-----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, ERwxQy80LV3csjJ0dsZb9l6TmbHKELzpXiXHJozrlW1y3feXjY+5Ul8YQDPWuBxy sh4mcTy9NOFPbntCF1R3lw== 0000926274-99-000279.txt : 19991227 0000926274-99-000279.hdr.sgml : 19991227 ACCESSION NUMBER: 0000926274-99-000279 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIDELITY FEDERAL BANCORP CENTRAL INDEX KEY: 0000910492 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 351894432 STATE OF INCORPORATION: IN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-22880 FILM NUMBER: 99718767 BUSINESS ADDRESS: STREET 1: 700 S GREEN RIVER ROAD STREET 2: SUITE 2000 CITY: EVANSVILLE STATE: IN ZIP: 47715 BUSINESS PHONE: 8124240921 MAIL ADDRESS: STREET 1: 18 NW FOURTH ST STREET 2: PO BOX 1347 CITY: EVANSVILLE STATE: IN ZIP: 47706-1347 10-K405 1 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 (fee required) For the fiscal year ended: June 30, 1999 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (no fee required) For the Transaction period from ____ to _____. --------------------------------- Commission File No. 0-22880 Fidelity Federal Bancorp ------------------------------------------------------ (Exact name of registrant as specified in its charter) Indiana 35-1894432 - ----------------------------------------------------------------------------- (State of other jurisdiction (I.R.S. Employer of Incorporation or Identification No.) Organization) 700 S. Green River Road, Suite 2000, PO Box 5584, Evansville, Indiana 47715 --------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's Telephone number, including area code (812) 469-2100 -------------- Securities registered pursuant to Section 12 (b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock, $1 Stated Value ----------------------------- (Title of Class) DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held November 17, 1999 are incorporated by reference into Part III Exhibit index is on page 78 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 past preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by checkmark 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 the 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] The aggregate market value of voting stock held by non-affiliates of the Registrant (for purposes of such calculation, includes persons who are not directors, executive officers, or holders of more than 10% of the registrant's common stock) based on the average bid and asked prices of such stock at September 15, 1999 was approximately $5,695,931. Indicated below is the number of shares outstanding of each of the registrant's classes of common stock as of September 15, 1999. Common Stock - 3,147,662 shares FIDELITY FEDERAL BANCORP Index PART I Page ---- ITEM 1 - Business 3 ITEM 2 - Properties 10 ITEM 3 - Legal Proceedings 10 ITEM 4 - Submission of Matters to a Vote of Security Holders 10 PART II ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters 11 ITEM 6 - Selected Financial Data 12 ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 13 ITEM 7 A Quantitative and Qualitative Disclosures About Market Risk 38 ITEM 8 - Financial Statements and Supplementary Data Report of Independent Auditors 40 Consolidated Balance Sheet 41 Consolidated Statement of Income 42 Consolidated Statement of Stockholders' Equity 43 Consolidated Statement of Cash Flows 45 Notes to Consolidated Financial Statements 47 ITEM 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 75 PART III ITEM 10 - Directors and Executive Officers of the Registrant 75 ITEM 11 - Executive Compensation 75 ITEM 12 - Security Ownership of Certain Beneficial Owners and Management 75 ITEM 13 - Certain Relationships and Related Transactions 75 PART IV ITEM 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K 76 SIGNATURES 77 2 PART I ITEM 1. BUSINESS - ------- SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain matters discussed in this Annual Report on Form 10-K are "forward-looking statements" intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as Fidelity Federal Bancorp ("Fidelity") "believes", "anticipates", "expects", "estimates" or words of similar import. Similarly, statements that describe Fidelity's future plans, objectives or goals are also forward-looking statements. Such forward-looking statements are subject to certain risks and uncertainties which are described in close proximity to such statements and which could cause actual results to differ materially from those anticipated as of the date of this report. Shareholders, potential investors and other readers are urged to consider these factors in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included herein are only made as of the date of this report and Fidelity undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. OVERVIEW Fidelity Federal Bancorp, incorporated in 1993 under the laws of the State of Indiana, is a registered savings and loan holding company with its principal office in Evansville, Indiana. Fidelity's savings bank subsidiary, United Fidelity Bank, fsb (United), was organized in 1914 and is a federally-chartered stock savings bank located in Evansville, Indiana. Fidelity, through its savings bank subsidiary, is engaged in the business of obtaining funds in the form of savings deposits and other borrowings and investing such funds in consumer, commercial, and mortgage loans, and in investment and money market securities. Fidelity has engaged in the business of owning, developing, building, renting and managing affordable housing projects through its wholly-owned subsidiaries, Village Management Corporation and Village Housing Corporation (collectively, the Affordable Housing Group). The Affordable Housing Group has structured and participated in multi-family housing developments which have been granted tax credits pursuant to Section 42 of the Internal Revenue Code of 1986 (Section 42), as amended (Code) and tax-exempt bonds. Village Housing Corporation, as general partner to the limited partnerships which own the developments, receives a percentage interest in the profits, losses and tax credits during the life of the project and receives a percentage of the annual cash flow and residual (sale or refinancing) proceeds during operation and at disposition or refinancing of the developments, respectively. Village Community Development Corporation, (a subsidiary merged into Village Housing Corporation during fiscal 1999) as contractor and developer, received construction and development fees as the projects were completed. As the developments progressed, development fee income was earned contractually on each project. These fees were not recognized as income until the limited partner's equity investment had been received or the syndication firm providing the equity had given a firm commitment to provide the funds. As part of Village Management's duties as project manager, it monitors compliance with the requirements of the Code to prevent recapture of all or a portion of the tax credits or forfeiture of the tax-exempt status of the bonds which would occur if certain tenant eligibility and rent restriction requirements were violated. Village Management Corporation, as manager of the completed project, receives a fee based on a percentage of rental payments received from the project's tenants. Fidelity has been engaged in affordable housing activities since September, 1992, through United, and since April, 1994, through Village Capital Corporation (VCC). Since June 30, 1994, VCC has earned fees by providing real estate mortgage banking services to unaffiliated borrowers. The June 30, 1999 audited financial statements include condensed financial information about both of Fidelity's business segments. While Fidelity has not participated in the development of any new projects that it manages, the performance of a majority of the projects that Fidelity is managing is below that which was originally projected when the projects were formed. This has resulted in lower than expected cash flows, which are needed to support debt repayment. Cash flows of the projects have been affected by a number of items, including lower than expected occupancy and/or rent levels, higher-than-expected expenses and, in certain situations, additional construction costs or delays which resulted in longer start-up periods for the projects. The areas in which many of the projects are located have seen increased competition in affordable housing, which has affected the project's ability to perform at the levels originally projected. Each of the projects are beyond the start-up or construction phase and have been in operation for a sufficient period of time to enable management to conclude that additional provisions and reserves were required. Fidelity's current plans are to not originate, participate or invest in any new or additional Section 42 projects. Fidelity believes that the properties' cash flows will not improve significantly unless a change in the properties' financing or debt structure occurs. It is currently pursuing a plan to refinance its Section 42 projects. The availability of such refinancing depends upon numerous factors, including, among other things, interest rates, third-party appraisals and the occupancy levels in the Section 42 projects. During fiscal 1999, one of Fidelity's primary goals was to seek refinancing opportunities with other potential financing sources. This is typically a lengthy process and Fidelity has been successful on a number of classified assets. Fidelity's classified assets and letters of credit have decreased $3.7 million to $37.5 million at June 30, 1999 from $41.3 million at June 30, 1998. Fidelity has a number of other credits in 3 process for refinancing to further reduce the classified assets during fiscal 2000. The refinancing and workout effort is anticipated to be a significant portion of the Fidelity and United business plan during fiscal 2000. The final subsidiary of United, Village Insurance Corporation, is engaged in the business of selling credit life insurance, as well as accident and health insurance, to United's loan customers. A second subsidiary of Fidelity, Village Affordable Housing Corporation, was formed in fiscal 1998. This company was formed to hold an interest in a housing partnership that was initially financed by United, which was subsequently charged off by Village Affordable Housing Corporation. Fidelity had consolidated total assets of $172.3 million and total shareholders' equity of $7.8 million as of June 30, 1999. Fidelity's subsidiaries at June 30, 1999, are listed below:
SUBSIDIARY PRINCIPAL OFFICE YEAR ORGANIZED ASSETS (in thousands) 1. United Fidelity Bank, fsb Evansville, IN 1914 $167,535 Subsidiaries of United Fidelity Bank, fsb: Village Capital Corporation Evansville, IN 1994 783 Village Insurance Corporation Evansville, IN 1980 85 Village Management Corporation Evansville, IN 1992 306 Village Housing Corporation Evansville, IN 1992 2,669 2. Village Affordable Housing Corporation Evansville, IN 1998 36
Fidelity's home office is located at 700 S. Green River Road, Suite 2000, Evansville, Indiana, 47715 and its telephone number is (812) 469-2100. COMPETITION Fidelity and United faces strong direct competition for deposits, loans and other financial-related services. United competes in Indiana, Kentucky and Illinois with the other thrifts, commercial banks, credit unions, stockbrokers, finance companies and insurance companies. Some of these competitors are local, while others are statewide or national. United competes for deposits principally by offering depositors a variety of deposit programs, convenient office locations, hours and other services, and for loan originations primarily through competitive interest rates and fees, the efficiency and quality of service provided and the variety of loan products offered. Some of the non-bank financial institutions and financial services organizations with which United competes are not subject to the same degree of regulation as that imposed on federal savings banks, thrifts, or thrift-holding companies. As a result, such competitors may have advantages over United in providing certain services. As of September 20, 1999, approximately 4 banks, 3 thrifts, and 11 credit unions operated in the Evansville, Indiana metropolitan area, which is United's principal deposit market area. United is currently the second largest thrift in this market. Many competitors are substantially larger or have significantly greater capital resources than United. Due to recently enacted legislation to allow unlimited interstate branching, Fidelity and United may experience heightened competition from existing competitors and other major financial institutions seeking to expand their regional banking presence in Indiana. Fidelity has discontinued development activities pertaining to the affordable housing industry and multifamily development in part because of increased levels of competition. REGULATION OF FIDELITY In addition to the general provisions discussed below, Fidelity and United are also subject to the provisions of the Supervisory Agreement entered into with the OTS in February 1999, which also impacts the operations of Fidelity and United. See page 62 of this document for further details. Fidelity is a savings and loan holding company within the meaning of the Home Owners' Loan Act of 1933 ("HOLA"), as amended. Fidelity is registered with the Office of Thrift Supervision ("OTS") and is subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, United is subject to certain restrictions in its dealings with Fidelity and with other companies affiliated with Fidelity. The HOLA generally prohibits a savings and loan holding company, without prior approval of the Director of the OTS, from (i) acquiring control of, or controlling the assets of, any other savings association or savings and loan holding company; or (ii) acquiring or retaining more than 5% of the voting shares of a savings association or savings and loan holding company which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and 4 loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may acquire control of any savings association, other than a subsidiary association, or any other savings and loan holding company. Fidelity operates as a unitary savings and loan holding company. There are generally no restrictions on the activities of a unitary savings and loan holding company. However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness, or stability of its subsidiary savings association, the Director of the OTS may impose such restrictions as deemed necessary to address such risk and limit (i) payment of dividends by the savings association, (ii) transactions between the savings association and its affiliates, and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet the Qualified Thrift Lender Test ("QTL test"), as discussed below, then such unitary holding company would become subject to the activities restrictions applicable to multiple savings and loan holding companies. Additional restrictions on the savings association's ability to obtain advances from the FHLB also apply. If Fidelity were to acquire control of another savings association, other than through merger or other business combinations with United, Fidelity would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority of the regulatory agencies to approve emergency thrift acquisitions and where each subsidiary savings association meets the QTL test, the activities of Fidelity and any of its subsidiaries (other than United or other subsidiary savings associations) would thereafter be subject to further restrictions. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings association shall commence or continue for a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof, any business activity other than (i) furnishing or performing management services for a subsidiary savings association, (ii) conducting an insurance agency or escrow business, (iii) holding, managing or liquidating assets owned by or acquired from a subsidiary savings association, (iv) holding or managing properties used or occupied by a subsidiary savings association, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by regulation as of March 5, 1987, to be engaged in by multiple savings and loan holding companies, or (vii) those activities authorized by regulation of the Board of Governors of the Federal Reserve System as permissible for bank holding companies, unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above must also be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company. The Director of the OTS may also approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings associations in more than one state, if the multiple savings and loan holding company involved controls a savings association which operated a home or branch office in the state of the association to be acquired as of March 5, 1987, or if the laws of the state in which the association to be acquired is located specifically permit associations to be acquired by state-chartered associations or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings associations). The Director of the OTS may also approve an acquisition resulting in a multiple savings and loan holding company controlling savings associations in more than one state in the case of certain emergency thrift acquisitions. Indiana law permits federal and state savings association holding companies with their home offices located outside of Indiana to acquire savings associations whose home offices are located in Indiana and savings and loan holding companies with their principal place of business in Indiana ("Indiana Savings and Loan Holding Companies") upon receipt of approval by the Indiana Department of Financial Institutions. Moreover, Indiana Savings and Loan Holding Companies may acquire savings associations with their home offices located outside of Indiana and savings association holding companies with their principal place of business located outside of Indiana upon receipt of approval by the Indiana Department of Financial Institutions. Subject to certain exceptions, commonly controlled banks and savings associations must reimburse the Federal Deposit Insurance Corporation ("FDIC") for any losses suffered in connection with a failed bank or savings association affiliate. Institutions are commonly controlled if one is owned by another or if both are owned by the same holding company. Such claims by the FDIC under this provision are subordinate to claims of depositors, secured creditors, and holders of subordinated debt, other than affiliates. SAVINGS BANK REGULATION General. As a federally chartered, SAIF-insured savings association, United is subject to extensive regulation by the OTS and the FDIC. The OTS periodically examines the books and records of United and, in conjunction with the FDIC in certain 5 situations, has examination and enforcement powers. This supervision and regulation are intended primarily for the protection of depositors and federal deposit insurance funds. United is also subject to federal and state regulation as to such matters as loans to officers, directors, or principal shareholders, required reserves, limitations as to the nature and amount of its loans and investments, regulatory approval of any merger or consolidation, issuance or retirements of its securities, and limitations upon other aspects of banking operations. In addition, its activities and operations are subject to a number of additional detailed, complex and sometimes overlapping federal and state laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-In-Lending Act and Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Community Reinvestment Act, anti-redlining legislation and antitrust laws. In May 1999 and July 1999 the United States Senate and the United States House of Representatives, respectively, each passed financial reform legislation. The legislation is intended to break down barriers between banking, securities and insurance activities, while continuing to restrict commercial activity by banks. The legislation also restricts the potential acquirers of unitary thrift holding companies. The Senate and the House must still agree on various aspects of the legislation and therefore, no assurance can be given as to whether or in what form the legislation will be enacted or its effect on Fidelity and United. Any changes in legislation or regulations, whether by legislation or regulatory action, could have a material impact on United and its operations. Neither Fidelity nor United can predict what, if any, future actions may be taken by legislative or regulatory authorities or what impact any such actions may have on the operations of Fidelity or United. Qualified Thrift Lender Requirement. In order for United to exercise the powers granted to federally-chartered savings associations and maintain full access to FHLB advances, it must be a "qualified thrift lender" ("QTL"). A savings association is a QTL if its qualified thrift investments equal or exceed 65% of the savings association's portfolio assets on a monthly basis in 9 out of every 12 months. Qualified thrift investments generally consist of (i) various housing related loans and investments (such as residential construction and mortgage loans, home improvement loans, manufactured housing loans, home equity loans and mortgage-backed securities), (ii) certain obligations of the FSLIC, the FDIC, the FSLIC Resolution Fund and the Resolution Trust Corporation (for limited periods), and (iii) shares of stock issued by any Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Association. At June 30, 1999, the qualified thrift investment percentage test for United was 99.66%. Liquidity. Under applicable federal regulations, savings associations are required to maintain an average daily balance of liquid assets (including cash, certain time deposits, certain banker's acceptances, certain corporate debt securities and highly rated commercial paper, securities of certain mutual funds and specified United States government, state or federal agency obligations) of not less than 4% of the average daily balance of the savings association's net withdrawable deposits plus short-term borrowing during the preceding calendar quarter. Under HOLA, this liquidity requirement may be changed from time to time by the Director of the OTS to any amount within the range of 4% to 10%, depending upon economic conditions and the deposit flows of member associations. At June 30, 1999, United was in compliance with these liquidity requirements, at 20.99%. Loans-to-One-Borrower Limitations. HOLA generally requires savings associations to comply with the loans-to-one-borrower limitations applicable to national banks. In general, national banks may make loans to one borrower in amounts up to 15% of the bank's unimpaired capital and surplus, plus an additional 10% of capital and surplus for loans secured by readily marketable collateral. At June 30, 1999, United's loan-to-one-borrower limitation was approximately $3.4 million and no loans to a single borrower exceeded that amount, except as provided herein. Under certain conditions, a savings association may make loans to one borrower for residential housing developments in amounts up to 30% of the bank's unimpaired capital and surplus provided that all loans made in reliance upon the increased lending limit do not, in the aggregate, exceed 150% of the bank's unimpaired capital and surplus. At June 30, 1999, United had made $7.5 million in such loans under this higher lending limit. Commercial Real Property Loans. HOLA limits the aggregate amount of commercial real estate loans that a federal savings association may make to an amount not in excess of 400% of the savings association's capital. Limitation on Capital Distributions. The OTS regulations impose limitations on capital distributions by savings associations. Under the rule, a savings association is classified as a tier 1 institution, a tier 2 institution, or a tier 3 institution, depending on its level of regulatory capital both before and after giving effect to a proposed capital distribution. A tier 1 institution may generally make capital distributions in any calendar year up to 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (i.e., the percentage by which the association's capital-to-assets ratio exceeds the ratio of its capital requirements to its assets) at the beginning of the calendar year. No regulatory approval of the capital distribution is required, but prior notice must be given to the OTS. Restrictions exist on the ability of tier 2 and tier 3 institutions to make capital distributions. Also, the OTS may prohibit any capital distribution otherwise permitted if such distribution would constitute an unsafe or unsound practice, such as a proposed distribution by 6 an institution whose capital is decreasing because of substantial losses or by an institution that is in need of more than normal supervision. Insurance of Deposits. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of banks and thrifts and safeguards the safety and soundness of the banking and thrift industries. The FDIC administers two separate insurance funds, the Bank Insurance Fund (the "BIF") for commercial banks and state savings banks and the SAIF for savings associations such as United. The FDIC is required to maintain designated levels of reserves in each fund. The FDIC is authorized to establish separate annual assessment rates for deposit insurance for members of the BIF and members of the SAIF. The FDIC may increase assessment rates for either fund if necessary to restore the fund's ratio of reserves to insured deposits to the target level within a reasonable time and may decrease these rates if the target level has been met. The FDIC has established a risk-based assessment system for both SAIF and BIF members. Under this system, assessments vary depending on the risk the institution poses to its deposit insurance fund. An institution's risk level is determined based on its capital level and the FDIC's level of supervisory concern about the institution. Annual deposit insurance premiums range between $0.00 and $0.27 per $100 of deposits are in effect, based on the assessment determined in accordance with the risk-assessment system discussed above. With respect to the funding of the obligations issued by the federally-chartered corporation ("FICO") which provided some of the financing to resolve the thrift crisis in the 1980's, BIF institutions pay approximately 20% of the rate paid by SAIF institutions on their deposits. After December 31, 1999, both BIF and SAIF institutions will be assessed at the same rate for FICO payments. Community Reinvestment Act. Ratings of depository institutions under the Community Reinvestment Act of 1977 ("CRA") must be disclosed. The disclosure includes both a four-tier descriptive rating using terms such as "outstanding," "satisfactory," "needs to improve," or "substantial non-compliance" and a written evaluation of each institution's performance. United received a satisfactory rating from the OTS in its most recent CRA examination. Also, the Federal Housing Finance Board has adopted regulations establishing standards of community investment and service for members of the FHLB System to meet to be eligible for long-term advances. These regulations take into account a savings association's CRA record and the member's record of lending to first-time home buyers. Brokered Deposits. Pursuant to the FDIC regulations, well-capitalized institutions are subject to no brokered deposits limitations, while adequately capitalized institutions are able to accept, renew or rollover brokered deposit only (i) with a waiver from the FDIC, and (ii) subject to certain restrictions on payment of rates. Undercapitalized institutions are not permitted to accept brokered deposits and may not solicit deposits by offering an effective yield that significantly exceeds the prevailing effective yields on insured deposits of comparable maturity in the institution's normal market area or in which such deposits are being solicited. Enforcement. The OTS has primary enforcement responsibility over savings associations and has the authority to bring enforcement action against all "institution-affiliated parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Civil penalties cover a wide range of violations and actions and range up to $25,000 per day unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. In addition, regulators are provided with far greater flexibility to impose enforcement action on an institution that fails to comply with its regulatory requirements, particularly with respect to the capital requirements. Possible enforcement action ranges from the imposition of a capital directive to receivership, conservatorship or the termination of deposit insurance. The FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Standards for Safety and Soundness. The federal banking agencies have prescribed for all insured depository institutions safety and soundness standards in the form of guidelines, relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset quality and growth, earnings, and compensation, fees and benefits. If an insured depository institution fails to meet any of the standards described above, it will be required to submit to the appropriate federal banking agency a plan specifying the steps that will be taken to cure the deficiency. If an institution fails to submit an acceptable plan or fails to implement the plan, the appropriate federal banking agency will issue an order requiring the institution to take immediate steps to correct a safety and soundness deficiency. Real Estate Lending Standards. OTS regulations require savings associations to establish and maintain written internal real estate lending policies. Each association's lending policies must be consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its operations. The policies must establish loan portfolio diversification standards; establish prudent underwriting standards, including loan-to-value limits that are clear and measurable; establish loan administration procedures for the association's real estate portfolio; and establish documentation, approval, and reporting requirements to monitor compliance with the association's real estate lending policies. The association's written real estate lending policies must be reviewed and approved by the association's Board of 7 Directors at least annually. Further, each association is expected to monitor conditions in its real estate market to ensure that its lending policies continue to be appropriate for current market conditions. Prompt Corrective Regulatory Action. The Federal Deposit Insurance Act ("FDI Act") establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the banking regulators are required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. Under the OTS prompt corrective action regulation, generally, a savings association that has a total risk-based capital of less than 8.0% or a tier 1 risk-based capital ratio or leverage ratio of less than 4.0% is considered to be undercapitalized. A savings association that has a total risk-based capital of less than 6.0%, a tier 1 risk-based capital ratio of less than 3%, or a leverage ratio that is less than 3.0% is considered to be "significantly undercapitalized" and a savings association that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Generally, a capital restoration plan must be filed with the OTS within 45 days of the date an association receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the associations, including, but not limited to, restrictions on growth, investment activities, capital distributions, and affiliate transactions. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Capital Requirements. The Director of the OTS has adopted capital standards under which savings associations must maintain (i) "core capital" in an amount not less than 3% of total adjusted assets, (ii) "tangible capital" in an amount not less than 1.5% of total adjusted assets, and (iii) a level of risk-based capital equal to 8.0% of risk-weighted assets. Under OTS regulations "core capital" includes common stockholders' equity, noncumulative perpetual preferred stock and related surplus, and minority interests in the equity accounts of consolidated subsidiaries, less nonqualifying intangible assets. In determining compliance with the capital standards, a savings association must deduct from capital its entire investment in and loans to any subsidiary engaged in activities not permissible for a national bank, other than subsidiaries (i) engaged in such non-permissible activities solely as agent for their customers; (ii) engaged in mortgage banking activities; or (iii) that are themselves savings associations or companies, the only investment of which is another savings association, acquired prior to May 1, 1989. In determining total risk-weighted assets for purposes of the risk-based requirement, (i) each off-balance sheet asset must be converted to its on-balance sheet credit equivalent by multiplying the face amount of each such item by a credit conversion factor ranging from 0% to 100% (depending upon the nature of the asset), (ii) the credit equivalent amount of each off-balance sheet asset and the book value of each on-balance sheet asset must be multiplied by a risk factor ranging from 0% to 100% (again depending upon the nature of the asset), and (iii) the resulting amounts are added together and constitute total risk-weighted assets. Total capital, for purposes of the risk-based requirement, equals the sum of core capital plus supplementary capital (which, as defined, includes, among other items, perpetual preferred stock not counted as core capital, limited life preferred stock, subordinated debt and general loan and lease loss allowances up to 1.25% of risk-weighted assets, less certain deductions). The amount of supplementary capital that may be counted towards satisfaction of the total capital requirement may not exceed 100% of core capital. Capital requirements higher than the generally applicable minimum requirement may be established for a particular savings association if the OTS determines that the association's capital was or may become inadequate in view of its particular circumstances. Individual minimum capital requirements may be appropriate where the savings association is receiving special supervisory attention, has a high degree of exposure to interest rate risk, or poses other safety or soundness concerns. In determining compliance with the risk-based capital requirements, a savings association must determine its interest rate risk and, if such risk exceeds a certain level, it must deduct an interest rate risk component in calculating its total capital for purposes of determining whether it meets its risk-based capital requirements. An association's interest rate risk (IRR) is measured by the decline in the net portfolio value (NPV) resulting from a 200 basis point increase or decrease in market interest rates, divided by the estimated economic value of its assets. If an association's measured IRR exposure exceeds 2%, it must then deduct an IRR component from total capital for determining its risk-based capital requirement. The IRR component is an amount equal to one-half the difference between its measured interest rate risk and 2%, multiplied by the estimated economic value of its total assets. United's Subsidiaries. The OTS regulations permit federal savings associations to invest in the capital stock, obligations or specified types of securities of subsidiaries (referred to as "service corporations") and to make loans to such subsidiaries and joint ventures in which such subsidiaries are participants in an aggregate amount not exceeding 3% of an association's assets, provided any investment over 2% is used for specified community or inner-city development purposes. In addition, federal regulations permit associations to make specified types of loans to such subsidiaries in an aggregate amount not 8 exceeding 50% of the association's regulatory capital if certain requirements and conditions are met. The FDIC may, after consultation with the OTS, prohibit specific activities if it determines such activities pose a serious threat to SAIF. Assessments. Savings associations are required by OTS regulation to pay assessments to the OTS to fund the operations of the OTS. The general assessment is computed upon the savings association's total assets, including consolidated subsidiaries, as reported in the Saving Bank's latest quarterly Thrift Financial Report. United's total assessment for the year ended June 30, 1999 was $65,000. ACQUISITIONS AND BRANCHING The Bank Holding Company Act specifically authorizes a bank holding company, upon receipt of appropriate regulatory approvals, to acquire control of any savings association or holding company thereof wherever located. Similarly, a savings and loan holding company may acquire control of a bank. Moreover, federal savings associations may acquire or be acquired by any insured depository institution. Regulations promulgated by the Federal Reserve Board restrict the branching authority of savings associations acquired by bank holding companies. Savings associations acquired by bank holding companies may be converted to banks if they continue to pay SAIF premiums, but as such they become subject to branching and activity restrictions applicable to banks. The OTS has adopted regulations which permit nationwide branching to the extent permitted by federal statute. Federal statutes permit federal savings associations to branch outside of their home state if the association meets the domestic building and loan test in Section 7701(a)(19) of the Internal Revenue Code or the asset composition test of Section 7701(c) of the Internal Revenue Code. Branching that would result in the formation of a multiple savings and loan holding company controlling savings associations in more than one state is permitted if the law of the state in which the savings association to be acquired is located specifically authorizes acquisitions of its state-chartered associations by state-chartered associations or their holding companies in the state where the acquiring association or holding company is located. Moreover, Indiana banks and savings associations are permitted to acquire other Indiana banks and savings associations and to establish branches throughout Indiana. TRANSACTIONS WITH AFFILIATES Pursuant to HOLA, transactions engaged in by a savings association or one of its subsidiaries with affiliates of the savings association generally are subject to the affiliate transaction restrictions contained in Sections 23A and 23B of the Federal Reserve Act in the same manner and to the same extent as such restrictions now apply to transactions engaged in by a member bank or one of its subsidiaries with affiliates of the member bank. Section 23A of the Federal Reserve Act imposes both quantitative and qualitative restrictions on transactions engaged in by a member bank or one of its subsidiaries with an affiliate, while Section 23B of the Federal Reserve Act requires, among other things, that all transactions with affiliates be on terms substantially the same, and at least as favorable to the member bank or its subsidiary, as the terms that would apply to or would be offered in a comparable transaction with an unaffiliated party. Section 22(h) of the Federal Reserve Act imposes restrictions on loans to executive officers, directors, and principal shareholders. Further, the Federal Reserve Board pursuant to Section 22(h) requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons. United was in compliance with these rules at June 30, 1999. FEDERAL HOME LOAN BANK SYSTEM United is a member of the Federal Home Loan Bank of Indianapolis. The Federal Home Loan Bank System consists of 12 regional Federal Home Loan Banks ("FHLBs"), each subject to supervision and regulation by the Federal Housing Finance Board (the "FHFB"). The FHLBs provide a central credit facility for member savings associations. As a member of the FHLB of Indianapolis, United is required to own shares of capital stock in the FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase contracts, and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. As of June 30, 1999, United was in compliance with this requirement. YEAR 2000 READINESS DISCLOSURE The federal banking agencies, including the OTS, have also established year 2000 readiness safety and soundness guidelines requiring all insured depository institutions to implement procedures by specified key dates to ensure the institution can continue business operations after January 1, 2000. Every institution must identity its internal and external "mission-critical" systems (i.e., those systems vital to the continuance of a core business activity) and develop a written plan establishing priorities, oversight and reasonable deadlines to complete the testing and renovation of mission-critical systems. In addition, an institution must prepare a written business resumption contingency plan that defines scenarios where mission-critical systems might fail, evaluates contingency options to keep business operations going and provides for testing of the contingency plan by an independent party. Every depository institution must also identify among its customers those persons that represent a material risk to the institution in the event the customer is not Year 2000 compliant and 9 implement appropriate risk controls to manage and mitigate the customer's Year 2000 risk to the institution. In the event the institution has failed to renovate its mission-critical systems or is not on schedule with key dates, the institution must draft a remediation contingency plan outlining alternative strategies to comply with the guidelines and locate available third party providers. The agencies may take certain actions, including enforcement action, to ensure an institution's Year 2000 readiness. For information regarding United's Year 2000 readiness, see page 23 of this document. PERSONNEL As of June 30, 1999 Fidelity had 92 full-time equivalent employees. The employees are not represented by any collective bargaining unit. Fidelity believes its relations with its employees are good. Fidelity maintains group life, hospital, surgical, dental, major medical, and long-term disability programs for full-time employees. Fidelity also participates in a defined benefit pension plan covering all eligible employees, as well as a defined contribution 401(k) plan. ITEM 2. PROPERTIES - ------- The following table sets forth the location of Fidelity's savings bank offices, all of which are owned by United, as well as certain additional information relating to these offices as of June 30, 1999. United currently has no plans to sell or close any existing branches. Year Facility Net Office Location Opened Book Value - --------------- ------------- ---------- Home Office 1974 $1,027,000 18 NW Fourth Street Evansville, IN 47708 Eastside Branch 1971 1,873,000 700 S. Green River Rd Evansville, IN 47715 Northside Branch 1976 97,000 4441 First Avenue Evansville, IN 47710 Westside Branch 1979 95,000 4801 W. Lloyd Expressway Evansville, IN 47712 Fidelity and the other non-bank subsidiaries use the premises of United's Home Office and 2nd floor of the Eastside Branch for its office and equipment needs and pays rental fees for such use. ITEM 3. LEGAL PROCEEDINGS - ------- There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Registrant's business, to which the Registrant or its subsidiaries is a party or of which any of their property is the subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- No matter was submitted to a vote of the Registrant's security holders during the fourth quarter of the fiscal year ended June 30, 1999. 10 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS Fidelity's common stock is traded on the NASDAQ National Market System under the symbol FFED. The following table sets forth, for the periods indicated, the high and low bid prices per share as reported by NASDAQ. The bid prices represent prices between dealers, do not include retail mark-up, mark-down, or commissions and may not represent actual transactions.
1999 1998 ------------------------------------------------ QUARTERLY DIVIDENDS COMMON STOCK BID PRICES Common Stock Bid Prices ------------------- ------------------------------------------------ YEAR ENDED JUNE 30 1999 1998 HIGH LOW High Low - ---------------------------------------------------------------------------------------- First quarter -0- $.10 $6 1/2 $3 1/2 $ 9 $8 1/4 Second quarter -0- .10 5 3 1/4 10 3/8 8 3/4 Third quarter -0- .10 4 2 1/2 10 3/8 8 3/4 Fourth quarter -0- .05 3 7/8 2 3/4 9 3/8 6 1/16
Fidelity declared no dividends during fiscal 1999 compared to $.35 per share for 1998 and $.60 per share in 1997. Fidelity's principal source of income and funds is dividends from its savings bank subsidiary (United) which currently is subject to dividend restrictions. Unlike United, Fidelity is not subject to any regulatory restriction on future dividends. Fidelity's dividend policy is to pay cash or distribute stock dividends when the Board of Directors deems it to be appropriate, taking into account Fidelity's financial condition and results of operations, economic and market conditions, industry standards, and other factors, including regulatory capital requirements of its savings bank subsidiary. United will not pay any dividends in the immediate future without regulatory approval. Refer to the "Other Restrictions" footnote in Fidelity's consolidated financial statements and Management's Discussion and Analysis for further details. United is uncertain when it will pay dividends in the future and the amount of such dividends, if any. Fidelity anticipates that it will not pay any dividends in the foreseeable future. (This space intentionally left blank) 11 ITEM 6. SELECTED FINANCIAL DATA - ------- FIDELITY FEDERAL BANCORP AND SUBSIDIARIES SELECTED STATISTICAL INFORMATION (Dollars in Thousands, Except Share and Per Share Data)
1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- SELECTED FINANCIAL DATA AS OF JUNE 30 Total assets $172,253 $197,046 $240,819 $262,216 $269,438 Interest-bearing deposits 14,668 6,266 1,765 4,107 6,549 Investment securities available for sale 27,325 9,854 13,790 17,459 15,404 Loans, net 110,436 156,683 203,183 216,162 222,387 Deposits 128,596 148,939 181,787 181,702 180,771 Short-term borrowings 128 2,531 5,191 5,693 9,297 Long-term debt 29,149 29,488 38,089 57,292 64,699 Stockholders' equity 7,814 7,515 12,936 14,295 12,405 SELECTED OPERATIONS DATA FOR YEAR ENDED JUNE 30 Interest income $ 14,094 $ 17,192 $ 20,282 $ 21,529 $ 15,794 Interest expense 9,730 11,586 13,831 15,525 10,263 -------------------------------------------------------------------------- Net interest income 4,364 5,606 6,451 6,004 5,531 Provision for loan losses (138) 4,543 975 455 420 -------------------------------------------------------------------------- Net interest income after provision for loan losses 4,502 1,063 5,476 5,549 5,111 Non-interest income 2,663 3,025 3,856 8,180 5,377 Non-interest expense 6,878 16,076 9,474 8,608 5,912 -------------------------------------------------------------------------- Income (loss) before income tax 287 (11,988) (142) 5,121 4,576 Income tax expense (benefit) (338) (5,194) (255) 1,886 1,515 -------------------------------------------------------------------------- Net income (loss) $ 625 $ (6,794) $ 113 $ 3,235 $ 3,061 ========================================================================== SELECTED FINANCIAL RATIOS Return on average assets .33% (3.12)% .04% 1.18% 1.54% Return on stockholders' equity 7.58 (50.68) .83 23.75 27.52 Net interest margin 2.48 2.79 2.72 2.29 2.87 Net interest spread 2.24 2.62 2.57 2.11 2.59 Tangible equity to assets at year end 8.49 6.31 6.93 7.08 6.02 Allowance for loan losses to loans 3.09 1.91 .87 .49 .32 Allowance for loan losses to non-performing loans 69.57 532.11 624.91 275.06 122.09 Dividend payout ratio N/A N/A 1,500.00 67.52 28.45 PER SHARE DATA Diluted net income (loss) $ .20 $ (2.30) $ .04 $ 1.17 $ 1.22 Basic net income (loss) .20 (2.30) .05 1.32 1.30 Cash dividends declared .35 .60 .79 .33 Book value at year end 2.63 2.40 5.20 5.73 5.21 Closing market price (bid) at year end 2.88 6.50 8.75 11.25 10.88 Number of average common and common equivalent shares outstanding 3,143,179 2,956,157 2,655,181 2,776,147 2,498,892
12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL Fidelity Federal Bancorp (Fidelity), incorporated in 1993 under the laws of the State of Indiana, is a registered savings and loan holding company with its principal office in Evansville, Indiana. Fidelity's savings bank subsidiary, United Fidelity Bank, fsb (United), was organized in 1914 and is a federally-chartered stock savings bank located in Evansville, Indiana. Fidelity, through its savings bank subsidiary, is engaged in the business of obtaining funds in the form of savings deposits and other borrowings and investing such funds in consumer, commercial, and mortgage loans, and in investment and money market securities. Fidelity has engaged in the business of owning, developing, building, renting and managing affordable housing projects through its wholly-owned subsidiaries, Village Management Corporation and Village Housing Corporation (collectively, the Affordable Housing Group). The Affordable Housing Group has structured and participated in multi-family housing developments which have been granted tax credits pursuant to Section 42 of the Internal Revenue Code of 1986 (Section 42), as amended (Code) and tax-exempt bonds. Village Housing Corporation, as general partner to the limited partnerships which own the developments, receives a percentage interest in the profits, losses and tax credits during the life of the project and receives a percentage of the annual cash flow and residual (sale or refinancing) proceeds during operation and at disposition or refinancing of the developments, respectively. Village Community Development Corporation, (a subsidiary merged into Village Housing Corporation during fiscal 1999) as contractor and developer, received construction and development fees as the projects were completed. As the developments progressed, development fee income was earned contractually on each project. These fees were not recognized as income until the limited partner's equity investment had been received or the syndication firm providing the equity had given a firm commitment to provide the funds. As part of Village Management's duties as project manager, it monitors compliance with the requirements of the Code to prevent recapture of all or a portion of the tax credits or forfeiture of the tax-exempt status of the bonds which would occur if certain tenant eligibility and rent restriction requirements were violated. Village Management Corporation, as manager of the completed project, receives a fee based on a percentage of rental payments received from the project's tenants. Fidelity has been engaged in affordable housing activities since September, 1992, through United, and since April, 1994, through Village Capital Corporation (VCC). Since June 30, 1994, VCC has earned fees by providing real estate mortgage banking services to unaffiliated borrowers. In 1992, the Board of Directors developed and began implementation of a new business plan for United to improve the financial performance of the organization. The key elements of this business plan included: (i) the formation of a holding company to provide financial flexibility and to develop and engage in non-banking business; (ii) the formation of an affordable housing group to engage in real estate development, management and financing of affordable housing projects; and (iii) the growth of assets through the origination and acquisition of loans. After the implementation of the business plan, the holding company as well as the affordable housing group, consisting of three non-bank subsidiaries of United, was formed. In 1995 and 1996, revenue generated from affordable housing activities increased dramatically and significant asset growth was achieved, also resulting in higher revenues. To conserve capital, Fidelity slowed its growth rate in fiscal 1996 and positioned Fidelity to reduce debt, increase core deposits, sell loans, and use the proceeds to fund new loan production. During 1996, Fidelity encountered increasing competition in the affordable housing group area. As a result, Fidelity re-evaluated its business plan in fiscal 1997 and closed its Indianapolis, Indiana real estate development office. In 1998, Fidelity's Affordable Housing Group discontinued the development of real estate but continued to actively manage existing Company affordable housing projects. As a result of this, fee income from real estate development and real estate investment banking fees declined significantly. There were no real estate development fees recorded in fiscal 1999 or 1998. Village Housing Corporation and Village Management Corporation continue to be fully operational at Fidelity's headquarters in Evansville. Fidelity's results in 1998 included an increase in the provision for loan losses of $3.6 million, a letter of credit valuation provision of $6.8 million, and an additional write-down of its investments in affordable housing projects 13 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION of $1.5 million. The majority of these charges relate to Fidelity's involvement in the Section 42 tax-credit real estate development program. The additional provision for loan loss and letter of credit valuation provision that was recorded in fiscal 1998 was recorded as a result of Fidelity's position that it was probable that the losses would occur and that the losses could be reasonably estimated. Statement of Financial Accounting Standards No. 5 "Accounting for Contingencies" (SFAS No. 5) requires that both of these conditions must be met before an estimated loss from a loss contingency is recorded. Prior to the third quarter of fiscal 1998, Fidelity had determined that the possibility of loss was "reasonably possible", but could not support that losses were "probable". During the third quarter of fiscal 1998, Fidelity came to the realization that it was probable that assets had been impaired (loans and equity investments) and liabilities had been incurred (the letter of credit reserves). Fidelity came to this realization because an adequate amount of time had passed since the inception of the projects to support Fidelity's realization that the poor performance of several of these projects was likely to continue. This performance was below that which was originally projected for the majority of the projects. Competing projects in several of the communities in which the projects were in operation caused Fidelity to reduce its estimates of future profitability. These projects are not designed to initially have positive cash flow, but the expectation is that they will have positive cash flow after the projects have been active for a certain amount of time. Prior to the third quarter of 1998, Fidelity determined that the reason for the projects not generating positive cash flows was principally due to the recent start-up of the projects. Fidelity was able to support that future improvements in monthly rents, monthly occupancies, expense control, and in some cases financing, would occur. This precluded Fidelity from determining that losses were "probable". The average amount of time that Fidelity's seventeen projects (those projects for which Fidelity's subsidiaries had equity investments) had been fully operational, as of March 31, 1998, was 36 months. While Fidelity has not participated in the development of any new projects that it manages, the performance of a majority of the projects that Fidelity is managing is below that which was originally projected when the projects were formed. This has resulted in lower than expected cash flows, which are needed to support debt repayment. Cash flows of the projects have been affected by a number of items, including lower than expected occupancy and/or rent levels, higher-than-expected expenses and, in certain situations, additional construction costs or delays which resulted in longer start-up periods for the projects. The areas in which many of the projects are located have seen increased competition in affordable housing, which has affected the project's ability to perform at the levels originally projected. Each of the projects are beyond the start-up or construction phase and have been in operation for a sufficient period of time to enable management to conclude that additional provisions and reserves were required. Fidelity's current plans are to not originate, participate or invest in any new or additional Section 42 projects. Fidelity believes that the properties' cash flows will not improve significantly unless a change in the properties' financing or debt structure occurs. It is currently pursuing a plan to refinance its Section 42 projects. The availability of such refinancing depends upon numerous factors, including, among other things, interest rates, third-party appraisals and the occupancy levels in the Section 42 projects. During fiscal 1999, one of Fidelity's primary goals was to seek refinancing opportunities with other potential financing sources. This is typically a lengthy process and Fidelity has been successful on a number of classified assets. Fidelity's classified assets and letters of credit have decreased $3.7 million to $37.5 million at June 30, 1999 from $41.3 million at June 30, 1998. Fidelity has a number of other credits in process for refinancing to further reduce the classified assets during fiscal 2000. The refinancing and workout effort is anticipated to be a significant portion of the Fidelity and United business plan during fiscal 2000. See "Allowance for Loan Losses" and "Classified Assets" for a more detailed discussion. The June 30, 1999 audited financial statements include condensed financial information about both of Fidelity's business segments. The following table details average balances, interest income/expense and average rates/yield for Fidelity's earning assets and interest bearing liabilities for the years ended June 30, 1999, 1998 and 1997: 14 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS (Dollars In Thousands on Fully Taxable Equivalent Basis)
1999 1998 1997 ------------------------------------------------------------------------------------------------- AVERAGE AVERAGE Average Average Average Average YEAR ENDED JUNE 30 BALANCES INTEREST RATES Balances Interest Rates Balances Interest Rates - ---------------------------------------------------------------------------------------------------------------------------- ASSETS Federal funds sold and other short-term money $ 18,962 $ 964 5.08% $ 5,533 $ 330 5.96% $ 3,594 $ 194 5.40% market investments Investment securities available for sale Taxable 15,455 955 6.18 10,806 650 6.01 16,168 1,033 6.39 Tax exempt (1) 444 36 8.33 963 85 8.83 Loans held for sale Federal Home Loan Bank Stock 3,920 314 8.01 3,920 316 8.06 3,920 307 7.83 Loans (2) (3) Commercial loans 8,055 791 9.82 11,683 1,124 9.62 11,695 1,154 9.87 Multi-family loans 33,918 2,999 8.84 25,573 2,672 10.45 22,768 2,374 10.43 Real estate mortgages 63,980 4,956 7.75 114,335 9,213 8.06 155,527 12,919 8.31 Consumer loans 31,840 3,115 9.78 28,939 2,863 9.89 23,803 2,245 9.43 ---------------------- ---------------------- ----------------------- Total loans 137,793 11,861 8.61 180,530 15,872 8.75 213,793 18,692 8.74 ---------------------- ---------------------- ----------------------- Total earning assets 176,130 14,094 8.00 201,233 17,204 8.55 238,438 20,311 8.52 ---------- ---------- ------------ Allowance for loan losses (3,414) (2,538) (1,664) Cash and due from banks 2,680 3,018 2,386 Premises and equipment 5,749 6,214 6,145 Other assets 10,426 9,799 8,825 ------------ ------------ ------------ Total assets $191,571 $217,726 $254,130 ============ ============ ============ LIABILITIES Interest-bearing deposits Interest-bearing $ 20,436 $ 716 3.50% $ 22,211 $ 942 4.24% $ 20,585 $ 868 4.22% checking Money market accounts 2,733 61 2.23 3,027 82 2.71 3,890 106 2.72 Savings accounts 5,082 118 2.32 4,813 136 2.83 4,793 139 2.90 Certificates of deposit 112,539 6,572 5.84 128,142 7,625 5.95 148,754 8,887 5.97 ---------------------- ----------------------- ----------------------- Total interest-bearing 140,790 7,467 5.30 158,193 8,785 5.55 178,022 10,000 5.62 Deposits Federal funds purchased 116 7 6.03 1,810 102 5.64 Other borrowings 15,167 1,384 9.13 17,673 1,523 8.62 19,664 1,616 8.22 Federal Home Loan Bank Advances 13,103 879 6.71 19,253 1,271 6.60 33,136 2,113 6.38 ---------------------- ----------------------- ----------------------- Total interest-bearing liabilities 169,060 9,730 5.76 195,235 11,586 5.93 232,632 13,831 5.95 ---------- ---------- ----------- Non-interest bearing demand Deposits 5,724 5,229 5,684 Advances by borrowers for Taxes and insurance 457 596 798 Other liabilities 8,079 3,260 1,420 ------------ ----------- ------------ Total liabilities 183,320 204,320 240,534 STOCKHOLDERS' EQUITY 8,251 13,406 13,596 ------------ ----------- ------------ Total liabilities and Stockholders' equity $191,571 $217,726 $254,130 ============ ============ ============ Net interest income/margin $ 4,364 2.48% $ 5,618 2.79% $ 6,480 2.72% ====================== ====================== ====================== Interest rate spread (4) 2.24% 2.62% 2.57% Average interest-bearing assets to average 104.18% 103.07% 102.50% interest-bearing liabilities
(1) Tax-exempt securities have been adjusted to a fully tax equipment basis using a marginal tax rate of 34%. (2) Nonaccrual loans have been included in the average balances. (3) Loan income includes interest and fees on loans. (4) Interest rate spread is calculated by subtracting combined weighted average interest rate cost from combined weighted average interest rate earned for the period indicated. 15 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income, Fidelity's largest component of income, represents the difference between interest and fees earned on loans, investments and other interest-earning assets, and interest paid on interest-bearing liabilities. It also measures how effectively management has balanced and allocated Fidelity's interest rate-sensitive assets and liabilities. Due to a significant decrease in earning assets, net interest income decreased to $4.4 million or 22.3% in 1999 from $5.6 million in 1998. The reduction in net interest income in 1999 was primarily due to the continued reduction in average earning assets of $25.1 million, which was partially offset by a decrease in average interest-bearing liabilities of $26.2 million. Fidelity's reduction in average earning assets and average interest bearing liabilities has occurred in fixed rate 1-4 family mortgage loans and certificates of deposit, primarily agent-acquired deposits. Average real estate mortgage loans have decreased $50.4 million, resulting in a decrease of $4.3 million in interest income. Certificates of deposit and borrowings partially offset this reduction in assets with a decrease of $15.6 million in certificates and $8.7 million in borrowings. This resulted in decreased interest expense of $1.1 million and $.5 million, respectively. Interest income for the year ended June 30, 1999 was $14.1 million compared to $17.2 million for the year ended June 30, 1998, a decrease of $3.1 million or about 18.0%. Interest expense for the year ended June 30, 1999 was $9.7 million compared to $11.6 million for the year ended June 30, 1998, a decrease of $1.9 million or 16.4%. The reduction in average earning assets was attributable to payoffs and the sale of several conventional real estate mortgage loans. The average balance of agent-acquired certificates of deposit, which had an average rate of 6.26% in 1998, was reduced from $42.4 million in 1998 to $33.5 million in 1999 with an average rate of 6.02%. The net interest margin decreased in 1999 to 2.48% from 2.79% in 1998. The average yield on interest-earning assets and average rate paid on interest-bearing liabilities of 8.00% and 5.76% declined from last year's average rates of 8.55% and 5.93%. The decrease in the net interest margin, as previously mentioned, is the result of loan payoffs on fixed rate 1-4 family loans and the sale of new loan production on the secondary market. Commercial loans and higher yielding multi-family loans continue to decrease due to refinancing and payoffs. This will likely be a continuing trend during the term of the Supervisory Agreement between United and the OTS, as certain lending activities are restricted. Net interest income decreased by 13.1% in 1998 compared to $6.5 million in 1997. The reduction in net interest income in 1998 was primarily due to a decrease in average earning assets of $37.2 million, which was partially offset by a decrease in average interest-bearing liabilities of $37.4 million. Interest income for the year ended June 30, 1998 was $17.2 million compared to $20.3 million for the year ended June 30, 1997, a decrease of $3.1 million or about 15.3%. Interest expense for the year ended June 30, 1998 was $11.6 million compared to $13.8 million for the year ended June 30, 1997, a decrease of $2.2 million or 16.2%. The reduction in average earning assets was attributable to a significant number of multi-family and commercial loan payoffs, as well as payoffs on conventional residential real estate mortgage loans. The average balance of agent-acquired certificates of deposit, which had an average rate of 6.26% in 1998, was reduced from $70.3 million in 1997 to $42.4 million in 1998 as Fidelity reduced the balance of this higher-cost source of funds. 16 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The net interest margin improved in 1998 to 2.79% from 2.72% in 1997. The average rate of interest-earning assets and average rate paid on interest-bearing liabilities of 8.55% and 5.93% were consistent with the rates in 1997 of 8.52% and 5.95%. The increase in the margin was affected positively by the maturing of agent-acquired certificates and an increase in the balance and average rate of consumer loans. The increase was affected negatively by a decrease in higher yielding multi-family construction and commercial real estate loans. QUARTERLY RESULTS OF OPERATIONS Notwithstanding the aforementioned loan and letter of credit reserves set aside in 1998, Fidelity's earnings may have experienced some variability from quarter to quarter due to the uncertainty of the timing when certain classified assets are refinanced or paid off, resulting in potential reversals of provision for loan losses and letter of credit reserves.
SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 TOTAL - --------------------------------------------------------------------------------------------------------------------------------- (In Thousands) 1999 Interest income $3,883 $3,709 $3,363 $3,139 $14,094 Interest expense 2,618 2,556 2,364 2,192 9,730 --------------------------------------------------------------------------------------- Net interest income 1,265 1,153 999 947 4,364 Provision for loan losses 75 75 (404) 116 (138) Non-interest income 895 738 571 459 2,663 Non-interest expense 1,841 1,788 1,874 1,375 6,878 --------------------------------------------------------------------------------------- Income (loss) before income tax 244 28 100 (85) 287 Income tax benefit (92) (73) (35) (138) (338) --------------------------------------------------------------------------------------- Net income $ 336 $ 101 $ 135 $ 53 $ 625 ======================================================================================= Net income per share Diluted net income $.11 $.03 $.04 $.02 $.20 Basic net income .11 .03 .04 .02 .20 Cash dividends* 1998 Interest income $4,887 $4,453 $3,993 $3,859 $17,192 Interest expense 3,285 3,057 2,700 2,544 11,586 --------------------------------------------------------------------------------------- Net interest income 1,602 1,396 1,293 1,315 5,606 Provision for loan losses 135 90 4,298 20 4,543 Non-interest income 850 974 590 611 3,025 Non-interest expense 1,649 1,697 11,070 1,660 16,076 --------------------------------------------------------------------------------------- Income (loss) before income tax 668 583 (13,485) 246 (11,988) Income tax expense (benefit) 159 175 (5,363) (165) (5,194) --------------------------------------------------------------------------------------- Net income (loss) $ 509 $ 408 $(8,122) $ 411 $ (6,794) ======================================================================================= Net income (loss) per share Diluted net income (loss) $.19 $.13 $(2.60) $.13 $(2.30) Basic net income (loss) .19 .13 (2.60) .13 (2.30) Cash dividends .10 .10 .10 .05 .35
*No cash dividends were paid in fiscal 1999. 17 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RATE/VOLUME ANALYSIS The following table sets forth an analysis of volume and rate changes in interest income and interest expense of Fidelity's average earning assets and average interest-bearing liabilities. The table distinguishes between the changes related to average outstanding balances of assets and liabilities (changes in volume holding the initial interest rate constant) and the changes related to average interest rates (changes in average rate holding the initial outstanding balance constant). The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
1999 COMPARED TO 1998 1998 Compared to 1997 INCREASE (DECREASE) DUE TO Increase (Decrease) Due To -------------------------------------------------------------------------------- VOLUME RATE NET Volume Rate Net - ---------------------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Interest income on average earning assets Loans $(3,758) $(254) ($4,012) $(2,908) $88 $(2,820) Investment securities 243 25 268 (388) (44) (432) Federal Home Loan Bank stock (2) (2) 9 9 Federal funds sold and other short-term money market investments 801 (167) 634 105 31 136 -------------------------------------------------------------------------------- Total interest income (2,714) (398) (3,112) (3,191) 84 (3,107) -------------------------------------------------------------------------------- Interest expense on average interest-bearing liabilities NOW accounts (75) (151) (226) 69 5 74 Money market deposit accounts (8) (13) (21) (24) (24) Passbook savings accounts 8 (26) (18) 1 (4) (3) Certificates of deposit (928) (125) (1,053) (1,231) (31) (1,262) Federal funds purchased (7) (7) (95) (95) Other borrowings (216) 77 (139) (164) 71 (93) Federal Home Loan Bank advances (406) 14 (392) (885) 43 (842) -------------------------------------------------------------------------------- Total interest expense on interest-bearing liabilities (1,632) (224) (1,856) (2,329) 84 (2,245) -------------------------------------------------------------------------------- Changes in net interest income $(1,082) $(174) $(1,256) $ (862) $ 0 $ (862) ================================================================================
18 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION PROVISION FOR LOAN LOSSES AND LETTER OF CREDIT RESERVES Fidelity makes provisions for possible loan losses in amounts estimated to be sufficient to maintain the allowance for loan losses at a level considered necessary by management to absorb possible losses in the loan portfolios. The provision for loan losses for fiscal 1999 had a credit of $138,000 compared to expense of $4.5 million in the prior year, a decrease of $4.6 million. During 1999, as a result of a reduction in classified and criticized assets and an overall improvement in the operating results of Fidelity's affordable housing portfolio, Fidelity reduced its provision for loan losses and reserve for letters of credit and recognized income of $138,000 and $715,000, respectively. The ratio of non-performing loans to the allowance for loan losses was 143.7% at June 30, 1999 compared to 18.8% at June 30, 1998. The increase in non-performing loans is due to one large multi-family loan to an unaffiliated borrower which is past due pending its refinancing. Fidelity is assisting the borrower in obtaining alternate refinancing; however, the ultimate refinancing of this credit with no additional losses cannot be assured. A specific reserve has been established for this loan. Changes in loan and letter of credit concentrations and terms did not affect the amount of the allowance for loan losses and letter of credit valuation reserve for each period. The primary factor that led Fidelity to determine that additional reserves were required, in 1998, was that enough time had passed since start-up of the projects to more accurately project the future performance of the projects. This changed Fidelity's evaluation of the quality of the applicable projects and its assessment of the quality of those credits which it held in its portfolio. The method used during the third quarter of fiscal 1998 to determine the amount of required reserves for affordable housing industry permanent and general partner loans, equity investments and letter of credit used past monthly cash flows as a determinant as to how much debt service the projects could support. Specifically, the method determined the amount of debt service as follows: 1. Cash flows from the projects were scheduled from internal project records. These were used to project annualized cash flows that were based on periods of time that were considered to be best reflective of future performance of that project. Certain items affecting cash flows during only certain months of the year, such as the payment of real estate taxes, were subtracted from the calculated annualized amounts so that monthly cash flows would be reflective of actual monthly operation. 2. A projected loan amount that could be supported by current cash flows was calculated using the computed cash flows for the most appropriate period (converted to a monthly cash flow amount), the current rate, and a 25-year amortization period. This amount was added to the computed residual value of the project at the end of a 15-year amortization period to reflect the total value of the project. 3. This information was used to determine proper classifications, and ultimately reserves, for the loan, letter of credit, general partner loan and equity investment amounts. A "potential tax credit market adjustment" was computed by taking the difference between the price paid by investors for tax credits at the project's inception and an amount that was determined to be better reflective of the true value of the credits. This market adjustment was used to determine what portion of the loan, letter of credit, general partner loan and equity investment would be classified as doubtful, which included a 50 percent reserve, and loss, which included a 100 percent reserve or charge-off of the related asset or reserve for the letter of credit. 4. The analyses were updated quarterly for current operating information of the actual projects. The assumptions used to compute reserves were not significantly changed for any of the quarters in fiscal 1999; only the data used to compute classifications was changed. The period of cash flows used was changed in certain instances if it was determined that a change better reflected future projected results. The percentages applied to the categories of substandard, doubtful and loss were 10, 50 and 100 percent. 19 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Prior to the quarter ended March 31, 1998, affordable housing industry loans and letters of credit were classified in the categories of pass, special mention, substandard, doubtful and loss. Percentages were applied to the balances classified in the respective categories that represented Fidelity's best estimate of loss for those classifications. Specific reserves are assigned to certain credits. The reserves are determined by management's evaluation of those credits. The results of internal loan reviews, OTS evaluations and recent events assist Fidelity in making that evaluation. The independent support for the allowance for loan losses and letter of credit valuation reserve includes documentation that supports the amount of recorded reserves for these credits. General reserves for loans and letters of credit not specifically reserved are also determined. Fidelity computes general reserves for the commercial, commercial mortgage, residential mortgage, consumer and credit card loan portfolios by utilizing historical information and information currently available about the loans within those portfolios that provides information as to the likelihood of loss. The potential effect of current economic conditions is also considered with respect to establishing general reserve percentages. NON-INTEREST INCOME Non-interest income decreased by $362,000 or 12.0% for the year ended June 30, 1999, compared to a decrease of $831,000 or 21.6% for the year ended June 30, 1998. The following table summarizes non-interest income for the three years ended June 30:
CHANGE FROM PRIOR YEAR INCREASE (DECREASE) ---------------------------------------------------- AMOUNT 1999 1998 ------------------------------------------------------------------------------------------- YEAR ENDED JUNE 30 1999 1998 1997 AMOUNT PERCENT Amount Percent - ---------------------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Fee income from real estate development and management $ 196 $ 191 $ 337 $ 5 2.6% $(146) (43.3)% Service charges on deposit accounts 437 436 316 1 .2 120 38.0 Gain on sale of Real estate loans 343 186 338 157 84.4 (152) (45.0) Investment securities 79 42 (79) (100.0) 37 88.1 Letter of credit fees 582 657 722 (75) (11.4) (65) (9.0) Real estate investment banking fees 78 139 963 (61) (43.9) (824) (85.6) Agent fee income 333 650 452 (317) (48.8) 198 43.8 Title fee income 72 10 41 62 620.0 (31) (75.6) Other 622 677 645 (55) (8.1) 32 5.0 ------------------------------------------------------------------------------------------- Total non-interest income $2,663 $3,025 $3,856 $(362) (12.0)% $(831) (21.6)% ===========================================================================================
Fidelity's level of activity in Section 42 real estate activities has continued to decrease. Fidelity has recorded no Section 42 real estate development fees over the past two years. Fee income from management activities was approximately the same as 1998 even though there was a reduction during the year in fee percentage from 5% to 4% collected on partnerships for which Village Housing Corporation is the general partner. Service charges on deposit accounts remained approximately the same as last year despite a reduction in the deposits. Net gains on the sale of single-family loans increased $157,000 over the same period in 1998 and slightly over 1997 levels, resulting from increased loan originations during the year. No securities were sold in the current year; gains of $79,000 and $42,000 were recorded in 1998 and 1997, respectively. Letter of credit fees in fiscal 1999 were $582,000 compared to $657,000 and $722,000 in fiscal years 1998 and 1997. Outstanding letters of credit at June 30, 1999 were $45.0 million compared to $55.4 and $54.4 million at June 30, 1998 and 1997, respectively. The decrease in fee income is due to the reduction in letters of credit outstanding. Real estate investment banking fees continue to decrease from prior years and will likely be minimal in future periods. 20 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION United has participated in an arrangement in which automobile loans are originated on behalf of another organization for the last three fiscal years. Agent fee income, which represents earned fees from these transactions, decreased $317,000 for the year ended June 30, 1999 compared to the same period last year. In January 1999, the head of United's consumer loan division and key members of the consumer loan division staff left United to accept employment with a competitor. United has been unable to continue to compete in this market segment since the departure of the staff. As such, United's revenue from consumer loans has been sharply reduced. During the fourth quarter of fiscal 1999, United hired a manager and staff to resume this lending activity. United commenced certain types of consumer lending, such as home equity lending as of June 30, 1999. United expects to fully resume indirect lending during the first quarter of fiscal 2000. Title fee income increased $62,000 over last year and $31,000 over 1997, due to increased loan volume. NON-INTEREST EXPENSE Non-interest expense decreased by $9.2 million or 57.2% for the year ended June 30, 1999, compared to 1998 after increasing by $6.6 million or 69.7% in 1998 from 1997. The following table summarizes non-interest expense for the three years ending June 30:
CHANGE FROM PRIOR YEAR INCREASE (DECREASE) ---------------------------------------------------- AMOUNT 1999 1998 ------------------------------------------------------------------------------------------- YEAR ENDED JUNE 30 1999 1998 1997 AMOUNT PERCENT Amount Percent - ---------------------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Salaries and employee benefits $3,414 $ 3,341 $4,318 $ 73 2.2% $ (977) (22.6)% Letter of credit valuation provision (715) 6,778 (7,493) (110.5)% 6,778 100.0 Write down of affordable housing partnership investments 545 1,478 335 (933) (63.1) 1,143 341.2 Legal and professional 379 304 303 75 24.7 1 .3 Occupancy expense 394 444 481 (50) (11.3) (37) (7.7) Equipment expense 299 354 374 (55) (15.5) (20) (5.3) Data processing expense 407 456 318 (49) (10.7) 138 43.4 Affordable housing group activity expenses 769 177 (769) (100.0) 592 334.5 Advertising 202 199 230 3 1.5 (31) (13.5) Deposit insurance 244 140 255 104 74.3 (115) (45.1) SAIF assessment 1,040 (1,040) (100.0) Correspondent bank charges 154 160 135 (6) (3.8) 25 18.5 Printing and supplies 104 130 181 (26) (20.0) (51) (28.2) Loss on investment 246 87 132 159 182.8 (45) (34.1) Telephone 74 74 111 (37) (33.3) Postage 95 79 96 16 20.3 (17) (17.7) Travel and lodging 44 68 95 (24) (35.3) (27) (28.4) Other operating expense 992 1,215 893 (223) (18.4) 322 36.1 ------------------------------------------------------------------------------------------- Total non-interest expense $6,878 $16,076 $9,474 $(9,198) (57.2)% $6,602 69.7% ===========================================================================================
21 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The decrease in total non-interest expense for 1999, as compared to 1998, relates primarily to expenses associated with Fidelity's Section 42 tax credit real estate development program in the previous year. Last year, Fidelity recorded specific reserves of $6.8 million related to letters of credit issued by Fidelity and United and also charged off equity investments in these projects of $1.5 million. Although the majority of the letters of credit reserve relates to the Section 42 program, a portion of this reserve relates to letters of credit that are not related to the Section 42 program. Fidelity funded one letter of credit with a specific reserve of $895,000. Upon the calling of the letter of credit, and the conversion of it to a loan, the reserve was transferred to the allowance for loan losses. This loan was paid in full during the second quarter. No other letters of credit have been called upon during fiscal 1999. Due to decreased activities in the Affordable Housing Group, no additional expenses were recognized in 1999 compared to $769,000 and $177,000 in fiscal 1998 and 1997, respectively. Also included in the 1998 expense of $769,000 were abandoned projects expense of $213,000 and write-offs of partnership management, investment banking, real estate development and letter of credit fees totaling $384,000. Abandoned projects expense consists of costs that were incurred at sites that will not be fully developed. Salaries and employee benefits increased $73,000 for the year ended June 30, 1999 compared to the same period last year. Salaries increased primarily due to an increase in incentives in the mortgage loan area as a result of increased originations over the prior year and some staffing replacements. Legal and professional fees increased $75,000 over last year due to additional costs incurred for workout activities with respect to various classified assets, and other legal actions commenced by Fidelity, including actions connected with Fidelity's efforts to divest of its Section 42 tax-credit property loans and investments. Occupancy and equipment expenses decreased by $50,000 and $55,000, respectively, compared to the prior year, as management continues to closely monitor expenses. Data processing expenses decreased $49,000 due to a smaller number of transactions with the data processor resulting from the reduction of asset size. Deposit insurance increased $104,000 over the prior year, due to the change in United's risk classification compared to the prior year. Fidelity has recorded its percentage share of losses, as accounted for under the equity method of accounting, for its investments in various IRS Section 42 developments by $246,000 compared to $87,000 and $132,000 in the prior years. These writedowns are partially offset by tax credits received and recorded as reductions of income tax expense. Non-interest expense for 1997 also included a one-time special Savings Association Insurance Fund assessment of approximately $.06 per $100 of deposits, or $1 million, that was imposed on thrifts in September 1996. Postage increased $16,000 over last year but was offset by a $24,000 decrease in travel and lodging due to decreased activities in the Multi-family and Affordable Housing Group segment. Other operating expense decreased $223,000 primarily due to the reduction in the size of Fidelity and its exit from certain nonprofitable lines of business. INCOME TAX BENEFIT The income tax benefit was $338,000 in 1999 compared to $5.2 million and $255,000 for 1998 and 1997, respectively. Income tax benefit decreased $4.9 million for the year ended June 30, 1999 compared to the same period in 1998, primarily due to an increase in taxable income. Included in the tax benefit of $338,000 for the year ended June 30, 1999 are tax credits of $460,000. These credits are received from Fidelity's investment in Section 42 affordable housing projects and comprise a portion of the return on these investments. Fidelity also receives the tax benefit of its percentage of the operating losses for those projects. Some of the benefits associated with these tax credits are partially offset by reductions of the investment in the Section 42 projects, which are included in the above table under the caption "Loss on Investment". The effective tax rate for the current year was 117.8% compared to 43.3% and 180% for 1998 and 1997, respectively. 22 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The change in the deferred tax asset balance from June 30, 1997 to June 30, 1998 was $3,368,000 and was due primarily to the loss incurred in fiscal 1998. At June 30, 1998, a portion of the net operating loss was carried forward and a portion was carried back to generate refunds from prior tax years. The portion that was carried back "freed up" credits utilized in prior years. These credits are now being carried forward. The remainder of the change in the deferred tax balance is primarily due to writedowns of assets that are not deductible for tax purposes for fiscal 1998. A determination of the need to record a valuation allowance for the deferred tax asset was made at June 30, 1999 and 1998 after projecting the reversal of the deferred items. These analyses was based on projected operating income in future years. These analyses showed that all carryforwards would get utilized within the carryforward time periods (federal and state) and therefore no valuation allowance was recorded. YEAR 2000 Fidelity has completed an assessment of its computer systems and identified those systems that it believes could be affected by the Year 2000 issue and has developed an implementation plan to address the issue. At June 30, 1999, Fidelity completed testing its internal mission critical hardware systems to determine if they are Year 2000 compliant. Fidelity's main data processor, mortgage loan software, personal computers, alarms, cameras, VCRs and other related equipment also have been tested. The results of the testing, while necessitating some modifications, have been satisfactory. While Fidelity has exposure to several risks related to the Year 2000, the primary risk is the potential inability to correctly process and record customer loan and deposit transactions. Fidelity is on schedule with regard to the requirements that have been established for the banking industry by the Federal Financial Institution Examination Council (FFIEC). These standards require that a series of procedures be performed by financial institutions within established timeframes to reduce the risk of noncompliance with the Year 2000 issue. Specifically, Fidelity developed a testing plan and a customer-based risk management plan. While Fidelity believes that it will continue to meet all of the FFIEC requirements, it cannot guarantee that the systems of other companies on which Fidelity's systems rely will be compliant. Third party non-compliance for the Year 2000 issue could potentially have a material impact on Fidelity. Fidelity has completed a contingency plan in the event its internal systems, or the systems of those material vendors on which it is reliant, would not be compliant with Year 2000 requirements. Fidelity has begun and will continue testing its contingency plan through the end of 1999, and modifying the plan, when appropriate, based on test results. A cash contingency supplement to the overall contingency plan has also been developed for potential Year 2000 liquidity issues. Fidelity has recognized expense of approximately $160,000 over the past two years for costs related to the Year 2000. The amounts that have been paid to date were to provide assistance to Fidelity with the initial assessment and formulation of a plan to ensure compliance with the Year 2000, for equipment to assist in the testing process and for replacement of non-compliant personal computers and equipment. At June 30, 1999, Fidelity has completed its assessment of the expected total cost of performing necessary procedures or purchasing equipment that is compliant with the Year 2000. Fidelity is anticipating costs of approximately $310,000 to ensure Year 2000 compliance. A portion of these costs have been capitalized with the purchase and replacement of non-compliant equipment. At June 30, 1999, total commitments to purchase new equipment, software or to incur material costs to modify existing systems were approximately $137,000. These costs do not include salaries paid to current employees related to time spent with the Year 2000 issue. 23 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fidelity outsources a significant portion of its data processing to an outside provider. A worst case scenario for Fidelity would likely involve non-compliance with the Year 2000 by its primary data processor in such a manner that would leave Fidelity in a position where it could not correctly process and record customer loan and deposit transactions. Fidelity has reviewed all of the data processing provider's test scripts and results. At this time, no material problems have come to Fidelity's attention with respect to test results. A failure by other third parties to effectively manage the Year 2000 issue, including Fidelity's payroll processor, utility company, telecommunications company, etc., could have an adverse effect on Fidelity's operations, customer service and net income. No assurance can be provided that these third parties will be Year 2000 compliant. Fidelity completed its assessment of the potential impact of the Year 2000 on its commercial lending customers, but believes that the impact, in terms of potential credit exposure, would not be material. The majority of Fidelity's commercial lending portfolio consists of commercial real estate loans that are made to companies that are not technologically intensive. Fidelity cannot provide any assurance that the effect of the Year 2000 will not be material to Fidelity's financial position or operating results. FINANCIAL CONDITION Total assets at June 30, 1999 decreased $24.7 million or 12.5% to $172.3 million from $197.0 million in 1998. Average assets for 1999 decreased 12.0% from 1998 to $191.6 million. Average interest-bearing liabilities decreased $26.2 million as Fidelity used loan payoff proceeds to reduce borrowings and agent-acquired certificates of deposit, which represent a higher-cost source of funds for Fidelity. The decrease in total assets is primarily the result of loan payoffs, refinancing and payments received on fixed 1-4 family mortgage loans. Fidelity has continued to sell current production of fixed 1-4 family mortgages to investors in the secondary market, therefore the mortgage loan portfolio continues to decline. LOANS The following table shows the composition of Fidelity's loan portfolio as of June 30:
JUNE 30 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) Real estate mortgage loans First mortgage loans Conventional $ 49,733 $ 71,343 $ 94,293 $106,344 $113,971 Construction 6,732 16,110 32,577 36,938 24,670 Commercial 14,140 20,753 26,668 18,267 7,133 Multi-family loans 7,597 5,742 9,602 15,420 26,147 First mortgage real estate loans purchased 2,061 2,704 3,184 7,612 4,921 ------------------------------------------------------------------------------------ 80,263 116,652 166,324 184,581 176,842 Commercial loans, other than secured by real estate 6,076 11,568 12,522 9,393 6,414 Consumer and home equity loans 27,618 31,512 26,118 23,247 39,844 ------------------------------------------------------------------------------------ Total loans 113,957 159,732 204,964 217,221 223,100 Allowance for loan losses (3,521) (3,049) (1,781) (1,059) (713) ------------------------------------------------------------------------------------ Net loans $110,436 $156,683 $204,964 $216,162 $222,387 ==================================================================================== Total assets $172,253 $197,046 $240,819 $262,216 $269,438 ==================================================================================== Total loans to total assets 66.2% 81.1% 85.4% 82.8% 82.8% ====================================================================================
24 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fidelity began selling current production of 1-4 family loans in 1997, recording the gain or loss and using the proceeds to fund new products. With this strategy in place, conventional real estate mortgage loans decreased $44.6 million from June 30, 1997 to June 30, 1999. Construction loans decreased by $9.4 million at June 30, 1999 from June 30, 1998. Construction loans at June 30, 1999 include $5.9 million of multi-family loans. Multi-family loans increased $1.9 million over the prior year due to the change in status from a multi-family construction loan to the multi-family loan category. Multi-family construction loans decreased $7.0 million from June 30, 1998 to June 30, 1999. Commercial real estate loans and commercial loans have continued to decrease since 1997 due to payoffs, paydowns and an overall decline in originations. Additional factors playing a role in this decrease is the Supervisory Agreement that United is currently under which restricts new commercial lending. Refer to the "Other Restrictions" footnote for additional information. The focus of United's commercial lending department has been to develop action plans to minimize potential losses relating to its classified commercial credits and its letter of credit exposure. Multi-family loans overall, including construction, have decreased since 1995 as Fidelity has sold participations in the loans or received payoffs because of the availability of more favorable financing alternatives. In several cases where multi-family loan borrowers required more favorable financing alternatives, Fidelity has issued a standby letter of credit and continued to assume the credit risk associated with the financing. Consumer and home equity loans decreased $3.9 million from June 30, 1998 to $27.6 million at June 30, 1999. The two primary reasons for the decrease are paydowns, payoffs and employee turnover in the consumer loan division as previously mentioned in the "non-interest income" discussion. Management anticipates that consumer loan volume will increase with the recent staff replacements to the consumer loan department. Fidelity's loan portfolio contains no loans to foreign governments, foreign enterprises, foreign operations of domestic companies or highly leveraged transactions, nor any concentration to borrowers engaged in the same or similar industries that exceed ten percent of total loans. LOAN MATURITIES The following table sets forth the remaining maturities for certain loan categories as of June 30, 1999: WITHIN ONE ONE TO FIVE AFTER FIVE JUNE 30 YEAR YEARS YEARS TOTAL - -------------------------------------------------------------------------------- (In Thousands) Real estate mortgage loans $ 9,224 $11,941 $58,640 $ 79,805 Consumer and home equity loans 11,176 15,430 1,012 27,618 Commercial loans 2,915 3,619 6,534 ----------------------------------------------- Total $23,315 $30,990 $59,652 $113,957 =============================================== Predetermined interest rates $ 8,889 $23,299 $28,430 $ 60,618 Floating interest rates 14,426 7,691 31,222 53,339 ----------------------------------------------- $23,315 $30,990 $59,652 $113,957 =============================================== 25 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NON-PERFORMING LOANS Fidelity discontinues the accrual of interest income on loans when, in the opinion of management, there is reasonable doubt as to the timely collectibility of interest or principal. When a loan reaches a ninety day or more past due status, the asset is generally repossessed or sold, if applicable, or the foreclosure process is started and the loan is moved to other real estate owned to be sold. A loan could be placed in a nonaccrual status sooner than ninty days, if management knows the customer has abandoned the collateral and has no intention of repaying the loan. At this point, management discontinues the accrual of interest and Fidelity would start the repossession or foreclosure process. Typically, when a loan reaches nonaccrual status, the accrued interest is reversed from income, unless strong evidence exists that the value of the collateral would support the collection of interest in a foreclosure situation. Nonaccrual loans are returned to an accrual status when, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the timely payment of principal and interest. Income received on nonaccrual loans was $10,000 and $157,000 in 1999, respectively, compared to nonaccrual interest income of $10,000 in 1998 and $11,000 in 1997. Additional interest income of approximately $214,000, $33,000 and $12,000 for 1999, 1998 and 1997, respectively, would have been recorded had income on nonaccruing and restructured loans been considered collectible and accounted for on an accrual basis. The following table provides information on Fidelity's non-performing loans as of June 30:
JUNE 30 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Non-accrual loans Real estate mortgage $ 76 $461 $256 $342 $ 47 Multi-family 4,112 Restructured Real estate mortgage 514 Consumer 77 90 days or more past due and accruing Consumer 164 86 29 43 23 Commercial 632 26 ----------------------------------------------------------------------- Total 90 days or more past due and accruing 796 112 29 43 23 ----------------------------------------------------------------------- Total non-performing loans $5,061 $573 $285 $385 $584 ======================================================================= Ratio of non-performing loans to total loans 4.44% .36% .14% .18% .26% =======================================================================
Non-performing loans were 4.44% of total loans at June 30, 1999, as compared to only .36% of total loans at June 30, 1998 and consisted primarily of commercial and multi-family loans. The increase in non-performing loans is due to one large multi-family loan to an unaffiliated borrower, which is past due pending its refinancing. Fidelity officials are assisting the borrower in obtaining alternate financing; however, the ultimate refinancing of this credit with no additional losses cannot be assured. Multi-family affordable housing loans, for which specific reserves have been computed, are currently performing with respect to debt service and are, therefore, not included in the above "non-performing loans" totals. In the past, the ability of the multi-family loans to remain performing has been in part due to general partner advances made by Fidelity to support cash flow deficits incurred by the affordable housing projects. During the current fiscal year, operating cash flows for most of the properties has improved and general partner advances have significantly decreased. There is no assurance that general partner advances will not be necessary in the future to support cash flow deficits. The majority of recorded general partner advances were charged off in fiscal 1998. 26 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION ANALYSIS OF ALLOWANCE FOR LOAN LOSSES AND LETTER OF CREDIT VALUATION ALLOWANCE Fidelity establishes its provision for loan losses and evaluates the adequacy of the allowance for loan losses based on management's evaluation of the performance of its loan and letter of credit portfolio. Such evaluation, which includes a review of all loans and letters of credit for which full collectibility may not be reasonably assured, considers among other matters, the present value of capitalized cash flows, the estimated fair value of the underlying collateral, economic conditions, historical loss experience, the composition of the portfolios and other factors that warrant recognition in providing for an adequate loan loss allowance and letter of credit valuation allowance. This evaluation is performed on a monthly basis and is designed to ensure that all relevant matters affecting collectibility will consistently be identified in a detailed review and that the outcome of the review will be considered in a disciplined manner by management in determining the necessary allowances and related provisions. The amounts actually reported in each period will vary with the outcome of this detailed review. CLASSIFIED ASSETS AND LETTERS OF CREDIT (In Thousands) JUNE 30 1999 1998 - ----------------------------------------------------------------------------- Classified assets $19,680 $16,071 Classified letters of credit 20,977 27,529 ------------------------ Total classified assets/letters of credit $40,657 $43,600 ======================== Classified and criticized assets of Fidelity totaled $40.7 million at June 30, 1999 compared to $43.6 million at June 30, 1998. Classified assets and letters of credit were 246.4% and 251.4% of Fidelity's capital and reserves at June 30, 1999 and 1998, respectively. Impaired loans are those that management believes will not perform under the original loan terms. At June 30, 1999, Fidelity had impaired loans totaling $16.5 million compared to $13.9 million at June 30, 1998. The allowance for losses on such impaired loans totaled $1.8 million and $1.9 million and is included in Fidelity's allowance for loan losses at June 30, 1999 and 1998, respectively. In addition, using the same guidelines for impaired loans, impaired letters of credit total $21.0 million versus $27.5 million at June 30, 1998. The valuation allowance on such impaired letters of credit totaled $5.2 million and $6.8 million and is included in Fidelity's letters of credit valuation allowance at June 30, 1999 and 1998, respectively. Impaired loans do not include large groups of homogeneous loans that are collectively evaluated for impairment, such as, residential mortgage and consumer installment loans. 27 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table sets forth loan charge-offs and recoveries by the type of loan and an analysis of the allowance for loan losses for the fiscal years ended June 30:
JUNE 30 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) Allowance for loan losses balance at July 1 $ 3,049 $ 1,781 $ 1,059 $ 713 $ 356 ---------------------------------------------------------------------------------------- Loan charge offs Real estate mortgage 15 100 12 8 Multi-family 3,089 Commercial 14 25 Consumer 324 195 142 128 74 ---------------------------------------------------------------------------------------- Total loan charge offs 338 3,299 267 140 82 ---------------------------------------------------------------------------------------- Loan recoveries Real estate mortgage 15 3 17 8 Commercial 3 Consumer 35 24 11 14 11 ---------------------------------------------------------------------------------------- Total loan recoveries 53 24 14 31 19 ---------------------------------------------------------------------------------------- Net charge offs 285 3,275 253 109 63 Transfer from letter of credit valuation allowance 895 Provision for loan losses (138) 4,543 975 455 420 ---------------------------------------------------------------------------------------- Allowance for loan losses at June 30 $ 3,521 $ 3,049 $ 1,781 $ 1,059 $ 713 ======================================================================================== Ratio of net charge offs to average loans outstanding during period .21% 1.81% .12% .05% .04% ======================================================================================== Ratio of provision for loan losses to average loans outstanding during period (.10)% 2.52% .46% .20% .24% ======================================================================================== Ratio of allowance for loan losses to total loans outstanding at year end 3.09% 1.91% .87% .49% .32% ======================================================================================== Average amount of loans outstanding for the period $137,794 $180,530 $213,793 $226,874 $173,980 ======================================================================================== Amount of loans outstanding at end of period $113,957 $159,732 $204,964 $217,221 $223,100 ========================================================================================
28 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The allowance for loan losses was $3.5 million at June 30, 1999 compared to $3.0 million at June 30, 1998. Net loan charge-offs were $285,000 or .21% of average loans for the year ended June 30, 1999 compared to $3.3 million or 1.81% of average loans for the year ended June 30, 1998. A letter of credit was funded during the first quarter of fiscal 1999 and was classified as a non-accrual loan upon conversion. This loan was previously classified as a substandard letter of credit with a specific reserve of $895,000. The loan was paid in full during the second quarter of fiscal 1999 and Fidelity reclassified the $895,000 specific reserve to the general allowance for loan losses, based on the most recent loan review by Fidelity. As discussed previously, Fidelity increased the provision for loan losses during fiscal 1998 primarily in connection with loans made to certain Section 42 tax-credit real estate development projects that Fidelity was currently managing. Fidelity has loans and letters of credit securing third-party loans to these projects and also has other loans and letters of credit outstanding that are related to other multi-family developments, most of which are outside Fidelity's geographic market. Fidelity also recorded a letter of credit valuation allowance and related provision of $6.8 million in fiscal 1998, the balance of which is $5.2 million at June 30, 1999. The decrease is primarily due to the transfer of $895,000 from the letter of credit valuation allowance to the allowance for loan losses and the reversal of $715,000 in letter of credit reserves. Multi-family letters of credit, an off-balance sheet item, carry the same risk characteristics as conventional loans and totaled $45 million at June 30, 1999. Specific reserves for letters of credit totaled 11.47% of outstanding letters of credit at June 30, 1999 compared to 12.22% at June 30, 1998. Classified loans and letters of credit to total loans and letters of credit were 24.2% at June 30, 1999 and 19.3% at June 30, 1998. Management is not aware of any additional letters of credit that are expected to be called or funded. Management considers the allowance for loan losses and letter of credit valuation reserve adequate to meet losses inherent in the loan portfolio as of June 30, 1999. ALLOCATION OF ALLOWANCE FOR LOAN LOSSES The allocation for loan losses and the percentage of loans within each category to total loans at June 30 are as follows:
ALLOCATION OF AMOUNT ---------------------------------------------------------------------------------------- JUNE 30 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) Real Estate Mortgage Conventional $ 99 $ 173 $ 153 $ 155 $208 Multi-family 2,177 1,868 994 420 195 Home equity and consumer 182 275 168 214 260 Commercial 1,063 733 466 270 50 ---------------------------------------------------------------------------------------- Total $3,521 $3,049 $1,781 $1,059 $713 ======================================================================================== PERCENTAGE OF LOANS TO TOTAL LOANS ---------------------------------------------------------------------------------------- JUNE 30 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------- Real Estate Mortgage Conventional 46.2% 48.7% 53.9% 63.2% 67.5% Multi-family 11.5 11.4 14.3 13.4 11.7 Home equity and consumer 24.2 19.7 12.7 10.7 17.9 Commercial 18.1 20.2 19.1 12.7 2.9 ---------------------------------------------------------------------------------------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ========================================================================================
29 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION ASSOCIATION WITH SECTION 42 As noted previously, Fidelity has various investments in seventeen real estate development projects located throughout Indiana, Illinois and Kentucky. Management considers the projects and properties to be in good condition. Fidelity has various Section 42 loans, general partner loans, equity investments and letters of credit associated with these projects. The following table summarizes Fidelity's association with these projects:
JUNE 30, JUNE 30, CONVENTIONAL BANK FINANCING ORIGINAL AMOUNT 1999 1998 --------------------------- --------------- -------- -------- Section 42 loans $8,044 $4,823 $5,325 Chargeoffs 416 Specific reserve 673 878 Provision for loan losses 401 1,294 GENERAL PARTNER General partner loans * 250 606 Chargeoffs 2,549 Specific reserve 125 56 Provision for loan losses 316 2,605 EQUITY INVESTMENTS Equity Investment 2,825 879 1,686 Chargeoffs 545 1,478 Specific reserve 75 LETTERS OF CREDIT Letters of credit 19,680 16,666 19,423 Chargeoffs (532) 5,300 Valuation allowance 4,768 5,300 ADDITIONAL NOTES Additional notes * 284 Chargeoffs Specific reserve 44 Provision for loan losses 166
*Per the partnership agreement, each partnership could request up to a specified amount additional money to cover shortfalls at the partnerships, therefore no original amount is specified. INVESTMENT SECURITIES United's investment policy is annually reviewed by its Board of Directors. Any significant changes to the policy must be approved by the Board. The Board has an asset/liability management committee, which is responsible for keeping the investment policy current. At June 30, 1999, the investment portfolio represented 15.9% of Fidelity's assets, compared to 5% at June 30, 1998, and is managed in a manner designed to meet the Board's investment policy objectives. Due to continued reductions in the loan portfolio, the excess liquidity has been reinvested in lower risk investment securities. The primary objectives, in order of priority, are to further the safety and soundness of Fidelity, to provide the liquidity necessary to meet day to day, cyclical, and long-term changes in the mix of Fidelity's assets and liabilities and to provide for diversification of risk and management of interest rate and economic risk. At June 30, 1999, the entire investment portfolio was classified as available for sale. The net unrealized loss at June 30, 1999, which is included as a component of stockholders' equity, was $458,000, which was comprised of gross losses of $759,000 and a tax benefit of $301,000. The increase in unrealized loss was caused by market interest rate changes during the period. Although the entire portfolio is available for sale, management has not identified specific investments for sale in future periods. 30 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table sets forth the components of United's available-for-sale investment portfolio as of June 30: JUNE 30 1999 1998 1997 - ------------------------------------------------------------------------------ (In Thousands) Investment securities available for sale U. S. Treasury $1,001 $ 1,000 Federal agency securities 2,985 2,944 Federal Home Loan Mortgage Corporation mortgage-backed securities $ 1,202 1,779 3,003 Federal National Mortgage Association mortgage-backed securities 1,510 1,945 1,562 Government National Mortgage Association mortgage-backed securities 24,613 2,144 4,223 Municipals 1,058 ------------------------------- Total securities available for sale $27,325 $9,854 $13,790 =============================== United's investment securities portfolio increased by $17.5 million to $27.3 million at June 30, 1999, compared to $9.9 million at June 30, 1998. In addition to maturities and paydowns, United purchased $25.4 million of securities during fiscal 1999. As mentioned above, this was the result of excess liquidity generated from the reduction in the loan portfolio. United holds various types of securities, including mortgage-backed securities. Inherent in mortgage-backed securities is prepayment risk. Prepayment rates generally can be expected to increase during periods of lower interest rates as some of the underlying mortgages are refinanced at lower rates. Conversely, the average lives of these securities generally are extended as interest rates increase. United's total investment securities portfolio decreased by $3.9 million at June 30, 1998, from June 30, 1997 as securities were sold during 1998 and as paydowns and early payoffs occurred. 31 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table sets forth the contractual maturities of investment and mortgage-backed securities as of June 30, 1999, and the weighted average yields of such securities. The contractual maturities of mortgage- backed securities are not typically indicative of the actual holding period for such investments, as pre-payments on the underlying mortgage loans will reduce the average life of the investment, based on the interest rate market.
AFTER ONE BUT AFTER FIVE BUT WITHIN ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS OVER TEN YEARS TOTAL ------------------------------------------------------------------------------------------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD - ---------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Federal Home Loan Mortgage Corporation $490 7.02% $ 14 8.43% $ 697 5.94% $ 1,201 6.40% Federal National Mortgage Association 491 7.00 1,019 5.89 1,510 6.22 Government National Mortgage Association $ 1 8.00% 2 7.00 2,337 6.50% 22,273 6.97 24,613 6.92 ------- ------ ------- ------- -------- Total $ 1 8.00% $983 7.01% $ 2,351 6.51% $23,989 6.89% $27,324 6.86% ======= ====== ======= ======= ======== Percent of total 0% 4% 9% 87% 100% ======= ====== ======= ======= ========
FUNDING SOURCES DEPOSITS Fidelity attracts both short-term and long-term deposits from the retail market by offering a wide assortment of accounts with different terms and different interest rates. These deposit alternatives include checking accounts, regular savings accounts, money market deposit accounts, fixed rate certificates with varying maturities, variable interest rate certificates, negotiable rate jumbo certificates ($100,000 or more), and variable rate IRA certificates. Average deposits decreased by $16.9 million for the year ended June 30, 1999. The decrease came primarily in the area of agent-acquired certificates and core certificates of deposit, for which the average balance decreased $9.0 million and $6.6 million, respectively. The average balance of NOW and money market accounts decreased by $1.8 million and $294,000 from 1998, while the average balance of demand and savings accounts increased $495,000 and $269,000, respectively, from 1998. Due to the excess liquidity created from payoffs and paydowns of the loan portfolio, Fidelity used this flexibility to allow agent-acquired certificates of deposit to mature or rollover at the prevailing retail rate. Agent-acquired certificates of deposit were acquired at rates higher than the current local market for retail deposits, but generally below rates charged for FHLB advances. 32 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table sets forth the average balances of and the average rate paid on deposits by deposit category for the years ended June 30, 1999, 1998 and 1997.
1999 1998 1997 ------------------------------------------------------------------------------------ AVERAGE DEPOSITS AMOUNT RATE Amount Rate Amount Rate - ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) Demand $ 5,724 $ 5,229 $ 5,684 NOW accounts 20,436 3.50% 22,211 4.24% 20,585 4.22% Money market accounts 2,733 2.23 3,027 2.71 3,890 2.72 Savings accounts 5,082 2.32 4,813 2.83 4,793 2.90 Certificates of deposit 79,072 5.76 85,699 5.80 78,408 5.68 Agent-acquired certificates of deposit 33,467 6.02 42,443 6.26 70,346 6.31 --------------- --------------- --------------- Totals $146,514 5.10% $163,422 5.38% $183,706 5.45% =============== =============== ===============
The following table summarizes certificates of deposit in amounts of $100,000 or more by maturity as of the following dates: JUNE 30 1999 1998 1997 - ------------------------------------------------------------------------------ (In Thousands) Three months or less $ 4,218 $ 2,716 $ 12,312 Three to six months 1,364 4,008 16,319 Six to twelve months 7,760 4,227 13,331 Over twelve months 3,763 11,471 11,119 ------------------------------------------ Totals $17,105 $22,422 $53,081 ========================================== BORROWINGS Fidelity's long-term debt decreased $339,000 from 1998 primarily due to a decrease in Federal Home Loan Bank advances of $2.3 million that was offset by new debt of $2.0 million. With the current dividend restrictions in the Supervisory Agreement, a loan was obtained to meet the anticipated cash requirements of the parent company for fiscal 2000. Alternate funding sources for United were provided by loan sales and loan payoffs, as well as through retail deposits for United. 33 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Short-term borrowings totaled only $128,000 at June 30, 1999, which represented a decrease of $2.4 million since June 30, 1998. During fiscal 1999, the guaranteed investment contracts matured.
GUARANTEED FEDERAL FUNDS FHLB ADVANCES TREASURY TAX AND INVESTMENT PURCHASED LOAN NOTE OPTION CONTRACTS - -------------------------------------------------------------------------------------------------------------- (In Thousands) JUNE 30, 1999 Outstanding at June 30 $128 Average amount outstanding 73 $404 Maximum amount outstanding at any month end 135 Weighted average interest rate During the year 4.76% 5.63% End of the year 4.73 JUNE 30, 1998 Outstanding at June 30 $115 $2,416 Average amount outstanding $ 116 81 2,861 Maximum amount outstanding at any month end 2,400 115 3,736 Weighted average interest rate During the year 6.03% 5.32% 5.61% End of the year 5.69 5.63
CAPITAL RESOURCES Fidelity's stockholders' equity increased $299,000 to $7.8 million at June 30, 1999, compared to $7.5 million at June 30, 1998. The increase in stockholders' equity was accounted for by net income of $625,000, and the issuance of stock totaling $90,000. Offsetting these increases was an increase in the net unrealized loss on securities available for sale of $416,000. There was no common stock repurchased in 1999. The common stock that was repurchased in 1997 and 1998 was retired upon purchase. Total capital for United consists of Tier I capital plus the allowance for loan losses. Minimum capital levels are 4% for the leverage ratio, which is, defined as Tier I capital as a percentage of total assets less goodwill and other identifiable intangible assets; 4% for Tier I to risk-weighted assets; and 8% for total capital to risk-weighted assets. United's capital ratios have exceeded each of these levels. The leverage ratio was 8.49% and 6.31%; tier I capital to risk-weighted assets was 10.47% and 6.78% and total capital to risk-weighted assets was 15.37% and 10.79% at June 30, 1999 and 1998. Book value per share, excluding unrealized losses on investment securities, increased to $2.63 at June 30, 1999, compared to $2.42 one year earlier. 34 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The capital category assigned to an entity can also be affected by qualitative judgements made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. At June 30, 1999 and 1998, the Bank is categorized as well capitalized and met all capital adequacy requirements at those dates; however, per the Supervisory Agreement, the OTS felt additional capital was necessary based on asset quality concerns. United evaluated and pursued this alternative during fiscal 1999 for the purpose of improving its capital ratios during 1999, and significantly improved its capital ratios by reducing the asset size of the institution. As noted above, risk-based capital increased to 15.37% at June 30, 1999 compared to 10.79% at June 30, 1998. LIQUIDITY Fidelity's principal source of income and funds is dividends from United and is not subject to any regulatory restrictions on the payment of dividends to its stockholders. However, United is restricted from paying any dividends to Fidelity without prior approval of the OTS. Fidelity recently obtained additional financing of $2.0 million to cover operating costs and servicing of debt at the holding company level. Additional sources of liquidity available to the holding company include the potential issuance of additional stock, potential execution of additional debt financing, dividends from United (with OTS approval). United is required by federal regulations to maintain specified levels of "liquid" assets consisting of cash and other eligible investments. Currently, liquid assets must equal at least four percent of net withdrawable savings plus borrowings payable upon demand or due within one year or less. As of June 30, 1999 and 1998, United's liquidity ratios were 16.99% and 6.7%. Management believes that this level of liquidity is sufficient to meet any anticipated requirements for United's operations. The primary sources of funds for operations are principal and interest payments on loans, deposits from customers, and sales and maturities of investment securities. In addition, United is authorized to borrow money from the FHLB and other sources as needed. United decreased its borrowings from the FHLB from $14.8 million at June 30, 1998, to $12.5 million at June 30, 1999. Fidelity has also decreased its utilization of agency-acquired certificates of deposit as total loans have decreased and the need for these types of funds has also decreased. SUPERVISORY AGREEMENT As noted previously and discussed in the footnotes under "Other Restrictions", United is currently operating under restrictions imposed by the Supervisory Agreement entered into with the OTS. The restrictions regarding certain activities in the Supervisory Agreement have had a significant impact on United's net interest margin, net interest income, and net income as a result of United's inability to participate in new commercial lending. Further, restrictions regarding consumer lending have had a negative impact on the ability of United to resume its automobile dealer lending program following the departure of its consumer lending staff discussed previously. Management has expended significant time ensuring that United has operated and will continue to operate in compliance with the Agreement. While the Supervisory Agreement remains in place, it is likely that total loans outstanding will continue to decline, and management efforts will be concentrated on compliance, rather than business development. This will likely have a further negative impact on the financial condition and the operating results of United and Fidelity. ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board has issued Statement No. 133, Accounting for Derivative Instruments and Hedge Activities, which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. The provisions of this statement were to become effective for fiscal years beginning after June 15, 1999. The effective date of the statement has been delayed by Statement No. 137 to fiscal years beginning after June 15, 2000. Fidelity does not expect the statement to have a material impact on Fidelity's financial condition or results of operations and plans on adopting it on July 1, 2000. 35 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION ASSET/LIABILITY MANAGEMENT Fidelity is subject to interest rate risk to the degree that its interest-bearing liabilities, primarily deposits with short and medium term maturities, mature or reprice at different rates than its interest-earning assets. Although having liabilities that mature or reprice less frequently than average assets will be beneficial in times of rising interest rates, such an asset/liability structure will result in lower net income during periods of declining interest rates, unless offset by other factors. The OTS utilizes a model, the "Office of Thrift Supervision Net Portfolio Value" ("NPV") model. which uses a net market value methodology to measure the interest rate risk exposure of savings associations. Under this model, an institution's "normal" level of interest rate risk in the event of an assumed change in interest rates is a decrease in the institution's NPV in an amount not exceeding 2% of the present value of its assets. Savings associations with over $300 million in assets or less than a 12% risk-based capital ratio are required to file OTS Schedule CMR. Data from Schedule CMR is used by the OTS to calculate changes in NPV (and the related "normal" level of interest rate risk) based upon certain interest rate changes (discussed below). Associations which do not meet either of the filing requirements are not required to file OTS Schedule CMR, but may do so voluntarily. United is not required to file a CMR since it exceeds the risk-based capital requirement and its assets are less than $300 million, but does so on a voluntary basis. Under the regulation, associations, which must file are required to take a deduction (the interest rate risk capital component) from their total capital available to calculate their risk based capital requirement if their interest rate exposure is greater than "normal". The amount of that deduction is one-half of the difference between (a) the institution's actual calculated exposure to a 200 basis point interest rate increase or decrease (whichever results in the greater pro forma decrease in NPV) and (b) its "normal" level of exposure which is 2% of the present value of its assets. Presented below, at June 30, 1999 and 1998, is an analysis performed by the OTS of United's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up and down 300 basis points. At June 30, 1999 and 1998, 2% of the present value of United's assets was approximately $3.4 and $3.9 million. Because the interest rate risk of a 200 basis point increase in market rates (which was greater than the interest rate risk of a 200 basis point decrease) was $1.8 million at June 30, 1999 and $1.1 million` at June 30, 1998, United would not have been required to make a deduction from its total capital available to calculate its risk based capital requirement. The increase in interest rate risk from 1999 to 1998 is due to interest rate changes and a change in United's balance sheet mix. INTEREST RATE RISK AS OF JUNE 30, 1999 NPV AS PERCENT OF PRESENT NET PORTFOLIO VALUE VALUE OF ASSETS -------------------------------------------------------------- CHANGE DOLLAR DOLLAR PERCENTAGE IN RATES AMOUNT CHANGE CHANGE NPV RATIO CHANGE - ------------------------------------------------------------------------ + 300 bp $11,390 $(3,126) (22)% 7.09% - 151 bp + 200 bp 12,763 (1,753) (12) 7.81 - 80 bp + 100 bp 13,916 (600) (4) 8.37 - 24 bp 0 bp 14,516 8.61 - - 100 bp 14,145 (371) (3) 8.31 - 30 bp - - 200 bp 13,203 (1,312) (9) 7.70 - 91 bp - - 300 bp 12,292 (2,224) (15) 7.10 - 150 bp 36 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION INTEREST RATE RISK AS OF JUNE 30, 1998 NPV AS PERCENT OF PRESENT NET PORTFOLIO VALUE VALUE OF ASSETS -------------------------------------------------------------- CHANGE DOLLAR DOLLAR PERCENTAGE IN RATES AMOUNT CHANGE CHANGE NPV RATIO CHANGE - ------------------------------------------------------------------------ + 300 bp 13,549 (2,111) (13) 7.20 - 80 bp + 200 bp 14,598 (1,062) (7) 7.64 - 36 bp + 100 bp 15,407 (253) (2) 7.95 - 04 bp 0 bp 15,660 8.00 - - 100 bp 15,524 (136) (1) 7.85 - 15 bp - - 200 bp 14,815 (845) (5) 7.44 - 56 bp - - 300 bp 14,277 (1,383) (9) 7.11 - 88 bp As with any method of measuring interest rate risk, certain shortcomings are inherent in the methods of analysis presented above. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features, which restrict changes in interest rates on a short-term basis and over the life of the assets. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumptions used in calculating the table. 37 ITEM 7 A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ASSET/LIABILITY MANAGEMENT Fidelity is subject to interest rate risk to the degree that its interest-bearing liabilities, primarily deposits with short and medium term maturities, mature or reprice at different rates than its interest-earning assets. Although having liabilities that mature or reprice less frequently than average assets will be beneficial in times of rising interest rates, such an asset/liability structure will result in lower net income during periods of declining interest rates, unless offset by other factors. The OTS utilizes a model, the "Office of Thrift Supervision Net Portfolio Value" ("NPV") model which uses a net market value methodology to measure the interest rate risk exposure of savings associations. Under this model, an institution's "normal" level of interest rate risk in the event of an assumed change in interest rates is a decrease in the institution's NPV in an amount not exceeding 2% of the present value of its assets. Savings associations with over $300 million in assets or less than a 12% risk-based capital ratio are required to file OTS Schedule CMR. Data from Schedule CMR is used by the OTS to calculate changes in NPV (and the related "normal" level of interest rate risk) based upon certain interest rate changes (discussed below). Associations which do not meet either of the filing requirements are not required to file OTS Schedule CMR, but may do so voluntarily. United is not required to file a CMR since it exceeds the risk-based capital requirement and its assets are less than $300 million, but does so on a voluntary basis. Under the regulation, associations, which must file are required to take a deduction (the interest rate risk capital component) from their total capital available to calculate their risk based capital requirement if their interest rate exposure is greater than "normal". The amount of that deduction is one-half of the difference between (a) the institution's actual calculated exposure to a 200 basis point interest rate increase or decrease (whichever results in the greater pro forma decrease in NPV) and (b) its "normal" level of exposure which is 2% of the present value of its assets. Presented below, at June 30, 1999 and 1998, is an analysis performed by the OTS of United's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up and down 300 basis points. At June 30, 1999 and 1998, 2% of the present value of United's assets was approximately $3.4 and $3.9 million. Because the interest rate risk of a 200 basis point increase in market rates (which was greater than the interest rate risk of a 200 basis point decrease) was $1.8 million at June 30, 1999 and $1.1 million` at June 30, 1998, United would not have been required to make a deduction from its total capital available to calculate its risk based capital requirement. The increase in interest rate risk from 1999 to 1998 is due to interest rate changes and a change in United's balance sheet mix. INTEREST RATE RISK AS OF JUNE 30, 1999 NPV AS PERCENT OF PRESENT NET PORTFOLIO VALUE VALUE OF ASSETS -------------------------------------------------------------- CHANGE DOLLAR DOLLAR PERCENTAGE IN RATES AMOUNT CHANGE CHANGE NPV RATIO CHANGE - ------------------------------------------------------------------------ + 300 bp $11,390 $(3,126) (22)% 7.09% - 151 bp + 200 bp 12,763 (1,753) (12) 7.81 - 80 bp + 100 bp 13,916 (600) (4) 8.37 - 24 bp 0 bp 14,516 8.61 - - 100 bp 14,145 (371) (3) 8.31 - 30 bp - - 200 bp 13,203 (1,312) (9) 7.70 - 91 bp - - 300 bp 12,292 (2,224) (15) 7.10 - 150 bp 38 INTEREST RATE RISK AS OF JUNE 30, 1998 NPV AS PERCENT OF PRESENT NET PORTFOLIO VALUE VALUE OF ASSETS -------------------------------------------------------------- CHANGE DOLLAR DOLLAR PERCENTAGE IN RATES AMOUNT CHANGE CHANGE NPV RATIO CHANGE - ------------------------------------------------------------------------ + 300 bp 13,549 (2,111) (13) 7.20 - 80 bp + 200 bp 14,598 (1,062) (7) 7.64 - 36 bp + 100 bp 15,407 (253) (2) 7.95 - 04 bp 0 bp 15,660 8.00 - - 100 bp 15,524 (136) (1) 7.85 - 15 bp - - 200 bp 14,815 (845) (5) 7.44 - 56 bp - - 300 bp 14,277 (1,383) (9) 7.11 - 88 bp As with any method of measuring interest rate risk, certain shortcomings are inherent in the methods of analysis presented above. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features, which restrict changes in interest rates on a short-term basis and over the life of the assets. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumptions used in calculating the table. 39 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA [LETTERHEAD OF OLIVE] INDEPENDENT AUDITOR'S REPORT Stockholders and Board of Directors Fidelity Federal Bancorp Evansville, Indiana We have audited the consolidated balance sheet of Fidelity Federal Bancorp and subsidiaries as of June 30, 1999 and 1998 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended June 30, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements described above present fairly, in all material respects, the consolidated financial position of Fidelity Federal Bancorp and subsidiaries as of June 30, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1999, in conformity with generally accepted accounting principles. /s/ Olive LLP Evansville, Indiana September 22, 1999 40 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Thousands, Except Share Data)
JUNE 30 1999 1998 - ---------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 1,599 $ 1,683 Short-term interest-bearing deposits 14,668 6,266 ---------------------- Total cash and cash equivalents 16,267 7,949 Investment securities available for sale 27,325 9,854 Loans, net of allowance for loan losses of $3,521 and $3,049 110,436 156,683 Premises and equipment 5,692 5,846 Federal Home Loan Bank of Indianapolis stock 3,920 3,920 Income tax receivable 3,660 6,690 Interest receivable and other assets 4,953 6,104 ---------------------- Total assets $ 172,253 $ 197,046 ====================== LIABILITIES Deposits Non-interest bearing $ 6,224 $ 4,760 Interest bearing 122,372 144,179 ---------------------- Total deposits 128,596 148,939 Short-term borrowings 128 2,531 Long-term debt 29,149 29,488 Advances by borrowers for taxes and insurance 392 426 Valuation allowance for letters of credit 5,168 6,778 Other liabilities 1,006 1,369 ---------------------- Total liabilities 164,439 189,531 ---------------------- STOCKHOLDERS' EQUITY Preferred stock, no par or stated value Authorized and unissued--5,000,000 shares Common stock, $1 stated value Authorized--5,000,000 shares Issued and outstanding--3,147,662 and 3,127,208 shares 3,147 3,127 Additional paid-in capital 10,869 10,799 Stock warrants 11 11 Retained earnings (5,755) (6,380) Accumulated other comprehensive income (458) (42) ---------------------- Total stockholders' equity 7,814 7,515 ---------------------- Total liabilities and stockholders' equity $ 172,253 $ 197,046 ======================
See notes to consolidated financial statements. 41 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (In Thousands, Except Share Data)
YEAR ENDED JUNE 30 1999 1998 1997 - ------------------------------------------------------------------------------------------------- INTEREST INCOME Loans receivable $ 11,861 $ 15,872 $ 18,692 Investment securities Taxable 955 650 1,033 Tax exempt 24 56 Federal funds sold 25 75 70 Deposits with financial institutions 939 255 124 Other dividend income 314 316 307 -------------------------------- Total interest income 14,094 17,192 20,282 -------------------------------- INTEREST EXPENSE Deposits 7,467 8,785 10,000 Short-term borrowings 26 170 359 Long-term debt 2,237 2,631 3,472 -------------------------------- Total interest expense 9,730 11,586 13,831 -------------------------------- NET INTEREST INCOME 4,364 5,606 6,451 Provision for loan losses (138) 4,543 975 -------------------------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 4,502 1,063 5,476 -------------------------------- OTHER INCOME Fee income--real estate development and management fees 196 191 337 Service charges on deposit accounts 437 436 316 Net realized gains on sales of securities available for sale 79 42 Net gains on loan sales 343 186 338 Letter of credit fees 582 657 722 Real estate investment banking fees 78 139 963 Agent fee income 333 650 452 Title fee income 72 10 41 Other income 622 677 645 -------------------------------- Total non-interest income 2,663 3,025 3,856 --------------------------------
42 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (In Thousands, Except Share Data) (Continued)
YEAR ENDED JUNE 30 1999 1998 1997 - ----------------------------------------------------------------------------------------- OTHER EXPENSES Salaries and employee benefits $ 3,414 $ 3,341 $ 4,318 Net occupancy expenses 394 444 481 Equipment expenses 299 354 374 Data processing fees 407 456 318 Deposit insurance expense 244 140 255 SAIF assessment 1,040 Legal and professional fees 379 304 303 Advertising 202 199 230 Letter of credit valuation provision (715) 6,778 Valuation allowance--affordable housing investments 545 1,478 335 Affordable housing group activities 769 177 Other expense 1,709 1,813 1,643 --------------------------------- Total non-interest expense 6,878 16,076 9,474 --------------------------------- INCOME (LOSS) BEFORE INCOME TAX 287 (11,988) (142) Income tax benefit (338) (5,194) (255) --------------------------------- NET INCOME (LOSS) $ 625 $ (6,794) $ 113 ================================= BASIC EARNINGS (LOSS) PER SHARE $ .20 $ (2.30) $ .05 DILUTED EARNINGS (LOSS) PER SHARE .20 (2.30) .04
See notes to consolidated financial statements. 43 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (In Thousands, Except Share Data)
ACCUMULATED COMMON STOCK COMPREHENSIVE OTHER --------------------- PAID-IN STOCK INCOME RETAINED COMPREHENSIVE SHARES AMOUNT CAPITAL WARRANTS (LOSS) EARNINGS INCOME TOTAL ------------------------------------------------------------------------------------- BALANCES, JULY 1, 1996 2,495,040 $ 2,495 $ 8,785 $ 266 $ 2,889 $ (140) $14,295 Comprehensive income Net income $ 113 113 113 Other comprehensive income, net of tax Unrealized gain on securities, net of reclassification adjustment 109 109 109 ------- Comprehensive income $ 222 ======= Cash dividends ($.60 per share) (1,494) (1,494) Exercise of stock options 407 4 4 Exercise of stock warrants 4,938 5 32 (2) 35 Purchase of stock (13,000) (13) (113) (126) ----------------------------------------- ------------------------------- BALANCES, JUNE 30, 1997 2,487,385 2,487 8,708 264 1,508 (31) 12,936 Comprehensive income Net loss $(6,794) (6,794) (6,794) Other comprehensive income, net of tax Unrealized loss on securities, net of reclassification adjustment (11) (11) (11) ------- Comprehensive income (loss) $(6,805) ======= Cash dividends ($.35 per share) (1,094) (1,094) Exercise of stock warrants 641,323 641 2,104 (253) 2,492 Purchase of stock (1,500) (1) (13) (14) ----------------------------------------- ------------------------------- BALANCES, JUNE 30, 1998 3,127,208 3,127 10,799 11 (6,380) (42) 7,515 Comprehensive income Net income $ 625 625 625 Other comprehensive income, net of tax Unrealized loss on securities (416) (416) (416) ------- Comprehensive income $ 209 ======= Sale of stock 20,458 20 70 90 Purchase of stock (4) ----------------------------------------- ------------------------------- BALANCES, JUNE 30, 1999 3,147,662 $ 3,147 $ 10,869 $ 11 $ (5,755) $(458) $ 7,814 ========================================= ===============================
See notes to consolidated financial statements. 44 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands)
YEAR ENDED JUNE 30 1999 1998 1997 - ----------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income (loss) $ 625 $ (6,794) $ 113 Adjustments to reconcile net income (loss) to net cash provided by operating activities Provision for loan losses (138) 4,543 975 Investment securities gains (79) (42) Letter of credit valuation provision (715) 6,778 Gain on sale of premises and equipment (21) (3) Gain on sale of mortgage servicing rights (134) Depreciation 402 449 424 Investment securities amortization (accretion), net 39 (16) 29 Valuation allowance for premises and equipment 100 Valuation allowance--affordable housing investments 791 1,478 335 Loans originated for sale (25,474) (9,755) (13,469) Proceeds from sale of loans 25,342 9,468 14,020 Amortization of net loan origination fees and points (61) (26) (3) Deferred income tax (benefit) (6) (3,389) 313 Changes in Interest payable and other liabilities 66 (682) (331) Interest receivable, tax receivable and other assets 3,396 (1,361) (1,473) -------------------------------- Net cash provided by operating activities 4,246 580 888 -------------------------------- INVESTING ACTIVITIES Purchases of securities available for sale (25,388) (1,906) (2,597) Proceeds from maturities of securities available for sale 7,189 2,476 3,806 Proceeds from sales of securities available for sale 3,451 2,624 Proceeds from sale of mortgage servicing rights 687 Net change in loans 45,683 42,270 11,417 Purchase of premises and equipment (267) (111) (1,233) Proceeds from sales of premises and equipment 40 56 23 -------------------------------- Net cash provided by investing activities 27,257 46,923 14,040 -------------------------------- FINANCING ACTIVITIES Net change in Noninterest-bearing, interest-bearing demand and savings deposits (1,430) 910 (2,054) Certificates of deposit (18,913) (33,758) 2,139 Short-term borrowings (2,403) (2,660) (567) Proceeds of long-term debt 5,000 7,600 Repayment of long-term debt (5,339) (8,601) (26,737) Net change in advances by borrowers for taxes and insurance (34) (248) (185) Purchase of stock (14) (126) Sale of stock 90 Cash dividends (156) (1,186) (1,745) Proceeds from exercise of stock options 4 Proceeds from exercise of stock warrants 2,492 35 -------------------------------- Net cash used by financing activities (23,185) (43,065) (21,636) --------------------------------
45 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands) (Continued)
YEAR ENDED JUNE 30 1999 1998 1997 - ------------------------------------------------------------------------------- NET CHANGE IN CASH AND CASH EQUIVALENTS $ 8,318 $ 4,438 $ (6,708) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 7,949 3,511 10,219 -------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 16,267 $ 7,949 $ 3,511 ================================ ADDITIONAL CASH FLOWS INFORMATION Interest paid $ 9,879 $ 11,900 $ 13,846 Income tax paid (refunded) (3,013) 625 710
See notes to consolidated financial statements. 46 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Nature of Operations and Summary of Significant Accounting Policies The accounting and reporting policies of Fidelity Federal Bancorp (Fidelity) and its wholly-owned subsidiaries conform to generally accepted accounting principles and reporting practices followed by the thrift industry. The more significant of the policies are described below. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fidelity is a registered thrift holding company whose principal activity is the ownership and management of United Fidelity Bank, fsb (United). United operates under a national thrift charter and provides full banking services. As a federally chartered thrift, United is subject to regulation by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation. United generates mortgage, consumer and commercial loans and receives deposits from customers located primarily in Vanderburgh County, Indiana and surrounding counties. Fidelity's loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Two of United's wholly-owned subsidiaries, Village Management Corporation and Village Housing Corporation (collectively, the Affordable Housing Group), are in the business of owning, renting and managing affordable housing projects. United's other wholly-owned subsidiaries are Village Capital Corporation, which primarily receives consulting fees for packaging various multi-family deals to be financed and completed, and Village Insurance Corporation, which offers an array of insurance products. Fidelity's other subsidiary is Village Affordable Housing Corporation, which is not operational. The Affordable Housing Group has discontinued the development of real estate, but continues actively managing affordable housing projects. CONSOLIDATION--The consolidated financial statements include the accounts of Fidelity and its subsidiaries after elimination of all material intercompany transactions. SECURITIES AVAILABLE FOR SALE are carried at fair value, with unrealized gains and losses reported separately in stockholders' equity, net of tax. Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses of securities are recorded on the specific-identification method. LOANS HELD FOR SALE are carried at the lower of aggregate cost or market value. Market is determined using the aggregate method. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income, based on the difference between estimated sales proceeds and aggregate cost. 47 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) LOANS are carried at the principal amount outstanding. Interest income is accrued on the principal balances of loans. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed when considered uncollectible. Interest income is subsequently recognized only to the extent cash payments are received. Certain loan fees and related direct costs are being deferred and amortized over the lives of the loans as an adjustment of yield on the loans. ALLOWANCE FOR LOAN LOSSES and letter of credit valuation allowance are maintained to absorb losses based on management's continuing review and evaluation of the loan and letter of credit portfolios and its judgment as to the impact of economic conditions on the portfolios. The evaluation by management includes consideration of past loss experience, changes in the composition of the portfolios, the current condition and amount of loans and letters of credit outstanding and the probability of collecting all amounts due. Impaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loan, if collateral dependent. The determination of the adequacy of the allowance for loan losses and the letter of credit valuation allowance is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of June 30, 1999, the allowance for loan losses and the letter of credit valuation allowance is adequate based on information currently available. A worsening or protracted economic decline in the area within which Fidelity operates could affect the possibility of additional losses due to credit and market risks and could create the need for additional loss reserves. PREMISES AND EQUIPMENT are carried at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method based principally on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations. FEDERAL HOME LOAN BANK (FHLB) STOCK is a required investment for institutions that are members of the FHLB system. The required investment in the common stock is based on a predetermined formula. INCOME TAX in the consolidated statement of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes. Fidelity files consolidated income tax returns with its subsidiaries. FEE INCOME on real estate development and management in the consolidated statement of income is attributable to activities of the Affordable Housing Group. The fees are recognized when earned under the applicable agreements and when collectibility is assured. Fee income related to insurance services is recognized when earned and collected. MORTGAGE SERVICING RIGHTS on originated loans are capitalized by allocating the total cost of the mortgage loans between the mortgage servicing rights and the loans based on their relative fair values. Capitalized servicing rights, which includes purchased servicing rights, are amortized in proportion to and over the period of estimated servicing revenues. 48 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) STOCK OPTIONS are granted for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. Fidelity accounts for and will continue to account for stock option grants in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognized no compensation expense for the stock option grants. EARNINGS PER SHARE have been computed based upon the weighted average common shares outstanding during the year. >> Restriction on Cash and Due From Banks United is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at June 30, 1999 was $386. >> Investment Securities Available for Sale
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------------------------------------------------------------- JUNE 30, 1999 Mortgage-backed securities $28,083 $(758) $27,325 ================================================================ JUNE 30, 1998 U. S. Treasury $ 1,000 $ 1 $ 1,001 Federal agencies 3,000 $ (15) 2,985 Mortgage-backed securities 5,923 4 (59) 5,868 ---------------------------------------------------------------- $ 9,923 $ 5 $ (74) $ 9,854 ================================================================
Securities with a carrying value of $27,322 and $8,512 were pledged at June 30, 1999 and 1998 to secure certain deposits and for other purposes as permitted or required by law. Proceeds from sales of investment securities available for sale during 1998 and 1997 were approximately $3,451 and $2,624. Gross gains of approximately $79 were realized on the 1998 sales. Gross gains of approximately $43 and gross losses of approximately $1 were realized on the 1997 sales. There were no sales of investment securities available for sale during 1999. 49 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Loans and Allowance
JUNE 30 1999 1998 - -------------------------------------------------------------------------------- Real estate mortgage loans First mortgage loans Conventional $ 49,733 $ 71,343 Construction 6,732 16,110 Commercial 14,140 20,753 Multi-family 7,597 5,742 First mortgage real estate loans purchased 2,061 2,704 Commercial loans--other than secured by real estate 6,076 11,568 Consumer and home equity loans 27,618 31,512 ---------------------- 113,957 159,732 Allowance for loan losses (3,521) (3,049) ---------------------- Total loans $ 110,436 $ 156,683 ======================
Multi-family first mortgage loans are loans made to affordable housing developments. An additional $5,937 and $12,904 in multi-family loans is included in construction loans at June 30, 1999 and 1998.
YEAR ENDED JUNE 30 ------------------------------ ALLOWANCE FOR LOAN LOSSES 1999 1998 1997 - --------------------------------------------------------------------------------- Balances, beginning of year $ 3,049 $ 1,781 $ 1,059 Provision for losses (138) 4,543 975 Transfer from Letter of Credit Valuation reserve 895 Recoveries on loans 53 24 14 Loans charged off (338) (3,299) (267) ------------------------------ Balances, end of year $ 3,521 $ 3,049 $ 1,781 ==============================
Information on impaired loans is summarized below: JUNE 30 1999 1998 - -------------------------------------------------------------- Impaired loans with an allowance $16,533 $13,925 =================== Allowance for impaired loans (included in allowance for loan losses) $ 1,842 $ 1,897 =================== YEAR ENDED JUNE 30 1999 1998 - ----------------------------------------------------------------- Average balance of impaired loans $13,868 $ 3,472 Interest income recognized on impaired loans 1,396 385 Cash-basis interest included above 1,396 385 50 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Letter of Credit Valuation Allowance In 1998, Fidelity recorded specific reserves related to letters of credit issued by Fidelity and United of approximately $6,800 primarily related to the permanent financing for certain affordable housing projects. Multifamily letters of credit, an off-balance sheet item, carry the same risk characteristics as conventional loans and totaled $45,000 and $55,000 at June 30, 1999, respectively.
1999 1998 1997 --------------------------------------------- Letter of credit valuation allowance Balances, beginning of year $6,778 Provision (715) $6,778 Transfer to allowance for loan losses (895) --------------------------------------------- Balances, end of year $5,168 $6,778 $0 =============================================
Fidelity funded one letter of credit totaling $4,200 during 1999. The valuation allowance for this letter of credit, totaling $895 was transferred to the allowance for loan losses. >> Premises and Equipment JUNE 30 1999 1998 - --------------------------------------------------------------------- Land $1,620 $1,611 Building and land improvements 5,337 5,288 Furniture, fixtures and equipment 2,256 1,943 -------------------------------- Total cost 9,213 8,842 Accumulated depreciation (3,521) (2,996) -------------------------------- Net $5,692 $5,846 ================================ 51 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Other Assets and Investments in Limited Partnerships Included in other assets at June 30, 1999 and 1998 are investments of $1,652 and $2,230 in limited partnerships which are organized to build, own and operate apartment complexes. The investments at June 30, 1999 are as follows: PERCENTAGE AND TYPE OF AMOUNT OF NUMBER OF PARTNERSHIP INTEREST INVESTMENT PARTNERSHIPS --------------------------------------------------------------- 1%--General $ 29 17 1%--General and 47%--Limited 378 1 1%--General and 39%--Limited 457 1 10%--Limited 362 1 10%--Limited 159 1 99%--Limited 267 2 Fidelity records income on the equity method in the income and losses of the limited partnerships, which resulted in losses of $246, $87 and $132 during the years ended June 30, 1999, 1998 and 1997. In addition to recording its equity in the losses of these projects, Fidelity has recorded the benefit of low-income housing tax credits of $460, $508 and $341 for the years ended June 30, 1999, 1998 and 1997. Combined condensed financial statements (unaudited) for the limited partnerships as of June 30, 1999 and 1998 and for the years ended June 30, 1999, 1998 and 1997 are as follows: JUNE 30 1999 1998 - ------------------------------------------------------------------ Combined condensed balance sheet (unaudited) Assets Cash $ 487 $ 310 Land and property 53,424 54,927 Other assets 1,516 1,720 ------------------ Total assets $55,427 $56,957 ================== Liabilities Notes payable $38,157 $38,039 Other liabilities 2,732 2,626 ------------------ Total liabilities 40,889 40,665 Partners' equity 14,538 16,292 ------------------ Total liabilities and partners' equity $55,427 $56,957 ================== 52 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data)
YEAR ENDED JUNE 30 1999 1998 1997 - --------------------------------------------------------------------------------------- Combined condensed statement of operations (unaudited) Total revenue $ 5,734 $ 5,259 $ 3,181 Total expenses 7,161 6,784 4,253 ------------------------------- Net loss $(1,427) $(1,525) $(1,072) ===============================
Approximately $5,542 and $5,433 of the notes payable are due to Fidelity from these partnerships at June 30, 1999 and 1998. Of the $5,542, Fidelity charged-off $2,500 in 1998. Of the remaining balance, specific reserves of $1,700 are included in the allowance for loan losses at June 30, 1999. Fidelity wrote down the investments in limited partnerships by $545 and $1,478 in 1999 and 1998, based on the performance of the underlying real estate operations. Included in other assets is interest receivable as follows: JUNE 30 1999 1998 - ------------------------------------------------------------------------- Interest receivable on loans $ 707 $1,015 Interest receivable on investment securities and other 180 114 ---------------- Total interest receivable $ 887 $1,129 ================ >> Deposits JUNE 30 1999 1998 - ---------------------------------------------------------------- Non-interest bearing transaction accounts $ 6,223 $ 4,760 Interest-bearing transaction accounts 18,829 21,365 Money market deposit accounts 2,715 2,847 Savings accounts 5,245 5,470 Certificates of $100 or more 17,105 22,422 Other certificates and time deposits 78,479 92,075 -------------------- Total deposits $128,596 $148,939 ==================== 53 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) Certificates maturing in years ending June 30: 2000 $63,534 2001 28,057 2002 1,949 2003 1,490 2004 552 Thereafter 2 ----------- $95,584 =========== >> Short-Term Borrowings JUNE 30 1999 1998 - ----------------------------------------------------- Treasury tax and loan note option $ 128 $ 115 Guaranteed investment contracts 2,416 ---------------- Total short-term borrowings $ 128 $2,531 ================ >> Long-Term Debt
JUNE 30 1999 1998 - ---------------------------------------------------------------------------------------------------------------------------- Note payable, 6.78%, adjusted annually, payable $15 per month, including interest, due April 2009, secured by specific multi-family mortgages $ 2,182 $ 2,210 Note payable, 8.48% adjusted annually, payable $8 per month, including interest, due September 2010, secured by specific multi-family mortgages 990 996 Note payable, 8.48% adjusted annually, payable $12 per month, including interest, due September 2010, secured by specific multi-family mortgages 1,517 1,529 Note payable, 9.50%, interest paid quarterly, due June 2001, secured by United stock 2,000 Junior subordinated notes, 9.125%, interest paid semi-annually, due April 2001, unsecured 1,476 1,476 Junior subordinated notes, 9.25%, interest paid semi-annually, due January 2002, unsecured 1,494 1,494 Senior subordinated notes, 10%, interest paid semi-annually, due June 2005, unsecured 7,000 7,000 Federal Home Loan Bank advances, due at various dates through 2003 (weighted average rates of 6.50% and 6.62% at June 30, 1999 and 1998) 12,490 14,783 ------------------------------------ Total long-term debt $29,149 $29,488 ====================================
54 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) The terms of a security agreement with the FHLB require United to pledge as collateral qualifying first mortgage loans in an amount equal to at least 125% of these advances and all stock in the FHLB or eligible securities with a market value in an amount equal to at least 110% of these advances. In addition to first mortgage loans pledged of $15,613, Fidelity had $26,481 of investment securities pledged at June 30, 1999. Certain advances are subject to restrictions or penalties in the event of prepayment. All long-term debt, except for Federal Home Loan Bank advances, is debt of the parent company and totals $16,659. The scheduled principal reduction of borrowings at June 30, 1999, is as follows: 2000, $4,044; 2001, $7,164; 2002, $2,319; 2003, $4,191; 2004, $77; and 2005 and later, $11,354. >> Loan Servicing Loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of mortgage loans serviced for others totaled $38,646, $19,481 and $64,517 at June 30, 1999, 1998 and 1997. The aggregate fair value of capitalized mortgage servicing rights at June 30, 1999 and 1998 approximated $483 and $244. Comparable market prices were used to estimate fair value. 1999 1998 1997 ------------------------ Mortgage servicing rights Balances, beginning of year $ 226 $ 721 $ 543 Servicing rights capitalized 250 127 250 Amortization of servicing rights (67) (69) (72) Sale of servicing rights (553) ------------------------ Balances, end of year $ 409 $ 226 $ 721 ======================== 55 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Income Tax
YEAR ENDED JUNE 30 1999 1998 1997 - ------------------------------------------------------------------------------------------- Income tax benefit Currently payable Federal $ (330) $(1,803) $ (515) State (2) (2) (53) Deferred Federal (39) (2,382) 240 State 33 (1,007) 73 ------------------------------ Total income tax benefit $ (338) $(5,194) $ (255) ============================== Reconciliation of federal statutory to actual tax benefit Federal statutory income tax at 34% $ 98 $(4,076) $ (48) Effect of state income taxes 21 (666) 13 Affordable housing tax credits and other (457) (452) (220) ------------------------------ Actual tax benefit $ (338) $(5,194) $ (255) ==============================
56 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) A cumulative deferred tax asset is included in other assets. The components of the asset are as follows:
JUNE 30 1999 1998 - ---------------------------------------------------------------------------------- ASSETS Differences in accounting for certain accrued liabilities $ 16 $ 15 Allowance for loan losses 1,252 738 Letter of credit allowance for loss 916 1,382 Loan fees 68 100 Unrealized gain/loss on available-for-sale securities 300 27 Alternative minimum tax credit 147 200 Low income housing credit carryforward 1,145 969 State net operating loss carryforward 703 699 Federal net operating loss carryforward 382 323 Other 6 26 ------------------- Total assets 4,935 4,479 ------------------- LIABILITIES Depreciation (40) (40) State income tax (239) (239) Differences in basis of FHLB stock (66) (66) Basis differential on certain partnership interests (938) (834) Differences in accounting for mortgage servicing rights (162) (90) ------------------- Total liabilities (1,445) (1,269) ------------------- $ 3,490 $ 3,210 ===================
At June 30, 1999, Fidelity has federal net operating loss carryforwards for tax purposes totaling $1,121. These loss carryforwards expire in varying amounts through the year 2019. Fidelity has state net operating loss carryforwards for tax purposes of $8,270. These loss carryforwards expire in varying amounts through the year 2014. Fidelity has affordable housing credit carryforwards of $1,145. These carryforwards expire in varying amounts through the year 2019. In addition, Fidelity has an alternative minimum tax credit carryforward of $147. Retained earnings include approximately $1,870 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses, including redemption of bank stock or excess dividends, or loss of "bank" status, would create income for tax purposes only, which income would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $635. 57 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Other Comprehensive Income
TAX BEFORE-TAX (EXPENSE) NET-OF-TAX AMOUNT BENEFIT AMOUNT ------------------------------------------------- YEAR ENDED JUNE 30, 1999 Unrealized losses on securities: Unrealized holding losses arising during the year--other comprehensive income $(689) $273 $(416) ================================================= YEAR ENDED JUNE 30, 1998 Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the year $90 $(54) $36 Less: reclassification adjustment for gains (losses) realized in net income 79 (32) 47 ------------------------------------------------- Net unrealized gains (losses)--other comprehensive income $11 $(22) $(11) ================================================= YEAR ENDED JUNE 30, 1997 Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the year $193 $(59) $134 Less: reclassification adjustment for gains (losses) realized in net income 42 (17) 25 ------------------------------------------------- Net unrealized gains (losses)--other comprehensive income $151 $(42) $109 =================================================
58 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Commitments and Contingent Liabilities In the normal course of business, there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. Fidelity's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. Fidelity uses the same credit policies in making such commitments as it does for instruments that are included on the consolidated balance sheet. 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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Fidelity evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Fidelity upon extension of credit, is based on management's credit evaluation. Collateral held varies, but may include residential real estate, income-producing commercial properties, or other assets of the borrower. At June 30, 1999 and 1998, commitments to extend credit, which represent financial instruments whose contract amount represents credit risk, were $5,372 and $17,169. Fidelity has issued standby letters of credit on affordable housing developments in which one of Fidelity's subsidiaries has a partnership interest. The letters of credit secure tax exempt bond issues and other permanent financing of limited partnerships in which one of Fidelity's subsidiaries owns a one percent general partner interest. The amount outstanding on these letters of credit at June 30, 1999 and 1998 was $16,666 and $19,423. Fidelity has also issued standby letters of credit on affordable housing developments in which the borrowers are not affiliated with Fidelity. The letters of credit secure tax-exempt bond issues and other permanent financing of limited partnerships. The amount outstanding on the letters of credit at June 30, 1999 and 1998 was $28,223 and $36,031. Fidelity also has standby letters of credit to guarantee the performance of a customer to a third party. The amount outstanding on the standby letters of credit at June 30, 1999 and 1998 was $160 and $1,034. Fidelity, in its role as general partner on various affordable housing developments through its subsidiaries, is committed to advance certain amounts to limited partnerships. These commitments potentially include short-term loans to the limited partners or an increase in the general partner's equity investment. Fidelity has entered into change in control agreements with six of its employees which provide for the continuation of a multiple of the employee's existing salary and certain benefits for a two-year period of time under certain conditions following a change in control. The capital infusion discussed elsewhere in this report is not a change in control, as defined in these agreements. Fidelity and subsidiaries are also subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of Fidelity. 59 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Year 2000 Like all entities, Fidelity and subsidiaries are exposed to risks associated with the Year 2000 Issue, which affects computer software and hardware; transactions with customers, vendors, and other entities; and equipment dependent upon microchips. It is not possible for any entity to guarantee the results of its own remediation efforts or to accurately predict the impact of the Year 2000 Issue on third parties with which the Fidelity and subsidiaries does business. If remediation efforts of Fidelity or third parties with which Fidelity and subsidiaries does business are not successful, the Year 2000 Issue could have negative effects on Fidelity's financial condition and results of operations in the near term. >> Dividend and Capital Restrictions Fidelity's dividend policy is to pay cash or distribute stock dividends when its Board of Directors deems it to be appropriate, taking into account Fidelity's financial condition and results of operations, economic and market conditions, industry standards, and other factors, including regulatory capital requirements of its savings bank subsidiary. Fidelity is not subject to any regulatory restrictions on payments to its stockholders. Fidelity's primary source of income is dividends from United. United has entered into a Supervisory Agreement (Agreement) with the OTS. One of the provisions of the Agreement restricts the payments of dividends from United to Fidelity without prior written OTS approval. The OTS, in 1999, permitted the payment of dividends to assist Fidelity in meeting interest payments on its outstanding debt; however, there can be no assurance that this approval will be granted going forward. Fidelity is uncertain when it will pay dividends in the future and the amount of such dividends, if any. >> Regulatory Capital United is subject to various regulatory capital requirements administered by the federal banking agencies and is assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations: total risk adjusted capital, Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. At June 30, 1999 and 1998, United is categorized as well capitalized and met all subject capital adequacy requirements at those dates. The Supervisory Agreement Fidelity has signed with the OTS indicates that United, because of asset quality concerns, needs to increase its capital. 60 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) United's actual and required capital amounts and ratios are as follows:
REQUIRED FOR TO BE WELL ACTUAL ADEQUATE CAPITAL* CAPITALIZED* ------------------------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------------------------------------------------------------------------------- AS OF JUNE 30, 1999 Total risk-based capital* (to risk- weighted assets) $20,591 15.4% $10,718 8.00% $13,398 10.00% Core capital* (to risk-weighted assets) 14,033 10.5 5,359 4.00 8,039 6.00 Core capital* (to adjusted total assets) 14,033 8.5 6,615 4.00 8,269 5.00 AS OF JUNE 30, 1998 Total risk-based capital* (to risk- weighted assets) $19,041 10.8% $14,111 8.00% $17,639 10.00% Core capital* (to risk-weighted assets) 11,961 6.8 7,056 4.00 10,583 6.00 Core capital* (to adjusted total assets) 11,961 6.3 7,581 4.00 9,476 5.00
*As defined by regulatory agencies United's tangible capital at June 30, 1999 was $14,033 which amount was 8.5 percent of tangible assets and exceeded the required ratio of 1.5 percent. 61 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Other Restrictions United entered into a Supervisory Agreement with the OTS on February 3, 1999 which is in effect until terminated, modified or suspended by the OTS. Under the terms of the Agreement, United must develop and submit to the OTS for approval a strategic plan which includes, at a minimum, capital targets; specific strategies; the completion of quarterly projections for a three-year period; concentration limits for all assets; a plan for reducing United's concentrations of high risk assets; review of infrastructure, staffing and expertise with respect to each area of United's operations; and capital planning. The strategic plan has been submitted, and is currently under OTS review. In addition, United must, among other things, take other specified actions within specified time frames. These actions include, among others; the development of and adherence to a written plan for the reduction of classified and criticized assets to specified levels; maintenance of sufficient allowances for loan and lease losses; quarterly reporting to the OTS relating to classified assets and workout plans; restriction of its growth in total assets to an amount not in excess of an amount equal to the net interest credited on deposit liabilities without prior OTS approval; limiting growth of its consumer loan portfolio to an amount not in excess of 25 percent of its total assets; development of a written plan to divest all real estate held for development; adoption of policies and procedures designed to avoid potential conflicts of interest; development of policies and procedures to increase liquidity; adoption of a policy with respect to its mortgage brokerage activity, which would address its operation and methods for risk management; development of a policy to administer the general partnerships held by Village Housing Corporation; and maintenance of a fully staffed and functioning internal audit and independent loan review processes. United is also prohibited from taking certain actions without prior approval, including but not limited to: investing in, purchasing, or committing to make or purchase any additional commercial loans or commercial real estate loans; requesting permission from the OTS to engage in additional commercial loan activity until United has hired an experienced loan staff and credit analyst; refinancing or extending classified or criticized commercial loans without the prior approval of the OTS; engaging in "sub prime" consumer lending activities; making capital distributions, including dividends to Fidelity; making any additional equity investments; developing any real estate without specific approval of the OTS; acquiring any additional real estate for future development; selling any asset to an affiliated party without prior written approval of the OTS; engaging in any new activities not included in the to-be developed strategic plan; and, refinancing or extending any non-classified or criticized commercial loan if additional funds are extended. United is also required to obtain OTS approval prior to adding or replacing any director or senior executive officer. United is also prohibited, without prior OTS approval, from entering into any contract with any executive officer or director which would require a "golden parachute" payment and from increasing the executive benefit package in an amount in excess of the annual cost of living. United is also required to develop a plan to reduce employee turnover, build an experienced staff, and provide for management succession. Management of United has begun taking, or refraining from taking, as applicable, some of the actions requested by the OTS and at June 30, 1999, United was in compliance with the conditions of its Supervisory Agreement. 62 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Stockholders' Equity In connection with Fidelity's first debt and equity rights offering completed April 30, 1994, Fidelity reserved 415,500 shares of its common stock for issuance upon exercise of 1,500 outstanding warrants. Each warrant represents the right to purchase 277 shares of common stock. The warrants were valued at $100 per warrant, carrying an exercise price of $6.22 per share, and expire on April 30, 2004. At June 30, 1999, a total of 397,218 of the shares originally reserved had been issued and 18,282 remained reserved and unissued. In connection with Fidelity's second debt and equity offering completed on January 31, 1995, Fidelity reserved 346,500 shares of its common stock for issuance upon exercise of 1,500 outstanding warrants. Each warrant represents the right to purchase 231 shares of common stock. The warrants were valued at $100 per warrant, carrying an exercise price of $8.93 per share, and expire on January 31, 2005. At June 30, 1999, a total of 337,029 of the shares originally reserved had been issued and 9,471 remained reserved and unissued. On September 22, 1997, Fidelity filed Schedule 13E4 with the Securities and Exchange Commission for a warrant tender offer to holders of its 1994 and 1995 warrants. The offer and withdrawal rights expired on October 31, 1997. Fidelity decreased the exercise price, upon the terms and subject to the conditions set forth in the Letter of Transmittal, to $3.70 for the 1994 warrants and $4.04 for the 1995 warrants. The proceeds from the exercise of the warrants under this offer totaled $2,500. >> Benefit Plans Fidelity is a participant in the Financial Institutions Retirement Fund (FIRF). This defined-benefit plan is a multi-employer plan; separate actuarial valuations are not made with respect to each participating employer. According to FIRF administrators, the market value of the fund's assets exceeded the value of vested benefits in the aggregate as of June 30, 1998, the date of the latest actuarial valuation. The plan provides pension benefits for substantially all of Fidelity's employees. Fidelity recorded pension expense of $64 in 1997, with no expense recorded in 1998 or 1999. Fidelity has a retirement savings Section 401(k) plan in which substantially all employees may participate. Fidelity matches employees' contributions at the rate of 25% up to 6% of the participant's salary. Fidelity's expense for the plan was $17, $19 and $28 for 1999, 1998 and 1997. 63 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Related Party Transactions Fidelity has entered into transactions with certain directors, executive officers, significant stockholders and limited partnerships in which Fidelity is an investor and their affiliates and associates. Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans, as defined, to such related parties were as follows: Balances, July 1, 1998 $6,292 Changes in composition of related parties (309) New loans, including renewals 382 Payments, etc., including renewals (88) --------- Balances, June 30, 1999 $6,277 ========= Total internally classified related party loans included in the total related party loans at June 30, 1999 and 1998 were $6,200 and $6,300. Specific reserves for these classified related party loans totaled $1,500 and are included in the allowance for loan losses. >> Stock Option Plans Under Fidelity's stock option plans, Fidelity grants stock option awards which vest and become exercisable at various dates. During fiscal 1999 and 1998, Fidelity authorized the grant of options for up to 12,500 and 71,531 shares of its common stock. The exercise price of each option was greater than the market price of Fidelity's stock on the date of grant; therefore, no compensation expense was recognized. Although Fidelity has elected to follow APB No. 25, SFAS No. 123 requires proforma disclosures of net income and earnings per share as if Fidelity had accounted for its employee stock options under that Statement. The proforma effect on net income and earnings per share of the options granted in 1999 and 1998 were not materially different from those presented on the consolidated statement of income. The following is a summary of the status of the Fidelity's stock option plans and changes in the plans as of and for the years ended June 30, 1999, 1998 and 1997. DIRECTORS' PLAN In August 1993, the Board of Directors of Fidelity adopted a non-qualified stock option plan (Directors' Plan) which provides for the grant of non-qualified stock options to individuals who are directors of Fidelity, or any of its subsidiaries. The Directors' Plan provides for the grant of non-qualified stock options to acquire shares of common stock of Fidelity for the price of not less than $2 above the average of the high and low bid quotations, as reported by NASDAQ, for the common stock of Fidelity for the five trading days immediately preceding the date the option is granted. A total of 233,779 shares have been reserved for issuance under the Directors' Plan. 64 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) At June 30, 1999, there were 115,486 options available for grant. A summary of the stock options activity for the Directors' Plan is as follows: JUNE 30 1999 1998 1997 - -------------------------------------------------------------------------- Shares under option Outstanding at beginning of year 118,293 86,762 86,762 Granted 31,531 Outstanding at end of year 118,293 118,293 86,762 Exercisable at end of year 118,293 118,293 86,762 Weighted option price per share Exercisable $ 7.92 $ 7.92 $6.50 Granted 11.81 1995 KEY EMPLOYEES' STOCK OPTION PLAN The 1995 Key Employees' Stock Option Plan (1995 Plan) provides for the granting of either incentive stock options (ISOs) pursuant to Section 422A of the Internal Revenue Code of 1986, as amended (Code), or stock options which do not qualify as incentive stock options (ISOs), or any combination thereof. Options may be granted to key employees and officers of Fidelity and its subsidiaries. The option price per share for ISOs will not be less than the fair market value of a share on the date the option is granted. The option price per share for ISOs granted to an employee owning 10 percent or more of the common stock of Fidelity will be not less than 110 percent of the fair market value of a share on the date the option is granted. The option price per share for ISOs will be determined by the compensation committee, but may not be less than 100 percent of the fair market value on the date of grant. A total of 236,500 shares have been reserved for issuance under the 1995 Plan. 65 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) At June 30, 1999, there were 159,222 options available for grant. A summary of the stock options activity for the 1995 Plan is as follows: JUNE 30 1999 1998 1997 - -------------------------------------------------------------------------- Shares under option Outstanding at beginning of year 64,220 80,443 80,850 Granted 23,058 40,000 Exercised (407) Forfeited/expired (10,000) (56,223) Outstanding at end of year 77,278 64,220 80,443 Exercisable at end of year 47,020 36,176 48,183 Weighted option price per share Exercisable $10.26 $10.68 $10.52 Exercised 9.63 Granted 3.22 10.81 >> Earnings Per Share Earnings per share were computed as follows:
1999 1998 1997 ------------------------------------------------------------------------------------------------ WEIGHTED PER- Weighted Per- Weighted Per- AVERAGE SHARE Income Average Share Average Share YEAR ENDED JUNE 30 INCOME SHARES AMOUNT (loss) Shares Amount Income Shares Amount - ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) $625 $(6,794) $113 ------------ ----------- ----------- Basic Earnings (Loss) Per Share Income available to common stockholders 625 3,143,179 $.20 (6,794) 2,956,157 $(2.30) 113 2,491,074 $.05 Effect of Dilutive Securities Options 26,869 Warrants 137,238 ------------------------------------------------------------------------------------------------ Diluted Earnings (Loss) Per Share Income available to common stockholders and assumed conversions $625 3,143,179 $.20 $(6,794) 2,956,157 $(2.30) $113 2,655,181 $.04 ================================================================================================
66 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) Options to purchase 152,694, 55,714 and 55,113 shares of common stock at an average price of $8.33 for 1999, $11.81 and $10.81 for 1998 and $10.42 for 1997 were outstanding at June 30, 1999, 1998 and 1997 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. For the years ended June 30, 1999 and 1998, the effect of outstanding options and warrants were anti-dilutive. >> Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument: CASH AND CASH EQUIVALENTS--The fair value of cash and cash equivalents approximates carrying value. INTEREST-BEARING DEPOSITS--The fair value of interest-bearing time deposits approximates carrying value. INVESTMENT SECURITIES--Fair values are based on quoted market prices. LOANS--For both short-term loans and variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans, including one-to-four family residential, are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. INTEREST RECEIVABLE/PAYABLE--The fair values of interest receivable/payable approximate carrying values. FHLB STOCK--The fair value is estimated to be the carrying value, which is par. All transactions in the capital stock of the FHLB of Indianapolis are executed at par. DEPOSITS--The fair values of non-interest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate 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 expected monthly maturities on such time deposits. SHORT-TERM BORROWINGS--The fair value of these borrowings is estimated using rates currently available to Fidelity for debt with similar terms and remaining maturities. These instruments adjust on a periodic basis and the carrying amount represents the fair value. 67 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) LONG-TERM DEBT--The fair value of these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt. Long-term debt consists of adjustable instruments tied to a variable market interest rate. OFF-BALANCE-SHEET COMMITMENTS--Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature. The fair value of the loan commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The carrying amounts of the commitments to purchase and originate mortgage loans and to sell mortgage loans, which are immaterial, are reasonable estimates of the fair value of these financial instruments. The carrying amount of the standby letters of credit, which consist of a letter of credit valuation allowance of $5,168, is a reasonable estimate of the fair value of those off-balance sheet items. The estimated fair values of Fidelity's financial instruments are as follows:
1999 1998 ----------------------------------------------------------------------- CARRYING FAIR Carrying Fair JUNE 30 AMOUNT VALUE Amount Value - ---------------------------------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 16,267 $ 16,267 $ 7,949 $ 7,949 Investment securities available for sale 27,325 27,325 9,854 9,854 Loans, net 110,436 110,594 156,683 155,108 Interest receivable 887 887 1,129 1,129 FHLB stock 3,920 3,920 3,920 3,920 Liabilities Deposits 128,596 128,856 148,939 149,135 Short-term borrowings 128 128 2,531 2,531 Long-term debt 29,149 28,896 29,488 29,542 Interest payable 272 272 421 421 Standby letters of credit 5,168 5,168 6,778 6,778
68 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Condensed Financial Information (Parent Company Only) Presented below is condensed financial information as to financial position, results of operations and cash flows of Fidelity: CONDENSED BALANCE SHEET JUNE 30 1999 1998 - ---------------------------------------------------------------------- ASSETS Cash and cash equivalents $ 2,220 $ 242 Interest-bearing deposits 6 Investment in common stock of subsidiaries 14,848 13,192 Loans 3,808 4,072 Subordinated debentures and other loan receivables from subsidiaries 4,875 6,063 Income tax receivable 1,744 2,147 Other assets 585 577 ------------------- Total assets $28,080 $26,299 =================== LIABILITIES Long-term debt $17,144 $15,195 Letter of credit valuation allowance 2,855 3,289 Other liabilities 267 300 ------------------- Total liabilities 20,266 18,784 STOCKHOLDERS' EQUITY 7,814 7,515 ------------------- Total liabilities and stockholders' equity $28,080 $26,299 =================== 69 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) CONDENSED STATEMENT OF INCOME
YEAR ENDED JUNE 30 1999 1998 1997 - ----------------------------------------------------------------------------------------- INCOME Dividends from subsidiaries $ 150 $ 875 $ 2,500 Interest income 1,010 1,089 1,092 Other income 8 10 148 ------------------------------- Total income 1,168 1,974 3,740 ------------------------------- EXPENSE Interest expense 1,400 1,402 1,397 Provision for loan losses 424 1,092 75 Letter of credit valuation provision (434) 3,289 Other expenses 461 555 619 ------------------------------- Total expense 1,851 6,338 2,091 ------------------------------- INCOME (LOSS) BEFORE INCOME TAX AND EQUITY IN UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF) INCOME OF SUBSIDIARIES (683) (4,364) 1,649 INCOME TAX BENEFIT (330) (2,075) (337) ------------------------------- INCOME (LOSS) BEFORE EQUITY IN UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF) INCOME OF SUBSIDIARIES (353) (2,289) 1,986 EQUITY IN UNDISTRIBUTED (DISTRIBUTIONS IN EXCESS OF) INCOME OF SUBSIDIARIES 978 (4,505) (1,873) ------------------------------- NET INCOME (LOSS) $ 625 $(6,794) $ 113 ===============================
70 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) CONDENSED STATEMENT OF CASH FLOWS
YEAR ENDED JUNE 30 1999 1998 1997 - ------------------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income (loss) $ 625 $(6,794) $ 113 Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities Depreciation and amortization 24 40 37 Provision for loan losses 424 1,092 75 Letter of credit valuation provision (434) 3,289 Undistributed net income of subsidiaries (978) 4,505 1,873 (Increase) decrease in other assets 371 (1,611) (491) (Increase) decrease in other liabilities 123 (1,045) 128 ------------------------------ Net cash provided (used) by operating activities 155 (524) 1,735 ------------------------------ INVESTING ACTIVITIES Decrease in interest-bearing deposits in other banks 6 1 Capital contributions to subsidiaries (1,094) (1,400) (80) Advance on note to subsidiary (250) Principal payments received on notes from subsidiaries 1,188 120 Net change in loans (160) 1,084 58 ------------------------------ Net cash provided (used) by investing activities (60) (566) 99 ------------------------------ FINANCING ACTIVITIES Payment of long-term debt (51) (52) (70) Proceeds from issuance of long-term debt 2,000 Proceeds from exercise of stock options 4 Proceeds from exercise of stock warrants 2,492 35 Cash dividends (156) (1,186) (1,745) Purchase of treasury stock (14) (126) Sale of common stock 90 ------------------------------ Net cash provided (used) by financing activities 1,883 1,240 (1,902) ------------------------------ CHANGE IN CASH AND CASH EQUIVALENTS 1,978 150 (68) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 242 92 160 ------------------------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 2,220 $ 242 $ 92 ==============================
71 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Business Segment Information Fidelity operates principally in two industries, banking and real estate development and management. Through United Fidelity, Fidelity offers traditional banking products, such as checking, savings and certificates of deposit, as well as mortgage, commercial and consumer loans. Through the Affordable Housing Group, Fidelity is or was involved in various aspects of developing, building, renting and managing affordable housing units. Banking revenue consists primarily of interest and fee income, while real estate development and management fee income consists primarily of real estate management, investment banking, development and other fees. All revenue is earned in the United States. Operating profit is total revenue less operating expenses. In computing operating profit, income taxes have been deducted. Identified assets are principally those used in each segment and are all held in the United States. Real estate development and management activities conducted by Fidelity are not asset intensive. 72 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) Presented below is condensed financial information relating to Fidelity's business segments:
1999 -------------------------------------------------------------------------- REAL ESTATE DEVELOPMENT BANKING & MANAGEMENT ELIMINATIONS TOTAL - ---------------------------------------------------------------------------------------------------------------------------- Interest income $ 14,175 $ 197 $ (278) $ 14,094 Other income 2,368 335 (40) 2,663 Interest expense 9,730 278 (278) 9,730 Other expense 5,916 1,002 (40) 6,878 Provision for loan losses (454) 316 (138) Income (loss) before tax 1,351 (1,064) 287 Income tax expense (benefit) 112 (450) (338) Total assets 172,864 2,975 (3,586) 172,253 Capital expenditures 263 4 267 Depreciation and amortization 390 12 402 1998 -------------------------------------------------------------------------- Real Estate Development Banking & Management Eliminations Total - ---------------------------------------------------------------------------------------------------------------------------- Interest income $ 17,332 $ 444 $ (584) $ 17,192 Other income 2,695 330 3,025 Interest expense 11,586 584 (584) 11,586 Other expense 13,660 2,416 16,076 Provision for loan losses 2,152 2,391 4,543 Income (loss) before tax (7,371) (4,617) (11,988) Income tax expense (benefit) (3,268) (1,926) (5,194) Total assets 200,082 9,720 (12,756) 197,046 Capital expenditures 103 8 111 Depreciation and amortization 430 19 449 1997 -------------------------------------------------------------------------- Real Estate Development Banking & Management Eliminations Total - ---------------------------------------------------------------------------------------------------------------------------- Interest income $ 20,276 $ 347 $ (341) $ 20,282 Other income 3,055 835 (34) 3,856 Interest expense 13,831 341 (341) 13,831 Other expense 7,711 1,797 (34) 9,474 Provision for loan losses 800 175 975 Income (loss) before tax 989 (1,131) (142) Income tax expense (benefit) 308 (563) (255) Total assets 241,054 11,819 (12,054) 240,819 Capital expenditures 1,106 127 1,233 Depreciation and amortization 354 70 424
73 FIDELITY FEDERAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands, Except Share Data) >> Capital Infusion On July 16, 1999, Fidelity signed a letter of intent with Lincolnshire Management, Inc. (Lincolnshire), whereby Lincolnshire would pay $4.40 per share for newly issued shares of Fidelity's outstanding common stock. The letter indicates that this common stock, when issued, will represent 51 percent of the fully diluted common stock of Fidelity. The total purchase price for these shares is expected to approximate $14,500. This transaction is subject to the execution and delivery of a definitive stock purchase agreement between Fidelity and Lincolnshire. This agreement is expected to contain several terms and conditions of the transaction, including a condition that the OTS agrees to eliminate the Supervisory Agreement. The potential elimination of the supervisory agreement will likely be accompanied by certain terms and restrictions on United's business and operations once the proceeds from the purchase of the stock are invested in United. The management of Fidelity believes that it is likely that this transaction will occur. (This space intentionally left blank) 74 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES No response to this item is required. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information to be provided under this Item is incorporated by reference to the information under the heading "Information Concerning Nominees, Directors and Executive Officers" on pages 5 and 6 and "Section 16(a) Beneficial Ownership Reporting Compliance" on page 16 of Fidelity's definitive proxy statement to be mailed and delivered to the stockholders of Fidelity in connection with the Annual Meeting of Shareholders to be held on November 17, 1999, as filed with the Securities and Exchange Commission pursuant to Regulation 14A. ITEM 11. EXECUTIVE COMPENSATION The information to be provided under this Item is incorporated by reference to the information under the heading "Executive Compensation and Other Information" on pages 8 through 14 of Fidelity's definitive proxy statement to be mailed and delivered to the stockholders of Fidelity in connection with the Annual Meeting of Shareholders to be held on November 17, 1999, as filed with the Securities and Exchange Commission pursuant to Regulation 14A. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information to be provided under this Item is incorporated by reference to the information under the caption "Beneficial Ownership" on pages 3 and 4 (up to but exclusive of the information presented under the caption "Proxies" on page 4), under the caption "Security Ownership of Management" on pages 15 and 16 (up to but exclusive of the information presented under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" on page 16), and under the heading "Possible Change in Control" on page 17 (up to but exclusive of the information presented under the caption "Shareholders Proposals" on page 17) of Fidelity's definitive proxy statement to be mailed and delivered to the stockholders of Fidelity in connection with the Annual Meeting of Shareholders to be held on November 17, 1999, as filed with the Securities and Exchange Commission pursuant to Regulation 14A. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information to be provided under this Item is incorporated by reference to the information under the caption "Certain Transactions and Other Matters Between Management and Fidelity" on page 7 (up to but exclusive of the information presented under the caption "Board Meetings" and "Board Committees") of Fidelity's definitive proxy statement to be mailed and delivered to the stockholders of Fidelity in connection with the Annual Meeting of Shareholders to be held on November 17, 1999, as filed with the Securities and Exchange Commission pursuant to Regulation 14A. 75 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) The following consolidated financial statements are included in Item 8: Page Number in 10-K Independent Auditor's Report on Consolidated Financial Statements 40 Consolidated Balance Sheet June 30, 1999 and 1998 41 Consolidated Statement of Income- For the years ended June 30, 1999, 1998, and 1997 42 and 43 Consolidated Statement of Changes in Stockholders' Equity - For the years ended June 30, 1999, 1998, and 1997 44 Consolidated Statement of Cash Flows - For the years ended June 30, 1999, 1998, and 1997 45 and 46 Notes to consolidated Financial Statements 47 through 74 (2) See response to Item 14 (a) (1). All other financial statement schedules have been omitted because they are not applicable, or the required information is shown in the consolidated financial statements or notes thereto. (3) List of Exhibits Exhibit Number Description -------------- ----------- 3 (a) Articles of Incorporation of Fidelity, filed as exhibit 3(a) to Fidelity's 1995 Annual Report on Form 10-K, are incorporated herein by reference. 3 (b) By-Laws of Fidelity, filed as exhibit 3(b) to Fidelity's 1994 Annual Report on Form 10-K, are incorporated herein by reference. 10 (a) The 1993 Director's Stock Option Plan, filed as exhibit 10(d) to Fidelity's 1995 Annual Report on Form 10-K, is incorporated herein by reference. (b) The 1995 Key Employee's Stock Option Plan, filed as exhibit 10(c) to Fidelity's 1996 Annual Report on Form 10-K, is incorporated herein by reference. (c) Severance Agreement between Fidelity and M. Brian Davis, filed as exhibit 10(c) to Fidelity's 1998 Annual Report on Form 10-K, is incorporated herein by reference. (d) Severance Agreement between Fidelity and Donald R. Neel, filed as exhibit 10(d) to Fidelity's 1998 Annual Report on Form 10-K, is incorporated herein by reference. (e) Severance Agreement between Fidelity and Terry G. Johnston, filed as exhibit 10(e) to Fidelity's 1998 Annual Report on Form 10-K, is incorporated herein by reference. 11 Statement regarding computation of per share earnings 21 Subsidiaries of Fidelity Federal Bancorp. 27 Financial Data Schedule. (b) No Form 8-K was filed during the last quarter of the fiscal year, (c) See the list of exhibits in Item 14 (a) (3). (d) No other financial statement schedules are required to be submitted. 76 SIGNATURES Pursuant to the requirements of Section 13 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 on the 27th day of September, 1999. FIDELITY FEDERAL BANCORP Registrant By /S/ M. BRIAN DAVIS ----------------------- M. Brian Davis President and Chief Executive Officer (Principal Executive Officer) By /S/ DONALD R. NEEL ----------------------- Donald R. Neel, Executive Vice President, Treasurer and Chief Financial Officer (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on September 27, 1999, by the following persons on behalf of the registrant and in the capacities indicated. By /S/ JACK CUNNINGHAM -------------------------------------- Jack Cunningham, Chairman By /S/ M. BRIAN DAVIS -------------------------------------- M. Brian Davis President, Chief Executive Officer and Director By: /S/ CURT J. ANGERMEIER -------------------------------------- Curt J. Angermeier, Director By /S/ WILLIAM R. BAUGH -------------------------------------- William R. Baugh, Director By /S/ BRUCE A. CORDINGLEY -------------------------------------- Bruce A. Cordingley By /S/ ROBERT F. DOERTER -------------------------------------- Robert F. Doerter, Director By /S/ DONALD R. NEEL -------------------------------------- Donald R. Neel, Director By /S/ BARRY A. SCHNAKENBURG -------------------------------------- Barry A. Schnakenburg, Director 77 INDEX TO EXHIBITS - ----------------- Page Exhibit Number Exhibit - ------------------------------------------------------------------------------- 66 11 Statement regarding computation of per share earnings. See (Earnings per Share) of this document. 79 21 Subsidiaries of Fidelity Federal Bancorp. 80 27 Financial Data Schedule. 78 EX-21 2 EXHIBIT 21 SUBSIDIARIES OF FIDELITY FEDERAL BANCORP JURISDICTION OF NAME INCORPORATION - ---- --------------- Fidelity Federal Bancorp: United Fidelity Bank, fsb Indiana Village Affordable Housing Corporation Indiana Also included are the subsidiaries of United Fidelity Bank, fsb: Village Insurance Corporation Indiana Village Housing Corporation Indiana Village Management Corporation Indiana Village Capital Corporation Indiana EX-27 3
9 1,000 12-MOS JUN-30-1999 JUL-01-1998 JUN-30-1999 1599 14668 0 0 27325 0 0 113957 3521 172253 128596 128 6566 29149 0 0 3147 4667 172253 11861 955 1278 14094 7467 2263 4364 (138) 0 6878 287 287 0 0 625 0.2 0.2 2.48 4188 796 77 0 3049 338 53 3521 3521 0 500
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