-----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, QYnrzeAZw6OFfOZVs96IcTCr8KqHIYUySPT7qn99kS91Jx78V6syTuNjgnvPSQHs 0kNEN/hSte1iRApAyYuNPA== 0000946275-97-000148.txt : 19970328 0000946275-97-000148.hdr.sgml : 19970328 ACCESSION NUMBER: 0000946275-97-000148 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970327 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: WELLS FINANCIAL CORP CENTRAL INDEX KEY: 0000934739 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 411799504 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: 1934 Act SEC FILE NUMBER: 000-25342 FILM NUMBER: 97564508 BUSINESS ADDRESS: STREET 1: 53 FIRST ST SW STREET 2: P.O. BOX 310 CITY: WELLS STATE: MN ZIP: 56097 BUSINESS PHONE: 5075533151 MAIL ADDRESS: STREET 1: 53 1ST ST SW STREET 2: PO BOX 310 CITY: WELLS STATE: MN ZIP: 56097 10KSB40 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - ----- EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1996 --------------------------------- - 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: 0-25342 ------- Wells Financial Corp. - ------------------------------------------------------------------------------- (Exact name of small business issuer in its charter) Minnesota 48-1799504 - -------------------------------------------- --------------------- (State or other jurisdiction of (I.R.S. employer of incorporation or organization) identification no.) 53 First Street, S.W., Wells, Minnesota 56097 - -------------------------------------------- --------------------- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (507) 553-3151 -------------- 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 $0.10 per share --------------------------------------- (Title of class) Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] Registrant's voting stock trades on the Nasdaq National Market under the symbol "WEFC." The aggregate market value of the voting stock held by non-affiliates of registrant, based upon the closing price of such stock as of March 10, 1997 ($14.375 per share), was $26.7 million. As of March 10, 1997, registrant had 2,018,860 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE 1. Part II -- Portions of Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1996. 2. Part III -- Portions of registrant's Proxy Statement for Annual Meeting of Stockholders to be held on April 16, 1997. PART I Item 1. Business - ---------------- General Wells Financial Corp. ("Registrant" or the "Company") is a unitary savings and loan holding company that was incorporated in December 1994 under the laws of the State of Minnesota for the purpose of acquiring all of the issued and outstanding common stock of Wells Federal Bank, fsb (the "Bank"). This acquisition occurred in April 1995 at the time the Bank simultaneously converted from a mutual to stock institution, and sold all of its outstanding capital stock to the Company and the Company made its initial public offering of common stock (the "Conversion"). As of December 31, 1996, the Company had total assets of $201.3 million, total deposits of $145.3 million, and stockholders' equity of $28.2 million or 14.0% of total assets under generally accepted accounting principles ("GAAP"). The only subsidiary of the Company is the Bank. The primary activity of the Company is directing and planning the activities of the Bank, the Company's primary asset. At December 31, 1996, the remainder of the assets of the Company were maintained in the form of a loan to the Bank, a loan to an employee stock ownership plan ("ESOP") that was established for the benefit of the Bank's employees, deposits in interest bearing accounts with other financial institutions and selected investments. The Company engages in no other significant activities. As a result, references to the Company or Registrant generally refer to the Bank, unless the context otherwise indicates. In the discussion of regulation, except for the discussion of the regulation of the Company, all regulations apply to the Bank rather than the Company. The Bank is a federally chartered stock savings bank headquartered in Wells, Minnesota. The Bank has seven full service offices located in Faribault, Martin, Blue Earth, Nicollet and Freeborn Counties and one loan origination office located in Steele County, Minnesota. The Bank was founded in 1934 and obtained its current name in 1991. The Bank's deposits have been federally insured by the Savings Association Insurance Fund ("SAIF") and its predecessor, the Federal Savings and Loan Insurance Corporation ("FSLIC"), since 1934, and the Bank is a member of the Federal Home Loan Bank ("FHLB") System. The Bank is a community oriented, full service retail savings institution offering traditional mortgage loan products. It is the Bank's intent to remain an independent community savings bank serving the local banking needs of Faribault, Martin, Blue Earth, Nicollet, Steele and Freeborn Counties, Minnesota. The Bank attracts deposits from the general public and uses such deposits primarily to invest in residential lending on owner occupied properties. The Bank also makes consumer loans, commercial loans, and agricultural related loans and purchases mortgage-backed and investment securities. The principal sources of funds for the Registrant's lending activities are deposits, advances from the Federal Home Loan Bank and the amortization, repayment, and maturity of loans, mortgage-backed securities, and investment securities. Principal sources of income are interest and fees on loans, mortgage-backed securities, investment securities, and deposits held in other financial institutions. The Registrant's principal expense is interest paid on deposits. Market Area The Company's primary market area consists of Faribault, Martin, Blue Earth, Nicollet, Steele and Freeborn Counties, Minnesota. Located southwest of Minneapolis, this area is primarily rural and 1 contains approximately 50 communities ranging in population size from 200 to 40,000. The primary lending concentration is in the Mankato and North Mankato area, an area with a relatively large population base. The Company has two offices in the Mankato and North Mankato area. Historically, the economy in the Company's market area has been dependent on agriculture and agriculture related industries. Economic growth in the Company's market area remains dependent upon the local economy. In addition, the deposit and loan activity of the Company is significantly affected by economic conditions in its market area including the agriculture industry. Lending Activities. The Company's loan portfolio predominantly consists of mortgage loans secured by one to four-family residences. The Company also makes consumer loans and commercial loans. For its mortgage loan portfolio, the Company originates and retains adjustable rate loans as well as lower loan-to-value ratio fixed-rate loans with original maturities that are greater than fifteen years. The Company sells other conventional fixed rate mortgage loans into the secondary market. The Company's consumer loan portfolio consists primarily of home equity or improvement loans secured by second liens on real estate on which the Company has the first lien. To a lesser extent, the consumer loan portfolio includes loans secured by vehicles and savings accounts. The Company also originates commercial and multi-family real estate loans, the vast majority of which are secured by farm land. In addition to loans secured by farm real estate, the Company makes commercial business loans, the majority of which are secured by farm operating equipment, livestock, crops on hand, growing crops and farm real estate. The consumer, commercial, and commercial business loan portfolios are primarily composed of adjustable rate loans. The Company's adjustable rate loans reprice based on a cost of funds index that is a lagging market index. A lagging index does not adjust as rapidly as market interest rates and may not adjust as rapidly as would other indices. During periods of increasing interest rates, use of a lagging index results in adjustable rate loans repricing upward at a slower rate than if a leading market index had been used. During periods of decreasing interest rates, use of a lagging index results in adjustable rate loans repricing downward at a slower rate than if a leading market index had been used. 2 Loan Portfolio Composition. The following table sets forth information concerning the composition of the Company's loan portfolio in dollar amounts and in percentages of the total loan portfolio (before deductions for loans in process, deferred loan origination fees and costs and allowances for losses) as of the dates indicated.
At December 31, ------------------------------------------------------------------------------------------ 1992 1993 1994 1995 1996 ---------------- ---------------- ----------------- ---------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Real Estate Loans: One- to four-family ................. $ 99,997 81.57% $118,294 82.08% $137,130 82.14% $136,022 79.38% $141,067 78.20% Multi-family ........................ 1,377 1.12 1,015 0.70 951 0.57 880 0.51 1,355 0.75 Commercial .......................... 7,804 6.37 8,384 5.82 9,654 5.78 10,554 6.16 10,878 6.03 Construction ........................ 1,359 1.11 1,517 1.05 2,149 1.29 2,774 1.62 2,081 1.15 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total real estate loans ......... 110,537 90.17 129,210 89.65 149,884 89.78 150,230 87.67 155,381 86.13 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Other Loans: Consumer Loans: Savings account ..................... 784 0.64 531 0.37 471 0.28 436 0.25 443 0.25 Vehicles ............................ 1,168 0.95 2,308 1.60 2,573 1.54 3,353 1.96 4,619 2.56 Home equity, home improvement and second mortgages ................... 6,566 5.36 8,135 5.65 10,392 6.23 12,875 7.51 15,197 8.42 Other ............................... 2,393 1.95 2,973 2.06 2,811 1.68 3,279 1.91 3,588 1.99 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans ............ 10,911 8.90 13,947 9.68 16,247 9.73 19,943 11.63 23,847 13.22 Commercial business loans ............. 1,135 0.93 957 0.67 810 0.49 1,191 0.70 1,171 0.65 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total other loans ............... 12,046 9.83 14,904 10.35 17,057 10.22 21,134 12.33 25,018 13.87 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans ..................... 122,583 100.00% 144,114 100.00% 166,941 100.00% 171,364 100.00% 180,399 100.00% ====== ====== ====== ====== ====== Less: Loans in process .................... 503 1,190 685 493 623 Deferred loan origination fees and costs .......................... 362 544 695 689 714 Allowance for loan losses ........... 479 398 376 512 615 ------- -------- -------- -------- -------- Total loans receivable, net...... $121,239 $141,982 $165,185 $169,670 $178,447 ======== ======== ======== ======= =======
3 Origination, Purchase, and Repayment of Loans. The following table sets forth the Company's loan originations, sales, and principal repayments for the periods indicated. The Company originates loans for retention in its portfolio and did not purchase loans during the years indicated.
Years Ended December 31, ----------------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- (In Thousands) Total gross loans receivable at beginning of year ............. $134,291 $122,583 $144,114 $166,941 $171,364 -------- -------- -------- -------- -------- Loans originated: One- to four-family residential 57,408 64,043 33,854 30,609 43,411 Commercial and multi-family real estate ....................... 296 1,042 1,623 1,366 1,759 Construction loans ............. 1,556 3,627 5,114 5,522 6,776 Consumer loans ................. 1,507 7,496 8,166 12,103 10,242 Commercial business loans ...... 670 1,257 1,760 1,567 610 -------- -------- -------- -------- -------- Total loans originated ........... 61,437 77,465 50,517 51,167 62,798 -------- -------- -------- -------- -------- Principal reductions: Loans sold ..................... 39,613 24,552 2,971 13,584 19,209 Loan principal repayments ...... 33,532 31,382 24,719 33,160 34,554 -------- -------- -------- -------- -------- Total principal reductions ....... 73,145 55,934 27,690 46,744 53,763 -------- -------- -------- -------- -------- Total gross loans receivable at end of year .................... $122,583 $144,114 $166,941 $171,364 $180,399 ======== ======== ======== ======== ========
Loan Sales. During 1996, the Company sold $19.2 million of mortgage loans into the secondary market. The Company sells the FHA and Veterans Administration ("VA") loans that it originates to another financial institution. The Company does not retain the servicing on the FHA/VA loans. The Company also sells conforming fixed-rate conventional loans with loan-to-value ratios of 90% or higher to the Federal Home Loan Mortgage Corporation ("FHLMC"). The Company retains the servicing rights on these loans. All loans sold to FHLMC ($17.7 million) were sold without recourse to the Company, except for documentation deficiencies that may require the Company to repurchase these loans within a limited time period following the sale to FHLMC. To a lesser extent, the Company has sold loans with high loan to value ratios to maintain its loan quality. 4 Loan Maturity Tables. The following table sets forth the maturity of the Company's loan portfolio at December 31, 1996. The table does not include prepayments, scheduled principal repayments or loans held for sale. All mortgage loans are shown as maturing based on contractual maturities.
1- to 4- Other Family Residential Commercial Real Estate and Business and Mortgage Commercial Construction Consumer Total -------- ---------- ------------ -------- ----- (In Thousands) Amounts Due: Within 1 year....... $ 439 $ 2 $2,081 $ 2,706 $ 5,228 1 to 3 years........ 1,281 513 -- 3,609 5,403 3 to 5 years........ 1,689 1,283 -- 5,298 8,270 5 to 10 years....... 8,228 937 -- 12,266 21,431 Over 10 years....... 129,430 9,498 -- 1,139 140,067 ------- ------ ----- ------ ------- Total amount due...... $141,067 $12,233 $2,081 $25,018 180,399 ======= ====== ===== ====== ------- Less: Allowance for loan losses.................................................. 615 Loans in process........................................................... 623 Deferred loan fees......................................................... 714 ------- Loans receivable, net.................................................... $178,447 =======
The following table sets forth the dollar amount of all loans due after December 31, 1997 that have pre-determined interest rates and which have floating or adjustable interest rates. This table does not include loans held for sale.
Floating or Fixed Rates Adjustable Rates Total ----------- ---------------- ----- (In Thousands) One- to four-family ................... $ 49,203 $ 91,425 $140,628 Commercial and multi-family real estate 3,286 8,945 12,231 Construction .......................... - - - Commercial business and consumer ...... 9,550 12,762 22,312 -------- -------- -------- Total ............................... $ 62,039 $113,132 $175,171 ======== ======== ========
One- to Four-Family Residential Loans. The Company's primary lending activity consists of the origination of single family residential mortgage loans secured by property located in the Company's primary market area. The Company generally originates one- to four-family residential mortgage loans without private mortgage insurance in amounts up to 80% of the lesser of the appraised value or selling price of the mortgaged property. The Company will not originate any loan which exceeds 95% of the lesser of the appraised value or selling price and typically requires private mortgage insurance on any loans at 80% or more of the value of the mortgaged property. Typically, fixed rate loans with loan-to-value ratios of 90% or higher will be sold into the secondary market. The Company originates adjustable rate mortgage loans for retention in its portfolio with loan-to-value ratios of up to 95% and requires private mortgage insurance when the loan-to-value ratio exceeds 80%. 5 For its adjustable rate loans, the Company may offer low initial interest rates ("teaser rates") but requires the borrower to qualify at the fully indexed rate. The Company's adjustable rate loans provide for annual 1%-2% interest rate adjustments with a maximum adjustment over the term of the loan of between 5% and 6%. The Company also permits adjustable rate loans to be converted into fixed-rate loans. Loan originations are generally obtained from existing customers, members of the local community, and referrals from realtors within the Company's lending area. Mortgage loans originated and held by the Company in its portfolio include due-on sale clauses which provide the Company with the contractual right to deem the loan immediately due and payable in the event that the borrower transfers ownership of the property without the Company's consent. The Company primarily originates fixed and adjustable rate mortgage loans with 15-30 year terms. The Company offers various loan programs, including low documentation loans for loans with lower loan-to-value ratios and other loan programs using cost of funds or one-year U.S. treasury indices for adjustable rate loan repricing. Interest rates charged on mortgage loans are competitively priced based on market conditions and the Company's cost of funds. Throughout the year, origination fees for loans were generally 1% of the loan amount. The Company's standard underwriting guideline for fixed-rate mortgage loans conform to FHLMC guidelines and the loans may be sold in the secondary market to private investors. The Company customarily sells all Federal Housing Administration and Veterans' Administration ("FHA/VA") loans as well as certain conforming fixed rate mortgage loans in the secondary market. The Company also originates adjustable rate mortgages ("ARMs") which adjust every year based upon various indices. At December 31, 1996, the Company was servicing approximately $66.1 million of loans for others, primarily long term fixed rate loans sold to FHLMC. Generally, the Company retains all servicing on loans sold to FHLMC and does not retain servicing on FHA/VA loans sold. Except for document deficiencies that may occur during origination that may require a repurchase by the Company, loans are sold without recourse. Consumer Loans. The Company offers second mortgage loans on one- to four-family residences which are typically offered as adjustable rate loans. Such loans are only made on owner-occupied one- to four-family residences and are subject to a 95% combined loan-to-value ratio. The Company holds the majority of the underlying first mortgages on these loans. The underwriting standards for second mortgage loans are similar to the Company's standards applicable to one- to four-family residential loans. To a lesser extent, the Company makes loans secured by vehicles and by savings accounts held with the Company. Loans secured by vehicles totalled $4.6 million, or 2.56%, of the loan portfolio at December 31, 1996. Federal regulations permit federally chartered thrift institutions to make secured and unsecured consumer loans up to 35% of an institution's assets. In addition, a federal thrift has lending authority above the 35% category for certain consumer loans, property improvement loans, and loans secured by savings accounts. The Company originates consumer loans in order to provide a wide range of financial services to its customers and because the shorter terms and normally higher interest rates on such loans help maintain a profitable spread between its average loan yield and its cost of funds. Consumer loans, however, tend to have a higher risk of default than residential mortgage loans. Typically, based on the Company's experience, a borrower faced with either paying a mortgage loan to avoid foreclosure on the borrower's home or defaulting on a consumer loan will continue paying the mortgage loan. At December 31, 1996, the Company had approximately $75,000 in consumer loans that were more than 90 days delinquent. 6 Commercial Real Estate Loans. In order to enhance yields on its assets, the Company originates loans secured by commercial real estate. Approximately three-quarters of this portfolio is secured by farm real estate. Most of the remainder of the portfolio is secured by church real estate. At December 31, 1996, loans secured by farm real estate were originated in amounts up to the lesser of 65% of the appraised value of the property or $1,000 per tillable acre. These loans are evaluated on a cash flow basis in addition to an asset value basis. Loans secured by church real estate are generally originated in amounts up to 70% of the appraised value of the property. At December 31, 1996, the Company's largest commercial real estate loan consisted of a $525,000 performing loan secured by a multi-family building in North Mankato, Minnesota. All commercial real estate loans, excluding those secured by farm real estate, require prior approval by the Bank's Board of Directors. As part of its underwriting, the Company requires that borrowers qualify for a commercial loan at the fully indexed interest rate rather than at the origination interest rate. Loans secured by commercial real estate generally involve a greater degree of risk than residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired. For loans secured by farm real estate, repayment may be affected by weather conditions and government policies and subsidies concerning farming. For loans secured by church real estate, repayment is dependent upon the continuing financial support of the church's members. Commercial Business Loans. The Company's commercial business loans consist of agricultural operating loans secured primarily by farm equipment, livestock, crops, and farm real estate. These loans are generally originated in amounts up to 70% of the appraised value of the property. These loans typically are adjustable rate loans with quarterly adjustments. Agricultural operating loans generally involve a greater degree of risk than residential mortgage loans. This increased credit risk is a result of several factors, including the effects of general economic conditions on income producing property and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of agricultural operating loans is typically dependent upon the successful operation of the related property. If the cash flow from the property is reduced, the borrower's ability to repay the loan may be impaired. Construction Loans. Construction loans are made on single family residential property to the individuals who are the owners and occupants upon completion of construction. These loans are made on a long term basis and are classified as construction permanent loans with no principal payments required during the first six months, after which the payments are set at an amount that will amortize over the term of the loan. The maximum loan-to-value ratio is 80% and is made at a variable or fixed interest rate. The Company does not originate many speculative loans to builders and limits the loan-to-value ratio to 70% with a maximum loan term of 18 months. In underwriting such loans, the Company takes into consideration the number of units that the builder has on a speculative basis that remain unsold. Construction lending is generally considered to involve a higher degree of credit risk than long-term financing of residential properties. The Company's risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost of construction. If the estimate of construction cost and the marketability of the property upon completion of the project prove to be inaccurate, the Company may 7 be compelled to advance additional funds to complete the development. Furthermore, if the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a property with a value that is insufficient to assure full repayment. For the small number of speculative loans originated to builders, the ability of the builder to sell completed dwelling units will depend, among other things, on demand, pricing, and availability of comparable properties and economic conditions. Loan Approval Authority and Underwriting. All loans, other than smaller dollar value consumer loans, must be approved by the Company's Loan Committee. A minimum of two committee members may approve loans on one- to four-family residential units, non-owner occupied residential properties that do not exceed eight units, farm real estate loans of $200,000 or less, farm operating loans of $100,000 and less, and all consumer loans. All commercial real estate loans and other loans that exceed the above limitations must be submitted to the Board of Directors for prior approval. For all loans originated by the Company, upon receipt of a completed loan application from a prospective borrower, a credit report is generally ordered, income and certain other information is verified and, if necessary, additional financial information is requested. For real estate loans, an appraisal of the real estate intended to be used as security for the proposed loan is obtained from an independent appraiser designated and approved by the Board of Directors of the Bank. In certain cases, an appropriate valuation is completed by Company staff as allowed by regulation. In addition, the relationship of the loan to the value of the collateral is considered. The Company makes construction/permanent loans on individual properties. Funds advanced during the construction phase are held in a loan-in-process account and disbursed based upon various stages of completion in accordance with the results of inspection reports that are obtained through physical inspection of the construction by an independent contractor hired by the Company or in some cases by a loan officer. For real estate loans, the Company will require either title insurance or a title opinion. Borrowers must also obtain hazard or flood insurance (for loans on property located in a flood zone, flood insurance is required) prior to the closing of the loan. Loan Commitments. The Company issues written commitments or verbal commitments to prospective borrowers on all real estate approved loans. Generally, the commitment requires acceptance within 90 days of the date of issuance. Commitments for consumer loans are given verbally and not in writing and generally expire in a shorter period of time. At December 31, 1996, the Company had $11.9 million of commitments to cover originations, undisbursed funds for loans in process and unused lines of credit. The Company estimates that the majority of the Company's commitments are funded. Loans to One Borrower. Loans-to-one borrower are limited in an amount equal to 15% of unimpaired capital and unimpaired surplus and an additional amount equal to 10% of unimpaired capital and unimpaired surplus if the loan is secured by readily marketable collateral (generally, financial instruments, not real estate) or $500,000, whichever is higher. The Company's maximum loan-to-one borrower limit was approximately $3.1 million as of December 31, 1996. At December 31, 1996, the Company's largest amount of loans to one borrower was $900,000, consisting of performing loans secured by multi-family buildings and real estate for approximately 19 dwelling units and a personal residence, all of which are located in the Company's market area. Loan Delinquencies. The Company's collection procedures provide that when a mortgage loan is 15 days past due, a notice of nonpayment is sent. If payment is still delinquent after 30 days past due the customer will receive a letter and/or telephone call and may receive a visit from a representative of the Company. If the delinquency continues, similar subsequent efforts are made to eliminate the 8 delinquency. If the loan continues in a delinquent status for 60 days past due and no repayment plan is in effect, a notice of right to cure default is mailed to the customer giving 30 additional days to bring the account current before foreclosure is commenced. The loan committee meets regularly to determine when foreclosure proceedings should be initiated and the customer is notified when foreclosure has been commenced. Loans are reviewed on a monthly basis and are generally placed on a non-accrual status when a mortgage loan or a non-mortgage loan becomes 120 or 90 days delinquent, respectively, and, in the opinion of management, the collection of additional interest is doubtful. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent interest payments, if any, are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. Non-accrual loans fluctuate over time due to a variety of factors. For the Company, non-accrual loans may be affected by the payments on one large loan or a delay in the harvesting of crops due to weather conditions. The Company's experience has been that these fluctuations are normal and are not dependant on any one factor over time. 9 The following table sets forth information regarding non-accrual loans, real estate owned, and certain other repossessed assets and loans. On January 1, 1995, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 114, as amended by SFAS No. 118. The adoption of this statement had no effect on the consolidated financial statements of the Company.
At December 31, --------------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- (Dollars in Thousands) Loans accounted for on a non-accrual basis: Mortgage loans: Construction loans ........................................... $ -- $ -- $ -- $ -- $ -- Permanent loans secured by 1- to 4-family residences ................................................. 942 614 556 265 164 All other mortgage loans ..................................... 20 75 168 -- 59 Non-mortgage loans: Commercial ................................................... 7 -- 5 7 -- Consumer ..................................................... 70 71 88 26 75 -------- ---------- ---- ---- ---------- Total .......................................................... $ 1,039 $ 760 $817 $298 $ 298 ======== ========== ==== ==== ========== Accruing loans which are contractually past due 90 days or more: Mortgage loans: Construction loans ........................................... $ -- $ -- $ -- $-- $ -- Permanent loans secured by 1- to 4-family residences ................................................. -- -- -- -- 147 All other mortgage loans ..................................... -- -- -- -- -- Non-mortgage loans: Commercial ................................................... -- -- -- -- -- Consumer ..................................................... -- -- -- 1 -- -------- ---------- ---- ---- ---------- Total .......................................................... $ -- $ -- $ -- $ 1 $ 147 ======== ========== ==== ==== ========== Total non-accrual and accruing loans past due 90 days or more ..................................... $ 1,039 $ 760 $817 $299 $ 445 ======== ========== ==== ==== ========== Foreclosed real estate ......................................... $ 136 $ 160 $151 $ 29 $ 78 ======== ========== ==== ==== ========== Other nonperforming assets ..................................... $ -- $ -- $ -- $ -- $ -- ======== ========== ==== ==== ========== Total nonperforming assets ..................................... $ 1,175 $ 920 $968 $328 $ 523 ======== ========== ==== ==== ========== Total non-accrual and accruing loans past due 90 days or more to net loans ............................. 0.86% 0.53% 0.50% 0.18% 0.25% ======== ========== ==== ==== ========== Total non-accrual and accruing loans past due 90 days or more to total assets........................... 0.59% 0.46% 0.45% 0.15% 0.22% ======== ========== ==== ==== ========== Total nonperforming assets to total assets...................... 0.67% 0.56% 0.53% 0.17% 0.26% ======== ========== ==== ==== ==========
Interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of such loans was immaterial for the year ended December 31, 1996. Amounts included in the Company's interest income on non-accrual loans for the year ended December 31, 1996 was likewise immaterial. Classified Assets. Office of Thrift Supervision ("OTS") regulations provide for a classification system for problem assets of insured institutions which covers all problem assets. Under this classification system, problem assets of insured institutions are classified 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 10 characterized by the "distinct possibility" that the insured institution 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. Assets may be designated "special mention" because of potential weakness that do not currently warrant classification in one of the aforementioned categories. When an insured institution 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 an insured institution classifies 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 institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which may order the establishment of additional general or specific loss allowances. A portion of general loss allowances established to cover possible losses related to assets classified as substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. The following table provides further information about the Company's problem assets as of December 31, 1996. (In Thousands) Special Mention............... $ 497 Substandard................... 496 Doubtful assets............... -- Loss assets................... 29 General loss allowance........ 615 Foreclosed Real Estate. Real estate acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired it is recorded at the lower of the loan balance or the fair value at the date of foreclosure less estimated costs of disposition. There may be significant other expenses incurred such as attorney and other extraordinary servicing costs involved with foreclosures. Foreclosed real estate, net of allowance for losses, totaled $78,000 at December 31, 1996. Allowance for Loan and Real Estate Losses. It is management's policy to provide for losses on unidentified loans in its loan portfolio and foreclosed real estate. A provision for loan losses is charged to operations based on management's evaluation of the potential losses that may be incurred in the Company's loan portfolio. Such evaluation, which includes a review of all loans of which full collectibility of interest and principal may not be reasonably assured, considers the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and current economic conditions. 11 Management will continue to review the entire loan portfolio to determine the extent, if any, to which further additional loss provisions may be deemed necessary. There can be no assurance that the allowance for losses will be adequate to cover losses which may in fact be realized in the future and that additional provisions for losses will not be required. 12 Allocation of Allowance for Loan Losses. The following table sets forth the allocation of the Company's allowance for loan losses by loan category and the percent of loans in each category to total loans receivable, at the dates indicated. The portion of the loan loss allowance allocated to each loan category does not represent the total available for future losses which may occur within the loan category since the total loan loss allowance is a valuation reserve applicable to the entire loan portfolio. The allocation of the allowance for loan losses is based on management's evaluation of the loans in the respective portfolios; the Company does not attempt to manage the percentage of the allocation between loan categories. As part of management's evaluation, for each loan category, the allowance is determined after examination of prior period experience but is adjusted for various factors such as delinquencies, expected charge-offs, recoveries, amount of classified assets, amount of non-accrual loans and any known local economic trends. As a result, the allocation of the allowance does not reflect relative levels of historic charge-offs between loan categories.
At December 31, ----------------------------------------------------------------------------------------------------- 1992 1993 1994 1995 1996 ------------------- ------------------ -------------------- ------------------ ------------------- Percent of Percent of Percent of Percent of Percent of Loans in Each Loans in Each Loans in Each Loans in Each Loans in Each Category to Category to Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- (Dollars in Thousands) At end of year allocated to: Mortgage................ $379 90.17% $272 89.65% $251 89.78% $394 87.67% $484 86.13% Consumer and non-mortgage 100 9.83 126 10.35 125 10.22 118 12.33 131 13.87 --- ------ --- ------ --- ------ --- ----- --- ------ Total allowance........ $479 100.00% $398 100.00% $376 100.00% $512 100.00% $615 100.00% === ====== === ====== === ====== === ====== === ======
13 Analysis of the Allowance for Loan Losses. The following table sets forth information with respect to the Company's allowance for loan losses for the years indicated:
At December 31, -------------------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- (Dollars in Thousands) Total loans outstanding....... $122,583 $144,114 $166,941 $171,364 $180,399 ======= ======= ======= ======= ======= Average loans outstanding..... $129,260 $130,026 $153,477 $170,395 $173,383 ======= ======= ======= ======= ======= Beginning allowance balances.. $ 515 $ 479 $ 398 $ 376 $ 512 Provision: One- to four-family......... 72 -- 32 166 180 Commercial and multi-family real estate............... -- -- -- -- -- Consumer.................... 100 -- 81 -- -- Charge-offs: One- to four-family......... 64 61 53 23 21 Commercial and multi-family real estate............... 80 -- -- -- -- Consumer.................... 93 59 91 18 67 Recoveries: One- to four-family......... 4 19 -- -- -- Commercial and multi-family real estate............... -- -- -- -- -- Consumer.................... 25 4 9 11 11 Other......................... -- 16 -- -- -- ------- ------- ------- ------- ------- Ending allowance balance...... $ 479 $ 398 $ 376 $ 512 $ 615 ======= ======= ======= ======= ======= Allowance for loan losses as a percent of total loans outstanding................. 0.39% 0.28% 0.23% 0.30% 0.34% Net loans charged off as a percent of average loans outstanding................. 0.16% 0.07% 0.09% 0.02% 0.04%
14 Analysis of the Allowance for Foreclosed Real Estate. The following table sets forth information with respect to the Company's allowance for losses on foreclosed real estate at the dates indicated.
At December 31, -------------------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- (Dollars in Thousands) Total foreclosed real estate and real estate in judgment, net ............................ $ 136 $ 160 $ 151 $ 29 $ 78 ===== ======= ====== ======= ==== Allowance balances - beginning ................ 34 16 -- -- -- Provision ..................................... -- -- -- -- -- Charge-offs ................................... 18 -- -- -- -- Recoveries .................................... -- -- -- -- -- Other ......................................... -- (16) -- -- -- ---- ------- ------ ------- ---- Allowance balances - ending ................... $ 16 $ -- $ -- $ -- $ -- ===== ======= ====== ======= ==== Allowance for losses on foreclosed real estate in judgment to net foreclosed real estate and real estate in judgment ..................... 11.76% --% --% --% --% ===== ======= ====== ======= ====
Mortgage-Backed Securities To supplement lending activities, the Company invests in residential mortgage-backed securities. Mortgage-backed securities can serve as collateral for borrowings (although the Company has not used them as such) and, through repayments, as a source of liquidity. At December 31, 1996, the mortgage-backed securities portfolio had a fair value of $428,000 and an amortized cost of $427,000. Because the portfolio is classified as available for sale (the Company had no mortgage-backed securities held to maturity at December 31, 1996), the portfolio is recorded at $428,000. The mortgage-backed securities portfolio at December 31, 1996 consisted solely of real estate mortgage investment conduits ("REMICs"), a form of collateralized mortgage obligations ("CMOs"). The Company receives monthly interest payments on the securities in this portfolio based on fixed coupon rates. These securities are guaranteed as to principal by the Federal National Mortgage Association ("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC") and management does not believe that there is a material credit risk associated with the repayment of principal. To assess price volatility, the Federal Financial Institutions Examination Council ("FFIEC") and OTS have adopted a policy that requires an annual "stress" test of mortgage derivative securities. This policy requires the Company to annually test its CMOs and other mortgage-related securities to determine whether they are high-risk or non-high-risk securities. At December 31, 1996, the Company's CMOs met the criteria established by the policy for non-high-risk securities. If interest rates remain stable, the weighted average life of the FNMA CMO is 0.66 years. According to stress tests mandated by the Company's regulators, a 300 basis point upward shift in interest rates increases the weighted average life of this security to 1.12 years. This same 300 basis point upward shift would result in a 2.72% decrease in price. Currently, the weighted average life of the FHLMC CMO is 0.17 years. A 300 basis point upward shift in interest rates increases the weighted average life to 0.27 years and results in a 0.75% decrease in the price. The carrying value of these securities is adjusted on a quarterly basis to reflect current market value. 15 Investment Activities The Company is required under federal regulations to maintain a minimum amount of liquid assets which may be invested in specified short-term securities and certain other investments. The Company has maintained a liquidity portfolio in excess of regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of future yield levels, as well as management's projections as to the short-term demand for funds to be used in the Company's loan origination and other activities. At December 31, 1996, the Company had an investment portfolio of approximately $9.8 million, consisting primarily of U.S. Treasury securities and U.S. government corporate and agency obligations. To a lesser extent, the portfolio also includes mutual funds, FHLMC stock, mortgage-backed securities, certificates of deposit and FHLB stock, as permitted by the OTS regulations. The Company classifies its investments, including debt and equity securities, as either held to maturity or available for sale, in accordance with SFAS 115. The Company will continue to seek high quality investments. The primary and secondary goals of the investment portfolio are safety of principal and rate of return, respectively. Investment Portfolio. The following table sets forth the carrying value of the Company's investments, including short-term investments, FHLB stock, and mortgage-backed securities, at the dates indicated. At December 31, 1996, the Company's securities that were classified as available for sale had an unrealized net gain of $583,000. The Company's securities that were classified as held to maturity had a net unrealized loss of $5,000. This unrealized loss is not reflected in the table below because these securities are carried at amortized cost in accordance with SFAS 115. At December 31, 1996, the market value for the interest bearing deposits shown below approximated their cost. At December 31, --------------------------------- 1994 1995 1996 ------- ------ -------- (In Thousands) Securities available for sale: Equity securities................ $ 5,951 $ 6,753 $ 7,100 Securities held to maturity: U.S. government securities........ 1,793 800 -- U.S. agency securities............ 4,198 3,399 2,049 ------ ------ ----- Total investment securities..... 11,942 10,952 9,149 Interest-bearing deposits.......... 100 800 200 Mortgage-backed securities available for sale........................ 961 867 428 ------ ------ ------ Total investments............... $13,003 $12,619 $ 9,777 ====== ====== ====== 16 Investment Portfolio Maturities. The following table sets forth certain information regarding the carrying values, weighted average yields and maturities of the Company's investment securities portfolio.
At December 31, 1996 -------------------------------------------------------------------------------------------------------- Total One Year or Less One to Five Years Five to Ten Years More than Ten Years Investment Securities ------------------ ----------------- ------------------- ------------------- ------------------------- Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market Value Yield Value Yield Value Yield Value Yield Value Yield Value -------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------ (Dollars in Thsands) Mortgage-backed Securities $ 428 6.81% $ -- --% $ -- -- % $ -- -- % $ 428 6.81% $ 428 U.S. Government Obligations -- -- -- -- -- -- -- -- -- -- -- U. S. Agency Obligations .. -- -- 2,049 6.44 -- -- -- -- 2,049 6.44 2,044 FHLB Stock ................ -- -- -- -- -- -- -- -- 1,633 -- 1,633 Equity Securities(1) ...... -- -- -- -- -- -- -- -- 5,467 -- 5,467 Interest Bearing Deposits . 200 5.75 -- -- -- -- -- -- 200 5.75 200 ----- ----- ----- ----- ----- ----- Total ................... $ 628 6.47 $2,049 6.44 $ -- -- -- -- $9,777 $9,772 ====== ====== ===== ===== ===== =====
- ------------------------ (1) Includes funds held by the Asset Management Fund for Financial Institutions for the Company in the following portfolios: $2,320,000 in the Short U.S. Government Securities Portfolio, $1,171,000 in the U.S. Government Mortgage Portfolio and $1,149,000 in the Intermediate Mortgage Securities Portfolio. 17 Sources of Funds General. Deposits are the major external source of the Company's funds for lending and other investment purposes. The Company derives funds from amortization and prepayment of loans and, to a much lesser extent, maturities of investment securities, borrowings and operations. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and market conditions. The Company may also borrow from the FHLB of Des Moines as a source of funds. Deposits. Consumer and commercial deposits are attracted principally from within the Company's primary market area through the offering of a broad selection of deposit instruments including regular savings accounts, NOW accounts, and term certificate accounts. The Company also offers IRA and KEOGH accounts. Deposit account terms vary according to the minimum balance required, the time period the funds must remain on deposit and the interest rate, among other factors. Jumbo Certificate Accounts. The following table indicates, at December 31, 1996, the amount of the Company's certificates of deposit of $100,000 or more by time remaining until maturity. Maturity Period (In Thousands) Within three months.................. $2,767 Three through six months............. 1,710 Six through twelve months............ 1,147 Over twelve months................... 3,823 ------ $9,447 ====== Borrowings. Deposits are the primary source of funds of the Company's lending and investment activities and for its general business purposes. Through the Bank, the Company may obtain advances from the FHLB of Des Moines to supplement its supply of lendable funds. Advances from the FHLB of Des Moines are typically secured by a pledge of the Bank's stock in the FHLB of Des Moines and a portion of the Company's first mortgage loans and certain other assets. The Bank, if the need arises, may also access the Federal Reserve Bank discount window to supplement its supply of lendable funds and to meet deposit withdrawal requirements. At December 31, 1996, the Company had $26.5 million in advances outstanding from the FHLB of Des Moines of which $12.5 million have fixed rates and $11.0 million and $3.0 million have variable rates that reprice monthly and daily, respectively. Most of these advances provide for a prepayment penalty. See Note 12 of the Notes to Consolidated Financial Statements. At December 31, 1996, the Bank had $4.0 million in borrowings (in the form of a loan) from the Company. The interest rate on this loan adjusts quarterly. The Company expects that the use of borrowings will continue and may increase after the Company uses available liquid assets to fund loan originations. During recent periods, the Company has found that obtaining wholesale funds through FHLB advances is less expensive than increasing the interest rates on deposit accounts to increase the amount of deposits. If, in the future, increased deposits become less expensive than FHLB advances, the Company will likely rely more on increased deposits than on FHLB advances. At December 31, 1996, the Company had the ability to borrow approximately 3.4 times its then outstanding advances. 18 The following table sets forth certain information as to FHLB advances at the dates indicated. As of and for the Years Ended December 31, ------------------------------------------ 1994 1995 1996 ---- ---- ---- (Dollars in Thousands) FHLB advances................... $ 23,650 $ 18,000 $ 26,500 Weighted average interest rate of FHLB advances.............. 5.64% 5.72% 5.74% Maximum amount of advances...... $ 23,650 $ 23,650 $ 28,500 Average amount of advances...... 12,610 18,938 19,269 Weighted average interest rate of average amount of advances. 4.96% 6.14% 5.64% Subsidiary Activity The Company has one wholly owned subsidiary, the Bank. The Bank has one wholly owned subsidiary, known as Wells Insurance Agency, Inc. (the "WIA"). The Bank is permitted to invest up to 2% of its assets in the capital stock of, or secured or unsecured loans to, subsidiary corporations, with an additional investment of 1% of assets when such additional investment is utilized primarily for community development purposes. Under the 2% limitation, as of December 31, 1996, the Bank was authorized to invest up to approximately $4.0 million in the stock of, or loans to, service corporations. WIA was incorporated under the laws of the State of Minnesota in 1976. WIA offers life, health, casualty, and business insurance on behalf of others and also offers fixed-rate annuities. The Bank's investment in WIA totalled $436,000 at December 31, 1996. Personnel As of December 31, 1996, the Bank had 50 full-time and 6 part-time employees. None of the Bank's employees are represented by a collective bargaining group. The Company, with no employees of its own, utilizes those of the Bank. Competition The competition for deposit products includes banks ranging in size from larger, Minneapolis- based regional banks with branches in the Company's market area to local independent community banks. Deposit competition also includes a number of insurance products sold by local agents and investment products sold by local and regional sales people. Loan competition varies depending upon market conditions. Loan competition includes branches of large Minneapolis-based commercial banks and thrifts, credit unions, mortgage bankers with local sales staff and local banks. The Company believes that it is one of the few area lenders that has consistently offered a variety of loans throughout all types of economic conditions. The Company has traditionally maintained a leadership position in mortgage loan volume and market share throughout its service area by virtue of its local presence. The Company believes that it has been able to effectively market its larger variety of loan and other financial products and services 19 when compared to other local-based institutions and its superior customer service when compared to branches of larger institutions based outside of the Company's market area. Regulation Set forth below is a brief description of certain laws that relate to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations. Regulation of the Company General. 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, should such subsidiaries be formed, which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. This regulation and oversight is intended primarily for the protection of the depositors of the Bank and not for the benefit of stockholders of the Company. Qualified Thrift Lender Test. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions, provided the Bank satisfies the Qualified Thrift Lender ("QTL") test. If the Company acquires 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 the Bank or any other SAIF-insured savings association) would become subject to restrictions applicable to bank holding companies unless such other associations each also qualify as a QTL and were acquired in a supervisory acquisition. See "-- Regulation of the Bank -- Qualified Thrift Lender Test." Regulation of the Bank General. As a federally chartered, SAIF-insured savings association, the Bank is subject to extensive regulation by the OTS and the Federal Deposit Insurance Corporation ("FDIC"). Lending activities and other investments must comply with various federal statutory and regulatory requirements. The Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board. The OTS, in conjunction with the FDIC, regularly examines the Bank and prepares reports for the consideration of the Bank's Board of Directors on any deficiencies that are found in the Bank's operations. The Bank's relationship with its depositors and borrowers is also regulated to a great extent by federal and state law, especially in such matters as the ownership of savings accounts and the form and content of the Bank's mortgage documents. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other savings institutions. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the SAIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulations, whether by the OTS, the 20 FDIC, or the Congress could have a material adverse impact on the Company, the Bank, and their operations. Insurance of Deposit Accounts. The Bank's deposit accounts are insured by the SAIF to a maximum of $100,000 for each insured member (as defined by law and regulation). Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the institution's primary regulator. The FDIC may also prohibit an insured depository institution from engaging in any activity the FDIC determines to pose a serious threat to the SAIF. The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund, depending upon the institution's risk classification. This risk classification is based on an institution's capital group and supervisory subgroup assignment. In addition, the FDIC is authorized to increase deposit insurance rates on a semi-annual basis if it determines that such action is necessary to cause the balance in the SAIF to reach the designated reserve ratio of 1.25% of SAIF-insured deposits within a reasonable period of time. The FDIC may impose special assessments on SAIF members to repay amounts borrowed from the U.S. Treasury or for any other reason deemed necessary by the FDIC. Prior to September 30, 1996, savings associations paid within a range of .23% to .31% of domestic deposits and the SAIF was substantially underfunded. By comparison, prior to September 30, 1996, members of the Bank Insurance Fund ("BIF"), predominantly commercial banks, were required to pay substantially lower, or virtually no, federal deposit insurance premiums. Effective September 30, 1996, federal law was revised to mandate a one-time special assessment on SAIF members such as the Bank of approximately .657% of deposits held on March 31, 1995. The Bank recorded a $1,085,000 pre-tax expense for this assessment at September 30, 1996. Beginning January 1, 1997, deposit insurance assessments for SAIF members will be reduced to approximately .064% of deposits on an annual basis; this rate may continue through the end of 1999. During this same period, BIF members are expected to be annually assessed approximately .013% of deposits. Thereafter, assessments for BIF and SAIF members should be the same and the SAIF and BIF may be merged. It is expected that these continuing assessments for both SAIF and BIF members will be used to repay outstanding Financing Corporation bond obligations. As a result of these changes, beginning January 1, 1997, the rate of deposit insurance assessed the Bank is expected to substantially decline. Regulatory Capital Requirements. OTS capital regulations require savings institutions to meet three capital standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) a leverage ratio (core capital) equal to at least 3% of total adjusted assets, and (3) a risk-based capital requirement equal to 8.0% of total risk-weighted assets. The Bank exceeded these minimum standards at December 31, 1996. The Bank's capital ratios are set forth in Note 15 to the Consolidated Financial Statements referenced in Items 7 and 13 to this Form 10-K. Savings associations with a greater than "normal" level of interest rate exposure may, in the future, be subject to a deduction for an interest rate risk ("IRR") component may be from capital for purposes of calculating their risk-based capital requirement. Dividend and Other Capital Distribution Limitations. OTS regulations require the Bank to give the OTS 30 days advance notice of any proposed declaration of dividends to the Company, and the OTS has the authority under its supervisory powers to prohibit the payment of dividends to the Company. In addition, the Bank may not declare or pay a cash dividend on its capital stock if the effect thereof 21 would be to reduce the regulatory capital of the Bank below the amount required for the liquidation account established in connection with the Conversion. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 institution") and has not been advised by the OTS that it is in need of more than the normal supervision can, after prior notice but without the approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year, or (ii) 75% of its net income over the most recent four quarter period. Any additional capital distributions require prior regulatory approval. At December 31, 1996, the Bank was a Tier 1 institution. In the event the Bank's capital fell below its fully phased-in requirement or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Finally, a savings association is prohibited from making a capital distribution if, after making the distribution, the savings association would be undercapitalized (not meet any one of its minimum regulatory capital requirements). Qualified Thrift Lender Test. Savings institutions must meet a QTL test. If the Bank maintains an appropriate level of Qualified Thrift Investments (primarily residential mortgages and related investments, including certain mortgage-related securities) ("QTIs") and otherwise qualifies as a QTL, it will continue to enjoy full borrowing privileges from the FHLB of Des Moines. The required percentage of QTIs is 65% of portfolio assets (defined as all assets minus intangible assets, property used by the institution in conducting its business and liquid assets equal to 20% of total assets). Certain assets are subject to a percentage limitation of 20% of portfolio assets. In addition, savings associations may include shares of stock of the FHLBs, FNMA and FHLMC as qualifying QTIs. As of December 31, 1996, the Bank was in compliance with its QTL requirement with 91.37% of its assets invested in QTIs. Loans-to-One Borrower. See "Business -- Loans-to-One Borrower." Federal Home Loan Bank System. The Bank is a member of the FHLB of Des Moines, 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. As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts, or similar obligations at the beginning of each year. Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non-personal time deposits. The balances 22 maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy the liquidity requirements that are imposed by the OTS. Recent and Proposed Legislation. Bills have been introduced to congressional committees that would consolidate the OTS with the Office of the Comptroller of the Currency ("OCC"). The resulting agency would regulate all federally chartered commercial banks and thrift institutions. In the event that the OTS is consolidated with the OCC, it is possible that the thrift charter could be eliminated and thrifts could be forced to convert to commercial banks. Legislation passed in 1996 required the recapture (for income tax purposes) of the Bank's post 1987 additions to bad debt reserves; however, this recapture did not have a material effect on the earnings of the Bank or the Company because the Bank had previously provided deferred taxes on its bad debt reserves. Under current law and regulations, a unitary savings and loan holding company, such as the Company, which has only one thrift subsidiary such as the Bank, has essentially unlimited investment authority. Legislation has also been proposed which, if enacted, would limit the non-banking related activities of savings and loan holding companies to those activities permitted for bank holding companies. Item 2. Description of Properties - --------------------------------- The Company does not own any real property but utilizes the offices of the Bank. The Bank operates from its main office located at 53 First Street, S.W., Wells, Minnesota with six full service branch offices and one loan origination office. The Bank owns the offices in Wells and one branch facility, and leases the remaining locations. The physical condition of each of the offices is good. Item 3. Legal Proceedings - ------------------------- There are various claims and lawsuits in which Registrant is periodically involved, such as claims to enforce liens, condemnation proceedings on properties in which Registrant holds security interests, claims involving the making and servicing of real property loans, and other issues incident to Registrant's business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------- Not Applicable. PART II Item 5. Market for Common Equity and Related Stockholder Matters - ------------------------------------------------------------------- The information contained under the section captioned "Stock Market Information" on pages 1 and 2 of the Company's Annual Report to Stockholders for the fiscal year ended December 31, 1996 (the "Annual Report"), is incorporated herein by reference. Item 6. Management's Discussion and Analysis or Plan of Operation - ------------------------------------------------------------------- The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference. 23 Item 7. Financial Statements - ------------------------------ The Registrant's consolidated financial statements listed under Item 13 are incorporated herein by reference. Item 8. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure ---------------------------------------------------------------------- Not applicable. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act ------------------------------------------------------------- The information contained under the section captioned "I. Information with Respect to Nominees for Director and Directors Continuing in Office" in Registrant's definitive proxy statement for Registrant's Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by reference. Item 10. Executive Compensation - -------------------------------- The information contained under the section captioned "Director and Executive Officer Compensation" in the Proxy Statement is incorporated herein by reference. Item 11. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" and to the first table under "I. Information with Respect to Nominees for Director and Directors Continuing in Office" in the Proxy Statement. (c) Management of Registrant knows of no arrangements, including any pledge by any person of securities of Registrant, the operation of which may at a subsequent date result in a change in control of Registrant. Item 12. Certain Relationships and Related Transactions - -------------------------------------------------------- The information required by this item is incorporated herein by reference to the section captioned "Certain Relationships and Related Transactions" in the Proxy Statement. 24 PART IV Item 13. Exhibits, List, and Reports on Form 8-K - ------------------------------------------------ (a) The following documents are filed as a part of this report: 1. The following financial statements and the report of independent accountants of Registrant included in Registrant's Annual Report to Stockholders are incorporated herein by reference and also in Item 7 hereof. Independent Auditor's Report. Consolidated Statements of Financial Condition as of December 31, 1996 and 1995. Consolidated Statements of Income for the Years Ended December 31, 1996, 1995, and 1994. Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995, and 1994. Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994. Notes to Consolidated Financial Statements. 2. Except for Exhibits 11 and 27 below, Financial Statement Schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable and therefore have been omitted. 3. The following exhibits are included in this Report or incorporated herein by reference: (a) List of Exhibits: 3(i) Articles of Incorporation of Wells Financial Corp.* 3(ii)Bylaws of Wells Financial Corp.* 10.1 1995 Stock Option Plan of Wells Financial Corp.** 10.2 Management Stock Bonus Plan and Trust Agreements** 10.3 Change in Control Severance Agreement with James D. Moll*** 10.4 Change in Control Severance Agreement with Gerald D. Bastian*** 11 Statement Regarding Computation of Earnings per Share 13 Annual Report to Stockholders for the fiscal year ended December 31, 1996 21 Subsidiaries of Registrant*** 25 23 Consent of McGladrey & Pullen, LLP 27 Financial Data Schedule (b) No reports on Form 8-K were filed during the last quarter of the period covered by this report. - --------------------- * Incorporated by reference to the registration statement on Form S-1 (File No. 33-87922) declared effective by the SEC on February 13, 1995. ** Incorporated by reference to the proxy statement for a special meeting of stockholders held on November 15, 1995 and filed with the SEC on October 2, 1995 (File No. 0-25342). *** Incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1995. 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized as of March 27, 1997. WELLS FINANCIAL CORP. By: /s/ Lawrence H. Kruse -------------------------------- Lawrence H. Kruse President and Chief Executive Officer (Duly Authorized Representative) Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of March 27, 1997. /s/ Lawrence H. Kruse /s/ James D. Moll - ------------------------------------------ -------------------------------- Lawrence H. Kruse James D. Moll President, Chief Executive Officer Treasurer and Principal Financial and Director (Principal Executive Officer) and Account Officer (Principal Financial and Accounting Officer) Date: March 27, 1997 Date: March 27, 1997 /s/ Wallace J. Butson /s/ Gerald D. Bastion - ----------------------------------------- --------------------------------- Dr. Wallace J. Butson Gerald D. Bastion Secretary and Director Vice President and Director Date: March 27, 1997 Date: March 27, 1997 /s/ Joseph R. Gadola /s/ Richard A. Mueller - ------------------------------------------ --------------------------------- Joseph R. Gadola Richard A. Mueller Director Director Date: March 27, 1997 Date: March 27, 1997 EX-11 2 EXHIBIT 11 EXHIBIT 11 Exhibit 11 WELLS FINANCIAL CORP. COMPUTATION OF EARNINGS PER SHARE For year ended December 31, 1996 Net income $ 1,200 Weighted average shares outstanding 1,953,731 Weighted average allocated ESOP shares 7,000 Incremental shares relating to stock options 6,454 --------- Weighted average number of common stock equivalents 1,967,185 ========= Per share, primary and fully diluted $ 0.61 ========= EX-13 3 EXHIBIT 13 EXHIBIT 13 [** LOGO **] WELLS FINANCIAL CORP. 1996 ANNUAL REPORT WELLS FINANCIAL CORP. ANNUAL REPORT WELLS SAVINGS BANK fsb TABLE OF CONTENTS
MAIN OFFICE: Profile and Stock Market Information..................... 1-2 Wells Selected Consolidated Financial and Other Data........... 3 53 First Street S.W. Wells, Minnesota 56097 Letter to Stockholders................................... 4 BRANCH OFFICES: Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 5-15 Blue Earth 303 South Main Street Independent Auditor's Report.............................. 16 Blue Earth, Minnesota 56013 Consolidated Statements of Financial Condition............ 17 Mankato - Madison East Madison East Center Consolidated Statements of Income......................... 18 1400 Madison Avenue Mankato, Minnesota 56001 Consolidated Statements of Stockholders' Equity........... 19 Mankato - Riverfront Consolidated Statements of Cash Flows.....................20-22 1300 South Riverfront Drive Mankato, Minnesota 56002 Notes to Consolidated Financial Statements................23-46 Fairmont Office Location and Other Corporate Information........... 47 Five Lakes Centre 300 South State Street Fairmont, Minnesota 56031 Albert Lea Skyline Mall 1710 West Main Street Albert Lea, Minnesota 56007 St. Peter 120 South Minnesota Avenue St. Peter, Minnesota 56082 LOAN ORIGINATION OFFICE: Owatonna Loan Origination Office 108 West Park Square Owatonna, Minnesota 55060
Wells Financial Corp. Profile Wells Financial Corp. (the "Company") is a Minnesota corporation organized in December 1994 at the direction of the Board of Directors of Wells Federal Bank, fsb (the "Bank") to acquire all of the capital stock that the Bank issued upon its conversion from mutual to stock form of ownership. The Company is a unitary savings and loan holding company which, under existing laws, generally is not restricted in the types of business activities in which it may engage provided that the Bank retains a specified amount of its assets in housing-related investments. At the present time, because the Company does not conduct any active business, the Company does not intend to employ any persons other than officers of the Bank but utilizes the support staff of the Bank from time to time. The Bank is a federally chartered stock savings bank headquartered in Wells, Minnesota. The Bank has seven full service offices located in Faribault, Martin, Blue Earth, Nicollet, and Freeborn Counties, Minnesota and one loan origination office located in Steele County, Minnesota. The Bank was founded in 1934 and its deposits have been federally insured by the Savings Association Insurance Fund ("SAIF") and its predecessor, the Federal Savings and Loan Insurance Corporation ("FSLIC"), since 1934. The Bank is a member of the Federal Home Loan Bank ("FHLB") System. The Bank is a community oriented, full service retail savings institution offering traditional mortgage loan products. The Bank attracts deposits from the general public and uses such deposits primarily to invest in residential lending on owner occupied properties. The Bank also makes consumer, commercial and agricultural real estate, agricultural operating and multi-family loans and purchases investment securities. Stock Market Information Since its issuance on April 11, 1995, the Company's common stock has been traded on the Nasdaq National Market under the symbol "WEFC." The following table reflects high and low bid information during the periods shown. The quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not represent actual transactions. HIGH LOW ----------------------- April 11, 1995 - June 30, 1995 $ 9.75 $ 8.50 July 1, 1995 - September 30, 1995 $11.25 $ 8.875 October 1, 1995 - December 31, 1995 $11.375 $ 10.875 January 1, 1996 - March 31, 1996 $11.50 $ 10.125 April 1, 1996 - June 30, 1996 $11.875 $ 9.875 July 1, 1996 - September 30, 1996 $12.25 $ 11.375 October 1, 1996 - December 31, 1996 $13.25 $ 12.50 The number of stockholders of record of common stock as of the record date of March 3, 1997, was approximately 593. This does not reflect the number of persons or entities who held stock in nominee or "street" name through various brokerage firms. At February 15, 1997, there were 2,023,860 shares outstanding. 1 No dividends were declared on the common stock during the years ended December 31, 1996 or 1995. The Company's ability to pay dividends to stockholders is subject to the requirements of Minnesota law. No dividend may be paid by the Company unless its board of directors determines that the Company will be able to pay its debts in the ordinary course of business after payment of the dividend. In addition, the Company's ability to pay dividends is dependent, in part, upon the dividends it receives from the Bank. The Bank may not declare or pay a cash dividend on any of its stock if the effect thereof would cause the Bank's regulatory capital to be reduced below (1) the amount required for the liquidation account established in connection with the Bank's conversion from mutual to stock form, or (2) the regulatory capital requirements imposed by the Office of Thrift Supervision ("OTS"). 2 WELLS FINANCIAL CORP. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(Dollars in thousands, except per share amounts) Financial Condition - -------------------------------------------------------------------------------------------------------------------- December 31, 1992 1993 1994 1995 1996 - -------------------------------------------------------------------------------------------------------------------- Total assets $ 176,357 $ 165,188 $ 182,716 $ 195,158 $ 201,326 Loans held for sale 2,253 775 114 1,944 1,791 Loans receivable, net 121,239 141,982 165,185 169,760 178,447 Mortgage-backed securities - 1,023 - - - Mortgage-backed securities available for sale - - 961 867 428 Securities available for sale - - 5,951 6,753 7,100 Investment securities 8,832 14,759 5,991 4,199 2,049 Certificates of deposit 3,074 424 100 800 200 Cash and cash equivalents 37,718 3,480 1,480 8,192 8,301 Deposits 166,512 153,769 146,412 146,686 145,349 Borrowed funds - - 23,650 18,000 26,500 Equity 8,985 10,181 11,506 28,852 28,202 Summary of Operations - -------------------------------------------------------------------------------------------------------------------- Years Ended December 31, 1992 1993 1994 1995 1996 - -------------------------------------------------------------------------------------------------------------------- Interest income $ 13,197 $ 11,164 $ 11,573 $ 13,489 $ 14,669 Interest expense 9,243 6,726 6,510 8,165 8,146 Net interest income 3,954 4,438 5,063 5,324 6,523 Provision for loan losses 172 - 113 166 180 Noninterest income 845 999 737 809 1,014 Noninterest expense (1) 3,247 3,356 3,574 3,855 5,245 Income before cumulative effect of change in accounting principle 805 1,179 1,283 1,270 1,200 Net income 805 1,248 1,283 1,270 1,200 Other Selected Data - -------------------------------------------------------------------------------------------------------------------- Years Ended December 31, 1992 1993 1994 1995 1996 - -------------------------------------------------------------------------------------------------------------------- Return on average assets before cumulative effect 0.45% 0.70% 0.74% 0.67% 0.61% Return on average assets after cumulative effect 0.45% 0.74% 0.74% 0.67% 0.61% Return on average equity before cumulative effect 9.39% 12.40% 11.66% 5.50% 4.24% Return on average equity after cumulative effect 9.39% 13.12% 11.66% 5.50% 4.24% Average equity to average assets 4.77% 5.62% 6.31% 12.11% 14.40% Equity to assets 5.09% 6.16% 6.30% 14.78% 14.01% Net interest rate spread (2) 2.22% 2.61% 2.80% 2.29% 2.72% Nonperforming assets to total loans (3) 0.67% 0.56% 0.53% 0.17% 0.19% Allowance for loan losses to total loans 0.39% 0.28% 0.23% 0.30% 0.34% Allowance for loan losses to nonperforming loans (3) 46.10% 52.37% 45.85% 171.24% 206.52% Earnings per share (4) N/A N/A N/A $0.50 $0.61
(1) For 1996, includes a special SAIF recapitalization assessment of $1,085. (2) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (3) Nonperforming loans are loans over 90 days past due. Nonperforming assets include nonperforming loans and foreclosed real estate. (4) Does not include earnings prior to April 11, 1995, the date of conversion to stock form. 3 To Our Stockholders: We are pleased to present our second annual stockholders' report. This report represents the first full calendar year of operations since the conversion from mutual to stock ownership. With the positive economic environment of 1996, our management team expected net income to increase over 1995. Our operating results, however, were negatively affected by two factors. The biggest impact came as a result of congressional action approving a special assessment on the industry to recapitalize the Savings Association Insurance Fund (SAIF). The Bank's portion of that assessment was $1,085,000, which negatively impacted earnings. While this assessment had a negative impact in 1996, we will benefit positively in future years as our annual deposit insurance premium rate was reduced from twenty three basis points per dollar of deposit to approximately six basis points. A further reduction in the deposit insurance premium rate is scheduled for the year 2000. The second factor was the installation of new data processing equipment and software. As a result of that conversion we are now able to offer our customers the latest in financial products in a cost effective manner. While this had a $132,000 non-recurring negative impact on our bottom line, the largest impact was on our dedicated staff who are to be congratulated for completing a monumental task. We consider 1996 to be a successful year. Even with the negative impacts described above, pre-tax income for 1996 equaled pre-tax income for 1995. We had scheduled the conversion of our loan origination office in Owatonna, Minnesota to a full service branch in 1996, however, that conversion was delayed until February 1997 and is operational as of this date. Your Board of Directors, management team and staff members continue to work on ways to improve and provide additional services to our customers as well as protect and enhance the value of your investment in Wells Financial Corp. To our stockholders who have been investors from the date of conversion and to our new stockholders who have invested since conversion, thank you for the confidence you have placed in us. Best Regards, /s/ Lawrence H. Kruse Lawrence H. Kruse President and Chief Executive Officer 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in Thousands) General The Company's business activities to date have been limited to its investment in and loan to the Bank and a loan made to the Bank's Employee Stock Ownership Plan ("ESOP") to enable the ESOP to purchase shares of the Company's common stock and, to a lesser degree, investing in securities and deposits in other financial institutions. The Company's investment securities consist of obligations issued by agencies of the U.S. government. As a result of the limited operations of the Company, this discussion primarily relates to the Bank. The principal business of the Bank consists of attracting deposits from the general public and using such deposits, together with borrowings, primarily to invest in residential lending on owner occupied properties. The Bank also makes consumer loans and agricultural related loans and purchases investment securities. The Bank's investment securities consist of U.S. government and agency obligations, mortgage-backed securities, equity securities and FHLB stock. The Bank's loans consist primarily of loans secured by residential real estate located in its market area and, to a lesser extent, commercial real estate loans and consumer loans. The Bank's net earnings are dependent primarily on its net interest income, which is the difference between interest income earned on its investment and loan portfolios and interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Bank's interest rate spread is affected by regulatory, economic, and competitive factors that influence interest rates, loan demand, and deposit flows. To a lesser extent, the Bank's net earnings also are affected by the level of noninterest income, which primarily consists of service charges and other fees. In addition, net earnings are affected by the level of noninterest (general and administrative) expenses. The operations of the Bank and the entire thrift industry are significantly affected by prevailing economic conditions, competition, and the monetary and fiscal policies of the federal government and governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates, and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities, and the levels of personal income and savings in the Bank's market area. Asset/Liability Management Net interest income, the primary component of the Bank's net earnings, is derived from the difference or "spread" between the yield on interest-earning assets and the cost of interest-bearing liabilities. The Bank has sought to reduce its exposure to changes in interest rates by matching more closely the effective maturities or repricing characteristics of its interest-earning assets and interest-bearing liabilities. The matching of the Bank's assets and liabilities may be analyzed by examining the extent to which its assets and liabilities are interest rate sensitive and by monitoring the expected effects of interest rate changes on its net portfolio value. An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. If the Bank's assets mature or reprice more quickly or to a greater extent than its liabilities, the Bank's net portfolio value and net interest income would tend to increase during periods of rising interest rates but decrease during periods of falling interest rates. If the Bank's assets mature or reprice more slowly or to a lesser extent than its liabilities, the Bank's net portfolio value and net interest income would tend to decrease during periods of rising interest rates but increase during periods of falling interest rates. The Bank's policy has been to mitigate the interest rate risk inherent in 5 (Dollars in Thousands) the historical savings institution business of originating long-term loans funded by short-term deposits by pursuing certain strategies designed to decrease the vulnerability of its earnings to material and prolonged changes in interest rates. The Bank's lending strategy is focused on the origination of traditional one- to four-family mortgage loans primarily secured by single family residences in the Bank's primary market area. In the Bank's market area, loan demand has exceeded deposits and the Bank has not found it necessary or desirable to purchase mortgage backed securities to any significant extent. During recent periods, the Bank has utilized borrowings as a way of accommodating loan demand, consistent with its goal of maintaining asset quality. The Bank also invests a portion of its assets in consumer and commercial business and commercial real estate loans and investment securities as a method of reducing interest rate risk. These loans typically have adjustable interest rates and are for shorter terms than residential first mortgage loans. The Bank's entire commercial business loan portfolio and most of the commercial real estate portfolio are secured by equipment or real estate used for farming. These loans typically have higher interest rates than one- to four-family loans but have not historically resulted in greater losses for the Bank. As a key element of its strategy, the Bank sells higher loan to value ratio fixed rate mortgage loans and mortgage loans with original maturities of fifteen years or less into the secondary market and retains adjustable rate mortgage loans and lower loan to value ratio fixed rate loans with original maturities greater than fifteen years. Although it is perceived that mortgage loans with original maturities of fifteen years or less offer greater protection from interest rate risk due to their shorter contractual maturities than mortgage loans with original maturities greater than fifteen years, it is management's belief that the actual average life of mortgage loans with original maturities of fifteen years or less is approximately equal to the average life of mortgage loans with original maturities greater than fifteen years. Management also believes that the benefit of higher yields on mortgage loans with original maturities that are greater than fifteen years more than offsets the higher contractual cash flows that are generated by mortgage loans with original maturities of fifteen years or less. In addition, the Bank retains servicing on most of the loans that it sells, enabling it to generate additional income and maintain certain economies of scale in loan processing. In order to improve the Bank's interest rate sensitivity, improve asset quality, and provide diversification in the asset mix, the Bank maintains a percentage of its assets in investment securities, which generally have either adjustable rates or shorter terms to maturity. The Bank's purchase of investment securities is designed primarily for safety of principal and secondarily for rate of return. On a weekly basis, the Bank monitors the interest rates of its competitors and sets its interest rates such that its rates are neither the highest or lowest in its market area. The Bank intends for its rates to be competitive and perhaps slightly above the average rates being paid in its market area. The Bank has sought to remain competitive in its market by offering a variety of products. The Bank attempts to manage the interest rates it pays on deposits while maintaining a stable deposit base and providing quality services to its customers. 6 (Dollars in Thousands) Net Portfolio Value To encourage associations to reduce their interest rate risk, the OTS adopted a rule incorporating an interest rate risk ("IRR") component into the risk-based capital rules. This rule in not yet in effect. The IRR component is a dollar amount that will be deducted from total capital for the purpose of calculating an institution's risk-based capital requirement and is measured in terms of the sensitivity of its net portfolio value ("NPV") to changes in interest rates. NPV is the difference between incoming and outgoing discounted cash flows from assets, liabilities, and off-balance sheet contracts. An institution's IRR is measured as the change to its NPV as a result of a hypothetical 200 basis point change in market interest rates. A resulting change in NPV of more than 2% of the estimated market value of its assets will require the institution to deduct from its capital 50% of that excess change. The rule provides that the OTS will calculate the IRR component quarterly for each institution. The Bank, based on asset size and risk-based capital, has been informed by the OTS that it is exempt from this rule. Nevertheless, the following table presents the Bank's NPV at December 31, 1996, as calculated by the OTS, based on information provided to the OTS by the Bank.
Percent of Change in Change Interest Estimated Amount of Estimated NPV NPV Ratio(4) Rates (basis points) NPV Change(1) NPV(2) Ratio(3) (basis points) -------------------- --------- --------- ---------- -------- -------------- (Dollars in thousands) +400 $10,168 $(14,999) (60)% 5.48% -691 bp +300 14,327 (10,841) (43)% 7.52% -486 bp +200 18,381 (6,787) (27)% 9.42% -297 bp +100 22,086 (3,081) (12)% 11.07% -131 bp -- 25,167 12.39% -100 27,388 2,220 9 % 13.29% 90 bp -200 28,681 3,513 14 % 13.79% 140 bp -300 29,741 4,573 18 % 14.18% 179 bp -400 31,272 6,104 24 % 14.75% 237 bp
(1) Represents the excess (deficiency) of the estimated NPV assuming the indicated change in interest rates minus the estimated NPV assuming no change in interest rates. (2) Calculated as the amount of change in the estimated NPV divided by the estimated NPV assuming no change in interest rates. (3) Calculated as the estimated NPV divided by average total assets. (4) Calculated as the excess (deficiency) of the NPV ratio assuming the indicated change in interest rates over the estimated NPV ratio assuming no change in interest rates. 7 (Dollars in Thousands) At December 31, 1996 ------------------- *** Risk Measures: 200 bp rate shock *** Pre-Shock NPV Ratio: NPV as % of PV of Assets 12.39 % Exposure Measure: Post-Shock NPV Ratio 9.42 % Sensitivity Measure: Change in NPV Ratio (297) bp Although the OTS has informed the Bank that it is not subject to the IRR component discussed above, the Bank is still subject to interest rate risk and, as can be seen above, rising interest rates will reduce the Bank's NPV. If the Bank were subject to the IRR component at December 31, 1996, a deduction from capital would have been required. Also, during periods of increasing interest rates, the Bank's interest rate sensitive liabilities would reprice faster than its interest rate sensitive assets (repricing periods on adjustable-rate loans affect the repricing of interest rate sensitive assets, with longer repricing periods delaying the repricing of such assets more than shorter repricing periods would delay the repricing of such assets), causing a decline in the Bank's interest rate spread and margin. In times of decreasing interest rates, the value of fixed rate assets could increase in value and the lag in repricing of interest rate sensitive assets could be expected to have a positive effect on the Bank. 8 - -------------------------------------------------------------------------------- Average Balance Sheet (Dollars in Thousands) - -------------------------------------------------------------------------------- The following table sets forth certain information relating to the Bank's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. The yields for the periods presented include loan origination fees that are considered adjustments to yield. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily average balances has caused any material difference in the information presented.
Years Ended December 31, ------------------------------------------------------------------------------------------- 1994 1995 1996 -------------------------------------------------------------------------------------------- Average Average Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost -------------------------------------------------------------------------------------------- Interest-earning assets: Loans receivable (1) $153,477 $10,813 7.05% $170,395 $12,571 7.38% $173,383 $13,617 7.85% Mortgage-backed securities 993 68 6.85% 949 55 5.80% 661 45 6.81% Investments (2) 15,025 692 4.61% 15,618 863 5.53% 18,281 1,007 5.51% ------------------ ------------------- ------------------- Total interest-earning assets $169,495 $11,573 6.83% 186,962 $13,489 7.22% 192,325 $14,669 7.63% --------- --------- -------- Noninterest earning assets 4,853 3,847 4,163 -------- ---------- --------- Total assets $174,348 $190,809 $196,488 ======== ========== ========= Interest bearing liabilities: Savings, NOW and money market accounts (3) $ 38,910 $ 857 2.20% $ 36,553 $ 937 2.56% $ 36,578 $ 949 2.59% Certificates of deposit 110,173 5,027 4.56% 110,169 6,066 5.51% 110,139 6,111 5.55% Borrowed funds 12,610 626 4.96% 18,938 1,162 6.14% 19,269 1,086 5.64% ------------------ -------------------- -------------------- Total interest bearing liabilities 161,693 $ 6,510 4.03% 165,660 $ 8,165 4.93% 165,986 $ 8,146 4.91% -------- --------- -------- Noninterest bearing liabilities 1,651 2,050 2,199 -------- ---------- --------- Total liabilities 163,344 167,710 168,185 Equity 11,004 23,099 28,303 -------- ---------- --------- Total liabilities and equity $174,348 $190,809 $196,488 ======== ========== ========= Net interest income $ 5,063 $ 5,324 $ 6,523 ========= ========= ======== Interest rate spread (4) 2.80% 2.29% 2.72% Net yield on interest earning assets(5) 2.99% 2.85% 3.39% Ratio of average interest earning assets to average interest bearing liabilities 1.05X 1.13X 1.16X
(1) Average balances include non-accrual loans and loans held for sale. (2) Includes interest-bearing deposits in other financial institutions. (3) For 1996, the average balance and average cost for savings accounts and demand deposit accounts were $16,219 and $20,359 and 2.65% and 2.55%, respectively. (4) Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (5) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets. 9 Rate/Volume Analysis (Dollars in Thousands) The table below sets forth certain information regarding changes in interest income and interest expense of the Bank for the years indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate); (ii) changes in rates (changes in rate multiplied by old average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume).
Years Ended December 31, -------------------------------------- --- --------------------------------------- 1995 vs. 1994 1996 vs. 1995 -------------------------------------- --------------------------------------- Increase (Decrease) Due to Increase (Decrease) Due to -------------------------------------- --------------------------------------- Rate/ Rate/ Volume Rate Volume Net Volume Rate Volume Net --------- -------- ---------- -------- --------- --------- --------- --------- Interest Income: Loans receivable $ 1,193 $ 506 $ 59 $1,758 $ 220 $ 811 $ 15 $ 1,046 Mortgage-backed securities (3) (10) - (13) (17) 10 (15) (22) Investments 27 138 6 171 147 (3) 12 156 --------- -------- ---------- -------- --------- --------- --------- --------- Total interest-earning assets 1,217 634 65 1,916 350 818 12 1,180 --------- -------- ---------- -------- --------- --------- --------- --------- Interest expense: Deposit accounts (93) 1,222 (10) 1,119 - 57 - 57 Borrowed funds 314 149 73 536 19 (94) (1) (76) --------- -------- ---------- -------- --------- --------- --------- --------- Total interest-bearing 221 1,371 63 1,655 19 (37) (1) (19) liabilities --------- -------- ---------- -------- --------- --------- --------- --------- Net change in interest income $ 996 $(737) $ 2 $ 261 $ 331 $ 855 $ 13 $ 1,199 ========= ======== ========== ======== ========= ========= ========= =========
10 (Dollars in Thousands) Financial Condition Total assets increased by $6,168 from $195,158 at December 31, 1995 to $201,326 at December 31, 1996. The increase in total assets was primarily the result of an $8,777 increase in the loan portfolio from $169,670 at December 31, 1995 to $178,447 at December 31, 1996. The increase in loans receivable is the result of management's decision to retain higher yielding thirty year fixed rate loans that were originated during 1996. The increase in the loan portfolio was partially offset by a $600 decrease in certificates of deposit which matured and a $2,150 decrease in securities held to maturity. The decrease in securities held to maturity was the result of $2,500 of securities issued by agencies of the United States being called during the last two months of 1996. Mortgage backed securities that are available for sale decreased by $439 due to the repayment of principal. Premises and equipment increased by $282 during 1996 primarily due to the upgrading by the Bank of its data processing system with new computer hardware and software. In accordance with the Bank's internal classification of assets policy, management evaluates the loan portfolio on a quarterly basis to identify and determine the adequacy of the allowance for loan losses. As of December 31, 1995 and December 31, 1996 the balance in the allowance for loan losses and the allowance for loan losses as a percentage of total loans was $512 and $615 and 0.30% and 0.34%, respectively. Loans on which the accrual of interest has been discontinued amounted to $298 at December 31, 1996 and 1995. The effect of nonaccrual loans was not significant to the results of operations. The Company includes all loans considered impaired under FASB Statement No. 114 in nonaccrual loans. The amount of impaired loans was not material at December 31, 1996 and 1995. Deposits decreased by $1,337 from $146,686 at December 31, 1995 to $145,349 at December 31, 1996. To fund the increase in loans receivable referred to above, borrowed funds increased by $8,500 during the same period. Equity decreased by $650 from $28,852 at December 31, 1995 to $28,202 at December 31, 1996. This decrease is primarily due to the repurchase of 163,640 shares of treasury stock, at a cost of $1,763, and the purchase of 49,735 of the Company's shares, at a cost of $539, for Management Stock Bonus Plan awards. These decreases in equity were partially offset by net income of $1,200, the allocation of $163 of employee stock ownership plan shares and the amortization of $259 of unearned compensation. Comparison of Operating Results for the Years Ended December 31, 1996 and 1995 General. For the year ended December 31, 1996, net interest income increased by $1,199 when compared to the same period in 1995. This increase in net interest income would normally result in an increase in income before income taxes. However, on September 30, 1996, a law was enacted which required savings institutions insured by the Savings Association Insurance Fund (SAIF) to pay a one time special assessment to recapitalize the SAIF. The Bank's assessment amounted to $1,085, which was recorded as an expense during the third quarter of 1996. This special SAIF assessment was the primary reason for income before income taxes for fiscal year 1996 being equal to income before income taxes for fiscal year 1995. Income tax expense for the year ended December 31, 1996 was $70 higher than income tax for the year ended December 31, 1995 primarily due to an increase in nondeductible expenses incurred by the Company, which resulted in a reduction in net income of $70 from $1,270 for the year ended December 31, 1995 to $1,200 for the year ended December 31, 1996. 11 (Dollars in Thousands) Interest Income. The Company's interest income increased by $1,180 for the year ended December 31, 1996 when compared to the year ended December 31, 1995. This is primarily the result of an upward repricing of the Bank's adjustable rate loan portfolio and the increase in loans receivable. To a lesser extent, the increase in interest income was the result of an increase in the average balance of investment securities. Interest Expense. The average amount of deposits during 1996 remained approximately equal to the average amount of deposits during 1995. An increase in the interest rates paid on deposits caused interest expense on deposits to increase by $57, from $7,003 for the year ended December 31, 1995 to $7,060 for the year ended December 31, 1996. The average amount of borrowed funds during 1996 increased by $331 when compared to 1995. This increase in the average amount of borrowed funds was offset by a decrease in the interest rates paid on borrowed funds, which resulted in a decrease in interest expense on borrowed funds. The decrease in the interest paid on borrowed funds offset the increase in interest paid on deposits and resulted in a $19 decrease in interest expense for fiscal year 1996 when compared to fiscal year 1995. Net Interest Income. Net interest income increased by $1,199 for the year ended December 31, 1996 when compared to the year ended December 31, 1995. Again, this is primarily the result of the increase in loans receivable and the result of the repricing of the Bank's adjustable rate loan portfolio as described above, as well as below under the 1995 to 1994 comparison under "Interest Income" and "Net Interest Income" and to a lesser extent, the result of the decrease in interest expense. During 1996, the adjustable rate loan portfolio repriced from the increase in interest rates that began in late 1994, making it unlikely that interest income will increase due to rate increases during the next several quarters. Provision for Loan Losses. The provision for loan losses increased by $14 for 1996 when compared to 1995. Management monitors the allowance for loan loss in relation to the size and quality of the loan portfolio and adjusts the provision for loan losses to adequately provide for loan losses. While the Company maintains its allowance for loan losses at a level that is considered to be adequate to provide for potential losses, there can be no assurance that further additions will not be made to the loss allowance and that losses will not exceed estimate amounts. Noninterest Income. Noninterest income increased by $205 from $809 for the year ended December 31, 1995 to $1,014 for the year ended December 31, 1996. This increase is primarily due to increases in the gain on sale of loans originated for sale and insurance commissions. The increase in the gain on the sale of loans originated for sale resulted primarily from the recording of mortgage servicing rights on loans sold during the year due to the adoption of FASB Statement No. 122 during the period. The increase in insurance commissions was the result of the acquisition of additional local accounts by the Bank's insurance subsidiary. Noninterest Expense. Noninterest expense increased by $1,390 from $3,855 for the year ended December 31, 1995 to $5,245 for the year ended December 31, 1996. As described above, the legislation that was signed into law on September 30, 1996 resulted in a one time special assessment to the Bank of $1,085. This assessment is the primary reason for the increase in noninterest expense. As a result of this legislation, the Bank's annual assessment was reduced from twenty three basis points per dollar of deposits to approximately six basis points per dollar of deposits. Also, as part of management's commitment to provide competitive products and excellent service to the Bank's customers, the Bank converted to a new data processing software system during the second quarter of 1996. The decision to convert the data processing software was based upon management's desire to improve marketing of the Bank's products to current as well as potential customers. The software conversion resulted in a non-recurring expense of approximately $132 that was 12 (Dollars in Thousands) recorded during 1996. In addition, approximately $498 in hardware and software costs were capitalized and will be depreciated over their useful lives. Income Tax Expense. While income before income taxes was the same for the years ended December 31, 1996 and 1995, income tax expense increased during 1996 primarily due to an increase in nondeductible expenses incurred by the Company. Income tax expense as a percentage of income before taxes for the years ended December 31, 1996 and 1995 was 43.18% and 39.87%, respectively. Comparison of Operating Results for the Years Ended December 31, 1995 and 1994 General. Net income decreased by $13 from $1,283 for the year ended December 31, 1994 to $1,270 for the year ended December 31, 1995. As discussed in more detail below, this decrease was due to an increase in noninterest expense, which was partially offset by an increase in net interest income and noninterest income. Interest Income. Interest income increased by $1,916 for the year ended December 31, 1995 as compared to the year ended December 31, 1994. This was primarily the result of the increase in loans receivable and other interest earning assets which were funded through the use of proceeds from the sale of common stock. To a lesser degree, the increase was due to the Company's adjustable rate loan portfolio, which constitutes approximately 60% of its total loan portfolio, repricing upward as this loan portfolio uses lagging indices. Interest Expense. Interest expense increased by $1,655 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. The increase resulted from increases of interest rates paid on deposits and borrowings. A portion of the proceeds from the sale of common stock were used to reduce interest sensitive Federal Home Loan Bank borrowings, which resulted in lower interest expense for the year ended December 31, 1995 than if those proceeds had been used for other purposes. Net Interest Income. Net interest income increased by $261 from $5,063 to $5,324 on December 31, 1994 and 1995, respectively. Because the Company's interest-bearing liabilities reprice faster than its interest-earning assets, the Company generally experiences a decrease in its net interest income when interest rates increase. However, since interest rates began rising in late 1994, the delayed effect in 1995 of the lagging indices on the Company's adjustable rate loan portfolio, coupled with the increase in its total loan portfolio, caused interest income to increase by more than interest expense during the year ended December 31, 1995. The Company therefore experienced an increase in net interest income. Provision for Loan Losses. The provision for loan losses increased by $53 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. In accordance with the Bank's internal classification of assets policy, management evaluates the loan portfolio on a quarterly basis to identify and determine the adequacy of the allowance for loan losses. During 1995, management made the decision to increase the provision for loan losses due to the increase in the Company's loan portfolios. While the Company maintains its allowance for loan losses at a level that it considers to be adequate to provide for potential losses, there can be no assurance that further additions will not be made to the loss allowances and that losses will not exceed estimated amounts. 13 (Dollars in Thousands) Noninterest Income. Noninterest income increased by $72, from $737 for the year ended December 31, 1994 to $809 for the year ended December 31, 1995. This increase was caused primarily by an increase of $80 in loan origination, commitment and other fees due to an increase in loan originations during 1995. In addition, insurance commissions increased by $34 resulting primarily from the acquisition of additional local accounts by the Bank's insurance subsidiary. These increases in noninterest income were partially offset by a decrease of $43 in loan servicing fees. This decrease was the result of a reduction in loans serviced for others during the first ten months of 1995. Noninterest Expense. Noninterest expense increased by $281 for the year ended December 31, 1995 when compared to the year ended December 31, 1994. The majority of this increase resulted from compensation and benefits which increased by $239, due primarily to increased employee benefit costs and normal compensation adjustments. These employee benefit costs are expected to further increase in 1996 as the result of vesting of shares awarded through the Management Stock Bonus Plan. The increase during 1996 is not expected to be as great as the increase during 1995. Professional fees associated with operating as a publicly traded company resulted in a $55 increase for the same period. Income Tax Expense. The Company's income tax expense as a percentage of income before income taxes remained stable at 39.9% for the year ended December 31, 1995 as compared to 39.3% for the year ended December 31, 1994. Liquidity and Capital Resources The Bank is required under applicable federal regulations to maintain specified levels of "liquid" investments in qualifying types of U.S. Government, federal agency and other investments having maturities of five years or less. Current OTS regulations require that a savings association maintain liquid assets of not less than 5% of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less, of which short-term liquid assets must consist of not less than 1%. At December 31, 1996, the Bank's liquidity, as measured for regulatory purposes, was 6.11%. The Bank adjusts liquidity as appropriate to meet its asset/liability objectives. The Bank's primary sources of funds are deposits, amortization and prepayment of loans, maturities of investment securities and funds provided from operations. While scheduled loan repayments are a relatively predictable source of funds, deposit flows and loan prepayments are significantly influenced by general interest rates, economic conditions and competition. If needed, the Bank's primary source of funds can be supplemented by wholesale funds obtained through additional advances from the Federal Home Loan Bank system. The Bank invests excess funds in overnight deposits, which not only serve as liquidity, but also earn interest as income until funds are needed to meet required loan funding. The Bank's most liquid asset is cash including investments in interest bearing accounts at the FHLB of Des Moines that have no withdrawal restrictions. The level of these assets are dependent on the Bank's operating, financing and investing activities during any given period. At December 31, 1996, the Bank's cash totaled $6,675. This compares to the Bank's cash at December 31, 1995 of $7,600. 14 (Dollars in Thousands) Also available to the Bank to meet liquidity requirements are borrowings from the Federal Home Loan Bank. At December 31, 1996, the Bank had $26,500 in outstanding advances from the FHLB of Des Moines, which have been used to fund loan originations. At December 31, 1996, the Bank had the ability to borrow approximately 3.5 times its then outstanding advances. The Bank has other sources of liquidity if a need for additional funds arises although the Bank has not used them. Additional sources of funds include borrowing against mortgage-backed or other securities. At December 31, 1996, the mortgage-backed securities portfolio consisted solely of collateralized mortgage obligations guaranteed as to principal by FNMA or FHLMC. These securities are considered non-high-risk securities under applicable criteria. These securities had a market value of $428 at December 31, 1996 and the carrying value of these securities are adjusted quarterly to reflect market value. In 1996, the Company approved stock buy back programs in which up to 317,188 shares of the common stock of the Company may be acquired. An additional 191,313 shares may be purchased in the future in accordance with these programs. The Bank is required to maintain specified amounts of capital. The capital standards generally require the maintenance of regulatory capital sufficient to meet a tangible capital requirement, a core capital requirement and a risk-based capital requirement. At December 31, 1996, the Bank's tangible capital totaled $20.5 million, or 10.31% of adjusted total assets, and core capital totaled $20.5 million, or 10.31% of adjusted total assets, which substantially exceeded the respective 1.5% tangible capital and 3.0% core capital requirements at that date by $17.5 million and $14.5 million, respectively, or 8.81% and 7.31% of adjusted total assets, respectively. The Bank's risk-based capital totaled $21.1 million at December 31, 1996 or 18.61% of risk-weighted assets, which exceeded the current requirements of 8.0% of risk-weighted assets by $12.0 million or 10.61% of risk-weighted assets. Impact of Inflation and Changing Prices The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. 15 [LOGO] McGLADREY & PULEN, LLP ---------------------- Certified Public Accountants and Consultants INDEPENDENT AUDITOR'S REPORT To the Board of Directors Wells Financial Corp. and Subsidiary Wells, Minnesota We have audited the accompanying consolidated statements of financial condition of Wells Financial Corp. and Subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 that 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 financial position of Wells Financial Corp. and Subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, effective January 1, 1994, the Company changed its method of accounting for investments in debt and marketable equity securities to adopt FASB Statement No. 115. /s/McGladrey & Pullen, LLP Rochester, Minnesota February 11, 1997 16 WELLS FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 1996 and 1995 (dollars in thousands) ASSETS 1996 1995 - --------------------------------------------------------------------------- Cash, including interest-bearing accounts 1996 $7,560; 1995 $6,316 $ 8,301 $ 8,192 Certificates of deposit (Note 2) 200 800 Securities available for sale (Notes 3 and 12) 7,100 6,753 Securities held to maturity (Note 4) 2,049 4,199 Mortgage-backed securities available for sale (Notes 3 and 5) 428 867 Loans held for sale, net of unrealized losses 1996 $30; 1995 $-0- (Note 6) 1,791 1,944 Loans receivable, net (Notes 6, 12, 16 and 17) 178,447 169,670 Accrued interest receivable 1,060 1,120 Premises and equipment (Note 9) 1,519 1,237 Foreclosed real estate (Note 8) 78 29 Other assets 353 347 ----------------------- Total assets $ 201,326 $ 195,158 ======================= LIABILITIES AND STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------- Liabilities Deposits (Note 10) $ 145,349 $ 146,686 Borrowed funds (Note 12) 26,500 18,000 Advances from borrowers for taxes and insurance 681 683 Income taxes (Note 13): Current - 54 Deferred 358 340 Accrued interest payable 126 221 Accrued expenses and other liabilities (Note 11) 110 322 ----------------------- Total liabilities 173,124 166,306 ----------------------- Commitments, contingencies and credit risk (Notes 14, 16, and 17) Stockholders' Equity (Notes 11, 15 and 20) Preferred stock, no par value; 500,000 shares authorized; none outstanding - - Common stock, $.10 par value; 7,000,000 shares authorized; 2,187,500 shares issued 219 219 Additional paid-in capital 16,588 16,537 Retained earnings, substantially restricted 13,986 12,786 Unrealized appreciation on securities available for sale, net of related taxes 348 318 Unearned Employee Stock Option Plan shares (896) (1,008) Unearned compensation-restricted stock awards (280) - Less cost of 163,640 shares of treasury stock (1,763) - ----------------------- Total stockholders' equity 28,202 28,852 ----------------------- Total liabilities and stockholders' equity $ 201,326 $ 195,158 ======================= See Notes to Consolidated Financial Statements. 17 WELLS FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands, except per share data) 1996 1995 1994 - -------------------------------------------------------------------------- Interest and Dividend Income Loans receivable First mortgage loans $ 11,558 $ 10,854 $ 9,505 Consumer and other loans 2,059 1,717 1,308 Investment securities and other interest- bearing deposits 1,052 918 760 ---------------------------------- Total interest income 14,669 13,489 11,573 ---------------------------------- Interest Expense Deposits 7,060 7,003 5,884 Borrowed funds 1,086 1,162 626 ---------------------------------- Total interest expense 8,146 8,165 6,510 ---------------------------------- Net interest income 6,523 5,324 5,063 Provision for loan losses (Note 6) 180 166 113 ---------------------------------- Net interest income after provision for loan losses 6,343 5,158 4,950 ---------------------------------- Noninterest Income Gain on sale of loans 102 31 8 Loan origination and commitment fees 81 60 30 Loan servicing fees 202 186 229 Insurance commissions 318 247 213 Fees and service charges 246 225 175 Other 65 60 82 ---------------------------------- Total noninterest income 1,014 809 737 ---------------------------------- Noninterest Expense Compensation and benefits (Note 11) 1,911 1,890 1,651 Occupancy and equipment (Note 14) 644 535 531 Federal insurance premiums and assessment (Note 10) 1,406 336 346 Data processing 359 263 243 Advertising 150 144 136 Other 775 687 667 ---------------------------------- Total noninterest expense 5,245 3,855 3,574 ---------------------------------- Income before income taxes 2,112 2,112 2,113 Income tax expense (Note 13) 912 842 830 ---------------------------------- Net income $ 1,200 $ 1,270 $ 1,283 ================================== Earnings per share (Note 18): Primary and fully diluted $ 0.61 $ 0.50 ====================== See Notes to Consolidated Financial Statements. 18 WELLS FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands)
Unrealized Unearned Appreciation Employee Unearned (Depreciation) Stock Compensation- Additional on Securities Ownership Restricted Total Common Paid-In Retained Available Plan Stock Treasury Stockholders' Stock Capital Earnings for Sale, net Shares Awards Stock Equity - ------------------------------------------------------------------------------------------------------------------------------------ Balances, December 31, 1993 $ - $ - $ 10,233 $ (52) $ - $ - $ - $ 10,181 Net income - - 1,283 - - - - 1,283 Net changes in unrealized appreciation (depreciation) on securities available for sale, net of related taxes - - - 42 - - - 42 ---------------------------------------------------------------------------------------------------- Balances, December 31, 1994 - - 11,516 (10) - - - 11,506 Proceeds from sale of 2,187,500 shares, net of offering costs of $775 (Note 20) 219 16,506 - - (1,120) - - 15,605 Net income - - 1,270 - - - - 1,270 Net changes in unrealized appreciation on securities available for sale, net of related taxes - - - 328 - - - 328 Allocated ESOP shares - 31 - - 112 - - 143 ---------------------------------------------------------------------------------------------------- Balances, December 31, 1995 219 16,537 12,786 318 (1,008) - - 28,852 Net income - - 1,200 - - - - 1,200 Net changes in unrealized appreciation on securities available for sale, net of related taxes - - - 30 - - - 30 Treasury stock purchases, 163,640 shares (Notes 11 & 15) - - - - - - (1,763) (1,763) Purchase of common stock for restricted stock awards (Note 11) - - - - - (539) - (539) Amortization of unearned compensation - - - - - 259 - 259 Allocated ESOP shares - 51 - - 112 - - 163 ---------------------------------------------------------------------------------------------------- Balances, December 31, 1996 $ 219 $ 16,588 $ 13,986 $ 348 $ (896) $ (280) $ (1,763) $ 28,202 ====================================================================================================
See Notes to Consolidated Financial Statements. 19 WELLS FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands) 1996 1995 1994 - -------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 1,200 $ 1,270 $ 1,283 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for loan losses 180 166 113 Gain on sale of loans (102) (31) (8) Amortization of mortgage servicing rights 17 - - FHLB stock dividends - (32) - Compensation on allocation of ESOP shares 163 143 - Amortization of unearned compensation 228 - - Write-down of foreclosed real estate 8 18 - Gain on sale of foreclosed realestate (17) (16) (25) Unrealized loss on loans held for sale 30 - - Loss on disposal of equipment 7 - 17 Deferred income taxes (8) 34 59 Depreciation and amortization on premises and equipment 264 192 203 Amortization of deferred loan origination fees (145) (136) (217) Amortization of excess servicing fees 14 14 15 Amortization of securities premiums and discounts (2) 1 (19) Loans originated for sale 19,207 (15,414) (2,310) Proceeds from the sale of loans held for sale (19,057) 13,615 2,979 Changes in assets and liabilities: Accrued interest receivable 60 (208) (94) Other assets 67 52 (192) Income taxes payable, current (54) 119 (336) Accrued expenses and other liabilities (276) 158 84 ------------------------------- Net cash provided by (used in) operating activities 1,784 (55) 1,552 ------------------------------- (Continued) 20 WELLS FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands) 1996 1995 1994 - ------------------------------------------------------------------------------- Cash Flows From Investing Activities Net increase in loans $ (8,999) $ (4,624) $(23,216) Certificates of deposit: Maturities 800 100 424 Purchases (200) (800) (100) Purchase of securities available for sale (287) (280) (233) Securities held to maturity: Maturities and calls 5,900 3,795 5,026 Purchases (3,749) (1,994) (1,860) Proceeds from principal repayments of mortgage backed securities 436 138 - Purchase of premises and equipment (552) (36) (147) Proceeds from the sale and redemption of foreclosed real estate 117 229 151 ---------------------------------- Net cash (used in) investing activities (6,534) (3,472) (19,955) ---------------------------------- Cash Flows From Financing Activities Net increase (decrease) in deposits (1,337) 274 (7,357) Net increase (decrease) from advances from borrowers for taxes and insurance (2) 10 110 Proceeds from borrowed funds 35,000 18,000 23,650 Repayments on borrowed funds (26,500) (23,650) - Proceeds from issuance of common stock - 15,605 - Purchase of treasury stock (1,763) - - Purchase of common stock for restricted stock awards (539) - - ---------------------------------- Net cash provided by financing activities 4,859 10,239 16,403 ---------------------------------- Net increase (decrease) in cash 109 6,712 (2,000) Cash Beginning 8,192 1,480 3,480 ---------------------------------- Ending $ 8,301 $ 8,192 $ 1,480 ---------------------------------- (Continued) 21 WELLS FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1996, 1995 and 1994 (dollars in thousands) 1996 1995 1994 - ---------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash payments for: Interest on deposits $ 7,164 $ 6,901 $ 5,862 Interest on borrowed funds 1,076 1,172 611 Income taxes 981 723 1,171 ================================= Supplemental Schedule of Noncash Investing and Financing Activities Transfers from loans to foreclosed real estate $ 157 $ 109 $ 117 Issuance of shares to ESOP in conjunction with conversion from mutual to stock form - 1,120 - Allocation of ESOP shares to participants 112 112 - Transfer of investment and mortgage-backed securities held for investment to investment and mortgage-backed securities available for sale (adoption of FASB Statement No. 115) - - 6,656 ================================= See Notes to Consolidated Financial Statements. 22 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 1. Summary of Significant Accounting Policies Nature of operations: Operations of Wells Financial Corp. (Company) primarily consist of banking services through it's subsidiary, Wells Federal Bank, fsb (Bank). The Bank's subsidiary, Wells Insurance Agency, Inc. is a property and casualty insurance agency. The Company serves it's customers through the Bank's seven locations in South Central Minnesota. Basis of financial statement presentation: The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statements of financial condition and revenues and expenses for the reporting period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. Management believes that the allowances for losses on loans are adequate. While management uses available information to recognize losses on loans, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowances for losses on loans. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Principles of consolidation: The accompanying consolidated financial statements include the accounts of Wells Financial Corp., its wholly owned subsidiary, Wells Federal Bank, fsb, and the Bank's wholly owned insurance subsidiary, Wells Insurance Agency, Inc. All significant intercompany transactions and balances are eliminated in consolidation. Securities and accounting change: The Company adopted the provisions of Financial Accounting Standards Board (FASB) Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, as of January 1, 1994. Statement No. 115 requires that management determine the appropriate classification of securities at the date of adoption, and thereafter, at the date individual securities are acquired, and that the appropriateness of such classification be reassessed at each reporting date. Securities to be held to maturity are those debt securities that the Company has both the positive intent and ability to hold to maturity regardless of changes in market condition, liquidity needs, or changes in general economic conditions. These securities are stated at amortized cost. Securities available for sale are those debt or equity securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at market value. Unrealized gains or losses are reported as increases or decreases in stockholders' equity, net of the related deferred tax effect. 23 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 1. Summary of Significant Accounting Policies (Continued) Prior to the adoption of Statement No. 115, debt securities which the Company had the intent and ability to hold to maturity were carried at amortized cost. Equity securities were carried at the lower of aggregate cost or market value net of unrealized losses which were recognized through a valuation allowance that was shown as a reduction in the carrying value of the related securities and as a corresponding reduction in stockholders' equity. Under both the newly adopted accounting standard and the Company's former accounting practices, premiums and discounts on securities are amortized over the contractual lives of those securities, except for mortgage-backed securities, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of securities are determined using the specific identification method. Declines in the fair value of individual securities classified as available for sale below their amortized cost that are determined to be other than temporary result in write-downs of the individual securities to their fair value with the resulting write-downs included in current earnings as realized losses. The effect of the adoption of Statement No. 115 on January 1, 1994 was to increase securities by $332, increase deferred tax liabilities by $136 and increase equity by $196. Loans held for sale: Loans held for sale are those loans that the Company may sell or intends to sell prior to maturity. They are carried at the lower of aggregate cost or market value. Gains and losses on sales of loans are recognized at settlement dates and are determined by the difference between the sales proceeds and the carrying value of the loans, after allocating a portion of the cost to the servicing rights retained. All sales are made without recourse. Loans receivable: Loans receivable are stated at the amount of unpaid principal, reduced by an allowance for loan losses and net deferred loan origination fees. The allowance for loan losses is increased by provisions charged to income and reduced by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and current economic conditions. While management uses its best information available to make its evaluation, it is possible that adjustments to the allowance may be necessary if there are significant changes in economic conditions. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the creditor will be unable to collect all principal and interest payments due in accordance with the terms of the loan agreement. The Company's loans considered impaired at December 31, 1996 and 1995 were immaterial. 24 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 1. Summary of Significant Accounting Policies (Continued) Interest on loans is recognized over the terms of the loans and is calculated using the simple-interest method on principal amounts outstanding. Accrual of interest is discontinued when management believes, after considering economics, business conditions, and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Interest on these loans is recognized only when actually paid by the borrower if collection of principal is likely to occur. Accrual of interest is generally resumed when, in management's judgment, the borrower's ability to make periodic interest and principal payments is back to normal. Loan origination fees and related costs: Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for estimated prepayments based on the Company's historical prepayment experience. Mortgage servicing rights: The Company generally continues to service mortgage loans sold to others and receives a servicing fee over the lives of the loans. Beginning January 1, 1996, a portion of the cost of such loans is allocated to the mortgage servicing rights retained and recognized as a separate asset. The recorded mortgage servicing rights are being amortized in proportion to, and over the period of, estimated net servicing income. Mortgage servicing rights recognized are periodically evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its mortgage servicing rights based on the interest rate and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed their fair value. Foreclosed real estate: Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at lower of cost or fair value less estimated costs to sell at date of foreclosure. Costs relating to improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management and charge-offs to operations are made if the carrying value of a property exceeds its estimated fair value less estimated costs to sell. Income taxes: Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss or tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the amounts of assets and liabilities recorded for income tax and financial reporting purposes. Deferred tax assets are reduced by a valuation allowance when management determines that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. 25 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 1. Summary of Significant Accounting Policies (Continued) Premises and equipment: Land is carried at cost. Bank premises, leasehold improvements, and furniture, fixtures, and equipment are carried at cost, less accumulated depreciation and amortization. Bank premises and furniture, fixtures, and equipment are depreciated using the straight-line method over the estimated useful lives of the assets ranging from 10 to 40 years for bank premises, 7 to 10 years for leasehold improvements and 3 to 7 years for furniture, fixtures and equipment. The cost of leasehold improvements is being amortized using the straight-line method over the terms of the related leases. Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: Cash: The carrying amounts reported in the consolidated statement of financial condition for cash and interest-bearing accounts approximate their fair values. Certificates of deposit: The carrying amounts reported in the consolidated statement of financial condition for certificate of deposits approximate their fair values. Securities: Fair values for securities available for sale, securities held to maturity and mortgage-backed securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments, except for stock in the Federal Home Loan Bank for which fair value is equal to cost. Loans held for sale: Fair values are based on quoted market prices of similar loans sold on the secondary market. Loans and accrued interest receivable: For variable-rate loans that reprice frequently and that have experienced no significant change in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying amount of accrued interest receivable approximates its fair value. Mortgage servicing rights: The fair value of mortgage servicing rights approximates its carrying value as the interest rate and repayment assumptions used in the calculation of mortgage servicing rights have not changed significantly. Deposits and other liabilities: The fair values of demand deposits and savings accounts equal their carrying amounts, which represent the amounts payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on those certificates. The carrying amounts of advances by borrowers for taxes and insurance and accrued interest payable approximate their fair values. 26 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 1. Summary of Significant Accounting Policies (Continued) Borrowed funds: The fair value of long term fixed rate borrowed funds are estimated by using a discounted cash flow analysis based on current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the variable rate borrowed funds approximates carrying value as these borrowings reprice monthly. Off-statement of financial condition instruments: Since the majority of the Company's off-statement of financial condition instruments consist of non fee-producing, variable rate commitments, the Company has determined they do not have a distinguishable fair value. Emerging accounting standards: The FASB issued Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement establishes basic principles that state that an entity should recognize only assets it controls and liabilities it has incurred. Assets should be "derecognized" only when control has been surrendered, liabilities should be "derecognized" only when they have been extinguished, and recognition of financial assets and liabilities should not be affected by the sequence of transactions unless the effect of the transactions is to maintain effective control over a transferred financial asset. This Statement applies to transactions that occur after December 31, 1996. FASB Statement No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125, defers certain provisions of Statement No. 125 to transactions after December 31, 1997. These Statements will not have a material effect on the financial position and results of operations of the Company or its subsidiary. Reclassification of certain income and expenses: Certain income and expenses on the consolidated statements of income for the years ended December 31, 1995 and 1994 have been reclassified, with no effect on net income, to be consistent with the classifications adopted for the year ended December 31, 1996. Note 2. Certificates of Deposit Certificates of deposit with a carrying value of $200 and $800 at December 31, 1996 and 1995, respectively, had weighted average yields of 5.75% and 6.58%, respectively, and contractual maturities of less than one year. 27 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 3. Securities Available for Sale December 31, 1996 ------------------------------------------ Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ------------------------------------------------------------------------------- Mutual Funds: Short term U.S. government securities fund $ 2,396 $ - $ (76) $ 2,320 U.S. Government mortgage securities fund 1,251 - (80) 1,171 Intermediate mortgage securities fund 1,209 - (60) 1,149 Stock in Federal Home Loan Bank 1,633 - - 1,633 FHLMC stock 29 798 - 827 ----------------------------------------- 6,518 798 (216) 7,100 Mortgage-backed securities 427 1 - 428 ----------------------------------------- $ 6,945 $ 799 $ (216) $ 7,528 ----------------------------------------- December 31, 1995 ------------------------------------------ Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ------------------------------------------------------------------------------- Mutual Funds: Short term U.S. government securities fund $ 2,261 $ - $ (22) $ 2,239 U.S. Government mortgage securities fund 1,170 - (32) 1,138 Intermediate mortgage securities fund 1,137 - (20) 1,117 Stock in Federal Home Loan Bank 1,633 - - 1,633 FHLMC stock 29 597 - 626 ----------------------------------------- 6,230 597 (74) 6,753 Mortgage-backed securities 862 5 - 867 ----------------------------------------- $ 7,092 $ 602 $ (74) $ 7,620 ----------------------------------------- Equity securities do not have contractual maturities. Mortgage-backed securities lack a single maturity date as the borrowers retain the right to prepay the obligations. The Company's subsidiary, as a member of the Federal Home Loan Bank system, is required to maintain an investment in capital stock of the Federal Home Loan Bank in an amount equal to 1% of its outstanding home loans. No ready market exists for the bank stock, and it has no quoted market value. For disclosure purposes, such stock is assumed to have a market value which is equal to cost. 28 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 3. Securities Available for Sale (Continued) Changes in unrealized appreciation (depreciation) on securities available for sale: Years Ended December 31, -------------------------- 1996 1995 1994 - -------------------------------------------------------------------------------- Balance, beginning $ 318 $ (10) $ - Transfer of unrealized loss on securities carried at the lower of cost or market at January 1, 1994 - - (52) Initial unrealized gain on date of adoption of statement No. 115, not of related deferred tax effect - - 196 Unrealized appreciation (depreciation) during the year 56 531 (291) Deferred tax effect relating to unrealized appreciation (depreciation) (26) (203) 137 --------------------- Balance, ending $ 348 $ 318 $ (10) --------------------- There were no sales of securities during the years ended December 31, 1996, 1995 and 1994. Securities with a carrying value of $-0- and $100 at December 31, 1996 and 1995, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. Note 4. Securities Held to Maturity
December 31, 1996 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ------------------------------------------------------------------------------------------------ Debt securities: U.S. Government corporations and agencies $ 2,049 $ - $ (5) $ 2,044 ====================================================
December 31, 1995 ---------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ------------------------------------------------------------------------------------------------ Debt securities: U.S. Treasury securities $ 800 $ - $ - $ 800 U.S. Government corporations and agences 3,399 2 (11) 3,390 ----------------------------------------------------- $ 4,199 $ 2 $ (11) $ 4,190 =====================================================
29 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 4. Securities Held to Maturity (Continued) Contractual maturities: All securities held to maturity as of December 31, 1996 have contractual maturities from over one year through five years. Note 5. Mortgage-Backed Securities Available For Sale The amortized cost and approximate market values of mortgage-backed securities available for sale, which consist solely of REMICs, are summarized as follows: Years Ended December 31, ------------------------ 1996 1995 - --------------------------------------------------------------------------- Cost: Principal balance $ 427 $ 862 Unamortized premiums - - ----------------------- $ 427 $ 862 ======================= Approximate fair value $ 428 $ 867 ======================= Note 6. Loans Receivable and Loans Held for Sale Composition of loans receivable:
Years Ended December 31, ------------------------ 1996 1995 - -------------------------------------------------------------------------------------------- First mortgage loans (principally conventional): Principal balances: Secured primarily by one-to-four family residences $ 140,444 $ 135,529 Secured by other properties, primarily agricultural real estate 12,233 11,434 Construction 2,081 2,774 Less net deferred loan origination fees (714) (689) ----------------------- Total first mortgage loans 154,044 149,048 ----------------------- Consumer and other loans: Principal balances: Home equity, home improvement and second mortgages 15,197 12,875 Agricultural operating loans 1,171 1,191 Vehicle loans 4,619 3,353 Other 4,031 3,715 ----------------------- Total consumer and other loans 25,018 21,134 ----------------------- Total loans 179,062 170,182 Less allowance for loan losses (615) (512) ----------------------- Loan receivable, net $ 178,447 $ 169,670 =======================
30 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 6. Loans Receivable and Loans Held for Sale (Continued) Allowance for loan losses: Years Ended December 31, ----------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------- Balance, beginning $ 512 $ 376 $ 398 Provision for loan losses 180 166 113 Loans charged off (88) (41) (144) Recoveries 11 11 9 ----------------------------------- Balance, ending $ 615 $ 512 $ 376 ----------------------------------- Nonaccrual loans: Loans on which the accrual of interest has been discontinued amounted to $298, $298 and $839 at December 31, 1996, 1995 and 1994, respectively. The effect of nonaccrual loans was not significant to the results of operations. The Company includes all loans considered impaired under FASB Statement No. 114 in nonaccrual loans. The amount of impaired loans was not material at December 31, 1996 and 1995. Related party loans: The Company has entered into transactions with its executive officers, directors, significant shareholders, and their affiliates (related parties). The aggregate amount of loans to such related parties at December 31, 1996 was $380. During 1996, new loans to such related parties were $8 and repayments were $52. Loans held for sale: As of December 31, 1996 and 1995, the Company's loans held for sale were $1,791 and $1,944, respectively, and consisted of one to four family residential real estate loans. Loans held for sale have been reduced by estimated unrealized losses of $30 and $-0- at December 31, 1996 and 1995, respectively. Outstanding commitments to sell loans at December 31, 1996 were $563. Note 7. Loan Servicing Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of these loans as of December 31, 1996 and 1995 were $66,125 and $56,263, respectively, and consist of one-to-four family residential real estate loans. These loans are serviced primarily for the Federal Home Loan Mortgage Corporation. The Company adopted FASB Statement No. 122, Accounting for Mortgage Servicing Rights, effective January 1, 1996 on a prospective basis. The Statement requires that a portion of the loan cost be allocated to the mortgage servicing rights retained and be recognized as a separate asset. Mortgage servicing rights in the amount of $105 were capitalized during the year ended December 31, 1996. The Company recognized amortization of the cost of mortgage servicing rights in the amount of $17 for the year ended December 31, 1996. This resulted in net income being $88 greater than had Statement No. 122 not been adopted. A valuation allowance was not required for the mortgage servicing rights at December 31, 1996. 31 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 8. Foreclosed Real Estate The Company had investment in real estate acquired through foreclosure or deeded to the Company in lieu of foreclosure of $78 and $29 as of December 31, 1996 and 1995, respectively. No allowances for losses on foreclosed real estate were required at these dates. Note 9. Premises and Equipment Premises and equipment are summarized as follows: Years Ended December 31, ----------------------- 1996 1995 - --------------------------------------------------------------------------- Cost: Land $ 71 $ 71 Buildings and improvements 1,075 1,075 Leasehold improvements 537 533 Furniture, fixtures and equipment 1,682 1,245 ----------------------- 3,365 2,924 Less accumulated depreciation and amortization 1,846 1,687 ----------------------- $ 1,519 $ 1,237 ======================= Note 10. Deposits Composition of deposits: Years Ended December 31, ----------------------- 1996 1995 - --------------------------------------------------------------------------- Demand and NOW accounts $ 21,638 $ 20,182 Savings accounts 16,312 15,878 Certificates of deposit 107,399 110,626 ----------------------- $ 145,349 $ 146,686 ======================= The aggregate amount of certificates of deposit over $100 was $9,447 and $7,152 at December 31, 1996 and 1995, respectively. 32 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 10. Deposits (Continued) A summary of scheduled maturities of certificates of deposits is as follows: Years Ending December 31, - ---------------------------------------------------------------------------- 1997 $ 80,023 1998 15,893 1999 10,570 2000 913 ----------- $ 107,399 =========== Eligible savings accounts are insured up to $100 by the Savings Association Insurance Fund (SAIF) under management of the Federal Deposit Insurance Corporation (FDIC). On September 30, 1996, legislation was signed into law requiring savings institutions insured by the SAIF to pay a special assessment to recapitalize the fund. The Company recorded its assessment of $1,085 in September, 1996. Note 11. Employee Benefit Plans Defined benefit plan: The Bank had a qualified, noncontributory defined-benefit retirement plan covering substantially all of its employees. The benefits were based on each employee's years of service and average monthly compensation and reduced by a percentage of the employee's social security benefit. It was the policy of the Bank to fund the maximum amount that could be deducted for federal income tax purposes. Effective December 31, 1995, the plan was amended such that no further benefits will be earned for employee service. In conjunction therewith, the Bank recognized a curtailment gain of $75 for the year ended December 31, 1995. The plan was terminated on November 1, 1996 and all obligations were settled on that date by payments to the participants in cash or by payments to their individual accounts in the Bank's 401(k) plan (see below). 33 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 11. Employee Benefit Plans (Continued) The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated statements of financial condition:
December 31, ----------------------- 1996 1995 - ---------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Accumulated benefit obligation: Vested $ - $ 896 Nonvested - - -------------------- Projected benefit obligation for service rendered to date - 896 Plan assets at fair value; primarily certificates of deposit issued by the Bank - 783 --------------------- Plan assets greater (less) than projected benefit obligation - 113 Unrecognized net transition obligation - - -------------------- Accrued pension liability (included in other liabilities) $ - $ 113 ====================
The components of net pension expense are summarized as follows:
Years Ended December 31, ----------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------------- Service cost-benefits earned during the period $ - $ 100 $ 93 Interest cost on projected benefit obligation 45 82 69 Actual return on plan assets (39) (39) (20) Net amortization and deferral - (22) (34) Curtailment gain - (75) - ------------------------------- Net pension expense $ 6 $ 46 $ 108 ===============================
Assumptions used to develop the net periodic cost were: December 31, ----------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------------- Discount rate N/A 8.0% 8.0% Expected long-term rate of return on assets N/A 9.0% 9.0% Rate of increase in compensation levels N/A N/A 5.5% 34 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 11. Employee Benefit Plans (Continued) Defined Contribution 401(k) Plan: The Bank provides a 401(k) plan which covers substantially all of the Bank's employees who are eligible as to age and length of service. A participant may elect to make contributions of up to 15 percent of the participant's annual compensation. At the discretion of the Board of Directors, the Bank may make matching contributions of up to 4 percent of each participant's contribution. Contributions made by the Bank for the years ended December 31, 1996, 1995 and 1994 were $-0-, $-0-, and $33, respectively. Employee Stock Ownership Plan: An Employee Stock Ownership Plan (ESOP) was adopted on April 11, 1995 covering all full-time employees of the Company who have attained age 21 and completed one year of service during which they work at least 1,500 hours. The Company makes annual contributions to the ESOP equal to the ESOP's debt service less any dividends received by the ESOP on unallocated shares. The ESOP's debt was incurred when the Company loaned the ESOP $1,120 which was used by the ESOP to purchase common stock of the Company. All dividends received by the ESOP on unallocated shares are used to pay debt service. The ESOP shares initially were pledged as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to employees based on the proportion of debt service paid in the year. The shares pledged as collateral are deducted from stockholders' equity as unearned ESOP shares in the accompanying statement of financial condition. As shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as compensation expense. Compensation expense for the ESOP was $163 and $143 for the years ended December 31, 1996 and 1995, respectively. Shares of the Company held by the ESOP at December 31, 1996 and 1995 are as follows: 1996 1995 - --------------------------------------------------------------------------- Shares released for allocation 28,000 14,000 Unreleased (unearned) shares 112,000 126,000 -------------------- 140,000 140,000 -------------------- Fair value of unreleased (unearned) shares $ 1,470 $ 1,386 ==================== Stock Option Plan: The Company, effective November 15, 1995, adopted a stock option plan (Plan). Pursuant to the Plan, stock options for 218,750 common shares may be granted to directors, officers and key employees of the Bank. Options granted under the Plan may be either options that qualify as Incentive Stock Options, as defined in Section 422 of the Internal Revenue Code of 1986, as amended, or options that do not so qualify. 35 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 11. Employee Benefit Plans (Continued) The exercise price under the awards was established at $11.00 per share which was the fair market price on the date of adoption. Under APB Opinion No. 25, no expense has been recorded for these options for the years ended December 31, 1996 and 1995 as the option price is the quoted market price of the shares at the date of the awards. Grants under the Plan are accounted for following APB Opinion No. 25 and related Interpretations. Accordingly, no compensation cost has been recognized, as noted above, for this Plan. Had compensation cost for the Plan been determined based on the grant date fair values of awards (the method described in FASB Statement No. 123), additional compensation cost charged to income would have been $176 and $23 for the years ended December 31, 1996 and 1995, respectively. Reported net income and earnings per common share would have been reduced to the pro forma amounts shown below: Years Ended December 31, ------------------------ 1996 1995 - ---------------------------------------------------------------------------- Net Income: As reported $ 1,200 $ 1,270 Pro forma 1,095 1,256 Primary and fully diluted earnings per share: As reported $ 0.61 $ 0.50 Pro forma 0.56 0.49 The Plan may grant options to purchase up to 218,750 shares of common stock, with a maximum term of 10 years, at the market price on the date of grant. The options vest at the rate of 20% per year. The fair value of the options granted was estimated at the grant date using the Black-Scholes option-pricing model using a dividend rate of 0%, price volatility of 10%, a risk-free interest rate of 5.65%, and an estimated life of 6 years. The estimated fair value was $408 at November 15, 1995, the grant date. The status of the Company's fixed stock option plan as of December 31, 1996 and 1995, and changes during the years ended on those dates is presented below:
Years Ended December 31, ------------------------------------------------------ 1996 1995 ------------------------------------------------------ Weighted-Average Weighted-Average Fixed Options Shares Exercise Price Shares Exercise Price - ----------------------------------------------------------------------------------------- Outstanding at beginning of year 125,405 $ 11 - $ - of year Granted - - 125,405 11 Exercised - - - - Forfeited - - - - ------------------------------------------------------ Outstanding at end of year 125,405 $ 11 125,405 $ 11 ======================================================
36 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 11. Employee Benefit Plan (Continued) As of December 31, 1996, there were 125,405 options outstanding, all options had an exercise price of $11.00 per share, and their remaining contractual life was 8.8 years. As of December 31, 1996 and 1995, 25,081 and -0- shares, respectively, were exercisable. Management Stock Bonus Plan: The Bank adopted a Management Stock Bonus Plan (Plan) which was approved by the Company's stockholders on November 15, 1995. Restricted stock awards covering shares representing an aggregate of up to 4% (87,500 shares) of the common stock issued by the Company in the mutual to stock conversion may be granted to directors and employees of the Bank. These awards vest at the rate of 20% per year of continuous service with the Bank. The status of shares awarded as of December 31, 1996 and 1995 and the changes during the years ended on those dates is presented below: Years Ended December 31, ---------------------- 1996 1995 - --------------------------------------------------------------------------- Outstanding at beginning of year 49,735 - Granted - 49,735 Vested and distributed (9,595) - Forfeited (1,760) - ---------------------- Outstanding at end of year 38,380 49,735 ====================== The Bank recorded expense of $228 relating to this Plan for the year ended December 31, 1996 and $31 for the year ended December 31, 1995. The Company contributed funds to the Plan's trust to allow the trust to purchase all 87,500 shares on the open market. The trust purchased these shares in 1996. 49,735 shares were purchased for outstanding awards and the remaining 37,765 shares are recorded as treasury stock. Unearned compensation cost, recognized in an amount equal to the fair value of the awarded shares at the award date, is recorded in stockholders' equity and amortized to operations as the shares vest. Note 12. Borrowed Funds Borrowed funds consisted of advances from Federal Home Loan Bank (FHLB), as follows: December 31, ----------------------- 1996 1995 - ------------------------------------------------------------------------- Due Date Interest Rate - ---------------------------------- 06/05/96 5.70% $ - $ 7,500 09/20/96 5.91% - 3,000 06/05/97 5.67% 7,500 7,500 06/05/97 5.91% 5,000 - 06/27/97 6.35% 3,000 - 05/04/98 5.46% 5,000 - 05/26/98 5.61% 6,000 - ----------------------- $ 26,500 $ 18,000 ======================= 37 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 12. Borrowed Funds (Continued) The Company had $2,000 of unused borrowings available on the advance due June 27, 1997 as of December 31, 1996. The advances due on June 5, 1997 have fixed interest rates. The advances due on June 27, 1997, May 4, 1998 and May 26, 1998 have variable interest rates, at December 31, 1996 the current rates were as stated above. Prepayment of the advances will result in prepayment penalties. The advances are collateralized by FHLB stock and first mortgage loans of $39,750 at December 31, 1996. Note 13. Income Tax Matters The Company and its subsidiary file consolidated federal income tax returns. For the years ended December 31, 1995 and 1994, if certain conditions are met in determining taxable income, the Company was allowed a special bad debt deduction based on a percentage of taxable income (8 percent) or on specified experience formulas. The Company used the taxable income method in 1995 and 1994. Effective for the year ended December 31, 1996, federal income tax laws changed to eliminate the percentage of taxable income formula for the Company and will only allow bad debt deductions based on actual charge-offs. The components of income tax expense are as follows: Years Ended December 31, ----------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------- Federal: Current $ 690 $ 612 $ 582 Deferred (credit) (6) 24 42 ----------------------------------- 684 636 624 ----------------------------------- State: Current 230 196 189 Deferred (credit) (2) 10 17 ----------------------------------- 228 206 206 ----------------------------------- Total $ 912 $ 842 $ 830 =================================== 38 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 13. Income Tax Matters (Continued) Total income tax expense differed from the amounts computed by applying the statutory U.S. Federal income tax rates to income before income taxes as a result of the following: Years Ended December 31, ---------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------- Statutory rate applied to income $ 739 $ 739 $ 740 before income taxes State income taxes, net of federal 137 137 137 benefit Effect of graduated rates (21) (21) (21) Other 57 (13) (26) ---------------------------------- Income tax expense $ 912 $ 842 $ 830 ================================== The net deferred tax liability included in liabilities in the accompanying statements of financial condition includes the following amounts of deferred tax assets and liabilities: December 31, ----------------------- 1996 1995 - --------------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses $ 189 $ 131 Deferred loan origination fees 40 94 Other 35 54 ----------------------- 264 279 Less valuation allowance - - ----------------------- 264 279 ----------------------- Deferred tax liabilities: Premises and equipment 169 192 Securities available for sale 236 210 FHLB stock dividends 217 217 ----------------------- 622 619 ----------------------- $ (358) $ (340) ======================= Retained earnings at December 31, 1996 and 1995 include approximately $1,839 related to the pre-1987 allowance for loan losses 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 debts 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 for financial statement purposes was approximately $736 at December 31, 1996 and 1995. 39 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 14. Lease Commitments The Company leases certain branch facilities under operating leases. Some leases require the Company to pay related insurance, maintenance and repairs, and real estate taxes. Future minimum rental commitments under operating leases as of December 31, 1996 are as follows: Years Ending - ---------------------------------------------------------------------------- 1997 $ 130 1998 68 1999 31 2000 26 2001 26 Thereafter 15 ----------- $ 296 =========== Total rental expense related to operating leases was approximately $162, $163 and $158 for the years ended December 31, 1996, 1995 and 1994, respectively. Note 15. Stockholders' Equity, Regulatory Capital and Dividend Restrictions In 1996, the Company approved two stock buy back programs in which up to 14.5% of the common stock of the Company may be acquired by April 11, 1997. In accordance with the provisions of its stock buy back programs, the Company had purchased 125,875 shares of treasury stock as of December 31, 1996. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank'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 Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. As of May 20, 1996, the most recent examination by the Office of Thrift Supervision categorized the Bank as "well capitalized" under the regulatory framework for Prompt Corrective Action. To be categorized as adequately capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios. There are no conditions or events since that notification that management believes have changed the Bank's category. 40 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 15. Regulatory Capital and Dividend Restrictions (Continued) The following table summarizes the Bank's compliance with its regulatory capital requirements at December 31, 1996: Bank's Capital Bank's Capital Bank's Capital --------------------------------------------------------- Amount Percent Amount Percent Amount Percent - -------------------------------------------------------------------------------- Tier 1 (core) capital $20,478 10.31 % $ 5,961 3.00 % $14,517 7.31 % Risk-based capital 21,064 18.61 % 9,054 8.00 % 12,010 10.61 % Under current regulations, the Bank is not permitted to pay dividends on its stock if its regulatory capital would reduce below (i) the amount required for the liquidation account established to provide a limited priority claim to the assets of the Bank to certain qualifying depositors who had deposits at the Bank and who continue to maintain those deposits after its conversion from a Federal mutual savings and loan association to a Federal stock savings bank pursuant to its Plan of Conversion (Plan) adopted October 19, 1994, or (ii) the Bank's regulatory capital requirements. As a "Tier 1" institution (an institution with capital in excess of its capital requirements, both immediately before the proposed capital distribution and after giving effect to such distribution), the Bank may make capital distributions without the prior consent of the Office of Thrift Supervision (OTS) in any calendar year. The capital distribution is 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 institution's tangible, core or risk-based capital exceeds its capital requirement for such capital commitment, as measured at the beginning of the calendar year or up to 75% of net income over the most recent four quarter period. Note 16. Financial Instruments with Off-Statement of Financial Condition Risk The Company is a party to financial instruments with off-statement of financial condition risk in the normal course of business to meet the financing needs of its customers. These financial instruments include primarily commitments to extend credit. Those instruments involve, to varying degrees, elements of credit risk and interest-rate risk in excess of the amount recognized in the consolidated statement of financial condition. The contract or notional amounts of those instruments reflect the extent of the Company's involvement in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-statement of financial condition instruments. Commitments to extend credit on loans totaled approximately $11,850 and $11,506 at December 31, 1996 and 1995, respectively. The portion of commitments to extend credit that related to fixed rate loans is $676 and $957 as of December 31, 1996 and 1995, respectively. 41 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 16. Financial Instruments with Off-Statement of Financial Condition Risk (Continued) Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but normally includes real estate and personal property. Note 7. Concentrations Concentration by geographic location: The Company makes agricultural, commercial, residential and consumer loans to customers primarily in south central Minnesota. Although the Company's loan portfolio is diversified, there is a relationship in this region between the agricultural economy and the economic performance of loans made to nonagricultural customers. The Company's lending policies for agricultural and nonagricultural customers require loans to be well-collateralized and supported by cash flows. Collateral for agricultural loans includes equipment, crops, livestock and land. Credit losses from loans related to the agricultural economy are consistent with credit losses experienced in the portfolio as a whole. The concentration of credit in the regional agricultural economy is consistent with credit losses experienced in the portfolio as a whole. The concentration of credit in the regional agricultural economy is taken into consideration by management in determining the allowance for loan losses. Concentration by institution: As of December 31, 1996 the Company had $7,554 on deposit with the FHLB of Des Moines. Note 18. Earnings Per Share Earnings per share is calculated by dividing net income by the weighted average number of shares of common and common equivalent shares outstanding, including shares issuable upon exercise of dilutive options outstanding. The weighted number of common and common equivalent shares outstanding for the year ended December 31, 1996 and the period from April 11, 1995 to December 31, 1995 were 1,967,185 and 2,063,166, respectively. The earnings per share calculation for 1995 includes earnings from April 11, 1995, the date of conversion, to December 31, 1995. 42 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 19. Fair Values of Financial Instruments The estimated fair values of the Company's financial instruments are as follows:
Years Ended December 31, ---------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value ---------------------------------------------- Financial assets Cash $ 8,301 $ 8,301 $ 8,192 $ 8,192 Certificates of deposit 200 200 800 800 Securities and mortgage backed securities available for sale 7,528 7,528 7,620 7,620 Securities held to maturity 2,049 2,044 4,199 4,190 Loans receivable, net 178,447 179,721 169,670 170,972 Loans held for sale 1,791 1,791 1,944 1,944 Mortgage servicing rights 88 88 - - Accrued interest receivable 1,060 1,060 1,120 1,120 Financial liabilities Deposits 145,349 145,702 146,686 146,966 Borrowed funds 26,500 26,502 18,000 18,012 Advances from borrowers for taxes and insurance 681 681 683 683 Accrued interest payable 126 126 221 221 ==============================================
Note 20. Conversion to Stock Form Ownership On October 19, 1994, the Board of Directors of the Bank adopted a Plan of Conversion (the "Conversion"). The OTS approved this transaction and the registration statement was declared effective by the SEC as of February 13, 1995. The institution converted from a federal mutual savings bank to a federal stock savings bank with the concurrent formation of a holding company on April 11, 1995. As part of the Conversion, the Company issued 2,187,500 shares of common stock (140,000 shares of which were acquired by the ESOP) at $8 per share in a community offering resulting in gross proceeds of $17,500. Expenses relating to the Conversion totaled $775. One-half of the net proceeds, excluding the common stock acquired by the ESOP, or $8,362, were used by the Company to acquire 100% of the common stock of the Bank. 43 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 20. Conversion to Stock Form Ownership (Continued) At the time of the Conversion, the Bank established a liquidation account in an amount equal to its retained earnings as of the date of the latest statement of financial condition appearing in the final prospectus. The liquidation account is maintained for the benefit of eligible and supplemental eligible account holders who continue to maintain their accounts at the Bank after the Conversion. The liquidation account will be reduced annually to the extent that eligible and supplemental eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible and supplemental eligible account holder's interest in the liquidation account. In the event of a complete liquidation, each eligible and supplemental eligible account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. Note 21. Financial Information of Wells Financial Corp. (Parent Only) The Company's condensed statements of financial condition as of December 31, 1996 and 1995 and related condensed statements of income and cash flows for the year ending December 31, 1996 and the period April 11, 1995, date of conversion, to December 31, 1995 are as follows: December 31, December 31, Condensed Statements of Financial Condition 1996 1995 - -------------------------------------------------------------------------------- Assets Cash, including deposits with Wells Federal Bank, fsb 1996 $203; 1995 $880 $ 1,829 $ 1,500 Certificates of deposit 200 800 Securities held to maturity 499 200 Investment in Wells Federal Bank, fsb 21,731 21,355 Loan to Wells Federal Bank, fsb 4,000 5,000 Accrued interest receivable 15 10 -------------------------- Total assets $ 28,274 $ 28,865 ========================== Liabilities and Stockholders' Equity Liabilities $ 72 $ 13 Stockholders' equity 28,202 28,852 -------------------------- Total liabilities and stockholders' equity $ 28,274 $ 28,865 ========================== Year Ended Period Ended December 31, December 31, Condensed Statements of Income 1996 1995 - -------------------------------------------------------------------------------- Interest income $ 466 $ 326 Other expense 73 87 ---------------------------- Income before income taxes 393 239 Income tax expense 169 97 ---------------------------- Net income before equity in net income of subsidiary 224 142 Equity in net income of subsidiary 976 889 ---------------------------- Net income $ 1,200 $ 1,031 ============================ 44 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - ------------------------------------------------------------------------------ Note 21. Financial Information of Wells Financial Corp. (Parent Only) (Continued)
Year Ended Period Ended December 31, December 31, Condensed Statements of Cash Flows 1996 1995 - --------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 1,200 $ 1,031 Adjustment to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiary (976) (889) Increase in accrued interest receivable (5) (10) Increase in other liabilities 59 13 ----------------------------- Net cash provided by operating activities 278 145 ----------------------------- Cash Flows From Investing Activities Purchase of certificates of deposit (200) (800) Purchase of securities held to maturity (1,999) (800) Proceeds from the maturities of certificates of deposit 800 - Proceeds from maturity of securities held to maturity 1,700 600 Investment in Wells Federal Bank, fsb - (8,362) (Increase) decrease in loan to Wells Federal Bank, fsb 1,000 (5,000) ----------------------------- Net cash provided by (used in) investing activities 1,301 (14,362) ----------------------------- Cash Flows From Financing Activities Net proceeds from sale of common stock - 15,605 Payments relating to ESOP stock 112 112 Purchase of treasury stock (1,362) - ----------------------------- Net cash provided by (used in) financing activities (1,250) 15,717 ----------------------------- Net increase in cash 329 1,500 Cash Beginning of period 1,500 - ----------------------------- End of period $ 1,829 $ 1,500 =============================
45 WELLS FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands) - --------------------------------------------------------------------------- Note 22. Selected Quarterly Financial Data (Unaudited) (dollars in thousands, except per share data) Year Ended December 31, 1996 - --------------------------------------------------------------------------- First Second Third Fourth ---------------------------------------------- Interest income $ 3,578 $ 3,583 $ 3,715 $ 3,793 Net interest income 1,552 1,577 1,686 1,708 Provision for loan losses 45 45 45 45 Net income (loss) 500 363 (144) 481 Earnings per share, primary and fully diluted 0.24 0.19 (0.07) 0.25 Year Ended December 31, 1995 - --------------------------------------------------------------------------- First Second Third Fourth ---------------------------------------------- Interest income $ 3,132 $ 3,299 $ 3,489 $ 3,569 Net interest income 1,120 1,302 1,405 1,497 Provision for loan losses 31 45 45 45 Net income 197 303 400 370 Earnings per share from April 11, 1995, the date of conversion: Primary and fully diluted - 0.13 0.19 0.18 46 OFFICE LOCATION AND OTHER CORPORATE INFORMATION CORPORATE OFFICE Wells Financial Corp. 53 First Street, S.W. Wells, Minnesota 56097 Board of Directors of Wells Financial Corp. Lawrence H. Kruse President, Wells Federal Bank Gerald D. Bastian Joseph R. Gadola Branch Manager, Wells Federal Bank Attorney, Gadola Law Office Wallace J. Butson Richard Mueller Secretary, Wells Federal Bank Pharmacist, Wells Drug, Co Executive Officers of Wells Financial Corp. Lawrence H. Kruse James D. Moll President and Chief Treasurer and Principal Financial Executive Officer and Accounting Officer Gerald D. Bastian Wallace J. Butson Vice President Secretary --------------------------- Corporate Counsel: Independent Auditors: Joseph R. Gadola, Esq. McGladrey & Pullen, LLP 28 South Broadway Suite 400 Wells, Minnesota 56097 102 South Broadway Rochester, Minnesota 55904 Special Counsel: Transfer Agent and Registrar: Malizia, Spidi, Sloane & Fisch, P.C. Registrar and Transfer Company One Franklin Square 10 Commerce Drive Suite 700 East Cranford, New Jersey 07016 1301 K Street, N.W. Washington, D.C. 20005 --------------------------- The Company's Annual Report for the Year Ended December 31, 1996, filed with the Securities and Exchange Commission on Form 10-K is available without charge upon written request. For a copy of the Form 10-K or any other investor information, please write the Secretary of the Company, at the Company's corporate office in Wells, Minnesota. The annual meeting of stockholders will be held on April 16, 1997 at 4:00 p.m. at the Corporate Office, Wells, Minnesota. 47 EX-23 4 EXHIBIT 23 EXHIBIT 23 INDEPENDENT ACCOUNTANT'S CONSENT Board of Directors Wells Financial Corp. 58 First Street S.W. Wells, Minnesota 56097 We hereby consent to the incorporation of our report dated February 11, 1997, included in this Form 10-KSB in the previously filed Registration Statement of Wells Financial Corp. on Form S-8 (No. 333-3520). /S/MCGLADREY & PULLEN, LLP Rochester, Minnesota March 26, 1997 EX-27 5 ARTICLE 9 FDS FOR FORM 10KSB40
9 1000 YEAR DEC-31-1996 DEC-31-1996 741 7,760 0 0 7,528 2,049 2,044 178,447 615 201,326 145,349 26,500 1,275 0 0 0 219 27,983 201,326 13,617 1,052 0 14,669 7,060 1,086 6,523 180 0 5,245 2,112 2,112 0 0 1,200 0.61 0.61 3.39 298 147 0 496 512 88 11 615 615 0 0
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