift Supervision limit the amount of dividends and other capital distributions that may be paid by a savings institution without prior approval of the Office of Thrift Supervision. This regulatory restriction is based on a three-tiered system with the greatest flexibility being afforded to well-capitalized institutions which maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios. The Bank currently meets the requirements of a Tier I institution and has not been informed by the OTS of the need for more than normal supervision. Accordingly, the Bank can make, without prior regulatory approval, distributions during a fiscal year up to 100% of its net income to date during a fiscal year, plus an amount that would reduce by one-half its "surplus capital ratio" (the excess over its Fully Phased-in Capital Requirements) at the beginning of the fiscal year. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 13 - Capital Requirements - Continued - ------------------------------------------ The following is a reconciliation of the Bank's equity under generally accepted accounting principles ("GAAP") to the Bank's tangible, leveraged and risk-based capital available to meet regulatory requirements:
June 30, ----------------------------------- 1997 1996 ---------------- ---------------- Total equity, per financial statements $ 29,061,493 $ 14,228,436 Add: Unrealized losses on available-for-sale securities 33,353 286,313 Less: Intangible assets, required to be deducted (1,415,223) (1,575,296) Advances to nonincludable subsidiaries (1,306,807) -- ----------- ----------- Tangible capital 26,372,816 12,939,453 Required deductions -- -- Core capital 26,372,643 12,939,453 General allowance for loan losses 1,492,473 1,283,234 ----------- ----------- Risk-based capital $ 27,865,116 $ 14,222,687 =========== ===========
At June 30, 1997 and 1996, the Heartland Community Bank's actual capital amounts and ratios are presented below:
For capital Adequacy Purposes and to Be Adequately Capitalized under the Prompt Corrective Action Provisions ------------------------------------------ Actual Provisions ------------------------ ------------------------------------------ Amount Ratio Amount Ratio ----------- ---------- ---------------------- ----------------- As of June 30, 1997 - --------------------- Total risk-based capital (to risk weighted assets) $27,865,116 30.07% Greater-than 7,414,535 Greater-than 8.0% Tier I capital (to risk-weighted assets) $26,372,643 28.46% Greater-than 3,707,218 Greater-than 4.0% Tier I capital (to adjusted total assets) $26,372,643 13.16% Greater-than 8,017,562 Greater-than 4.0% As of June 30, 1996 - --------------------- Total risk-based capital (to risk-weighted assets) $14,222,687 18.42% Greater-than 5,942,160 Greater-than 8.0% Tier I capital (to risk-weighted assets) 12,939,453 17.42% Greater-than 2,971,080 Greater-than 4.0% Tier I capital (to adjusted total assets) 12,939,453 7.43% Greater-than 6,786,401 Greater-than 4.0%
HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 14 - Significant Group Concentrations of Credit Risk - --------------------------------------------------------- The Bank grants real estate loans for 1-4 family residential housing and consumer loans primarily in the designated trade areas within and adjacent to Camden, Arkansas and Central Arkansas. In addition, real estate mortgage loans for multi-family residential and commercial real estate, which meet pre-established "loan to value" ratios and other financial criteria are also granted in specific areas outside this trade area under the Bank's loan diversification policies. As of June 30, 1997 and 1996, loans secured by real estate mortgages amounted to 89% and 95% respectively, of the Bank's total consolidated loan portfolio. Real estate mortgage loans in areas outside the Camden, Arkansas and Central Arkansas trade areas and identified as preferred markets by the loan diversification policy equaled 12% and 15% of the Bank's real estate loan portfolio at June 30, 1997 and 1996. The Bank 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 (Note 6 and 19). The Bank exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of these instruments. The Bank and its subsidiary use 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 and may require payment of a fee. Since some of the commitments will expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterpart. NOTE 15 - Related Party Transactions - ------------------------------------ In the normal course of business, the Bank has made loans to its directors, officers and their related business interests. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectability. The aggregate dollar amount of loans outstanding to directors, officers and their related business interests total approximately $207,805 and $435,200 as of June 30, 1997 and 1996 respectively. Activity for the year ended June 30, 1997 included loan originations of $124,000 and repayments of $351,395. NOTE 16 - Purchase of Subsidiary - -------------------------------- On May 3, 1996 the Bank purchased 100% of the outstanding stock of Heartland Community Bank, FSB (formerly Heritage Banc Holding, Inc.), a federal savings bank, in Little Rock, Arkansas, ("FSB"). HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 16 - Purchase of Subsidiary - Continued - -------------------------------------------- The investment in FSB was $3,500,451 and was accounted for using the purchase method. As a result of the investment, cost in excess of the fair value of net assets of $1,600,732, was recognized and recorded as "pushed down goodwill" on the accounts of the subsidiary. (See also Note 23) The accompanying consolidated statement of income and cash flows for the year ended June 30, 1996, includes the operations of the subsidiary for the year ended June 30, 1997 and the period May 4, 1996 through June 30, 1996. The aforementioned "goodwill" is to be amortized over a period of ten years. For the period May 4, 1996 to June 30, 1996, $160,073 and $25,436 of amortization expense was recorded. The following supplemental information gives proforma effect for the subsidiary purchase, annualized for the fiscal year ended June 30, 1996.
Supplemental Disclosure 1996 1995 ----------------------- ---------------- -------------- Interest Income $ 12,145,063 $ 10,952,927 Interest Expense 7,896,737 6,341,253 ----------- ---------- Net interest income 4,248,326 4,611,674 ----------- ---------- Provision for loan losses 500,824 -0- ----------- ---------- 3,747,502 4,611,674 Noninterest income ( 563,780) 120,577 Goodwill amortization (160,073) (160,073) Noninterest expense (2,806,670) (2,523,182) ----------- ---------- Net income before income taxes and cumulative effect of accounting change 216,979 2,048,996 Provision for income taxes (benefits) ( 90,046) (784,561) Cumulative effect of accounting change (Note 1c) 77,767 ---------- Net income (proforma) $ 126,933 $ 1,342,202 =========== ==========
NOTE 17 - 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 whereas 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. For the years ended June 30, 1997 and 1996, the plan was funded with $232,308 and $242,511. NOTE 18 - Change of Name to Heartland Community Bank - ----------------------------------------------------- Subsequent to year end June 30, 1996, the Bank (formerly known as First Federal Savings & Loan Association of Camden), applied for and obtained approval from the proper regulatory authorities to change its name along with its wholly-owned subsidiary, Heritage Bank, FSB to "Heartland Community Bank". The effective date of the change was effective as of September 9, 1996. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 19 - Fair Values of Financial Instruments - ---------------------------------------------- The estimated fair values of the Bank's consolidated financial instruments are as follows:
June 30, 1997 June 30, 1996 ----------------------------------- ---------------------------------- Carrying Carrying Amount Fair Value Amount Fair Value ---------------- --------------- ---------------- --------------- Financial assets: Cash and cash equivalents $19,456,092 $19,456,092 $17,291,882 $17,291,882 Investment securities: Available-for-sale 16,155,755 16,155,755 5,279,625 5,279,625 Mortgage-backed securities: Available-for-sale 20,090,406 20,090,406 12,155,199 12,155,199 Held-to-maturity 35,869,295 36,194,353 45,212,891 44,934,074 Loans, net of allowances 98,642,635 99,131,271 84,131,024 85,344,161 Financial Liabilities Deposits, savings and NOW accounts 35,655,735 35,655,735 30,188,282 30,188,282 Deposits, time certificates 115,553,028 114,856,342 115,730,969 116,540,019 Advances FHLB 10,000,000 10,000,000 10,000,000 10,000,000 Unrecognized Financial Instruments: Commitment to extend credit $ 4,027,495 $ 4,027,495 $ 3,151,300 $ 3,151,300 ========== ========== ========== ==========
NOTE 20 - Incorporation of HCB Properties, Inc. - ----------------------------------------------- In September, 1996, the Bank formed a wholly-owned subsidiary named HCB Properties, Inc. The Bank is the sole stockholder of the Company. HCB Properties, Inc. was formed to hold, as necessary, property acquired by the Bank for future expansion and that in part, is expected to be sold by the Bank when and if the original purchase does not fully meet with the future business plan of the Bank. As of June 30, 1997, HCB Properties, Inc. held two parcels of land and improvements due to new construction with a book value of $1,705,000. All intercompany transactions have been eliminated in the financial statements for the year ended June 30, 1997 respectively. NOTE 21 - Stockholders' Equity/Stock Conversion - ----------------------------------------------- On April 30, 1996, HCB Bancshares, Inc. completed and closed its stock offering. Gross proceeds from the sale of 2,645,000 shares (excluding the 211,600 shares purchased by the ESOP) amounted to $26,450,000 and were reduced by conversion costs of $689,014. The Corporation paid $15,000,000 for all common stock of the Bank and retained the remaining net proceeds. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 21 - Stockholders' Equity/Stock Conversion - Continued - ----------------------------------------------------------- Concurrent with the conversion, the Bank established a liquidation account in an amount equal to its net worth as reflected in its latest statement of financial condition used in its final offering circular. The liquidation account will be maintained for the benefit of eligible deposit account holders and supplemental eligible deposit account holders who continue to maintain their deposit accounts in the Bank after the Conversion. Only in the event of a complete liquidation will eligible deposit account holders and supplemental eligible deposit account holders be entitled to receive a liquidation distribution from the liquidation account in the amount of the then current adjusted sub-account balance for deposit accounts then held before any liquidation distribution may be made with respect to common stockholders. Subject to applicable law, the Board of Directors of Heartland Community Bank and HCB Bancshares, Inc. may each provide for the payment of dividends. Future declaration of cash dividends, if any, by the Corporation may depend upon dividend payments by the Bank to the Corporation. Subject to regulations promulgated by the OTS, the Bank will not be permitted to pay dividends on its common stock if its stockholders' equity would be reduced below the amount required for the liquidation account or its capital requirement. In addition, as a Tier I institution, or an institution that meets all of its fully phased-in capital requirements, the Bank may pay a cash dividend to HCB Bancshares, Inc. With notification but without prior OTS approval, during a calendar year an amount not to exceed the greater of (i) 100% of the Bank's net income to date during the calendar year plus the amount that would reduce by one-half its surplus capital ratio at the beginning of the calendar year or (ii) 75% of its net income over the most recent four quarter period. No dividend was declared or paid during the period April 30, 1997 to June 30, 1997. NOTE 22 - SAIF Assessment - ------------------------- In September, 1996, the Bank and its subsidiary was assessed a one time charge of $ 889,011. The special assessment, is to be used to replenish the SAIF reserves depleted by prior years savings & loan industry losses. The assessment has been charged to current operations as a current period expense in the year ended June 30, 1997. The assessment was paid on November 27, 1996. Prior to the "SAIF assessment", the Bank's deposit insurance rate was .23 percent. Subsequent to the assessment, the rate of insurance on deposits decreased to .065 percent. NOTE 23 -Event(s) Subsequent to June 30, 1996 - Review of Allowance for Loan - ---------------------------------------------------------------------------- Losses - ------ During the year ended June 30, 1997, and subsequent to the issuance of the auditors' report on the June 30, 1996 financial statements, dated August 28, 1998, the Bank's management initiated an extensive review of all existing loan files at all locations and its subsidiary savings bank. The objectives of this in depth detailed review was to evaluate the standardization of loan origination and credit review practices at all Bank branches and subsidiary and update existing loan policies for the planned growth of the Bank's loan portfolio in the commercial, nonresidential real estate and consumer markets. At the conclusion of the review, which was performed by selected Bank personnel as well as a third party consultant, it was determined that a substantial shortfall existed in the allowance for loan losses at the subsidiary savings bank due to a combination of loan file documentation weaknesses and an increase in past due loans. After further review of the loan review procedures performed and resulting findings, it was determined that an addition to the allowance was required and that the circumstances that gave rise to the needed increase were in two categories. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 23 -Event(s) Subsequent to June 30, 1996 - Review of Allowance for Loan - ---------------------------------------------------------------------------- Losses - Continued - ------------------ Those categories were for conditions existing as of the date of acquisition of the subsidiary savings bank, which was May 3, 1996, and in part to circumstances and events that had occurred or materialized subsequent to June 30, 1996. Therefore, the consolidated financial statements as of June 30, 1996 and for the year then ended, were restated to give effect for the resulting revision to the acquired allowance for loan losses of the subsidiary savings bank and the related accrued and deferred income taxes. In addition, as referenced above, a determination was made by management that a provision to the allowance for loan losses of the subsidiary savings bank was necessary for the year ended June 30, 1997. A summary of the amounts and net effects on the statements for the year ended June 30, 1996, herein included, are presented below:
1996 -------------- Increase provision to allowance to loan losses None Increase in amortization of goodwill (expense) 4,998 Increase in cost in excess of fair value (goodwill) 344,498 Net change in accrued and deferred income tax (benefits) (1,803)
NOTE 24 - Employment Agreements - ------------------------------- During 1996, the Association entered into employment agreements with three key executive officers to ensure a stable and competent management base. The agreements provide for three-year term, but upon each anniversary, the agreements will automatically extend so that the remaining term shall always be three years unless the Board of Directors expressly acts to limit the extension. The agreements provide for benefits as spelled out in the contract and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officer's right to receive vested rights, including compensation, for the remaining term of the agreements. In the event of a change in control of the Association and termination of the officers, as defined in the agreement, the officers will receive a lump sum equal to 2.99 times their average salary paid during the prior five years. NOTE 25 - Employee Stock Ownership Plan - --------------------------------------- The Association has established an employee stock ownership plan (ESOP) to benefit substantially all employees. The ESOP originally purchased 211,600 shares of common stock in the Conversion with proceeds received from a loan from the Corporation. The Corporation's note receivable is to be repaid based upon one principal installment of $125,675 on June 30, 1997, one principal installment of $297,525 on June 30, 1998 and eight installments of $211,600 on June 30th each year through 2006. Interest is based upon prime, which will be adjusted and paid quarterly. The note may be prepaid without penalty. The unallocated shares of stock held by the ESOP are pledged as collateral for the debt. The ESOP is funded by contributions made by the Bank in amounts sufficient to retire the debt. At June 30, 1997, the outstanding balance of the note receivable is $1,990,325 and is presented as a reduction of stockholders' equity. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 25 - Employee Stock Ownership Plan - Continued - --------------------------------------------------- Shares released as the debt is repaid 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 five years of credited service. Forfeitures of nonvested benefits will be reallocated among remaining participating employees in the same proportion as contributions. Dividends on unallocated shares may be used by the ESOP to repay the debt to the Corporation and are not reported as dividends in the financial statements. Dividends on allocated or committed to be allocated shares are credited to the accounts of the participants and reported as dividends in the financial statements. Expense of $195,308 during 1997 has been incurred in connection with the ESOP. The expense includes, in addition to the cash contribution necessary to fund the ESOP, $36,130, which represents the difference between the fair market value of the shares which have been released or committed to be released to participants, and the cost of these shares to the ESOP. The Association has credited this amount to paid-in capital in accordance with the provisions of AICPA Statement of Position 93-6. At June 30, 1997, 12,568 shares held by the ESOP have been released or committed to be released to the plan's participants. The fair value of the unallocated shares amounted to approximately $2,562,537 at June 30, 1997. NOTE 26 - Future Reporting Requirements - --------------------------------------- The Financial Accounting Standards Board has issued SFAS No. 123, Accounting for Stock-Based Compensation which the Corporation has not been required to adopted as of June 30, 1997. The Statement, which will be in effect for the Corporation's fiscal year ending June 30, 1998, will require that the Corporation account for stock based compensation plans using a fair value based method which measures compensation cost at the grant date based upon the value of the award, which is then recognized over the service period, usually the vesting period. The accounting requirements of the Statement apply to grants or awards entered into in fiscal years that begin after December 15, 1995. The Statement allows entities to continue to use APB Opinion No. 25 to measure compensation cost, but requires that the proforma effects on net income and earnings per share be disclosed to reflect the difference between the compensation cost, if any, from applying APB Opinion No. 25 and the related cost measured by the air value method defined in the Statement. The Statement is not expected to have a material impact on the Corporation's accounting for stock compensation plans because (I) the Statement does not apply to the ESOP plan nor will it change the accounting requirements of the proposed restricted stock plan, and (ii) the Corporation expects to account for proposed stock option plans using the accounting treatment permitted under APB Opinion No. 25. In June 1996, the Financial Accounting and Standards Board (the"FASB") issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. Related to SFAS No. 125 the FASB has issued SFAS No. 127 which delays the effective date for certain transactions until after December 31, 1997. Earlier or retroactive application is not permitted. HCB BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 26 - Future Reporting Requirements - Continued - --------------------------------------------------- Effective for accounting periods ending after December 15, 1997, SFAS No. 128, "Earnings per Share," replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement of all publicly held companies with complex capital structure. The FASB has issued SFAS No. 129, "Disclosure of Information about Capital Structure," effective for periods ending after December 15, 1997. This statement presents standards for disclosing information about an entity's capital structure. It applies to all entities and continues previous requirements to disclose certain information about an entity's capital structure. Examples of the information required to be disclosed include dividend and liquidation preferences, participation rights, call features, conversion or exercise prices and pertinent dates, sinking fund requirements and unusual voting rights. NOTE 27 - Events and Purchase Commitments subsequent to June 30, 1997 - ---------------------------------------------------------------------- In July, 1997 the Bank completed the construction of one of two new branch facilities which were under construction at June 30, 1997. The second branch facilty was opened by the end of August, 1997. The expected capital outlay to complete both of these projects was not to exceed $1,156,000. In addition to the above, the Bank entered into a contract during the year ended June 30, 1997 to upgrade its computer and communications network. The contract was for $400,000 and the project was partially complete as of year end June 30, 1997. The balance remaining on the contract, subject to completion of installation and training, was $142,000. HEARTLAND COMMUNITY BANK, FSB (formerly Heritage Banc Holding, Inc.) AND SUBSIDIARY Consolidated Statements of Income For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
July 1, 1995 to June 30, Interest Income May 3, 1996 1995 - --------------- --------------- ------------- Interest and fees on loans $ 1,515,653 $ 1,589,616 Investment securities 119,514 249,658 Mortgage-backed and related securities 123,933 109,715 Other interest income 56,846 159,156 ------------- ------------- Total interest income $ 1,815,946 $ 2,108,145 ------------- ------------- Interest Expense - ---------------- Deposits (Note 8) $ 1,052,448 $ 1,123,359 Borrowed funds 559 15,025 Notes payable 77,133 90,388 ------------- ------------- Total interest expense $ 1,130,140 $ 1,228,772 ------------- ------------- Net interest income $ 685,806 $ 879,373 Provision for loan losses (Note 4) $ 458,341 $ - - ------------- ------------- Net interest income after provision for loan losses $ 227,465 $ 879,373 ------------- ------------- Noninterest Income - ------------------ Net realized gain (loss) on sales of available for sale securities (Note 14) $ - - $ (245,223) Amortization of negative goodwill 63,040 75,648 Other income 133,319 94,129 ------------- ------------- Total noninterest income (loss) $ 196,359 $ (75,446) ------------- ------------- Noninterest Expense 1996 1995 - ------------------- ------------- ------------- Salaries and compensation $ 330,563 $ 442,801 Occupancy and equipment 81,968 87,277 Federal deposit insurance premiums 48,787 55,821 Data processing expenses 62,866 72,029 Professional fees 6,025 19,741 Other expenses 175,395 235,552 ------------- ------------- Total noninterest expense $ 705,604 $ 913,221 ------------- ------------- Income (loss) before income tax expense (benefit) $ (281,780) $ (109,294) Provision for income tax (benefit) (88,873) (57,877) ------------- ------------- Net income (loss) $ (192,907) $ (51,417) ============= =============
See notes to unaudited consolidated financial statements. HEARTLAND COMMUNITY BANK, FSB (formerly Heritage Banc Holding, Inc.) AND SUBSIDIARY Consolidated Statements of Stockholders' Equity For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
July 1, 1995 to June 30, Common Stock May 3, 1996 1995 - ------------ ----------------- ------------- Common stock; $20 par value; 1,000 shares $ 20,000 $ 20,000 issued and outstanding Additional Paid-in Capital - -------------------------- Balance beginning of period $ 601,300 $ 601,300 Additional contributed capital 1,470,800 1,470,800 ------------- ------------- Balance end of period $ 2,072,100 $ 2,072,100 ------------- ------------- Retained Earnings - ----------------- Balance beginning of period $ 343,667 $ 436,584 Net income (loss) (192,907) (51,417) Dividends paid (57,000) (41,500) ------------- ------------- Balance end of period $ 93,760 $ 343,667 ------------- ------------- Unrealized Depreciation on Securities - ------------------------------------- Available for Sale ------------------ Balance beginning of period $ (51,359) $ (218,690) Net increase (decrease), net of applicable deferred income taxes 19,247 167,331 ------------- ------------- Balance end of period $ (32,112) $ (51,359) ------------- ------------- Total equity at period end $ 2,185,860 $ 2,384,408 ============= =============
See notes to unaudited consolidated financial statements. HEARTLAND COMMUNITY BANK, FSB (formerly Heritage Holding, Inc.) AND SUBSIDIARY Consolidated Statements of Cash Flow For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
July 1, 1995 to June 30, Cash Flows from Operating Activities May 3, 1996 1995 - ------------------------------------ ------------- ------------- Net Income (Loss) $ (192,907)$ (51,417) ------------- ------------- Adjustments to reconcile net income to cash provided by operating activities: Depreciation $ 26,052 $ 25,012 Amortization Deferred loan origination fees 5,791 (7,990) Amortization Negative goodwill (63,040) (75,648) Amortization Premiums and discounts on investment securities, loans (10,240) 24,755 Provision for loan loss 458,341 - - Net (gain) loss on sale of investments: - - 245,223 Decrease (increase) in accrued interest receivable (15,761) 28,452 Increase in accrued interest payable (40,469) 75,142 (Increase) decrease in other assets 88,343 (36,857) Increase in other liabilities (43,967) 39,698 (Increase) decrease in prepaid / payable income taxes (87,220) (44,334) ------------- ------------- Total adjustments $ 317,830 $ 273,453 ------------- ------------- Net cash flows provided (used) by operating activities $ 124,923 $ 222,036 ------------- ------------- Cash Flows from Investing Activities: - ------------------------------------ Loan originations and principal payments on loans $ (2,479,546)$ (1,299,129) Proceeds from sale of investment securities: - - 4,198,178 Purchase of investment securities available for sale (463,000) (2,100,000) Principal payments on investment securities 1,372,720 1,575,984 Purchases of premises and equipment (144,935) (488,096) ------------- ------------- Net cash flows used by investing activities $ (1,714,761)$ 1,886,937 ------------- ------------- Cash Flows from Financing Activities: - ------------------------------------ Net increase (decrease) in demand deposits, NOW accounts, passbook savings accounts and certificates of deposits $ (790,839)$ 1,498,938 Net (decrease) increase in mortgage escrow funds (82,037) 40,860 Dividends paid (57,000) (41,500) Payment of FHLB advances - - (650,000) ------------- ------------- Net cash flows provided (used) by financing activities $ (929,876)$ 848,298 ------------- ------------- Net increase (decrease) in cash and cash equivalents $ (2,519,714)$ 2,957,271 Cash and cash equivalents, beginning of year $ 4,582,661 $ 1,625,390 ------------- ------------- Cash and cash equivalents, end of year $ 2,062,947 $ 4,582,661 ============= ============= Supplemental disclosures of cash flow information: - ------------------------------------------------- Cash paid during the period for: Interest $ 1,093,322 $ 1,048,289 Income taxes $ 17,500 $ 26,500
See notes to unaudited consolidated financial statements. --------- HEARTLAND COMMUNITY BANK, FSB (formerly Heritage Banc Holding, Inc.) AND SUBSIDIARY Notes to Consolidated Financial Statements For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996 (UNAUDITED) NOTE 1 - Summary of Significant Accounting Policies - --------------------------------------------------- Basis of Consolidation - ---------------------- The consolidated financial statements as of the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996 include the accounts of Heritage Banc Holding, Inc. and its wholly-owned subsidiary, Heritage Bank, FSB. All material intercompany balances and transactions have been eliminated in the consolidation. The unaudited statements reflect all adjustments, consisting of normal recurring accruals, which are in the opinion of management, necessary for fair presentation of the results of operations, changes in stockholders' equity and cash flows for the period July 1, 1994 to May 3, 1996. EX-27 3 FINANCIAL DATA SCHEDULE
9 YEAR JUN-30-1997 JUN-30-1997 1,182,210 18,273,882 0 0 36,246,161 35,869,295 36,194,353 98,642,635 1,492,473 200,365,778 151,208,763 10,000,000 1,417,502 0 0 0 2,645 37,736,868 200,365,778 8,038,783 4,436,436 626,457 13,101,676 7,534,445 8,195,782 4,905,894 221,671 (21,215) 5,578,934 (589,644) (589,644) 0 0 (422,999) (.017) 0 2.84 133,386 380,382 281,441 0 1,283,234 22,985 10,553 1,492,473 1,399,061 0 93,412
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