-----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, NAUe5kGIGidelIC1Fgy1icZks3DvL2dB+Tqqe6BBQv/PqR8teHFEUyHqeOwfU4Ae sMFIvMXtnPnpqlmAuv8hYw== 0000914317-98-000742.txt : 19981228 0000914317-98-000742.hdr.sgml : 19981228 ACCESSION NUMBER: 0000914317-98-000742 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981223 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EAST TEXAS FINANCIAL SERVICES INC CENTRAL INDEX KEY: 0000929646 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 752559089 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-24848 FILM NUMBER: 98774914 BUSINESS ADDRESS: STREET 1: 1200 S BECKHAM AVE CITY: TYLER STATE: TX ZIP: 75701 BUSINESS PHONE: 9035931767 MAIL ADDRESS: STREET 1: 1200 SOUTH BECKHAM AVE CITY: TYLER STATE: TX ZIP: 75701 10KSB 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended September 30, 1998 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from __________________ to ___________________ Commission file number: 0-24848 EAST TEXAS FINANCIAL SERVICES, INC. - -------------------------------------------------------------------------------- (Name of small business issuer as specified in its charter) Delaware 75-2559089 - -------------------------------------------------------------------------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No. 1200 South Beckham Avenue, Tyler, Texas 75701 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (903) 593-1767 -------------- Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Check whether the issuer (1) 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 issuer was required to file such reports), and (2) has been subject to such requirements for the past 90 days. YES [ X ] NO [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained herein, 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 the issuer's revenues for its most recent fiscal year: $8,624,000. The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the average of the closing bid and ask prices of such stock on the OTC Electronic Bulletin Board as of December 9, 1998 was $9.4 million. (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.) As of December 9, 1998, there were issued and outstanding 1,464,056 shares of the Registrant's Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Part II of Form 10-KSB - Portions of Annual Report to Stockholders for the fiscal year ended September 30, 1998. Part III of Form 10-KSB - Portions of Proxy Statement for 1999 Annual Meeting of Stockholders. Transitional Small Business Disclosure Format: YES [ ] NO [ X ] PART I Item 1. Description of Business General East Texas Financial Services, Inc. (the "Company") is a Delaware corporation organized in 1994 to be the savings and loan holding company of First Federal Savings and Loan Association of Tyler ("First Federal" or the "Association"). First Federal was founded in 1923 as a Texas chartered institution and converted in 1939 to a federally chartered mutual savings and loan association. The Company owns all of the outstanding stock of the Association issued on January 10, 1995, in connection with the completion of its conversion from the mutual to the stock form of organization (the "Conversion"). All references to the Company, unless the context otherwise requires, all references herein to the Association or the Company include the Company and Association on a consolidated basis. The Company's common Stock is traded on the OTC Electronic Bulletin Board under the symbol "ETFS." The Company and the Association are subject to comprehensive regulation, examination and supervision by the Office of Thrift Supervision, Department of the Treasury ("OTS") and by the Federal Deposit Insurance Corporation ("FDIC"). The Association is a member of the Federal Home Loan Bank ("FHLB") System and its deposits are insured by the Savings Association Insurance Fund ("SAIF") to the maximum extent permitted by the FDIC. The Company serves its primary market area, East Texas with a concentration in Smith County, through its main office and loan production office, which are located in Tyler, Texas, a loan production office located in Lindale, Texas and a full service branch located in Whitehouse, Texas. At September 30, 1998, the Company had total assets of $124.0 million, deposits of $86.6 million, borrowings from the FHLB of Dallas of $14.9 million, and stockholders' equity of $20.4 million. The principal business of the Company consists of attracting retail deposits from the general public and investing those funds primarily in one- to four-family residential mortgage loans. To a lesser extent, the Company also originated commercial real estate, one- to four-family construction, multi-family and consumer loans. The Company also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. At September 30, 1998, substantially all of the Company's real estate mortgage loans (excluding mortgage-backed securities) were secured by properties located in Texas, with most of them located in the Company's primary market area. See "--Originations, Purchases and Sales of Loans." The Company has initiated an expansion into full-service commercial banking products and services. In January 1999, the Company will begin offering new products and services, including but not limited to commercial and consumer loans, debit and credit cards, an ATM machine and cards, safe deposit boxes and investment brokerage services. The goal of the expansion is to better serve the Company's existing customers, to attract new customers to diversify into lending products with higher yields and shorter terms, and to increase non-interest income. The Company has established a new branch office location in its primary market and has hired additional personnel to develop commercial and consumer products and services. The Company's revenues are derived primarily from interest earned on loans, mortgage-backed securities and investments and, to a lesser extent, from service charges and loan originations, gains on sales of loans and mortgage-backed securities, and loan servicing fee income. The Company does not originate loans to fund leveraged buyouts, and has no loans to foreign corporations or governments. The Company currently offers a variety of deposit accounts having a wide range of interest rates and terms. The Company's deposits include passbook and money market accounts, NOW checking accounts, and certificate accounts with terms ranging from one month to five years. The Company solicits deposits in its primary market area and does not accept brokered deposits. The Company has recently begun utilizing its borrowing privileges as a member of the FHLB of Dallas. The Company borrows funds from the FHLB of Dallas to fund long term loans and to invest in mortgage-backed securities. "See Mortgage-Backed Securities, Sources of Funds, and Borrowings." The executive offices of the Company are located at 1200 South Beckham Avenue, Tyler, Texas 75701. The telephone number at that address is (903) 593-1767. Forward-Looking Statements When used in this Form 10-KSB or future filings by the Company with the Securities and Exchange Commission, in the Company's press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project", "believe" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, changes in levels of market interest rates, credit risks of lending activities, and competitive and regulatory factors, could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected. The Company does not undertake, and specifically disclaims any obligation, to publicly release the results of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Lending Activities General. Historically, the Company originated fixed-rate one- to four- family mortgage loans. In the early 1980's, the Company began the origination of adjustable-rate mortgage ("ARM") loans for retention in its portfolio, in order to increase the percentage of loans in its portfolio with more frequent repricing or shorter maturities than fixed-rate mortgage loans. The Company has continued to originate fixed-rate residential mortgage loans, however, in response to consumer demand. The Company underwrites the majority of its fixed-rate residential mortgage loans under secondary market guidelines allowing them to be saleable primarily to the Federal National Mortgage Association ("FNMA") with the servicing retained, without recourse, in order to generate fee income and reduce the company's exposure to changes in interest rates. See"--Loan Portfolio Composition" and "--One- to Four-Family Residential Mortgage Lending." The Company's primary focus in lending activities is on the origination of loans secured by first mortgages on owner-occupied one- to four-family residences. To a lesser extent, the Company originates loans secured by commercial real estate, one- to four-family construction, multi-family and consumer loans. At September 30, 1998, the Company's net loans held in portfolio totaled $61.1 million, which constituted 49.3% of the Company's total assets. At that date, the Company had no loans held for sale. The Loan Committee, comprised of Director L. Lee Kidd (Chairman), President Gerald W. Free, Senior Vice President-Lending Joe C. Hobson, Chief Financial Officer Derrell W. Chapman, Treasurer William L. Wilson and Vice President-Compliance/Marketing M. Earl Davis, has the responsibility for the supervision of the Company's loan portfolio with an overview by the full Board of Directors. Loans may be approved by the Loan Committee, depending on the size of the loan, with all loans subject to ratification by the full Board of Directors. Loans in excess of $500,000 require full board approval. In addition, foreclosure actions or the taking of deeds-in-lieu of foreclosure are subject to oversight by the Board of Directors. The aggregate amount of loans that the Company is permitted to make under applicable federal regulations to any one borrower, including related entities, or the aggregate amount that the Company could have invested in any one real estate project, is generally the greater of 15% of unimpaired capital and surplus or $500,000. See "Regulation--Federal Regulation of Savings Associations." At September 30, 1998, the maximum amount that the Company could have lent to any one borrower and the borrower's related entities was approximately $2.8 million. At September 30, 1998, the Company had no loans or lending relationships with an outstanding balance in excess of this amount. The largest amount outstanding to any one borrower, or group of related borrowers, was approximately $1.4 million at September 30, 1998, and was secured by a lien on a commercial real estate property in Tyler being operated as a retail furniture store. The next largest lending relationship outstanding at September 30, 1998 was for $600,000 and was secured by a commercial real estate property operating as a manufacturing firm in Tyler, Texas. At September 30, 1998, the next three largest lending relationships totaled $556,000, $484,000, and $461,000 respectively. The $556,000 loan was secured by a country club located in Tyler, Texas, and the $484,000 loan was secured by a restaurant located in the Tyler, Texas. The $461,000 loan was secured by several duplex rental properties located in the Tyler area. At September 30, 1998, all of these loans were performing in accordance with their respective repayment terms. The Company had no other lending relationships in excess of $450,000 at September 30, 1998. Loan Portfolio Composition. The following information sets forth the composition of the Company's loan portfolios in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts, allowances for losses and loans held for sale) as of the dates indicated.
September 30, --------------------------------------------------------------------------------------------- 1998 1997 1996 1995 Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Real estate loans: One- to four-family residential ........... $52,298 83.34 % $49,412 83.88 % $42,773 85.98 % $34,947 81.55 % Other residential property 551 0.88 569 0.97 701 1.41 724 1.69 Nonresidential property .. 4,106 6.54 4,023 6.83 3,458 6.95 4,387 10.24 Construction loans ....... 2,256 3.60 3,600 6.11 1,806 3.63 1,879 4.38 ------- ----- ------- ----- ------- ----- ------- ----- Total real estate loans 59,211 94.36 57,604 97.79 48,738 97.97 41,937 97.86 ------- ------ ------- ------ ------- ------ ------- ------ Other loans: Loans secured by deposits 403 0.64 488 0.83 500 1.00 404 0.94 Home improvement ......... 517 0.82 563 0.96 455 0.92 451 1.05 Home Equity .............. 2,454 3.91 0 0.00 0 0.00 0 0.00 Commercial ............... 168 0.27 252 0.42 54 0.11 63 0.15 ------- ----- ------- ----- ------- ----- ------- ----- Total other loans ...... 3,542 5.64 1,303 2.21 1,009 2.03 918 2.14 ------- ----- ------- ----- ------- ----- ------- ----- Total loans .............. $62,753 100.00 % 58,907 100.00 % 49,747 100.00 % 42,855 100.00 % ------- ----- ------- ----- ------- ----- ------- ----- Less: Loans in process 1373 1,506 1,514 777 Deferred fees and discounts 28 18 19 22 Allowance for loan losses 233 273 289 296 ------- ------ ------ ------- Total loans receivable, 61,119 57,110 47,925 41,760 net Less: Loans held for sale 0 0 0 0 -------- -------- --------- -------- Net portfolio loans $ 61,119 $ 57,110 $ 47,925 $ 41,760 ======== ======== ========= ========
The following table shows the composition of the Company's loan portfolio by fixed and adjustable rate at the dates indicated.
September 30, ----------------------------------------------------------------------------------------- 1998 1997 1996 1995 ------------------- -------------------- ----------------- ---------------- Amount Percent Amount Percent Amount Percent Amount Percent -------- -------- -------- -------- -------- -------- ------- -------- (Dollars in Thousands) Fixed-Rate Loans Real estate loans: One- to four-family residences $ 41,730 66.50 % $ 36,708 62.32 % $ 29,635 59.57 % $ 24,313 56.73 % Other residential property 551 0.88 569 0.97 701 1.41 724 1.69 Nonresidential property 3,838 6.12 3,595 6.10 2,610 5.25 2,739 6.39 Construction loans 2,256 3.60 3,600 6.11 1,806 3.63 295 0.69 -------- -------- -------- -------- -------- -------- ------- -------- Total fixed-rate real estate loans 48,375 77.09 44,472 75.50 34,752 69.86 28,071 65.50 -------- -------- -------- -------- -------- -------- ------- -------- Other Loans: Loans secured by deposits 403 0.64 488 0.83 500 1.00 404 0.94 Home improvement 517 0.82 563 0.96 455 0.92 451 1.05 Home Equity 2,454 3.91 0 0.00 0 0.00 0 0.00 Commercial 168 0.27 252 0.42 54 0.11 63 0.15 -------- -------- -------- -------- -------- -------- ------- -------- Total other fixed-rate loans 3,542 5.64 1,303 2.21 1,009 2.03 918 2.14 -------- -------- -------- -------- -------- -------- ------- -------- Total fixed-rate loans 51,917 82.73 45,775 77.71 35,761 71.89 28,989 67.64 -------- -------- -------- -------- -------- -------- ------- -------- Adjustable-Rate Loans Real estate loans: One- to four-family 10,568 16.84 12,704 21.56 13,138 26.41 10,634 24.81 residences Other residential property 0 0.00 0 0.00 0 0.00 0 0.00 Nonresidential property 268 0.43 428 0.73 848 1.70 1,648 3.85 Construction loans 0 0.00 0 0.00 0 0.00 1,584 3.70 -------- -------- -------- -------- -------- -------- ------- -------- Total adjustable-rate real estate loans 10,836 17.27 13,132 22.29 13,986 28.11 13,866 32.36 -------- -------- -------- -------- -------- -------- ------- -------- Total loans 62,753 100.00 % 58,907 100.00 % 49,747 100.00 % 42,855 100.00 % ====== ====== ====== ======
Less: Loans in process 1,373 1,506 1,514 777 Deferred fees and discounts 28 18 19 22 Allowance for loan losses 233 273 289 296 -------- -------- ------- -------- Total loans receivable, net 61,119 57,110 47,925 41,760 -------- -------- ------- -------- Less: Loans Held For Sale 0 0 0 0 -------- -------- ------- -------- Net Portfolio Loans $ 61,119 $ 57,110 $ 47,925 $ 41,760 ======== ======== ======= ========
The following schedule illustrates the interest rate sensitivity of the Company's loan portfolio at September 30, 1998. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
Real Estate ----------------------------------------------------------------------------------------------------------------------- One- to Other Four-Family Residential Nonresidential Construction Other Loans Total Loans ----------------- ---------------- ------------------ ----------------- --------------- ---------------- Weighted Weighted Weighted Weighted Weighted Weighted Average Average Average Average Average Average Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate ------ ---- ------ ---- ------ ---- ------ ---- ------ ---- ------ ---- Due During (Dollars in Thousands) Periods Ending September 30, - ------------ 1999 $ 1,242 8.06 % $ 0 0.00 % $ 311 8.33 % $ 883 8.63 % $ 236 7.41 % $ 2,672 8.22 % 2000 3,603 7.69 0 0.00 0 0.00 0 0.00 162 7.58 3,765 7.69 2001 3,303 7.25 0 0.00 181 7.89 0 0.00 159 7.78 3,643 7.31 2002 2,419 7.94 314 7.62 15 9.00 0 0.00 616 7.44 3,364 7.82 2003 1,204 7.44 0 0.00 101 9.50 0 0.00 433 7.69 1,738 7.62 2004 638 8.40 0 0.00 0 0.00 0 0.00 174 8.08 812 8.33 2005 to 4,988 7.86 142 8.79 267 8.20 0 0.00 1,200 8.18 6,597 7.95 2008 2009 to 32,215 7.37 95 7.75 3,231 8.32 0 0.00 562 8.33 36,103 7.47 2018 2019 and 2,425 9.34 0 0.00 0 0.00 0 0.00 0 0.00 2,425 9.34 ------- ------- ------- ------ -------- -------- Total $52,037 $ 551 $ 4,106 $ 883 $ 3,542 $ 61,119 ======= ======= ======= ====== ======== ========
The total amount of loans due after September 30, 1999 which have predetermined interest rates is $49.1 million while the total amount of loans due after such date which have floating or adjustable interest rates is $9.3 million. One- to Four-Family Residential Mortgage Lending. The Company focuses its lending efforts primarily on the origination of conventional loans for the acquisition of owner-occupied, one- to four-family residences. At September 30, 1998, the Company's one- to four-family residential mortgage loans totaled $52.4 million, or 83.6% of the Company's gross loan portfolio. The Company originates these loans primarily from referrals from real estate agents, existing customers, walk-in customers, builders and from responses to the Company's marketing campaign, directed primarily to individuals in its market area. The Company currently originates fixed-rate and ARM loans. During the year ended September 30, 1998, the Company originated $30.4 million and $861,000 of fixed-rate mortgage and adjustable rate mortgage loans, respectively, which were secured by one- to four-family residences. During the same period, the Company sold $10.0 million of fixed-rate real estate loans which were secured by one- to four-family residences. The Company currently originates one- to four-family residential mortgage loans in amounts up to 95% of the appraised value of the security property and generally requires that private mortgage insurance be obtained in an amount sufficient to reduce the Company's exposure to or below 80% of such value. The terms of such loans are generally for up to a maximum term of 30 years. Interest charged on these mortgage loans is competitively prived according to local market conditions. The Company currently offers ARMs with one, three and five year initial terms with adjustments occurring annually thereafter as well as loans that adjust once after five or seven years. All of the annually adjusting ARM loans currently adjust at a margin over the yield on the one year Constant Maturity Treasury Securities Rate. Initial rates on the three and five year ARMs and adjusted rates on the five and seven year ARM products are currently based upon the rate of a United States Treasury Note with a comparable term. ARM loans offered by the Company generally provided for up to a 200 basis point annual cap and a lifetime cap of 500 or 600 basis points greater than the initial rate. ARM loans may not adjust below the initial rate. As a consequence of using caps, the interest rates on the ARMs may not be as rate sensitive as the Company's cost of funds. Borrowers of adjustable rate loans are qualified at the fully indexed rate of interest. The Company has not experienced difficulty with the payment history for these loans. In underwriting one- to four-family residential real estate loans, the Company evaluates both the borrower's ability to make monthly payments and the value of the property securing the loan. Properties securing real estate loans made by the Company are appraised by independent fee appraisers approved and qualified by the Board of Directors. The Company generally requires borrowers to obtain title insurance and fire, property and flood insurance (if required) in an amount not less than the amount of the loan. Real estate loans originated by the Companygenerally contain a "due on sale" clause allowing the Company to declare the unpaid principal balance due and payable upon the sale of the security property. Commercial Real Estate and Multi-Family Residential Lending. The Company engages in multi-family and commercial real estate lending, including permanent loans secured primarily by apartment buildings, office buildings, and retail establishments in the Company's primary market area. At September 30, 1998, the Company had $4.1 million and $551,000, respectively, of commercial real estate and multi-family loans, which represented 6.5% and .9% respectively, of the Company's gross loan portfolio. Generally, commercial and multi-family real estate loans originated by the Company are fixed-rate loans. To a lesser extent, the Company originates adjustable-rate loans, with annual adjustments based upon either the one year Constant Maturity Treasury Securities Rate or the Chase Manhattan Prime Rate, subject to limitations on the maximum annual and total interest rate increase or decrease over the life of the loan. Commercial real estate loans typically do not exceed 80% of the appraised value of the property securing the loan. The Company analyzes the financial condition of the borrower, the borrower's credit history, the reliability and predictability of the net income generated by the property securing the loan and the value of the property itself. The Company generally requires personal guaranties of the borrowers in addition to the security property as collateral for such loans and personal financial statements on an annual basis. Appraisals on properties securing commercial and multi-family real estate loans originated by the Company are generally performed by independent fee appraisers approved by the Board of Directors. Loans secured by multi-family and commercial real estate are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Commercial real estate and multi-family loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial real estate and multi-family properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. Construction Lending. The Company engages in residential construction lending, with $2.3 million, or 3.6% or its gross loan portfolio in construction loans as of September 30, 1998. The Company offers loans to owner-occupants and builders for the construction of one- to four-family residences. Currently, such loans are offered with terms to maturity of up to nine months and in amounts generally up to 80% of the appraised value of the security property. The Company's construction loans require the payment of interest only on a quarterly basis. The Company generally makes permanent loans on the underlying property consistent with its underwriting standards for one- to four-family residences. The Company also offers loans to a few selected builders in its primary market area to build residential properties in anticipation of the sale of the house or where the house has been presold. Such loans are made for a term of nine months. The Company usually disburses funds on construction loans directly to the builder at certain intervals based upon the completed percentage of the project and inspections of the loans in process are performed by the Company's staff. At September 30, 1998, $2.3 million, or 100% of the Company's gross construction loans, were to builders for the construction of residences which had not been pre-sold. Construction lending generally affords the Company an opportunity to receive interest at rates higher than those obtainable from residential lending. Nevertheless, construction lending is generally considered to involve a higher level of credit risk than one- to four-family residential lending since the risk of loss on construction loans is dependent largely, upon the accuracy of the initial estimate of the individual property's value upon completion of the project and the estimated cost (including interest) of the project. If the cost estimate proves to be inaccurate, the Company may be required to advance funds beyond the amount originally committed to permit completion of the project. In addition, to the extent the borrower is unable to obtain a permanent loan on the underlying property, the Company may be required to modify or extend the terms of the loan. In an effort to reduce these risks, the application process includes a submission to the Company of accurate plans, specifications and costs of the project to be constructed. These items are also used as a basis to determine the appraised value of the subject property. Loans are based on a lesser of current appraised value and/or the cost of construction (land plus building). Construction loans to borrowers other than owner-occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans. Consumer Loans. The Company offers loans secured by savings deposits, home equity and home improvement loans. Substantially all of the Company's consumer loans are originated in its primary market area. These loans are originated on a direct basis. At September 30, 1998, the Company's consumer loan portfolio totaled $3.5 million, or 5.50% of its total gross loan portfolio. Home equity loans accounted for $2.5 million of the total. All consumer loans are currently originated with fixed rates of interest. The Company made the decision to begin offering home equity loans during the fiscal year ended September 30, 1998. Home equity lending was approved by Texas voters in an amendment to the Texas Constitution in November of 1997. Financial institutions were able to begin making loans on January 1, 1998. The Company currently offers home equity loans for up to 80% of the borrower's equity in the property, the maximum allowed by Texas law. Loan terms of up to 15 years are offered at interest rates that are fixed for the term of the loan. Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The underwriting standards employed by the Company for consumer loans include an application, a determination of the applicant's payment history on other debts, employment stability and an assessment of ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Although the level of delinquencies in the Company's consumer loan portfolio has historically been low, at September 30, 1998, four loans, totaling $4,600, or approximately .12% of the consumer loan portfolio, was 60 days or more delinquent. There can be no assurance that delinquencies will not increase in the future. Commercial Business Loans. At September 30, 1998, the Company also had $168,000 in commercial business loans outstanding, or .27 percent of the Company's total loan portfolio. The Company's commercial business lending activities have encompassed loans with a variety of purposes and security, including loans to finance inventory and equipment. Generally, the Company's commercial business lending has been limited to borrowers headquartered, or doing business, in the Company's market area. The Company anticipates significantly increasing its commercial business lending activity during the next fiscal year. Management believes that a sufficient demand for small to medium size commercial business loans exists in the Tyler market to warrant expanding its efforts in commercial lending. In conjunction with a new full-service office to be located in South Tyler, the predominant area of growth in the city, the Company anticipates adding one full-time commercial lending officer and one full-time loan processor to begin its commercial lending program. 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 the 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 on the success of the business itself. Further, 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 itself. Originations, Purchases, Sales and Servicing of Loans and Mortgage-Backed Securities Real estate loans are generally originated by the Company's staff of salaried loan officers. Loan applications are taken and processed at its main office and its loan production offices. In fiscal 1998, the Company originated $31.3 million of loans, compared to $24.7 million and $25.2 million in fiscal 1997 and 1996, respectively. Management attributes the sustained lending activity to continued lower interest rates and economic conditions in the Tyler area. In fiscal 1998, $27.5 million of loans and mortgage-backed securities were repaid, compared to $18.2 million and $21.1 million in fiscal 1997 and 1996, respectively. The Company currently sells its fixed-rate one- to four-family residential mortgage loans with maturities of greater than 15 years, without recourse, to FNMA, generally on a servicing retained basis. Sales of whole loans generally are beneficial to the Company since these sales may generate income at the time of sale, produce future servicing income, provide funds for additional lending and other investments and increase liquidity. The Company sold whole loans in aggregate amounts of $10.0 million, $4.7 million and $7.7 million during the years ended September 30, 1998, 1997, and 1996, respectively. The Company sells loans pursuant to forward sales commitments and, therefore, an increase in interest rates after loan origination and prior to sale should not adversely affect the Company's income at the time of sale. In periods of economic uncertainty, the Company's ability to originate large dollar volumes of real estate loans may be substantially reduced or restricted with a resultant decrease in related loan origination fees, other fee income and operating earnings. In addition, the Company's ability to sell loans may substantially decrease as potential buyers (principally government agencies) reduce their purchasing activities. When loans are sold, the Company typically retains the responsibility for servicing the loans. The Company receives a fee for performing these services. The Company serviced for others mortgage loans amounting to $42.6 million, $39.4 million and $40.1 million at September 30, 1998, 1997, and 1996, respectively. From time to time, the Company has purchased whole loans or loan participations consistent with its loan origination underwriting standards. The company does not currently purchase loans because there is sufficient product available for origination but will consider favorable purchase opportunities as they arise. In addition, the Company purchases mortgage-backed securities, consistent with its asset/liability management objectives to complement its mortgage lending activities. The Board believes that the slightly lower yield carried by mortgage-backed securities is somewhat offset by the lower level of credit risk and the lower level of overhead required in connection with these assets, as compared to one- to four-family, non-residential, multi-family and other types of loans. See "--Mortgaged-Backed Securities." The following table shows the loan and mortgage backed and related securities originations, purchase, sale and repayment activities of the Company for the periods indicated.
Year Ended September 30, ------------------------------------------------ 1998 1997 1996 1995 -------- -------- -------- -------- (Dollars in Thousands) Originations by type: Adjustable rate: Real estate - one- to four-family ..... $ 861 $ 1,874 $ 4,841 $ 9,923 - multi-family ...... 0 0 0 0 - commercial ........ 0 0 0 0 Non-real estate - consumer ............ 0 0 0 0 - commercial business 0 0 0 0 -------- -------- -------- -------- Total adjustable-rate ............... 861 1,874 4,841 9,923 -------- -------- -------- -------- Fixed rate: Real estate - one- to four-family ..... 27,740 21,170 20,208 9,736 - multi-family ...... 0 0 0 0 - commercial ........ 2,506 1,592 170 0 Non-real estate - consumer ............ 52 54 4 3 - commercial business 140 0 0 138 -------- -------- -------- -------- Total fixed-rate .................... 30,438 22,816 20,382 9,877 -------- -------- -------- -------- Total loans originated .............. 31,299 24,690 25,223 19,800 -------- -------- -------- -------- Purchases: Real estate - one- to four-family ....... 0 0 0 0 - multi-family ...... 0 0 0 0 - commercial ........ 0 0 0 0 Non-real estate - consumer .............. 0 0 0 0 - commercial business 0 0 0 0 -------- -------- -------- -------- Total loans purchased ............... 0 0 0 0 Mortgage-backed securities (excluding REMICs and CMOs) .................... 2,482 4,982 913 38,172 REMICs and CMOs ......................... 9,031 0 0 0 -------- -------- -------- -------- Total purchases ............... 11,513 4,982 913 38,172 -------- -------- -------- --------
Sales and Repayments: Real estate - one- to four-family ....... 10,032 4,740 7,718 5,191 - multi-family ...... 0 0 0 0 - commercial ........ 0 0 0 0 Non-real estate - consumer .............. 0 0 0 0 - commercial business 0 0 0 0 -------- -------- -------- -------- Total loans sold .................... 10,032 4,740 7,718 5,191 Mortgage-backed securities .............. 0 0 0 0 -------- -------- -------- -------- Total sales ........................ 10,032 4,740 7,718 5,191 Principal repayments - Loans ............ 17,421 10,742 11,434 8,087 Principal repayments - mortgage-backed securities ............................ 10,069 7,416 9,648 4,371 -------- -------- -------- -------- Total reductions .............. 37,522 22,898 28,800 17,649 -------- -------- -------- -------- Increase (decrease) in other items, net . (38) (30) 37 (159) -------- -------- -------- -------- Net increase (decrease) ............. $ 5,252 $ 6,744 $ (2,627) $ 40,164 ======== ======== ======== ========
Asset Quality Generally, when a borrower fails to make a required payment on real estate secured loans and other loans by the 17th day after such payment is due, the Company institutes collection procedures by mailing a delinquency notice. The customer is contacted again by telephone or letter when the delinquency is not promptly cured. In most cases delinquencies are cured promptly; however, if a loan secured by real estate or other collateral has been delinquent for more than 80 days, a final letter is sent or a telephone call is made demanding payment and the customer is requested to make arrangements to bring the loan current or, if the situation merits, a 30 day foreclosure notice is sent to the borrower. Once a payment is 90 days past due, a 30 day foreclosure notice is sent (if not previously sent) and, unless satisfactory arrangements have been made, immediate repossession or foreclosure procedures will commence. Generally, when a loan becomes delinquent 90 days or more, or when the collection of principal or interest becomes doubtful, the Company will place the loan on a non-accrual status and, as a result, previously accrued by unpaid interest income on the loan is taken out of current income. Each account is handled on an individual basis. The loan will be transferred back to an accrual status if the borrower brings the loan current. The following table sets forth the Company's loan delinquencies by number, amount and percentage of loan category at September 30, 1998.
Loans Delinquent for: ---------------------------------------------------------------- 60 - 89 Days 90 Days and Over Total Delinquent Loans ------------------------------- ------------------------------ --------------------------------- Percent Percent Percent of Loan of Loan of Loan Number Amount Category Number Amount Category Number Amount Category ------ ------ -------- ------ ------ -------- ------ ------ -------- (Dollars in Thousands) Real Estate: One- to four-family 27 $423 0.69 % 12 $217 0.36 % 39 $640 1.05 % Multi-family ...... 1 65 0.11 0 0 0.00 1 65 0.11 Commercial ........ 0 0 0.00 0 0 0.00 0 0 0.00 Construction or development ..... 0 0 0.00 0 0 0.00 0 0 0.00 Consumer .......... 0 0 0.00 4 5 0.00 4 5 0.00 Commercial business 0 0 0.00 0 0 0.00 0 0 0.00 -- ---- ---- -- ---- ---- -- ---- ---- Total ........ 28 $488 0.80 % 16 $222 0.36 % 44 $710 1.16 %
Non-Performing Assets. The table below sets forth the amounts and categories of non-performing assets in the Company's loan portfolio. At all dates presented, the Company had no troubled debt restructurings (which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates). Foreclosed assets include assets acquired in settlement of loans.
September 30, --------------------------------------- 1998 1997 1996 1995 ---- ---- ---- ---- (Dollars in Thousands) Non-accruing loans: One- to four-family ..................... $187 $306 $449 $294 Other loans ............................. 0 4 1 0 ---- ---- ---- ---- Total ............................... 187 310 450 294 ---- ---- ---- ---- Accruing loans delinquent more than 90 days: One- to four-family ..................... 6 0 0 12 ---- ---- ---- ---- Total ............................... 6 0 0 12 ---- ---- ---- ---- Foreclosed assets: One- to four-family ..................... 35 0 0 90 ---- ---- ---- ---- Total ............................... 35 0 0 90 ---- ---- ---- ---- Total non-performing assets ................ $228 $310 $450 $396 ==== ==== ==== ==== Total as a percentage of total assets ...... 0.18% 0.27% 0.39% 0.34% ==== ==== ==== ====
For the year ended September 30, 1998, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $17,000. The amount was included in interest income on such loans was $13,000 for the year ended September 30, 1998. Other Assets of Concern. As of September 30, 1998, there were no assets classified by the Company because of known information about the possible credit problems of the borrowers or the cash flows of the security property have caused management to have some doubts as to the ability of the borrowers to comply with present loan repayment terms and which could result in the future inclusion of such item in the non-performing asset categories. Classified Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by the OTS to be of lesser quality as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the savings association will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. When a savings association classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When a savings association classified problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An association's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the association's Regional Director at the regional OTS office, who may order the establishment of additional general or specific loss allowances. In connection with the filing of its periodic reports with the OTS and in accordance with its classification of assets policy, the Company regularly reviews the loans in its portfolio to determine whether any loans require classification in accordance with applicable regulations. On the basis of management's review of its assets, at September 30, 1998, the Company had classified $570,000 assets as substandard, none as doubtful, and none as loss. Classified assets and nonperforming assets differ in that classified assets may include loans less than 90 days delinquent. Also, assets guaranteed by governmental agencies such as the Veterans Administration or the Federal Housing Administration are not included in classified assets but are included in nonperforming assets. Allowance for Loan Losses. 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 changes in the nature and volume of its loan activity, including those loans which are being specifically monitored by management. Such evaluation, which includes a review of loans for which full collectibility may not be reasonably assured, considers among other matters, the estimated fair 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. Real estate properties acquired through foreclosure are recorded at the lower of cost or fair market value, less estimated disposition costs. If fair value at the date of foreclosure is lower than the balance of the related loan, the difference will be charged-off to the allowance for loan losses at the time of transfer. Valuations are periodically updated by management, and if the value declines, a specific provision for losses on such property is established by a charge to operations. Although management believes that it uses the best information available to determine the allowance, unforeseen market conditions could result in adjustments, and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. Future additions to the Company's allowance will be the result of periodic loan, property and collateral reviews and thus cannot be predicted in advance. At September 30, 1998, the Company had a total allowance for loan losses of $233,000, which equaled 102.2% of nonperforming loans, .38% of total loans and .19% of total assets. See Note 1 of the Notes to Consolidated Financial Statements. The following table sets forth an analysis of the Company's allowance for loan losses.
Year Ended September 30, ------------------------------------------ 1998 1997 1996 1995 ----- ----- ----- ----- (Dollars in Thousands) Balance at beginning of period ............... $ 273 $ 289 $ 296 $ 300 Charge-offs: One- to four-family ....................... (40) (26) (7) (4) Other loans ............................... 0 (1) 0 0 ----- ----- ----- ----- Total charge-offs ..................... (40) (27) (7) (4) ----- ----- ----- ----- Recoveries: One- to four-family ....................... 0 6 0 0 Other loans ............................... 0 0 0 0 ----- ----- ----- ----- Total recoveries ...................... 0 6 0 0 ----- ----- ----- ----- Net charge-offs .............................. (40) (21) (7) (4) Additions charged to operations .............. 0 5 0 0 ----- ----- ----- ----- Balance at end of period ..................... $ 233 $ 273 $ 289 $ 296 ===== ===== ===== ===== Ratio of net charge-offs during the period to average loans outstanding during the period 0.07 % 0.04 % 0.02 % 0.01 % ===== ===== ===== ===== Ratio of net charge-offs during the period to average non-performing assets ............. 14.87 % 5.53 % 1.66 % 1.14 % ===== ===== ===== =====
The distribution of the Company's allowance for losses on loans at the dates indicated is summarized as follows:
September 30, ------------------------------------------------------------------------------------------------------------ 1998 1997 1996 --------------------------------- --------------------------------- ----------------------------------- Percent Percent Percent of Loans of Loans of Loans Loan in Each Loan In Each Loan In Each Amount of Amounts Category Amount Amounts Category Amount of Amounts Category Loan Loss by to Total Loan Loss by to Total Loan by to Total Allowance Category Loans Allowance Category Loans Allowance Category Loans --------- -------- ----- --------- -------- ----- --------- -------- ----- (Dollars in Thousands) One- to four-family $ 52 $52,298 83.34 % $ 88 $49,412 83.88 % $ 102 $42,773 85.98 % Multi-family ........ 0 551 0.88 0 569 0.97 0 701 1.41 Commercial real ..... 0 4,106 6.54 0 4,023 6.83 0 3,458 6.95 estate Construction or ..... 0 2,256 3.60 0 3,600 6.11 0 1,806 3.63 development Other loans ......... 0 3,542 5.64 0 1,303 2.21 0 1,009 2.03 Unallocated ......... 181 0 0.00 185 0 0.00 187 0 0.00 ------- ------- ------ ------ ------- ------ ----- ------- ------ Total ............ $ 233 $62,753 100.00 % $ 273 $58,907 100.00 % $ 289 $49,747 100.00 % ======= ======= ====== ======= ======= ====== ===== ======= ======
Investment Activities Generally, the investment policy of the Company is to invest funds among various categories of investments and maturities based upon the Company's need for liquidity, asset/liability management policies, investment quality and marketability, liquidity needs and performance objectives. At September 30, 1998, the Company had two investment portfolios, one consisting primarily of adjustable rate mortgage-backed securities and the other consisting principally of fixed rate debentures. Both portfolios consisted entirely of U.S. Government or U.S. Government Agency obligations. These investments were made in order to generate income, and because these securities carry a low risk weighting for OTS risk-based capital purposes, to satisfy OTS liquid-asset requirements. See "Regulation - Capital Requirements" and "--Liquidity." At September 30, 1998, the Company's fixed rate investment securities totaled $29.8 million or 24.0% of total assets and mortgage-backed securities totaled $23.8 million or 19.2% of total assets. For information regarding the amortized cost, market and accounting classification values of the Company's investment securities portfolio, see Note 3 of the Notes to Consolidated Financial Statements. At September 30, 1998, the weighted average term to maturity or repricing of the investment securities portfolio, excluding FHLB stock, was 2.6 years. For information regarding the amortized cost, market values and accounting classification of the Company's mortgage-backed securities portfolio, see Note 4 of the Notes to Consolidated Financial Statements. Mortgage-Backed Securities. The Company purchases mortgage-backed and related securities to complement its mortgage lending activities. The Company began making significant purchases of mortgage-backed and related securities in 1991 as an alternative to home mortgage originations for its portfolio. Management determined that such investments would produce relatively higher risk-adjusted yields for the Company when compared to other investment securities and substituted for loan originations, in light of the competition for home mortgages in the Company's market area. The Company has emphasized mortgage-backed and related securities with high credit quality, high cash flow, low interest-rate risk, high liquidity and acceptable prepayment risk. The Company's mortgage-backed and related securities portfolio consists primarily of securities issued under government-sponsored agency programs, including those of GNMA, FNMA and FHLMC. The securities consist of modified pass-through mortgage-backed securities that represent undivided interest in underlying pools of fixed-rate, or certain types of adjustable rate, single-family residential mortgages issued by these government-sponsored entities and collateralized mortgage obligations (debt obligations of the issuer backed by mortgage loans as mortgage-backed securities). The securities generally provide the certificate holder a guarantee of timely payments of interest, whether or not collected. Mortgage-backed securities generally yield less than the loans that underlie such securities, because of the cost of payment guarantees or credit enhancements that reduce credit risk to holders. Mortgage-backed securities are also more liquid than individual mortgage loans and may be used to collateralize obligations of the Company. In general, mortgage-backed securities issued or guaranteed by FNMA, FHLMC and certain AAA- or AA-rated mortgage-backed pass-through securities are weighted at no more than 20% for risk-based capital purposes, and mortgage-backed securities issued or guaranteed by GNMA are weighted at 0% for risk-based capital purposes, compared to an assigned risk weighting of 50% to 100% for whole residential mortgage loans. These types of securities thus allow the Company to optimize regulatory capital to a greater extent than non-securitized whole loans. While mortgage-backed securities carry a reduced credit risk as compared to whole loans, such securities remain subject to the risk that a fluctuating interest rate environment, along with other factors such as the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of such mortgage loans and so affect both the prepayment speed, and value, of such securities. The following table sets forth the composition of the Company's mortgage-backed securities at the dates indicated.
September 30, --------------------------------------------------------------------------------------- 1998 1997 1996 1995 ------------------ ----------------- ------------------ -------------- Book % of Book % of Book % of Book % of Value Total Value Total Value Total Value Total ----- ----- ----- ----- ----- ----- ----- ----- (Dollars in Thousands) Mortgage-backed securities available-for-sale U.S. Government agency pass- through mortgage-backed securities ...................... $ 4,217 17.76 % $ 4,200 18.66 % 0 0.00 % $ 0 0.00 % U.S. Government agency collateralized mortgage obligations ..................... 8,360 35.20 0 0.00 0 0.00 0 0.00 ------- ------ ------- ------ ------- ------ -------- ------ Subtotal ................... 12,577 52.95 4,200 18.66 0 0.00 0 0.00 Mortgage-backed securities held-to-maturity U.S. Government agency pass-through mortgage-backed securities ...... 10,878 45.80 18,085 80.35 24,858 99.64 33,588 99.55 ------- ------ ------- ------ ------- ------ -------- ------ Subtotal ......................... 10,878 45.80 18,085 80.35 24,858 99.64 33,588 99.55 ------- ------ ------- ------ ------- ------ -------- ------ Unamortized premium (discounts), net ... 296 1.25 223 0.99 91 0.36 153 0.45 ------- ------ ------- ------ ------- ------ -------- ------ Total mortgage-backed securities $23,751 100.00 % $22,508 100.00 % $24,949 100.00 % $ 33,741 100.00 ======= ====== ======= ====== ======= ====== ======== ======
The following table sets forth the contractual maturities of the Company's mortgage-backed securities at September 30, 1998.
Due In Total Mortgage-Backed Securities ------------------------------------------------- ----------------------- 5 Years 5 to 10 10 to 20 Over 20 Amortized Market or Less Years Years Years Cost Value ------- ----- ----- ----- ---- ----- (Dollars in Thousands) Mortgage-backed securities available-for-sale U.S. Government agency pass-through mortgage-backed securities .......... $ 0 $ 0 $ 379 $ 4,151 $ 4,530 $ 4,450 U.S. Government agency collateralized mortgage obligations ................ 0 0 0 8,379 0 8,360 ------- ------- ------- ------- ------- ------- Total available-for-sale ........... 0 0 379 12,530 12,909 12,810 ------- ------- ------- ------- ------- ------- Mortgage-backed securities held-to-maturity U.S. Government agency pass-through mortgage-backed securities .......... 1,900 0 0 9,040 10,940 11,089 ------- ------- ------- ------- ------- ------- Total mortgage-backed securities .. $ 1,900 $ 0 $ 379 $21,570 $23,849 $23,899 ======= ======= ======= ======= ======= ======= Weighted average yield ................. 6.20% 0.00% 5.44% 6.73% 6.67%
The following table sets forth the composition of the Company's investment securities, excluding mortgage-backed securities, at the dates indicated.
September 30, ----------------------------------------------------------------------------- 1998 1997 1996 ----------------------------------------------------------------------------- Book % of Book % of Book % of Value Total Value Total Value Total ----------------------------------------------------------------------------- (Dollars in Thousands) U.S. government securities $ 0 0.00 % $ 0 0.00 % 0 0.00 % Federal agency obligations 0 0.00 0 0.00 0 0.00 Mutual funds 0 0.00 0 0.00 0 0.00 Other securities 0 0.00 0 0.00 0 0.00 --------- ------- -------- -------- --------- --------- Subtotal 0 0.00 0 0.00 0 0.00 --------- ------- -------- -------- --------- --------- Investment securities held-to-maturity U.S. government securities 2,505 7.42 2,511 7.65 1,998 5.23 Federal agency obligations 27,262 80.78 20,547 62.64 28,141 73.61 Other securites(1) 0 0.00 0 0.00 0 0.00 --------- ------- -------- -------- --------- --------- Subtotal 29,767 88.20 23,058 70.29 30,139 78.84 --------- ------- -------- -------- --------- --------- Total investment securities 29,767 88.20 23,058 70.29 30,139 78.84 --------- ------- -------- -------- --------- --------- Average remaining life of investment 2.6 yrs 1.4 yrs 1.4 yrs securities Other interest-earning assets: FHLB stock 789 2.34 1,006 3.07 949 2.48 Interest-bearing deposits with banks(2) 3,064 9.08 7,988 24.35 6,658 17.42 Other overnight deposits(3) 129 0.38 754 2.29 480 1.26 --------- ------- -------- -------- --------- --------- Total other interest-earning assets 3,982 11.80 9,748 29.71 8,087 21.16 --------- ------- -------- -------- --------- --------- Total investment securities, FHLB stock and other interest-earning assets $ 33,749 100.00 % $ 32,806 100.00 % 38,226 100.00 % ========= ======== ========= ======= ========= ========
(1) Includes investments in adjustable rate mortgage-backed mutual funds. (2) Includes investments in insured certificates of deposit. (3) Includes securities purchased under agreement to resell and federal funds sold. The following table sets forth the composition and maturities of the Company's investment securities portfolio as of September 30, 1998.
At September 30, 1998 ------------------------------------------------------------------------------------------ No Less Than 1 to 3 3 to 5 Over Stated Total Investment 1 Year Years Years 5 Years Maturity Securities Amort Amort Amort Amort Amort Amort Market Cost Cost Cost Cost Cost Cost Value ---- ---- ---- ---- ---- ---- ----- (Dollars in Thousands) Investment securities available-for-sale U.S. government securities .......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 Federal agency obligations .......... 0 0 0 0 0 0 0 Mutual funds ........................ 0 0 0 0 0 0 0 Other securities .................... 0 0 0 0 0 0 0 Investment securities held-to-maturity U.S. government securities .......... 2,505 0 0 0 0 2,505 2,534 Federal agency obligations .......... 5,509 8,019 13,009 725 0 27,262 27,582 Other securities .................... 0 0 0 0 0 0 0 ------- ------- ------- ------- ------- ------- ------- Total investment securities....... $ 8,014 $ 8,019 $13,009 $ 725 $ 0 $29,767 $30,116 ======= ======= ======= ======= ======= ======= ======= Weighted average yield ................. 5.91% 6.13% 6.04% 6.08% 0.00% 6.03%
The OTS has issued guidelines regarding management oversight and accounting treatment for securities, including investment securities, loans, mortgage-backed securities and derivative securities. The guidelines require thrift institutions to reduce the carrying value of securities to the lesser of cost or market value unless it can be demonstrated that a class of securities is intended to be held to maturity. Sources of Funds General. The Company's primary sources of funds are deposits, amortization and prepayment of loan principal, borrowings, interest earned on, maturation and sales of investment securities and short-term investments, and net earnings. Borrowings may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels, and may be used on a longer-term basis to support expanded lending activities or to increase the effectiveness of the Company's asset/liability management program. In this regard, in order to enhance both the return on the capital raised in the Conversion and its interest rate spread, the Company may utilize advances form the FHLB of Dallas and attempt to match the maturities of such liabilities with assets such as mortgage-backed securities having similar effective maturities but higher yields compared to the rate paid on such advances. Deposits. The Company offers the following types of deposit accounts: passbook savings, NOW checking accounts, money market deposit accounts and certificates of deposit. The Company solicits deposits from its market area and does not accept brokered deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates, and competition. The Company relies primarily on competitive pricing policies, advertising and customer service to attract and retain these deposits. The variety of deposit accounts offered by the Company has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. The Company has become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. In this regard, deposits decreased from $88.6 million at September 30, 1997 to $86.6 million at September 30, 1998. Management believes that the decrease in deposits was due to its decision not to pay the highest rates in the local market. Based on its experience, the Company believes that its deposits are relatively stable sources of funds. However, the ability of the Company to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by the Company for the periods indicated.
September 30, ----------------------------------------------------------------------------------------------- 1998 1997 1996 1995 ----------------------------------------------------------------------------------------------- Percent Percent Percent Percent Amount of Total Amount Of Total Amount of Total Amount of Total ------ -------- ------ -------- ------ -------- ------ -------- Transactions and (Dollars in Thousands) Savings Deposits: Non-interest checking $ 1,528 1.76 % $ 1,882 2.13 % $ 1,997 2.20 % $ 2,692 2.91 % NOW accounts 1,312 1.51 1,279 1.44 1,514 1.67 1,467 1.59 Passbook accounts 3,032 3.50 5,681 3.03 3,010 3.32 2,906 3.14 Money market accounts 6,162 7.11 5,812 6.56 6,575 7.24 6,140 6.64 --------- ------ --------- ------ --------- ------ ----------- ------ Total Non- certificates 12,034 13.89 11,654 13.16 13,096 14.43 13,205 14.28 --------- ------ --------- ------ --------- ------ ----------- ------ Certificates: 0.00 - 3.99% 434 0.50 383 0.43 0 0.00 222 0.24 4.00 - 4.99% 14,753 17.03 15,163 17.12 18,669 20.57 21,570 23.32 5.00 - 5.99% 53,641 61.91 54,522 61.57 52,775 58.14 46,612 50.40 6.00 - 6.99% 3,857 4.45 4,756 5.37 4,147 4.57 8,605 9.31 7.00 - 7.99% 1,914 2.21 2,073 2.35 2,081 2.29 2,245 2.43 8.00 - 8.99% 11 0.01 0 0.00 0 0.00 15 0.02 --------- ------ --------- ------ --------- ------ ----------- ------ Total Certificates 74,610 86.11 76,897 86.84 77,672 85.57 79,269 85.72 --------- ------ --------- ------ --------- ------ ----------- ------ Total Deposits $ 86,644 100.00 % $ 88,551 100.00 % $ 90,768 100.00 % $ 92,474 100.00 % ========= ====== ========= ====== ========= ====== =========== ======
The following table sets forth the savings flows at the Company during the periods indicated.
Year Ended September 30, ---------------------------------------------------------- 1998 1997 1996 1995 --------- --------- --------- --------- (Dollars in Thousands) Opening balance ........... $ 88,551 $ 90,768 $ 92,474 $ 102,200 Deposits .................. 25,131 14,394 16,039 16,264 Withdrawals ............... 29,302 18,823 19,902 26,951 Interest credited ......... 2,264 2,212 2,157 961 --------- --------- --------- --------- Ending balance ............ $ 86,644 $ 88,551 $ 90,768 $ 92,474 ========= ========= ========= ========= Net increase (decrease) ... $ (1,907) $ (2,217) $ (1,706) $ (9,726) ========= ========= ========= ========= Percent increase (decrease) (2.15)% (2.44)% (1.84)% (9.52)% ========= ========= ========= =========
The following table shows rate and maturity information for the Company's certificates of deposit as of September 30, 1998.
8.00% 0.00- 4.00- 5.00- 6.00- 7.00- or Percent 3.99% 4.99% 5.99% 6.99% 7.99% Greater Total of Total ---------- ----------- ----------- --------- --------- ---------- -------------------- (Dollars in Thousands) Certificate accounts maturing in quarter ending: December 31, 1998 $ 434 $ 6,941 $ 13,494 $ 151 $ 15 $ 0 $ 21,035 28.19% March 31, 1999 0 3,095 8,683 208 6 0 11,992 16.07% June 30, 1999 0 1,293 9,051 469 0 0 10,813 14.49% September 30,1999 0 1,346 7,096 125 0 0 8,567 11.48% December 31, 1999 0 885 2,796 344 156 0 4,181 5.60% March 31, 2000 0 643 2,477 268 1,634 0 5,022 6.73% June 30, 2000 0 275 2,474 394 0 0 3,143 4.21% September 30, 2000 0 275 2,302 668 0 0 3,245 4.35% December 31, 2000 0 0 1,738 730 1 0 2,469 3.31% March 31, 2001 0 0 1,228 500 0 0 1,728 2.32% June 30, 2001 0 0 777 0 0 0 777 1.04% September 30, 2001 0 0 408 0 0 0 408 0.55% Thereafter 0 0 1,117 0 102 11 1,230 1.65% -------- --------- --------- ------- ------- -------- ------- --------- Total $ 434 $ 14,753 $ 53,641 $ 3,857 $ 1,914 $ 11 $ 74,610 100.00% ======== ========= ========= ======= ======= ======== ======= ========= Percent of total 0.50% 19.72% 70.90% 6.18% 2.70% 0.00% ======== ========= ========= ======= ======= ========
The following table indicates the amount of the Company's certificates of deposit and other deposits by time remaining until maturity as of September 30, 1998.
Maturity ----------------------------------------------------------------------- Over Over 3 Months 3 to 6 6 to 12 Over or Less Months Months 12 Months Total ----------------------------------------------------------------------- Certificates of deposit less than $100,000 $ 7,086 $ 8,838 $ 12,715 $ 17,258 $ 45,897 Certificates of deposit of $100,000 or more 9,470 6,067 7,873 5,303 28,713 -------- ----------- ---------- ---------- ---------- Total certificates of deposit $ 16,556 $ 14,905 $ 20,588 $ 22,561 $ 74,610 ======== =========== ========== ========== ==========
Borrowings. The Company has the ability to use advances for the FHLB of Dallas to supplement its deposits when the rates are favorable. As a member of the FHLB of Dallas, the Company is required to own capital stock and is authorized to apply for advances. Each FHLB credit program has its own interest rate, which may be fixed or variable, and includes a range of maturities. The FHLB of Dallas may prescribe the acceptable uses to which these advances may be put, as well as limitations on the size of the advances and repayment provisions. During the fiscal year ended September 30, 1998, the Company continued borrowing funds through the FHLB of Dallas advance program. The Company used the proceeds to invest in adjustable rate mortgage-backed securities with yields greater than the cost of the advance. The intent of the program was to make better use of the Company's excess capital by increasing the overall size of the Company's balance sheet. The advances used in the program are short-term, usually 30-35 days. The rates of the advances, which are established by the FHLB of Dallas, generally are linked to comparable short term U.S. Treasury interest rates or a short term index such as the 30 day London Interbank Offering Rate (LIBOR). The Company invests the advance proceeds in a dollar-for-dollar matching program in adjustable mortgage-backed pass-through securities and collateralized mortgage obligations. The program is designed to achieve a positive spread between the cost of the advances and the investment yield. The mortgage-backed securities are held in an "available-for-sale" accounting classification. See "Mortgage-Backed Securities" and "Sources of Funds." The following table sets forth the maximum month-end balance of FHLB Advances, securities sold under agreements to repurchase and other borrowings for the periods indicated.
Year Ended September 30, --------------------------------------------------- 1998 1997 1996 1995 ------------------------------------------------------ (Dollars In Thousands) Maximum Balance: FHLB Advances $ 14,946 $ 4,195 $ 0 $ 0 Securities sold under agreements to 0 0 0 0 repurchase Other borrowings 0 0 0 0 Average Balance: FHLB Advances $ 9,724 $ 2,621 $ 0 $ 0 Securities sold under agreements to 0 0 0 0 repurchase Other borrowings 0 0 0 0
The following table sets forth certain information as to the Association's borrowings at the dates indicated.
Year Ended September 30, ---------------------------------------------------- 1998 1997 1996 1995 --------- --------- -------- ------- (Dollars In Thousands) FHLB Advances $ 14,946 $ 4,195 $ 0 $ 0 Securities sold under agreements to repurchase 0 0 0 0 Other borrowings 0 0 0 0 --------- --------- -------- ------- Total Borrowings $ 14,946 $ 4,195 $ 0 $ 0 ========= ========= ======== ======= Weighted average interest rate of FHLB advances 5.55 % 5.54 % 0.00 % 0.00 % Weighted average interest rate of securities sold under agreements to repurchase 0.00 % 0.00 % 0.00 % 0.00 % Weighted average interest rate of other borrowings 0.00 % 0.00 % 0.00 % 0.00 %
Subsidiary Activities As a federal savings and loan association, First Federal is permitted by OTS regulations to invest up to 2% of its assets or approximately $2.5 million at September 30, 1998, in the stock of, or unsecured loans to, service corporation subsidiaries. First Federal may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. At September 30, 1998, the Association did not have any subsidiaries. REGULATION General First Federal is a federally chartered savings and loan association, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Association is subject to broad federal regulation and oversight extending to all its operations. First Federal is a member of the FHLB of Dallas and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). As the savings and loan holding company of First Federal, the Company also is subject to federal regulation and oversight. The purpose of the regulation of the Company and other holding companies is to protect subsidiary savings associations. The Association is a member of the Savings Association Insurance Fund ("SAIF"), which together with the Bank Insurance Fund (the "BIF") are the two deposit insurance funds administered by the FDIC, and the deposits of First Federal are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Association. Certain of these regulatory requirements and restrictions affecting First Federal and the Company are discussed below or elsewhere in this document. Federal Regulation of Savings Associations The OTS has extensive authority over the operations of savings associations. As part of this authority, First Federal is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last regular OTS and FDIC examinations of First Federal were as of April 27, 1998 and August 17, 1990, respectively. Under agency scheduling guidelines, another examination will be initiated within the next 12-18 months. When these examinations are conducted by the OTS and FDIC, the examiners may require the Association to provide for higher general or specific loan loss reserves. All savings associations are subject to a semi-annual assessment, based upon the savings association's total assets, to fund the operations of the OTS. The Association's OTS assessment for the fiscal year ended September 30, 1998 was $28,000. The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Association and the Company. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required. In addition, the investment, lending and branching authority of First Federal is prescribed by federal laws and it is prohibited form engaging in any activities not permitted by such laws. For instance, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal associations in loans secured by nonresidential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings associations are also generally authorized to branch nationwide. The Association is in compliance with the noted restrictions. The Association's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At September 30, 1998, the Association's lending limit under this restriction was $2.8 million. First Federal is in compliance with the loans-to-one-borrower limitation. The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan. Insurance of Accounts and Regulation by the FDIC First Federal is a member of the SAIF, which is administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 of core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. Effective January 1, 1997, the premium schedule for BIF and SAIF insured institutions ranged from 0 to 27 basis points. However, SAIF-insured institutions are required to pay a Financing Corporation (FICO) assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s, equal to approximately 6.48 basis points for each $400 in domestic deposits, while BIF-insured institutions pay an assessment equal to approximately 1.52 basis points for each $100 in domestic deposits. The assessment is expected to be reduced to 2.43 basis points no later than January 1, 2000, when BIF-insured institutions fully participate in the assessment. These assessments, which may be revised based upon the level of BIF and SAIF deposits will continue until the bonds mature in the year 2017. Regulatory Capital Requirements Federally insured savings associations, such as First Federal, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained income, and certain noncumulative perpetual preferred stock and related income. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital for calculating compliance with this requirement. At September 30, 1998, the Association had no intangible assets that were required to be deducted from tangible capital. The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks or engaged in certain other activities solely as agent for its customers are "includable" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership. For excludable subsidiaries the debt and equity investments in such subsidiaries are deducted from assets and capital. The Association currently has no subsidiaries. At September 30, 1998, the Association had tangible capital of $18.6 million, or 14.9% of adjusted total assets, which is approximately $16.7 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date. The capital standards also require core capital equal to at least 3% of adjusted total assets. Core capital generally consists of tangible capital plus certain intangible assets, including a limited amount of purchased credit card relationships. As a result of the prompt corrective action provisions discussed below, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio. At September 30, 1998, the Association had core capital equal to $18.6 million, or 14.9% of adjusted total assets, which is $13.6 million above the minimum leverage ratio requirement of 4% as in effect on that date. The OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is also authorized to require a savings association to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. At September 30, 1998, the Association had no capital instruments that qualify as supplementary capital and $233,000 of general loss reserves, which was less than 1.25% of risk-weighted assets. Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. First Federal had exclusions from capital and assets totaling $4,000 at September 30, 1998. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk of 50% for prudently underwritten permanent one- to four-family first lien mortgage loans not more than 90 days delinquent and having a loan to value ratio of not more than 80% at origination unless insured to such ratio by a insurer approved by the FNMA or FHLMC. OTS regulations also require that every savings association with more than normal interest rate risk exposure to deduct from its total capital, for purposes of determining compliance with such requirement, an amount equal to 50% of its interest-rate risk exposure multiplied by the present value of its assets. This exposure is a measure of the potential decline in the net portfolio value of a savings association, greater than 2% of the present value of its assets, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline). Net portfolio value is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The rule will not become effective until the OTS evaluates the process by which savings associations may appeal an interest rate risk deduction determination. It is uncertain as to when this evaluation may be completed. Any savings association with less than $300 million in assets and a total capital ratio in excess of 12% is exempt from this requirement unless the OTS determines otherwise. On September 30, 1998, First Federal had total risk based capital of $18.8 million (including $18.5 million in core capital and no qualifying supplementary capital) and risk-weighted assets of $49.1 million (including no converted off-balance sheet assets); or total risk based capital of 38.3% of risk-weighted assets. This amount was $14.8 million above the 8% requirement in effect on that date. The OTS and FDIC are authorized and, under certain circumstances required, to take certain actions against savings associations that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risk-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions that are applicable to significantly undercapitalized associations. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements. Any savings association that fails to comply with its capital plan or is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions which may cover all aspects of its operations and include a forced merger or acquisition of the association. An association that becomes "critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, the OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized association is also subject to the general enforcement authority of the OTS and the FDIC, including the appointment of a conservator or receiver. The OTS is also generally authorized to reclassify an association into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The imposition by the OTS or the FDIC of any of these measures on First Federal may have a substantial adverse effect on the Association's operations and profitability and the value of the common stock of the Company. Company stockholders do not have preemptive rights, and therefore, if the Company is directed by the OTS or the FDIC to issue additional shares of Common Stock, such issuance may result in the dilution in the percentage of ownership of the Company held by the existing stockholders of the Company. Limitations on Dividends and Other Capital Distributions OTS regulations impose various restrictions on savings associations with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. OTS regulations also prohibit a savings association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion. Generally, savings associations, such as First Federal, that before and after the proposed distribution meet their capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its capital requirement for such capital component, as measured at the beginning of the calendar year, or 75% of its net income for the most recent four quarter period. However, an association deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS. First Federal may pay dividends in accordance with this general authority. Savings associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. Savings associations that do not, or would not meet their current minimum capital requirements following a proposed capital distribution, however, must obtain OTS approval prior to making such distribution. The OTS may object to the distribution during that 30-day period notice based on safety and soundness concerns. See "--Regulatory Capital Requirements." The OTS has proposed regulations that would revise the current capital distribution restrictions. Under the proposal a savings association may make a capital distribution without notice to the OTS (unless it is a subsidiary of a holding company) provided that it has a CAMEL 1 or 2 rating, is not of supervisory concern, and would remain adequately capitalized (as defined in the OTS prompt corrective action regulations) following the proposed distribution. Savings associations that would remain adequately capitalized following the proposed distribution but do not meet the other noted requirements must notify the OTS 30 days prior to declaring a capital distribution. The OTS stated it will generally regard as permissible that amount of capital distributions that do not exceed 50% of the institution's excess regulatory capital plus net income to date during the calendar year. A savings association may not make a capital distribution without prior approval of the OTS and the FDIC if it is undercapitalized before, or as a result of, such a distribution. As under the current rule, the OTS may object to a capital distribution if it would constitute an unsafe or unsound practice. No assurance may be given as to whether or in what form the regulations may be adopted. Liquidity All savings associations, including First Federal, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. For a discussion of what First Federal includes in liquid assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources," contained in the Annual Report to Shareholders. This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. As of September 30, 1998, the minimum liquid asset ratio was 4%. The Association was in compliance with an overall liquid asset ratio of 40.1%. Qualified Thrift Lender Test All savings associations, including First Federal, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by regulation) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternate, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans and investments. At September 30, 1998, the Association met the test and has always met the test since its effectiveness. Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the BIF. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "--Holding Company Regulation." Community Reinvestment Act Under the Community Reinvestment Act ("CRA"), every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices 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 that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with the examination of the Association, 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, such as a merger or the establishment of a branch by First Federal. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. The federal banking agencies, including the OTS, have recently revised the CRA regulations and the methodology for determining an institution's compliance with the CRA. Due to the heightened attention being given to the CRA in the past few years, the Association may be required to devote additional funds for investment and lending in its local community. The Association was examined for CRA compliance in February 1997 and received a rating of "Needs Improvement." As a result of the February 1997 CRA examination, the Association's Board of Directors implemented a loan program designed to lend money to low to moderate income borrowers and targeted to specific census tract locations that were considered low to moderate income areas. The program, entitled Housing Assistance Program (HAP) initially set aside $500,000 to reach low to moderate income borrowers. The Association significantly relaxed its normal loan underwriting guidelines in order to qualify the applicants. The HAP program was successful and the Association was able to loan all of the designated funds in approximately six months. In 1998, the Board set aside $350,000 to lend to low to moderate income borrowers. The Company was able to loan all of the designated amount. As a result of the Association's lending efforts to low to moderate income areas and borrowers, the Association received a "satisfactory" rating on its April 6, 1998 CRA examination. Transactions with Affiliates Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association's capital. Affiliates of the Association include the Company and any company, which is under common control with the Association. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. First Federal's Subsidiaries are not deemed affiliates, however; the OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis. Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals. Holding Company Regulation The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings association subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. If the holding company acquired control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of the Company and any of its subsidiaries (other than First Federal or any other SAIF-insured savings association) would become subject to such restrictions unless such other associations each qualify as a QTL and were acquired in a supervisory acquisition. If the Association fails the QTL test, the Company must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within one year of such failure the Company must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See "--Qualified Thrift Lender Test." The Company must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association. Federal Securities Law The stock of the Company is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Accordingly, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. Company stock held by persons who are affiliates (generally officers, directors, and principal stockholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period. Federal Reserve System The Federal Reserve Board requires all depository institutions to maintain noninterest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At September 30, 1998, First Federal was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "--Liquidity." Savings associations are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank. Federal Home Loan Bank System First Federal is a member of the FHLB of Dallas, which is one of 12 regional FHLBs, that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures, established by the board of directors of the FHLB, which are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. As a member, First Federal is required to purchase and maintain stock in the FHLB of Dallas. At September 30, 1998, First Federal had $789,000 in FHLB stock, which was in compliance with this requirement. In past years, first Federal has received substantial dividends on its FHLB stock. Over the past five calendar years such dividends have averaged 5.80% and were 6.00% for fiscal year 1998. Under federal law the FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to low and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of First Federal's FHLB stock may result in a corresponding reduction in First Federal's capital. For the fiscal year ended September 30, 1998, dividends paid by the FHLB of Dallas to First Federal totaled $54,000, which constitutes a $3,000 decrease over the amount of dividends received in fiscal year 1997. The $12,000 dividend received for the quarter ended September 30, 1998 reflects an annualized rate of 6.02%, or ten basis points above the rate for fiscal 1998. Federal and State Taxation Savings associations such as the Association that meet certain conditions prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), are permitted to establish reserves for bad debts and to make annual additions thereto which may, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes. The amount of the bad debt reserve deduction is computed under the experience method. Under the experience method, the bad debt reserve deduction is an amount determined under a formula based generally upon the bad debts actually sustained by the savings association over a period of years. In August 1996, legislation was enacted that repealed the percentage of taxable income method of accounting used by many thrifts, including the Association, to calculate their bad debt reserve for federal income tax purposes. As a result, large thrifts such as the Association must recapture that portion of the reserve that exceeds the amount that could have been taken under the experience method for post-1987 tax years. The recapture may be deferred over a six-year period, the commencement of which will be delayed until the first taxable year beginning after December 31, 1997, provided the institution meets certain residential lending requirements. The Company elected to recapture the total amount of its excess reserves of approximately $7,000 in the fiscal year ended September 30, 1997. In addition to the regular income tax, corporations, including savings associations such as the Association, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. To the extent earnings appropriated to a savings association's bad debt reserves for "qualifying real property loans" and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for loan losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). As of September 30, 1998, the Association's Excess for tax purposes totaled approximately $2.7 million. The Association files federal income tax returns on a fiscal year basis using the accrual method of accounting. The Company files a consolidated federal income tax returns with the Association. The Association has been audited by the IRS with respect to federal income tax returns for the tax years through December 31, 1988. With respect to years examined by the IRS, any deficiencies have been satisfied. In the opinion of management, any examination of still open returns would not result in a deficiency which could have a material adverse effect on the financial condition of the Bank. Texas Taxation. The State of Texas does not have a corporate income tax, but it does have a corporate franchise tax. Prior to January 1, 1992 savings and loan associations had been exempt from the corporate franchise tax. The tax for the year 1998 is the higher of 0.25% of taxable capital (usually the amount of paid in capital plus retained earnings) or 4.5% of "net taxable earned surplus." "Net taxable earned surplus" is net income for federal income tax purposes increased by the compensation of directors and executive officers and decreased by interest on obligations guaranteed by the U.S. government. Net income cannot be reduced by net operating loss carryforwards form years prior to 1991, and operating loss carryovers are limited to five years. Delaware Taxation. As a Delaware Company, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. The Company is also subject to an annual franchise tax imposed by the State of Delaware. Competition The Company faces strong competition, both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other commercial banks, savings associations, credit unions and mortgage bankers making loans secured by real estate located in the Company's market area. The Company competes for loans principally on the basis of the quality of services it provides to borrowers, interest rates and loan fees it charges, and the types of loans it originates. The Company attracts all of its deposits through its retail banking offices, primarily from the communities it serves. Therefore, competition for those deposits is principally from other commercial banks, savings associations and brokerage houses located in the same communities. The Company competes for these deposits by offering deposit accounts at competitive rates and convenient business hours. The Company's primary market area covers Smith County, Texas. There are 14 commercial banks, one savings association and 13 credit unions which compete for deposits and loans in the Company's primary market area. The Company estimates its share of the residential mortgage loan market and savings deposit base to be not more than 15% and 5%, respectively. Employees The Company had 28 full-time employees and one part-time employee as of September 30, 1998, none of whom was represented by a collective bargaining agreement. The Company believes that its relations with its personnel have been good. Executive Officers Who Are Not Directors The following is a description of the Company's and the Association's executive officers who were not also directors as of September 30, 1998. Derrell W. Chapman, age 40, is Vice President, Chief Operating Officer and Chief Financial Officer of the Company and the Association. He has held such positions with the Company since its formation and the Association since 1989. Mr. Chapman was appointed an Advisory Director in 1998. Prior to his employment with the Association, Mr. Chapman was Vice President and Controller of Jasper Federal Savings and Loan Association, located in Jasper, Texas. Mr. Chapman is a certified public accountant. Joe C. Hobson, age 45, is Senior Vice President--Lending of the Association, a position he has held since 1992. Mr. Hobson has served the Association in various capacities since 1975. Item 2. Description of Property The Company conducts its business at its main office and a drive-through facility located in Tyler, Texas, a full service branch office located in Whitehouse, Texas and loan production offices located in Tyler and Lindale, Texas. The following table sets forth information relating to each of the Company's properties as of September 30, 1998. Total September 30, Owned Approximate 1998 Year or square Book Location Acquired Leased Footage Value - -------- -------- ------ ------- ----- (In Thousands) Main Office: 1200 South Beckham 1962 Owned 10,000 $415 Tyler, Texas Full-Service Branch: 107 Highway 110 North 1984 Owned 2,500 $275 Whitehouse, Texas 7205 South Broadway 1998 Owned n/a $1,241* Loan Agencies: 4550 Kinsey Drive 1994 Owned 2,200 $148 Tyler, Texas 904 South Main 1997 Leased 1,200 $11** Lindale, Texas * The amount shown is for land only. The building located at 7205 South Broadway is leased. ** Leasehold improvements. The Company believes that its current facilities are adequate to meet the present and foreseeable needs of the Association and the Company, subject to possible future expansion. The Company maintains an on-line database with a service bureau servicing financial institutions. The net book value of the data processing and computer equipment utilized by the Company at September 30, 1998 was $130,000. Item 3. Legal Proceedings The Company is involved form time to time as plaintiff or defendant in various legal actions arising in the normal course of business. While the ultimate outcome of these proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing the Company in the proceedings, that the resolution of these proceedings should not have a material effect on the Company's results of operations. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year, through the solicitation of proxies or otherwise during the year ended September 30, 1998. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Pages 30 through 31 of the Company's 1998 Annual Report to Stockholders is incorporated herein by reference. Item 6. Management's Discussion and Analysis or Plan of Operation Pages 6 through 31 of the Company's 1998 Annual Report to Stockholders is incorporated herein by reference. Item 7. Financial Statements Pages 33 through 37 of the Company's 1998 Annual Report to Stockholders is incorporated herein by reference. Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There has been no Current Report on Form 8-K filed within 24 months prior to the date of the most recent financial statements reporting a change of accountants and/or reporting disagreements on any matter of accounting principle or financial statement disclosure. Part III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act Directors Information concerning Directors of the Company is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 20, 1999, a copy of which will be filed not later than 120 days after the close of the fiscal year. Executive Officers Information regarding the business experience of the executive officers of the Company and the Association who are not also directors contained in Part I of this Form 10-KSB is incorporated herein by reference. Compliance with Section 16(a) Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than 10% of a registered class of the Bank's equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports are required, during the fiscal year ended September 30, 1998, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10 percent beneficial owners were complied with. Item 10. Executive Compensation Information concerning executive compensation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 20, 1999, a copy of which will be filed not later than 120 days after the close of the fiscal year. Item 11. Security Ownership of Certain Beneficial Owner and Management Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 20, 1999, a copy of which will be filed not later than 120 days after the close of the fiscal year. Item 12. Certain Relationships and Related Transactions Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 20, 1999, a copy of which will be filed not later than 120 days after the close of the fiscal year. Item 13. Exhibits and Reports on Form 8-K (a) Exhibits Reference to Prior Filing or Exhibit Number Attached Regulation Document Hereto - ---------- -------- ------ 3(a) Articles of Incorporation * 3(b) Amended and Restated By-Laws ** 4 Instruments defining the rights of security * holders, including debentures 10 Material contracts (a) Employment Contract between Gerald W. * Free and the Association (b) Employment Contract between Derrell W. * Chapman and the Association (c) 1995 Stock Option and Incentive Plan ** (d) Recognition and Retention Plan ** 11 Statement re: computation of per share earnings 11 13 Annual Report to Security Holders 13 21 Subsidiaries of Registrant 21 23 Consents of Experts and Counsel 23 27 Financial Data Schedule 27 99 Additional Exhibits None * Filed as exhibits to the Company's Form S-1 registration statement (File No. 33-83758) filed on September 6, 1994 pursuant to Section 5 of the Securities Act of 1933. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-B. ** Filed as exhibits to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31, 1996 (File No. 0-24848). These previously filed documents are hereby incorporated herein by reference in accordance with item 601 of Regulation S-B. (b) Reports on Form 8-K A Form 8-K, dated July 22, 1998, was filed during the quarter ended September 30, 1998 to report the issuance of a press release by the Company announcing a cash dividend and earnings for the quarter ended June 30, 1998. A Form 8-K, dated July 30, 1998, was filed during the quarter ended September 30, 1998, to announce a 5% stock repurchase program. A Form 8-K, dated August 19, 1998, was filed during the quarter ended September 30, 1998, to announce the completion of the Company's stock repurchase program. SIGNATURES Pursuant to the requirements of Section 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EAST TEXAS FINANCIAL SERVICES, INC. Date: December 23, 1998 By: /s/Gerald W. Free ------------------- Gerald W. Free, President, Chief Executive Officer and Director (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated. /s/Gerald W. Free /s/Jack W. Flock - ----------------- ---------------- Gerald W. Free, President, Chief Jack W. Flock, Executive Officer and Director Chairman of the Board (Principal Executive Officer) Date: December 23, 1998 Date: December 23, 1998 /s/Derrell W. Chapman /s/M. Earl Davis - --------------------- ---------------- Derrell W. Chapman, Vice President, M. Earl Davis, Director Chief Operating Officer and Chief Financial Officer (Principal Financial And Accounting Officer) Date: December 23, 1998 Date: December 23, 1998 /s/James W. Fair /s/Charles R. Halstead - ---------------- ---------------------- James W. Fair, Director Charles R. Halstead, Director Date: December 23, 1998 Date: December 23, 1998 /s/L. Lee Kidd /s/H. H. Richardson, Jr. - -------------- ------------------------ L. Lee Kidd, Director H. H. Richardson, Jr., Director Date: December 23, 1998 Date: December 23, 1998 /s/Jim M. Vaughn, M.D. - ---------------------- Jim M. Vaughn, M.D., Director Date: December 23, 1998 EX-11 2 EXHIBIT 11 Statement re: Computation of Per Share Earnings
EAST TEXAS FINANCIAL SERVICES, INC. Statement re: Computation of Per Share Earnings Fiscal Year Ended September 30, 1998 Total Shares Unallocated Total Shares Outstanding ESOP Shares* For EPS Calculation ----------- ------------ ------------------- September 30, 1997 1,539,461 97,593 1,441,868 October 31, 1997 1,539,461 97,593 1,441,868 November 30, 1997 1,539,461 97,593 1,441,868 December 31, 1997 1,539,461 97,593 1,441,868 January 31, 1998 1,539,461 97,593 1,441,868 February 28, 1998 1,539,461 97,593 1,441,868 March 31, 1998 1,539,461 97,593 1,441,868 April 30, 1998 1,539,461 97,593 1,441,868 May 31, 1998 1,539,461 97,593 1,441,868 June 30, 1998 1,539,461 97,593 1,441,868 July 31, 1998 1,541,029 97,593 1,443,436 August 31, 1998 1,464,056 97,593 1,366,463 September 30, 1998 1,464,056 81,536 1,382,520 Weighted average number of shares outstanding for the year ended September 30, 1998, for earnings per share calculation 1,431,623 Stock options outstanding at September 30, 1998: 148,843 ------- Exercise price of stock options: $9.42 per share --------------- Average stock price for the 12 month period ended September 30, 1998 $14.3109 -----------
12 Months Ended Basic Earnings Per Share September 30, - ------------------------ ------------- 1998 1997 ---- ---- Income available to common stockholders $560,946 $766,775 ======== ======== Weighted average number of common shares outstanding for basic EPS calculation 1,431,623 1,470,358 ========= ========= Basic Earnings Per Share $.39 $.52 ==== ==== Diluted Earnings Per Share Income available to common stockholders $560,946 $766,775 ======== ======== Weighted average number of common shares outstanding for basic EPS calculation 1,431,623 1,470,358 ========= ========= Weighted average common shares issued under stock options plans 150,019 151,587 Less weighted average shares assumed repurchased with proceeds (98,755) (122,466) Weighted average number of common shares outstanding for diluted EPS calculation 1,482,887 1,499,479 Basic Earnings Per Share $.38 $.51 ==== ====
EX-13 3 EXHIBIT 13 Annual Report to Security Holders East Texas Financial Services, Inc. and Subsidiary Table of Contents Selected Financial Data 2 Letter to Shareholders 3 Glossary 5 Management's Discussion and Analysis of Financial Condition and Operating Results 6 Forward Looking Information 6 General 6 Results of Operations Net Income 6 Interest Income 9 Interest Expense 12 Net Interest Income 13 Provisions for Loan Losses 14 Other Operating Income 14 Operating Expense 16 Income Tax Expense 18 Financial Condition Balance Sheet Summary 18 Loans 19 Mortgage-Backed Securities 21 Investment Securities 22 Deposits and Borrowings 22 Interest Rate Sensitivity 22 Asset Quality 25 Liquidity and Capital Position 26 Impact of Accounting Pronouncements 27 Year 2000 Compliance Assessment 29 Impact of Inflation and Changing Prices 30 Market Price of Common Stock 30 Report of Independent Accountants 32 Consolidated Financial Statements 33 Notes To Consolidated Financial Statements 38 Corporate Directory 62 Shareholder Reference 63
Selected Financial Data (Dollars in Thousands, except share data) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------------ At September 30, Total assets $ 124,017 $ 115,949 $ 114,373 $ 117,077 $ 114,935 Loans receivable, net Held for sale 0 0 0 0 0 Held in portfolio 61,119 57,110 47,925 41,760 35,337 Investment securities - held-to-maturity 29,767 23,058 30,139 30,263 0 Mortgage-backed securities - available-for-sale 12,810 4,356 0 0 0 Mortgage-backed securities -- held-to-maturity 10,941 18,152 24,949 33,741 0 Deposits 86,644 88,551 90,768 92,474 102,200 FHLB Advances 14,946 4,195 0 0 0 Stockholders' equity 20,384 20,879 20,931 23,146 11,458 Common shares outstanding 1,464,056 1,026,366 1,079,285 1,256,387 N.A. Book value per share 13.92 20.34 19.39 18.42 N.A. For The Year Ended September 30, Net interest income $ 3,298 $ 3,419 $ 3,552 $ 3,658 $ 3,040 Provision for loan losses 0 5 0 0 121 Other operating income 361 302 371 299 (2,118) Operating expenses 2,768 2,523 3,200 2,335 1,981 Net income 561 767 458 1,071 (759) Selected Financial Ratios Return on average assets 0.46 % 0.67 % 0.40 % 0.92 % (0.66) % Return on average equity 2.72 3.67 2.08 5.47 (6.41) Interest rate spread (average) 2.00 2.21 2.27 2.49 2.33 Net interest margin 2.83 3.12 3.16 3.21 2.67 Ratio of interest-earning assets to interest- bearing liabilities 119.58 122.29 122.23 119.13 110.08 Operating expenses to average assets 2.31 2.19 2.77 2.01 1.72 Efficiency ratio 78.96 69.24 84.10 59.70 61.70 Net interest income to operating expenses 1.20 x 1.35 x 1.11 x 1.57 x 1.47 x
Asset Quality Ratios Non-performing assets to total assets 0.18 % 0.27 % 0.39 % 0.34 % 0.27 % Non-performing loans to total loans 0.37 0.54 0.94 0.95 0.87 receivable Allowance for loan losses to non-performing 102.19 88.06 64.22 74.75 97.72 loans Allowance for loan losses to total loans 0.38 0.48 0.60 0.71 0.85 Allowance for loan losses to total assets 0.18 0.24 0.25 0.25 0.26 Regulatory Capital Ratios (Association only) Total capital to total assets 14.91 % 15.21 % 15.39 % 14.40 % 9.97 % Tangible capital ratio 14.95 15.20 15.30 14.40 9.97 Core capital ratio 14.95 15.20 15.30 14.40 9.97 Risk-based capital ratio 38.29 40.22 44.23 43.44 31.06
2 To Our Shareholders: The past twelve months have been challenging for the traditional thrift institution relying primarily on interest income on mortgage related products as its primary source of income. Continued lower interest rates and a narrowing of the difference in shorter and longer-term interest rates caused a decrease in our net interest margin during the fiscal year. Competition for single-family lending in the Tyler market and the propensity for a borrower to refinance a mortgage at the slightest decline in interest rates has caused a decrease in the overall yield on interest earning assets. Further, our reliance on certificates of deposit as our primary funding source and demands from certificate holders for the highest interest rates have contributed to the decline in our net interest margin as well. We believe that this trend is unlikely to reverse at any time in the foreseeable future and in fact may never return to levels that will allow for long term profitability in the traditional mortgage lending business. As a result, and after substantial research and planning, we made the decision in 1998 to expand our lines of business. The need for higher yielding assets with less likelihood to refinance, less reliance on certificates of deposit as our primary source of funds, and a greater reliance on income from sources other than net interest income are the principal objectives of our decision to introduce additional business lines. By the time you receive this annual report, we will be well on our way to opening a new office location in the rapidly growing area of south Tyler. The new office will focus primarily on commercial and consumer lending with a reliance on transaction accounts as its primary funding source. We will offer all of the products usually associated with a commercial banking organization, such as credit and debit cards, an ATM machine and cards, safe deposit boxes, investment brokerage services, and both commercial and personal transaction accounts. We will also expand all of these services to each of our existing full service locations. The initial costs associated with adding these new lines of business will be extensive and we do not expect them to be profitable immediately. However, we believe that this is the direction we should be moving and that the long term future of the Company is dependent upon our success in doing so. The past twelve months have also been a challenge for bank stock values. We have seen the per share price of our stock decline from approximately $13.67 per share on September 30, 1997, as adjusted for a three for two stock split in 1998, to its closing price of $13.25 per share on September 30, 1998. Our stock price further declined to approximately $9.85 by December 9, 1998, the record date for our upcoming annual meeting. The decrease in price through December 9, 1998 is approximately 28% and while we are disappointed, we believe that the decline in the price of our stock is somewhat indicative of the overall decline in small bank stocks during the year. 3 We continued to repurchase stock during the year, acquiring 76,973 shares of stock at an average price of approximately $14.04 per share. At year-end, we held 420,436 shares of treasury stock at an average purchase price of approximately $11.40 per share. We expect, from time-to-time as market conditions warrant, to continue to repurchase shares of treasury stock. We ended the year with 1,464,056 outstanding shares of stock, an increase of 438,000 shares over the 1,026,366 outstanding as of September 30, 1997. The increase was primarily due to the three for two stock split completed in 1998. After the split, we continued our policy of paying a quarterly cash dividend of $.05 per share in fiscal 1998. Based on the September 30, 1998 ending stock price, our dividend yield is approximately 1.51%. We expanded our wholesale funded arbitrage program in 1998. At year end, we had borrowed approximately $14.9 million in short term advances from the Federal Home Loan Bank of Dallas and invested the proceeds in primarily adjustable rate mortgage related securities. Our margin on the difference in the yield on the securities and the cost of the advance was approximately .42%, an after tax basis at year end. Subsequent to year end, after the Federal Reserve lowered short term interest rates, the cost of the borrowings in the program decreased substantially. As of December 9, 1998, the after tax margin on the program was approximately .82%. We expect to expand this program as market conditions warrant during the upcoming fiscal year. We invite you to attend our annual meeting of stockholders. The meeting will be held at 2:00 p.m. on January 20, 1999 at the offices of the Company, 1200 South Beckham, Tyler, Texas. Once again, we remain confident about the future of the Company. Our goal is to continue to try and maximize the long-term value of your investment. Sincerely, /s/Jack W. Flock /s/Gerald W. Free ---------------- ----------------- Jack W. Flock Gerald W. Free Chairman of the Board Vice Chairman, President and Chief Executive Officer 4 G l o s s a r y Book Value Per Share Indicates the amount of stockholders' equity attributable to each outstanding share of common stock. It is determined by dividing total stockholders' equity by the total number of common shares outstanding at the end of a period. Earnings Per Share Indicates the amount of net income attributable to each share of common stock. It is determined by dividing net income for the period by the weighted average number of common shares outstanding during the same period. Efficiency Ratio A measure of operating efficiency determined by dividing total operating expenses by the sum of net interest income after provisions for loan losses and non-interest income, excluding net gains or losses on sale of assets. Interest Rate Sensitivity A measure of the sensitivity of the Company's net interest income to changes in market interest rates. It is determined by analyzing the difference between the amount of interest-earning assets maturing or repricing within a given time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. Interest Rate Spread The difference between the average yield earned on the Company's interest-earning assets and the average rate paid on its interest-bearing liabilities. Net Interest Income The dollar difference between the interest earned on the Company's interest-earning assets and the interest paid on its interest-bearing liabilities. Net Interest Margin Net interest income as a percentage of average interest-earning assets. Net Portfolio Value The present value of future expected cash flows on interest-earning assets less the present value of future expected cash flows on interest-bearing liabilities. Non-Performing Assets Loans on which the Company has discontinued accruing interest or are delinquent more than ninety days and still accruing interest and foreclosed real estate. Return On Average Assets A measure of profitability determined by dividing net income by average assets. Return On Average Stockholders' Equity A measure of profitability determined by dividing net income by average stockholders' equity. 5 Management's Discussion and Analysis of Financial Condition and Operating Results Results of Operation Forward-Looking Information Except for the historical information contained herein, the matters discussed in the Annual Report may be deemed to be forward-looking statements that involve risks and uncertainties, including the acceptance of new products, the impact of competitive products and pricing, and the other risks detailed from time to time in the Company's SEC reports, including the report on Form 10-KSB, for the year ended September 30, 1998. Actual strategies and results in future periods may differ materially from those currently expected. These forward-looking statements represent the Company's judgment as of the date of this Report. The Company disclaims, however, any intent or obligation to update these forward-looking statements. General The principal business of the Company consists of attracting retail deposits from the general public and investing those funds primarily in one- to four-family residential mortgage loans. To a lesser extent, the Company also originates commercial real estate, one- to four-family construction, multi-family and consumer loans. The Company also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. The Company's revenues are derived primarily from interest earned on loans, mortgage-backed securities and investments and, to a lesser extent, from service charges and loan originations, gains on sales of loans and mortgage-backed securities, and loan servicing fee income. The Company currently offers a variety of deposit accounts having a wide range of interest rates and terms. The Company's deposits include passbook and money market accounts, NOW checking accounts, and certificate accounts with terms ranging from one month to five years. The Company solicits deposits in its primary market area and does not accept brokered deposits. Net Income 1998 and 1997 Comparison Net income was $561,000, or $.39 in basic earnings per share for the year ended September 30, 1998, compared to $767,000, or $.52 in basic earnings per share for the year ended September 30, 1997. On a diluted basis, earnings per share was calculated at $.38 and $.51 for the years ended September 30, 1998 and 1997 respectively. Per share earnings for the year ended September 30, 1997 were restated for comparative purposes as a result of the Company's three for two stock split in the 6 form of a 50% stock dividend completed in 1998. The decrease in net income was primarily attributable to a $245,000 increase in non-interest expense to $2.8 million for the year ended September 30, 1998, compared to $2.5 million for the year ended September 30, 1997. Additionally, a $117,000 decline in net interest income after provision for loan losses from $3.4 million for the year ended September 30, 1997 to $3.3 million for the year ended September 30, 1998 contributed to the overall decline in net income. Partially offsetting the increase in non-interest expense and the decline in net interest income after provision for loan losses was a $59,000 increase in non-interest income from $302,000 for the year ended September 30 1997 to $361,000 for the year ended September 30, 1998. In addition, a $97,000 decrease in income tax expenses from $427,000 for the year ended September 30, 1997 to $329,000 for the year ended September 30, 1998 offset the decline in net income. For the year ended September 30, 1998, the Company reported a return on average assets of approximately .46%, compared to .67% for the year ended September 30, 1997. Return on average stockholders' equity was reported as 2.72% for the year ended September 30, 1998, compared to 3.67% for the year ended September 30, 1997. 1997 and 1996 Comparison For the year ended September 30, 1997, net income was $767,000, or $.52 per share, compared to $458,000, or $.28 per share, for the year ended September 30, 1996. Per share earnings for both years were restated due to the Company's three for two stock split in 1998. Diluted earnings per share were $.51 and $.28 for the years ended September 30, 1997 and 1996 respectively. The increase in net income was primarily attributable to a $677,000 reduction in total non-interest expenses to $2.5 million for the year ended September 30, 1997, compared to $3.2 million for the year ended September 30, 1996. Total non-interest expenses were higher in 1996 due to the special one time assessment charged to all Savings Association Insurance Fund ("SAIF") insured institutions to recapitalize the SAIF insurance fund. The Company's portion of the one time assessment was approximately $645,000, before the effects of income taxes were considered. Partially offsetting the decrease in total non-interest expense was a $133,000 reduction in net interest income before provisions for loan losses from $3.6 million for the year ended September 30, 1996 to $3.4 million for the year ended September 30, 1997. Also, total non-interest income declined during the year to $302,000 for the year ended September 30, 1997 from $371,000 for the same period in 1996 and income tax expense increased to $427,000 for the year ended September 30, 1997 from $265,000 for the year ended September 30, 1996. For the year ended September 30, 1997, return on average assets was .67%, compared to .40% for the year ended September 30, 1996. Return on average stockholders' equity equaled 3.67% for the year ended September 30, 1997, compared to 2.08% for 1996. 7 Net Interest Income Analysis
Year Ended September 30, --------------------------------------------------------------------------------------------- 1998 1997 1996 Interest Interest Interest Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate Balance Paid Rate ------------------------------ ---------------------------- ---------------------------- (Dollars in Thousands) Interest-earning assets: Loans receivable .................. $ 60,563 $ 4,771 7.88% $ 52,192 $ 4,191 8.03% $ 44,406 $ 3,641 8.20% Mortgage-backed securities ........ 22,665 1,526 6.73 22,412 1,564 6.98 28,912 2,000 6.92 Investment securities ............. 32,249 1,913 5.93 34,165 2,080 6.09 38,155 2,368 6.21 FHLB stock ........................ 905 54 5.92 972 57 5.86 917 55 6.00 -------- -------- ---- -------- ------- ---- -------- ------- ---- Total interest-earning assets (1) $116,382 8,264 7.10 $109,741 $ 7,892 7.19% $112,390 $ 8,064 7.18% ======== ===== ==== ======== ======= ==== ======== ======= ==== Interest-bearing liabilities: Demand accounts ................... $ 1,284 $ 0 0.00 $ 1,285 $ 0 0.00% $ 2,401 $ 0 0.00% NOW accounts ...................... 1,427 29 2.03 1,448 29 2.00 1,468 30 2.04 Savings accounts .................. 2,852 86 3.02 2,913 87 2.99 2,948 88 2.99 Money market checking ............. 5,905 197 3.34 6,099 209 3.43 6,329 213 3.37 Certificate accounts .............. 76,138 4,114 5.40 77,146 4,101 5.32 78,807 4,181 5.31 Borrowings ........................ 9,724 540 5.55 850 47 5.53 0 0 0.00 -------- -------- ---- -------- ------- ---- -------- ------- ---- Total interest-bearing liabilities ....................... 97,330 4,966 5.10 $ 89,741 $ 4,473 4.98% $ 91,953 $ 4,512 4.91% -------- -------- ---- -------- ------- ---- -------- ------- ---- Net interest income................... $ 3,298 $ 3,419 $ 3,552 ======== ======= ======= Net interest rate spread (2).......... 2.00% 2.21% 2.27% ==== ===== ==== Net earning assets ................... $ 19,052 $ 20,000 $ 20,437 ======== ======== ========= Net yield on average interest earning assets (3) 2.83% 3.12% 3.16% ===== ==== ===== Average interest-earning assets to average interest-bearing liabilities ...................... 119.58% 122.29% 122.23% ====== ====== =======
- -------------------------- (1) Calculated net of deferred loan fees, loan discounts, loans in process, loss reserves and premiums or discounts. (2) Net interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (3) Net yield on interest-earning assets represents annualized net interest income as a percentage of average interest-earning assets. 8 Rate/Volume Analysis
Year Ended September 30, -------------------------------------------------------------------------------------------------- 1998 vs 1997 1997 vs 1996 1996 vs 1995 ------------------------------ -------------------------------- ------------------------------ Increase Increase Increase (Decrease) (Decrease) (Decrease) Total Due to Total Due to Total Due to Increase ------------------- Increase ----------------- Increase ---------------- ---------- Volume Rate (Decrease) Volume Rate (Decrease) Volume Rate (Decrease) ------------------- ---------- ----------------- ---------- ---------------- --------- (Dollars in Thousands) (Dollars in Thousands) Interest-earning assets: Loans receivable ......... $ 672 $ (92) $ 580 $ 638 $ (88) $ 550 $ 439 $(185) $ 254 Mortgage-backed securities 18 (56) (38) (450) 14 (436) (122) 414 292 Investment securities .... (117) (50) (167) (248) (40) (288) (296) (138) (434) FHLB stock ............... (4) 1 (3) 3 (1) 2 4 (3) 1 ----- ----- ----- ----- ----- ----- ----- ----- ----- Total interest-earning assets ................ $ 569 $(197) $ 372 $ (57) $(115) $(172) $ 25 $ 88 $ 113 ===== ===== ===== ===== ===== ===== ===== ===== ===== Interest-bearing liabilities: NOW accounts ............. $ 0 $ 0 $ 0 $ 0 $ (1) $ (1) $ (2) $ 1 $ (1) Savings deposits ......... (2) 1 (1) (1) 0 (1) 1 4 5 Money market checking accounts ................ (7) (5) (12) (8) 4 (4) (16) 19 3 Certificate accounts ..... (54) 67 13 (88) 8 (80) (155) 367 212 Borrowings ............... 491 2 493 47 0 47 0 0 0 ----- ----- ----- ----- ----- ----- ----- ----- ----- Total interest-bearing liabilities ........... $ 428 $ 65 $ 493 $ (50) $ 11 $ (39) $(172) $ 391 $ 219 ===== ===== ===== ===== ===== ===== ===== ===== ===== Net change in interest income $(121) $(133) $(106) ====== ===== ===== Net interest income $3,298 $3,419 $3,552 ====== ====== ======
Interest Income Interest income is dependent upon the composition and dollar amounts of the Company's interest-earning assets, the yield on those assets and the current level of market interest rates. Interest income is generated by the earnings of the Company's loans receivable, investment securities and mortgage-backed securities portfolios. The Company's loans receivable portfolio is primarily comprised of fixed rate, single family residential mortgages and, to a lesser extent, adjustable rate single family mortgages and other real estate loans of both fixed and adjustable rates. Generally, all fixed rate one- to four-family mortgage loans with final maturities of more than fifteen years are sold into the secondary market upon origination. Depending upon the mortgage rate, fixed rate loans with maturities of fifteen years or less may be placed into portfolio or sold into the secondary market. All adjustable rate loans are held in portfolio. A significant portion of interest income is also derived from the Company's investment and mortgage-backed securities portfolios. The investment securities portfolio is comprised of U. S. Treasury and agency securities with a weighted average maturity of approximately 2.6 years. With portions of the portfolio scheduled to mature on a staggered basis, the portfolio provides liquidity for the Company's operations and additional flexibility with regard to asset and liability management. Additionally, 79.7% of the mortgage-backed securities portfolio is comprised of securities that have interest rate adjustment 9 frequencies of either six months or one year. The remainder of the portfolio is comprised of fixed rate securities all having final maturities of less than five years. 1998 and 1997 Comparison The Company reported total interest income of $8.3 million for the year ended September 30, 1998, an increase of $372,000 or 4.7% from the $7.9 million reported for the year ended September 30, 1997. The increase in interest income was a direct result of a $6.7 million increase in average interest earning assets from $109.7 million for the year ended September 30, 1997 to $116.4 million for the year ended September 30, 1998 which was only partially offset by a nine basis point decline in the average yield on interest earning assets from 7.19% for the year ended September 30, 1997 to 7.10% for the year ended September 30, 1998. The increase in average interest earning assets was primarily the result of an $8.4 million increase in average loans receivable balances outstanding from $52.2 million for the year ended September 30, 1997 to $60.6 million for the year ended September 30, 1998. As a result, interest income on loans receivable increased by $580,000 or 13.8% from $4.2 million for the year ended September 30, 1997 to $4.8 million for the year ended September 30, 1998. The increase in average loans receivable balances was a direct result of the Company's decision to continue placing into portfolio all fixed rate one- to four-family loans with terms of 15 years or less and with interest rates of greater than 7.00%. For most of the year ended September 30, 1998, interest rates on mortgage loans in the Company's market allowed the Company to continue this policy. In addition, the Company began making home equity loans in 1998, the first year allowed under Texas law. All home equity loans currently meet the Company's criteria for placing real estate related loans into portfolio. As a result of both conditions, the Company was able to substantially increase its loans receivable portfolio during 1998. As long term interest rates continued to decline during 1998 and mortgage rates on one- to four-family loans fell below 7.00%, the Company elected, towards the end of the fiscal year, to begin selling its 15-year and shorter one- to four-family loans into the secondary market. The Company continued to place all home equity loans into portfolio throughout the year. For the fiscal year ending September 30, 1999, the Company's ability to continue to increase its one- to four-family loans receivable portfolio will be primarily dependent upon the overall level of interest rates. Continued declines in interest rates could have the effect of increasing prepayments on the Company's existing mortgage portfolio if customers refinance their mortgages at lower interest rates or refinance with other lenders. In addition, the Company's ability to increase its one- to four-family loan portfolio will be dependent upon the Company's ability to meet its loan production targets, which are in turn primarily dependent upon the continued strong economic environment experienced in the Company's market over the past several quarters. See - --"Financial Condition - Loans" Offsetting the increase in interest income on loans receivable was a $117,000 decline in interest on the Company's short term U.S. Treasury and agency portfolio and a $38,000 decline in interest income on the Company's mortgage-backed securities portfolio. 10 During the fiscal year ended September 30, 1998, the Company elected to continue to increase its wholesale arbitrage program, by borrowing funds from the Federal Home Loan Bank of Dallas and investing in mortgage-backed securities. As a result, despite increased prepayments on its mortgage-backed securities portfolio as interest rates continued to decline, the Company was able to increase its mortgage-backed securities portfolio to $23.8 million at September 30, 1998 from $22.5 million at September 30, 1997. In fact, the average balance outstanding in the portfolio increased slightly to $22.7 million for the year ended September 30, 1998 from $22.4 million for the year ended September 30, 1997. As interest rates continued to decline throughout the year and the loans underlying the mortgage-backed securities refinanced into lower interest rates, the overall yield on the Company's mortgage-backed securities portfolio declined approximately 25 basis points from 6.98% for the year ended September 30, 1997 to 6.73% for the year ended September 30, 1998. The decline in average yield accounted for the overall decline in interest income on mortgage-backed securities for the year ended September 30, 1998. See -- "Financial Condition - -Mortgage-backed securities. The average balance in the Company's U.S. Treasury and agency portfolio declined approximately $1.9 million from $34.2 million for the year ended September 30, 1997 to $32.2 million for the year ended September 30, 1998. In addition as the overall level of interest rates decreased during the year and securities matured and were replaced with lower yielding securities, the average yield on the portfolio decreased to approximately 5.93% for the year ended September 30, 1998 from 6.09% for the year ended September 30, 1997. The result was an overall decline in interest income from the portfolio of approximately $167,000. 1997 and 1996 Comparison Interest income was reported as $7.9 million for the year ended September 30, 1997, a decrease of $172,000 or 2.1% from $8.1 million for the same period in 1996. The decrease in interest income was attributable to a $2.6 million decrease in average interest-earning asset balances during the year to $109.7 million for the year ended September 30, 1997 from $112.4 million for the year ended September 30, 1996. The decline in average total interest-earning assets was attributable to the Company's decision to fund deposit withdrawals with maturing investment and mortgage-backed securities. As a result and for a portion of the year ended September 30, 1997, total interest-earning assets and total assets of the Company declined. During the year, the Company began replacing retail deposits with wholesale borrowings from the Federal Home Loan Bank of Dallas. By September 30, 1997, total interest-earning assets increased to a level greater than that at September 30, 1996; however, the average balance for the year declined. The weighted average yield on average total interest-earning assets was 7.19% for 1997, up one basis point from the 7.18% reported for 1996. During the year, the Company also elected to divert cash flow from maturing investment securities and payments on mortgage-backed securities into the loans receivable portfolio. In addition, the average yield on the investment security portfolio declined from 6.21% for the fiscal year ended September 30, 1996 to 6.09% for the year ended September 30, 1997. As a result, 11 interest income from the investment security and mortgage-backed security portfolios declined to $3.4 million for the year ended September 30, 1997 from $4.1 million for the year ended September 30, 1996. Partially offsetting the decline in interest income from investment and mortgage-backed securities was an increase in interest income from loans receivable to $4.1 million for the year ended September 30, 1997 from $3.6 million for the year ended September 30, 1996. The average loans receivable balance increased to $52.1 million for 1997 from $44.4 million in 1996. The increase in average loans receivable outstanding was partially offset by a decline in the average yield on the portfolio from 8.20% for the year ended September 30, 1996 to 8.03% for the year ended September 30, 1997. Interest Expense The Company's interest expense is dependent upon the pricing and volume of its interest-bearing liabilities, comprised primarily of certificates of deposit and, to a lesser extent, savings accounts, NOW accounts, money market accounts, and borrowed funds. The level of interest expense depends upon the composition, pricing and dollar amount of the Company's interest-bearing liabilities, competition for deposits and the current level of market interest rates. Competition for certificate of deposit accounts continues to have an impact on the Company's ability to control interest expense. 1998 and 1997 Comparison Total interest expense increased approximately $494,000 to $5.0 million for the year ended September 30, 1998, compared to $4.5 million for the year ended September 30, 1997. The increase was primarily attributable to an increase in average interest-bearing liabilities from $89.7 million for the year ended September 30, 1997 to $97.3 million for the year ended September 30, 1998. The Company's overall cost of interest-bearing liabilities, despite a general decline in the level of interest rates throughout the year, actually increased by approximately 12 basis points from 4.98% for the year ended September 30, 1997 to 5.10% for the year ended September 30, 1998. The increase in average interest-bearing liabilities was directly attributable to the Company's decision to continue its wholesale funding arbitrage through the Federal Home Loan Bank of Dallas. During the year ended September 30, 1998, the Company increased its borrowings from the FHLB to $14.9 million at September 30, 1998 from $4.2 million at September 30, 1997. The Company's total deposit accounts declined slightly from $88.6 million at September 30, 1997 to $86.6 million at September 30, 1998. The increase in average cost of funds was primarily attributable to continued competitive pressure in the Company's local market for certificate of deposit accounts and the cost of the FHLB borrowings. 1997 and 1996 Comparison Total interest expense remained unchanged at $4.5 million for the year ended September 30, 1997, compared to the year ended September 30, 1996. Average total interest-bearing liabilities declined to $89.7 million for the year ended September 30, 1997 from $92.0 million for the year ended September 30, 1996, a $2.2 million decrease. The decline in average total interest- 12 bearing liabilities was primarily the result of a $1.7 million decrease in average balances outstanding in certificate of deposit accounts. Continued competition in the Company's local market and the Company's decision not to pay the highest rates in the market accounted for the decline in average certificate of deposit balances. The Company's average cost of interest-bearing liabilities increased 7 basis points to 4.98% for the year ended September 30, 1997, compared to 4.91% for the year ended September 30, 1996. The increase resulted partially from a 6 basis point increase in the average cost of money market checking accounts from 3.37% for 1996 to 3.43% for 1997. Also, the Company reported an average balance outstanding of $850,000 for borrowed funds for the fiscal year ended September 30, 1997, compared to none for the fiscal year ended September 30, 1996. The Company began a program of borrowing funds from the Federal Home Loan Bank of Dallas and investing in various mortgage-backed securities in order to achieve a positive margin on the transaction. The weighted-average cost of borrowings for the year ended September 30, 1997 was 5.53%. Net Interest Income Net interest income is the Company's principal source of earnings, and is directly affected by the relative level, composition and pricing of interest sensitive assets and liabilities. These factors are, in turn, affected by current economic conditions and the overall level of interest rates. 1998 and 1997 Comparison Net interest income after provision for loan losses totaled $3.3 million for the year ended September 30, 1998, a $117,000 or 3.4% decline from the $3.4 million reported for the year ended September 30, 1997. During the year ended September 30, 1998, the Company's average net interest spread was approximately 2.00%, compared to 2.21% for the year ended September 30, 1997. The Company's net interest margin on average interest earning assets was approximately 2.83% for the year ended September 30, 1998, compared to 3.12% for the year ended September 30, 1997. Continued competitive pressure for interest rates on certificates of deposit, refinancing of mortgage loans, and a "flat" interest rate environment contributed to the decline in the Company's net interest spread and net interest margin for the year. 1997 and 1996 Comparison Net interest income totaled $3.4 million for the year ended September 30, 1997, a decrease of $133,000 or 3.7% from the $3.6 million reported for the year ended September 30, 1996. The decline in net interest income was primarily the result of the $172,000 decrease in total interest income. For the year ended September 30, 1997, the Company reported an average net interest spread of 2.21%, down 6 basis points from the 2.27% reported for the year ended September 30, 1996. The Company's net interest margin on average interest-earning assets was 3.12% for 1997, compared to 3.16% for 1996 while the Company's ratio of average interest-earning assets to average interest-bearing liabilities was 122.29% for 1997, compared to 122.23% for 1996. 13 Provision for Loan Losses The Company's provision for loan losses is determined by management's periodic assessment of the adequacy of the allowance for loan losses. Management's assessment of the desired level of the allowance for loan losses is affected by factors such as the composition of the loan portfolio and the risk characteristics of various classes of loans, the current level of non-performing loans, economic conditions and real estate values, as well as current regulatory trends. 1998 and 1997 Comparison For the year ended September 30, 1998, the Company made no provision for loan losses, compared to $5,000 for the year ended September 30, 1997. The continued strength of the economy in the Company's market and the continued quality of its loan portfolio contributed to the decision to make no additional provisions for loan losses during the year ended September 30, 1998 and only $5,000 for the year ended September 30, 1997. The Company anticipates adding to its allowance for loan losses and thereby increasing its provision for loan losses as commercial and consumer loans are introduced in 1999. Non-performing assets to total assets were down to .18% of total assets at September 30, 1998, compared to .27% at September 30, 1997. Non-performing loans to total loans receivable totaled .37% at September 30,1998, compared to .54% at September 30, 1997. The Company's allowance for loan losses as a percentage of loans receivable equaled .38% at September 30, 1998, compared to .48% at September 30, 1997 while the allowance for loan losses as a percentage of non-performing loans increased to 102.19% at September 30, 1998 from 88.06% at September 30, 1997. 1997 and 1996 Comparison During the year ended September 30, 1997, the Company reported provisions for loan losses of $5,000 compared to zero for the year ended September 30, 1996. At September 30, 1997, non-performing assets to total assets were .27% compared to .39% at September 30, 1996. Non-performing loans to total loans receivable were .54% at September 30, 1997, compared to .94% at September 30, 1996. Allowance for loans losses as a percentage of non-performing loans was 88.06% at September 30, 1997, compared to 64.22% at September 30, 1996, while the allowance for loan losses declined to .48% of loans receivable at September 30, 1997 from .60% of loans receivable at September 30, 1996, due to the increase in the size of the loans receivable portfolio. Other Operating Income Other operating income consists primarily of fee income from service charges, origination fees and servicing fees on the Company's loan portfolio, gains or losses on the sale of loans and fees from transaction accounts. 14 1998 and 1997 Comparison Other operating income equaled $361,000 for the year ended September 30, 1998, an increase of $58,000 from the $302,000 reported for the year ended September 30, 1997. The increase in other operating income was primarily the result of an $81,000 increase in gains on sales of loans to $153,000 for the year ended September 30, 1998, compared to $72,000 for the year ended September 30, 1997. As interest rates on mortgage loans fell below the Company's threshold for placing such loans into its loan portfolio in the fiscal year ended September 30, 1998, the Company began selling more loans into the secondary market. The result was additional gains on the sale of such loans both on a cash basis and under Statement of Financial Accounting Standards No. 122, Accounting For Mortgage Servicing Rights. SFAS No. 122 requires that the present value of the estimated servicing income from a loan sold be recorded as a gain on the sale of the loan. The recorded gain on the sale of the loan is subsequently amortized over the estimated life of the loan against loan servicing fee income. Proceeds from the sale of mortgage loans totaled approximately $10.1 million during the year ended September 30, 1998, compared to $4.8 million for the year ended September 30, 1997. Gains on the sale of loans due to originated mortgage servicing rights totaled $120,000 for the year ended September 30, 1998, compared to $58,000 for the year ended September 30, 1997. Cash gains on the sale of loans totaled $32,000 and $14,000 for the years ended September 30, 1998 and 1997 respectively. Offsetting a portion of the additional gains on sales of loans into the secondary market was a $25,000 decline in loan servicing fees to $70,000 for the year ended September 30, 1998, compared to $95,000 for the year ended September 30, 1997. The decline in loan servicing fees resulted primarily from additional amortization of originated mortgage servicing rights on previously recorded loans that were paid off or refinanced during the year. Loans serviced for others totaled $42.6 million at September 30, 1998, compared to $39.4 million at September 30, 1997. Loan servicing fee income before the reduction for the amortization of originated mortgage servicing rights totaled $123,000 for the year ended September 30, 1998, compared to $124,000 for the year ended September 30, 1997. However, the amortization of previously recorded mortgage servicing rights totaled $53,000 for the year ended September 30, 1998, compared to $29,000 for the year ended September 30, 1997. The net result was a decline in loan servicing fee income, despite the fact that loan balances serviced for others increased during the year. With the introduction of the consumer and commercial banking products associated with its additional lines of business, the Company anticipates an increase in other operating income for 1999. 1997 and 1996 Comparison Other operating income totaled $302,000 for the year ended September 30, 1997, a decrease of $69,000 from the $371,000 reported for the year ended September 30, 1996. The decrease in other operating income was attributable to the Company's decision to continue to place loans into portfolio rather than sell loans into the secondary market. For the year ended September 30, 1997, the Company continued its policy of placing all single family real estate loans with a term of less than or 15 equal to 15 years and with an interest rate of greater than 7.00% into its loan portfolio. Loans with longer terms or with lower interest rates were sold into the secondary market. That policy, in conjunction with continued lower mortgage rates and a preference of loan customers for shorter term fixed rate loans, affected the Company's reported gains on sales of loans under the requirements of SFAS No. 122. Net gains on the sale of loans totaled $72,000 for the year ended September 30,1997, a $44,000 or 38.2% decrease from the $116,000 reported for the year ended September 30, 1996 as more loans were placed into portfolio and fewer gains on the sales of the loans were recorded under SFAS No. 122. In addition, loan origination and commitment fees declined to $66,000 for the year ended September 30, 1997 from $84,000 for 1996 as the borrowers for single family real estate loans in the Company's market area continued to demand loans with little or no initial fees. Loan servicing fees declined to $95,000 for the year ended September 30, 1997 from $111,000 for the year ended September 30, 1996. The decline was the result, as borrowers paid off or refinanced their mortgages, of a continued decrease in older loans in the Company's servicing portfolio with higher servicing margins. Also, in order to remain competitive in its local market on thirty year fixed rate loans and still be able to sell such loans into the secondary market, the Company has been forced to minimize the amount of servicing spread built into those transactions. In addition, the Company's decision to retain its fifteen year loans in portfolio and a local market preference for them, has resulted in fewer additions to the loan servicing portfolio, and the continued amortization of originated mortgage servicing assets recorded under SFAS No. 122 accounted for the decline in servicing fees. At September 30, 1997, the Company serviced approximately $39.4 million in loans sold to other lenders, compared to $40.1 million at September 30, 1996. Operating Expenses Operating expenses are comprised of compensation and benefits, occupancy and equipment and general and administrative expense, together with FDIC insurance premiums. 1998 and 1997 Comparison Operating expenses totaled $2.8 million for the year ended September 30, 1998, a $245,000 or 9.7% increase from the $2.5 million reported for the year ended September 30, 1997. The increase in total non-interest expense was primarily the result of a $165,000 increase in compensation and benefits expense, a $34,000 increase in occupancy and equipment expenses and a $63,000 increase in miscellaneous operating expenses. The increase in compensation and benefits expense was the result of an $85,000 increase in salaries paid to employees, a $50,000 increase in funding costs on the Company's defined benefit pension plan and a $20,000 increase in expenses associated with the release of shares under the Company's ESOP. The increase in salaries paid to employees was due to additional lending personnel added to the Company's staff during 1997. Compensation expense for such employees were for a twelve month period in fiscal 1998 compared to only a portion of fiscal 1997. The additional pension expense was also the result of additions to the Company's staff and increased funding requirements as participants in the plan receive salary increases and increase their length of employment. The additional ESOP expense was due to the accounting requirements of 16 American Institute of Certified Public Accountants Statement of Operating Procedures No. 93-6. Under this procedure, ESOP expense is determined by the number of shares released during the year and the average fair market value of the Company's stock. The average fair market value of the Company's stock increased in 1998 as compared to 1997. Occupancy and equipment expense totaled $192,000 for the year ended September 30, 1998, compared to $157,000 for the year ended September 30, 1997. The increase was primarily due to additional depreciation expense associated with the addition of computer and other equipment added to the Company's operations in 1998. The Company anticipates significant increases in its operating expenses in 1999 with the introduction of its commercial and consumer lines of business. Total non-interest expense as a percentage of average total assets was 2.31% for the year ended September 30, 1998, compared to 2.19% for the year ended September 30, 1997. The Company's efficiency ratio was 78.96% for the year ended September 30, 1998, compared to 69.24% for the year ended September 30, 1997. 1997 and 1996 Comparison Operating expenses were reported as $2.5 million for the year ended September 30, 1997, a $677,000 decrease from the $3.2 million reported for the year ended September 30, 1996. The decrease in total non-interest expense was primarily attributable to the elimination of the one time special assessment, mandated by the U.S. Congress, and charged to all SAIF insured institutions during the fiscal year ended September 30, 1996. The Company's portion of the special assessment was approximately $645,000. In addition, for the year ended September 30, 1997, SAIF deposit insurance premiums were $80,000, compared to $223,000 for the fiscal year ended September 30, 1996, a $143,000 decrease. The decrease was a result of reduced SAIF insurance premium rates once the fund attained its minimum required level (after the special assessment.) Partially offsetting the decline in SAIF insurance premiums was a $92,000 increase in compensation and benefits expense. The increase was partially the result of additional personnel added during the year to staff the Company's new loan agency offices. In addition, an increase in the funding requirements for the Company's defined benefit pension plan and an increase in reported ESOP expense accounted for the remainder of the increase in compensation and benefits expense. The additional ESOP expense was the result of an increase, due to the increase in the stock price, in the average value of the shares of Company stock scheduled to be released to participants during the year. Total non-interest expense as a percentage of average total assets was 2.19% for the year ended September 30, 1997, compared to 2.77% for the year ended September 30, 1996. The Company's efficiency ratio, which considers operating expenses as a percentage of net interest income and other operating income (excluding gains and losses on sales of assets), was 69.2% in 1997, compared to 84.1% in 1996. 17 Income Tax Expense Income tax expense is comprised of federal income tax. The Company does not incur any state or local income tax liability. 1998 and 1997 Comparison Income tax expense totaled $329,000 for the year ended September 30, 1998 or 37.0% of pre-tax income, compared to $427,000 or 35.8% of pre-tax income for the year ended September 30, 1997. The decrease in income tax expense was attributable to the reduction in pre-tax income from $1.2 million for the year ended September 30, 1997 to $890,000 for the year ended September 30, 1998. 1997 and 1996 Comparison Income tax expense was reported as $427,000 or 35.8% of pre-tax income for the fiscal year ended September 30, 1997, compared to $265,000 or 36.7% of pre-tax income in 1996. The increase in income tax expense was directly attributable to the additional pre-tax income reported for the year ended September 30, 1997. Financial Condition Balance Sheet Summary During the year ended September 30, 1998, management made a determined effort to increase the total assets of the Company. A continued focus on one- to four-family portfolio lending and a commitment to continue the wholesale arbitrage program begun in 1997 allowed the Company to increase its total assets from $115.9 million at September 30, 1997 to $124.0 million at September 30, 1998. Based upon its ability to access the FHLB for short-term liquidity needs, the Company elected to deploy more of its excess short-term overnight funds into investment securities. The balance in total cash and cash equivalents equaled $1.7 million at September 30, 1998, compared to $6.9 million at September 30, 1997. Consequently, the Company's investment securities portfolio of U.S. Treasury securities and agency increased to $29.8 million at September 30, 1998 from $23.1 million at September 30, 1997. Mortgage-backed securities available-for-sale increased as the Company expanded its wholesale arbitrage program begun. However, lower interest rates had the effect of decreasing the Company's held-to-maturity mortgage-backed securities portfolio as borrowers on the adjustable rate loans underlying the securities refinanced into fixed rate loans. 18 Loans receivable increased as a result of the Company's policy of continuing to place its fixed rate loans with original maturities of less than 15 years into portfolio. Premises and equipment increased substantially to $2.3 million at September 30, 1998 compared to $1.1 million at September 30, 1997. The increase was due to the Company's acquisition of approximately 4.2 acres of land in south Tyler for its new full service location. Competition for certificates of deposit accounts and the Company's decision not to pay the highest rates in the market resulted in an overall decline in deposit accounts during the year. However, total interest-costing liabilities increased as the Company borrowed additional funds from the FHLB to fund its wholesale arbitrage program. Stockholders' equity decreased by $496,000 during the year. The decline was primarily the result of the Company's stock repurchase made during the year ended September 30, 1998 and cash dividends paid to stockholders. Loans The Company continued its focus on one- to four-family portfolio lending throughout the fiscal year ended September 30, 1998. For most of the year, the interest rates on one- to four-family loans remained at levels that allowed the Company to place into portfolio all of its fixed rate loans with an original maturity of 15 years or less. The Company continued its policy to sell all fixed rate loans with an original maturity of greater than 15 years into the secondary market. Fixed rate loans continued to be the predominant choice of mortgage borrowers in the Company's market. For the year ended September 30, 1998, the Company originated a total of approximately $31.3 million in loans. Fixed interest rate loans accounted for approximately 97.2% of the total while adjustable rate loans accounted for approximately 2.8%. At September 30, 1998, approximately 82.7% of the Company's loan portfolio was comprised of loans with fixed rates of interest and approximately 17.3% of the portfolio was comprised of loans with adjustable interest rates. At September 30, 1998, the weighted-average yield on the Company's loan portfolio was 7.71%, compared to 7.92% at September 30, 1997. The portfolio was comprised of approximately $52.3 million in one- to four-family loans or approximately 83.3% of gross loans-receivable. The Company expects to continue to focus on one- to four-family portfolio lending in 1999. However, the overall level of interest rates and therefore the level of mortgage rates will dictate the Company's ability to place such loans into portfolio. A continued period of lower interest rates and a strong local economy will help the Company's overall one- to four-family lending efforts, but loans could be made at interest rates that will not meet the Company's guidelines for placing such loans into portfolio. The result would be an overall substantial decline in interest income on loans receivable and a decline in net income as cash flow is redirected to other interest earning assets at lower interest rates. Gross interim construction loans totaled $2.3 million or approximately 3.6% of the gross loan portfolio at September 30, 1998. Interim construction one- to four-family loans are generally made for terms of up to nine months and usually at or near the prime lending rate. The interest rate is fixed for the term of the loam. The Company does not expect to increase its one- to four-family interim construction lending significantly in 1999. The Company began offering home equity loans on January 1, 1998, the first time allowed by Texas law. Home equity loans are generally made with terms of between 5 and 15 years. These loans are made with fixed rates of interest at or near the 19 prime lending rate. Rates vary according to the term and size of the loan. At September 30, 1998, the Company had approximately $2.5 million in home equity loans in its loan portfolio. The Company expects to continue to increase the balance in home equity loans during the fiscal year ended September 30, 1999. Nonresidential real estate loans totaled $4.1 million at September 30, 1998, compared to $4.0 million at September 30, 1997. Nonresidential real estate loans are generally made with fixed rates of interest and for terms of up to 15 years. Interest rates on such loans are generally made at or near the prime lending rate. The Company anticipates increasing the balance in nonresidential real estate loans significantly during the upcoming fiscal year. As interest rates on traditional one- to four-family loans continued to decline during the year and borrowers continued to refinance their mortgages to lower interest rates, the Company continued to experience a decline in its overall net interest margin on earning assets. The result was a continued decline in net income for the Company. As a result of this decline, the Company made the decision during the fiscal year ended September 30, 1998 to expand its current lines of business into commercial and consumer lending. The Company's strategy will be to increase its total loan production, to diversify into lending products with higher yields and shorter terms, and reverse the trend of declining margins that all traditional one- to four-family lenders have experienced as interest rates have declined. In conjunction with this change of business strategy, the Company announced its intention to open a new branch office facility in the rapidly growing area of South Tyler. The location will offer all of the lines of business the Company has traditionally offered. In addition, the new location and all of the Company's full service locations will begin offering a full line of commercial banking services, including commercial and consumer lending, commercial checking accounts, personal banking products such as credit and debit cards, investment brokerage services, automated teller machines, and extended banking hours. The Company anticipates initially hiring approximately nine additional full time and two additional part time employees to open the new office location. The staff will include persons responsible for starting the commercial and consumer lending programs for the Company. The Company anticipates hiring lenders from within the Tyler market. The additional expense from starting such an operation will be extensive, and the Company does not anticipate that the operation will be profitable within the first year of operation. However, the Company believes that the long-term benefits from adding these additional business lines offset the initial costs of starting the operation. 20 Loan Portfolio Analysis
September 30, ------------------------------------------------------------------------------------ 1998 1997 1996 Amount Percent Amount Percent Amount Percent ------------------------------------------------------------------------------------ (Dollars in Thousands) Real estate loans: One- to four-family residences $ 52,298 83.34 % $ 49,412 83.88 % $ 42,773 85.98 % Other residential property 551 0.88 569 0.97 701 1.41 Nonresidential property 4,106 6.54 4,023 6.83 3,458 6.95 Construction loans 2,256 3.60 3,600 6.11 1,806 3.63 --------- ----- ---------- ----- ---------- ----- Total real estate loans 59,211 94.36 57,604 97.79 48,738 97.97 --------- ----- ---------- ----- ---------- ----- Other loans: Loans secured by deposits 403 0.64 488 0.83 500 1.00 Home improvement 517 0.82 563 0.96 455 0.92 Home Equity 2,454 3.91 0 0.00 0 0.00 Commercial 168 0.27 252 0.42 54 0.11 --------- ----- ---------- ----- ---------- ----- Total other loans 3,542 5.64 1,303 2.21 1,009 2.03 --------- ----- ---------- ----- ---------- ----- Total loans 62,753 100.00 % 58,907 100.00 % 49,747 100.00 % ====== ====== ====== Less: Loans in process 1373 1,506 1,514 Deferred fees and discounts 28 18 19 Allowance for loan losses 233 273 289 --------- ---------- ---------- Total loans receivable, net 61,119 57,110 47,925 Less: Loans held for sale 0 0 0 --------- ---------- ---------- Net portfolio loans $ 61,119 $ 57,110 $ 47,925 ========= ========== ==========
Mortgage-backed Securities At September 30, 1998, the Company reported $23.8 million in mortgage-backed securities, a $1.3 million increase from the $22.5 million at September 30, 1997. Mortgage-backed securities in an available-for-sale classification totaled $12.8 million and securities in a held-to-maturity classification totaled $10.9 million. The weighted-average yield on the entire portfolio was approximately 6.67% at September 30, 1998. The increase in the available-for-sale securities was a result of the Company's decision to continue its program of borrowing wholesale funds from the FHLB and investing the proceeds in adjustable rate mortgage-backed securities. The securities have interest rate adjustment frequencies of either monthly, quarterly, semi-annually or annually. The interest rates earned on the securities are determined by an index and generally have a margin above the index of 100 to 225 basis points. The index is typically based upon market interest rates such as the one year U.S. Treasury rate or the one, three, or six month LIBOR. Management's intention is to continue to increase the balance, in the program, as market conditions are favorable. The goal of the program would be to leverage a portion of the Company's excess capital and to achieve a rate of return on the difference in 21 the rate earned on the securities and the cost of the advance of approximately 100 to 150 basis points on a pre-tax basis. The advances from the FHLB generally will have terms of 30 to 35 days. Interest rates on the advances, which are established by the FHLB, are based on short-term interest rates such as the one-month U.S. Treasury bill rate or the one-month LIBOR. At September 30, 1998, the Company had approximately $12.9 million in the program. Investment Securities Investment securities totaled $29.8 million at September 30, 1998, a $6.7 million increase from the $23.1 million reported at September 30, 1997. The entire portfolio was in a held-to-maturity classification and had a composite yield of approximately 6.04% at year-end. All of the securities had fixed interest rates. The increase in the outstanding balances was a result of the Company's decision to transfer excess interest-earning bank balances and federal funds sold into longer term higher yielding investments. At September 30, 1998, the portfolio contained $8.0 million in securities with remaining terms until maturity of less than one year, $8.0 million with remaining terms of one through three years, $13.8 million with remaining terms of three through five years. Of the $29.8 million in the portfolio at September 30, 1998, $15.7 million are callable at various dates between November 1998 and June 2001. Deposit and Borrowings Total deposits were reported as $86.6 million at September 30, 1998, a $1.9 million decrease from the $88.6 million at September 30, 1997. Continued local competition for certificate of deposit accounts and the Company's decision to not pay the highest interest rates in the local market accounted for the decrease in total deposit account. Certificate of deposit accounts declined by $2.3 million during the year. In addition, the Company utilized its borrowing privileges from the FHLB to fund a greater portion of its interest earning assets during the year. Advances from the FHLB totaled $14.9 million at September 30, 1998, a $10.7 million increase from the $4.2 million at September 30, 1997. The increase in FHLB advances was primarily the result of the Company's decision to continue its wholesale arbitrage program of borrowing adjustable rate advances from the FHLB and investing the proceeds in adjustable rate mortgage-backed securities. Also during the year ended September 30, 1998, the Company utilized approximately $3.0 million in fixed term interest rate FHLB advances to fund matching- term commercial real estate loans. Interest Rate Sensitivity Interest rate sensitivity is a measure of the extent to which the Company's net interest income and net portfolio value may be affected by future changes in market interest rates. Numerous assumptions, primarily future changes in interest rates, changes in cash flows on assets and liabilities and future product preferences of customers, which are affected by assumptions about future pricing of products, are required to arrive at the approximation of the net interest income impact. 22 The Company also monitors interest rate risk by measuring the difference between rate sensitive assets and rate sensitive liabilities that mature or reprice within a given time period, adjusted for the effects of estimated prepayments and early withdrawals on interest sensitive assets and liabilities. Certain deficiencies are inherent in the assumptions and methods used to calculate the Company's level of interest rate sensitivity. For example, changes in the overall levels of interest rates could affect prepayment and early withdrawal assumptions assumed in the calculations. Also, interest rates on certain assets and liabilities may change in advance of or lag behind changes in market rates. The Office of Thrift Supervision adopted a final rule in August of 1993 incorporating an interest rate risk component into the risk-based capital rules. Under the rule, an institution with a greater than normal level of interest rate risk will be subject to a deduction of its interest rate component from total capital for purposes of calculating the risk-based capital requirement. An institution with greater than normal interest rate risk is defined as an institution that would suffer a loss of net portfolio value exceeding 2.0% of the estimated market value of its assets in the event of a 200 basis point increase or decrease in interest rates. Net portfolio value is the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts. A resulting change in net portfolio value of more than 2.0% of the estimated market value of an institution's assets will require the institution to deduct from its capital 50% of that excess change when calculating regulatory capital ratios. The effective date of the rule has been postponed by the Office of Thrift Supervision until further notice. Further, institutions with less than $300 million in total assets and a risk-based capital ratio of greater than 12.0% are generally exempt from the requirements of the rule and exempt from filing information with the Office of Thrift Supervision necessary to calculate the component. Under the current rule, the Association would not be subject to the interest rate risk component. In an attempt to ensure that interest rate risk is maintained within limits established by the Board of Directors, management presently monitors and evaluates the potential impact of interest rate changes upon the market value of the Association's equity and the level of its net interest income on a quarterly basis. Management conducts this analysis with an asset and liability management simulation model using estimated prepayment rates for various classes of interest sensitive assets and estimated decay rates for interest-bearing NOW accounts, money market accounts and savings accounts. The assumptions used may not be indicative of future withdrawals of deposits or prepayments on loans and mortgage-backed securities. 23 The following table presents the Association's analysis of its net portfolio value and net interest income under various instantaneous changes in interest rates at September 30, 1998.
Net Portfolio Value Net Interest Income --------------------------------------------- --------------------------------------------- Change In Interest Rates Estimated Amount Of Percent Net Interest Amount Of Percent Of (basis points) NPV Change Of Change Income Change Change - ---------------- ----------- ----------- ------------ ----------- ----------- ------------- (Dollars in Thousands) +400 $ 13,846 $ (8,430) (37.8) % $ 2,242 $ (883) (28.3) % +300 15,963 (6,313) (28.3) 2,520 (605) (19.4) +200 18,138 (4,138) (18.6) 2,761 (364) (11.6) +100 20,138 (2,138) (9.6) 2,938 (187) (6.0) 0 22,276 3,125 -100 24,524 2,248 10.1 3,295 170 5.4 -200 23,834 1,558 7.0 3,159 34 1.1 -300 25,490 3,214 14.4 2,981 (144) (4.6) -400 27,302 5,026 22.6 2,706 (419) (13.4)
The table indicates that the Association's estimated net portfolio value (market value of assets less market value of liabilities) is approximately $22.3 million or 17.3% of the market value of assets at September 30, 1998. The estimated net portfolio value is approximately $3.8 million more than the Association's reported net worth of $18.5 million, which is approximately 14.9% of total assets. In addition, under a worst case scenario of a 400 basis point immediate and permanent increase in interest rates, the Association's estimated net portfolio value would only decline by 37.8% to $13.8 million and would still be approximately 11.9% of market value of assets. The table also shows that the Association's net interest income, in an unchanged rate scenario, would approximate $3.1 million and would only vary by $883,000 or 28.3%, under changes in the level of interest rates up to 400 basis points. 24 Asset Quality The following table sets forth an analysis of the Company's allowance for loan losses:
Year Ended September 30, --------------------------------------------------------------------- 1998 1997 1996 1995 --------------- --------------- --------------- ----------------- (Dollars in Thoousands) Balance at beginning of period $ 273 $ 289 $ 296 $ 300 Charge-offs: One- to four-family (40) (26) (7) (4) Other loans 0 (1) 0 0 ------------- ------------- ------------- ------------- Total charge-offs (40) (27) (7 ) (4) ------------- ------------- ------------- ------------- Recoveries: One- to four-family 0 6 0 0 Other loans 0 0 0 0 ------------- ------------- ------------- ------------- Total recoveries 0 6 0 0 ------------- ------------- ------------- ------------- Net charge-offs (40) (21) (7) (4) Additions charged to operations 0 5 0 0 ------------- ------------- ------------- ------------- Balance at end of period $ 233 $ 273 $ 289 $ 296 ============= ============= ============= ============= Ratio of net charge-offs during the period to Average loans outstanding during the period 0.07 % 0.04 % 0.02 % 0.01 % ============= ============= ============= ============= Ratio of net charge-offs during the period to Average non-performing assets 14.87 % 5.53 % 1.66 % 1.14 % ============= ============= ============= =============
At September 30, 1998, non-performing assets were $228,000 or .18% of total assets, compared to $310,000 or .27% of total assets at September 30, 1997. At September 30, 1998, non-performing assets were comprised of non-accruing loans, all of which were one- to four-family residential loans and one foreclosed real estate property. All of the Company's multi-family, commercial real estate and construction loans were performing at year end. The Company's allowance for loan losses totaled $233,000 at September 30, 1998, down $40,000 from $273,000 at September 30, 1997. At September 30, 1998, the Company's allowance for loan losses was .38% of loans receivable, compared to .48% at September 30, 1997, and was 102.2% of non-performing loans at September 30, 1998, compared to 88.1% at September 30, 1997. 25 The following table presents the amounts and categories of non-performing assets of the Company:
September 30, ----------------------------------------------------------------------- 1998 1997 1996 1995 -------------- -------------- -------------- -------------- (Dollars in Thousands) Non-accruing loans: One- to four-family $ 187 $ 306 $ 449 $ 294 Other loans 0 4 1 0 ---------- ----------- ---------- ---------- Total 187 310 450 294 ---------- ----------- ---------- ---------- Accruing loans delinquent more than 90 days: One- to four-family 6 0 0 12 ---------- ----------- ---------- ---------- Total 6 0 0 12 ---------- ----------- ---------- ---------- Foreclosed assets: One- to four-family 35 0 0 90 ---------- ----------- ---------- ---------- Total 35 0 0 90 ---------- ----------- ---------- ---------- Total non-performing assets $ 228 $ 310 $ 450 $ 396 ========== =========== ========== ========== Total as a percentage of total assets 0.18 % 0.27 % 0.39 % 0.34 % ========== =========== ========== ==========
Liquidity and Capital Position The Company's principal sources of funds are deposits from customers, advances from the FHLB, amortization and prepayments of loan principal (including mortgage-backed securities), maturities of securities, sales of loans and operations. As of September 30, 1998, Office of Thrift Supervision regulations required cash and eligible investments (liquid assets), in an amount not less than 4.0% of net withdrawable savings deposits and borrowings payable on demand or within five years or less be held by the Association. Liquid assets include cash, certain time deposits, and U. S. Government and agency securities having maturities of less than five years. At September 30, 1998, the Association's liquid asset ratio equaled 40.1%. The Company uses its liquidity and capital resources principally to meet ongoing commitments to fund maturing certificates of deposit and loan commitments, maintain liquidity and pay operating expenses. At September 30, 1998, the Company had outstanding commitments to extend credit on $4.1 million of single family residential loans. Cash and cash equivalents totaled $1.7 million at September 30, 1998, compared to $6.9 million at September 30, 1997. The primary use of funds during the year was to fund loan originations, purchase securities, and purchase treasury stock. The primary source of funds during the year was from maturing investment securities and payments on mortgage-backed securities and loans and borrowings from the FHLB. Management believes that it has adequate resources to fund all of its current commitments. 26 During the fiscal year ended September 30, 1998, the Company repurchased an additional 76,973 shares of stock at an average price of $14.04 per share. The Company also issued an additional 1,568 shares of treasury stock in conjunction with the exercise of stock options during the year under the Company's 1995 Stock Option and Incentive Plan. At September 30, 1998, the Company owned 420,436 shares of treasury stock at an average price of $11.40 per share. The Company ended the year with 1,464,056 shares outstanding. The closing stock price on that date was $13.25 per share. The high and low prices for the year were $16.25 and $13.00 respectively. The Company continued its current dividend policy by declaring and paying four quarterly cash dividends of $.05 per share for a total of $257,000 during the year. Based on the September 30, 1998 closing stock price of $13.25 per share, the annualized dividend amount of $.20 per share would equal an annual dividend rate of 1.51%. Total stockholders' equity equaled $20.4 million at September 30, 1998, a decrease of $496,000 from the $20.9 million reported at September 30, 1997. As of September 30, 1998, the Company's reported book value per share, using a total stockholders' equity of $20.4 million (net of unallocated ESOP and RRP shares) and 1,464,056 outstanding shares of common stock (the total outstanding shares including unallocated ESOP and RRP shares), equaled $13.92 per share. Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), Congress imposed a three part capital requirement for thrift institutions. At September 30, 1998, the Association's actual and required capital amounts under each of the three requirements were as follows: - Tangible Capital (stockholders' equity plus certain intangible assets) was $18.6 million, or 14.95% of total assets, exceeding the minimum requirement of 1.5% by $16.7 million. - Core Capital (tangible capital plus certain intangible assets) was $18.6 million, or 14.95% of total assets, exceeding the minimum requirements of 4.0% by $13.6 million. - Risk-based capital (core capital plus general loan and valuation allowances) equaled $18.8 million, or 38.29% of risk weighted assets, as of September 30, 1998, exceeding the minimum requirement of 8.0% of risk weighted assets by $14.9 million. At September 30, 1998, the Association met all of the requirements to be considered a "well capitalized" institution under the Federal Deposit Insurance Corporation Improvement Act. Impact of Accounting Pronouncements SFAS NO. 128 In February 1997, the FASB issued SFAS No. 128, Earnings Per Share. SFAS No. 128 establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. The Statement simplifies the standards for computing EPS and makes them comparable with international EPS standards. 27 SFAS No. 128 replaces the presentation of primary EPS previously prescribed in APB No. 15, Earnings Per Share, with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS does not include dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to APB Opinion No. 15. The Statement is effective for financial statements issued for periods ending after December 15, 1997. SFAS No. 130 In June of 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS ) No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in general purpose financial statements. Comprehensive income includes net income and several other items that current accounting standards require to be recognized outside of net income. SFAS No. 130 requires companies to display comprehensive income in its financial statements, to classify items of comprehensive income by their nature in their financial statements and to display accumulated balances of comprehensive income in stockholders' equity separately from retained earnings and addition paid-in capital. The Statement is effective for fiscal years beginning after December 31, 1997. The Company adopted the Statement effective October 1, 1998. SFAS No. 131 In June of 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 131, Disclosure About Segments of and Enterprise and Related Information. The Statement requires entities to report certain information about their operating segments in a complete set of financial statements. It requires them to report certain enterprise-wide information about their products and services, activities in different geographic regions and their reliance on major customers, and to disclose certain segment information in their interim financial statements. The Statement is effective for fiscal years beginning after December 15, 1997. The Company has not determined the effects, if any, that the disclosure requirements will have on its financial statements. The Company adopted the Statement effective October 1, 1998. SFAS No. 132 In February of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. SFAS No. 132 revises 28 current disclosures for employers' disclosures for pensions and other postretirement benefit plans. It standardizes the disclosure requirements for these plans to the extent possible, and it requires additional information about changes in the benefit obligations and the fair value of plan assets that are expected to enhance financial analysis. It does not change measurement or recognition standards for these plans. SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. The Company anticipates changing the disclosure requirements of its defined benefit pension plan as a result of the statement. The Company has no other postretirement benefit plans. Year 2000 Compliance Assessment The Year 2000 or Century Date Change issue is a result of computer programs being written using two digits rather than four digits to define the applicable year. The possibility that a computer system may recognize "00" as the year 1900 rather than the year 2000, could result in a system failure or miscalculations causing disruptions of operations. The Company has established a management committee to identify all of its systems potentially affected by the year 2000 and to ensure that reprogramming of affected systems is completed. The committee is responsible for testing all company computer systems and ensuring that all third party computer system vendors complete Year 2000 remediation. Financial institution regulators have increased their focus upon Year 2000 compliance issues and have issued guidance concerning the responsibilities of senior management and directors. Federal banking agencies have asserted that Year 2000 testing and certification is a primary safety and soundness issue in conjunction with regulatory examinations and, thus, that an institution's failure to properly address Year 2000 issues could result in supervisory action, including the reduction of an institution's supervisory ratings, the denial of applications for approval of mergers or acquisitions, or the imposition of civil monetary penalties. During 1997, the Company formulated its plan to address the Year 2000 issue. Since that time, the Company has taken the following steps: Established a senior management team to coordinate Year 2000 issues; Completed an inventory of application and system software; Initiated and verified Year 2000 compliance by third party software vendors; Identified any large customers that may be affected by the Year 2000 issue; Tested all personal and network computers used by the Company for Year 2000 compliance; Designed test scripts and tested the Company's third party major data processing service provider; Reviewed the results from the Company's major data processing service provider's proxy testing of application systems. 29 Discussed strategies for notifying customers about the risks of Year 2000; Implemented the design of a business resumption plan as it relates to the Year 2000 issue that will interface with the Company's Disaster Recovery Plan. Based upon the Company's own internal testing and the results of proxy testing by the Company's major data processing service provider, the Company believes that the risk that the major data processing service provider will not be Year 2000 compliant is low. As a result, the Company believes that a contingency plan with respect to its major data processing service provider is not required. The Company has also received correspondence from all other third party software providers that indicate that all of such software will be Year 2000 compliant. The Company has budgeted approximately $25,000 for its Year 2000 program. As of September 30, 1998, the Company has expensed or is aware of future expenditures totaling approximately $8,000. The Company is in the process of developing a business resumption plan that will interface with its existing Disaster Recovery and Contingency Plan. Such plan will address the likelihood that major systems, other than the Company's major data processing service provider, will not be available. Major systems include but are not limited to telephone, electrical, transportation and other similar systems. The business resumption plan will address cash and liquidity needed to meet customer demands as the year 2000 approaches. Impact of Inflation and Changing Prices The consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted account principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative power of money due to inflation. Most of the Company's assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or at the same magnitude as the prices of goods and services. Market Price of Common Stock At September 30, 1998, East Texas Financial Services, Inc. traded on The Nasdaq National Market under the symbol "ETFS". On such date, the Company had 1,464,056 shares outstanding and approximately 450 stockholders of records. Subsequent to the year end, the Company was notified by Nasdaq Stock Market that it did not meet the minimum number of round lot 30 stockholders required for continued listing on either the National or the SmallCap Market. The Company has approximately 275 round lot stockholders. As a result, the Company's stock was moved to the Over-The-Counter Electronic Bulletin Board on November 27, 1998. The following table sets forth the cash dividends paid per share and the high, low and closing prices for the fiscal periods indicated: High Low Close Dividends Fiscal 1998 First Quarter $15.83 $12.92 $15.83 $0.05 Second Quarter $15.83 $14.00 $15.00 $0.05 Third Quarter $16.25 $14.22 $15.00 $0.05 Fourth Quarter $15.50 $13.00 $13.25 $0.05 High Low Close Dividends Fiscal 1997 First Quarter $16.50 $14.75 $16.38 $0.05 Second Quarter $19.00 $16.88 $17.75 $0.05 Third Quarter $18.88 $16.88 $18.00 $0.05 Fourth Quarter $20.50 $18.00 $20.50 $0.05 High Low Close Dividends Fiscal 1996 First Quarter $17.00 $15.13 $16.25 0 Second Quarter $16.75 $14.50 $14.81 $0.05 Third Quarter $15.75 $14.50 $14.63 $0.05 Fourth Quarter $15.50 $14.00 $15.50 $0.05 31 Report of Independent Accountants Board of Directors and Shareholders East Texas Financial Services, Inc. Tyler, Texas We have audited the accompanying consolidated statements of financial condition of East Texas Financial Services, Inc. and Subsidiary as of September 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years ended September 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of East Texas Financial Services, Inc. and Subsidiary as of September 30, 1998 and 1997, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. Tyler, Texas November 13, 1998 32
East Texas Financial Services, Inc. and Subsidiary Consolidated Statements of Financial Condition September 30, 1998 and 1997 Assets 1998 1997 ------------- ------------- Cash and due from banks ............................................. $ 592,363 $ 508,729 Interest-bearing deposits due from banks ............................ 1,104,695 6,422,404 ------------- ------------- Total cash and cash equivalents ................................ 1,697,058 6,931,133 Interest-earning time deposits ...................................... 1,959,617 1,565,573 Federal funds sold .................................................. 129,187 753,847 Securities held-to-maturity (fair value of $30,115,954 in 1998 and $23,128,073 in 1997) ......................................... 29,766,844 23,058,359 Mortgage-backed securities available-for-sale ....................... 12,810,165 4,356,271 Mortgage-backed securities held-to-maturity (fair value of $11,088,555 in 1998 and $18,611,834 in 1997) ................... 10,940,500 18,151,765 Loans, net .......................................................... 61,119,047 57,110,029 Accrued interest receivable ......................................... 978,378 885,383 Federal Home Loan Bank stock, at cost ............................... 789,100 1,005,700 Premises and equipment, net ......................................... 2,273,067 1,123,311 Foreclosed real estate, net ......................................... 34,500 0 Mortgage servicing rights, net ...................................... 216,879 149,094 Other assets ........................................................ 1,303,120 858,147 ------------- ------------- Total assets ........................................................ $ 124,017,462 $ 115,948,612 ============= ============= Liabilities and Stockholders' Equity Liabilities: Demand deposits ................................................ $ 1,528,374 $ 1,882,109 Savings and NOW deposits ....................................... 10,504,973 9,771,266 Other time deposits ............................................ 74,610,310 76,897,274 ------------- ------------- Total deposits ............................................. 86,643,657 88,550,649 Advances from Federal Home Loan Bank ........................... 14,945,852 4,195,000 Advances from borrowers for taxes and insurance ................ 844,188 881,685 Federal income taxes Current .................................................... 0 0 Deferred ................................................... 31,618 127,909 Accrued expenses and other liabilities ......................... 1,168,453 1,314,001 ------------- ------------- Total liabilities .......................................... 103,633,768 95,069,244 ------------- ------------- Commitments and contingencies
Stockholders' equity: Preferred stock, $0.01 par value, 500,000 shares authorized, none outstanding Common stock, $0.01 par value, 5,500,000 shares authorized 1,884,492 shares issued and 1,464,056 outstanding at September 30, 1998, and 1,256,387 shares issued and 1,026,366 outstanding at September 30, 1997 .................. 18,845 12,564 Additional paid-in capital ..................................... 12,319,624 12,196,879 Deferred compensation - RRP shares ............................. (213,366) (329,748) Unearned employee stock ownership plan shares .................. (543,564) (650,614) Retained earnings (substantially restricted) ................... 13,661,392 13,365,792 Net unrealized gain on available-for-sale securities, net of tax (64,974) 15,512 Treasury stock, at cost, 420,436 shares at September 30, 1998, and 345,031 shares at September 30, 1997 ..................... (4,794,263) (3,731,017) ------------- ------------- Total stockholders' equity ................................. 20,383,694 20,879,368 ------------- ------------- Total liabilities and stockholders' equity .......................... $ 124,017,462 $ 115,948,612 ============= =============
The accompanying notes are an integral part of the consolidated financial statements. 33
East Texas Financial Services, Inc. and Subsidiary Consolidated Statements of Income Years Ended September 30, 1998, 1997, and 1996 1998 1997 1996 ---------- ---------- ---------- Interest income Loans receivable: First mortgage loans ......................... $4,665,915 $4,104,554 $3,564,258 Consumer and other loans ..................... 104,721 86,614 77,456 Securities available-for-sale .................... 53,616 57,360 55,329 Securities held-to-maturity ...................... 1,687,024 1,803,994 2,074,033 Mortgage-backed securities available-for-sale .... 473,084 52,207 0 Mortgage-backed securities held-to-maturity ...... 1,053,114 1,511,985 2,000,439 Deposits with banks .............................. 226,256 275,517 292,525 ---------- ---------- ---------- Total interest income ........................ 8,263,730 7,892,231 8,064,040 ---------- ---------- ---------- Interest expense Deposits ......................................... 4,425,979 4,425,797 4,511,934 Advances from Federal Home Loan Bank ............. 540,094 46,752 0 ---------- ---------- ---------- Total interest expense ....................... 4,966,073 4,472,549 4,511,934 ---------- ---------- ---------- Net interest income .......................... 3,297,657 3,419,682 3,552,106 Provisions for loan losses ............................ 0 5,000 0 ---------- ---------- ---------- Net interest income after provision for loan losses ............................ 3,297,657 3,414,682 3,552,106 ---------- ---------- ---------- Noninterest income Net gain on sale of loans ........................ 152,603 71,888 116,316 Net realized gain on sale of investment securities 0 1,381 0 Loan origination and commitment fees ............. 74,086 65,990 83,769 Loan servicing fees .............................. 70,417 94,969 110,576 Other ............................................ 63,535 67,906 60,156 ---------- ---------- ---------- Total noninterest income ..................... 360,641 302,134 370,817 ---------- ---------- ----------
Noninterest expense Compensation and benefits ........................ 1,843,610 1,678,962 1,586,838 Occupancy and equipment .......................... 191,671 157,488 154,321 SAIF deposit insurance premium ................... 56,471 80,462 867,859 Loss on foreclosed real estate ................... 12,911 5,538 4,826 Other ............................................ 663,416 600,772 586,067 ---------- ---------- ---------- Total noninterest expense .................... 2,768,079 2,523,222 3,199,911 ---------- ---------- ---------- Income before provision for income taxes .............. 890,219 1,193,594 723,012 Income tax expense .................................... 329,273 426,819 265,136 ---------- ---------- ---------- Net income ............................................ $ 560,946 $ 766,775 $ 457,876 ========== ========== ========== Basic earnings per common share ....................... $ .39 $ .52 $ .28 ========== ========== ========== Diluted earnings per common share ..................... $ .38 $ .51 $ .28 ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. 34
East Texas Financial Services, Inc. and Subsidiary Consolidated Statements of Changes in Stockholders' Equity Years Ended September 30, 1998, 1997, and 1996 Net Deferred Unearned Unrealized Compensation Employee Gain (Loss) Additional Recognition Stock on Available- Common Paid-in Retained Treasury & Retention Ownership for-sale Stock Capital Earnings Stock Plan Plan Shares Securities Total ------- ----------- ----------- ----------- ----------- --------- --------- ----------- Balance at September 30, 1995 $ 12,564 $12,048,775 $12,529,044 $ (562,511) $(881,477) $23,146,395 Net income 457,876 457,876 Deferred compensation amortization 116,382 116,382 Release of employee stock ownership plan shares 118,271 118,271 Appreciation in employee stock ownership plan shares released 63,741 63,741 Purchase of treasury stock at cost (179,192 shares) $(2,831,237) (2,831,237) Exercise of stock options (2,090 shares) (4,702) 34,224 29,522 Cash dividends of $0.15 per share (170,337) (170,337) ------- ----------- ----------- ----------- ----------- --------- --------- -----------
Balance at September 30, 1996 12,564 12,112,516 12,811,881 (2,797,013) (446,129) (763,206) 20,930,613 Net income 766,775 766,775 Deferred compensation amortization 116,381 116,381 Release of employee stock ownership plan shares 112,592 112,592 Appreciation in employee stock ownership plan shares released 84,363 84,363 Net change in unrealized gain on mortgage-backed securities available-for-sale net of deferred taxes of $7,991 $ 15,512 15,512 Purchase of treasury stock at cost (53,964 shares) (951,116) (951,116) Exercise of stock options (1,045 shares) (2,351) 17,112 14,761 Cash dividends of $0.20 per share (210,513) (210,513) ------- ----------- ----------- ----------- ----------- --------- --------- -----------
Balance at September 30, 1997 12,564 12,196,879 13,365,792 (3,731,017) (329,748) (650,614) 15,512 20,879,368 Common stock split effected in the form of a dividend 6,281 (6,281) 0 Net income 560,946 560,946 Deferred compensation amortization 116,382 116,382 Release of employee stock ownership plan shares 107,050 107,050 Appreciation in employee stock ownership plan shares released 122,745 122,745 Net change in unrealized gain on mortgage-backed securities available-for-sale net of deferred tax benefit of $41,462 (80,486) (80,486) Purchase of treasury stock at cost (76,973 shares) (1,080,369) (1,080,369) Exercise of stock options (1,568 shares) (2,352) 17,123 14,771 Cash dividends of $0.20 per share (256,713) (256,713) ------- ----------- ----------- ----------- ----------- --------- --------- ----------- Balance at September 30, 1998 18,845 $12,319,624 $13,661,392 $(4,794,263) $ (213,366) $(543,564) $ (64,974) $20,383,694 ======= =========== =========== =========== =========== ========= ========= ===========
The accompanying notes are an integral part of the consolidated financial statements. 35
East Texas Financial Services, Inc. and Subsidiary Consolidated Statements of Cash Flows Years Ended September 30, 1998, 1997, and 1996 1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income .............................................. $ 560,946 $ 766,775 $ 457,876 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of deferred loan origination fees ...... (2,474) (486) (2,988) Amortization of premiums and discounts on investment securities, mortgage-backed securities, and loans ............................. 136,080 106,306 201,336 Amortization of deferred compensation ............... 116,382 116,382 116,382 Amortization of mortgage servicing rights ........... 52,710 28,730 15,618 Compensation charge related to release of ESOP shares ........................ 132,587 99,747 84,805 Depreciation ........................................ 96,236 68,952 74,424 Provision for loan losses and losses on real estate . 0 5,000 0 Deferred income taxes ............................... (54,829) 250,743 (193,299) Stock dividend on FHLB stock ........................ (53,500) (57,200) (55,100) Net (gain) loss on sale of: Investment securities held-to-maturity: Obligations-U.S. Govt. and agencies ........ 0 (1,381) 0 Loans held for sale ............................ (32,108) (13,908) (22,326) Equipment ...................................... 2,512 (9,563) 4,101 Foreclosed real estate ......................... 2,124 0 0 Proceeds from sale of loans ............................. 10,064,554 4,753,985 7,740,431 Originations of loans held for sale ..................... (10,032,446) (4,740,077) (7,718,105) (Increase) decrease in: Accrued interest receivable ......................... (92,995) 45,274 125,669 Other assets ........................................ (444,973) (441,331) 44,255 Increase (decrease) in: Federal income tax payable .......................... 0 (5,044) (33,638) Accrued expenses and other liabilities .............. (145,548) (438,386) 482,275 ------------ ------------ ------------ Net cash provided by operating activities .................... 305,258 534,518 1,321,716 ------------ ------------ ------------
Cash flows from investing activities: Net (increase) decrease in interest-earning time deposits (394,044) 98,000 (781,573) Net (increase) decrease in fed funds sold ............... 624,660 (273,562) 146,311 Purchase of securities held-to-maturity ................. (18,765,094) (6,495,391) (11,633,820) Proceeds from maturities of securities held-to-maturity . 12,000,000 12,500,000 11,615,000 Proceeds from sales of obligations - U. S. Govt. and agencies held-to-maturity ............. 0 1,000,937 0 Purchases of mortgage-backed securities available-for-sale .................................... (11,513,223) (4,469,653) 0 Principal payments on mortgage-backed securities available-for-sale ......................... 2,862,783 129,747 0 Purchases of mortgage-backed securities held-to-maturity 0 (512,122) (913,080) Principal payments on mortgage-backed securities held-to-maturity ........................... 7,206,392 7,286,201 9,647,677 Proceeds from redemption of FHLB stock .................. 270,100 0 0 Net increase in loans ................................... (4,073,492) (9,591,071) (6,071,127) Proceeds from sale of foreclosed real estate ............ 30,670 401,595 (680) Acquisition costs related to foreclosed real estate ..... (346) 0 0 Proceeds from sales of equipment ........................ 0 17,500 0 Expenditures for premises and equipment ................. (1,248,504) (230,016) (27,744) Origination of mortgage servicing rights ................ (120,495) (57,979) (93,990) ------------ ------------ ------------ Net cash provided (used) by investing activities ............. (13,120,593) (195,814) 1,886,974 ------------ ------------ ------------
(continued) 36
East Texas Financial Services, Inc. and Subsidiary Consolidated Statements of Cash Flows Years Ended September 30, 1998, 1997, and 1996 1998 1997 1996 ------------- ------------- ------------- Cash flows from financing activities: Net increase (decrease) in: Noninterest-bearing deposits, savings, and NOW accounts ....................... $ 379,972 $ (1,442,629) $ 784,276 Time deposits ............................. (2,286,964) (774,392) (1,596,950) Advances from borrowers ................... (37,497) (35,537) (61,361) Proceeds from advances from Federal Home Loan Bank ................................... 114,351,500 13,104,841 0 Payments of advances from Federal Home Loan Bank ................................... (103,600,648) (8,909,841) 0 Purchase of treasury stock at cost ............ (1,080,369) (951,116) (2,831,237) Exercise of stock options ..................... 14,771 14,761 29,522 Dividends paid ................................ (256,713) (210,513) (170,337) ESOP loan repayment ........................... 97,208 97,208 97,208 ------------- ------------- ------------- Net cash provided (used) by financing activities ... 7,581,260 892,782 (3,748,879) ------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents (5,234,075) 1,231,486 (540,189) Cash and cash equivalents at beginning of year ..... 6,931,133 5,699,647 6,239,836 ------------- ------------- ------------- Cash and cash equivalents at end of year ........... $ 1,697,058 $ 6,931,133 $ 5,699,647 ============= ============= ============= Supplemental disclosure of cash flow information Cash paid for: Interest on deposits ...................... $ 2,161,979 $ 2,213,797 $ 2,354,934 Interest on FHLB advances ................. 521,896 42,233 0 Income taxes .............................. 173,358 415,820 492,083 Transfers from loans to real estate acquired through foreclosures ........................ 246,620 482,578 0 Loans made to facilitate the sale of REO ...... 140,000 60,800 84,000
The accompanying notes are an integral part of the consolidated financial statements. 37 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 1 - Nature of Operations and Summary of Significant Accounting Policies East Texas Financial Services, Inc. (the Company) is a savings and loan holding company for its wholly-owned subsidiary, First Federal Savings and Loan Association of Tyler, (the Association). The Association offers customary banking services, including acceptance of checking, saving and time deposits and the making of mortgage, commercial, and consumer loans to customers located primarily in Tyler and Smith County, Texas, and surrounding areas. The Association operates under a federal savings and loan charter and is subject to regulations by the Office of Thrift Supervision. Principles of consolidation - The consolidated financial statements include the accounts of East Texas Financial Services, Inc. and its wholly-owned subsidiary, which owns all of the Association's premises. All intercompany transactions and balances have been eliminated in consolidation. Cash and cash equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, deposits due from banks, and interest-bearing deposits due from banks. Use of estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Securities - Securities that management has both the positive intent and ability to hold to maturity are classified as securities held-to-maturity and are carried at cost, adjusted for amortization of premium or accretion of discounts using the interest method. Securities that may be sold prior to maturity for asset/liability management purposes, or that may be sold in response to changes in interest rates, to changes in prepayment risk, to increase regulatory capital or to other similar factors, are classified as other similar securities available-for-sale and carried at fair value with any adjustments to fair value, after tax, reported as a separate component of shareholders' equity. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary have resulted in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. Securities purchased for trading purposes are held in the trading portfolio at fair value, with changes in fair value included in noninterest income. Interest and dividends on securities, including the amortization of premiums and the accretion of discounts, are reported in interest and dividends on securities using the interest method. Gains and losses on the sale of securities are recorded on the trade date and are calculated using the specific-identification method. Loans held for sale - Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. The Company did not have any loans held for sale on hand at September 30, 1998, 1997, or 1996. Loans - Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans or unamortized premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Discounts and premiums are amortized to income using the interest method. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. 38 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 1 - Nature of Operations and Summary of Significant Accounting Policies, continued Loans are generally classified as nonaccrual when there exists reasonable doubt as to the full, timely collection of interest or principal of the loan (usually when a loan is delinquent for greater than 90 days). Uncollectible interest on loans that is contractually past due is charged off, or an allowance is established based on management's periodic valuation. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is back to normal, in which case the loan is returned to accrual status. Allowance for loan losses - The allowance for loan losses is established through charges to operations in the form of a provision for loan losses. Increases and decreases in the allowance due to changes in the measurement of the impaired loans are included in the provision for loan losses. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. When a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance. The adequacy of the allowance for loan losses is periodically evaluated by the Company. Such evaluation includes a review of loans on which full collectibility may not be reasonably assured and considers the estimated value of the underlying collateral on the loan, current and anticipated economic conditions, and other factors, which in management's judgment deserve recognition. The evaluation of the adequacy of loan collateral is often based upon estimates and appraisals. Because of changing economic conditions, the valuations determined from such estimates and appraisals may also change. Accordingly, losses may ultimately be incurred in amounts different from management's current estimates. Additionally, the Association is subject to regulatory examinations and may be directed to record loss allowances by regulatory authorities. Adjustments to the allowance for estimated losses will be reported in the period such adjustments become known or are reasonably estimable. The Association's most recent regulatory examination, dated April 1998, did not result in an increase to the allowance for loan losses. Federal Home Loan Bank stock - The FHLB stock is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in the common stock is based on a predetermined formula and is carried at cost. Premises and equipment - Land is carried at cost. Buildings, furniture, fixtures, and equipment are carried at cost, less accumulated depreciation. Depreciation is provided over the estimated useful lives of the respective assets on a straight-line basis. Maintenance and repairs are charged to operating expense, and renewals and betterments are capitalized. Gains or losses on dispositions are reflected currently in the statement of income. Foreclosed real estate - Real estate acquired in settlement of loans is initially recorded at the lower of the outstanding loan balance or fair value. Fair value is defined as the amount of cash or cash-equivalent value of other consideration that a real estate parcel would yield in a current sale between a willing buyer and a willing seller - that is, in other than a forced or liquidation sale. The resulting loss, if any, is charged to the allowance for loan losses. Subsequent to foreclosure, real estate is carried at the lower of its new cost basis or fair value minus selling costs. Costs of improvements to property are capitalized. Operating expenses, including depreciation, of such properties, net of related income, and gains and losses on disposition are included in current operations. Recognition of gain on sale of real estate is dependent upon the transaction meeting certain criteria relating to the nature of the property sold and the terms of the sale. Under certain circumstances, the gain, or a portion thereof, is deferred until the necessary criteria are met. 39 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 1 - Nature of Operations and Summary of Significant Accounting Policies, continued Mortgage servicing rights - Effective January 1, 1997, the Company adopted Statement of Financial Accounting Standards No. 125 (SFAS 125), Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which superseded SFAS 122, Accounting for Mortgage Servicing Rights. However, the adoption of SFAS 125 did not result in any significant changes in the accounting for mortgage servicing rights. For originated mortgage servicing rights, the Company allocates the net cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. Fair values are based on quoted market prices in active markets for loans and loan servicing rights. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income which approximates the level-yield method. The Company stratifies mortgage servicing rights based on one or more of the predominant risk characteristics of the underlying loans. The Company periodically evaluates the carrying value of the mortgage servicing rights in relation to the present value of the estimated future net servicing revenue based on management's best estimate of remaining loan lives. Impairment is recognized through a valuation allowance for an individual stratum, and the amount of impairment is the amount by which the mortgage servicing rights for a stratum exceed their fair value. Income taxes - Deferred tax assets and liabilities are determined using the liability method. Under this method, the net deferred tax asset or liability is determined based on the differences between the book and tax bases of the various statement of financial condition assets and liabilities and gives current recognition to changes in tax rates and laws. Advertising - The Company expenses the costs of advertising the first time the advertising takes place. Financial instruments - All derivative financial instruments held or issued by the Company are held or issued for purposes other than trading. In the ordinary course of business the Company has entered into off-balance-sheet financial instruments consisting of commitments to extend credit. Such financial instruments are recorded in the financial statements when they are funded. Reclassifications - Certain amounts previously reported in the financial statements for 1997 and 1996 have been reclassified to facilitate comparability with 1998. These reclassifications had no effect on net income or stockholders' equity. Accounting pronouncements - Effective October 1, 1998, the Company adopted Statements of Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive Income, No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, No. 132 (SFAS 132), Employers' Disclosure about Pensions and Other Post Retirement Benefits, and No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities. The adoption of the above referenced statements will not have a material impact on the Company's financial position or results of operations. 40 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 2 - Conversion of the Association The Association completed a conversion from a mutual to a stock savings and loan association on January 10, 1995. Simultaneous with the conversion was the formation of the Holding Corp., incorporated in the State of Delaware. The initial issuance of shares of common stock in the Holding Corp. on January 10, 1995, was 1,215,900 shares at $10 per share and was accomplished through an offering to a tax-qualified employee stock ownership plan, eligible account holders of record, and other members of the Association. The cost of the conversion and stock offering was accounted for as a reduction of the proceeds from the issuance of common stock of the Holding Corp. Upon closing of the stock offering, the Holding Corp. purchased all common shares issued by the Association for $5,750,000. This transaction was accounted for in a manner similar to the pooling of interests method. The following schedule summarizes the issuance of common stock by the Holding Corp. in the conversion: Deposit accounts converted to purchase stock $ 1,906,000 Stock issued to ESOP 972,150 Proceeds received from other investors 9,273,750 ------------ 12,151,900 Conversion costs (700,215) ------------ $ 11,451,685 ============ Federal regulations require that, upon conversion from a mutual to stock form of ownership, a "liquidation account" be established by restricting a portion of retained earnings for the benefit of eligible savings account holders who maintain their savings accounts with the Association after conversion. In the event of complete liquidation (and only in such event), each savings account holder who continues to maintain his savings account shall be entitled to receive a distribution from the liquidation account after payment to all creditors, but before any liquidation distribution with respect to capital stock. This account will be proportionately reduced for any subsequent reduction in the eligible holders' savings accounts. Federal regulations impose limitations on the payment of dividends and other capital distributions, including, among others, that the Association may not declare or pay a cash dividend on any of its stock if the effect thereof would cause the Association's capital to be reduced below the amount required for the liquidation account or the capital requirements imposed by the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and the Office of Thrift Supervision (The "OTS"). Note 3 - Investment Securities The amortized cost and fair values of investment securities held-to-maturity, consisting of U.S. Government and agency obligations, are summarized as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ----------- ----------- ----------- September 30, 1998 $29,766,844 $ 349,110 $ 0 $30,115,954 =========== =========== =========== =========== September 30, 1997 $23,058,359 $ 81,219 $ 11,505 $23,128,073 =========== =========== =========== ===========
41 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 3 - Investment Securities, continued The following is a summary of amortized cost and fair value of investment securities held-to-maturity at September 30, 1998, by contractual maturity:
Amortized Fair Cost Value ----------- ----------- Due in one year or less .................... $ 8,014,309 $ 8,068,931 Due after one year through five years ...... 21,027,535 21,320,748 Due after five years through ten years ..... 725,000 726,275 Due after ten years ........................ 0 0 ----------- ----------- $29,766,844 $30,115,954 =========== ===========
Information related to sales of investment securities for 1998, 1997, and 1996 is as follows:
1998 1997 1996 ------------- ------------- ------------- Debt securities: Sales proceeds 0 $ 1,000,937 $ 0 Amortized cost 0 999,556 0 ------------ ------------- ------------- Realized gain (loss) $ 0 $ 1,381 $ 0 ============ ============= =============
The Company's management sold securities during the year ended September 30, 1997, since the securities were within sixty days of maturity. It was management's determination that changes in market interest rates would not have significantly affected the securities' fair value. Note 4 - Mortgage-backed Securities The amortized cost and fair values of mortgage-backed securities available-for-sale are summarized as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- -------- ----------- ----------- September 30, 1998: U.S. government agency pass-through certificates ........ $ 4,529,973 $ 0 $ 79,722 $ 4,450,251 U.S. government agency collateralized mortgage obligations 8,378,638 51,670 70,394 8,359,914 ----------- -------- ----------- ----------- $12,908,611 $ 51,670 $ 150,116 $12,810,165 ----------- -------- ----------- ----------- September 30, 1997: U.S. government agency pass-through certificates ........ $ 4,332,768 $ 23,503 $ 0 $ 4,356,271 =========== ======== =========== ===========
42 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 4 - Mortgage-backed Securities, continued There were no sales of mortgage-backed securities available-for-sale for 1998 and 1997. The following is a summary of the amortized cost and fair value of mortgage-backed securities available-for-sale at September 30, 1998, by contractual maturity. These contractual maturities do not take into consideration the effects of scheduled repayments or the effects of possible prepayments.
Amortized Fair Cost Value ----------- ----------- Due in one year or less $ 0 $ 0 Due after one year through five years 0 0 Due after five years through ten years 0 0 Due after ten years 12,908,611 12,810,165 ----------- ----------- $12,908,611 $12,810,165 ----------- -----------
The amortized cost and fair values of mortgage-backed securities held-to-maturity are summarized as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------ ----------- ------------ ----------- September 30, 1998: U.S. government agency pass-through certificates ...... $10,940,500 $ 148,897 $ 842 $11,088,555 =========== =========== =========== =========== September 30, 1997: U.S. government agency pass-through certificates ...... $18,151,765 $ 508,606 $ 48,537 $18,611,834 =========== =========== =========== ===========
There were no sales of mortgage-backed securities held-to-maturity for 1998, 1997, or 1996. The following is a summary of the amortized cost and fair value of mortgage-backed securities held-to-maturity at September 30, 1998, by contractual maturity. These contractual maturities do not take into consideration the effects of scheduled repayments or the effects of possible prepayments.
Amortized Fair Cost Value ----------- ----------- Due in one year or less .............. $ 1,084,538 $ 1,086,380 Due after one year through five years 815,760 818,093 Due after five years through ten years 0 0 Due after ten years .................. 9,040,202 9,184,082 ----------- ----------- $10,940,500 $11,088,555 =========== ===========
43 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 5 - Loans Receivable Loans receivable are summarized as follows:
1998 1997 ------------ ------------ First mortgage loans (principally conventional): Principal balances: Secured by one-to-four family residences $ 54,752,183 $ 49,412,358 Secured by other residential property .. 550,666 568,458 Secured by nonresidential property ..... 4,106,448 4,023,304 Construction loans ..................... 2,255,867 3,600,405 ------------ ------------ 61,665,164 57,604,525 Less: Undisbursed portion of loans ............... (1,373,029) (1,506,002) Net deferred loan origination fees ......... (28,098) (18,028) ------------ ------------ Total first mortgage loans ............. 60,264,037 56,080,495 ------------ ------------ Consumer and other loans: Principal balances: Loans to depositors, secured by savings 403,381 487,584 Commercial ............................. 167,869 251,500 Home improvement ....................... 516,940 563,301 ------------ ------------ Total consumer and other loans ......... 1,088,190 1,302,385 ------------ ------------ Less allowance for loan losses .................. (233,180) (272,851) ------------ ------------ $ 61,119,047 $ 57,110,029 ============ ============
A summary of the changes in the allowance for loan losses is as follows (charge-offs include transfers to allowance for losses on real estate acquired in settlement of loans):
1998 1997 1996 --------- --------- ---------- Balance at beginning of year ...... $ 272,851 $ 289,120 $ 295,800 Provision charged to income ....... 0 5,000 0 Charge-offs and recoveries, net ... (39,671) (21,269) (6,680) --------- --------- --------- Balance at end of year ............ $ 233,180 $ 272,851 $ 289,120 ========= ========= =========
The Company does not have any loans which are considered troubled debt restructured loans as defined by SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructuring. As of September 30, 1998 and 1997, in the opinion of management, there are no loans which should be considered as impaired as defined by SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure. 44 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 5 - Loans Receivable, continued At September 30, 1998 and 1997, the Company had discontinued the accrual of interest on nonperforming loans aggregating approximately $187,279 and $309,524, respectively. Net interest income for 1998, 1997, and 1996 would have been higher by $3,963, $8,768, and $10,654, respectively, had interest been accrued at contractual rates on the nonperforming loans. The Company has no commitments to lend additional funds to debtors whose loans are nonperforming. Certain officers, directors, and employees were indebted to the Association in the aggregate amount of $438,595 and $487,301 as of September 30, 1998 and 1997, respectively. In the opinion of management, these loans were substantially on the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers and did not involve more than a normal risk of collectibility or present any other unfavorable features to the Association. A summary of the activity of loans to directors and executives in excess of $60,000 is as follows:
1998 1997 --------- ---------- Balance, beginning of year ............. $ 475,212 $ 530,066 New loans .............................. 0 17,985 Repayment .............................. (36,617) (72,839) --------- --------- Balance, end of year ................... $ 438,595 $ 475,212 ========= =========
Note 6 - Loan Servicing The principal balances of loans serviced for investors are not included in the consolidated statement of financial condition. Information related to mortgage loans serviced for investors is summarized as follows:
September 30, -------------------------------- 1998 1997 ----------- ----------- Principal balance .................... $42,566,350 $39,390,855 Custodial escrow balance ............. 965,653 1,129,082
The following is an analysis of the changes in loan servicing rights capitalized:
1998 1997 --------- ---------- Balance, beginning of year ............. $ 149,094 $ 119,845 Addition ............................... 120,495 57,979 Amortization ........................... (52,710) (28,730) --------- --------- Balance, end of year ................... $ 216,879 $ 149,094 ========= =========
45 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 7 - Accrued Interest Receivable Accrued interest receivable is summarized as follows:
1998 1997 ---------- ---------- Investment securities ........................ $ 453,895 $ 338,840 Mortgage-backed securities ................... 184,151 221,505 Loans receivable ............................. 351,437 338,889 Allowance for uncollectible interest ......... (11,105) (13,851) --------- --------- $ 978,378 $ 885,383 ========= =========
Note 8 - Foreclosed Real Estate The Company has acquired various properties through loan foreclosures. At September 30, 1998 and 1997, the properties are summarized as follows:
1998 1997 ------- --------- Residential ..................... $34,500 $ 0 ======= =========
There was no activity in the allowance for real estate losses during 1998, 1997, and 1996. Note 9 - Premises and Equipment Premises and equipment are summarized as follows:
1998 1997 ----------- ------------ Land ..................................... $ 1,523,439 $ 282,503 Buildings and premises ................... 949,263 949,263 Furniture, fixtures, and equipment ....... 452,959 523,317 Autos .................................... 58,742 58,742 ----------- ----------- 2,984,403 1,813,825 Less accumulated depreciation ............ (711,336) (690,514) ----------- ----------- $ 2,273,067 $ 1,123,311 =========== ===========
Certain premises and equipment are leased under operating leases. Rental expense was $7,350 in 1998, $3,662 in 1997, and $-0- in 1996. 46 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 9 - Premises and Equipment, continued Future minimum rental commitments under noncancelable leases are: 1999 $ 59,862 2000 64,434 2001 9,225 ----------- $ 133,521 =========== Note 10 - Other Assets Other assets are summarized below:
1998 1997 ---------- ---------- Principal receivable on mortgage-backed securities $ 381,748 $ 326,754 Prepaid federal income tax ....................... 23,842 234,587 Funds due from sales of loans .................... 776,625 230,900 Prepaid expenses ................................. 88,554 58,383 Other ............................................ 32,351 7,523 ---------- ---------- $1,303,120 $ 858,147 ========== ==========
Note 11 - Deposits The aggregate amount of accounts with a minimum denomination of $100,000 was approximately $28,712,775 and $29,054,138 at September 30, 1998 and 1997. At September 30, 1998, scheduled maturities of certificates of deposit are as follows: 1999 $ 52,407,187 2000 15,591,133 2001 5,382,483 2002 267,873 2003 698,510 Thereafter 263,124 ------------- $ 74,610,310 ============= 47 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 11 - Deposits, continued Interest expense on deposits is summarized as follows:
1998 1997 1996 ----------- ----------- ---------- Demand deposits ................ $ 0 $ 0 $ 0 Savings and NOW deposits ....... 303,617 324,480 331,326 Time deposits .................. 4,122,362 4,101,317 4,180,608 ---------- ---------- ---------- $4,425,979 $4,425,797 $4,511,934 ========== ========== ==========
The Association held deposits of approximately $3,403,167 and $3,032,639 for related parties at September 30, 1998 and 1997, respectively. Note 12 - Advances from Federal Home Loan Bank The outstanding advances from the FHBL consisted of the following at September 30, 1998 and 1997:
Maturity 1998 Rate 1997 Rate -------- ---- ---- ---- ---- October 23, 1997 .................... $ 4,195,000 5.54% October 2, 1998 ..................... $13,150,000 5.38% December 31, 2004 ................... 260,412 6.09% January 3, 2005 ..................... 129,059 6.03% January 1, 2013 ..................... 486,106 6.09% January 1, 2013 ..................... 461,845 6.13% February 1, 2013 .................... 458,430 5.91% ----------- $14,945,852 5.94% $ 4,195,000 5.54% =========== ===========
Pursuant to collateral agreements with the Federal Home Loan Bank (FHLB), advances are secured by all stock and deposit accounts in the FHLB, mortgage collateral, securities collateral, and other collateral. Note 13 - Pension Plan The Company has a qualified, noncontributory defined benefit retirement plan covering substantially all of its employees. Benefits are based on years of service and the employee's highest average rate of earnings for the five consecutive years during the last ten full years before retirement. The benefits are reduced by a specified percentage of the employee's social security benefits. An employee becomes fully vested upon completion of five years of qualifying service. It is the policy of the Company to fund the maximum amount that can be deducted for federal income tax purposes. 48 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 13 - Pension Plan, continued The following table sets forth the plan's funded status and amounts recognized in the Company's statements of financial condition at September 30:
1998 1997 1996 ----------- ----------- ----------- Actuarial present value of benefit obligations: Accumulated benefit obligation: Vested ................................. $ 1,586,361 $ 1,156,009 $ 1,247,505 Nonvested .............................. 145,237 136,719 91,899 ----------- ----------- ----------- $ 1,731,598 $ 1,292,728 $ 1,339,404 =========== =========== =========== Projected benefit obligation for service rendered to date .............................. $(2,364,813) $(2,145,930) $(1,856,303) Plan assets at fair value, primarily certificates of deposit and U.S. government securities ..... 2,149,711 2,035,418 1,907,532 ----------- ----------- ----------- Plan assets in excess (shortfall) of benefit obligation .................................... (215,102) (110,512) 51,229 Unrecorded net loss from past experience different from that assumed and effects of changes in assumptions ..................... 480,213 361,361 210,557 Prior service cost not yet recognized in periodic pension cost ...................... 101,422 108,781 116,140 Unrecognized net assets at 10-1-88 being recognized over 20.658 years ............ (351,490) (384,470) (417,450) ----------- ----------- ----------- (Accrued) prepaid pension cost .................. $ 15,043 $ (24,840) $ (39,524) =========== =========== ===========
A summary of the components of income follows:
1998 1997 1996 --------- --------- --------- Service cost-benefits earned during the year $ 144,524 $ 106,287 $ 125,062 Interest cost on projected benefit obligation 157,582 139,094 133,210 Return on plan assets ....................... (172,048) (151,525) (110,589) Net asset gain recognition .................. 8,783 0 0 Amortization of unrecognized net asset ...... (32,980) (32,980) (32,980) Amortization of prior service cost .......... 7,359 7,359 7,359 --------- --------- --------- Net periodic pension cost ................... $ 113,220 $ 68,235 $ 122,062 ========= ========= =========
Assumptions used in the accounting for the pension plan were as follows:
1998 1997 1996 ---- ---- ---- Weighted average discount rate 7.50% 8.00% 7.00% Rate of increase in future compensation levels 5.00% 5.00% 5.00% Expected long-term rate of return on assets 8.00% 8.00% 7.00%
The Company contributed $153,103, $82,919, and $124,284 to the plan in 1998, 1997, and 1996, respectively. 49 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 14 - Income Taxes The Company and the Association file a consolidated federal income tax return. The consolidated provision for income taxes for 1998, 1997, and 1996 consists of the following:
1998 1997 1996 --------- --------- ---------- Current (benefit) ......... $ 384,102 $ 176,076 $ 458,435 Deferred (benefit) ........ (54,829) 250,743 (193,299) --------- --------- --------- $ 329,273 $ 426,819 $ 265,136 ========= ========= =========
Total income tax expense differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to income before income taxes and cumulative effect of change in accounting for income taxes as a result of the following:
1998 1997 1996 -------- -------- --------- Expected income tax expense at statutory tax rate of 34% ....... $302,674 $405,822 $245,828 Other ............................. 26,599 20,997 19,308 -------- -------- -------- $329,273 $426,819 $265,136 ======== ======== ======== Effective tax rate ................ 37% 36% 37% ======== ======== ========
Deferred tax assets and liabilities included in the statement of financial condition at September 30 consist of the following:
1998 1997 --------- ---------- Deferred tax assets: Allowance for loan losses ........................... $ 66,945 $ 66,945 Deferred compensation ............................... 28,373 25,028 Other ............................................... 8,471 5,222 --------- --------- 103,789 97,195 --------- --------- Deferred tax liabilities: FHLB stock .......................................... (11,390) (85,034) Mortgage servicing rights ........................... (73,739) (50,692) Depreciable assets .................................. (36,241) (36,484) Unrealized gain (loss) on loans held for sale ....... 25,992 (1,293) Pension liability ................................... (73,500) (43,610) Net unrealized (gain) loss on market value adjustment to mortgage-backed securities available-for-sale .. 33,471 (7,991) --------- --------- (135,407) (225,104) --------- --------- Net deferred tax asset (liability) ....................... $ (31,618) $(127,909) ========= =========
50 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 14 - Income Taxes, continued No valuation allowance for deferred tax assets was recorded as of September 30, 1998 and 1997, as management believes that the amounts representing future deferred tax benefits will more likely than not be recognized since the Company is expected to have sufficient taxable income of an appropriate character within the carryback and carryforward period as permitted by the tax law to allow for utilization of the future deductible amounts. Retained earnings at September 30, 1998 and 1997, includes approximately $2,692,722, for which no deferred federal income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which would be subject to the then current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $915,525 at September 30, 1998 and 1997. Note 15 - Stock Option and Incentive Plan The 1995 Stock Option and Incentive Plan (the "Stock Option Plan") provides for awards in the form of stock options, stock appreciation rights, limited stock appreciation rights, and restricted stock. Options to purchase shares of common stock of the Company may be granted to selected directors, officers, and key employees. The number of shares of common stock reserved for issuance under the stock option plan was equal to 182,278 or 10% of the total number of common shares issued pursuant to the conversion. The option exercise price cannot be less than the fair market value of the underlying common stock as of the date of the option grant, and the maximum option term cannot exceed ten years. Awards vest at a rate of 20% per year beginning at the date of the grant. The Company plans to use treasury stock for the exercise of options. The following is a summary of changes in options outstanding:
Options outstanding Balance, September 30, 1996 ............................... 101,321 Granted ............................................... 0 Exercised at $14.125 per share ........................ (1,045) Forfeited and expired ................................. 0 -------- Balance, September 30, 1997 ............................... 100,276 Increase due to 3 for 2 stock split ................... 50,135 Granted ............................................... 0 Exercised at $9.42 per share .......................... (1,568) Forfeited and expired ................................. 0 -------- Balance, September 30, 1998 ............................... 148,843 ======== Options exercisable at year end under stock option plan ........ 86,807 ======== Shares available for future grants ............................. 27,162 ========
51 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 15 - Stock Option and Incentive Plan, continued Stock appreciation rights ("SARs") may be granted under the Option and Incentive Plan giving the participant the right to receive the excess of the market value of the shares on the date exercised over the exercise price. Upon exercise, the participant will receive either cash or shares as determined by the Company. Limited SARs may be granted which are exercisable only for a limited period of time in the event of a tender or exchange offer for shares of Holding Corp. stock. Payment upon exercise of a limited SAR shall be in cash. No SARs or limited SARs have been granted. Restricted stock may also be granted under the Option and Incentive Plan, subject to forfeiture if the participant fails to remain in the continuous service of the Company. The time period for such restriction may be removed or accelerated at the Company's discretion. Note 16 - Employee Stock Ownership Plan (ESOP) In conjunction with the stock conversion, the Company established an ESOP for eligible employees. Employees with at least one year of employment and who have attained the age of twenty-one are eligible to participate. The ESOP borrowed funds in the amount of $972,080 from the Company to purchase 145,823 common shares issued in the conversion. Collateral for the loan is the common stock purchased by the ESOP. The ESOP loan is payable in quarterly principal payments of $24,302 over a ten-year period plus interest at an annual rate of 7.93%. In accordance with generally accepted accounting principles, the unpaid balance of the ESOP loan on the Association's books and the related receivable on the Holding Corp.'s books have been eliminated in the consolidated statement of financial condition. The cost of shares not committed to be released and unallocated shares is reported as a reduction of stockholders' equity. Shares are released to participants' accounts under the shares allocated method. The Company intends to make annual contributions to the ESOP in an amount to be determined annually by the Board of Directors, but not less than the amount required to pay any currently maturing obligations under loans made to the ESOP. The Company will not make contributions if such contributions would cause the Company to violate its regulatory capital requirements. Company contributions to the ESOP and shares released from the suspense account in an amount proportional to the repayment of the ESOP loan will be allocated among ESOP participants on the basis of compensation in the year of allocation. Benefits generally become 100% vested after five years of credited service. Prior to the completion of five years of credited service, a participant who terminates employment for reasons other than death, retirement (or normal retirement), or disability will not receive any benefit under the ESOP. Forfeitures will be reallocated among the remaining participating employees, in the same proportion as contributions. Benefits may be payable in the form of stock or cash upon termination of employment. 52 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 16 - Employee Stock Ownership Plan (ESOP), continued ESOP compensation expense for the years ended September 30, 1998, 1997, and 1996, totaled $229,795, $196,955, and $182,013, respectively. The fair value of unearned ESOP shares at September 30, 1998 and 1997, totaled $1,080,339 and $1,333,751, respectively. Following is a summary of ESOP shares at September 30:
1998 1997 ------ ------ Shares allocated ............................. 63,713 48,230 Shares committed to be released .............. 0 0 Unearned ..................................... 81,534 97,593 ------- ------- Total ........................................ 145,247 145,823 ======= =======
The share amounts for 1997 are restated to reflect a 3 for 2 stock split during 1998. Note 17 - Recognition and Retention (RRP) On July 26, 1995, the stockholders approved the Company's formation of a RRP which was authorized to award 4%, or 72,912 shares (48,608 shares prior to stock split), of the total shares of common stock issued in the conversion. On July 26, 1995, the RRP awarded 61,796 (41,197 shares prior to stock split) shares of common stock to directors and employees in key management positions in order to provide them with a proprietary interest in the Company in a manner designed to encourage such employees to remain with the Company. Unearned compensation of $581,908, representing the shares' fair market value of $14.125 per share at the date of award, will be charged to income on a straight-line basis over the five year vesting period as the Company's directors and employees perform the related future services. The unamortized balance, which is comparable to deferred compensation, is reflected as a reduction of stockholders' equity. The Company recognized $116,382 as compensation and benefits expense relating to this plan for the years ended September 30, 1998, 1997, and 1996. 53 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 18 - Earnings per Common Share Basic earnings per common share are computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the period, adjusted retroactively for a 3 for 2 stock split in the form of a stock dividend, which was authorized by the Board of Directors on February 18, 1998, to shareholders of record as of March 11, 1998. Diluted earnings per share reflect per share amounts that would result if dilutive potential common stock had been converted to common stock. The following reconciles amounts reported in the financial statements:
1998 1997 ------------------------------------- ----------------------------------------- Income Shares Per-Share Income Shares Per-Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- ------ ----------- ------------- ------ Income from continuing operations ..... $ 560,946 $ 766,775 Less preferred stock dividends 0 0 Income available to common stockholders - basis earnings per share ...... 560,946 1,431,623 $ 0.39 766,775 1,470,358 $ 0.52 Effect of dilutive securities: Options .......... 0 51,266 0 29,122 Income available to common stockholders - diluted earnings per share ...... $ 560,946 1,482,889 $ 0.38 $ 766,775 1,499,480 $ 0.51 ========== ========= ========== ========== ========= =============
1996 -------------------------------------------- Income Shares Per-Share (Numerator) (Denominator) Amount ------------- ------------- ---------- Income from continuing operations ..... $ 457,876 Less preferred stock dividends 0 ---------- Income available to common stockholders - basis earnings per share ...... 457,876 1,627,323 $ 0.28 Effect of dilutive securities: Options .......... 0 12,635 --------- --------- Income available to common stockholders - diluted earnings per share ...... $ 457,876 1,639,958 $ 0.28 ========== ========== ==============
Note 19 - Subsequent Event At the October 14, 1998, directors' meeting, a cash dividend of $0.05 was declared. This dividend is to holders of record on November 11, 1998, and payable on November 25, 1998. Note 20 - Significant Group Concentration of Credit Risk The Company invests a portion of its cash in deposit accounts with various financial institutions in amounts which may exceed the insured amount of $100,000. The Company has not experienced any losses on these investments which typically are payable on demand. The Company performs ongoing evaluations of the financial institutions in which it invests deposits and periodically assesses its credit risk with respect to these accounts. At September 30, 1998 and 1997, the Company had $1,104,695 and $4,354,021, respectively, on deposit with the Federal Home Loan Bank of Dallas, and $533,610 and $1,086,177, respectively, on deposit with Nations Bank of Texas. 54 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 21 - Financial Instruments The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk and interest-rate risk in excess of the amount recognized in the consolidated statements of financial condition. The exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and condition obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount and nature of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter-party. Such collateral includes primary real estate. The Company has not been required to perform on any financial guarantee during the past two years. The Company has not incurred any losses on its commitments in either 1998 or 1997. The Association had outstanding commitments to originate loans as follows:
September 30, 1998 September 30, 1997 -------------------------------------- -------------------------------------- Fixed Variable Fixed Variable Rate Rate Total Rate Rate Total ---------- ---------- ---------- ---------- ---------- ---------- First mortgage $4,114,767 $ 0 $4,114,767 $4,281,570 $ 0 $4,281,570 Consumer and other loans 0 0 0 0 0 0 ---------- ---------- ---------- ---------- ---------- ---------- $4,114,767 $ 0 $4,114,767 $4,281,570 $ 0 $4,281,570 ========== ========== ========== ========== ========== ==========
Note 22 - Fair Value of Financial Instruments Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends and have not been reevaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year end. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company's assets. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company's financial instruments at September 30, 1998 and 1997: 55 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 22 - Fair Value of Financial Instruments, continued Cash and cash equivalents. The carrying amounts of cash and cash equivalents approximate their fair value. Interest-earning time deposits. Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates. Available-for-sale and held-to-maturity securities. Fair values for securities, excluding restricted equity securities, are based on available quoted market prices. If quoted market prices are unavailable, fair values are based on quoted market prices of comparable instruments. Available-for-sale securities are carried at their aggregate fair value. Loans receivable. Fair values for loans receivable are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Federal Home Loan Bank stock. The fair value of stock in the Federal Home Loan Bank of Dallas is estimated to be equal to its carrying amount, since it is not a publicly traded equity security, has an adjustable dividend rate, and transactions in the stock have been executed at the stated par value. Deposit liabilities. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit (CDS) approximate their fair values at the reporting date. Fair values for fixed-rate CDS are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Borrowings. The estimated fair value of the FHLB advance is based upon the discounted value of the difference between contractual rates and current market rates for similar agreements. Advance from borrowers for taxes and insurance. The carrying amount of escrow accounts approximate fair value. Accrued interest. The carrying amounts of accrued interest approximate their fair values. Off-balance-sheet instruments. Commitments to extend credit were evaluated and fair value was estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. 56 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 22 - Fair Value of Financial Instruments, continued The estimated fair values of the Company's financial instruments were as follows at:
September 30, 1998 September 30, 1997 ------------------------------- ------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value ------------- -------------- ------------- -------------- Financial assets: Cash and cash equivalents $ 1,697,058 $ 1,697,058 $ 6,931,133 $ 6,931,133 Interest-earning time deposits 1,959,617 1,988,000 1,565,573 1,568,000 Securities held-to-maturity 29,766,844 30,115,954 23,058,359 23,128,073 Mortgage-backed securities available-for-sale 12,810,165 12,810,165 4,356,271 4,356,271 Mortgage-backed securities held-to-maturity 10,940,500 11,088,555 18,151,765 18,611,834 Loans receivable, net 61,119,047 64,421,000 57,110,029 58,145,000 Accrued interest receivable 978,378 978,378 885,383 885,383 Federal Home Loan Bank stock 789,100 789,100 1,005,700 1,005,007 Financial liabilities: Deposit liabilities 86,643,657 87,374,000 88,550,649 90,346,500 Advances from Federal Home Loan Bank 14,945,852 15,058,000 4,195,000 4,196,000 Advances from borrowers for taxes and insurance 844,188 844,188 881,685 881,685
The carrying amounts in the preceding table are included in the statement of financial condition under the applicable captions. The contract or notional amounts of the Company's financial instruments with off-balance-sheet risk are disclosed in Note 21. Note 23 - Regulatory Matters The Association is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Association and the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Association must meet specific capital guidelines that involve quantitative measures of the Association's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Association's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Association to maintain minimum amounts and ratios (set forth in the table below) of total risk-based capital and Tier 1 capital to risk-weighted assets (as defined in the regulations), Tier 1 capital to adjusted total assets (as defined), and tangible capital to adjusted total assets (as defined). Management believes, as of September 30, 1998, that the Association meets all capital adequacy requirements to which it is subject. 57 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 23 - Regulatory matters, continued As of September 30, 1998, the most recent notification from the Office of Thrift Supervision categorized the Association as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Association must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage, and tangible capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------------- -------------------- ------------------------ Amount Ratio Amount Ratio Amount Ratio ----------- ----- --------- ----- --------- ------ (dollars in thousands) As of September 30, 1998: Total risk-based capital (to risk-weighted assets) $ 18,784 38.3% $ 3,926 8.0% $ 4,907 10.0% Tier 1 capital (to risk-weighted assets) $ 18,555 37.8% $ 1,963 4.0% $ 2,944 6.0% Tier 1 capital (to adjusted total assets) $ 18,555 14.9% $ 4,965 4.0% $ 6,206 5.0% Tangible capital (to adjusted total assets) $ 18,555 14.9% $ 1,862 1.5% $ 1,862 1.5% As of September 30, 1997: Total risk-based capital (to risk-weighted assets) $ 17,895 40.2% $ 3,559 8.0% $ 4,449 10.0% Tier 1 capital (to risk-weighted assets) $ 17,622 39.6% $ 1,780 4.0% $ 2,670 6.0% Tier 1 capital (to adjusted total assets) $ 17,622 15.2% $ 4,637 4.0% $ 5,796 5.0% Tangible capital (to adjusted total assets) $ 17,622 15.2% $ 1,739 1.5% $ 1,739 1.5%
Note 24 - Compensated Absences Employees of the Company are entitled to paid vacation after one year of employment. The vacation time does not vest; therefore, no accrual for vacation was recorded due to the immateriality. Sick leave is not accrued because it does not vest. The costs of these compensated absences are recognized when paid. Note 25 - Interest and Dividends on Investment Securities Dividends on Federal Home Loan Bank stock of $53,616, $57,360, and $55,329 were received for the years ended September 30, 1998, 1997, and 1996, respectively. Interest income received from investment securities for the years ended September 30, 1998, 1997, and 1996 was taxable. 58 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 26 - Other Noninterest Income and Expense Other noninterest income and expense amounts are summarized as follows:
1998 1997 1996 -------- -------- -------- Other noninterest income: Loan late charges ......................... $ 29,127 $ 25,346 $ 25,825 Bank service charges and fees ............. 21,773 22,345 22,503 Other ..................................... 12,635 20,215 11,828 -------- -------- -------- $ 63,535 $ 67,906 $ 60,156 ======== ======== ======== Other noninterest expense: Advertising and promotion ................. $ 34,895 $ 28,023 $ 36,983 Data processing ........................... 99,501 89,203 86,716 Professional fees ......................... 72,634 77,953 80,434 Supervisory examination ................... 36,307 35,697 36,435 Printing, postage, stationery, and supplies 54,660 51,634 43,829 Telephone ................................. 22,519 18,136 18,884 Insurance and bond premiums ............... 52,332 60,877 61,261 Loan servicing expenses ................... 42,246 22,268 20,686 Franchise taxes ........................... 94,363 94,545 94,304 Other ..................................... 153,959 122,436 106,535 -------- -------- -------- $663,416 $600,772 $586,067 ======== ======== ========
Note 27 - Impact of Year 2000 (Unaudited) The Year 2000 (Y2K) issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including the temporary inability to process transactions or engage in similar normal business activities. The Company currently does not expect to incur any significant internal costs relating to the Y2K issue as no internal modifications are necessary, with the exception of its third party processing system. For this system, the Company has initiated formal communications and testing procedures with its third party processor as the Company's interface systems are vulnerable to the processor's failure to remediate its own Y2K issues. The Company receives regular status reports from the processor indicating the progress to date and estimated completion date. The processor estimates that Y2K modifications to the systems which interface with the Company will be completed no later than June 30, 1999, which is prior to any anticipated impact on the Company's operating systems. The Company believes that with the processor's modifications to existing software and conversion to new software, the Y2K issue will not pose significant operational problems for its computer systems. However, if such modifications and conversions are not made or completed timely by the processor, the Y2K issue could have a material impact on the operations of the Company. 59 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 28 - Condensed Parent Company Only Financial Statements The following condensed statements of financial condition as of September 30, 1998 and 1997, and related condensed statements of income and statements of cash flows for the years ended September 30, 1998 and 1997, should be read in conjunction with the consolidated financial statements and the related notes.
1998 1997 ------------ ------------ STATEMENT OF FINANCIAL CONDITION Assets: Cash ........................................................... $ 975,288 $ 2,146,805 Note receivable - ESOP Trust ................................... 607,550 704,758 Investment in the Association .................................. 18,703,457 17,967,563 Receivable from subsidiary ..................................... 118,102 78,902 Prepaid expenses ............................................... 5,611 6,432 ------------ ------------ Total assets ........................................................ $ 20,410,008 $ 20,904,460 ============ ============ Liabilities: Other liabilities .............................................. $ 26,314 $ 25,092 ------------ ------------ Stockholders' Equity: Common stock ................................................... 18,845 12,564 Additional paid-in capital ..................................... 12,319,624 12,196,879 Retained earnings .............................................. 13,661,392 13,365,792 Treasury stock ................................................. (4,794,263) (3,731,017) Unearned ESOP shares ........................................... (543,564) (650,614) Deferred compensation - RRP shares ............................. (213,366) (329,748) Net unrealized gain on available-for-sale securities, net of tax (64,974) 15,512 ------------ ------------ Total stockholders' equity ................................. 20,383,694 20,879,368 ------------ ------------ Total liabilities and stockholders' equity .......................... $ 20,410,008 $ 20,904,460 ============ ============
STATEMENT OF INCOME Income: Equity in earnings of Association .............................. $ 709,330 $ 1,012,661 Interest income ................................................ 53,730 61,546 ------------ ------------ Total income ............................................... 763,060 1,074,207 ------------ ------------ Expenses: Management expenses paid to subsidiary ......................... 130,500 303,097 Franchise tax expense .......................................... 50,295 51,014 Professional fees .............................................. 43,843 42,867 Other .......................................................... 53,917 37,122 ------------ ------------ 278,555 434,100 Total expenses ............................................. _____________ _____________ Income before federal income taxes .................................. 484,505 640,107 Federal income taxes (benefit) ...................................... (76,441) (126,668) ------------ ------------ Net income .......................................................... $ 560,946 $ 766,775 ============ ============
60 East Texas Financial Services, Inc. and Subsidiary Notes to Consolidated Financial Statements Note 28 - Condensed Parent Company Only Financial Statements, continued
1998 1997 ----------- ----------- STATEMENT OF CASH FLOWS Cash flows from operating activities: Net income ............................................... $ 560,946 $ 766,775 Equity in earnings of the Association, net of dividends .. (709,330) 202,529 (Increase) decrease in prepaid expenses .................. 821 (1,236) Increase in other liabilities ............................ 1,222 6,670 ----------- ----------- Net cash provided (used) by operating activities ..... (146,341) 974,738 ----------- ----------- Cash flows from investing activities: ESOP loan repayment ...................................... 97,208 97,208 Increase in receivable from subsidiary ................... (39,200) (67) ----------- ----------- Net cash provided by investing activities ............ 58,008 97,141 ----------- ----------- Cash flows from financing activities: Net proceeds from issuance of common stock ............... 239,127 200,744 Purchase of treasury stock at cost ....................... (1,080,369) (951,116) Sale of treasury stock for exercise of stock options ..... 14,771 14,761 Dividends paid ........................................... (256,713) (210,513) ----------- ----------- Net cash used by financing activities ................ (1,083,184) (946,124) ----------- ----------- Net increase (decrease) in cash and cash equivalents .......... (1,171,517) 125,755 Cash and cash equivalents at beginning of year ................ 2,146,805 2,021,050 ----------- ----------- Cash and cash equivalents at end of year ...................... $ 975,288 $ 2,146,805 =========== =========== Supplemental disclosure of cash flow information Cash paid for: Income tax paid ...................................... $ 0 $ 415,820 Receivable from subsidiary for ESOP shares issued ........ 122,745 84,363
61 Corporate Directory East Texas Financial Services, Inc. Board of Directors* Jack W. Flock Gerald W. Free Jim M. Vaughn, M.D. Chairman of Vice Chairman, Retired Physician the Board President and Chief Investments Of Counsel to Executive Officer Ramey & Flock, P. C. L. Lee Kidd M. Earl Davis Charles R. Halstead Oil and Gas Interests Vice President Geologist Compliance and Oil and Gas Interests Marketing of the Association James W. Fair H.H. Richardson, Jr. Real Estate Investment President Oil and Gas Interests H.H. Richardson, Jr. Construction Company Officers Gerald W. Free Derrell W. Chapman ** Sandra J. Allen Vice Chairman, Vice President and Corporate Secretary President and Chief Chief Operating and Executive Officer Chief Financial Officer First Federal Savings and Loan Association of Tyler Officers Gerald W. Free Derrell W. Chapman ** Vice Chairman, Vice President and President and Chief Chief Operating and Executive Officer Chief Financial Officer William L. Wilson M. Earl Davis Treasurer and Vice President Controller Compliance and Marketing Joe C. Hobson Sandra J. Allen Sr. Vice President Corporate Secretary Mortgage Lending Elizabeth G. Taylor Marcia R. Shelton Vice President and Assistant Secretary Loan Officer and Loan Office Earlene Cool Assistant Treasurer * Directors of the Company also serve as directors of the Association ** Advisory Director 62 Shareholder R e f e r e n c e Executive Offices 1200 South Beckham Avenue Tyler, Texas 75701 SEC Counsel Silver, Freedman and Taff, L.L.P. 1100 New York Avenue, N.W. Washington, D.C. 20005-3934 Transfer Agent Registrar and Transfer Company 10 Commerce Drive Cranford, N.J. 07016 Independent Auditors Bryant and Welborn, L.L.P. 601 Chase Drive Tyler, Texas 75701 Investor Relations Shareholders, analysts and others seeking information about East Texas Financial Services, Inc., are invited to contact: Gerald W. Free, Vice Chairman, President and CEO or Derrell W. Chapman, Vice President and COO, CFO at (903) 593-1767 (903) 593-1094 (Fax) Copies of the Company's earnings releases and other financial publications, including the annual report on Form 10-KSB filed with the Securities and Exchange Commission, are available without cost upon request. Annual Meeting of Shareholders January 20, 1999, at 2:00 p.m. Company Offices 1200 South Beckham Avenue Tyler, Texas 63 EX-21 4 EXHIBIT 21 Subsidiaries of the Registrant
SUBSIDIARIES OF THE REGISTRANT Ownership Percentage State of Parent Subsidiary of Organization Incorporation ------ ---------- --------------- ------------- East Texas Financial First Federal Savings 100% United States Services, Inc. and Loan Association of Tyler
The financial statements of the Registrant are consolidated with its subsidiary. EX-23 5 EXHIBIT 23 Consent of Expert Board of Directors East Texas Financial Services, Inc. 1200 S. Beckham Tyler, Texas 75701 Members of the Board: We consent to the incorporation by reference in this Registration Statement on Form S-8 of East Texas Financial Services, Inc. (the "Company") of our report on the financial statements included in the Company's Annual Report on Form 10-KSB for the year ended September 30, 1998, filed pursuant to the Securities Exchange Act of 1934, as amended. /s/ Bryant & Welborn L.L.P. --------------------------- Bryant & Welborn L.L.P. Tyler, Texas December 21, 1998 EX-27 6
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF EAST TEXAS FINANCIAL SERVICES, INC., AT SEPTEMBER 30, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS SEP-30-1998 SEP-30-1998 592,363 3,064,312 129,187 0 12,810,165 53,517,509 54,014,674 61,352,227 233,180 124,017,462 86,643,657 13,150,000 2,044,259 1,795,852 0 0 18,845 20,364,849 124,017,642 4,770,636 3,266,838 226,256 8,263,730 4,425,979 540,094 4,966,073 0 0 63,535 890,219 890,219 0 0 560,946 .39 .38 2.00 228,000 0 0 488,000 273,000 40,000 0 233,180 52,000 00,000 181,000
-----END PRIVACY-ENHANCED MESSAGE-----