-----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, KVfsAHBBe0pCyiRdQyNKe+fpKTyj0zr09lIbtm+SLojxzLfypG24m2BuWy4LfZFe bPY5CFZQTv0QJXKVhqemSg== 0001047469-99-020535.txt : 19990517 0001047469-99-020535.hdr.sgml : 19990517 ACCESSION NUMBER: 0001047469-99-020535 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HF FINANCIAL CORP CENTRAL INDEX KEY: 0000881790 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 460418532 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 033-44383 FILM NUMBER: 99622938 BUSINESS ADDRESS: STREET 1: 225 SOUTH MAIN AVE CITY: SIOUX FALLS STATE: SD ZIP: 57102 BUSINESS PHONE: 6053337556 10-Q 1 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-19772 HF FINANCIAL CORP. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 46-0418532 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 225 South Main Avenue, Sioux Falls, SD 57104 - -------------------------------------------------------------------------------- (Address of principal executive office) (ZIP Code) (605) 333-7556 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of May 10, 1999 there were 4,753,218 issued and outstanding shares of the Registrant's Common Stock, with $.01 par value. HF FINANCIAL CORP. FORM 10-Q INDEX Page PART I. Financial Information - ---------------------------------------- Item 1. Financial Statements (Unaudited): Consolidated Statements of Financial Condition As of March 31, 1999 and June 30, 1998 1 Consolidated Statements of Income for the Three and Nine months ended March 31, 1999 and 1998 2 Consolidated Statement of Stockholders' Equity for the Nine months ended March 31, 1999 3 Consolidated Statements of Cash Flows for the Nine months ended March 31, 1999 and 1998 4-5 Notes to Consolidated Financial Statements 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-21 Item 3. Quantitative and Qualitative Disclosures about Market Risk 22 PART II. Other Information - ------------------------------------ Item 1. Legal Proceedings 23 Item 2. Changes in Securities 23 Item 3. Default upon Senior Securities 23 Item 4. Submission of Matters to a Vote of Security Holders 23 Item 5. Other Information 23 Item 6. Exhibits and Reports on Form 8-K 23 Signatures 24 Item 1. HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in Thousands) (Unaudited)
ASSETS March 31, June 30, 1999 1998 --------------------- Cash and cash equivalents $ 15,686 $ 25,458 Securities available for sale 49,642 44,232 Mortgage-backed securities available for sale 45,211 39,647 Loans receivable 454,789 426,522 Loans held for sale 11,073 9,616 Accrued interest receivable 4,035 4,338 Foreclosed real estate and other properties 207 229 Office properties and equipment, at cost, net of accumulated depreciation 14,154 14,317 Prepaid expenses and other assets 3,658 1,999 Mortgage servicing rights 1,685 1,423 Deferred income taxes 4,045 3,198 --------------------- $604,185 $570,979 --------------------- --------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits $443,545 $446,424 Advances from Federal Home Loan Bank and other borrowings 88,876 50,635 Advances by borrowers for taxes and insurance 8,806 4,792 Accrued interest payable 6,002 5,898 Other liabilities 5,488 6,629 --------------------- Total liabilities 552,717 514,378 --------------------- Stockholders' Equity Preferred stock, $.01 par value, 500,000 shares authorized, none outstanding ---- ---- Series A Junior Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized, none outstanding ---- ---- Common stock, $.01 par value, 10,000,000 shares authorized, 4,753,218 and 4,730,276 shares outstanding at March 31,1999 and June 30, 1998 48 47 Additional paid-in capital 15,106 14,863 Retained earnings, substantially restricted 47,844 46,561 Unearned compensation (340) (340) Accumulated other comprehensive income (235) (9) Less cost of treasury stock, March 31, 1999 663,992 shares, June 30, 1998 334,222 shares (10,955) (4,521) --------------------- 51,468 56,601 --------------------- $604,185 $570,979 --------------------- ---------------------
See Notes to Consolidated Financial Statements Page 1 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in Thousands, Except Per Share Data) (Unaudited)
Three Months Nine Months Ended March 31, Ended March 31, --------------------- -------------------- 1999 1998 1999 1998 -------- -------- --------- ------- Interest and dividend income: Loans receivable $ 9,973 $ 9,855 $ 30,118 $ 30,102 Mortgage-backed securities 710 468 1,996 1,403 Investment securities and interest-bearing deposits 714 1,079 2,021 3,224 -------- ------- -------- -------- 11,397 11,402 34,135 34,729 -------- ------- -------- -------- Interest expense: Deposits 4,933 5,296 15,233 16,468 Advances from Federal Home Loan Bank and other borrowings 1,207 899 3,063 2,867 -------- ------- -------- -------- 6,140 6,195 18,296 19,335 -------- ------- -------- -------- Net interest income 5,257 5,207 15,839 15,394 Provision for losses on loans 2,041 898 5,299 2,228 -------- ------- -------- -------- Net interest income after provision for losses on loans 3,216 4,309 10,540 13,166 -------- ------- -------- -------- Noninterest income: Credit card fee income 2,647 1,533 7,808 3,517 Fees on deposits 557 518 1,721 1,623 Loan servicing income 329 309 947 863 Loan fees and service charges 234 253 840 930 Gain on sale of loans 184 193 484 777 Other (90) 249 1,151 985 -------- ------- -------- -------- 3,861 3,055 12,951 8,695 -------- ------- -------- -------- Noninterest expense: Compensation and employee benefits 2,770 2,590 8,010 7,522 Credit card processing expense 2,195 799 6,057 1,655 Other general and administrative expenses 1,109 1,064 3,187 3,126 Occupancy and equipment 719 689 2,103 1,990 Federal insurance premiums 75 68 226 205 Other 31 42 129 265 -------- ------- -------- -------- 6,899 5,252 19,712 14,763 -------- ------- -------- -------- Income before income taxes 178 2,112 3,779 7,098 Income tax expense 131 696 1,352 2,376 -------- ------- -------- -------- Net income $ 47 $ 1,416 $ 2,427 $ 4,722 -------- ------- -------- -------- -------- ------- -------- -------- Earnings per share: Basic $0.01 $0.32 $0.57 $1.06 -------- ------- -------- -------- -------- ------- -------- -------- Diluted $0.01 $0.31 $0.56 $1.03 -------- ------- -------- -------- -------- ------- -------- --------
See Notes to Consolidated Financial Statements Page 2 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Nine Months Ended March 31, 1999 (Dollars In Thousands, Except Per Share Data) (Unaudited)
Accumulated Additional Other Total Common Paid-In Retained Unearned Comprehensive Treasury Stockholders' Stock Capital Earnings Compensation Income Stock Equity ------- ---------- -------- ------------ ------------- ------------ ------------- Balance, June 30, 1998 $ 47 $ 14,863 $46,561 $ (340) $ (9) $ (4,521) $ 56,601 Comprehensive income: Net income - - - - - - - - 2,427 - - - - - - - - - - - - 2,427 Change in unrealized gain (loss), Securities available for sale, net Of related deferred taxes of ($118) - - - - - - - - - - - - - - - - (226) - - - - (226) ------- ---------- -------- ----------- ------------- ------------ ------------- Total comprehensive income - - - - - - - - 2,427 - - - - (226) - - - - 2,201 Exercise of stock options for 22,942 - - - - shares 1 243 - - - - - - - - - - - - - - - - 244 Cash dividends paid ($0.27 per share) on common stock - - - - - - - - (1,144) - - - - - - - - - - - - (1,144) Purchase of treasury stock - - - - - - - - - - - - - - - - - - - - (6,434) (6,434) ------- ---------- -------- ------------ ------------- ------------ ------------- Balance, March 31, 1999 $ 48 $ 15,106 $47,844 $ (340) $ (235) $ (10,955) $ 51,468 ------- ---------- -------- ------------ ------------- ------------ ------------- ------- ---------- -------- ------------ ------------- ------------ -------------
See Notes to Consolidated Financial Statements Page 3 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited)
Nine Months Ended March 31, ------------------------------------ 1999 1998 ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,427 $ 4,722 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on loans 5,299 2,228 Depreciation 1,181 1,127 Amortization of premiums and discounts, net: Securities available for sale (15) (10) Mortgage-backed securities available for sale 17 (101) Reduction in cost of intangible assets - - - - 3 Reduction in mortgage servicing rights 202 155 Increase (decrease) in deferred loan fees 254 (93) Loans originated for resale (60,901) (62,080) Proceeds from the sale of loans 61,385 62,560 (Gain) on sale of loans (484) (777) Mortgage servicing rights capitalized (296) (145) (Gain) on sale of securities, net (3) (10) Losses and provision for losses on sales of foreclosed real estate and other properties, net 25 156 (Gain) loss on disposal of office properties and equipment, net 29 (9) Decrease in accrued interest receivable 303 122 (Increase) decrease in prepaid expenses and other assets (1,659) 227 (Increase) decrease in deferred income taxes (729) 142 (Decrease) in accrued interest payable and other liabilities (1,037) (1,570) ----------- ---------- Net cash provided by operating activities $ 5,998 $ 6,647 ----------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Loans purchased (27,114) (11,535) Loans made to customers (140,855) (122,888) Principal collected on loans 129,767 125,422 Sale of participation interests in loans 2,500 16,550 Mortgage-backed securities available for sale: Sales 4,489 - - - - Purchases (21,430) (12,507) Repayments 11,210 4,051 Securities available for sale: Sales and maturities 29,590 39,975 Purchases (35,176) (46,117) Proceeds from sale of office properties and equipment 44 55 Purchase of office properties and equipment (1,091) (742) Purchase of mortgage servicing rights (168) (220) Proceeds from sale of foreclosed real estate and other properties, net 423 734 ----------- ---------- Net cash (used in) investing activities $ (47,811) $ (7,222) ----------- ----------
See Notes to Consolidated Financial Statements Page 4 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (Dollars in Thousands) (Unaudited)
Nine Months Ended March 31, --------------------------------------- 1999 1998 ---------------- ---------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in deposits $ (2,879) $ 18,051 Proceeds of advances from Federal Home Loan Bank and other borrowings 62,600 25,000 Payments on advances from Federal Home Loan Bank and other borrowings (24,359) (39,136) Increase in advances by borrowers for taxes and insurance 4,014 3,483 Purchase of treasury stock (6,434) (1,736) Proceeds from issuance of common stock 243 140 Cash dividends paid (1,144) (939) ---------------- ---------------- Net cash provided by financing activities $ 32,041 $ 4,863 ---------------- ---------------- Increase (decrease) in cash and cash equivalents $ (9,772) $ 4,288 Cash and Cash Equivalents Beginning 25,458 17,957 ---------------- ---------------- Ending $ 15,686 $ 22,245 ---------------- ---------------- ---------------- ----------------
See Notes to Consolidated Financial Statements Page 5 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For The Nine months ended March 31, 1999 and 1998 (Dollars in Thousands) (unaudited) NOTE 1. SELECTED ACCOUNTING POLICIES BASIS OF PRESENTATION: The foregoing consolidated financial statements are unaudited. However, in the opinion of management, all adjustments (which consist of normal recurring accruals) necessary for a fair presentation of the consolidated financial statements have been included. Results for any interim period are not necessarily indicative of results to be expected for the year. The interim consolidated financial statements include the accounts of HF Financial Corp. (the "Company"), its subsidiaries, HomeFirst Mortgage Corp. (formerly known as HF Mortgage Corp.), HF Card Services L.L.C. and Home Federal Savings Bank, (the "Bank") and the Bank's subsidiaries. NOTE 2. REGULATORY CAPITAL The following table sets forth the Bank's compliance with its capital requirements at March 31, 1999:
AMOUNT PERCENT ------- ------- Tier I (Core) capital: Required . . . . . . . . . . . . . $18,090 3.00% Actual . . . . . . . . . . . . . . . 44,774 7.43 Excess . . . . . . . . . . . . . . . 26,684 4.43 Risk-based capital: Required. . . . . . . . . . . . . . $33,080 8.00% Actual . . . . . . . . . . . . . . . 49,981 12.09 Excess . . . . . . . . . . . . . . . 16,901 4.09
NOTE 3. EARNINGS PER SHARE Earnings (loss) per share are calculated in accordance with the provisions of Financial Accounting Standards Board ("FASB") Statement No. 128, "Earnings Per Share", which was effective for fiscal year 1998. This Statement establishes standards for computing and presenting earnings (loss) per share ("EPS"). It 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 for all entities with complex capital structures. Basic earnings per share is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding. The weighted average number of common shares outstanding for the three month period ended March 31, 1999 and 1998 as adjusted was 4,114,774 and 4,462,689 respectively. The weighted average number of common shares outstanding for the nine month period ended March 31, 1999 and 1998 as adjusted was 4,239,648 and 4,459,295 respectively. Dilutive earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive options outstanding had been exercised. The weighted average number of common and dilutive potential common shares outstanding for the three month period ended March 31, 1999 and 1998 as adjusted was 4,276,486 and 4,598,439 respectively. The weighted average number of common and dilutive potential common shares outstanding for the nine month period ended March 31, 1999 and 1998 as adjusted was 4,343,678 and 4,587,918 respectively. Page 6 NOTE 4. NEW STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ("SFAS") The FASB issued SFAS No. 130, " Reporting Comprehensive Income". This Statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This Statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. This Statement was adopted July 1, 1998 and is reflected in the accompanying consolidated financial statements. The FASB issued SFAS No. 131, "Disclosures about Segments of Enterprise and Related Information". This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This Statement is effective for financial statements for periods beginning after December 15, 1997. Management anticipates providing the required disclosures in its June 30, 1999 consolidated financial statements. The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits". This Statement standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets, and eliminates certain disclosures that are no longer useful. This Statement also permits reduced disclosures for nonpublic entities. This Statement supersedes the disclosure requirements in FASB Statements No. 87, "Employers' Accounting for Pensions", No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", and No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". This Statement is effective for financial statements for periods beginning after December 15, 1997. Management anticipates providing the required disclosures in its June 30, 1999 consolidated financial statements. The FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Earlier application of all of the provisions of this Statement is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance of this Statement. This Statement should not be applied retroactively to financial statements of prior periods. Management is evaluating the impact of this Statement on the Company's consolidated financial statements. The FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise". This statement further amends SFAS No. 65, "Accounting for Certain Mortgage Banking Activities" to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage Banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. This Statement conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage Banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a nonmortgage Banking enterprise. This Statement is effective for the first fiscal quarter beginning after December 15, 1998. As of March 31, 1999, the Company has no securitized mortgage loans held for sale. There is no impact from this Statement on the Company's consolidated financial statements at March 31, 1999. Page 7 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL HF Financial Corp. ("Company") was incorporated under the laws of the State of Delaware in November 1991 for the purpose of owning all of the outstanding stock of Home Federal Savings Bank ("Bank") issued in the mutual to stock conversion of the Bank. The Company acquired all of the stock of the Bank on April 8, 1992. In October 1994, the Company acquired and began operating a new mortgage subsidiary as HomeFirst Mortgage Corp. ("Mortgage Corp."). The Company ceased operation of the Mortgage Corp. during fiscal 1998. In May, 1996 the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of this entity. The Company became the owner of 100% of HF Card Services in February 1999. The activities of the Company itself have no significant impact on the results of operations on a consolidated basis. Unless otherwise indicated, all activities discussed herein relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank, HF Card Services and the Mortgage Corp. HomeFirst Mortgage Corp. is a South Dakota Corporation which had an office in Omaha, Nebraska. Mortgage Corp. was a mortgage Banking operation that originated one- to four-family residential loans which were sold into the secondary market and to the Bank. The Company ceased operation of HomeFirst Mortgage Corp. during the first quarter of fiscal 1998. HF Card Services was established to provide secured, partially secured and unsecured credit cards nationwide. The target market for HF Card Services is sub-prime credit customers who have either an insufficient credit history or a negative credit history and are unable to obtain a credit card from more traditional card issuers. The Company's net income is primarily dependent upon the difference (or "spread") between the average yield earned on loans, mortgage-backed securities and investments and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. The interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. The Company, like other financial institutions, is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on a different basis, than its interest-earning assets. To better insulate itself from such risk, the Company has, over the last few years, attempted to increase both numerically and on a percentage basis its holding of consumer and commercial loans. The Company's net income is also affected by, among other things, gains and losses on sales of foreclosed property, loans, mortgage-backed securities and securities available for sale, provisions for loan losses, service charge fees, subsidiary activities, operating expenses and income taxes. THIS DISCUSSION AND ANALYSIS CONTAINS CERTAIN FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES," "ANTICIPATES," "WILL," AND "INTENDS," OR COMPARABLE TERMINOLOGY. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED. POTENTIAL PURCHASERS OF THE COMPANY'S SECURITIES ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS WHICH ARE QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONS AND RISKS DESCRIBED HEREIN AND IN OTHER REPORTS FILED BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION. ACQUISITION OF DAKOTA STATE BANK On December 15, 1998 the Bank and Dakota State Bank ("DSB") jointly announced the signing of a definitive Stock Purchase Agreement whereby the Bank will acquire 100% of the outstanding capital stock of DSB for cash consideration. With the acquisition, the Company's assets will increase to approximately $650.0 million. Regulatory approval was obtained on May 10, 1999 with anticipated date of legal closing to be in late May 1999. The new locations along the Interstate 29 highway corridor between Sioux Falls and Brookings support the Company's expansion into commercial and agricultural markets. The Company will operate 25 branches in 18 South Dakota communities and will continue to offer Internet Banking which serves customers nationwide. Page 8 YEAR 2000 The Year 2000 issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Bank is heavily dependent on computer processing in its business activities and the Year 2000 issue creates risk for the Bank from unforeseen problems in the Bank's computer system and from third parties with whom the Bank processes financial information. Such failures of the Bank's computer system and/or third parties computer systems could have a material impact on the Bank's ability to conduct its business. In May 1997, the Company developed a five-step plan that follows the guidelines as specified by the Federal Financial Institutions Examination Councils. As this council provides new requirements, the plan is modified to reflect the new requirements. Management of the Company is updated at least monthly on the status of the plan and the Bank's Information Systems Steering Committee has changed from a quarterly meeting to a bi-monthly meeting to be more proactive on Year 2000. In addition, the Board of Directors of the Company is updated on the status of the Year 2000 project on a quarterly basis at its regularly scheduled meetings or as circumstances may change requiring new information to be shared with the Board of Directors. The five stages of the plan are as follows: awareness, assessment, renovation, validation and implementation. The awareness and assessment phases were completed by December 31, 1997. The assessment phase included hardware, software and third party vendors that provide a service to the Company (i.e. utility companies, alarm companies, payroll providers, electronic funds transfer providers, insurance providers, loan participation companies, mortgage loan secondary market agencies, and governmental agencies). The renovation, validation and implementation phases are completed as planned. All mission critical systems known to be non-compliant with Year 2000 have been renovated as of March 31, 1999. In May 1996, the Bank installed new hardware and operations systems software that the vendor has represented to be Year 2000 compliant. Testing has been completed and verified for the Bank's core processing system for the dates of September 9,1999, December 31, 1999, January 2, 2000, February 29, 2000, and March 31, 2000. Testing for December 31, 2000 is currently being performed. All mission critical PC software applications have been tested for all specific dates as determined by the Federal Financial Institution Examination Council's guidelines. In addition, testing will be performed with service providers that are providing the capability to test with the Bank. The Company will continue its Year 2000 plan in 1999 by continually monitoring updates as provided by vendors. The Bank has written contingency plans for all software and hardware providers. In addition, contingency plans are also written for all outside service providers. These contingency plans are now under review for adequacy and if applicable, will be tested. The Bank is also involved in a customer awareness and employee education program regarding the year 2000. Based on the Bank's review of its computer systems, management believes the cost of the corrections to make the systems Year 2000 compliant to be less than $65,000. Approximately $20,000 was incurred in fiscal 1998 with an additional $45,000 incurred in the nine months ended March 31, 1999. The Bank does not anticipate further major expenditures that are Year 2000 related. In addition, approximately 2,000 to 2,500 man hours are expected to be incurred by Bank personnel related to Year 2000 issues which have an estimated cost of $70,000. Such costs will be charged against income as they are incurred. FINANCIAL CONDITION DATA At March 31, 1999, the Company had total assets of $604.2 million, an increase of $33.2 million from the level at June 30, 1998. The increase in assets was due primarily to an increase in loans receivable of $28.3 million, mortgage-backed securities of $5.6 million and securities available for sale of $5.4 million. The increase in loans receivable, mortgage-backed securities and securities available for sale was funded primarily by a decrease in cash and cash equivalents of $9.8 million, an increase in advances from Federal Home Loan Bank ("FHLB") and other borrowings of $38.2 million and an increase in advances by borrowers for taxes and insurance of $4.0 million from the levels at June 30, 1998. The remaining excess funds received from advances from FHLB and other borrowings and advances by borrowers for taxes and insurance were used to offset the decrease in deposits of $2.9 million and the increase in prepaid expenses and other assets of $1.7 million from the levels at June 30, 1998. In addition, stockholders' equity decreased from $56.6 million at June 30, 1998 to $51.5 million at March 31, 1999, primarily due to the purchase of treasury stock of $6.4 million and the payment of cash dividends of $1.1 million which was partially offset by net income of $2.4 million. Page 9 The increase in loan receivables of $28.3 million was primarily the result of originations exceeding amortizations, sales and prepayments of principal. The increase in loan receivables resulted partially from growth in the credit card loan portfolio of $7.7 million to $20.0 million at March 31, 1999 as compared to $12.3 million at June 30, 1998. The increase in mortgage-backed securities of $5.6 million was primarily the result of purchases exceeding sales, amortizations and prepayments of principal. The Bank purchased mortgage-backed securities in the amount of $21.4 million and sold mortgage-backed securities in the amount of $4.5 million during the nine months ended March 31, 1999. The Bank's purchases of mortgage-backed securities included $14.9 million of thirty year, fixed-rate, mortgage-backed securities and $6.5 million of thirty year, fixed-rate, mortgage-backed securities that have a principal payment balloon in the seventh year. The increase in securities of $5.4 million from the level at June 30, 1998 is primarily due to purchases of securities available for sale of $35.2 million exceeding calls and maturities of $30.0 million during the nine months ended March 31, 1999. The Bank's purchases of securities available for sale were comprised primarily of U.S. Government agency securities which have a maturity of five years or less that have a call feature that varies from three months to two years. The $2.9 million decrease in deposits was primarily due to a decrease in savings accounts of $14.0 million and a decrease in certificates of deposit of $10.4 million which were substantially offset by an increase in money market accounts of $19.0 million and an increase in demand and now accounts of $2.4 million. As of March 31, 1999, the Bank had total deposits from local governmental entities of $54.8 million compared to $51.6 million at June 30, 1998. Advances from the FHLB and other borrowings increased $38.2 million for the nine month period ended March 31, 1999 primarily due to the Company obtaining new advances in the amount of $62.6 million which were partially offset by payments of $24.4 million on advances and other borrowings during the nine month period ended March 31, 1999. The $4.0 million increase in advances by borrowers for taxes and insurance was due primarily to the receipt of escrow payments in excess of amounts paid out. The major escrow payments are primarily paid semiannually in April and October. Page 10 ANALYSIS OF NET INTEREST INCOME Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. AVERAGE BALANCES, INTEREST RATES AND YIELDS. The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The table does not reflect any effect of income taxes. All average balances are monthly average balances and include the balances of nonaccruing loans. The yields and costs for the three and nine months ended March 31, 1999 and 1998 include fees which are considered adjustments to yield.
THREE MONTHS ENDED MARCH 31, -------------------------------------------------------------------------- 1999 1998 ------------------------------------- ---------------------------------- AVERAGE INTEREST AVERAGE INTEREST OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/ BALANCE PAID RATE BALANCE PAID RATE -------------------------------------------------------------------------- (Dollars in Thousands) Interest-earning assets: Loans receivable (1) $470,401 $ 9,973 8.48% $440,438 $ 9,855 8.95% Mortgage-backed securities 47,448 710 5.99% 29,598 468 6.32% Other investment securities (2) 44,817 645 5.76% 69,203 995 5.75% FHLB stock 4,433 69 6.23% 5,222 84 6.43% ------------ ---------- ---------- ------------- ---------- --------- Total interest-earning assets $567,099 $ 11,397 8.04% $544,461 $ 11,402 8.38% ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Noninterest-earning assets 30,623 28,783 ------------ ------------ Total assets $597,722 $573,244 ------------ ------------ ------------ ------------ Interest-bearing liabilities: Deposits: Checking and money market $112,987 $ 723 2.56% $91,174 $ 567 2.49% Savings 49,961 381 3.05% 53,510 468 3.50% Certificates of deposit 274,878 3,829 5.57% 291,067 4,261 5.86% ------------ ---------- ---------- ------------- ---------- --------- Total deposits $437,826 $ 4,933 4.51% $435,751 $ 5,296 4.86% FHLB advances and other borrowings 89,394 1,207 5.40% 63,276 899 5.68% ------------ ---------- ---------- ------------- ---------- --------- Total interest-bearing liabilities $527,220 $ 6,140 4.66% $499,027 $ 6,195 4.97% ---------- ---------- ---------- -------- ---------- ---------- ---------- -------- Other liabilities 18,614 18,296 ------------ ------------ Total liabilities $545,834 $517,323 51,888 55,921 ------------ ------------ Total liabilities and equity $597,722 $573,244 ------------ ------------ ------------ ------------ Net interest income; interest rate spread $ 5,257 3.38% $ 5,207 3.41% ------------ ------------ --------- -------- ------------ ------------ --------- -------- Net interest margin (3) 3.71% 3.83% ------------ -------- ------------ -------- - ----------------------------------------------------------------------------------------------------------------
(1) Includes interest on accruing loans past due 90 days or more. (2) Includes primarily U.S. Government securities. (3) Net interest margin is net interest income divided by average interest-earning assets. Page 11
NINE MONTHS ENDED MARCH 31, --------------------------------------------------------------------------- 1999 1998 ------------------------------------- ------------------------------------- AVERAGE INTEREST AVERAGE INTEREST OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/ BALANCE PAID RATE BALANCE PAID RATE ------------- ----------- ---------- ------------- ---------- ----------- (Dollars in Thousands) Interest-earning assets: Loans receivable (1) $456,806 $ 30,118 8.79% $446,817 $ 30,102 8.98% Mortgage-backed securities 44,929 1,996 5.92% 29,370 1,403 6.37% Other investment securities (2) 41,597 1,825 5.85% 67,761 2,956 5.82% FHLB stock 4,019 196 6.50% 5,222 268 6.84% ------------ ---------- ---------- ------------ ---------- ----------- Total interest-earning assets $547,351 $ 34,135 8.32% $549,170 $ 34,729 8.43% ---------- ---------- ---------- ----------- Noninterest-earning assets 30,072 29,753 ------------ ------------ Total assets $577,423 $578,923 ------------ ------------ ------------ ------------ Interest-bearing liabilities: Deposits: Checking and money market $106,621 $ 2,049 2.56% $86,890 $ 1,641 2.52% Savings 47,360 1,112 3.13% 54,765 1,492 3.63% Certificates of deposit 278,236 12,072 5.79% 297,657 13,335 5.97% ------------ ---------- ---------- ------------ ---------- ----------- Total deposits $432,217 $ 15,233 4.70% $439,312 $ 16,468 5.00% FHLB advances and other borrowings 73,744 3,063 5.54% 66,234 2,867 5.77% ------------ ---------- ---------- ------------ ---------- ----------- Total interest-bearing liabilities $505,961 $ 18,296 4.82% $505,546 $ 19,335 5.10% ---------- ---------- ---------- ----------- Other liabilities 17,779 18,491 ------------ ------------ Total liabilities $523,740 $524,037 Equity 53,683 54,886 ------------ ------------ Total liabilities and equity $577,423 $578,923 ------------ ------------ ------------ ------------ Net interest income; interest rate spread $ 15,839 3.50% $ 15,394 3.33% ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net interest margin (3) 3.86% 3.74% ---------- ---------- ---------- ---------- - ------------------------------------------------------------------------------------------------------------------
(1) Includes interest on accruing loans past due 90 days or more. (2) Includes primarily U.S. Government securities. (3) Net interest margin is net interest income divided by average interest-earning assets. Page 12 RATE/VOLUME ANALYSIS OF NET INTEREST INCOME The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increases and decreases due to fluctuating outstanding balances that are due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31, ------------------------------------ ------------------------------------ 1999 vs 1998 1999 vs 1998 ------------------------------------ ------------------------------------ INCREASE INCREASE INCREASE INCREASE (DECREASE) (DECREASE) TOTAL (DECREASE) (DECREASE) TOTAL DUE TO DUE TO INCREASE DUE TO DUE TO INCREASE VOLUME RATE (DECREASE) VOLUME RATE (DECREASE) ---------- ---------- ---------- ---------- ---------- ---------- (Dollars in Thousands) Interest-earning assets: Loans receivable (1) $ 653 $(535) $ 118 $ 666 $(650) $ 16 Mortgage-backed securities 275 (33) 242 717 (124) 593 Other investment securities (2) (351) 1 (350) (1,145) 14 (1,131) FHLB stock (12) (3) (15) (60) (12) (72) ---------- ---------- ---------- ---------- ---------- ---------- Total interest-earning assets $ 565 $(570) $ (5) $ 178 $(772) $ (594) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Interest-bearing liabilities: Deposits: Checking and money market $ 138 $ 18 $ 156 $ 376 $ 32 $ 408 Savings (29) (58) (87) (188) (192) (380) Certificates of deposit (231) (201) (432) (856) (407) (1,263) ---------- ---------- ---------- ---------- ---------- ---------- Total deposits (122) (241) (363) (668) (567) (1,235) FHLB advances and other borrowings 362 (54) 308 319 (123) 196 ---------- ---------- ---------- ---------- ---------- ---------- Total interest-bearing liabilities $ 240 $(295) $ (55) $ (349) $(690) $(1,039) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net interest income increase $ 50 $ 445 ---------- --------- ---------- --------- - -----------------------------------------------------------------------------------------------------------------------
(1) Includes interest on loans past due 90 days or more. (2) Includes primarily U.S. Government securities. Page 13 [OBJECT OMITTED] ASSET QUALITY In accordance with the Bank's internal classification of assets policy, management evaluates the loan portfolio on a monthly basis to identify loss potential and determine the adequacy of the allowance for possible loan losses. The following table sets forth the amounts and categories of the Bank's nonperforming assets for the periods indicated.
NONPERFORMING ASSETS AS OF ------------------------------------------- MARCH 31, JUNE 30, ------------------ ------------------ 1999 1998 ------------------ ------------------ (Dollars in Thousands) Nonaccruing loans: One- to four-family $ 380 $ 623 Commercial real estate 420 719 Multi-family - - - - - - - - Mobile homes 43 31 Credit cards - - - - - - - - Consumer 342 482 Agriculture 666 - - - - Commercial business 177 396 ----------- ---------- Total $ 2,028 $ 2,251 ----------- ---------- Accruing loans delinquent more than 90 days: One- to four-family $ - - - - $ - - - - Commercial real estate - - - - - - - - Multi-family - - - - - - - - Mobile homes - - - - - - - - Credit cards 1,499 530 Consumer - - - - - - - - Agriculture - - - - - - - - Commercial business - - - - - - - - ----------- ---------- Total $ 1,499 $ 530 ----------- ---------- Foreclosed assets: One- to four-family $ 140 $ 22 Commercial real estate - - - - - - - - Multi-family - - - - - - - - Mobile homes 41 67 Credit cards - - - - - - - - Consumer 26 140 Agriculture - - - - - - - - Commercial business - - - - - - - - ----------- ---------- Total $ 207 $ 229 ----------- ---------- Total nonperforming assets $ 3,734 $ 3,010 ----------- ---------- ----------- ---------- Ratio of nonperforming assets to total assets 0.62% 0.53% ----------- ---------- ----------- ---------- Ratio of nonperforming loans to total loans 0.74% 0.63% ----------- ---------- ----------- ----------
When a loan becomes 90 days delinquent, except for credit card loans, the Bank places the loan on a nonaccrual status and, as a result, accrued interest income on the loan is taken out of income. Future interest income is recognized on a cash basis. The loan will remain on a nonaccrual status until the borrower has brought the loan current. Credit card loans remain in accrual status until 120 days, when accrued interest income on the loan is taken out of income. Page 14 Nonperforming assets increased to $3.7 million at March 31, 1999 from $3.0 million at June 30, 1998, an increase of $724,000. In addition, the ratio of nonperforming assets to total assets, which is one indicator of credit risk exposure, increased to 0.62% at March 31, 1999 as compared to 0.53% at June 30, 1998. Nonaccruing loans decreased from $2.3 million at June 30, 1998 to $2.0 million at March 31, 1999, a decrease of $223,000. Included in nonaccruing loans at March 31, 1999 were nine loans totaling $380,000 secured by one- to four-family real estate, three loans totaling $420,000 secured by commercial real estate, four mobile home loans totaling $43,000, twenty-eight consumer loans totaling $342,000, five agriculture loans totaling $666,000 and ten commercial business loans totaling $177,000. For the nine months ended March 31, 1999, gross interest income of $90,000 would have been recognized on loans accounted for on a nonaccrual basis had such loans been current in accordance with their original terms. Gross interest income of $15,000 was recognized as income on loans accounted for on a nonaccrual basis. Accruing credit card loans delinquent more than 90 days increased to $1.5 million at March 31, 1999 from $530,000 at June 30, 1998. Additionally, $4.3 million of credit card loans are delinquent 30 days at March 31, 1999 as compared to $2.4 million at June 30, 1998. Management has determined that increased delinquencies were primarily due to a change in loan underwriting criteria during the fourth quarter of fiscal 1998 that had the impact of reducing the overall quality of credit card loans that were originated from the fourth quarter of fiscal 1998 through the first nine months of fiscal 1999. Management has reviewed the increased level of credit card delinquencies, and the loan underwriting criteria and collection procedures in the credit card portfolio and ceased processing credit card applications under the current underwriting criteria in March 1999. Net charge-offs for the nine months ended March 31, 1999 were $3.2 million as compared to $358,000 for the same period in fiscal 1998. Using historical stratification data on the current product, management expects credit card loan write-offs not to exceed $8.6 million in the next six months. Of this amount, historically about 37% will be a charge-off against allowance for credit card loan losses, of which the Company currently maintains an allowance for credit card loan losses equal to 22% of the outstanding credit card loan balance. Historically, the remaining 63% will be charged against deferred credit card fee income, interest income and credit card fee income in future periods. Based upon lack of performance, the Company will be exiting the subprime credit card business. Foreclosed assets decreased from $229,000 at June 30, 1998 to $207,000 at March 31, 1999, a decrease of $22,000. At March 31, 1999, the Bank had approximately $7.3 million of other loans of concern that management has determined need to be closely monitored because of possible credit problems of the borrowers or the cash flows of the secured properties. These loans were considered in determining the adequacy of the allowance for possible loan losses. The allowance for possible loan losses is established based on management's evaluation of the risks inherent in the loan portfolio and changes in the nature and volume of loan activity. Such evaluation, which includes a review of all loans for which full collectability may not be reasonably assured, considers the estimated fair market value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an adequate loan loss allowance. Although the Bank's management believes that the March 31, 1999 recorded allowance for loan losses was adequate to provide for potential losses on the related loans, there can be no assurance that the allowance existing at March 31, 1999 will be adequate in the future. Page 15 The following table sets forth information with respect to activity in the Bank's allowance for loan losses during the periods indicated.
NINE MONTHS ENDED ---------------------------- 3/31/99 3/31/98 --------- --------- (Dollars in Thousands) Balance at beginning of period $ 7,199 $ 4,526 Charge-offs: One- to four-family (48) (77) Commercial - - - - - - - Multi-family - - - - - - - Commercial business (93) - - - Consumer (700) (797) Agriculture (487) - - - Credit cards (3,356) (519) Mobile homes (53) (154) --------- -------- Total charge-offs $ (4,737) $(1,547) --------- -------- Recoveries: One- to four-family $ 13 $ 12 Commercial - - - - - - Multi-family - - - - - - Commercial business 72 - - - Consumer 156 134 Agriculture - - - - - - Credit cards 178 161 Mobile homes 41 25 --------- -------- Total recoveries $ 460 $ 332 --------- -------- Net (charge-offs) $ (4,277) $(1,215) Additions charged to operations 5,299 2,228 --------- -------- Balance at end of period $ 8,221 $ 5,539 --------- -------- --------- -------- Ratio of net (charge-offs) recoveries during the period to average loans outstanding during the period (0.94)% (0.27)% --------- -------- --------- -------- Ratio of allowance for loan losses to total loans at end of period 1.73% 1.26 % --------- -------- --------- -------- Ratio of allowance for loan losses to nonperforming loans at end of period (1) 233.09% 240.30 % --------- -------- --------- --------
(1) Nonperforming loans includes nonaccruing loans and accruing loans delinquent more than 90 days. Page 16 The distribution of the Bank's allowance for loan losses at the dates indicated is summarized as follows:
AT MARCH 31, 1999 AT JUNE 30, 1998 ------------------------------ ---------------------------- PERCENT OF PERCENT OF LOANS IN LOANS IN EACH EACH CATEGORY TO CATEGORY TO AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS -------------- ------------- ------------ ------------ (Dollars in Thousands) One- to four-family $1,108 27.85% $ 1,203 29.12% Commercial and multi-family real estate (1) 974 24.49% 967 23.41% Commercial business 399 10.04% 377 9.13% Consumer 1,104 27.75% 1,219 29.49% Agricultural 161 4.04% 150 3.63% Credit cards 4,401 3.98% 3,181 2.74% Mobile homes 74 1.85% 102 2.48% -------------- ------------- ------------ ------------ Total $ 8,221 100.00% $ 7,199 100.00% -------------- ------------- ------------ ------------ -------------- ------------- ------------ ------------
(1) Includes construction loans. The allowance for loan losses was $8.2 million at March 31, 1999 as compared to $7.2 million at June 30, 1998. The ratio of the allowance for loan losses to total loans was 1.73% at March 31, 1999 and 1.62% at June 30, 1998. The Bank's management has considered nonperforming assets and other assets of concern in establishing the allowance for loan losses. The Bank continues to monitor its allowance for possible loan losses and make future additions or reductions in light of the level of loans in its portfolio, historical experience and as economic conditions dictate. The current level of the allowance for loan losses is a result of management's assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on all commercial business, agricultural, construction and multi-family and commercial real estate loans, including purchased loans, that exceed $250,000 and a monthly credit review and reporting process on all types of loans that results in the calculation of the guidelines reserves based on the risk within the portfolio. This assessment of risk takes into account the composition of the loan portfolio, historical loss experience for each loan category, previous loan experience, concentrations of credit and other factors that in management's judgment deserve recognition. In regard to credit card loans, the Company has been providing a reserve in a range of 22% to 30% of the loan balance until the credit card portfolio becomes seasoned. As of March 31, 1999, $4.4 million of the $8.2 million allowance for loan losses was reserved for the credit card loan portfolio. The Company has historically maintained a positive variance from the minimum estimated allowance for loan losses based on the analyses that are conducted by Bank management and corporate credit personnel. This unallocated portion of the allowance is based upon assessment of general economic conditions as well as specific economic factors in the individual locations the Company serves. This determination inherently involves a higher degree of uncertainty and considers current risk factors that may not have yet manifested themselves in the Company's historical loss factors; and it recognizes that knowledge of the portfolio may be incomplete. Management has reviewed the allocations in the various classifications of loans and believes the allowance was adequate at all times during the nine months ended March 31, 1999 and the fiscal year ended June 30, 1998. Page 17 COMPARISON OF THE NINE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 GENERAL. The Company's net income decreased $2.3 million to $2.4 million for the nine months ended March 31, 1999 as compared to $4.7 million for the nine months ended March 31, 1998. As discussed in more detail below, this decrease was due primarily to an increase in noninterest expense of $4.9 million and an increase in provision for losses on loans of $3.1 million. These increases were partially offset by an increase in noninterest income of $4.3 million and a reduction in income tax expense of $1.0 million. INTEREST INCOME. Interest income decreased $594,000 from $34.7 million for the nine months ended March 31, 1998 to $34.1 million for the nine months ended March 31, 1999. This decrease was primarily due to a decrease in the interest earned on interest-earning assets. The average yields earned on interest-earning assets decreased from 8.43% for the nine months ended March 31, 1998 to 8.32% for the nine months ended March 31, 1999. INTEREST EXPENSE. Interest expense decreased $1.0 million from $19.3 million for the nine months ended March 31, 1998 to $18.3 million for the nine months ended March 31, 1999. This decrease was largely attributable to a decrease in the rates paid on interest-bearing liabilities. The average rates paid on interest-bearing liabilities decreased from 5.10% to 4.82% for the nine months ended March 31, 1998 and March 31, 1999, respectively. NET INTEREST INCOME. The Company's net interest income for the nine months ended March 31, 1999 increased $445,000, or 2.89%, to $15.8 million as compared to $15.4 million for the same period ended March 31, 1998. The increase in the net interest income reflects an overall increase in the net interest spread on average interest-earning assets from 3.33% for the nine months ended March 31, 1998 to 3.50% for the nine months ended March 31, 1999. The increase in the net interest spread was primarily due to a decrease in the rates paid on interest-bearing liabilities from 5.10% for the nine months ended March 31, 1998 to 4.82% for the nine months ended March 31, 1999. During the nine months ended March 31, 1999, the Company increased its average balances of commercial, agricultural and credit card loans. The Company anticipates activity in this type of lending to continue in future years subject to market demand except for subprime credit card loans fore which the Company ceased processing applications in March 1999. In addition, the Company sold the majority of conventional single-family residential real estate loan originations into the secondary market. Net interest income is expected to trend upward as a result of this lending activity as interest rate yields are generally higher on these types of loans compared to the yield provided by conventional single-family residential real estate loans. However, lending activity will carry a higher level of risk due to the nature of the collateral and the size of the individual loans. As such, the Company anticipates continued increases in its allowance for loan losses. PROVISION FOR LOSSES ON LOANS. During the nine months ended March 31, 1999, the Company recorded a provision for losses on loans of $5.3 million as compared to $2.2 million for the nine months ended March 31, 1998 an increase of $3.1 million. All of the increase is related to the growth of the subprime credit card loan portfolio from $6.0 million at March 31, 1998 to $20.0 million at March 31, 1999. The provision for losses on loans of $5.3 million for the nine months ended March 31, 1999 compared to the same period in fiscal 1998 is primarily to provide for future expected write-offs on credit card loans and reflects management's continued evaluation of the loan portfolio in light of general economic conditions. See "Asset Quality" for further discussion. During the nine months ended March 31, 1999, the Company had net charge-offs of credit card loans of $3.2 million as compared to $358,000 for the nine months ended March 31, 1998. The net charge-offs for the nine months ended March 31, 1999 exceeded management's expectations. Delinquencies on credit card loans increased from 19.66% at June 30, 1998 to 21.39% at March 31, 1999. NONINTEREST INCOME. Noninterest income was $13.0 million for the nine months ended March 31, 1999 as compared to $8.7 million for the nine months ended March 31, 1998, an increase of $4.3 million. The increase in credit card fee income of $4.3 million for the nine months ended March 31, 1999 as compared to the same period in fiscal 1998 is primarily due to an increase in fees received on unsecured credit cards. This is a result of the credit card loan portfolio increasing from $12.3 million at June 30, 1998 to $20.0 million at March 31, 1999. The credit card loan portfolio had a balance of $6.0 million at March 31, 1998. The fee income represents processing fees, interchange fees, annual fees, late fees and other miscellaneous fees. This credit card program was initiated in fiscal 1997. The Company ceased processing credit card applications in March 1999. This will decrease the level of these fees. Interest income on credit card loans is included in interest income on loans. Page 18 NONINTEREST EXPENSE. Noninterest expense increased $4.9 million from $14.8 million for the nine months ended March 31, 1998 to $19.7 million for the nine months ended March 31, 1999. There was an increase of $4.4 million in the cost of third party processors of credit cards. This included $1.1 million of nonrecurring expenses associated with the decision to stop marketing subprime credit cards. This expense represents costs for processing of applications, collecting loans, and marketing costs for the acquisition of credit cards for the increased amount of unsecured credit card loans. The Company began processing credit cards in the second quarter of fiscal 1997. INCOME TAX EXPENSE. The Company's income tax expense for the nine months ended March 31, 1999 was $1.4 million as compared to $2.4 million for the nine months ended March 31, 1998, a decrease of $1.0 million. This decrease was primarily due to the decrease in the Company's income before income tax. COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 GENERAL. The Company's net income decreased $1.4 million to $47,000 for the three months ended March 31, 1999 as compared to $1.4 million for the three months ended March 31, 1998. As discussed in more detail below, this decrease was due primarily to an increase in noninterest expense of $1.6 million and an increase in provision for losses on loans of $1.1 million. These increases were partially offset by an increase in noninterest income of $806,000 and a reduction in income tax expense of $565,000. INTEREST INCOME. Interest income remained relatively stable at $11.4 million when comparing the three months ended March 31, 1999 to the three months ended March 31, 1998, respectively. The decrease in the average yield of interest-earnings assets was offset by an increase in the average balance of interest-earning assets. The average yield on interest-earning assets decreased from 8.38% to 8.04% for the three months ended March 31, 1998 and March 31, 1999, respectively. The average balance of interest-earning assets increased $22.6 million when comparing the three months ended March 31, 1999 to the same period in the prior fiscal year. INTEREST EXPENSE. Interest expense decreased $55,000 from $6.2 million for the three months ended March 31, 1998 to $6.1 million for the three months ended March 31, 1999. This decrease was largely attributable to a decrease in the average rate paid on interest-bearing liabilities and was partially offset by an increase in the average balance of interest-bearing liabilities. The average rates on interest-bearing liabilities decreased from 4.97% to 4.66% for the three months ended March 31, 1998 and March 31, 1999, respectively. The average balance of interest-bearing liabilities increased $28.2 million when comparing the three months ended March 31, 1999 to the same period in the prior fiscal year. NET INTEREST INCOME. The Company's net interest income for the three months ended March 31, 1999 increased $50,000 to $5.3 million as compared to $5.2 million for the same period in fiscal 1998. The net interest spread on average interest-earning assets remained relatively stable at 3.38% and 3.41% for the three months ended March 31, 1999 and March 31, 1998, respectively. The increase in the net interest income reflects a decrease in the rates paid on interest-bearing liabilities from 4.97% for the three months ended March 31, 1998 to 4.66% for the three months ended March 31, 1999. During the three months ended March 31, 1999, the Company increased its average balances of commercial, agricultural and credit card loans. The Company anticipates activity in this type of lending to continue in future years, subject to market demand, except for subprime credit card loans fore which the Company ceased processing applications in March 1999. In addition, the Company sold the majority of conventional single-family residential real estate loan originations into the secondary market. Net interest income is expected to trend upward as a result of this lending activity as interest rate yields are generally higher on these types of loans compared to the yield provided by conventional single-family residential real estate loans. However, lending activity will carry a higher level of risk due to the nature of the collateral and the size of the individual loans. As such, the Company anticipates continued increases in its allowance for loan losses. PROVISION FOR LOSSES ON LOANS. During the three months ended March 31, 1999, the Company recorded a provision for losses on loans of $2.0 million as compared to $898,000 for the three months ended March 31, 1998. The provision for losses on loans of $2.0 million for the three months ended March 31, 1999 compared to the same period in fiscal 1998 is primarily to provide for future expected write-offs on credit card loans and to management's continued evaluation of the loan portfolio in light of general economic conditions. See "Asset Quality" for further discussion. Page 19 NONINTEREST INCOME. Noninterest income was $3.9 million for the three months ended March 31, 1999 as compared to $3.1 million for the three months ended March 31, 1998, an increase of $806,000. The increase in credit card fee income of $1.1 million for the three months ended March 31, 1999 as compared to the same period in fiscal 1998 is primarily due to an increase in fees received on unsecured credit cards. This is the result of the balance of the credit card portfolio increasing to $20.0 million at March 31, 1999 as compared to $6.0 million at March 31, 1998. The fee income represents processing fees, interchange fees, annual fees, late fees and other miscellaneous fees. This credit card program was initiated in fiscal 1997. The Company ceased processing credit card applications in March 1999. This will decrease the level of these fees. Interest income on credit card loans is included in interest income on loans. NONINTEREST EXPENSE. Noninterest expense increased $1.6 million from $5.3 million for the three months ended March 31, 1998 to $6.9 million for the three months ended March 31, 1999. There was an increase of $1.4 million in the cost of third party processors of credit cards. This included $1.1 million of nonrecurring expenses associated with the decision to stop marketing subprime credit cards. This expense represents costs for processing of applications, collecting loans, and marketing costs for the acquisition of credit cards for the increased amount of unsecured credit card loans. The Company began processing credit cards in the second quarter of fiscal 1997. INCOME TAX EXPENSE. The Company's income tax expense for the three months ended March 31, 1999 was $131,000 as compared to $696,000 for the three months ended March 31, 1998, a decrease of $565,000. This decrease was primarily due to the decrease in the Company's income before income tax. LIQUIDITY AND CAPITAL RESOURCES The Bank's primary sources of funds are deposits, amortization and prepayments of loan principal (including mortgage-backed securities), advances from the FHLB and, to a lesser extent, sales of mortgage loans, sales and/or maturities of securities, mortgage-backed securities, and short-term investments. While scheduled loan payments and maturing securities are relatively predictable, deposit flows and loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Bank attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight funds. Federal regulations have historically required the Bank to maintain minimum levels of liquid assets. The required percentage has varied from time to time based upon economic conditions and savings flows and is currently 4% of net withdrawable savings deposits and current borrowings. Liquid assets for purposes of this ratio include cash, certain time deposits, U. S. Government and corporate securities and other obligations generally having remaining maturities of less than five years. The Bank has historically maintained its liquidity ratio at a level in excess of that required by these regulations. At March 31, 1999, the Bank's regulatory liquidity ratio was 9.34%. Liquidity management is both a daily and long-term responsibility of management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) the objectives of its asset/liability management program. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. During the nine months ended March 31, 1999, the Bank required funds beyond its ability to generate funds internally. Thus it used its borrowing capacity with the FHLB by obtaining advances, which increased its borrowings with the FHLB by $38.2 million. The Bank anticipates that it will have sufficient funds available to meet current loan commitments. At March 31, 1999, the Bank had outstanding commitments to originate or purchase loans of $69.5 million and to sell loans of $22.6 million. The Bank had commitments to purchase securities available for sale of $260,000 and no commitments to sell securities available for sale. The Bank had no commitments to purchase or sell mortgage-backed securities. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings where the funds can be invested in either loans or securities at a positive rate of return or to use the funds for short term liquidity purposes. See "Financial Condition Data" for further analysis. In April of 1997, the Company initiated a stock buy back program in which up to 10% of the common stock of the Company could be acquired beginning May 1, 1997 through April 30, 1998. A total of 111,750 shares of common stock were purchased pursuant to this program. In April of 1998, the Company initiated another stock buy back program in which up to Page 20 10% of the common stock of the Company may be acquired beginning May 1, 1998 through April 30, 1999. In accordance with the provisions of the current stock buy back program, the Company purchased 364,350 shares of common stock in this stock buy back program that expired April 30, 1999. In May of 1999, the Company initiated another stock buy back program in which up to 10% of the common stock of the Company may be acquired through April 30, 2000. Purchases may be made periodically in either open market or private transactions or both, in accordance with guidelines established by the Securities and Exchange Commission, which includes volume restrictions designed to minimize the impact of such repurchases. The number of shares of common stock actually acquired by the Company will depend upon subsequent developments and corporate needs, and such repurchases may be interrupted or discontinued at any time. Savings institutions insured by the Federal Deposit Insurance Corporation are required by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") to meet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure. Institutions not in compliance may apply for an exemption from the requirements and submit a recapitalization plan. Under these capital requirements, at March 31, 1999, the Bank met all current capital requirements. The OTS has adopted a core capital requirement for savings institutions comparable to the requirement for national Banks. The OTS core capital requirement is 3% of total adjusted assets for thrifts that receive the highest supervisory rating for safety and soundness. The Bank had core capital of 7.43% at March 31, 1999. Pursuant to FDICIA, the federal Banking agencies, including the OTS, have also proposed regulations authorizing the agencies to require a depository institution to maintain additional total capital to account for concentration of credit risk and the risk of non-traditional activities. No assurance can be given as to the final form of any such regulation. During the first quarter of fiscal 1997, the Small Business Job Protection Act of 1996 was signed into law which repealed the percentage of taxable income method of computing the bad debt deduction for savings institutions for tax years beginning after December 31, 1995. Beginning in fiscal year 1997, the Bank is required to recapture into income the excess of its June 30, 1996 loan loss reserves for "qualifying" and "nonqualifying" loans over its June 30, 1988 loan loss reserves for "qualifying" and "nonqualifying" loans. This excess which was $720,000 at June 30, 1998, is required to be recaptured ratably over a six year period. The onset of recapture was delayed in fiscal years 1998 and 1997 since the Bank met a residential loan origination requirement which allowed for a two year delay in recapture. At June 30, 1998, the Bank's recorded deferred tax liability of $245,000 provides for the recapture of the loan loss reserves. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and Notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. Page 21 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The composition of the Bank's balance sheet results in maturity mismatches between interest-earning assets and interest-bearing liabilities. The scheduled maturities of the Bank's fixed rate interest-earning assets are longer than the scheduled maturities of its fixed rate interest-bearing liabilities. This mismatch exposes the Bank to interest rate risk. In a rising rate scenario, as measured by the OTS interest rate risk exposure simulation model, the estimated market or portfolio value ("PV") of the Bank's assets would decline in value to a greater degree than the change in the PV of the Bank's liabilities, thereby reducing net portfolio value ("NPV"), the estimated market value of its shareholders' equity. As of September 30, 1998, under a rate shock scenario of plus 200 basis points ("bp"), the Bank's pre-shock NPV ratio (NPV as a % of PV of assets) was estimated in the OTS model to be 10.64%. The post-shock NPV ratio was estimated to be 10.11%, a decline of 53bp. As of December 31, 1998, the most recent report available, the Bank's sensitivity to interest rate changes decreased slightly. The post-shock ratio for a 200 bp decrease in market interest rates as of December 31, 1998 was estimated to be 9.93%, a decrease of 31bp from the pre-shock NPV ratio estimate of 10.24%. In managing the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. The effect of this policy will generally be to reduce the Bank's sensitivity to interest rate changes. The goal of this policy is to provide a relatively consistent level of net interest income in varying interest rate cycles and to minimize the potential for significant fluctuations from period to period. Other types of market risk, such as foreign exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. Page 22 HF FINANCIAL CORP. FORM 10-Q PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS None Item 2. CHANGES IN SECURITIES None Item 3. DEFAULTS UPON SENIOR SECURITIES None Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None Item 5. OTHER INFORMATION None Item 6. EXHIBITS AND REPORTS OF FORM 8-K a. Exhibit 27.1 and Exhibit 27.2 are attached. b. Refer to Form 8-K filed on May 13, 1999. - ----------------------------------------------------------------------- No other information is required to be filed under Part II of the form. Page 23 HF FINANCIAL CORP. FORM 10-Q SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HF Financial Corp. ------------------------------------ (Registrant) Date: 5/14/99 by /s/ Curtis L. Hage ------- ------------------------------------ Curtis L. Hage, Chairman, President And Chief Executive Officer (Duly Authorized Officer) Date: 5/14/99 by /s/ Brent E. Johnson ------- ------------------------------------ Brent E. Johnson, Senior Vice President, Chief Financial Officer And Treasurer (Principal Financial and Accounting Officer) Page 24 EX-27.1 2 EX. 27.1
9 0000881790 HF FINANCIAL CORP. 1,000 9-MOS JUN-30-1999 JUL-01-1998 MAR-31-1999 10,686 5,000 0 0 94,853 0 0 474,083 8,221 604,185 443,545 0 20,296 88,876 0 0 15,154 36,314 604,185 30,118 4,017 0 34,135 15,223 18,296 15,839 5,299 3 19,712 3,779 3,779 0 0 2,427 0.57 0.56 8.32 2,028 1,499 0 0 7,199 4,737 460 8,221 8,221 0 0
EX-27.2 3 EX. 27.2
9 0000881790 HF FINANCIAL CORP. 1,000 9-MOS JUN-30-1998 JUL-01-1997 MAR-31-1998 11,245 11,000 0 0 92,290 0 0 438,849 5,539 570,420 436,237 0 18,124 60,607 0 0 14,866 40,586 570,420 30,102 4,627 0 34,729 16,468 19,335 15,394 2,228 10 14,763 7,098 7,098 0 0 4,722 1.06 1.03 8.43 2,014 291 0 0 4,526 1,547 332 5,539 5,539 0 0
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