-----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, BgHHr3f2s/TWpCMevRh1ERFREkUeLp/hdjgi0lhqr039IQDei1jw95gj20B7s1hL cKsztA4WReLxqh9vtJkBeA== 0000916527-98-000006.txt : 19980709 0000916527-98-000006.hdr.sgml : 19980709 ACCESSION NUMBER: 0000916527-98-000006 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980616 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTHWEST EQUITY CORP CENTRAL INDEX KEY: 0000916527 STANDARD INDUSTRIAL CLASSIFICATION: 6036 IRS NUMBER: 391772981 STATE OF INCORPORATION: WI FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 000-24606 FILM NUMBER: 98648928 BUSINESS ADDRESS: STREET 1: 234 KELLER AVE SOUTH CITY: AMERY STATE: WI ZIP: 54001 BUSINESS PHONE: 7152687105 MAIL ADDRESS: STREET 1: 234 S KELLER AVE STREET 2: PO BOX 46 CITY: AMERY STATE: WI ZIP: 54001 10KSB 1 ANNUAL REPORT FOR NORTHWEST EQUITY CORP. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-KSB ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 1998 Commission file number 0-24606 NORTHWEST EQUITY CORP. (Exact name of small business issuer as specified in its charter) Wisconsin 39-1772981 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 234 Keller Avenue South Amery, Wisconsin 54001 (Address of principal executive offices) (Zip code) (715) 268-7105 (Registrant's telephone number, including area code) Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such report(s) and (2) has been subject to such filing requirements for the past 90 days. (1) Yes __x__ No_____ (2) Yes __x__ No_____ Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. x State issuer's revenues for its most recent fiscal year: $8,371,000 (Total interest and dividend income and total non-interest income). As of May 31, 1998 there were issued and outstanding 825,301 shares of Common Stock of the Registrant. The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the average of the bid and asked price of such shares of Common Stock as of May 31, 1998, was $13.0 million. Solely for purposes of this calculation, all executive officers and directors of the Registrant are considered to be affiliates; also included as "affiliate shares" are certain shares held by various employee benefit plans in which the trustee are directors of the Registrant or are required to vote a portion of unallocated shares at the direction of executive officers or directors of the Registrant. The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant that such person is an affiliate of the Registrant. DOCUMENTS INCORPORATED BY REFERENCE Parts II and IV of Form 10-KSB: Portions of the Annual Report to Shareholders for the fiscal year ended March 31, 1998 are incorporated by reference into Parts II and IV hereof. Part III of Form 10-KSB: Portions of the Proxy Statement for the 1998 Annual Meeting of Shareholders are incorporated by reference into Part III hereof. 1 PART I ITEM 1. DESCRIPTION OF BUSINESS General Northwest Equity Corp., a Wisconsin corporation (the "Company" or the "Registrant"), is the holding company for Northwest Savings Bank, a Wisconsin chartered stock savings bank (the "Bank"). The Bank is regulated by the Wisconsin Department of Financial Institutions (the "DFI") and the Federal Deposit Insurance Corporation (the "FDIC"). The Company and the Bank are subject to extensive regulation, supervision and examination by the Wisconsin Department of Financial Institutions (the "DFI") and the Federal Deposit Insurance Corporation (the "FDIC"). The Bank was organized in 1936, and has three full service offices located in Polk, St. Croix and Burnett Counties, Wisconsin. Because the Company's only significant business operations are that of the Bank, the business of the Bank is essentially the only business of the Company. The Bank is a community-oriented, full-service financial institution offering a variety of retail financial services to meet the needs of the communities it serves. The Company's principal business consists of attracting funds in the form of deposits and other borrowings and investing such funds, primarily in residential real estate loans, mortgage-backed and related securities, and various types of commercial and consumer loans. At March 31, 1998, the Company had total assets of $98.7 million, total deposits of $62.3 million, and shareholders' equity of $11.5 million. The Bank is a member of the FHLB-Chicago, which is one of the twelve regional banks that comprise the FHLB system. The Company's executive office is headquartered at 234 South Keller Avenue, Amery, Wisconsin 54001. Its telephone number at that address is 715-268-7105. Its E-mail address is (nwsbank@win.bright.net). The Company's primary sources of funds are deposits, repayments on loans and mortgage-backed and related securities and, to a lesser extent, advances from the FHLB-Chicago. The Company's deposits totaled $62.3 million at March 31, 1998, of which 35.1% were core deposits, consisting of NOW, passbook and money market deposit accounts. The Company utilized these funds to invest primarily in one-to-four family residential loans and, to a lesser extent, consumer, commercial and other loans, and to invest in mortgage-backed and related securities and other investment securities. At March 31, 1998, the Company's gross loan portfolio totaled $78.9 million, that consisted of $58.1 million of one-to-four family loans, $8.6 million of other real estate loans, $4.4 million of commercial loans, and $7.8 million of consumer loans. At March 31, 1998, the Company's gross loans included $61.4 million of ARM loans. The Company's strategic business plan provides for investments in mortgage-backed and related securities in addition to its investments in United States Treasury and agency securities. Management believes this investment portfolio provides numerous benefits, including the ability to provide and maintain adequate regulatory liquidity levels, maintain a balance of high quality, diversified investments, and better manage the interest rate risk of the Company. At March 31, 1998, the Company's mortgage-backed and related securities held for investment and FHLB-Chicago stock totaled $7.6 million consisting of $6.4 million or 6.5% of total assets in mortgage-backed and related securities held for investment and $1.2 million or 1.21% of total assets in FHLB-Chicago stock. Market Area and Competition The Company offers a variety of deposit products, services and mortgage loans primarily in northwestern Wisconsin. The Company's main office is located at 234 South Keller Avenue, Amery, Wisconsin. The City of Amery is located approximately 40 miles northeast of Minneapolis and St. Paul, Minnesota. The Company, in addition to its Amery office, has two full-service branches. One is located in New Richmond and the other in Siren, Wisconsin. Both are located near Amery and together account for approximately $21.7 million or 34.8% of the Company's total deposits at March 31, 1998. All of the Company's locations are in counties generally characterized as rural with a total population of approximately 100,000. 2 The Company has significant competition in both its mortgage and consumer lending business, as well as in attracting deposits. The Company's primary competition for loans are principally from other savings banks, thrift institutions, mortgage banking companies, insurance companies and commercial banks. Its most direct competition for deposits historically has come from other savings banks, thrift institutions, commercial banks, and credit unions. The Company has faced additional competition for funds from a number of institutions, including the availability of short-term money market funds and other corporate and government securities funds offered by other financial service companies, such as brokerage firms and insurance companies. - - -Recapitalizaiton of SAIF The Savings Association Insurance Fund ("SAIF") of the FDIC was recapitalized during 1996 by a one-time special assessment imposed on all SAIF members. The $350,000 assessment paid by the Bank had a significant impact on the fiscal year ended March 31, 1997, financial results. However, the effect of the recapitalization is a significant reduction in federal deposit insurance premiums for SAIF-insured institutions on an ongoing basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Lending Activities General The largest component of the Company's gross loan receivable of $78.9million at March 31, 1998, was first mortgage loans secured by owner-occupied one-to-four family residences and totaled $58.0 million at March 31, 1998, or 73.6% of gross loans. Other real estate loans were $8.6 million or 10.9% of gross loans at March 31, 1998. Of gross loans, $61.4 million or 77.9% were ARM loans. As part of its strategy to manage interest rate risk, the Company originates primarily ARM loans that have short and intermediate-term maturities for its own loan portfolio. The Company also offers longer-term fixed rate loans, most of which are sold immediately to secondary market investors. In general, the Company's total loan portfolio has increased in recent years due to its ability to originate ARM loans that it retains in its loan portfolio. 3 Composition of Loan Portfolio The following table sets forth the composition of the Company's loan portfolio, including loans held for sale, in dollar amounts and in percentages of the gross loan portfolio at the dates indicated. At March 31, ----------------------------------------------------------------------------------------- 1998 1997 1996
Amount Percent Amount Percent Amount Percent (Dollars in thousands) Real estate loans: One-to-four family $ 58,120 73.64% $ 55,581 71.14% $ 48,360 68.00% Multi-family 536 0.67% 931 1.19% 1,266 1.78% Commercial 5,261 6.67% 6,443 8.25% 6,813 9.58% Construction and land 2,785 3.53% 3,299 4.22% 3,165 4.45% ---------- --------- --------- -------- ---------- --------- Total real estate loans 66,702 84.51% 66,254 84.80% 59,604 83.81% ---------- --------- --------- -------- ---------- --------- Consumer loans: Home equity - - - - 7 0.01% Automobile 5,706 7.23% 4,856 6.22% 4,832 6.79% Credit card 312 0.40% 304 0.39% 241 0.34% Other consumer loans 1,809 2.29% 2,047 2.62% 1,817 2.56% ---------- -------- -------- -------- --------- --------- Total consumer loans 7,827 9.92% 7,207 9.23% 6,897 9.70% ---------- -------- -------- -------- --------- --------- Commercial loans 4,397 5.57% 4,663 5.97% 4,612 6.49% ---------- -------- -------- -------- --------- --------- Gross loans receivable 78,926 100.00% 78,124 100.00% 71,113 100.00% -------- -------- --------- -------- -------- --------- Add: Accrued interest, net 492 448 506 Less: Loans in process - - - Deferred fees and discounts - - - Allowance for uncollected interest (3) (8) - Allowance for loan losses (484) (461) (433) --------- --------- --------- Total additions/deductions 5 (21) 73 --------- --------- --------- Loans receivable, net $ 78,931 $ 78,103 $ 71,186 ---------- --------- --------- ---------- --------- ---------
4 Loan Maturity The following table shows the contractual maturity of the Company's loan and mortgage-backed and related securities portfolio at March 31, 1998. Loans that have adjustable rates are shown as being due in the period during which the underlying contracts mature. Demand loans that have no schedule for repayment and no stated maturity are reported as due in one year or less. The table does not include estimated prepayments or scheduled principal amortization. At March 31, 1998 -------------------------------------------------------------------------------------------------
Total Mortgage- One-to- Commercial Construction Backed and Four Multi- Real and Related Family Family Estate Land Commercial Consumer Securities Total Amounts due : Within one year $989 $ - $191 $1,662 $2,938 $1,052 $ - $6,832 After one year: One to three years 1,975 - 469 36 1,004 2,743 - 6,227 Three to five years 3,045 - 16 92 293 3,655 - 7,101 Five to ten years 4,474 64 1,973 255 162 208 - 7,136 Ten to twenty years 11,947 - 1,235 887 - 140 1,029 15,238 Over twenty years 34,760 472 1,377 783 - 29 5,369 42,790 -------- ----- ------- ------- ------- ------- ------- ------- Total due after one year 56,201 536 5,070 2,053 1,459 6,775 6,398 78,492 ======== ===== ======= ======= ======= ======= ======= ======= Total amounts due 57,190 536 5,261 3,715 4,397 7,827 6,398 85,324 ======== ===== ======= ======= ======= ======= ======= ======= Less: Allowance for loan losses (50) (1) (5) (2) (346) (80) - - (484) Loans receivable and mortgage- backed securities, net $57,140 $535 $5,256 $3,713 $4,051 $7,747 $6,398 $84,840 ======== ===== ======= ======= ======= ======= ======= =======
5 The following table sets forth at March 31, 1998 the dollar amount of all loans and mortgage-backed and related securities due after March 31, 1999, such loans and whether such loans have fixed interest rates or adjustable interest rates. ----------------------------------------- Due After March 31, 1999 ----------------------------------------- ----------------------------------------- Fixed Adjustable Total ----------------------------------------- (In thousands) Mortgage loans: One-to-four family $ 7,202 $ 48,999 $ 56,201 Multi-family - 536 536 Commercial 904 4,166 5,070 Construction and land 46 2,007 2,053 Total mortgage loans 8,152 55,708 63,860 Consumer loans 6,498 277 6,775 Comercial loans 590 869 1,459 Gross loans receivable 15,240 56,854 72,094 Mortgage-backed securities 5,833 565 6,398 Gross loans receivable and mortgage- backed and related securities $ 21,073 $ 57,419 $ 78,492 6 One-to-Four Family Mortgage Lending The Company's primary lending activity is the origination of first mortgage loans secured by one-to-four family, owner-occupied residences within the Company's primary lending area. The Company sells substantially all of its fixed rate mortgage loans it originates to government secondary market investors. Generally, loans sold to government secondary market investors are sold as whole loans with servicing retained. Substantially all of the ARM loans originated by the Company are retained in its loan portfolio. The Company follows Federal Home Loan Mortgage Corporation ("FHLMC") underwriting guidelines for its one-to-four family mortgage loans and rarely originates loans in excess of the FHLMC limit of $227,150. The Company offers a variety of rates, fees, origination terms and mortgage products. Mortgage loan originations are solicited from real estate brokers, builders, existing customers, community groups and residents of local communities located in the Company's primary market area through its loan origination staff. The Company also advertises its products through local newspapers, periodicals and radio. Upon receipt of a completed mortgage application from a prospective borrower, a credit report is ordered, an appraisal from an independent third party is obtained, income and other deposit information are verified, and, as necessary, additional financial information is requested. The Company requires title insurance or evidence of marketable title and lien position (consisting of an abstract and legal opinion) on all first mortgage loans. Borrowers must present evidence of appropriate hazard insurance and flood insurance (if applicable) prior to the closing. On loans with high loan to value ratios, borrowers are required to advance funds on a monthly basis, together with payments of principal and interest, to a mortgage escrow account from which the Company makes disbursements for items such as real estate taxes, hazard insurance, and in some cases, flood insurance. On those loans with no escrow requirement, the Company verifies payment of real estate taxes on a semi-annual basis and requires evidence from the borrower annually of hazard insurance and flood insurance. The lending policy of the Company restricts mortgage loan amounts to 80% of the lesser of the appraised value or purchase price of the real estate to be mortgaged to the Company. The Company makes mortgage loans in amounts up to 95% of the lesser of the appraised value or purchase price, subject to availability of private mortgage insurance insuring the amount in excess of 80% of the appraised value or purchase price. Exceptions to this policy are ARM loans, in which case the Company loans up to 90% of the appraised value or purchase price with the appropriate private mortgage insurance, and loans to its most credit worthy customers, in which case the Company loans up to 90% of the appraised value without private mortgage insurance. The Company also currently offers a program for low to moderate income families to lend up to 90% of the appraised value of the property without private mortgage insurance, provided certain credit, property and cost criteria are met. The Company's underwriting department reviews all the pertinent information and makes a credit decision for approval or denial within established Company policy guidelines. Recommendations to deny applications based on underwriting considerations are reviewed by the Company's senior underwriter prior to a final disposition of the loan application. Summaries of all one-to-four family mortgage loan applications are reviewed on a monthly basis by the Board of Directors and the Loan Committee. Mortgage loans held in the Company's loan portfolio generally include due-on-sale clauses, which provide the Company with the contractual right to deem the loan immediately due and payable in the event the borrower transfers the ownership of the property without the Company's prior consent. The Company enforces the due-on-sale clauses of its mortgage loans. The Company makes loans under various governmental programs including the Wisconsin Housing and Economic Development Authority ("WHEDA"), the Federal Housing Administration, the Farmers Home Administration ("FHA") and the Federal Veterans Administration ("VA"). These programs generally have lower down payment and less restrictive qualification ratios. The WHEDA loans are serviced through WHEDA and originated for them, and the Federal Housing Administration, FHA and VA loans are sold in the secondary market with servicing retained. The Company offers one, three and five-year ARM loans. ARM loans currently adjust a maximum of two percentage points per year with a lifetime interest cap of six percentage points above the initial interest rate. Monthly payments of principal and interest are adjusted when the interest rate adjusts to maintain full amortization of the mortgage loan within the remaining term. The initial rates offered on ARM loans fluctuate with general interest rate changes and are determined by competitive conditions and the Company's yield requirements. The Company currently uses the one-year, three-year or five-year as applicable, Constant Maturity United States Treasury index to determine the interest rate payable upon the adjustment date of outstanding ARM loans. The Company also 7 originates ARM loans with initial interest rates below the fully indexed rate by permitting the borrower to choose the number of percentage points the initial interest rate is below the fully indexed rate (up to two points) and pay origination points in a corresponding amount. Borrowers choosing these ARM loans can effectively lower the lifetime interest rate cap by decreasing the initial interest rate. ARM loans generally pose different risks than fixed rate loans. In a rising interest rate environment, the underlying ARM loan payment rises, increasing the potential for default, and the marketability of the underlying property may be adversely affected. In a decreasing interest rate environment, mortgagors tend to refinance to fixed rate loans. The Company's delinquency experience on its ARM loans generally has been satisfactory to date. The Company has continued to generate a significant amount of adjustable rate loans. Adjustable rate loans originated amounted to 35.6%, 44.7% and 52.8% of the Company's total loans originated for the fiscal years ended March 31, 1998, 1997, and 1996, respectively. The Company's continued ability to originate ARM loans is primarily due to the nature of its market area, which includes rural and vacation properties. Loans on properties with excessive acreage, hobby farm activities or three-season cabins generally cannot be sold into the secondary market, thus making these loans less attractive to competitors of the Company that only originate loans for sale into the secondary market. Furthermore, many of the Company's customers desiring a loan term of short-to-medium-duration (i.e., less than ten years) often prefer ARM loans because of the generally lower closing costs compared to fixed rate loans. The Company generally obtains an abstract and title opinion, rather than title insurance, on loans originated for retention in its portfolio and has not experienced losses attributable to the lack of title insurance. Commercial Real Estate Lending At March 31, 1998, the Company's commercial real estate loan portfolio totaled $5.3 million or 6.67% of gross loans compared to $6.4 million or 8.3% of gross loans at March 31, 1997. The decrease reflects that principal repayments of $1.3 million exceeded commercial real estate loans originated of $0.2 million for the fiscal year ended March 31, 1998. The commercial real estate loans in the Company's portfolio consist of fixed rate and ARM loans generally secured by small office buildings, retail stores and farms, and occupied by the borrower. The Company currently originates ARM loans secured by commercial real estate at 375 to 525 basis points above the rate on U.S. Treasury securities for comparable maturities. These loans typically do not exceed 65% of the lesser of the purchase price or the appraised value of the underlying collateral. At March 31, 1998, the largest outstanding commercial real estate loan was $.8 million. In underwriting commercial real estate loans, the Company's underwriting procedures require verification of the borrower's credit history, an analysis of the borrower's income taxes, personal financial statements and banking relationships, a review of the borrower's property management experience, and a review of the property, including cash flow projections, historical operating statements, environmental concerns, compliance with regulations and prevailing market conditions. Loans secured by commercial real estate properties involve a greater degree of risk than residential mortgage loans. Payments on loans secured by commercial real estate properties are often susceptible to adverse conditions in the real estate market or the economy. The Company seeks to minimize these risks by originating commercial real estate loans principally in its primary market area where it has the ability to more closely monitor and anticipate adverse conditions. Commercial Lending The Company engages in a limited amount of commercial business lending activities, generally with existing customers, including secured and unsecured loans and letters of credit. Commercial loans may not exceed 10% of total assets and involve many different industries. At March 31, 1998, the Company had $4.4 million in commercial business loans outstanding, which represented 5.6% of gross loans. Term loans are amortized over a one to five year term and lines of credit are reviewed annually. Such loans generally are originated at 375 to 525 basis points above the rate on U.S. Treasury securities for comparable maturities. At March 31, 1998, the largest outstanding commercial loan was $0.6 million. The Company originated a majority of the commercial loans held in its loan portfolio in the mid-1980's when it hired a commercial loan officer to expand its activity in this area. During the last three fiscal years, the Company charged off approximately $19,000 of such loans. The Company currently is not actively seeking new commercial lending business and substantially all of its commercial lending consists of renewals of existing commercial loans. With the exception of the commercial loan discussed under Asset Quality in the Annual Report attached to this 8 document, the remaining commercial loans in the portfolio are generally performing and, management believes, adequately reserved. Unlike residential mortgage loans which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent upon the general economic environment. The Company's commercial business loans usually include personal guarantees and are usually, but not always, secured by business assets, such as accounts receivable, equipment and inventory as well as real estate. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Consumer Lending The Company originates a variety of consumer loans, consisting primarily of new and used automobile loans. At March 31, 1996, 1997 and 1998, consumer loans totaled $6.9 million, $7.2 million and $7.8 million, respectively, or 9.7%, 9.2% and 10.0%, respectively, of gross loans at those dates. The Company's marketing strategy emphasizes auto loans as a means of establishing more relationships with its customers and developing new customers through soliciting auto dealerships for loans to non-customers. Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. Consumer loans generally are dependent on the borrower's continuing financial stability and thus are more likely to be affected by adverse personal circumstances. Often the loans are secured by rapidly depreciable personal property, such as automobiles. Automobile loans generally are underwritten in amounts up to 90% of the purchase price for new and used vehicles. The term of the loans generally cannot exceed six years for new vehicles and five years for used vehicles. The Company's delinquent consumer loans as a percentage of gross loans has been minimal. Multi-Family Lending The Company held $.5million or .67% gross loans of multi-family loans at March 31, 1998. The rates charged on the Company's multi-family loans typically are slightly higher than those charged on loans secured by one-to-four family residential properties. Multi-family ARM loans typically adjust in a manner similar to that of the Company's other ARM loans, although generally at a slightly higher margin. An origination fee equal to 1% of the principal amount is usually charged on such loans. Multi-family loans are generally underwritten in amounts of up to 80% of the lesser of the appraised value or purchase price of the underlying property. Appraisals that secure multi-family loans are performed by an independent appraiser designated by the Company at the time the application is submitted. In addition, the Company's underwriting procedures require verification of the borrower's credit history, an analysis of the borrower's income, personal financial statements and banking relationships and a review of the property, including cash flow projections and historical operating results. The Company evaluates all aspects of multi-family lending to mitigate risk to the extent possible. The Company seeks to ensure that the property securing the loans will generate sufficient cash flow to adequately cover operating expenses and debt service payments. The Company obtains individual guarantees for substantially all of its multi-family loans. Loans secured by multi-family real estate generally involve a greater degree of credit risk than one-to-four family mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loans may be impaired. Despite the risks inherent in multi-family real estate lending, the Company's delinquent multi-family loans as a percentage of gross loans has been minimal. 9 Construction and Land Lending The Company offers one-to-four family residential and other construction loans. At March 31, 1998, construction and land loans totaled $2.8 million or 3.53% of gross loans compared to $3.3 million or 4.2% of gross loans at March 31, 1997. Construction loans are made to individuals intending to occupying the home who have signed construction contracts with a builder. These loans have loan-to-value ratios not exceeding 90%. When the loan-to-value ratios exceed 80%, private mortgage insurance is required which insures payment of a portion of the principal balance, reducing the Company's exposure to 75% loan-to-value or less. The Company offers permanent financing, primarily one-to five-year ARM loans, on residential construction loans that enables borrowers to avoid duplicative closing costs normally associated with temporary financing during construction periods and permanent financing upon completion of construction. The Company has had minimal delinquent residential construction loans to date. Loan Approval and Monitoring Loan approval is based on a customer's aggregate amount of loans outstanding, including the loan application under review. Loan amounts of $100,000 or less may be approved by one member of the Loan Committee and a loan officer. Loan amounts exceeding $100,000 up to $500,000 require the approval of two members of the Loan Committee and a loan officer. Any single loan exceeding $500,000 requires approval from the Board of Directors and a loan officer. Any loans over $25,000 that exceed the aggregate amount of $625,000 require Board approval. Loans held in the Company's portfolio are reviewed annually by a loan officer to ensure compliance with the Company's lending policy and the loans-to-one borrower limitations. The borrower's financial statements and income tax returns also are reviewed annually to enable the Company to anticipate potential problem loans and, if necessary, classify the loan or place it on non-accrual status. Originations, Purchase and Sales of Loans Mortgage loans are solicited from real estate brokers, builders, developers, existing or past customers, and residents of the local communities located in the Company's primary market areas. The Company advertises its mortgage products in newspapers and other media in addition to using its loan officers to directly solicit potential borrowers. The following table sets forth the Company's loan originations, purchases, sales and principal repayments for the periods indicated. Mortgage loans and mortgage-backed and related securities held for sale are included in the totals. 10 Fiscal Years Ended March 31, ---------------------------- 1998 1997 1996 (In thousands) Mortgage loans (gross) At beginning of period $66,254 $59,604 $50,071 Mortgage loans originated: One-to-four family 25,216 21,223 16,486 Commercial 226 1,072 - Multi-family - - 490 Construction and land 3,809 6,690 5,737 ------ ------ ------ Total mortgage loans originated 29,251 28,985 22,713 Mortgage loans purchased 368 101 2,466 ------ ------ ------ Total mortgage loans originated and purchased 29,619 29,086 25,179 Transfer of mortgage loans to foreclosed real estate (159) (72) (127) Principal repayments (17,796) (17,890) (9,606) Sales of fixed rate loans (11,216) (4,474) (5,913) -------- -------- -------- Total reductions (29,171) (22,436) (15,646) -------- -------- -------- At end of period $66,702 $66,254 $59,604 Consumer loans: At beginning of period $7,207 $6,897 $4,313 Consumer loans originated 6,796 5,313 6,685 Principal repayments (6,176) (5,003) (4,101) ------- ------- ------- At end of period $7,827 $7,207 $6,897 ------- ------ ------ Commercial loans: At beginning of period $4,663 4,612 4,450 Commercial loans originated and purchased 3,879 3,356 5,402 Principal repayments (4,145) (3,305) (5,240) ------- ------- ------- At end of period $4,397 $4,6$3 $4,612 ------ ------ ------ Mortgage-backed and related securities: At beginning of period $7,421 $5,373 $2,001 Mortgage-backed securities purchased - 2,772 3917 Amortization and repayments (1,023) (724) (545) ------- ----- ----- At end of period $6,398 $7,421 $5,373 11 The following table sets forth the Company's loan originations and purchases in various loan categories according to whether the loan is fixed rate versus adjustable rate for the periods indicated. Fiscal Years Ended March 31, ---------------------------------------------------------------------------------------- 1998 1997 1996 ----------------------------------------------------------------------------------------
Fixed Adjustable Total Fixed Adjustable Total Fixed Adjustable Total ---------------------------------------------------------------------------------------- Mortgage loans: One-to-four family $12,658 $12,926 $25,584 $7,796 $13,427 $21,222 $6,930 $9,556 $16,486 Multi-family - - - - - - - 490 490 Commercial - 226 226 69 1,003 1,072 56 2,410 2,466 Construction and land 3,102 707 3,809 5,423 1,368 6,791 1,680 4,057 5,737 ------- ------- ------- ------ ------- ------- ------ ------ ------- Total mortgage loans 15,760 13,859 29,619 13,288 15,798 29,086 8,666 16,513 25,179 Consumer loans 6,781 15 6,796 5,313 - 5,313 6,449 236 6,685 Comercial loans 3,432 447 3,879 2,308 1,048 3,356 2,493 2,909 5,402 ------- ------- ------- ------- ------- ------- ------- ------- ------- Total loans originated and purchased $25,973 $14,321 $40,294 $20,909 $16,846 $37,755 $17,608 $19,658 $37,266 ------- ------- ------- ------- ------- ------- ------- ------- -------
12 Participation Loans In order to meet asset/liability management objectives that are enhanced by loans with higher rates and shorter repricing periods, the Company has purchased from time to time participation interests in a variety of real estate loans, including commercial real estate loans. Prior to purchase, the Company reviews each participation to ensure that the underlying loan complies with the Company's lending policy as in effect and the loans-to-one borrower limitations. The purchase of participation loans involves the same risks as the origination of the same types of loans as well as additional risks related to the purchaser's lower level of control over the origination and subsequent administration of the loan. Many of the participation loans purchased by the Company in the past also have been on projects located outside the State of Wisconsin, primarily in the Minneapolis/St. Paul, Minnesota area. Management does not anticipate future purchases to be significant, and will continue to investigate purchase opportunities on an individual basis. Sale of Mortgage Loans The Company sells loans that it originates, on a non-recourse basis, into the secondary market to the FHLMC, Federal National Mortgage Association ("FNMA") and WHEDA. The amount of loans sold by the Company is based upon market conditions and the Company's asset/liability strategy. For the past three fiscal years, the Company has sold substantially all of the fixed rate loans originated to governmental secondary market purchasers in order to manage interest rate risk. For the fiscal year ended March 31, 1998, the Company's fixed rate loan sales to governmental investors totaled $11.2 million with associated gains of $130,000. For the fiscal years ended March 31, 1997 and 1996, the Company's fixed rate loan sales to governmental investors totaled $4.5 million and $5.9 million with associated gains of $59,000 and $61,000, respectively. The Company is subject to interest rate risk on fixed rate loans in its pipeline from the point in time that the rate is locked with the borrower until it is sold into the secondary market. In a declining interest rate environment, the interest rate is locked in at the time of loan approval and held for sale to take advantage of the market rate of interest. In order to minimize the interest rate risk in a rising interest rate environment, the interest rate is locked in at the time of loan approval and a commitment to sell the loan is obtained simultaneously. These loans are sold on an individual basis when the loan is closed. All mortgage loans are made and underwritten pursuant to the requirements of secondary market investors. The Company retains servicing on loans sold to FHLMC and FNMA, receiving a servicing fee, which represents the difference between the contract rate on the loans sold and the yield at which such loans are sold. The servicing spread earned by the Company is typically 0.25%. The Company also acts as a conduit for loans sold to WHEDA. For those borrowers who qualify under WHEDA guidelines, the Company originates the loan for a $500 fee and sells the loan to WHEDA, on a non-recourse basis, servicing released. Loan Origination, Servicing and Other Fees In addition to interest earned on loans, the Company receives income through fees in connection with loan originations, loan sales, loan modifications, late payments and for miscellaneous services related to its loans, including loan servicing. Income from these activities varies from period to period with the volume and type of loans originated. In connection with the origination of mortgage loans, the Company requires borrower reimbursement for out-of-pocket costs associated with obtaining independent appraisals, credit reports, title insurance or abstract and title opinion, private mortgage insurance and other items. While origination fees ranging from zero to two points generally have been quoted on mortgage loans in recent years, most of the Company's borrowers typically accept a slightly higher interest rate and pay zero points. For loans sold to FHLMC and FNMA, the Company retains the responsibility for servicing such loans. At March 31, 1998, 1997 and 1996, the Bank serviced $30.7 million, $25.3 million and $22.9 million loans for others, respectively. Fee income received in connection with loans serviced for others was $77,000, $77,000 and $72,000 for the fiscal years ended March 31, 1998, 1997 and 1996, respectively. 13 The contractual right to service mortgage loans sold has an economic value. The value results from the future income stream of the servicing fees, the availability of the cash balances associated with escrow funds collected monthly for real estate taxes and insurance, the availability of the cash from monthly principal and interest payments from the collection date to the remittance date, and the ability of the servicer to cross-sell other products and services. The actual value of a servicing portfolio is dependent upon such factors as the age, maturity and prepayment rate of the loans in the portfolio, the average dollar balance of the loans, the location of the collateral property, the average amount of escrow funds held, the interest rates and delinquency experience of the loans, the types of loans and other factors. Delinquencies, Nonperforming Assets and Classified Assets Delinquent Loans When a borrower fails to make a required payment by the end of the month in which the payment is due, the Company generally initiates collection procedures. The Company will send a late notice, and in most cases, delinquencies are cured promptly. However, if a loan becomes delinquent for more than 60 days, the Company contacts the borrower directly, to determine the reason for the delinquency and effect a cure. Where it believes appropriate, the Company may review the condition of the property and the financial position of the borrower. At that time, the Company may: (i) accept a repayment program for the arrearage; (ii) seek evidence of efforts by the borrower to sell the property; (iii) request a deed in lieu of foreclosure; or (iv) initiate foreclosure proceedings. When a loan secured by a mortgage is delinquent for three or more monthly installments, the Company generally will initiate foreclosure proceedings. With respect to delinquencies on loans sold to FHLMC or FNMA, or insured by FHA or guaranteed by VA, the Company follows the appropriate notification and foreclosure procedures prescribed by the respective agencies. On mortgage loans or loan participations purchased by the Company, the Company receives monthly reports from its loan servicers with which it monitors the loan portfolio. Based upon servicing agreements with the servicers of the loan, the Company relies upon the servicer to contact delinquent borrowers, collect delinquent amounts and to initiate foreclosure proceedings, when necessary, all in accordance with applicable laws, regulations and the terms of the servicing agreements between the Company and its servicing agents. Total loans delinquent 90 days or more increased from 45 loans totaling $1.1 million at March 31, 1997, to 49 loans totaling $1.4 million at March 31, 1998. The increase in the amount is primarily due to an increase in delinquent commercial loans from 3 loans with a balance of $556,000 at March 31, 1997, to 9 loans with a balance of $858,000 at March 31, 1998. Total loans delinquent 31-89 days decreased from 95 loans totaling $3.3 million to 61 loans totaling $1.5 million. One-to-four family loans delinquent 31-89 days decreased from 45 loans totaling $2.4 million at March 31, 1997, to 22 loans totaling $0.7 million at March 31, 1998. Management views the increase in total loans delinquent 90 days or more as a major area of concern warranting increased scrutiny. However, the latest available peer group comparison of nonperforming loans and real estate owned as a percentage of total loans as prepared by America's Community Bankers was 1.44% for the Company at September 30, 1997, compared to 1.43% on a nation wide basis, 0.90% of a geographic basis, 1.25% by an asset size basis and 1.70% on an owner type basis. Management also views the decrease in loans 31-89 days as a favorable trend that may indicate improved future performance. 14 At March 31, 1998, 1997, and 1996, delinquencies in the Company's loan portfolio were as follows: At March 31, 1998 At March 31, 1997 At March 31, 1996 ------------------------------------------------------------------------------------------------- 31-89 Days 90 Days or more 31-89 Days 90 Days or more 31-89 Days 90 Days or more ------------------------------------------------------------------------------------------------
Number Principal Number Principal Number Principal Number Principal Number Principal Number Principal of Balance of Balance of Balance of Balance of Balance of Balance Loans of Loans Loans of Loans Loans of Loans Loans of Loans Loans of Loans Loans of Loans ------------------------------------------------------------------------------------------------- Mortgage loans: One-to-four family 22 $ 754 5 $ 109 45 $2,399 7 $ 179 34 $1,253 9 $ 386 Multi-family - - - - - - - - - - - - - - - - - - - - - - - - Residential construction 1 62 - - - - 1 84 - - - - 2 252 2 121 Commercial 6 471 3 280 6 406 2 199 6 539 - - - - -- ------ - --- - ----- - --- - --- --- --- Total mortgage loans 29 $1,287 8 $ 389 52 $2,889 9 $ 378 42 $2,044 11 507 Consumer loans 31 161 32 129 39 191 33 137 37 166 9 60 Comercial loans 1 3 9 858 4 204 3 556 4 197 6 64 -- ------ -- ------ -- ------ -- ------ -- ------ -- ---- Total 61 $1,451 49 $1,376 95 $3,284 45 $1,071 83 $2,407 26 $ 631 -- ------- -- ------ -- ------ -- ------ -- ------ -- ---- Delinquent loans to 1.84% 1.74% 4.16% 1.36% 3.05% 0.80% gross loans(2) - - -------------------------------- -1 The Company discontinues the accrual of interest on loans when the borrower is delinquent as to a contractually due principal or interest payment by 90 days or more. -2 Excluding mortgage-backed and related securities. The following table sets forth the Company's loan originations and purchases in various loan categories according to whether the loan is fixed rate versus adjustable rate for the periods indicated.
15 Classification of Assets Federal regulators require each federally insured bank to classify its assets on a regular basis. In connection with examinations of insured banks, examiners have authority to identify problem assets as Substandard, Doubtful or Loss. Substandard assets have one or more well defined weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of Substandard assets, with the additional characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. An asset classified as Loss is considered uncollectible and of such little value that continuance as an asset of the bank is not warranted. The Company has adopted an asset classification methodology that parallels that required by federal regulators. At March 31, 1998, based upon the Company's asset classification methodology, the Company had assets classified as Substandard of $1.5 million, none as Doubtful and none as Loss. At March 31, 1997, assets classified as Substandard were $1.1 million, none as Doubtful and none as Loss. Assets that are classified as Loss are reserved at 100% of the indicated loss amount. The FDIC examination policies include a Special Mention category, consisting of assets that currently do not expose the Company to a sufficient degree of risk to warrant adverse classification, but do possess credit deficiencies deserving management's close attention. At March 31, 1998, $289,000 of the Company's assets were classified as Special Mention. The Company's classified assets consist of the non-performing assets and the other loans and assets of concern. As of the date hereof, the Company's classifications are consistent with those of the FDIC and DFI. Non-Performing Assets Loans are placed on non-accrual status when, in the judgment of Company management, the probability of collection of principal or interest is deemed insufficient to warrant further accrual of interest. In any event, the Company discontinues the accrual of interest on loans when the borrower is delinquent as to a contractually due principal or interest payment by 90 days or more. When a loan is placed on non-accrual status, all of the accrued interest on that loan is reversed by way of a charge to interest income. Accrual of interest on a non-accrual loan is resumed when payments are less than 90 days past due and when management believes the outstanding loan principal and contractually due interest is no longer doubtful of collection. Property acquired by the Company as a result of a foreclosure, property upon which a judgment of foreclosure has been entered but prior to foreclosure sale and property that is deemed in-substance foreclosed are classified as foreclosed properties. "In-substance foreclosed" loans are defined as loans for which current and future collection is dependent on the income producing capacity and fair market value of the underlying real estate collateral, rather than the borrower's ability to service the debt. Foreclosed properties are recorded at the lower of the unpaid principal balance of the related loan or fair value. The amount by which the recorded loan balance exceeds the fair value at the time a property is classified a foreclosed property, along with expenses incurred to maintain or dispose of a foreclosed property, is charged against current earnings. At March 31, 1998, the Company had $159,000 in foreclosed or in foreclosure properties. 16 Nonperforming loans include loans placed on non-accrual status and troubled debt restructurings. Non-performing assets include non-performing loans and foreclosed properties. The following table sets forth non-performing loans and assets. March 31, ------------------------- 1998 1997 1996 (Dollars in Thousands) Non-accrual mortgage loans 90 days or more past due $ 389 $ 378 $ 386 Non-accrual consumer loans 90 days or more past due 116 128 47 Non-accrual commerical loans 90 days or more past due 858 556 64 Loans 90 days or more past due and still accruing 14 9 134 Troubled debt restructurings 11 - 62 ------ ------ ----- Total non-performing loans $1,388 $1,071 $ 693 ------ ------ ----- Total real estate owned and in judgement, net of related allowance for losses 159 - 127 Total non-performing assets $1,547 $1,071 $ 820 ------ ------ ----- Total non-performing loans to gross loans receivable 1.76% 1.37% 0.97% Total non-performing assets to total assets 1.57% 1.13% 0.95% Total classified assets $1,885 $1,330 $ 778 Total classified assets to total assets 1.91% 1.40% 0.90% Interest income that would have been recorded on non- performing loans if current $ 89 $ 59 $ 13 Interest income on non-performing loans included in net income $ 21 $ 13 $ 17 As of March 31, 1998, there were no other loans not included in the foregoing tables or discussed above where known information about the possible credit problems of borrowers caused management to have serious doubts as to the ability of the borrower to comply with present loan repayment terms and which may result in disclosure of such loans in the future. Allowance for Loan Losses Under federal regulations, when an insured institution classifies problem assets as either Substandard or Doubtful, it is required to establish a general allowance for loan losses in an amount deemed prudent by management. In addition to general valuation allowances, the Company may establish specific loss reserves against specific assets in which a loss may be realized. General allowances represent loss allowances that have been established to recognize the inherent risks associated with lending activities, but which, unlike specific allowances, have not been allocated to recognize probable losses on particular problem assets. The Company's determination as to its classification of assets and the amount of its specific and general valuation allowances are subject to review by the DFI and the FDIC, either one of which can order the establishment of additional general or specific loss allowances. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation, which includes a review of all loans on which full collectibility may not be reasonably assured, considers, among other matters, the estimated net realizable value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an adequate loan loss allowance. The ratio of allowance for loan losses to gross loans receivable increased from 0.59% at March 31, 1997, to 0.61.% at March 31, 1998. Based on the actual loss experience an allowance of 0.34% would be adequate at March 31, 1998. The ratio of allowance for loan losses to nonperforming loans decreased from 0.430 at March 31, 1997 to 0.349 at March 31, 1998 due to the increase in nonperforming loans over the period. 17 The following table sets forth activity in the Company's allowance for loan losses during the periods indicated. For the Fiscal Year Ended March 31, ----------------------------------- 1998 1997 1996 (Dollars in thousands) Balance at beginning of period $ 461 $ 433 $ 434 Additions charged to operations: One-to-four family 0 0 0 Multi-family and commercial real estate 0 0 0 Commercial 76 75 0 Consumer 24 6 24 --- -- -- 100 81 24 Recoveries: One-to-four family 0 19 0 Multi-family and commercial real estate 3 3 4 Commercial 0 0 0 Consumer 7 0 2 -- -- - 10 22 6 Charge-offs: One-to-four family 0 0 (5) Multi-family and commercial real estate 0 0 0 Commercial 0 (19) 0 Consumer (87) (56) (26) --- --- --- (87) (75) (31) Net charge-offs (77) (53) (25) ----- ----- ----- Balance at end of period $ 484 $ 461 $ 433 Percentage of loans to gross loans receivable Mortgage loans 84.51% 83.82% 85.11% Consumer loans 9.92% 9.70% 7.33% Ratio of allowance for loan losses to gross loans receivable at the end of period 0.61% 0.65% 0.74% Ratio of allowance for loan losses to non-performing loans at the end of period(1) 34.871 43.04 66.52 Ratio of net charge-offs to average gross loans during period 0.10% 0.08% 0.05% Average gross loans outstanding $79,471 $65,615 $54,783 Gross loans receivable at the end o period $78,926 $71,113 $58,834 (1) Non-performing loans include non-accrual loans, loans 90 days or more past due and still accruing, and troubled debt restructurings. 18 The following table show the Company's allowance for loan losses and the allocation to the various categories of loans held for investment at the dates indicated. Allocations to a particular category do not restrict the Company's ability to use such allowance in any other category. At March 31, ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- 1998 1997 1996 -------------------------------------------------------------------------------
Loans In Loans In Loans In Category Category Category % of to Total % of to Total % of to Total total Out- total Out- total Out- Loans by standing Loans by standing Loans by standing Amount Category Loans Amount Category Loans Amount Category Loans (Dollars in thousands) Breakdown of allowance: Mortgage loans: One-to-four family $ 50 0.09% 73.64% $ 36 0.06% 71.14% $ 85 0.14% 72.24% Multi-family 1 0.19% 0.67% - - 1.19% 1 0.08% 2.10% Commercial/nonresidential 5 0.10% 6.67% 34 0.65% 8.25% 22 0.50% 8.09% Construction and land 2 0.07% 3.53% 1 0.04% 4.22% 19 0.13% 2.68% -- ----- -- ----- Total mortgage loans 58 84.51% 71 84.80% 127 85.11% Consumer loans 80 1.02% 9.92% 50 0.69% 9.23% 16 0.12% 7.33% Commercial loans 346 7.87% 5.57% 340 7.29% 5.97% 290 7.71% 7.56% ----- ------ --- ------ ----- ------ Total allowance for loan losses $ 484 100.00% $ 461 100.00% $ 433 100.00%
19 Investment Activities General The investment policy of the Company, which is established by the Board of Directors and implemented by the Company's President, is designed to provide a required level of liquidity and minimize potential losses due to interest rate fluctuations without incurring undue credit risk. The Company is authorized by regulation to invest in various types of liquid assets, including United States Treasury obligations, securities issued by various federal agencies and state and municipal governments, deposits at the FHLB-Chicago, certain certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds. The Company also invests in mortgage-backed and related securities, securities that are either of investment grade or issued or guaranteed by FHLMC, the FNMA or the Government National Mortgage Association ("GNMA"), and investment grade corporate debt. The Company categorizes the securities it purchases into a "Held-to-Maturity" or an "Available-For-Sale" portfolio as follows: 1. Securities Held-to-Maturity. The Company has the ability and intent to hold these assets to maturity. Upon acquisition, securities are classified as to the Company's intent and a sale would only be effected due to deteriorating investment quality. The investment portfolio is not used for speculative purposes and is carried at amortized cost. In the event the Company sells securities from this portfolio for other than credit quality reasons, all securities within the investment portfolio with matching characteristics may be reclassified as assets held for sale. 2. Securities Available-for-Sale. The Company does not intend to hold the assets to maturity and thus are carried at fair value, with the unrealized gains or losses, net of tax, reported as a separate component of the stockholders equity. This portion of the securities portfolio is designed to meet anticipated loan demand and deposit runoff or to take advantage of market opportunities. Effective April 1, 1993, the Company adopted SFAS No. 115 that requires that the Company classify investments in marketable equity securities with readily determinable fair value and all investments in debt securities as held-to-maturity, trading or available-for-sale. The Company classified the securities as of the date of adoption of SFAS 115 and subsequently at the time of purchase and reviews the appropriateness of the classification at each reporting date as follows: 1. Securities Held-to-Maturity. The Company has both the intent and ability to hold these debt securities to maturity. Securities in this category are carried at amortized cost. 2. Securities Classified as Trading. The Company acquires these securities with the intent to resell them in the near term and are held only for a short period of time. Securities in this category are carried at fair value, with unrealized holding gains and losses included in earnings. 3. Securities Available-for-Sale. This category includes all securities not classified as held-to-maturity or trading. Securities in this category are carried at fair value, with unrealized holding gains and losses reported, net of deferred income taxes, in a separate component of equity. These securities may be sold, for example, in response to changes in market interest rates, liquidity needs, availability of higher yielding instruments and changes in funding sources. The investment activities of the Company consist primarily of investments in mortgage-backed and related securities and other investment securities, consisting primarily of securities issued or guaranteed by the United States Government or agencies thereof. Typical investments include federally sponsored agency mortgage pass-throughs, and federally sponsored agency and mortgage related securities. Investment and aggregate investment limitations and credit quality parameters of each class of investment are prescribed in the Company's investment policy. The Company performs analyses on mortgage related securities prior to purchase and on an ongoing basis to determine the impact on earnings and market value various interest rate and prepayment conditions. 20 Mortgage-Backed Securities Mortgage-backed securities represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators through intermediaries (generally federal government-sponsored enterprises) that pool and repackage the participation interest in the form of securities to investors such as the Company. Such federal government-sponsored enterprises, which guarantee the payment of principal and interest to investors, include FHLMC, FNMA and GNMA. Mortgage-backed securities generally increase the quality of the Company's assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company. FHLMC, and FNMA were established to provide support for low and middle-income housing. There are limits to the maximum size of loans that qualify for these programs. Currently, FNMA limits a single family loan to $203,150 and FHLMC limits a single family loan to $227,150. Mortgage-backed securities typically are issued with stated principal amounts and the securities are backed by pools of mortgage loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgage loans can be composed of either fixed rate mortgage or ARM loans. Mortgage-backed securities commonly are referred to as mortgage participation certificates or pass-through certificates. As a result, the interest rate risk characteristics of the underlying pool of mortgage loans, i.e., fixed rate or adjustable rate, as well as prepayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgage loans. The actual maturity of a mortgage-backed security varies, depending on when the mortgages prepay or repay the underlying mortgage loans. Prepayments of the underlying mortgage loans may shorten the life of the investment, thereby adversely affecting its yield to maturity and the related market value of the mortgage-backed security. The yield is based upon the interest income and the amortization of the premium or accretion of the discount related to the mortgage-backed security. Premiums and discounts on mortgage-backed securities are amortized or accreted over the estimated term of the securities using a level yield method. The prepayment assumption used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security and these assumptions are reviewed periodically to reflect the actual prepayment. The actual prepayment of the underlying mortgage loans depends on many factors, including type of mortgage loans, the coupon rate, the age of the mortgage loans, the geographical location of the real estate collateralizing the mortgage loans and general levels of market interest rates. The difference between the interest rates on the underlying mortgage loans and the prevailing mortgage interest rates is an important determinant in the rate of prepayments.. During periods of falling mortgage interest rates, prepayments generally increase. If the coupon rate of the underlying mortgage loans significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgage loans. Prepayment experience is more difficult to estimate for adjustable rate mortgage-backed securities. Investment Securities The Company invests in various types of liquid assets that are permissible investments for Wisconsin-chartered savings banks, including United States Treasury obligations and securities of various federal agencies. The Company also invests its assets in commercial paper and mutual funds, the assets of which conform to the investments that a Wisconsin-chartered savings bank is otherwise authorized to make directly The Company's current investment policy permits purchases only of investments rated investment grade by a nationally recognized rating agency and does not permit purchases of securities of non-investment grade quality. Composition of Securities Held-to-Maturity At March 31, 1998, the Company held $9.4 million in its securities held-to-maturity portfolio, consisting of $6.4 million in mortgage-backed certificates issued by various federal agencies. The estimated market value of those securities at that date was $6.5 million. At March 31, 1998, the mortgage-backed securities portfolio represented 6.5% of the Company's total assets. At March 31, 1998, the Company held $3.0 million in its investment securities, consisting of securities of various federal agencies. At March 31, 1998, the investment securities portfolio represented 3.0% of the Company's total assets. 21 Composition of Securities Classified as Trading At March 31, 1998 and 1997, the Company did not have any investment securities or mortgage-related securities classified as trading. Composition of Securities Available for Sale At March 31, 1998, the Company did not have any investment securities or mortgage-related securities classified as available for sale. 22 The table below sets forth certain information regarding the carrying value, composition and market value of the Company's securities available for sale and mortgage-backed and related securities held-to-maturity at March 31, 1998, 1997, 1996. At March 31, 1998 At March 31, 1997 At March 31, 1996
Carrying % of Market Carrying % of Market Carrying % of Market Value Total Value Value Total Value Value Total Value (Dollars in thousands) Securities available-for-sale: U.S. govt securities and other agency obligations FNMA $ - - $ - $1,963 71.33% $1,963 $1,956 68.42% $1,956 FHLB - - - 488 17.73% 488 485 16.96% 485 FHLMC - - - 300 10.90% 300 304 10.63% 304 Money Market Mutual Fund - - - 1 0.04% 1 114 3.99% 114 Total securities available-for-sale $ - - $ - $2,752 100.00% $2,752 $2,859 100.00% $2,859 Securities held-to-maturity Mortgage-backed securities FNMA $3,868 41.16% $3,926 4,622 62.28% $4,523 $2,220 41.32% $2,206 FHLMC 377 4.01% 384 434 5.85% 420 494 9.19% 487 GNMA 2,153 22.91% 2,236 2,365 31.87% 2,365 2,659 49.49% 2,693 U.S. govt securities and other agency obligations FFCB 500 5.32% 500 - - - - - - FHLB 1,700 18.09% 1,700 - - - - - - FHLMC 800 8.51% 799 - - - - - - Total securities held-to-maturity $9,398 100.00% $9,545 $7,421 100.00% $7,308 $5,373 100.00% $5,386
At March 31, 1998, the aggregate book value and the aggregate market value of securities issued by FNMA totaled $3.9 million and $3.9 million, respectively. At March 31, 1998, the aggregate book value and the aggregate market value of securities issued by GNMA totaled $2.2 million and $2.2 million, respectively. Both FNMA and GNMA securities exceed 10% of stockholder equity at March 31, 1998. 23 The following table shows the maturity or period to repricing of the Company's mortgage-backed securities portfolio held-to-maturity at March 31, 1998: At March 31, 1998 --------------------------------------- Adjustable Fixed Rate Rate Total Mortgage Mortgage Mortgage- Backed Backed backed Securities Securities Securities Amounts due or repricing: Within one year $565 - - $ 565 After one year: One to three years - - - - - - Five to ten years - - - - - - Ten to 20 years - - 1029 1029 Over 20 years - - 4,804 4,804 --- ----- ----- Total due or repricing after one year - - 5,833 5,833 Total due or repricing 565 5,833 6,398 --- ----- ----- Less: Unearned discounts and premiums, net - - - - - - Mortgage-backed securities, net $565 $5,833 $6,398 At March 31, 1998, the stated average maturity of the Company's mortgage-backed and related securities was 23.9 years. Sources of Funds General The Company's primary sources of funds for use in lending, investing and for other general purposes are deposits, proceeds from principal and interest payments on loans, mortgage-backed and related securities and investment securities, and to a lesser extent, FHLB-Chicago advances. Contractual loan payments are a relatively stable source of funds, while deposit inflows and outflows and loan payments are significantly influenced by general market interest rates and economic conditions. Borrowings may be used on a short-term basis to compensate for seasonal or other reductions in normal sources of funds or for deposit inflows at less than projected levels. Borrowings also may be used on a longer-term basis to support expanded lending or investment activities. The Company primarily utilizes advances from the FHLB-Chicago as sources for its borrowings. At March 31, 1998, 1997 and 1996 the Company had advances from the FHLB-Chicago of $19.1 million or 19.3% of total assets, $17.6 million or 18.5% of total assets, and $12.6 million or 14.6% of total assets, respectively. Of the Company's outstanding FHLB-Chicago advances at March 31, 1998, $5.1 million will mature before March 31, 1999. The Company also had borrowings consisting of repurchase agreements and a note payable from a bank of $5.3 million, $4.5 million and $4.4 million at March 31, 1998, 1997 and 1996, respectively. 24 Deposits The Company offers a variety of deposit accounts having a range of interest rates and terms. The Company's deposits principally consist of core deposits (NOW, money market deposit and passbook accounts) and certificates of deposits. The flow of deposits is influenced significantly by general economic conditions, changes in prevailing interest rates and competition. The Company's deposits are obtained primarily from the areas in which its branches are located, and the Company relies principally on customer service, marketing programs and long-standing relationships with customers to attract and retain these deposits. Various types of advertising and promotion to attract and retain deposit accounts also are used. The Company does not currently solicit or accept brokered deposits. Management monitors the Company's certificates of deposit and, based on historical experience, management believes it will retain a large portion of such accounts upon maturity. Management considers Company profitability, the matching of term lengths with assets, the attractiveness to customers and rates offered by competitors in considering its deposit offerings and promotions. The Company believes it has been competitive in the types of accounts and interest rates it has offered on its deposit products. The Company intends to continue its efforts to attract and retain deposits as a primary source of funds for supporting its lending and investing activities. Fiscal Year Ended March 31, 1998 1997 1996 (In thousands) Net Deposits (Withdrawals) $(1,613) $ 1,627 $ 4,486 Interest credited on deposits 2,334 2,674 2,143 ----- ----- ----- Total increase (decrease) in deposits $ 721 $ 4,301 $ 6,629 The Company attributes the increase in deposits during the two most recent fiscal years to maintaining competitive rates on deposits and general market conditions. At March 31, 1998, the Company had outstanding $3.2 million in certificates of deposit in amounts of $100,000 or more maturing as follows: Amount at March 31, 1998 (In thousands) Three months or less $ 891 Over three through six months 406 Over six through 12 months 309 Over 12 months 1,637 ------- Total $ 3,243 ------- 25 The following table sets forth the distribution of the Company's core deposits and certificate accounts at the dates indicated and the weighted average nominal interest rates on each category of deposits presented: At March 31, --------------------------------------------------------------------------------------------------- 1998 1997 1996 --------------------------------- ------------------------------- -----------------------------
Weighted Weighted Weighted Percent Average Percent Average Percent Average of total Nominal of total Nominal of total Nominal Amount deposits Rate Amount deposits Rate Amount deposits Rate (Dollars in thousands) Core Deposits: Non-interest bearing $ 3,823 6.14% - $ 2,792 4.54% - $ 2,069 3.61% - NOW accounts 5,910 9.49% 2.15% 5,989 9.73% 2.26% 6,173 10.78% 2.57% Money market 6,026 9.68% 4.87% 5,029 8.17% 4.61% 2,314 4.04% 4.77% Passbook 6,091 9.78% 2.31% 5,905 9.59% 2.16% 6,829 11.93% 2.51% ------ ----- ---- ------ ----- ---- ------ ----- ---- Total 21,850 35.08% 2.57% 19,715 32.03% 2.51% 17,385 30.36% 2.53% Certificates accounts (current term to maturity): One to six months 22,514 36.15% 5.69% 15,941 25.90% 5.43% 14,332 25.03% 5.68% six to 12 months 6,889 11.06% 5.75% 9,443 15.34% 5.71% 14,499 25.32% 5.60% 13 to 36 months 9,435 15.15% 6.05% 14,151 22.99% 6.07% 7,524 13.14% 5.97% 37 to 60 months 1,389 2.22% 6.08% 2,110 3.44% 6.11% 3,226 5.63% 6.35% 61 to 96 months 167 0.27% 6.54% 120 0.19% 6.33% 290 0.51% 6.44% 97 to 132 months 34 0.05% 6.35% 77 - 6.96% - - - ------ ----- ---- ------ ----- ---- ------ ----- ----- Total certificates 40,428 64.92% 5.75% 41,842 67.97% 5.75% 39,871 69.64% 5.85% Total deposits $62,278 100.00% 4.62% $61,557 100.00% 4.71% $57,256 100.00% 4.84% ------- ------ ---- ------- ------ ---- ------- ------ ----
26 The following table presents, by various rate categories, the amount of certificates of deposit outstanding at March 31, 1997 and March 31, 1998: At March 31, ------------ 1998 1997 ---- ---- Certificates of Deposit: (In thousands) -------------- 2.00% to 2.99% 100 - 3.00% to 3.99% - - 4.00% to 4.99% 538 1,442 5.00% to 5.99% 22,861 21,018 6.00% to 6.99% 16,229 18,527 7.00% to 7.99% 670 825 8.00% to 8.99% 30 30 ------- ------- Total $40,428 $41,842 ------- ------- Borrowings and Other Financing Transactions Although deposits are the Company's primary source of funds, the Company's policy has been to utilize borrowings as part of its assets/liability management strategy. Borrowings are secured when management believes it can profitably re-invest those funds for the benefit of the Company. The Company's primary form of borrowing consists of advances from the FHLB-Chicago. These advances are collateralized by the capital stock of the FHLB-Chicago held by the Company and certain of its mortgage loans and mortgage-backed and related securities. Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount the FHLB-Chicago will advance to member institutions, including the Company, for purposes other than meeting withdrawals fluctuates from time to time in accordance with policies the FHLB-Chicago. The Company will have to purchase additional FHLB stock, if advances exceed $19.1 million. At March 31, 1998, the Company's FHLB-Chicago advances totaled $19.1 million, representing 21.9% of total liabilities, an increase from the $17.6 million outstanding at March 31, 1997. The Company intends to continue to leverage its capital base by utilizing FHLB borrowings to originate or purchase loans in fiscal 1999. The Company's borrowings from time to time include repurchase agreements. These agreements generally are entered into with local businesses and institutions that seek to deposit funds in excess of insurable limits. These transactions are treated as borrowings collateralized by the securities sold, which generally are mortgage-backed securities, and are therefore included as other borrowings in the Company's Consolidated Financial Statements. While increases in borrowings and changes in the collateralization levels due to market interest rate changes could require the Company to add collateral to secure its borrowings, the Company does not anticipate having a shortage of qualified collateral to pledge against its borrowings. At March 31, 1998 and March 31, 1997, there were $5.3 million and $4.4 million in reverse repurchase agreements outstanding. 27 The following table sets forth certain information regarding the Company's FHLB-Chicago advances and repurchases agreements at or for the periods ended on the dates indicated. At or For the Fiscal Years Ended March 31, 1998 1997 1996 (Dollars in thousands) FHLB- Chicago advances: Average balance outstanding $ 17,912 $ 15,751 $ 7,629 Maximum amount outstanding at any month-end during the period 23,173 18,245 12,556 Balance outstanding at end of period 19,062 17,634 12,556 Weighted average interest rate during the period(1) 5.88% 5.87% 6.00% Weighted average interest rate at end of period 5.49% 5.91% 5.92% Repuchase agreements: Average balance outstanding $ 4,937 $ 4,808 $ 3,634 Maximum amount outstanding at any month-end during the period 6,501 5,761 4,442 Balance outstanding at end of period 5,258 4,463 4,356 Weighted average interest rate during the period 6.00% 5.74% 6.58% Weighted average interest rate at end of period 6.08% 6.13% 6.08% Total advances and repurchase agreements: Average balance outstanding $ 22,850 $ 20,559 $ 11,263 Maximum amount outstanding at any month-end during the period 29,674 24,006 16,998 Balance outstanding at end of period 24,320 22,097 16,912 Weighted average interest rate during the period 5.91% 5.78% 6.19% Weighted average interest rate at end of period 5.62% 5.95% 5.96% - - ------------------------------- (1) Computed on the basis of average monthly balances. Subsidiary Activities The Bank has two wholly owned subsidiaries, Amery Service Agency, Inc. ("ASA"), organized as a Wisconsin corporation in 1970 and Northwest Investments Inc. ("NWI") organized as a Nevada corporation in 1997. ASA engages in insurance agency activities permissible under state and federal law, including the sale of credit life and disability products, and maintenance of a third party brokerage relationship. The ASA and the Bank have received approval of the Wisconsin Department of Financial Institutions and the FDIC to engage in the insurance and brokerage activities. In January 1983, ASA formed the Pondhurst Condominium Association and developed 64 residential lots for condominium duplexes and four-plexes on land adjacent to a golf course in Amery, Wisconsin (the "Pondhurst Project"). As of March 31, 1998, all 64 residential lots had been sold. On May 8, 1998, ASA sold an adjacent undeveloped 7.5 acre parcel of land for $65,000. The parcel has a book value $15,163. With the sale of the 7.5 acre parcel , the Bank and ASA has complied with a request by the Federal Reserve bank of Minneapolis that ASA divest its holdings in the Pondhurst Project by May 31, 2000. As of March 31, 1998, ASA had total assets of $53,000. 28 Because the establishment and operation of a investment subsidiary through incorporation and operation in the state of Nevada may provide certain corporate tax advantages to the Bank and the subsidiary, on May 30, 1997, NWI was established as an investment subsidiary of Bank to manage a portion of its investments. As of March 31, 1998, NWI had total assets of $22.9 million. Personnel At March 31, 1998, the Company had 30 full-time employees and 5 part-time employees. The employees of the Company are not represented by a collective bargaining unit and the Company believes its relationship with its employees to be good. Federal Taxation General The following discussion of tax matters is intended to be a summary of the material tax rules applicable to the Company and the Bank and does not purport to be a comprehensive description of all applicable tax rules. The Bank and the Company report their income on a fiscal year basis using the accrual method of accounting and will be subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The Company and its subsidiaries currently file and will continue to file a consolidated federal income tax return. For its taxable year end March 31, 1998, the Bank was subject to a blended federal income tax rate of approximately 34%. Bad Debt Reserves On August 20, 1996, the President of the United States signed the Small Business Job Protection Act of 1996 ("the Act"). The Act repealed the "reserve method" of accounting for bad debts by most thrift institutions, effective for taxable years beginning after 1996. Most thrift institutions such as the Bank are now required to use the "specific charge-off method". The Act also grants partial relief from reserve recapture provisions which are triggered by the change in method. This legislation is not expected to have a material impact on the Bank's financial condition or results of operations. Distributions To the extent that Bank makes "non-dividend distributions" to stockholders that are considered to result in distributions from (i) the Bank's reserve for losses on qualifying real property loans exceeds the amount that would have been allowed under an experience method, or (ii) the supplemental reserve for losses on loans ("Excess Distributions"), then an amount equal to such Excess Distributions must be included in the Bank's taxable income. Non-dividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. In contrast, distributions made from the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, rather than the Bank's bad debt reserves are generally considered dividends for federal income tax purposes and therefore would not be included in the Bank's taxable income. Further, under certain circumstances, such as tax-free reorganizations, non-dividend distributions may not be required to be included in the Bank's taxable income. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if after the Conversion, certain portions of the Bank's accumulated tax bad debt reserve are used for any purpose other than to absorb qualified bad debt loans, such as for the payment of dividends or other distributions with respect to the Bank's capital stock (including distributions upon redemption or liquidation) and such payments or other distribution is not otherwise excluded from the provisions generally applicable to Excess Distributions, approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state taxes). 29 State Taxation The State of Wisconsin imposes a tax on the Wisconsin taxable income of corporations, including savings banks, at the rate of 7.9%. Wisconsin taxable income is generally similar to federal taxable income except that interest from state and municipal obligations is taxable, no deduction is allowed for state income taxes and net operating losses may be carried forward but not back. Wisconsin law does not provide for filing of consolidated state income tax returns. The income of NWI is only subject to taxation in Nevada which currently does not impose a corporate income or franchise tax. Regulation The Bank is a Wisconsin-chartered stock savings bank and its deposit accounts are insured up to applicable limits by the FDIC under the Savings Association Insurance Fund ("SAIF"). The Bank is subject to extensive regulation by the DFI, as its chartering agency, and by the FDIC, as its deposit insurer and principal federal regulator. The lending and investment authority of the Bank is prescribed by Wisconsin law and regulations, as well as applicable federal law and regulations, and the Bank is prohibited from engaging in any activities not permitted by such law and regulations. The Company is a one-bank holding company subject to regulatory oversight by the Federal Reserve Board ("FRB"), the Wisconsin Department of Financial Institutions ("DFI") and the Securities and Exchange Commission ("SEC"). Wisconsin Savings Bank Regulation Regulations adopted by the Department of Financial Institutions govern various aspects of the activities and operation of Wisconsin-chartered savings banks. Examinations and Assessments As a Wisconsin-chartered stock savings bank, the Bank is subject to regulation and supervision by the DFI. The Bank is required to file periodic reports with and is subject to periodic examinations by the DFI. Savings banks are required to pay examination fees and annual assessments to fund the supervisory operations of the DFI. On June 25, 1997, the DFI assessed the Bank a $3,376 fee based the Bank's total assets of $96.5 million at December 31, 1996. Loans and Investments Under Wisconsin law, the Bank is authorized to make, invest in, sell, purchase, participate or otherwise deal in mortgage loans or interests in mortgage loans without geographic restriction, including loans made on the security of residential and commercial property. Savings banks may also lend funds for commercial or consumer purposes. Loans are subject to certain limitations, including percentage restrictions, based on the Bank's total assets. Savings banks may invest funds in certain types of debt and equity securities, including obligations of federal, state and local governments agencies. Investment in debt securities of local governmental units may not exceed 50% of capital and temporary borrowings of any local governmental unit maturing within one year from the date of issue may not exceed 60% of capital. Investment in short-term commercial paper issued by a financial institution, corporation or other borrower must have a maturity of two to 270 days and be rated in one of the four highest categories by a nationally recognized rating service. Subject to the prior approval of the DFI, compliance with capital requirements and certain other restrictions, savings banks may invest in residential housing development projects. Savings banks may invest in service corporations or subsidiaries with the prior approval of the DFI and subject to the condition that the service corporation or subsidiary engages in only those activities pre-approved by the DFI, agrees to be audited annually by a certified public accountant, agrees to bear the expense of all examinations and audits conducted by the DFI, and agrees not to enter into a business venture, directly or indirectly, with an officer, director or employee of the savings bank. 30 The lending and investment powers of Wisconsin savings banks also are limited by FDIC regulations and other federal law and regulations. See "Federal Deposit Insurance Corporation Improvement Act of 1991-Restrictions Upon State-Chartered Banks". Loans to One Borrower Wisconsin-chartered savings banks may make loans and extensions of credit, both direct and indirect, to one borrower in amounts up to 15% of capital plus an additional 10% for loans fully secured by readily marketable collateral. In addition, savings banks may make loans to one borrower for any purpose in an amount not to exceed $500,000, or to develop domestic residential housing units in an amount not to exceed the lesser of $30 million or 30% of capital, provided certain conditions are satisfied. At March 31, 1998, the Bank did not have any loans that exceeded the loans-to-one borrower limitations. Qualified Thrift Requirement As a Wisconsin-chartered savings bank, the Bank must qualify for and maintain a level of qualified thrift investments equal to 60% of its assets as prescribed in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended ("Internal Revenue Code"). At March 31, 1998, the Bank maintained 97.8% of its assets in qualified thrift investments and therefore met the qualified thrift requirement. Dividend Limitations A savings bank that meets its regulatory capital requirement may declare dividends on capital stock based upon net profits, provided that its paid-in surplus equals its capital stock. If the paid-in surplus of the savings bank does not equal its capital stock, the board of directors may not declare a dividend unless at least 10% of the net profits of the preceding half year in the case of quarterly or semi-annual dividends, or 10% of the net profits of the preceding half year in the case of quarterly or semi-annual dividends, or 10% of the net profits of the preceding year in case of annual dividends, has been transferred to paid-in surplus. In addition, prior approval of the DFI is required before dividends exceeding 50% of profits for any calendar year may be declared and before a dividend may be may be declared out of retained earnings. Under the DFI's regulations, a savings bank that has converted from mutual to stock form also is prohibited from paying a dividend on its capital stock if the effect thereof would cause the regulatory capital of the savings bank to be reduced below the amount required for its liquidation account. Liquidity Under the DFI's regulations, savings banks are required to maintain an average daily balance of liquid assets of not less than 8% of its average daily balance during the preceding calendar month of its net withdrawable accounts plus its short-term borrowings. At least 50% of the minimum liquid assets shall consist of primary 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. Other liquid assets that are not primary liquid assets include mortgage backed securities, certain mortgage derivative securities, securities issued by other states and political subdivisions in other states, and other securities authorized by the DFI as investments for which a secondary resale market exists, including authorized mutual fund investments. On March 31, 1998, the Bank's liquidity ratio was 15.2%. Federal Deposit Insurance Corporation Improvement Act of 1991 The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), enacted in December 1991, addressed the safety and soundness of deposit insurance funds, and supervision and other regulatory actions relating to the banking industry. The goal of FDICIA was to reduce the overall risks within the thrift and banking system and financial markets. FDICIA addressed the following issues: (i) development of a system of risk-based deposit insurance assessments; (ii) supervisory and accounting reforms; (iii) prompt corrective regulatory action; (iv) brokered deposits and interest rate limitations thereon; (v) establishment of uniform lending standards; and (vi) general standards for safety and soundness of insured financial institutions. 31 Risk-Based Insurance Assessments FDICIA required the FDIC to develop a system of risk-based insurance assessments. Under a system implemented in 1994, higher insurance assessment rates are charged to those banks and thrifts deemed to pose greater risk to the deposit insurance funds. Under this system, the FDIC places each insured depository in one of nine risk categories based on its level of capital and other relevant information (such as supervisory evaluations). Each institution's insurance assessment rate is then determined by the risk category in which it has been classified by the FDIC. There is an twenty-seven basis point spread between the highest and lowest assessment rates for SAIF-insured institutions, so that institutions classified as strongest by the FDIC are subject to an annual rate of $0.00 per one hundred dollars of deposits, and institutions classified as weakest by the FDIC are subject to an annual rate of $0.27 per one hundred dollars of deposits (with intermediate annual rates of $0.03, $0.10, $0.17 and $0.24 per $100 of deposits). The Bank has been classified in a risk category that will result in annual assessments of $0.00 per one hundred dollars of deposits. The (FICO) quarterly multiplier is not tied to the FDIC risk calculation. The FICO rate is determined quarterly. For the second quarter of 1997, the FICO SAIF annual rate is $0.065 per one hundred dollars of deposits. The FICO debt service requirement became applicable to all insured institutions on January 1, 1997, in accordance with the Deposit Insurance Act of 1996. The Bank's expense related to federal deposit insurance premiums to the SAIF was $39,000 for the fiscal year ended March 31, 1998. Placement of the Bank in any risk category other than the category having the lowest assessment rate will result in increased SAIF insurance assessments, with a corresponding decrease in net earnings and capital. The Bank does not presently expect that any reasonable foreseeable insurance assessments would significantly impair the Bank's overall financial condition or results of operations. (See Insurance of Deposits) Improved Examinations and Audits FDICIA revised examination and audit procedures to require annual on-site examinations for all depository institutions except those well-capitalized institutions with assets of less $100 million; annual audits by independent public accountants for all insured institutions with assets in excess of $500 million; management of depository institutions to prepare certain financial reports annually and to establish internal compliance procedures; implementation of accounting objectives, standards and requirements through regulations; and restrictions on the receipt of "brokered deposits" and the rates of interest which may be paid on any deposits by institutions which are not "well capitalized" (even if they meet minimum regulatory capital requirements). Prompt Corrective Regulatory Action FDICIA established a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, federal bank regulators are required to take certain supervisory actions with respect to undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. The regulations provide that an insured institution that has total capital to risk-based assets of less than 8.0%, core capital to risk-based assets of less than 4.0%, or a leverage ratio that is less than 4.0%, would be considered "undercapitalized". An insured institution that has total capital to risk-based assets of less than 6.0%, core capital to risk-based assets of less than 3.0%, or a leverage ratio that is less than 3.0%, would be considered "significantly undercapitalized" and an insured institution that has tangible capital to assets ratio equal to or less than 2.0% would be deemed "critically undercapitalized". Subject to limited exceptions, insured institutions in any of the undercapitalized categories are prohibited from declaring dividends, making any other capital distribution or paying a management fee to a controlling person. Undercapitalized and significantly undercapitalized institutions face more severe restrictions. The Bank currently exceeds all applicable regulatory capital requirements and therefore is not subject to prompt corrective action. Brokered Deposits; Interest Rate Limitations FDIC regulations govern the acceptance of brokered deposits by insured depository institutions. The capital position of an institution determines whether and with what limitations an institution may accept brokered deposits. A "well-capitalized" institution (one that significantly exceeds specified capital ratios) may accept brokered deposits 32 without restriction. "Undercapitalized" institutions (those that fail to meet minimum regulatory capital requirements) may not accept brokered deposits and "adequately capitalized" institutions (those that are not "well-capitalized" or "under-capitalized") may only accept such deposits with the consent of the FDIC. The definition of "well-capitalized", "adequately capitalized" and "undercapitalized" governing the acceptance of brokered deposits conform to the definitions used in the regulations implementing the prompt corrective action provisions of the FDICIA. The Bank is a "well-capitalized" institution and therefore may accept brokered deposits without restriction. At March 31, 1998, the Bank had no brokered deposits. Uniform Lending Standards Savings institutions must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit secured by liens or interests in real estate or made for the purpose of financing permanent improvements to real estate. Those policies must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value limits) that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. The real estate lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies adopted by federal bank regulators. The Bank has adopted and maintains such policies. Standards for Safety and Soundness FDICIA required federal bank regulators to prescribe operational and managerial standards for all insured depository institutions and depository institution holding companies relating to internal controls, information systems and audit systems; loan documentation; credit underwriting interest rate risk exposure; asset growth; and compensation fees and benefits. The compensation standards would prohibit employment contracts, compensation or benefit arrangements, stock option plans, fee arrangements or other compensatory arrangements that would provide excessive compensation, fees or benefits or could lead to material financial loss. In addition, federal bank regulators were required to prescribe standards relating to asset quality, earnings and stock valuation that the regulators determined to be appropriate. On September 23, 1994, the Riegle Community Development and Regulatory Improvement Act of 1994 (the "RCDRIA") was enacted. The RCDRIA amended Section 39 of the Federal Deposit Insurance Act of 1950 ("FDI Act"): (1) To authorize the federal bank regulators to establish safety and soundness standards by regulation or by guideline for all insured depository institutions; (2) to give the regulators greater flexibility in prescribing asset quality and earnings standards; and (3) to eliminate the requirement that standards prescribed under Section 39 apply to depository institution holding companies. On July 10, 1996, federal bank regulators adopted Interagency Guidelines Establishing Standards for Safety and Soundness (the "Guidelines") and also adopted a final rule establishing deadlines for submission and review of safety and soundness compliance plans. Federal bank regulators are authorized, but not required, to soundness standards set out in the Guidelines. An institution must file a compliance plan within 30- days of a request to do so from the institution's primary federal regulator. Regulators expect to request a compliance plan from an institution whose failure to meet one or more of the standards is of such severity that it could threaten the safe and sound operation of the institution. With respect to internal controls, information systems and internal audit systems of institutions, the Guidelines prescribe the functions that adequate internal controls and information systems must be able to perform, rather than providing the types of controls or systems that must be present in every case. Each institution is required to have an internal audit system that provides for adequate testing and review of internal controls and information systems. The Guidelines do not specify in detail what loan documentation must contain. Documentation practices would be evaluated based upon each institution's ability to: make informed decisions and assess risk on an ongoing basis; identify the purpose of the loan and assess the ability of the borrower to repay the indebtedness in a timely manner; insure that any claim against a borrower is legally enforceable; demonstrate appropriate administration and monitoring of the loan; and take account of the size and complexity of the loan. The Guidelines would establish general parameters of safe and sound credit underwriting practices, and require each institution to establish and 33 maintain prudent credit underwriting practices commensurate with the size of the institution and the nature and scope of its lending activities With respect to interest rate risk management, the Guidelines require institutions to manage interest rate risk in a manner appropriate to the size of the institution and the complexity of its assets and liabilities. Larger institutions that are exposed to significant interest rate risk would be expected to significant interest rate risk would be expected to maintain a more formal system for the measurement and management of such risk. Further, an institution is required to base its asset growth on a plan that reflects consideration of: (i) the source, volatility and use of the funds that support asset growth; (ii) any increase in credit risk or interest rate as a result of growth; and (iii) the effect of growth on institution's capital. The Guidelines also require an institution to base its asset growth on a plan that fully considers the source of an institution's growth, the risks presented by such growth and the effect of growth on the institution's capital. Regulators will evaluate asset growth against an institution's overall strategic plan for growth. In addition, the Guidelines require that each institution maintain safeguards to prevent the payment of compensation, fees, or benefits that are excessive or could lead to material financial loss. Compensation that is unreasonable or disproportionate to the services actually performed by the individual being compensated would be considered excessive. In making such a determination, the federal regulators would consider all relevant factors, including the compensation history of the individual and other individuals with comparable expertise at the institution, the financial condition of the institution, comparable compensation packages at comparable institutions, and any connection between an individual and any wrongdoing at the institution. The final rule does not set forth any standards related to asset quality and earnings in the final Guidelines. Federal regulators intend to add revised asset quality and earnings standards to the Guidelines after receiving comments and finalizing such standards. The federal regulators also concluded that establishing stock valuation standards for publicly traded institutions is not appropriate. Regulators intend to continue monitoring of publicly-traded institutions through the review of stock price market price to book value rations, bond ratings and other indicators of the market's assessment of an institution's performance. The Bank believes that its operational and managerial standards substantially comply with the standards set forth in the Guidelines and that compliance with the Guidelines will therefore not impose a significant burden on Bank operations. Restrictions Upon State-Chartered Banks The FDICIA added a new Section 24 to the Federal Deposit Insurance Act of 1050 ("FDI Act") which generally limits the activities and equity investments of FDIC-insured state-chartered banks and their subsidiaries to those permissible for federally chartered national banks and their subsidiaries, unless such activities and investments are specifically exempted by Section 24 or consented to by the FDIC. FDIC regulations governing the equity investments of such banks generally prohibit certain equity investments by such banks and require the divestiture of such investments by December 19, 1996. Banks holding impermissible equity investments that do not receive FDIC approval must submit to the FDIC a plan for divesting such investments as quickly and as prudently as possible. The Bank had FDIC approval to hold its impermissible equity investment until May 31, 2000. On May 8, 1998, the Bank sold all of its impermissible equity investments. Under FDIC regulations, insured savings banks must obtain the FDIC's prior approval before directly, or indirectly through a majority-owned subsidiary, engaging "as principal" in any activity that is not permissible for a national bank unless certain exceptions apply. Under the activity regulations, FDIC-supervised state banks will not be permitted to directly engage in commercial ventures or any insurance underwriting activity other than to the extent such activities are permissible in commercial ventures or any insurance underwriting activity other than to the extent such activities are permissible for a national bank or a national bank subsidiary or except for certain limited insurance underwriting activities. In addition, the activity regulations provide that state banks which meet all regulatory capital requirements may engage in certain activities that are not permissible for national banks which are deemed not to present a significant risk to the insurance fund, including guaranteeing certain obligations of other, activities which the FRB has found to be closely related to banking and certain securities activities conducted through 34 subsidiaries. The FDIC will not approve an activity it determines would present a significant risk to the FDIC insurance funds. The activities of the Bank are of a type permissible under the FDICIA and FDIC regulations. As an SAIF-insured, state-chartered savings bank which was formerly a state-chartered savings association, the Bank continues to be subject to certain restrictions which are imposed by federal law on state-chartered savings associations, including a prohibition against engaging in activities (other than as agent for its customers) that are not permissible for a federally chartered savings association or engaging in activities authorized for federally chartered associations, but to a greater extent than authorized for federally chartered associations, unless the association met its fully phased-in capital requirements and the FDIC determined that the activity will not pose a significant risk to the deposit insurance fund. Effective December 8, 1993, the FDIC amended its regulations to delete certain provisions requiring SAIF-insured state banks to continue to comply with certain restrictions applicable to state-chartered savings associations. The effect of such amendment is to treat SAIF-insured state banks and Bank Insurance Fund ("BIF") member state banks the same rather than subject such institutions to additional restrictions based on insurance fund membership. Effect of FDICIA on Operations and Financial Condition of the Bank While management of the Bank cannot predict the final impact of FDICIA upon the financial condition and operations of the Bank, management believes that FDICIA may subject the Bank to significantly increased operational costs through higher deposit insurance premiums and compliance costs and, if the capital ratios of the Bank should decline significantly, the Bank may become subject to more severe regulatory action than was possible under prior law and regulations. Capital Maintenance FDIC Regulation FDIC-insured institutions are required to follow certain capital adequacy guidelines that prescribe minimum levels of capital and require that institutions meet certain risk-based and leverage capital requirements. Under the FDIC capital regulations, the Bank is required to meet the following capital standards: (i) "Tier 1 capital" in an amount not less than 3% of total assets; (ii) "Tier 1 capital" in an amount not less than 4% of risk-weighted assets; and (iii) "total capital" in an amount not less than 8% of risk-weighted assets. FDIC-insured institutions in the strongest financial and managerial condition (with a composite rating of "1" under the Uniform Financial Institutions Rating System established by the Federal Financial Institutions Examination Council) are required to maintain "Tier 1 capital" equal to at least 3% of total assets (the "leverage limit requirement"). Tier 1 capital is defined to include the sum of common stockholders' equity, noncumulative perpetual preferred stock (including any related surplus), and minority interests in consolidated subsidiaries, minus all intangible assets (with certain exceptions), identified losses and qualifying investments in securities subsidiaries. An institution that fails to meet the minimum leverage limit requirement must file a capital restoration plan with the appropriate FDIC regional director that details the steps it will take to reach capital 35 compliance. At March 31, 1998, the Bank's ratio of Tier 1 capital to total assets was 9.21% or 6.21% in excess of the minimum leverage limit requirement. FDIC-insured institutions also are required to adhere to certain risk-based capital guidelines that are designed to provide a measure of capital more sensitive to the risk profiles of individuals banks. In evaluating capital adequacy, the FDIC also will assess the exposure to declines in the economic value of the Bank's capital due to changes in interest rates. Under the risk-based capital guidelines, capital is divided into two tiers: core (Tier 1) capital, as defined above, and supplementary capital (Tier 2). Tier 2 capital is limited to 100% of core capital and includes cumulative perpetual preferred stock, perpetual preferred stock, mandatory convertible securities, subordinated debt, unrealized losses on securities, intermediate preferred stock and allowance for possible loan and lease losses. Allowance for possible loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Total capital is the sum of Tier 1 and Tier 2 capital. The risk-based capital framework assigns balance sheet assets to one of four broad risk categories that are assigned risk-weights ranging from 0% to 100% based primarily on the degree of credit risk associated with the obligor. Off-balance sheet items are converted to an on-balance sheet "credit equivalent" amount utilizing certain conversion factors. The weighted sum of the four risk-weighted categories equals risk-weighted assets. At March 31, 1998, the Bank's risk-weighted capital ratio was 14.74%, or 6.74% in excess of the FDIC requirement and the Bank's total capital ratio was 9.72% or 5.72% in excess of the FDIC requirement. Wisconsin Regulation Wisconsin-chartered savings banks are required to maintain a minimum capital to assets ratio of 6% and must maintain total capital necessary to ensure the continuation of insurance of deposit accounts by the FDIC. If the DFI determines that the financial condition, history, management or earning prospects of a savings bank are not adequate, the DFI may require a higher minimum capital level for the savings bank. If a savings bank's capital ratio falls below the required level, the DFI may direct the savings bank to adhere to a specific written plan established by the DFI to correct the savings bank's capital deficiency, as well as a number of other restrictions on the savings bank's operations, including a prohibition on the declaration of dividends. At March 31, 1998, the Bank's total capital, as calculated under Wisconsin law, was $ 9.2 million or 9.06% of total assets, which was 3.06% in excess of the required amount. Insurance of Deposits The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. Two separated insurance funds, the Bank Insurance Fund ("BIF") and the Savings Associations Insurance Fund ("SAIF") are maintained and administered by the FDIC. The Bank is a member of SAIF and the FDIC has examination authority over the Bank. The FDIC is authorized to establish separate annual assessment rates for deposit insurance for members of the BIF and SAIF. The FDIC may increase assessment rates for either fund if necessary to restore the fund's ratio of reserves to insured deposits to it target level within a reasonable time and may decrease such assessment rates if such target level has been met. The FDIC has established a risk-based assessment system for both SAIF and BIF members. Under this system, assessments are set within a range, based on the risk the institution poses to its deposit insurance fund. This risk level is determined based on the institution's capital level and the FDIC's level of supervisory concern about the institution. Because a significant portion of the assessments paid into the SAIF by savings associations were used to pay the cost of prior thrift failures, the reserves of the SAIF were below the level required by law. The BIF had, however, met its required reserve level during the third calendar quarter of 1995. As a result, deposit insurance premiums for deposits insured by the BIF were substantially less than premiums for SAIF-insured deposits. On September 30, 1996, President Clinton signed banking legislation to resolve the deposit insurance premium disparity. The banking package also included extensive regulatory relief for banks and thrifts. The BIF-SAIF package contains the following core elements for resolving the deposit premium disparity: Special Assessment. A one-time special assessment on SAIF deposits was imposed to bring the fund's reserve ration to the statutory 1.25 percent. The assessment rate was approximately 65.7 basis points on deposits as of March 31, 1995. The bill clarifies that the special assessment is deductible for tax purposes in the year paid. The special assessment amounted to $350,000 to the Bank and is reflected in the financial data reported as of March 31, 1997. FICO Sharing. Pro-rata sharing of the Financing Corporation obligation among BIF-SAIF members will begin by January l, 2000. This obligation was previously paid by only SAIF members. From 1997 through 1999, partial sharing will occur, with SAIF deposits assessed 6.44 basis points and BIF deposits 1.29 basis points. SAIF and BIF Rates. Through December 31, 1998, the assessment rate for SAIF deposits cannot be lower than the rate for BIF deposits. Reserve Ratio, Rebates The FDIC is prohibited from setting the semiannual assessment at a rate in excess of what is needed to maintain or meet the required reserve ratio. Until the funds are merged, the FDIC is permitted to rebate or credit excess premiums to BIF members only. Deposit Migration For a three-year period, the banking regulators are authorized to prevent SAIF-insured institutions from "facilitating or encouraging" customers to shift their deposits to BIF-insured affiliates for the purpose of evading the SAIF premium. 36 Funds Merger. The BIF and SAIF insurance funds will merge to form the Deposit Insurance Fund on January 1, 1999, if there are no savings associations (not including state savings banks) in existence on that date. The statute is silent on when, how or if rechartering will occur. Timetable. Pro-rata FICO sharing will begin and the ban on deposit shifting will end on the earlier of January 1, 2000, or when the last savings association ceases to exist. Charter Reform. The Treasury Department was directed to report to Congress by March 31, 1997, with its recommendations on a common charter for banks and savings institutions. Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the DFI. Management of the Bank does not know of any practice, condition or violation that might lead to the termination of deposit insurance. On October 5, 1994, the FDIC issued an "Advanced Notice of Proposed Rulemaking" pursuant to which the FDIC is soliciting comments on whether the deposit-insurance assessment base currently provided for in the FDIC's assessment regulations should be redefined. As a result of the recent transition to a risk-based deposit insurance system, effective January 1, 1994, the assessment base, which had been determined by statute pursuant to the FDI Act, is now determined by the FDIC by regulation. At present, however, the FDIC's assessment base regulations continue to be based on the statutory provisions under the FDI Act. Under current law, insurance premiums paid to the FDIC are calculated by multiplying the institution's assessment base (which equals total domestic deposits, as adjusted for certain elements) by its assessment rate. Based on the change to the new deposit insurance system, developments in the financial services industry, changes in the activities of depository institutions and other factors, the FDIC seeks comments on whether the assessment base should be redefined. The FDIC has stated that review of the definition of "assessment base" does not signal any intent to enhance the total dollar amount of assessments collected, but that such redefinition may impact the assessments paid on an institution-by-institution basis. Until final regulations are adopted affecting the definition of an institution's assessment base, the Bank cannot predict what impact such regulation may have on Bank operations. Restrictions on Loans to and Transactions with Insiders and Affiliates In accordance with Section 22(h) of the Federal Reserve Act of 1913, as amended ("Federal Reserve Act"), FRB regulations limit the total amount a savings bank may lend to its executive officers, directors, principal shareholders and their related interests ("affiliated persons"). Generally, an affiliated person may borrow an aggregate amount not exceeding 15% of a savings bank's unimpaired capital and unimpaired surplus on an unsecured basis and an additional 10% on a secured basis. The regulations limit, with certain exceptions, the aggregate amount a depository institution may lend to affiliated persons as a class to an amount not exceeding the institution's unimpaired capital and surplus. FRB regulations also provide for certain exceptions from the definition of :extension of credit" that pose a minimal risk to institutions, including extensions of credit secured by obligations fully guaranteed by the federal government, unconditional takeout commitments or guarantees of any U.S. agency, department or wholly owned corporation, or a segregated deposit account at the institution. In addition, the DFI's regulations establish restrictions on loans and other transactions with the Bank's affiliated persons, to ensure that such loans and transactions are on terms that would be available to members of the general public of similar credit status. FDIC-insured state-chartered savings banks must comply with Sections 23A and 23B of the Federal Reserve Act ("Sections 23A and 23B") relating to transactions with affiliates in the same manner and to the same extent as if the savings banks were a Federal Reserve member bank. Generally, Sections 23A and 23B limit the extent to which an insured institution or its subsidiaries may engage in certain covered transactions with an affiliate to an amount equal to 10% of such institution's capital and surplus, and require that all transactions 37 be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, the purchase of assets, issuance of a guaranty and similar other types of transactions. The FDIC, for safety and soundness reasons, may impose more stringent restrictions on savings banks but may not exempt transactions from or otherwise abridge Sections 23A and 23B. Unless prior approval of the DFI is obtained, a savings bank may not purchase, lease or acquire a site for an office building or an interest in real estate from an affiliated person, including a stockholder owning more than 10% of its capital stock, or from any firm, corporation, entity or family in which an affiliated person or 10% stockholder has a direct or indirect interest. The Bank has not been significantly affected by the applicable restrictions on loans to and transactions with affiliates. Community Reinvestment Act Under the Community Reinvestment Act of 1977, as amended ("CRA"), as implemented by FDIC regulations, the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services it believes are best suited to its particular community. The CRA requires the FDIC, in connection with its examination of a bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The Financial Institutions Reform Recovery and Enforcement Act of 1989 ("FIRREA") amended the CRA to require, effective July 1, 1990, public disclosure of an institution's CRA rating and require the FDIC to provide a written evaluation of an institution's CRA performance. The Bank had a CRA examination on February 12, 1998, and received a "Outstanding" CRA rating. On May 4, 1995, the federal banking regulators adopted a final rule ("Final CRA Rule") governing compliance with CRA. The Final CRA Rule eliminates the previous CRA regulation's twelve assessment factors and substitutes a performance based evaluation system. The Final CRA Rule will be phased in over a period of time and become fully effective by July 1, 1997. Under the Final CRA Rule, an institution's performance in meeting the credit needs of its entire community, including low- and moderate-income areas, as required by the CRA, will generally be evaluated under three assessment tests relating to lending, investment and service. The lending test analyzes lending performance using five criteria: (i) the number and amount of loans in the institution's assessment area, (ii) the geographic distribution of lending, including the proportion of lending in the assessment area, the dispersion of lending in the assessment area, and the number of amount of loans in low-, moderate-, and upper-income areas in the assessment area. (iii) borrower characteristics, such as the income level of individual borrowers and the size of businesses or farms, (iv) the number and amount, as well as the complexity and innovativeness of an institution's community development lending and (v) the use of innovative or flexible lending practices in a safe and sound manner to address the credit needs of low- or moderate-income individuals or areas. The investment test analyzes investment performance using four criteria: (i) the dollar amount of qualified investments, (ii) the innovativeness or complexity of qualified investments, (iii) the responsiveness of qualified investments to credit and community development needs, and (iv) the degree to which the qualified investments made by the institution are not routinely provided by private investors. The service test analyzes service performance using six criteria: (i) the institution's branch distribution among low-, moderate-, and upper-income areas, (ii) its record of opening and closing branches, particularly in low- and moderate-income areas, (iii) the availability and effectiveness of alternative systems for delivering retail banking services, (iv) the rate of services provided in low-, moderate-, middle- and upper-income areas and extent to which those services are tailored to meet the needs of those areas, (v) the extent to which the institution provides community development services, and (vi) the innovativeness and responsiveness of community development services provided. Financial institutions with assets of less than $250 million, or a financial institution with assets of less than $250 million that is a subsidiary of a holding company with assets of less than $1 billion, will be evaluated 38 under a streamlined assessment method based primarily on its lending record. The streamlined test considers an institution's loan-to-deposit ration adjusted for seasonal variation and special lending activities, its percentage of loans and other lending related businesses and farms of different sizes, the geographic distribution of its loans and its record of taking action, if warranted, in response to written complaints. In lieu of being evaluated under the three assessment tests or the streamlined test, a financial institution can adopt a "strategic plan" and elect to be evaluated on the basis of achieving the goals and benchmarks outline in the strategic plan. Based upon a review of the Final CRA Rule, management of the Company does not anticipate that the new CRA regulations will adversely affect the Bank. Federal Reserve System Regulation D, promulgated by the FRB, imposes reserve requirements on all depository institutions, including savings institutions, which maintain transaction accounts or non-personal time deposits. Checking accounts, NOW accounts and certain other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits (including certain money market deposit accounts) at a savings institution. A depository institution must maintain average daily reserves equal to 3% of the first $47.8 million of net transaction accounts and 10% of net transaction accounts in excess of $47.8 million. There has been a 0% reserve requirement on non-personal deposits since December 27, 1990. In addition, the first $4.4 million of otherwise reserveable liabilities are exempt from the reserve requirement. These percentages and tranches are subject to adjustment by the FRB. The Bank satisfies its reserve requirements on an on-going basis by maintaining average balances of vault cash and non-interest bearing reserve deposits with the FHLB-Chicago (which are passed through to the FRB) which in total are greater than or equal to its required daily average balance. Thrift institutions also have authority to borrow from the Federal Reserve Bank "discount window", but FRB policy generally requires thrift institutions to exhaust all sources before borrowing from the Federal Reserve System. The Bank had no discount window borrowings as of March 31, 1998. Federal Home Loan Bank System The Federal Home Loan Bank System, consisting of twelve FHLBs, is under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated duties of the FHFB are to supervise the FHLBs; ensure that the FHLBs carry out their housing finance mission; ensure that the FHLBs remain adequately capitalized and able to raise funds in the capital market; and ensure that the FHLBs operate in a safe and sound manner. The Bank, as a member of the FHLB-Chicago, is required to acquire and hold shares of capital stock in the FHLB-Chicago in an amount equal to the greater of (i) 1% of the aggregate outstanding principal amount of residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, (ii) 0.3% of total assets, or (iii) 1/20 of its advances (borrowings) from the FHLB-Chicago. The Bank is in compliance with this requirement with an investment in FHLB-Chicago stock of $1,159,000 at March 31, 1998. Among other benefits, the FHLBs provide a central credit facility primarily for member institutions. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes advances to members in accordance with policies and procedures established by the FHFB and the Board of Directors of the FHLB-Chicago. At March 31, 1998, the Bank had $19.1 million in advances from the FHLB-Chicago. Holding Company Regulation Federal Regulation The Company is a registered bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the "BHCA"). The Company is subject to examination, regulation and periodic reporting under the BHCA, as administered by the FRB. The FRB has adopted capital adequacy guidelines for bank holding companies (on a consolidated basis) substantially similar to those of the FDIC for the Bank. The Company's total and Tier 1 capital significantly exceed such capital adequacy requirements. 39 The Company is required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior FRB approval will be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of such bank or bank holding company. The BHCA also prohibits the acquisition by the Company of more than 5% of the voting shares or substantially all the assets of a bank located outside the State of Wisconsin unless such an acquisition is specifically authorized by the laws of the state in which such bank is located The Company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities of the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemption's during the preceding twelve months, is equal to 10% or more of the Company's consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. A bank holding company generally is prohibited from engaging in, or acquiring direct or indirect control of any company engaged in, non-banking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities the FRB has determined by regulation to be so closely related to banking are: (i)making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring and/or operating a savings and loan association. Under FIRREA, depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This law would have potential applicability if the Company ever acquired as a separate subsidiary a depository institution in addition to the Bank. Pursuant to FRB policy, dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with its capital needs, asset quality and overall financial condition. The FRB policy also requires that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity. These policies could affect the ability of the Company to pay cash dividends. Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions imposed by the Federal Reserve Act on any extension of credit to, or purchase of assets from, or letter of credit on behalf of, the bank holding company or its subsidiaries, and on the investment in or acceptance of stocks or securities of such holding company or its subsidiaries as collateral for loans. In addition, provisions of the Federal Reserve Act and FRB regulations limit the amounts of, and establish required procedures and credit standards with respect to, loans and other extensions of credit to officers, directors and principal shareholders of the Bank, the Company, any subsidiary of the Company and related interests of such persons. See "Restrictions of Loans to and Transactions with Insiders and Affiliates". Moreover, subsidiaries of bank holding companies are prohibited from engaging in certain tie-in arrangements (with the Company or any of its subsidiaries) in connection with any extension of credit, lease or sale of property or furnishing of services. The Company and its subsidiary, the Bank are affected by the monetary and fiscal policies of various agencies of the United States government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is impossible for management of the Company to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of the Company. 40 State Savings Bank Holding Company Regulation In addition to the FRB bank holding company regulations, a bank holding company that owns or controls, directly or indirectly, more than 25% of the voting securities of a state savings bank also is subject to regulation as a savings bank holding company by the Commissioner. The FDIC has not yet issued proposed regulations governing savings bank holding companies. Acquisition of the Holding Company Under the federal Change in Bank Control Act of 1978, as amended ("CBCA"), a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company's shares of Common Stock outstanding, unless the FRB has found that the acquisition will not result in a change in control of the Company. Under the CBCA, the FRB has 60 days within which to act on such notices, taking into consideration certain factors, including the financial and managerial resources of the acquirer, the convenience and needs of the communities served by the Company and the Bank, and the anti-trust effects of the acquisition. Under the BHCA, any company would be required to obtain prior approval generally is defined to mean the ownership to control in any manner the election of a majority of the Company's directors. in addition, the BHCA prohibits the acquisition of the Company by a bank holding company located outside the State of Wisconsin, unless such acquisition is specifically authorized by Wisconsin law. Federal Securities Laws The Company filed with the SEC a registration statement under Securities Act of 1933, as amended (the "Securities Act"), for the registration of the Common Stock issued pursuant to the Conversion. Upon completion of the Conversion, the Company's Common Stock was registered with the SEC under Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act. The registration under the Securities Act of the shares of the Common Stock does not cover the resale of such shares. Shares of Common Stock purchased by persons who are not affiliates of the Company may be resold without registration. Shares purchased by an affiliate of the Company will be subject to the resale restrictions of Rule 144 under the Securities Act. If the Company meets the current public information requirements of Rule 144 under the Securities Act, each affiliate of the Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of certain other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (i) 1% of the outstanding shares of Common Stock of the Company, or (ii) the average weekly volume of trading in such shares during the preceding four calendar weeks. 41 ITEM 2. DESCRIPTION OF PROPERTY. Properties The Company conducts its business through three full-service office locations that are located in Polk, St. Croix and Burnett Counties, Wisconsin. The Company owns all of the properties on which its offices are located. Management believes the Company's current facilities are adequate to meet its present and immediately foreseeable needs. A list of the Company's offices is as follows: Net Book Value of Properties and Year Improvements at Office Location Opened March 31, 1998 - - --------------- ------- -------------- Amery/Home Office 1936 $1,210,000 234 S Keller Avenue PO Box 46 Amery, WI 54001 New Richmond Office 1972 910,000 532 S. Knowles Avenue New Richmond, WI 54017 Siren Office 1975 127,000 24082 Highway 35 N ---------- Siren, WI 54872 Net Book Value $2,247,000 ---------- 42 ITEM 3. LEGAL PROCEEDINGS The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business, which in the aggregate involve amounts that are believed by management to be material to the financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of shareholders of the Company during the three months ended March 31, 1998. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Information required by this item is included under the heading "Notes to Financial Statements of Northwest Equity Corp." and "Shareholder Information" in the Registrant's Annual Report to Shareholders for the fiscal year ended March 31, 1998, which has been filed separately pursuant to Rule 14a-3 under the Securities Exchange Act of 1934 as amended and in accordance with General Instruction E(2) to Form 10-KSB, and which sections are hereby incorporated herein by reference. The Board of Directors of the Registrant declared a dividend of $0.16 per share to shareholders of record on April 24, 1998. Future payments of dividends will be subject to determination and declaration by the Registrant's Board of Directors, which will take into account the Registrant's financial condition, results of operations, tax considerations, industry standards, economic conditions and other factors, including the regulatory restrictions which affect the payment of dividends by the Bank to the Company. There can be no assurance that dividends will be paid on the shares of Common Stock or that, if paid, such dividends will not be reduced or eliminated in future periods. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Information required by this item is included under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations of Northwest Equity Corp." in the Registrant's Annual Report to Shareholders for the fiscal year ended March 31, 1998, which has been filed with the Securities and Exchange Commission separately pursuant to Rule 14a-3 under the Securities Exchange Act of 1934 as amended and in accordance with General Instruction E(2) to Form 10-KSB, and which section is hereby incorporated herein by reference. ITEM 7. FINANCIAL STATEMENTS. Information required by this item is included under headings "Consolidated Financial Statements of Northwest Equity Corp." and "Notes to Consolidated Financial Statements of Northwest Equity Corp." in the Registrant's Annual Report to Shareholders for the fiscal year ended March 31, 1998, which has been filed with Securities and Exchange Commission separately pursuant to Rule 14a-3 under the Securities Exchange Act of 1934, as amended and in accordance with General Instruction E(2) to Form 10-KSB, and which sections are hereby incorporated herein by reference. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 43 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, AND CONTROL PERSONS: COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. ---------------------------------------------------- Information required by this item with respect to directors is included under the heading "Matter 1. Election of Directors" in the Registrant's definitive Proxy Statement dated June 17, 1998, relating to the 1998 Annual Meeting of the Shareholders scheduled for July 14, 1998, which has been filed separately with the Securities and Exchange Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934, as amended and in accordance with General Instruction E(3) to Form 10-KSB, not later than 120 days after the end of the Registrant's fiscal year, and which section is hereby incorporated herein by reference. The following information as to the business experience during the past five years is supplied with respect to executive officers of the Registrant who do not serve on the Registrant's Board of Directors. There are no arrangements or understandings between the persons named and any other person pursuant to which such officers were selected, nor are there any family relationships among them. James L. Moore has been Senior Vice President of the Bank since 1990. Mr. Moore joined the Bank in 1975 as an assistant branch manager and was promoted to Vice President in 1988. Information required by this item with respect to Item 405, Compliance with Section 16(a) of the Securities Exchange Act of 1934 as amended is included under the heading "Section 16 Compliance" in the Registrant's definitive Proxy Statement dated June 17, 1998 relating to the 1998 Annual Meeting of Shareholders scheduled for July 14, 1998, which has been filed separately with the Securities and Exchange Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934, as amended and in accordance with General Instruction E(3) to Form 10-KSB, not later than 120 days after the end of the Registrant's fiscal year, and which section is hereby incorporated herein by reference. ITEM 10. EXECUTIVE COMPENSATION. Information required by this item is included under the heading "Compensation of Executive Officers and Directors" in the Registrant's definitive Proxy Statement dated June 17, 1998, relating to the 1998 Annual Meeting of Shareholders scheduled for July 14, 1998, which was been filed separately with the Securities and Exchange Commission pursuant to Rule 14a-6 under Securities Exchange Act of 1934, as amended and in accordance with General Instruction E(3) to Form 10-KSB, not later than 120 days after the end of the Registrant's fiscal year, and which section is hereby incorporated herein by reference. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information required by this item is included under the heading "Security Ownership of Certain Beneficial Owners" in the Registrant's definitive Proxy Statement dated June 17, 1998, relating to the 1998 Annual Meeting of Shareholders Scheduled for July 14, 1998, which has been filed separately with the Securities and Exchange Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934, as amended and in accordance with General Instruction E(3) to Form 10-KSB, not later than 120 days after the end of the Registrant's fiscal year, and which section is hereby incorporated herein by reference. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information required by this item is included under the heading "Indebtedness of Management and Certain Transactions" in the Registrant's definitive Proxy Statement dated June 17, 1998, relating to the 1998 Annual Meeting of Shareholders scheduled for July 14, 1998, which has been filed separately with the Securities and Exchange Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934, as amended and in accordance with General Instruction E(3) to Form 10-KSB, not later than 120 days after the end of the Registrant's fiscal year, and which section is hereby incorporated herein by reference. 44 PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits Required by Item 601: Page Number 2.1 Plan of Conversion of Northwest Savings Bank (as amended)(1) 3.1 Articles of Incorporation of Registrant (1) 3.2 By-Laws of Registrant(1) 3.3 Stock Articles of Incorporation of Northwest Savings Bank (1) 3.4 By-Laws of Northwest Savings Bank (1) 4.1 Specimen Stock Certificate of Registrant (1) 4.2 Specimen Stock Certificate of Northwest Savings Bank (1) 10.1 Northwest Savings Bank Money Purchase Pension Plan (1) 10.2 Northwest Savings Bank Employee Stock Ownership Plan (1) 10.3 Credit Agreement by and between Northwest Savings Bank Employee Stock Ownership Trust and Registrant (1) 10.4 Northwest Savings Bank Incentive Plan (as amended) (1) 10.5 1994 Northwest Equity Corp. Stock Option Plan (1) 10.6 Northwest Equity Corp. Incentive Plan (2) 10.7 Northwest Equity Corp. 1995 Stock Option Plan(2) 10.8 Employment Agreement - Mr. Brian L. Beadle (1) 10.9 Employment Agreement - Mr. James L. Moore (1) 11.1 Statement Regarding Computation of Per Share Earnings 50 13.1 1998 Annual Report to Shareholders 51 21.1 Subsidiaries of Registrant 52 23.1 Consent of Wipfli Ullrich Bertelson LLP 53 99.1 Proxy Statement for 1998 Annual Meeting of Shareholders 54 - - ---------------------------- (1) Incorporated by reference to exhibits filed with Registrant's Form SB-2 Registrant Statement declared effective on August 5, 1994 (Registration Number 33-73264). (2) Incoporated by reference to exhibits filed with Registrant's Form S-8 Registration Statement declared effective on January 23, 1996 (Registration Number 333-878). (b) Reports on Form 8-K A report on Form 8-K dated January 2, 1998, was filed by the Registrant during the three months ended March 31, 1998. Item 4. Changes in Registrant's Certifying Account notified the SEC that Keller and Yoder, the principal accountants that reported on the consolidated financial statements of Northwest Equity Corp. and subsidiaries on April 24, 1997; was acquired by Wipfli Ullrich Bertelson LLP. 45 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NORTHWEST EQUITY CORP. Dated: June 9, 1998 By____/s/Brian L. Beadle______ Brian L. Beadle, President (Principal Executive Officer and Principal Financial and Accounting Officer) In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date __/s/Brian L. Beadle President (Principal Executive Officer June 9, 1998 Brian L. Beadle and Principal Financial Accounting Officer) and Director __/s/Gerald J. Ahlin Director June 9, 1998 Gerald J. Ahlin __/s/Verm E. Albrecht Director June 9, 1998 Vern E. Albrecht __/s/Michael D. Jensen Director June 9, 1998 Michael D. Jensen __/s/Donald M. Michels Director June 9, 1998 Donald M. Michels __/s/Norman M. Osero Director June 9, 1998 Norman M. Osero 46 INDEX TO EXHIBITS Sequentially Numbered Page Exhibit Where Attached Number Exhibits are located 11.l Statement Regarding Computation of Per Share Earnings 48 13.1 1998 Annual Report to Shareholders 49 21.1 Subsidiaries of the Registrant 50 23.1 Consent of Wipfli Ullrich Bertelson LLP 51 99.1 Proxy Statement for 1998 Annual Meeting of Shareholders 52 47 EXHIBIT 11.1 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS Earnings per share is calculated by dividing net income for the period by the weighted average number of shares of common stock outstanding. The computation of net income per common share is as follows: For the twelve months For the twelve months ended March 31, 1998 ended March 31, 1997 ------------------------ -----------------------
Basic Diluted Basic Diluted Net income 1,120,000 1,120,000 710,000 710,000 Common shares issued 1,032,517 1,032,517 1,032,517 1,032,517 Net treasury shares 198,405 198,405 111,677 111,677 Unallocated ESOP shares 59,000 59,000 73,750 73,750 Ungranted shares in incentive plan - - - - Weighted average common shares outstanding 775,112 775,112 847,090 847,090 Common stock equivalents based on the treasury stock method - 39,603 - 11,198 Total weighted average common shares 775,112 814,715 847,090 858,288 and equivalents outstanding Earnings per share $1.44 $1.37 $0.84 $0.83
48 EXHIBIT 13.1 1998 ANNUAL REPORT TO SHAREHOLDERS 49 EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT State of Subsidiary's Ownership Incorporation or Parent Subsidiary Percentage Organization Northwest Equity Corp. Northwest Savings Bank 100% Wisconsin Northwest Savings Bank Amery Service Agency, Inc. 100% Wisconsin Northwest Savings Bank Northwest Investments, Inc. 100% Nevada 50 EXHIBIT 23.1 CONSENT OF WIPFLI ULLRICH BERTELSON LLP ACCOUNTANT'S CONSENT We consent to the use and/or incorporation by reference in the Annual Report on Form n10-KSB of Northwest Equity Corp. for the year ended March 31, 1998, of our report dated April 30, 1998, accompanying the financial statements and schedules of the Company contained, or incorporated by reference, in such Annual Report. __/s/Wipfli Ullrich Bertelson LLP__ Wipfli Ullrich Bertelson LLP Wisconsin Rapids, Wisconsin June 9, 1998 51 EXHIBIT 99.1 PROXY STATEMENT FOR 1998 ANNUAL MEETING OF SHAREHOLDERS 52 EX-27 2 EX 27-FINANCIAL
9 1000 YEAR MAR-31-1998 MAR-31-1998 2,642 3,405 0 0 0 9,545 9,398 78,439 484 98,739 62,278 9,474 627 14,846 0 0 1,033 10,481 98,739 6,969 794 0 7,763 2,893 4,243 3,520 100 0 2,298 1,730 1,120 0 0 1,120 1.44 1.37 3.50 1,363 14 11 289 461 87 10 484 0 0 0
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