-----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, UoBLjLWGh689kIEse26DX/PRwzpvmXfvyLxahMb34gXeYtIu/iG3zoM7AWBRi3fl L8HVqe/8h8H6NPh6e9po2A== 0000946275-99-000175.txt : 19990325 0000946275-99-000175.hdr.sgml : 19990325 ACCESSION NUMBER: 0000946275-99-000175 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990323 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: 10KSB SEC ACT: SEC FILE NUMBER: 000-25342 FILM NUMBER: 99570901 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 10KSB 1 FORM 10KSB 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, 1998 ------------------------------------------------------ - OR - |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to ------------------ --------------------- Commission file number: 0-25342 ----------- 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. [ ] Registrant's revenues for the year ended December 31, 1998 were $17.3 million. 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 5, 1999 ($16.00 per share), was $23.2 million. As of March 8, 1999, registrant had 1,652,160 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, 1998. 2. Part III -- Portions of Registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders. PART I WELLS FINANCIAL CORP. (THE "COMPANY") MAY FROM TIME TO TIME MAKE WRITTEN OR ORAL "FORWARD-LOOKING STATEMENTS", INCLUDING STATEMENTS CONTAINED IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION (INCLUDING THIS ANNUAL REPORT ON FORM 10-KSB AND THE EXHIBITS THERETO), IN ITS REPORTS TO STOCKHOLDERS AND IN OTHER COMMUNICATIONS BY THE COMPANY, WHICH ARE MADE IN GOOD FAITH BY THE COMPANY PURSUANT TO THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS, THAT ARE SUBJECT TO CHANGE BASED ON VARIOUS IMPORTANT FACTORS (SOME OF WHICH ARE BEYOND THE COMPANY'S CONTROL). THE FOLLOWING FACTORS, AMONG OTHERS, COULD CAUSE THE COMPANY'S FINANCIAL PERFORMANCE TO DIFFER MATERIALLY FROM THE PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS EXPRESSED IN SUCH FORWARD-LOOKING STATEMENTS: THE STRENGTH OF THE UNITED STATES ECONOMY IN GENERAL AND THE STRENGTH OF THE LOCAL ECONOMIES IN WHICH THE COMPANY CONDUCTS OPERATIONS; THE EFFECTS OF, AND CHANGES IN, TRADE, MONETARY AND FISCAL POLICIES AND LAWS, INCLUDING INTEREST RATE POLICIES OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, INFLATION, INTEREST RATE, MARKET AND MONETARY FLUCTUATIONS; THE TIMELY DEVELOPMENT OF AND ACCEPTANCE OF NEW PRODUCTS AND SERVICES OF THE COMPANY AND THE PERCEIVED OVERALL VALUE OF THESE PRODUCTS AND SERVICES BY USERS, INCLUDING THE FEATURES, PRICING AND QUALITY COMPARED TO COMPETITORS' PRODUCTS AND SERVICES; THE WILLINGNESS OF USERS TO SUBSTITUTE COMPETITORS' PRODUCTS AND SERVICES FOR THE COMPANY'S PRODUCTS AND SERVICES; THE SUCCESS OF THE COMPANY IN GAINING REGULATORY APPROVAL OF ITS PRODUCTS AND SERVICES, WHEN REQUIRED; THE IMPACT OF CHANGES IN FINANCIAL SERVICES' LAWS AND REGULATIONS (INCLUDING LAWS CONCERNING TAXES, BANKING, SECURITIES AND INSURANCE); TECHNOLOGICAL CHANGES, ACQUISITIONS; CHANGES IN CONSUMER SPENDING AND SAVING HABITS; AND THE SUCCESS OF THE COMPANY AT MANAGING THE RISKS INVOLVED IN THE FOREGOING. THE COMPANY CAUTIONS THAT THE FOREGOING LIST OF IMPORTANT FACTORS IS NOT EXCLUSIVE. THE COMPANY DOES NOT UNDERTAKE TO UPDATE ANY FORWARD- LOOKING STATEMENT, WHETHER WRITTEN OR ORAL, THAT MAY BE MADE FROM TIME TO TIME BY OR ON BEHALF OF THE COMPANY. 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 a stock institution, and sold all of its outstanding capital stock to the Company and the 1 Company made its initial public offering of common stock (the "Conversion"). As of December 31, 1998, the Company had total assets of $191.9 million, total deposits of $158.4 million, and stockholders' equity of $25.9 million or 13.5% 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, 1998, the remainder of the assets of the Company were maintained in the form of 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 eight full service offices located in Faribault, Martin, Blue Earth, Nicollet, Freeborn and Steele Counties, 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, and investment securities. Principal sources of income are interest and fees on loans, 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 contains approximately 50 communities ranging in population size from 200 to 40,000. The primary lending concentration is in the Mankato, North Mankato and Owatonna areas. These areas have a relatively large population base. The Company has an office in each of the Mankato, North Mankato and Owatonna areas. 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. Currently, the Company is selling substantially all of the conventional fixed rate mortgage loans that it originates into the secondary market. The Company's consumer loan portfolio consists primarily of home 2 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. 3 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, ------------------------------------------------------------------------------------------- 1994 1995 1996 1997 1998 ----------------- ---------------- -------------- --------------- ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Real Estate Loans: One- to four-family............... $137,130 82.14% $136,022 79.38% $141,067 78.20% $141,697 76.82% $105,088 67.25% Multi-family...................... 951 0.57 880 0.51 1,355 0.75 1,167 0.63 950 0.61 Commercial........................ 9,654 5.78 10,554 6.16 10,878 6.03 10,845 5.88 20,068 12.84 Construction...................... 2,149 1.29 2,774 1.62 2,081 1.15 1,943 1.05 1,279 0.82 ------- ----- --- ----- ------- ----- ------- ----- ------- ----- Total real estate loans....... 149,884 89.78 150,230 87.67 155,381 86.13 155,652 84.38 127,385 81.52 ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- Other Loans: Consumer Loans: Savings account................... 471 0.28 436 0.25 443 0.25 349 0.19 395 0.25 Vehicles.......................... 2,573 1.54 3,353 1.96 4,619 2.56 4,988 2.70 4,644 2.97 Home equity, home improvement and second mortgages.............. 10,392 6.23 12,875 7.51 15,197 8.42 18,781 10.18 18,475 11.83 Other............................. 2,811 1.68 3,279 1.91 3,588 1.99 3,411 1.85 2,970 1.90 ----- ---- ----- ---- ----- ---- ----- ---- ----- ---- Total consumer loans.......... 16,247 9.73 19,943 11.63 23,847 13.22 27,529 14.92 26,484 16.95 Commercial business loans........... 810 0.49 1,191 0.70 1,171 0.65 1,299 0.70 2,394 1.53 ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- Total other loans............. 17,057 10.22 21,134 12.33 25,018 13.87 28,828 15.62 28,878 18.48 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------- Total loans................... 166,941 100.00% 171,364 100.00% 180,399 100.00% 184,480 100.00% 156,263 100.00% ====== ====== ====== ====== ====== Less: Loans in process.................. 685 493 623 351 655 Deferred loan origination fees and costs........................ 695 689 714 642 450 Allowance for loan losses......... 376 512 615 763 853 ------- ------- ------- ------- ------- Total loans receivable, net... $165,185 $169,670 $178,447 $182,724 $154,305 ======= ======= ======= ======= =======
4 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, ------------------------------------------------- 1994 1995 1996 1997 1998 -------- -------- -------- -------- -------- (In Thousands) Total gross loans receivable at beginning of year......................... $144,114 $166,941 $171,364 $180,399 $184,480 -------- -------- -------- -------- -------- Loans originated: One- to four-family residential............ 33,854 30,609 43,411 28,035 93,546 Commercial and multi-family real estate................................... 1,623 1,366 1,759 2,286 9,364 Construction loans......................... 5,114 5,522 6,776 5,182 1,196 Consumer loans............................. 8,166 12,103 10,242 16,102 18,944 Commercial business loans.................. 1,760 1,567 610 1,983 1,170 ----- ----- --- ----- ----- Total loans originated....................... 50,517 51,167 62,798 53,588 124,220 ------ ------ ------ ------ ------- Principal reductions: Loans sold................................. 2,971 13,584 19,209 14,735 85,316 Loan principal repayments.................. 24,719 33,160 34,554 34,772 67,121 ------ ------ ------ ------ ------ Total principal reductions................... 27,690 46,744 53,763 49,507 152,437 ------ ------ ------ ------ ------- Total gross loans receivable at end of year................................ $166,941 $171,364 $180,399 $184,480 $156,263 ======== ======== ======== ======== ========
Due to the historically low interest rates on residential mortgage loans during 1998, many of the customers in the Company's market area elected to refinance their mortgage loans which resulted in the increase in loan originations. Loan Sales. During 1998 the Company sold $85.3 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 ($84.7 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. 5 Loan Maturity Tables. The following table sets forth the maturity of the Company's loan portfolio at December 31, 1998. 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................. $ 287 $ 163 $ 1,279 $ 3,274 $ 5,003 1 to 3 years.................. 1,052 1,243 -- 4,200 6,495 3 to 5 years.................. 2,052 2,834 -- 5,184 10,070 5 to 10 years................. 11,409 4,213 -- 15,486 31,108 Over 10 years................. 90,288 12,565 -- 734 103,587 --------- -------- ------- -------- ------- Total amount due................ $ 105,088 $ 21,018 $ 1,279 $ 28,878 156,263 ========= ======== ======= ======== -------
Less: Allowance for loan losses............................................................. 853 Loans in process...................................................................... 655 Deferred loan fees.................................................................... 450 ------- Loans receivable, net...............................................................$ 154,305 =======
The following table sets forth the dollar amount of all loans due after December 31, 1999 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.................................. $ 40,010 $ 64,791 $104,801 Commercial and multi-family real estate.............. 13,788 7,067 20,855 Construction......................................... -- -- -- Commercial business and consumer..................... 12,501 13,103 25,604 -------- -------- -------- Total.............................................. $ 66,299 $ 84,961 $151,260 ======== ======== ========
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. 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%. 6 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, 1998, the Company was servicing approximately $136.3 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 90% 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 2.97%, of the loan portfolio at December 31, 1998. 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, 1998, the Company had approximately $68,000 in consumer loans that were more than 90 days delinquent. 7 Commercial Real Estate Loans. In order to enhance yields on its assets, the Company originates loans secured by commercial real estate. Approximately 88% 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, 1998, 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, 1998, the Company's largest commercial real estate loan consisted of a $784,000 performing loan secured by farm real estate. 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 be compelled to advance additional funds to complete the development. Furthermore, if the estimate of 8 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, 1998, the Company had $22.7 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 $2.4 million as of December 31, 1998. At December 31, 1998, the Company's largest amount of loans to one borrower was $804,000, consisting of performing loans secured by multi-family buildings and real estate for approximately 19 dwelling units, a commercial office building, 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 9 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. The following table sets forth information regarding non-accrual loans, real estate owned, and certain other repossessed assets and loans.
At December 31, -------------------------------------------------- 1994 1995 1996 1997 1998 --------- -------- ------- ------ -------- (Dollars in Thousands) Loans accounted for on a non-accrual basis: Mortgage loans: Permanent loans secured by 1- to 4-family residences...................................... $ 556 $ 265 $ 164 $ 219 $ 192 All other mortgage loans.......................... 168 -- 59 -- -- Non-mortgage loans: Commercial........................................ 5 7 -- -- -- Consumer.......................................... 88 26 75 18 68 ------- ------ ----- ----- ----- Total............................................... $ 817 $ 298 $ 298 $ 237 $ 260 ======= ====== ===== ===== ===== Accruing loans which are contractually past due 90 days or more: Mortgage loans: Construction loans................................ $ -- $ -- $ -- $ -- $ -- Permanent loans secured by 1- to 4-family residences...................................... -- -- 147 201 100 All other mortgage loans.......................... -- -- -- -- -- Non-mortgage loans: Commercial........................................ -- -- -- -- -- Consumer.......................................... -- 1 -- 4 -- ------- ------ ----- ----- ----- Total............................................... $ -- $ 1 $ 147 $ 205 $ 100 ======= ====== ===== ===== ===== Total non-accrual and accruing loans past due 90 days or more.......................... $ 817 $ 299 $ 445 $ 442 $ 360 ======= ====== ===== ===== ===== Foreclosed real estate.............................. $ 151 $ 29 $ 78 $ 35 $ -- ======= ====== ===== ===== ===== Other nonperforming assets.......................... $ -- $ -- $ -- $ -- $ -- ======= ====== ===== ===== ===== Total nonperforming assets.......................... $ 968 $ 328 $ 523 $ 477 $ 360 ======= ====== ===== ===== ===== Total non-accrual and accruing loans past due 90 days or more to net loans.................. 0.50% 0.18% 0.25% 0.24% 0.23% ===== ===== ===== ===== =====
10
At December 31, -------------------------------------------------- 1994 1995 1996 1997 1998 --------- -------- ------- ------ -------- (Dollars in Thousands) Total non-accrual and accruing loans past due 90 days or more to total assets............... 0.45% 0.15% 0.22% 0.22% 0.19% ===== ===== ===== ===== ===== Total nonperforming assets to total assets.......... 0.53% 0.17% 0.26% 0.24% 0.19% ===== ===== ===== ===== =====
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, 1998. Amounts included in the Company's interest income on non-accrual loans for the year ended December 31, 1998 were 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 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, 1998. (In thousands) Special Mention............................. $ 553 Substandard................................. 357 Doubtful assets............................. -- Loss assets................................. 3 ===== General loss allowance...................... $ 853 ===== 11 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. The Company had no foreclosed real estate at December 31, 1998. 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. 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.
1994 1995 1996 1997 1998 -------------------- ------------------- ------------------- ------------------- ------------------ Percent of Percent of Percent of Percent of Percent of Loans in Loans in Loans in Loans in Loans in Each Each Each Each 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 ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- At end of year allocated to: Mortgage......................$251 89.78% $394 87.67% $484 86.13% $617 84.38% $ 722 81.52% Consumer and non-mortgage..... 125 10.22 118 12.33 131 13.87 146 15.62 131 18.48 ---- ------ ---- ------ ---- ------ ----- ------- ----- ------ Total allowance...............$376 100.00% $512 100.00% $615 100.00% $763 100.00% 853 100.00% ==== ====== ==== ====== ==== ====== ===== ======= ===== =======
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, --------------- 1994 1995 1996 1997 1998 -------- -------- -------- -------- -------- Total loans outstanding..................... $166,941 $171,364 $180,399 $184,480 $156,263 ======= ======== ======= ======= ======= Average loans outstanding................... $153,477 $170,395 $173,383 $183,591 $172,219 ======= ======= ======= ======= ======= Beginning allowance balances................ $ 398 $ 376 $ 512 $ 615 $ 763 Provision: One- to four-family....................... 32 166 180 180 120 Commercial and multi-family real estate............................. -- -- -- -- -- Consumer.................................. 81 -- -- -- -- Charge-offs: One- to four-family....................... 53 23 21 12 -- Commercial and multi-family real estate............................. -- -- -- -- -- Consumer.................................. 91 18 67 54 46 Recoveries: One- to four-family....................... -- -- -- -- -- Commercial and multi-family real estate............................. -- -- -- -- -- Consumer.................................. 9 11 11 34 16 Other....................................... -- -- -- -- -- ------- ------- ------- ------- -------- Ending allowance balance.................... $ 376 $ 512 $ 615 $ 763 $ 853 ======= ======= ======= ======== ======= Allowance for loan losses as a percent of total loans outstanding................ 0.23% 0.30% 0.34% 0.41% 0.55% Net loans charged off as a percent of average loans outstanding................. 0.09% 0.02% 0.04% 0.02% 0.02%
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, ------------------------------------------------ 1994 1995 1996 1997 1998 --------- -------- -------- -------- -------- (Dollars in Thousands) Total foreclosed real estate and real estate in judgment, net.............................. $151 $ 29 $ 78 $ 35 $ -- ==== ==== ==== ==== ==== Allowance balances - beginning.................. -- -- -- -- -- Provision....................................... -- -- -- -- -- Charge-offs..................................... -- -- -- -- -- Recoveries...................................... -- -- -- -- -- Other........................................... -- -- -- -- -- ---- ---- ---- ---- ---- Allowance balances - ending..................... $ -- $ -- $ -- $ -- $ -- ===== ==== ==== ==== ==== Allowance for losses on foreclosed real estate in judgment to net foreclosed real estate and real estate in judgment....................... --% --% --% --% --% ==== ==== ==== ==== ====
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, 1998, the Company had an investment portfolio of approximately $9.0 million, consisting primarily of U.S. Treasury securities and U.S. government corporate and agency obligations. To a lesser extent, the portfolio also includes FHLMC stock, 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. 15 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, 1998, the Company's securities that were classified as available for sale had an unrealized net gain of $1.5 million. The Company's securities that were classified as held to maturity had a net unrealized gain of $3,000. This unrealized gain is not reflected in the table below because these securities are carried at amortized cost in accordance with SFAS 115. At December 31, 1998, the market value for the interest bearing deposits shown below approximated their cost.
At December 31, ---------------------------- 1996 1997 1998 -------- ------- ------- (In Thousands) Securities available for sale: Equity securities................................ $ 7,100 $2,640 $2,968 Securities held to maturity: U.S. agency securities........................... 2,049 3,198 5,539 ----- ----- ----- Total investment securities.................... 9,149 5,838 8,507 Interest-bearing deposits.......................... 200 1,850 500 Mortgage-backed securities available for sale........................................ 428 86 -- ----- ----- ----- Total investments.............................. $ 9,777 $7,774 $9,007 ===== ===== =====
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, 1998 -------------------- One Year or Less One to Five Years Five to Ten Years More than Ten Years Total 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 Thousands) U.S. Agency Obligations..... -- --% 5,539 5.88% -- -- 5,539 5.88% 5,542 FHLB Stock.................. -- -- -- -- -- 1,421 -- 1,421 Equity Securities........... -- -- -- -- -- 1,547 -- 1,547 Interest Bearing Deposits... 500 5.81% -- -- -- 500 5.81% 500 ----- ----- ----- ----- ----- ----- ----- Total..................... $ 500 $5,539 $ -- $ -- $9,007 $9,010 ===== ====== ===== ===== ===== ====== ======
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, 1998, 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..................... $ 5,418 Three through six months................ 953 Six through twelve months............... 1,305 Over twelve months...................... 2,848 ------ $10,524 ====== 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, 1998, the Company had a $5.0 million fixed rate advance outstanding from the FHLB of Des Moines. The advance is callable beginning January 16, 2003 and provides for a prepayment penalty. See Note 10 of the Notes to the Company's Consolidated Financial Statements. Future use of advances depends on the rates on advances as compared to the rates on deposits. 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, ------------------------------------------ 1996 1997 1998 ---- ---- ---- (Dollars in Thousands) FHLB advances...................... $26,500 $24,500 $ 5,000 Weighted average interest rate of FHLB advances................. 5.74% 5.92% 5.34% Maximum amount of advances......... $28,500 $29,500 $29,500 Average amount of advances......... $19,269 $26,808 $14,615 Weighted average interest rate of average amount of advances.... 5.64% 5.75% 5.74% Subsidiary Activity The Company has one wholly owned subsidiary, the Bank. The Bank has two wholly owned subsidiaries, known as Wells Insurance Agency, Inc. ("WIA") and Greater Minnesota Mortgage, Inc. ("GMM"). 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, 1998, the Bank was authorized to invest up to approximately $3.7 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 $620,000 at December 31, 1998. GMM was incorporated under the laws of Minnesota in 1997. GMM originates loans through referrals from community commercial banks and, primarily, sells these loans to the secondary market. During 1998, GMM originated $8.0 million in single family dwelling loans, which were sold to the secondary market. At December 31, 1998, the Bank's investment in GMM totalled $105,000. Personnel As of December 31, 1998, the Bank had 65 full-time and 4 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. 19 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 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. 20 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 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. On January 1, 1997, deposit insurance assessments for SAIF members were reduced to approximately .064% of deposits on an annual basis; this rate may continue through the end of 1999. During this same period, members of the Bank Insurance Fund ("BIF"), predominantly commercial banks, 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 substantially declined. 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. In addition, the OTS prompt corrective action regulation provides that a savings institution that has a leverage capital ratio of less than 4% (3% for institutions receiving the highest examination rating) will be deemed to be "undercapitalized" and may be subject to certain restrictions. The Bank exceeded these minimum standards at December 31, 1998. The Bank's capital ratios are set forth in Note 12 to the Company's Consolidated Financial Statements. 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. 21 Dividend and Other Capital Distribution Limitations. Current 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 would be to reduce the regulatory capital of the Bank below the amount required for the liquidation account established in connection with the Conversion. During 1998, the Bank paid $9.0 million in dividends to the Company. Current 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, 1998, 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). In January 1999, the OTS issued an amendment to its current regulations with respect to capital distributions by savings associations. The amended regulations will be effective April 1, 1999. Under the new regulation, savings associations that would remain at least adequately capitalized following the capital distribution, and that meet other specified requirements, would not be required to file a notice or application for capital distributions (such as cash dividends) declared below specified amounts. Under the new regulation, savings associations which are eligible for expedited treatment under current OTS regulations are not required to file a notice or an application with the OTS if (i) the savings association would remain at least adequately capitalized following the capital distribution and (ii) the amount of capital distribution does not exceed an amount equal to the savings association's net income for that year to date, plus the savings association's retained net income for the previous two years. Thus, under the new regulation, only undistributed net income for the prior two years may be distributed in addition to the current year's undistributed net income without the filing of an application with the OTS. Savings associations which do not qualify for expedited treatment or which desire to make a capital distribution in excess of the specified amount, must file an application with, and obtain the approval of, the OTS prior to making the capital distribution. A savings association that is a subsidiary of a savings and loan holding company, and under certain other circumstances, will be required to file a notice with OTS prior to making the capital distribution. The new OTS limitations on capital distributions are similar to the limitations imposed upon national banks. During 1998, the Company paid one $0.12 per share quarterly dividend and three $0.15 per share quarterly dividends to its shareholders. The Company's dividend payout ratio for 1998 was 40.0%. The Company's dividend payment ratio for 1997 was 20.34%. 22 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, 1998, the Bank was in compliance with its QTL requirement with 93.34% 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 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. 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. 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 and eight full service branch offices. The Bank owns the offices in Wells and one branch facility, and leases the remaining locations. In the opinion of the Bank's management, the physical condition of each of the offices is good and is adequate for the conduct of the Bank's business. 23 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 1998 Annual Report to Stockholders (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. Item 7. Financial Statements - ------------------------------ 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. Independent Auditor's Report. Consolidated Statements of Financial Condition as of December 31, 1998 and 1997. Consolidated Statements of Income for the Years Ended December 31, 1998, 1997, and 1996. Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997, and 1996. Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. 24 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 "Information with Respect to Nominees for Director and Directors Continuing in Office" in the Registrant's definitive proxy statement for Registrant's 1998 Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by reference. The information contained under the section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement is also 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 first table under "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. PART IV Item 13. Exhibits, List, and Reports on Form 8-K - ------------------------------------------------ (a) The following exhibits are included in this Report or incorporated herein by reference: 3(i) Articles of Incorporation of Wells Financial Corp.* 25 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*** 13 Annual Report to Stockholders for the fiscal year ended December 31, 1998 21 Subsidiaries of Registrant*** 23 Consent of McGladrey & Pullen, LLP 27 Financial Data Schedule (in electronic filing only) (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 23, 1999. 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 23, 1999. /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 Accounting Officer (Principal Financial and Accounting Officer) /s/Dr. Wallace J. Butson /s/Gerald D. Bastian - ------------------------------------- ----------------------------------- Dr. Wallace J. Butson Gerald D. Bastian Secretary and Director Vice President and Director /s/Randel I. Bichler /s/Richard A. Mueller - -------------------------------------- ----------------------------------- Randel I. Bichler Richard A. Mueller Director Director /s/David Buesing - -------------------------------------- David Buesing Director EX-3.(II) 2 EXHIBIT 3.(II) BYLAWS OF WELLS FINANCIAL CORP. ARTICLE I Home Office The home office of Wells Financial Corp. (the "Corporation") shall be at 53 First Street, S.W., City of Wells, County of Fairbault, in the State of Minnesota. The Corporation may also have offices at such other places within or without the State of Minnesota as the board of directors shall from time to time determine. ARTICLE II Stockholders SECTION 1. Place of Meetings. All annual and special meetings of stockholders shall be held at the home office of the Corporation or at such other place within or without the State of Minnesota as the board of directors may determine and as designated in the notice of such meeting. SECTION 2. Annual Meeting. A meeting of the stockholders of the Corporation for the election of directors and for the transaction of any other business of the Corporation shall be held annually at such date and time as the board of directors may determine. SECTION 3. Special Meetings. Special meetings of the stockholders for any purpose or purposes may be called at any time by the majority of the board of directors, the chief executive officer or the president, and only such persons as are specifically permitted to call meetings by the Minnesota Business Corporation Act in accordance with the provisions of the Corporation's Articles of Incorporation. SECTION 4. Conduct of Meetings. Annual and special meetings shall be conducted in accordance with the rules and procedures established by the board of directors. The board of directors shall designate, when present, either the chairman of the board or president to preside at such meetings. SECTION 5. Voting. At each election for directors every stockholder entitled to vote at such election shall be entitled to one vote for each share of stock held by him. Unless otherwise provided in the Articles of Incorporation, by Statute, or by these Bylaws, a majority of those votes cast by stockholders at a lawful meeting shall be sufficient to pass on a transaction or matter. SECTION 6. Notice of Meetings. Written notice stating the place, day and hour of the meeting and the purpose or purposes for which the meeting is called shall be mailed by the secretary or the officer performing his duties, not less than ten days nor more than sixty days before the meeting to each stockholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the stockholder at his address as it appears on the stock transfer books or records of the Corporation as of the record date prescribed in Section 7 of this Article II, with postage thereon prepaid. If a stockholder is present at a meeting, or in writing waives notice thereof before or after the meeting, notice of the meeting to such stockholder shall be unnecessary. When any stockholders' meeting, either annual or special, is adjourned for 120 days, notice of the adjourned meeting shall be given as in the case of an original meeting. It shall not be necessary to give any notice of the time and place of any meeting adjourned for less than 120 days or of the business to be transacted at such adjourned meeting, other than an announcement at the meeting at which such adjournment is taken. SECTION 7. Fixing of Record Date. For the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders, or any adjournment thereof, or stockholders entitled to receive payment of any dividend, or in order to make a determination of stockholders for any other proper purpose, the board of directors shall fix in advance a date as the record date for any such determination of stockholders. Such date in any case shall be not more than sixty days, and in case of a meeting of stockholders, not less than ten days prior to the date on which the particular action, requiring such determination of stockholders, is to be taken. When a determination of stockholders entitled to vote at any meeting of stockholders has been made as provided in this section, such determination shall apply to any adjournment thereof. SECTION 8. Quorum. A majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of stockholders. If less than a majority of the outstanding shares are represented at a meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. The stockholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. SECTION 9. Proxies. A shareholder may cast or authorize the casting of a vote by filing a written appointment of a proxy with an officer of the Corporation at or before the meeting at which the appointment is to be effective. A written appointment of a proxy may be signed by the shareholder or authorized by the shareholder by transmission of a telegram, cablegram, or other means of electronic transmission, provided that the corporation has no reason to believe that the telegram, cablegram, or other electronic transmission was not authorized by the shareholder. Any reproduction of the writing or transmission may be substituted or used in lieu of the original writing or transmission for any purpose for which the original transmission could be used, provided that the copy, facsimile telecommunication, or other reproduction is a complete and legible reproduction of the entire original writing or transmission. Proxies solicited on behalf of the management shall be voted as directed by the stockholder or, in the absence of such direction, as determined by a majority of the board of directors. No proxy shall be valid after eleven months from the date of its execution unless otherwise provided in the proxy. SECTION 10. Voting of Shares in the Name of Two or More Persons. When ownership of stock stands in the name of two or more persons, in the absence of written directions to the Corporation to the contrary, at any meeting of the stockholders of the Corporation any one or more of such stockholders may cast, in person or by proxy, all votes to which such ownership is entitled. In the event an attempt is made to cast conflicting votes, in person or by proxy, by the several persons in whose name shares of stock stand, the vote or votes to which these persons are entitled shall be cast as directed by a majority of those holding such stock and present in person or by proxy at such meeting, but no votes shall be cast for such stock if a majority cannot agree. - 2 - SECTION 11. Voting of Shares by Certain Holders. Shares standing in the name of another corporation may be voted by any officer, agent or proxy as the bylaws of such corporation may prescribe, or, in the absence of such provision, as the board of directors of such corporation may determine. Shares held by an administrator, executor, guardian trustee or conservator may be voted by him, either in person or by proxy, without a transfer of such shares into his name. Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without the transfer thereof into his name if authority to do so is contained in an appropriate order of the court or other public authority by which such receiver was appointed. A stockholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee and thereafter the pledgee shall be entitled to vote the shares so transferred. Neither treasury shares of its own stock held by the Corporation, nor shares held by another corporation, if a majority of the shares entitled to vote for the election of directors of such other corporation are held by the Corporation, shall be voted at any meeting or counted in determining the total number of outstanding shares at any given time for purposes of any meeting. SECTION 12. Inspectors of Election. In advance of any meeting of stockholders, the board of directors may appoint any persons, other than nominees for office, as inspectors of election to act at such meeting or any adjournment thereof. The number of inspectors shall be either one or three. If the board of directors so appoints either one or three inspectors, that appointment shall not be altered at the meeting. If inspectors of election are not so appointed, the chairman of the board or the president may make such appointment at the meeting. In case any person appointed as inspector fails to appear or fails or refuses to act, the vacancy may be filled by appointment by the board of directors in advance of the meeting or at the meeting by the chairman of the board or the president. Unless otherwise prescribed by applicable law, the duties of such inspectors shall include: determining the number of shares of stock and the voting power of each share, the shares of stock represented at the meeting, the existence of a quorum, the authenticity, validity and effect of proxies; receiving votes, ballots or consents; hearing and determining all challenges and questions in any way arising in connection with the right to vote; counting and tabulating all votes or consents; determining the result; and such acts as may be proper to conduct the election or vote with fairness to all stockholders. SECTION 13. Nominating Committee. The board of directors shall act as a nominating committee for selecting the management nominees for election as directors. Except in the case of a nominee substituted as a result of the death or other incapacity of a management nominee, the nominating committee shall deliver written nominations to the secretary at least twenty days prior to the date of the annual meeting. Provided such committee makes such nominations, no nominations for directors except those made by the nominating committee shall be voted upon at the annual meeting unless other nominations by stockholders are made in writing and delivered to the secretary of the Corporation in accordance with the provisions of the Corporation's Articles of Incorporation. - 3 - ARTICLE III Board of Directors SECTION 1. General Powers. The business and affairs of the Corporation shall be under the direction of its board of directors. The board of directors shall annually elect a president and a chief executive officer from among its members and may also elect a chairman of the board from among its members. The board of directors shall designate, when present, either of the chairman of the board or president to preside at its meetings. SECTION 2. Number, Term and Election. The board of directors shall consist of six members and shall be divided into three classes as nearly equal in number as possible. The members of each class shall be elected for a term of three years and until their successors are elected or qualified. The board of directors shall be classified in accordance with the provisions of the Corporation's Articles of Incorporation. Directors are to be elected by a plurality of votes cast by the shares entitled to vote in the election at a meeting of stockholders at which a quorum is present. The board of directors may increase the number of members of the board of directors but in no event shall the number of directors be increased in excess of fifteen. SECTION 3. Qualifications. Each Director of the Corporation must at all times be a resident of the State of Minnesota and the beneficial owner of not less than 100 shares of capital stock of the Corporation after its initial public sale of stock. For the purpose of this section, "resident" means any natural person who occupies a dwelling within Minnesota, has an intention to remain within Minnesota for a period of time (manifested by establishing a physical, on-going, non-transitory presence within Minnesota) and continues to reside in Minnesota for the term of his or her directorship. SECTION 4. Place of Meetings. All annual and special meetings of the board of directors shall be held at the home office of the Corporation or at such other place within or without the State in which the home office of the Corporation is located as the board of directors may determine and as designated in the notice of such meeting. SECTION 5. Regular Meetings. A regular meeting of the board of directors shall be held without other notice than this Bylaw at such time and date as the board of directors may determine. SECTION 6. Special Meetings. Special meetings of the board of directors may be called by or at the request of the chairman of the board or president, or by two-thirds of the directors. The persons authorized to call special meetings of the board of directors may fix any place within or without the State of Minnesota as the place for holding any special meeting of the board of directors called by such persons. Members of the board of directors may participate in special meetings by means of conference telephone or similar communications equipment by which all persons participating in the meeting can hear each other. SECTION 7. Nominating Committee. The board of directors shall act as a nominating committee for selecting the nominees for election as directors. Except in the case of a nominee substituted as a result of the death or other incapacity of a management nominee, the nominating committee shall deliver written nominations to the secretary at least twenty days prior to the date of the - 4 - annual meeting. Provided such committee makes such nominations, no nominations for directors except those made by the nominating committee shall be voted upon at the annual meeting unless other nominations by stockholders are made in writing and delivered to the secretary of the Corporation in accordance with the provisions of the Corporation's Articles of Incorporation. SECTION 8. Notice. Written notice of any special meeting shall be given to each director at least two days previous thereto delivered personally or by telegram or at least five days previous thereto delivered by mail at the address at which the director is most likely to be reached. Such notice shall be deemed to be delivered when deposited in the United States mail so addressed, with postage thereon prepaid if mailed or when delivered to the telegraph company if sent be telegram. Any director may waive notice of any meeting by a writing filed with the secretary. The attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any meeting of the board of directors need be specified in the notice or waiver of notice of such meeting. SECTION 9. Quorum. A majority of the number of directors fixed by Section 2 of Article III shall constitute a quorum for the transaction of business at any meeting of the board of directors, but if less than such majority is present at a meeting, a majority of the directors present may adjourn the meeting from time to time. Notice of any adjourned meeting shall be given in the same manner as prescribed by Section 8 of Article III. SECTION 10. Manner of Acting. The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors, unless a greater number is prescribed by these Bylaws, the Articles of Incorporation, or the laws of Minnesota. SECTION 11. Action Without a Meeting. Any action required or permitted to be taken by the board of directors at a meeting may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the directors. SECTION 12. Resignation. Any director may resign at any time by sending a written notice of such resignation to the home office of the Corporation addressed to the chairman of the board or president. Unless otherwise specified herein such resignation shall take effect upon receipt thereof by the chairman of the board or president. SECTION 13. Vacancies. Any vacancy occurring in the board of directors shall be filled in accordance with the provisions of the Corporation's Articles of Incorporation. Any directorship to be filled by reason of an increase in the number of directors may be filled by the affirmative vote of two-thirds of the directors then in office. The term of such director shall be in accordance with the provisions of the Corporation's Articles of Incorporation. SECTION 14. Removal of Directors. Any director or the entire board of directors may be removed for cause and then only in accordance with the provisions of the Corporation's Articles of Incorporation. SECTION 15. Compensation. Directors, as such, may receive a stated fee for their services. By resolution of the board of directors, a reasonable fixed sum, and reasonable expenses of attendance, if any, may be allowed for actual attendance at each regular or special meeting of the board of directors. - 5 - Members of either standing or special committees may be allowed such compensation for actual attendance at committee meetings as the board of directors may determine. Nothing herein shall be construed to preclude any director from serving the Corporation in any other capacity and receiving remuneration therefor. SECTION 16. Presumption of Assent. A director of the Corporation who is present at a meeting of the board of directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent or abstention shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who votes in favor of such action. ARTICLE IV Committees of the Board of Directors The board of directors may, by resolution passed by a majority of the whole board, designate one or more committees, as they may determine to be necessary or appropriate for the conduct of the business of the Corporation, and may prescribe the duties, constitution and procedures thereof. Each committee shall consist of one or more directors of the Corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. The board of directors shall have power, by the affirmative vote of a majority of the authorized number of directors, at any time to change the members of, to fill vacancies in, and to discharge any committee of the board. Any member of any such committee may resign at any time by giving notice to the Corporation provided, however, that notice to the board, the chairman of the board, the chairman of such committee, or the secretary shall be deemed to constitute notice to the Corporation. Such resignation shall take effect upon receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. Any member of any such committee may be removed at any time, either with or without cause, by the affirmative vote of a majority of the authorized number of directors at any meeting of the board called for that purpose. ARTICLE V Officers SECTION 1. Positions. The officers of the Corporation shall be a president, a chief executive officer, one or more vice presidents, a secretary and a treasurer, each of whom shall be elected by the board of directors. The offices of the secretary and treasurer may be held by the same person and a vice president may also be either the secretary or the treasurer. The board of directors may designate one or more vice presidents as executive vice president or senior vice president. The board of directors may designate the treasurer as chief financial officer. The board may designate the president as chief executive officer. The board of directors may also elect or authorize the appointment of such other officers as the business of the Corporation may require. The officers shall have such authority and perform such duties as the board of directors may from time to time authorize or determine. In the - 6 - absence of action by the board of directors, the officers shall have such powers and duties as generally pertain to their respective offices. SECTION 2. Election and Term of Office. The officers of the Corporation shall be elected annually by the board of directors at the first meeting of the board of directors held after each annual meeting of the stockholders. If the election of officers is not held at such meeting, such election shall be held as soon thereafter as possible. Each officer shall hold office until his successor shall have been duly elected and qualified or until his death or until he shall resign or shall have been removed in the manner hereinafter provided. Election or appointment of an officer, employee or agent shall not of itself create contract rights. The board of directors may authorize the Corporation to enter into an employment contract with any officer in accordance with state law; but no such contract shall impair the right of the board of directors to remove any officer at any time in accordance with Section 3 of this Article V. SECTION 3. Removal. Any officer may be removed by vote of the majority of the board of directors whenever, in its judgment, the best interests of the Corporation will be served thereby, but such removal, other than for cause, shall be without prejudice to the contract rights, if any, of the person so removed. SECTION 4. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the board of directors for the unexpired portion of the term. SECTION 5. Remuneration. The remuneration of the officers shall be fixed from time to time by the board of directors and no officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the Corporation. ARTICLE VI Contracts, Loans, Checks and Deposits SECTION 1. Contracts. To the extent permitted by applicable law, and except as otherwise prescribed by the Articles of Incorporation or these Bylaws with respect to certificates for shares, the board of directors may authorize any officer, employee, or agent of the Corporation to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation. Such authority may be general or confined to specific instances. SECTION 2. Loans. No loans shall be contracted on behalf of the Corporation and no evidence of indebtedness shall be issued in its name unless authorized by the board of directors. Such authority may be general or confined to specific instances. SECTION 3. Checks, Drafts, Etc. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by one or more officers, employees or agents of the Corporation in such manner as shall from time to time be determined by resolution of the board of directors. SECTION 4. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in any of its duly authorized depositories as the board of directors may select. - 7 - ARTICLE VII Certificates for Shares and Their Transfer SECTION 1. Certificates for Shares. The shares of the Corporation shall be represented by certificates signed by the chairman of the board of directors, by the president or vice president, by the treasurer/chief financial officer or by the secretary of the Corporation, and may be sealed with the seal of the Corporation or a facsimile thereof. Any or all of the signatures upon a certificate may be facsimiles if the certificate is countersigned by a transfer agent, or registered by a registrar, other than the Corporation itself or an employee of the Corporation. If any officer who has signed or whose facsimile signature has been placed upon such certificate shall have ceased to be such officer before the certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer at the date of its issue. SECTION 2. Form of Share Certificates. All certificates representing shares issued by the Corporation shall set forth upon the face or back that the Corporation will furnish to any shareholder upon request and without charge a full statement of the designations, preferences, limitations, and relative rights of the shares of each class authorized to be issued, the variations in the relative rights and preferences between the shares of each such series so far as the same have been fixed and determined, and the authority of the board of directors to fix and determine the relative rights and preferences of subsequent series. Each certificate representing shares shall state upon the face thereof: that the Corporation is organized under the laws of the State of Minnesota; the name of the person to whom issued; the number and class of shares; the date of issue; the designation of the series, if any, which such certificate represents; the par value of each share represented by such certificate, or a statement that the shares are without par value. Other matters in regard to the form of the certificates shall be determined by the board of directors. SECTION 3. Payment for Shares. No certificate shall be issued for any shares until such share is fully paid. SECTION 4. Form of Payment for Shares. The consideration for the issuance of shares shall be paid in accordance with the provisions of Minnesota law. SECTION 5. Transfer of Shares. Transfer of shares of capital stock of the Corporation shall be made only on its stock transfer books. Authority for such transfer shall be given only by the holder of record thereof or by his legal representative, who shall furnish proper evidence of such authority, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Corporation. Such transfer shall be made only on surrender for cancellation of the certificate for such shares. The person in whose name shares of capital stock stand on the books of the Corporation shall be deemed by the Corporation to be the owner thereof for all purposes. SECTION 6. Stock Ledger. The stock ledger of the Corporation shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list required by Minnesota law or the books of the Corporation, or to vote in person or by proxy at any meeting of stockholders. - 8 - SECTION 7. Lost Certificates. The board of directors may direct a new certificate to be issued in place of any certificate theretofore issued by the Corporation alleged to have been lost, stolen, or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen, or destroyed. When authorizing such issue of a new certificate, the board of directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen, or destroyed certificate, or his legal representative, to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen, or destroyed. SECTION 8. Beneficial Owners. The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and shall not be bound to recognize any equitable or other claim to or interest in such shares on the part of any other person, whether or not the Corporation shall have express or other notice thereof, except as otherwise provided by law. ARTICLE VIII Fiscal Year; Annual Audit The fiscal year of the Corporation shall end on the last day of December of each year. The Corporation shall be subject to an annual audit as of the end of its fiscal year by independent public accountants appointed by and responsible to the board of directors. ARTICLE IX Dividends Subject to the provisions of the Articles of Incorporation and applicable law, the board of directors may, at any regular or special meeting, declare dividends on the Corporation's outstanding capital stock. Dividends may be paid in cash, in property or in the Corporation's own stock. ARTICLE X Corporate Seal The corporate seal of the Corporation shall be in such form as the board of directors shall prescribe. ARTICLE XI Amendments The Bylaws may be altered, amended or repealed or new Bylaws may be adopted in the manner set forth in the Articles of Incorporation. - 9 - EX-13 3 EXHIBIT 13 [** LOGO **] WELLS FINANCIAL CORP. ANNUAL REPORT
WELLS FINANCIAL CORP. ANNUAL REPORT Wells Federal 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 SW Wells, Minnesota 56097 Letter to Stockholders................................... 4 BRANCH OFFICES: Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 5-17 Blue Earth 303 South Main Street Independent Auditor's Report............................. 18 Blue Earth, Minnesota 56013 Consolidated Statements of Financial Condition........... 19 Mankato - Madison East Madison East Center Consolidated Statements of Income........................ 20 1400 Madison Avenue Mankato, Minnesota 56001 Consolidated Statements of Stockholders' Equity.......... 21 North Mankato Consolidated Statements of Cash Flows....................22-24 1800 Commerce Drive North Mankato, Minnesota 56003 Notes to Consolidated Financial Statements...............25-47 Fairmont Office Location and Other Corporate Information.......... 48 Five Lakes Centre 300 South State Street Fairmont, Minnesota 56031 Albert Lea Skyline Mall 1710 West Main Street Albert Lea, Minnesota 56007 St. Peter 523 South Third Street St. Peter, Minnesota 56082 Owatonna 496 North Street 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 eight full service offices located in Faribault, Martin, Blue Earth, Nicollet, Freeborn and Steele Counties, 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. The Bank attracts deposits from the general public and uses such deposits primarily to invest in residential lending on owner occupied properties, home equity loans and other consumer loans. Other lending activities include agricultural real estate, agricultural operating, multi-family residential and commercial real estate loans. Cash in excess of what is needed for lending operations is used to purchase investment securities and to maintain required liquidity. The Bank has two subsidiaries, Greater Minnesota Mortgage (GMM) and Wells Insurance Agency (WIA). GMM originates loans through referrals from community commercial banks and, primarily, sells these loans to the secondary market. WIA is a full service insurance agency the sells property, casualty, life and health insurance products. 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, markdown, or commission, and may not represent actual transactions. HIGH LOW ----------------------- January 1, 1997 - March 31, 1997 $16.00 $12.875 April 1, 1997 - June 30, 1997 $15.50 $14.00 July 1, 1997 - September 30, 1997 $17.00 $15.00 October 1, 1997 - December 31, 1997 $19.00 $16.50 January 1, 1998 - March 31, 1998 $19.75 $16.125 April 1, 1998 - June 30, 1998 $21.938 $19.25 July 1, 1998 - September 30, 1998 $21.50 $15.75 October 1, 1998 - December 31, 1998 $18.00 $15.25 The number of stockholders of record of common stock as of the record date of March 8, 1999, was approximately 560. 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, 1999, there were 1,652,160 shares outstanding. 1 The Company declared quarterly cash dividends of $0.12 per share on January 21, 1998 and $0.15 per share on April 15, 1998, July 15, 1998 and October 21, 1998. The Company declared quarterly cash dividends of $0.12 per share on July 16, 1997 and October 15, 1997. No dividends were declared during 1995 or 1996. 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"). During 1998, the Bank paid $9.0 million in cash dividends to the Company. 2 WELLS FINANCIAL CORP. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (Dollars in thousands, except per share amounts)
Financial Condition - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 1994 1995 1996 1997 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Total assets $ 182,716 $ 195,158 $ 201,326 $ 201,436 $ 191,876 Loans held for sale 114 1,944 1,791 2,012 6,097 Loans receivable, net 165,185 169,760 178,447 182,724 154,305 Mortgage-backed securities available for sale 961 867 428 86 - Securities available for sale 5,951 6,753 7,100 2,640 2,968 Investment securities 5,991 4,199 2,049 3,198 5,539 Certificates of deposit 100 800 200 1,850 500 Cash and cash equivalents 1,480 8,192 8,301 5,971 19,446 Deposits 146,412 146,686 145,010 145,378 158,441 Borrowed funds 23,650 18,000 26,500 24,500 5,000 Equity 11,506 28,852 28,202 29,641 25,892 Summary of Operations - ------------------------------------------------------------------------------------------------------------------------------------ Years Ended December 31, 1994 1995 1996 1997 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Interest income $ 11,573 $ 13,489 $ 14,669 $ 15,325 $ 14,890 Interest expense 6,510 8,165 8,146 8,522 8,178 Net interest income 5,063 5,324 6,523 6,803 6,712 Provision for loan losses 113 166 180 180 120 Noninterest income 737 809 1,014 1,109 2,405 Noninterest expense (1) 3,574 3,855 5,245 3,987 4,769 Net income 1,283 1,270 1,200 2,220 2,476 Other Selected Data - ------------------------------------------------------------------------------------------------------------------------------------ Years Ended December 31, 1994 1995 1996 1997 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Return on average assets 0.74% 0.67% 0.61% 1.10% 1.26% Return on average equity 11.66% 5.50% 4.24% 7.71% 8.85% Average equity to average assets 6.31% 12.11% 14.40% 14.24% 14.25% Equity to assets 6.30% 14.78% 14.01% 14.71% 13.49% Net interest rate spread (2) 2.80% 2.29% 2.72% 2.75% 2.81% Nonperforming assets to total loans (3) 0.53% 0.17% 0.29% 0.26% 0.23% Allowance for loan losses to total loans 0.23% 0.30% 0.34% 0.41% 0.53% Allowance for loan losses to nonperforming loans (3) 45.85% 171.24% 138.20% 172.62% 236.94% Basic earnings per share (4) N/A $ 0.50 $ 0.61 $ 1.18 $ 1.42 Diluted earnings per share (4) N/A $ 0.50 $ 0.61 $ 1.16 $ 1.38
- ------------------------------ (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 [LOGO] WELLS FINANCIAL 53 FIRST ST. S.W., P.O.BOX 310, WELLS, MN 56097-0310 CORP. 507/553-3151 To Our Stockholders: We are pleased to present our fourth annual stockholder's report that provides a summary of the Company's operations for 1998. I urge that you review it in detail. Our net income of $2.5 million for the year was the highest in our history. As the earnings trend became apparent early in the year, the Board of Directors felt it was appropriate to increase the cash dividends from $0.12 per share declared for the first quarter to $0.15 per share for the following three quarters. The Board also concluded that repurchasing additional shares of stock was an appropriate method to enhance stockholder value. Details of this activity are also included in the report. In the letter to the stockholders included with the 1997 report, I touched briefly on the formation of Greater Minnesota Mortgage, Inc. (GMM), a wholly owned subsidiary of Wells Federal Bank. GMM completed its first full year of operation. The success in originating loans through referrals from community commercial banks and the resulting profit contribution to the Company far exceeded our highest expectations. We continue to expand marketing of this service and explore areas of additional business relationships that might be of mutual benefit to the parties involved. Your Board of Directors, the management team and the staff continue to strive to provide better service to our customers and search for ways to enhance the value of your investment in Wells Financial Corp. Your continued confidence and support is greatly appreciated. Best Regards, /s/ Lawrence H. Kruse - -------------------------------------- Lawrence H. Kruse President and Chief Executive Officer Chairman of the Board 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, agricultural real estate loans, 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 level of noninterest income, which primarily consists of service charges and other fees, also affects the Bank's net earnings. In addition, the level of noninterest (general and administrative) expenses affects net earnings. 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. The demand for and supply of housing, competition among lenders, the level of interest rates, and the availability of funds influence lending activities. 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. 5 (Dollars in Thousands) 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 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. These strategies include obtaining longer term fixed rate borrowings at favorable rates and, due to the lower rates currently available, the sale of all newly originated fixed rate mortgage loans to the secondary market. 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. 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, agricultural real estate and agricultural operating loans, 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. Historically, 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 ratios fixed rate loans with original maturities greater than fifteen years. Due to the lower than normal interest rate environment during 1998 the Bank elected to sell the majority of the fixed rate loans it originated during 1998, regardless of the loan to value ratio or the contractual maturity. 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 the NPV ratio of more than 2% (200 bp) will require the institution to deduct from its capital 50% of the amount of change in NPV. The rule provides that the OTS will calculate the IRR component quarterly for each institution. The OTS has informed the Bank, based on asset size and risk-based capital, that it is exempt from this rule. Nevertheless, the following table presents the Bank's NPV at December 31, 1998, 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 $13,033 $(8,918) (41)% 7.42% -424 bp +300 15,801 (6,151) (28)% 8.82% -285 bp +200 18,309 (3,643) (17)% 10.03% -164 bp +100 20,408 (1,543) (7)% 10.99% -67 bp -- 21,951 11.67% -100 23,213 1,262 6% 12.19% 52 bp -200 24,609 2,657 12% 12.76% 109 bp -300 26,508 4,557 21% 13.53% 186 bp -400 28,306 6,354 29% 14.23% 256 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, 1998 ------------------------ *** Risk Measures: 200 bp rate shock *** Pre-Shock NPV Ratio: NPV as % of PV of 11.67% Assets Exposure Measure: Post-Shock NPV Ratio 10.03% Sensitivity Measure: Change in NPV Ratio 164 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, 1998, no 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, ----------------------------------------------------------------------------------------- 1996 1997 1998 ----------------------------------------------------------------------------------------- Average Average Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost ----------------------------------------------------------------------------------------- Interest-earning assets: Loans receivable (1) 173,383 13,617 7.85% 183,591 14,570 7.94% 172,219 13,888 8.06% Mortgage-backed securities 661 45 6.81% 250 18 7.20% 12 1 8.33% Investments (2) 18,281 1,007 5.51% 14,426 737 5.11% 20,167 1,001 4.96% --------- ------ --------- ------ --------- ------ Total interest-earning assets 192,325 14,669 7.63% 198,267 15,325 7.73% 192,398 14,890 7.74% ------ ------ ------ Noninterest earning assets 4,163 3,979 4,049 --------- --------- --------- Total assets $ 196,488 $ 202,246 $ 196,447 ========= ========= ========= Interest bearing liabilities: Savings, NOW and money market accounts 36,578 949 2.59% 37,010 966 2.61% 40,300 1,046 2.60% Certificates of deposit 110,139 6,111 5.55% 107,394 6,014 5.60% 110,836 6,293 5.68% Borrowed funds 19,269 1,086 5.64% 26,808 1,542 5.75% 14,615 839 5.74% --------- ------ --------- ------ --------- ------ Total interest bearing liabilities 165,986 8,146 4.91% 171,212 8,522 4.98% 165,751 8,178 4.93% ------ ------ ------ Noninterest bearing liabilities 2,199 2,232 2,706 --------- --------- --------- Total liabilities 168,185 173,444 168,457 Equity 28,303 28,802 27,990 --------- --------- --------- Total liabilities and equity $ 196,488 $ 202,246 $ 196,447 ========= ========= ========= Net interest income 6,523 6,803 6,712 ====== ====== ====== Interest rate spread (3) 2.72% 2.75% 2.81% Net yield on interest earning assets (4) 3.39% 3.43% 3.49% Ratio of average interest earning assets to average interest bearing liabilities 1.16X 1.16X 1.16X ========= ========= ======
- ------------------------------ (1) Average balances include non-accrual loans and loans held for sale. (2) Includes interest-bearing deposits in other financial institutions. (3) Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (4) 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, ------------------------------------------------------------------------------- 1997 vs. 1996 1998 vs. 1997 ---------------------------------------- -------------------------------------- Increase (Decrease) Due to Increase (Decrease) Due to ---------------------------------------- -------------------------------------- Rate/ Rate/ Volume Rate Volume Net Volume Rate Volume Net ---------------------------------------- -------------------------------------- Interest Income: Loans receivable $ 801 $ 156 $ (4) $ 953 $ (903) $ 220 $ 1 $ (682) Mortgage-backed securities (28) 3 (2) (27) (17) 3 (3) (17) Investments (212) (73) 15 (270) 293 (22) (7) 264 ---------------------------------------- -------------------------------------- Total interest-earning assets 561 86 9 656 (627) 201 (9) (435) ---------------------------------------- -------------------------------------- Interest expense: Deposit accounts (141) 62 (1) (80) 279 82 (2) 359 Borrowed funds 425 21 10 456 (701) (3) 1 (703) ---------------------------------------- -------------------------------------- Total interest-bearing liabilities 284 83 9 376 (422) 79 (1) (344) ---------------------------------------- -------------------------------------- Net change in interest income $ 277 $ 3 $ - $ 280 $ (205) $ 122 $ (8) $ (91) ======================================== ======================================
10 (Dollars in Thousands) Financial Condition Total assets decreased by $9,560 from $201,436 at December 31, 1997 to $191,876 at December 31, 1998 primarily due to a $24,334 decrease in loans, from $184,736 at December 31, 1997 to $160,402 at December 31, 1998. Due to low interest rates on residential mortgage loans during 1998, many of the Company's customers refinanced their existing loans. Management elected to sell the majority of the residential loans originated during 1998 to the secondary market. This is the primary reason for the decrease in loans. 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, 1997 and December 31, 1998 the balance in the allowance for loan losses and the allowance for loan losses as a percentage of total loans was $763 and $853 and 0.41% and 0.53%, respectively. Loans on which the accrual of interest has been discontinued amounted to $237 and $260 at December 31, 1997 and 1998, 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, 1997 and 1998. Deposits increased by $13,063 from $145,378 at December 31, 1997 to $158,441 at December 31, 1998. Borrowed funds decreased by $19,500 at year end 1998 when compared to year end 1997 through the use of cash received from the increase in deposits and from the sale into the secondary market of refinanced loans from the Company's loan portfolio. Equity decreased by $3,749 from $29,641 at December 31, 1997 to $25,892 at December 31, 1998. The decrease in equity was primarily the result of net income for 1998 of $2,476 being offset by the payment of $1,001 in cash dividends and by the repurchase of 307,200 shares of treasury stock at a cost of $5,937. Also affecting equity was the allocation of $312 of employee stock ownership plan shares, the amortization of $84 of unearned compensation and a $317 increase in accumulated other comprehensive income. Comparison of Operating Results for the Years Ended December 31, 1998 and 1997 General. Net income for the year ended December 31, 1998 was $2,476; an increase of $256 when compared to net income for the year ended December 31, 1997. The increase in net income for 1998 when compared to 1997 was primarily the result of a $1,296 increase in noninterest income being partially offset by a $91 decrease in net interest income and a $782 and $227 increase in noninterest expense and income tax expense, respectively. 11 (Dollars in Thousands) Interest Income. Interest income decreased by $435 for the year ended December 31, 1998 when compared to the year ended December 31, 1997. A $682 decrease in interest on loans was partially offset by a $247 increase in interest income from investments. The decrease in interest income from loans was the result of a decrease in the average amount of the loan portfolio during 1998 when compared to 1997. Due to lower interest rates on residential mortgages, management elected to sell the majority of the residential loans originated during 1998 to the secondary market. Included in the loans originated and sold during 1998 were loans from the Company's mortgage loan portfolio that were refinanced. This is the primary reason for the decrease in the average amount of the loan portfolio. The increase in interest income from investments was the result of an increase in the average amount of investments during 1998 when compared to 1997. Interest Expense. During 1998, average borrowed funds decreased by $12,193 when compared to average borrowed funds during 1997 and average deposits increased by $3,290 during 1998 when compared to average deposits during 1997. The decrease in the average amount of borrowed funds during 1998 when compared to average borrowed funds during 1997 is the primary reason for the decrease in interest expense for the year ended December 31, 1998 when compared to the year ended December 31, 1997. Net Interest Income. Net interest income decreased by $91 for the year ended December 31, 1998 when compared to the year ended December 31, 1997 due to the changes in interest income and interest expense described above. Provision for Loan Losses. The provision for loan loss decreased by $60 for the year ended December 31, 1998 when compared to the year ended December 31, 1997. 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. Based on the decrease in size of the loan portfolio during 1998 when compared to 1997 and management's evaluation of the quality of the loan portfolio, management felt that a reduction in the provision for loan losses was warranted. 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 estimated amounts. Noninterest Income. Noninterest income increased by $1,296 for 1998 when compared to 1997. The increase in noninterest income was primarily due to increases in loan origination and commitment fees of $791 and the gain on sale of loans of $353 for the year ended December 31, 1998 when compared to the year ended December 31, 1997. These increases resulted from a greater amount of loans originated and sold to the secondary market during 1998 when compared to 1997. Also affecting noninterest income were increases in fees and service charges and loan servicing fees of $85 and $69, respectively. 12 (Dollars in Thousands) Noninterest Expense. Noninterest expense increased by $782 for the year ended December 31, 1998 when compared to the year ended December 31, 1997 primarily due to increases in compensation and benefits, occupancy and equipment and other noninterest expense. Late in the second quarter of 1997, the Company converted its loan origination office in Owatonna, Minnesota to a full service banking facility by employing additional staff and moving to a larger facility. The lease on the branch office at Riverfront Drive in Mankato expired during the fourth quarter of 1998. The Company relocated this branch office to a larger office with full drive-up facilities on Commerce Drive in North Mankato, an area that management feels will provide greater growth potential for the Company. These changes in facilities resulted in increased compensation and benefits and occupancy and equipment. Also affecting compensation and benefits were annual compensation increases. Other noninterest expense increased by $196 for 1998 when compared to 1997, primarily due to an increase in the amortization of mortgage servicing rights of $95 for the year ended December 31, 1998 when compared to the year ended December 31, 1997. Income Tax Expense. Income tax expense increased by $227 for the year ended December 31, 1998 when compared to the year ended December 31, 1997. This increase was the result of an increase in income before income taxes for 1998 when compared to 1997. Comparison of Operating Results for the Years Ended December 31, 1997 and 1996 General. Net income for the year ended December 31, 1997 was $2,220; an increase of $1,020 when compared to net income for the year ended December 31, 1996. The increase in net income for 1997 when compared to 1996 was primarily the result of legislation that was passed on September 30, 1996 which required savings institutions insured by the Savings Association Insurance Fund (SAIF) to pay a one time special assessment on September 30, 1996 to recapitalize the SAIF. The Bank's assessment amounted to $1,085, $640 net of tax affects. Net interest income and noninterest income increased by $280 and $95, respectively, for 1997 when compared to 1996. Noninterest expense decreased by $1,258, primarily due to the legislation mentioned above, and income taxes increased by $624 for 1997 when compared to 1996. Interest Income. Interest income increased by $656 for the year ended December 31, 1997 when compared to the year ended December 31, 1996. This increase is primarily the result of an increase in the average size of the loan portfolio during 1997 when compared to 1996 and also, to a lesser extent, due to an increase in interest rates on the loan portfolio. Interest Expense. During 1997, average borrowed funds increased by $7,539 when compared to average borrowed funds during 1996 and average deposits decreased by $2,313 during 1997 when compared to average deposits during 1996. The increase in average borrowed funds during 1997 when compared to average borrowed funds during 1996 is the primary reason for the $376 increase in interest expense for the year ended December 31, 1997 when compared to the year ended December 31, 1996. To a lesser extent, an increase in the interest rates paid on deposits and borrowings also increased interest expense for 1997 when compared to 1996. Net Interest Income. Net interest income increased by $280 for the year ended December 31, 1997 when compared to the year ended December 31, 1996. Again, this change is the result of the changes in interest income and interest expense that are discussed above. 13 (Dollars in Thousands) Provision for Loan Losses. The provision for loan losses remained constant for 1997 when compared to 1996. 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 $95 from $1,014 for the year ended December 31, 1996 to $1,109 for the year ended December 31, 1997. This increase is primarily due to an increase in loan origination and commitment fees and an increase in fees and service charges. Noninterest Expense. Noninterest expense decreased by $1,258 from $5,245 for the year ended December 31, 1996 to $3,987 for the year ended December 31, 1997. 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 increased noninterest expense during 1996 when compared to 1997. As a result of his legislation, the Bank's annual SAIF assessment was reduced from twenty-three basis points per dollar of deposits to approximately six basis points per dollar of deposits. Data processing expense decreased by $114 from $359 for the year ended December 31, 1996 to $245 for the year ended December 31, 1997. 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 software conversion during 1996 resulted in a non-recurring expense of approximately $132 that was recorded during 1996. Income Tax Expense. Income tax expense increased by $613 from $912 for the year ended December 31, 1996 to $1,525 for the year ended December 31, 1997. This increase resulted from the $1,633 increase in income before income taxes for the year ended December 31, 1997 when compared to the year ended December 31, 1996. Income tax expense as a percentage of income before taxes for the years ended December 31, 1997 and 1996 was 40.72% and 43.18%. 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, 1998, the Bank's liquidity, as measured for regulatory purposes, was 10.3%. 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. 14 (Dollars in Thousands) 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 levels of these assets are dependent on the Bank's operating, financing and investing activities during any given period. At December 31, 1998, the Bank's cash totaled $14,560. This compares to the Bank's cash at December 31, 1997 of $5,902. Also available to the Bank to meet liquidity requirements are borrowings from the Federal Home Loan Bank. At December 31, 1998, the Bank had $5,000 in outstanding advances from the FHLB of Des Moines, which have been used to fund loan originations. At December 31, 1998, the Bank had the ability to borrow approximately 16.5 times its then outstanding advances. In 1996 and 1998, the Company approved stock buy back programs in which up to 535,340 shares of the common stock of the Company could be acquired. The Company bought 307,200 shares of its common stock during 1998, which completed these approved buy back programs. During January 1999, the Company approved a stock buy back program in which up to 129,660 shares of the common stock of the Company can be acquired. 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, 1998, the Bank's tangible capital totaled $15.9 million, or 8.70% of adjusted total assets, and core capital totaled $15.9 million, or 8.70% of adjusted total assets, which substantially exceeded the respective 1.5% tangible capital and 3.0% core capital requirements at that date by $13.2 million and $10.4 million, respectively, or 7.20% and 5.70% of adjusted total assets, respectively. The Bank's risk-based capital totaled $16.7 million at December 31, 1998 or 14.78% of risk-weighted assets, which exceeded the current requirements of 8.0% of risk-weighted assets by $7.7 million or 6.78% 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. Impact of New Accounting Standards Effective January 1, 1997, the Company adopted FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement establishes the basic principles that an entity should recognize only assets it controls and liabilities it has incurred. Assets 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. Statement No. 125 also continues the recognition of mortgage servicing rights on loans sold and supersedes Statement No. 122 for transactions after January 1, 1997. 15 (Dollars in Thousands) In accordance with the provisions of Statements No. 122 and 125, mortgage servicing rights in the amounts of $662, $107 and $105 were capitalized during the years ended December 31, 1998, 1997 and 1996, respectively. The Company recognized amortization of the cost of mortgage servicing rights in the amounts of $125, $30 and $17 for the years ended December 31, 1998, 1997 and 1996, respectively. The effect of adopting Statements No. 122 and 125 was to increase net income by $77 and $88 for the years ended December 31, 1997 and 1996, respectively. Effective January 1, 1998, the Company adopted Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement No. 130), which was issued in June 1997. Statement No. 130 establishes new rules for the reporting and display of comprehensive income and its components, but has no effect on the Company's net income or total stockholder's equity. Statement No. 130 requires unrealized gains and losses on the Company's available for sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement No. 130. Effective January 1, 1998, the Company adopted Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related information (Statement No. 131). Statement No. 131 supersedes FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement No. 131 establishes standards for how public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement No. 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has determined that, for purposes of Statement No. 131, it has only one operating segment and no additional disclosure is required. The adoption of Statement No. 131 did not affect results of operations or financial position. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement No. 133) which is required to be adopted in years beginning after June 15, 1999. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Because the Company does not use derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on the Company's earnings or financial position. Year 2000 Evaluation Rapid and accurate data processing is essential to the Company's operations. Many computer programs that can only distinguish the final two digits of the year entered are expected to read entries for the year 2000 as the year 1900 or as zero and incorrectly attempt to compute payment, interest, delinquency and other data. We have been evaluating both information technology (our computer systems) and non-information technology systems (e.g., heating, cooling and ventilation controls). We have contacted the third party suppliers of non-information technology systems (utility companies, etc.) and examined all of our non- information technology systems. The third party suppliers of non-information technology systems have 16 (Dollars in Thousands) assured us they are aware of the possible year 2000 issue and are working to become year 2000 compliant before December 31, 1999. We do not expect any material costs to address our non-information technology systems and have not had any material costs to date. We have determined that the information technology systems we use have substantially more year 2000 risk than the non-information technology systems we use. We have evaluated our information technology systems risk in three areas: (1) our own computers, (2) computers of others used by our borrowers, and (3) computers of others who provide us with data processing. Our own computers. Our strategy to address the year 2000 issue in regards to the computers that we own is to replace all computers that are not year 2000 compliant. At December 31, 1998, the majority of our computers had been replaced. We expect to spend approximately $14 between December 31, 1998 and September 30, 1999 to replace the remaining computers that are not year 2000 compliant. Computers of others used by our borrowers. We have evaluated most of our borrowers and do not believe that the year 2000 problem should, on an aggregate basis, impact the borrowers' ability to make payments to the Company. We believe that most of the Company's residential and consumer borrowers are not dependent on their home computers for income. As a result, we have not contacted residential or consumer borrowers concerning this issue and do not consider this issue in our residential and consumer loan underwriting process. The majority of the Company's commercial real estate loans are collateralized by agricultural real estate and the majority of the Company's commercial operating loans are for farm machinery and farm inputs. We feel that the year 2000 issue should not significantly impact the Company's commercial borrowers' ability to make payments to the Company. Computers of others who provide us with data processing. This risk is primarily focused on one third party service bureau that provides virtually all of the Company's data processing. The software that is used by this service bureau was designed to be year 2000 compliant. We are monitoring the progress this service bureau is making in regards to testing their software and hardware to be year 2000 compliant. Testing of this risk that has been completed includes: testing of the software by the software vendor, testing of the software and hardware by the service bureau, proxy testing of the software and hardware by us and other banks using the service bureau's system and testing by us of the communication links between the Company and the service bureau. We have completed our testing of the software, hardware and communication links and are currently evaluating the results. We estimate that we will spend approximately $70 from December 31, 1998 to September 30, 1999 to complete the testing and upgrading of our data processing and communication systems. Contingency plan. Should this data processing system fail, the Company has developed a contingency plan. The contingency plan provides for the service bureau to furnish to the Company a complete database tape of our customers' accounts, complete with account history as of December 28, 1999. This information will also be supplied in printed form. Each of the Company's offices will be supplied with a computer workstation loaded with a database front-end entry screen program for recording transactions on their customers' accounts. If this labor-intensive approach is necessary, the Company's employees will become much less efficient. However, we believe the Company will be able to operate in this manner until the existing service bureau, or its replacement, is able to again provide data processing services. Despite our best efforts to address the year 2000 issue, the vast number of external entities that have direct and indirect relationships with us makes it impossible to assure that a failure to achieve compliance by one or more of these entities would not have a material adverse impact on the operations of the Company. 17 [LOGO] MCGLADREY & PULLEN, LLP -------------------------------------------- Certified Public Accountants and Consultants Independent Auditor's Report To the Board of Directors and Stockholders 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, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe 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, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ McGladrey & Pullen, LLP ---------------------------------- Rochester, Minnesota February 8, 1999 18 Wells Financial Corp. and Subsidiary Consolidated Statements of Financial Condition December 31, 1998 and 1997 (dollars in thousands)
ASSETS 1998 1997 - -------------------------------------------------------------------------------------- Cash, including interest-bearing accounts 1998 $18,523; 1997 $4,838 $ 19,446 $ 5,971 Certificates of deposit (Note 2) 500 1,850 Securities available for sale (Notes 3 and 10) 2,968 2,640 Securities held to maturity (Note 4) 5,539 3,198 Mortgage-backed securities available for sale (Note 3) -- 86 Loans held for sale (Note 5) 6,097 2,012 Loans receivable, net (Notes 5, 10, 16 and 17) 154,305 182,724 Accrued interest receivable 843 1,106 Premises and equipment (Note 8) 1,249 1,425 Foreclosed real estate (Note 7) -- 35 Other assets (Note 6) 929 389 ----------------------- Total assets $ 191,876 $ 201,436 ======================= LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------------- Liabilities Deposits (Note 9) $ 158,441 $ 145,378 Borrowed funds (Note 10) 5,000 24,500 Advances from borrowers for taxes and insurance 1,220 1,080 Income taxes (Note 11): Current 128 111 Deferred 885 474 Accrued interest payable 100 139 Accrued expenses and other liabilities 210 113 ----------------------- Total liabilities 165,984 171,795 ----------------------- Commitments, contingencies and credit risk (Notes 15, 16, and 17) Stockholders' Equity (Notes 12 and 14) 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 16,840 16,694 Retained earnings, substantially restricted 17,211 15,736 Accumulated other comprehensive income 901 584 Unearned Employee Stock Ownership Plan shares (591) (757) Unearned compensation-restricted stock awards (67) (151) Less cost of treasury stock, 1998 535,340 shares; 1997 228,140 shares (8,621) (2,684) ----------------------- Total stockholders' equity 25,892 29,641 ----------------------- Total liabilities and stockholders' equity $ 191,876 $ 201,436 =======================
See Notes to Consolidated Financial Statements. 19 Wells Financial Corp. and Subsidiary Consolidated Statements of Income Years Ended December 31, 1998, 1997 and 1996 (dollars in thousands, except per share data) 1998 1997 1996 - ----------------------------------------------------------------------------- Interest and Dividend Income Loans receivable First mortgage loans $ 11,257 $ 12,112 $ 11,558 Consumer and other loans 2,631 2,458 2,059 Investment securities and other interest- bearing deposits 1,002 755 1,052 -------------------------------- Total interest income 14,890 15,325 14,669 -------------------------------- Interest Expense Deposits 7,339 6,980 7,060 Borrowed funds 839 1,542 1,086 -------------------------------- Total interest expense 8,178 8,522 8,146 -------------------------------- Net interest income 6,712 6,803 6,523 Provision for loan losses (Note 5) 120 180 180 -------------------------------- Net interest income after provision for loan losses 6,592 6,623 6,343 -------------------------------- Noninterest Income Gain on sale of loans 434 81 102 Loan origination and commitment fees 965 174 81 Loan servicing fees 267 198 202 Insurance commissions 334 313 318 Fees and service charges 381 296 246 Other 24 47 65 -------------------------------- Total noninterest income 2,405 1,109 1,014 -------------------------------- Noninterest Expenses Compensation and benefits (Note 14) 2,521 2,037 1,911 Occupancy and equipment (Note 15) 735 681 644 Federal insurance premiums and assessment (Note 9) 91 94 1,406 Data processing 281 245 359 Advertising 190 175 150 Other 951 755 775 -------------------------------- Total noninterest expenses 4,769 3,987 5,245 -------------------------------- Income before income taxes 4,228 3,745 2,112 Income tax expense (Note 11) 1,752 1,525 912 -------------------------------- Net income $ 2,476 $ 2,220 $ 1,200 ================================ Earnings per share (Note 13): Basic $ 1.42 $ 1.18 $ 0.61 ================================ Diluted $ 1.38 $ 1.16 $ 0.61 ================================ See Notes to Consolidated Financial Statements. 20 Wells Financial Corp. and Subsidiary Consolidated Statements of STOCKHOLDERS' Equity Years Ended December 31, 1998, 1997 and 1996 (dollars in thousands)
Unearned Employee Unearned Accumulated Stock Compensation- Additional Other Ownership Restricted Total Comprehensive Common Paid-In Retained Comprehensive Plan Stock Treasury Stockholders' Income Stock Capital Earnings Income Shares Awards StStock Equity - ----------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1995 $ 219 $ 16,537 $ 12,786 $ 318 $ (1,008) $ $ $ 28,852 Comprehensive Income: Net income $ 1,200 1,200 1,200 Other comprehensive income, net of tax: Unrealized gains on securities, net of related taxes 30 30 30 ------------- Comprehensive income $ 1,230 ============= Treasury stock purchases, 163,640 shares (Notes 12 and 14) (1,763) (1,763) Purchase of common stock for restricted stock awards (Note 14) (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 Comprehensive Income: Net income $ 2,220 2,220 2,220 Other comprehensive income, net of tax: Unrealized gains on securities, net of related taxes 236 236 236 ------------- Comprehensive income $ 2,456 ============= Treasury stock purchases, 64,500 shares (Note (921) (921) 12) Cash dividends declared ($.24 per share) (470) (470) Amortization of unearned compensation 129 129 Allocated ESOP shares 106 139 245 -------------------------------------------------------------------------------------- Balances, December 31, 1997 219 16,694 15,736 584 (757) (151) (2,684) 29,641 Comprehensive Income: Net income $ 2,476 2,476 2,476 Other comprehensive income, net of tax: Unrealized gains on securities, net of related taxes 317 317 317 ------------- Comprehensive income $ 2,793 ============= Treasury stock purchases, 307,200 shares (Note (5,937) (5,937) 12) Cash dividends declared ($.57 per share) (1,001) (1,001) Amortization of unearned compensation 84 84 Allocated ESOP shares 146 166 312 -------------------------------------------------------------------------------------- Balances, December 31, 1998 $ 219$ 16,840$ 17,211$ 901 $ (591) $ (67)$ (8,621)$ 25,892 ======================================================================================
See Notes to Consolidated Financial Statements. 21 Wells Financial Corp. and Subsidiary Consolidated Statements of Cash Flows Years Ended December 31, 1998, 1997 and 1996 (dollars in thousands)
1998 1997 1996 - ----------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 2,476 $ 2,220 $ 1,200 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 120 180 180 Gain on sale of loans (434) (81) (102) Amortization of mortgage servicing rights 125 30 17 Compensation on allocation of ESOP shares 312 218 163 Amortization of unearned compensation 84 129 228 Write-down of foreclosed real estate -- 12 8 Loss (gain) on sale of foreclosed real estate 2 (12) (17) Unrealized loss (gain) on loans held for sale (14) (16) 30 Gain on premises and equipment (28) 7 Deferred income taxes 188 (48) (8) Depreciation and amortization on premises and equipment 279 273 264 Amortization of deferred loan origination fees (245) (151) (145) Amortization of excess servicing fees 13 13 14 Amortization of securities premiums and discounts 9 -- (2) Loans originated for sale (89,160) (14,914) (19,057) Proceeds from the sale of loans held for sale 85,089 14,709 19,207 Changes in assets and liabilities: Accrued interest receivable 263 (46) 60 Other assets (678) (52) 67 Income taxes payable, current 17 111 (54) Accrued expenses and other liabilities 58 16 (276) ------------------------------- Net cash provided by (used in) operating activities (1,524) 2,591 1,784 -------------------------------
(Continued) 22 Wells Financial Corp. and Subsidiary Consolidated Statements of Cash Flows (continued) Years Ended December 31, 1998, 1997 and 1996 (dollars in thousands)
1998 1997 1996 - ------------------------------------------------------------------------------------------- Cash Flows From Investing Activities Net (increase) decrease in loans $ 28,945 $ (4,252) $ (8,999) Certificates of deposit: Maturities 6,650 200 800 Purchases (5,300) (1,850) (200) Purchase of securities available for sale -- (171) (287) Proceeds from sales of securities available for sale 212 5,033 -- Securities held to maturity: Maturities and calls 4,491 3,649 5,900 Purchases (6,841) (4,798) (3,749) Proceeds from principal repayments of mortgage-backed securities available for sale 86 340 436 Proceeds from the disposal of leasehold improvements 75 -- -- Purchase of premises and equipment (150) (179) (552) Proceeds from the sale and redemption of foreclosed real estate 69 102 117 Investment in foreclosed real estate (3) (32) -- ---------------------------------- Net cash provided by (used in) investing activities 28,234 (1,958) (6,534) ---------------------------------- Cash Flows From Financing Activities Net increase (decrease) in deposits 13,063 368 (1,337) Net increase (decrease) from advances from borrowers for taxes and insurance 140 60 (2) Proceeds from borrowed funds 5,000 13,500 35,000 Repayments on borrowed funds (24,500) (15,500) (26,500) Purchase of treasury stock (5,937) (921) (1,763) Purchase of common stock for restricted stock awards -- -- (539) Dividends paid (1,001) (470) -- ---------------------------------- Net cash provided by (used in) financing activities (13,235) (2,963) 4,859 ---------------------------------- Net increase (decrease) in cash 13,475 (2,330) 109 Cash Beginning 5,971 8,301 8,192 ---------------------------------- Ending $ 19,446 $ 5,971 $ 8,301 ==================================
(Continued) 23 Wells Financial Corp. and Subsidiary Consolidated Statements of Cash Flows (continued) Years Ended December 31, 1998, 1997 and 1996 (dollars in thousands)
1998 1997 1996 - ----------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information Cash payments for: Interest on deposits $ 7,348 $ 6,982 $ 7,164 Interest on borrowed funds 869 1,527 1,076 Income taxes 1,547 1,450 981 ============================= Supplemental Schedule of Noncash Investing and Financing Activities: Other real estate acquired in settlement of loans $ 33 $ 27 $ 157 Allocation of ESOP shares to participants 166 139 112 Net change in unrealized gain on securities available for sale 317 236 30 =============================
See Notes to Consolidated Financial Statements. 24 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 its subsidiary, Wells Federal Bank, fsb (Bank). One of the Bank's subsidiaries, Wells Insurance Agency, Inc., is a property and casualty insurance agency. The other subsidiary of the Bank, Greater Minnesota Mortgage, Inc., is a mortgage banking company that originates loans through referrals from commercial banks. The Company serves its customers through the Bank's eight 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. Effective January 1, 1998, the Company adopted Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement No. 130), which was issued in June 1997. Statement No. 130 establishes new rules for the reporting and display of comprehensive income and its components, but has no effect on the Company's net income or total stockholders' equity. Statement No. 130 requires unrealized gains and losses on the Company's available for sale securities, which prior to adoption were reported separately in stockholders' equity, to be included in comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement No. 130. Effective January 1, 1998, the Company adopted Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (Statement No. 131). Statement No. 131 supersedes FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement No. 131 establishes standards for how public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement No. 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has determined that, for purposes of Statement No. 131, it has only one operating segment and no additional disclosure is required. The adoption of Statement No. 131 did not affect results of operations or financial position. 25 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 1. Summary of Significant Accounting Policies (Continued) 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 subsidiaries, Wells Insurance Agency, Inc. and Greater Minnesota Mortgage, Inc. All significant intercompany transactions and balances are eliminated in consolidation. Securities held to maturity: Debt securities for which the Company has both the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, is included in interest income. Securities available for sale: Securities classified as available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as 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 fair value. Unrealized gains or losses, net of the related deferred tax effect, are reported as a net amount in other comprehensive income. Amortization of premiums and accretion of discounts, computed by the interest method over their contractual lives, is recognized in interest income. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Declines in the fair value of individual securities classified as either held to maturity or 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. 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. All sales are made without recourse. Loans receivable: Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, reduced by an allowance for loan losses and net deferred loan origination fees. 26 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 1. Summary of Significant Accounting Policies (Continued) 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. 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. 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. 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. Loan servicing: The Company generally retains the right to service mortgage loans sold to others. The cost allocated to the mortgage servicing rights retained has been recognized as a separate asset and is being amortized in proportion to and over the period of estimated net servicing income. Mortgage servicing rights 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 capitalized 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. 27 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 1. Summary of Significant Accounting Policies (Continued) 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. 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 for cash and interest-bearing accounts approximate their fair values. Certificates of deposit: The carrying amounts reported for certificate of deposits approximate their fair values. Securities: Fair values for securities available for sale and securities held to maturity 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. 28 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 1. Summary of Significant Accounting Policies (Continued) 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. 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. Note 2. Certificates of Deposit Certificates of deposit with a carrying value of $500 and $1,850 at December 31, 1998 and 1997, respectively, had weighted average yields of 5.81% and 5.68%, respectively, and contractual maturities of less than one year. Note 3. Securities Available for Sale
December 31, 1998 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - --------------------------------------------------------------------------------------------------------------- Stock in Federal Home Loan Bank $ 1,421 $ -- $ -- $ 1,421 FHLMC stock 24 1,523 -- 1,547 ----------------------------------------------------------- $ 1,445 $ 1,523 $ -- $ 2,968 =========================================================== December 31, 1997 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - --------------------------------------------------------------------------------------------------------------- Stock in Federal Home Loan Bank $ 1,633 $ -- $ -- $ 1,633 FHLMC stock 24 983 -- 1,007 ----------------------------------------------------------- 1,657 983 -- 2,640 Mortgage-backed securities 86 -- -- 86 ----------------------------------------------------------- $ 1,743 $ 983 $ -- $ 2,726 ===========================================================
29 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 3. Securities Available for Sale (Continued) 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. Changes in unrealized gains on securities available for sale:
Years Ended December 31, --------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------- Balance, beginning $ 584 $ 348 $ 318 Unrealized gains during the year 540 399 56 Deferred tax effect relating to unrealized appreciation (223) (163) (26) --------------------------------------------------- Balance, ending $ 901 $ 584 $ 348 ===================================================
Note 4. Securities Held to Maturity
December 31, 1998 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ----------------------------------------------------------------------------------------------------------- Debt securities: U.S. Government corporations and agencies $ 5,539 $ 10 $ (7) $ 5,542 =============================================================
December 31, 1997 ------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ----------------------------------------------------------------------------------------------------------- Debt securities: U.S. Government corporations and agencies $ 3,198 $ 4 $ (1) $ 3,201 =============================================================
Contractual maturities: The scheduled maturities of securities held to maturity at December 31, 1998 were as follows:
Amortized Fair Cost Value - -------------------------------------------------------------------------------------------------------------- Due in one year or less $ -- $ -- Due from one to five years 5,539 5,542 ---------------------------------- $ 5,539 $ 5,542 ----------------------------------
Securities with a carrying value of $700 and $500 at December 31, 1998 and 1997, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. 30 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 5. Loans Receivable and Loans Held for Sale
Composition of loans receivable: Years Ended December 31, ------------------------ 1998 1997 - ---------------------------------------------------------------------------------------------- First mortgage loans (principally conventional): Principal balances: Secured primarily by one-to-four family residences $ 104,433 $ 141,346 Secured by other properties, primarily agricultural real estate 21,018 12,012 Construction 1,279 1,943 Less net deferred loan origination fees (450) (642) ----------------------- Total first mortgage loans 126,280 154,659 ----------------------- Consumer and other loans: Principal balances: Home equity, home improvement and second mortgages 18,475 18,781 Agricultural operating loans 2,394 1,299 Vehicle loans 4,644 4,988 Other 3,365 3,760 ----------------------- Total consumer and other loans 28,878 28,828 ----------------------- Total loans 155,158 183,487 Less allowance for loan losses (853) (763) ----------------------- Loan receivable, net $ 154,305 $ 182,724 =======================
Allowance for loan losses: Years Ended December 31, --------------------------- 1998 1997 1996 - --------------------------------------------------------------- Balance, beginning $ 763 $ 615 $ 512 Provision for loan losses 120 180 180 Loans charged off (46) (66) (88) Recoveries 16 34 11 --------------------------- Balance, ending $ 853 $ 763 $ 615 =========================== Nonaccrual loans: Loans on which the accrual of interest has been discontinued totaled $260, $237, and $298 at December 31, 1998, 1997 and 1996, respectively. The effect of nonaccrual loans was not significant to the results of operations. The Company includes all loans considered impaired in nonaccrual loans. The amount of impaired loans was not material at December 31, 1998 and 1997. Related party loans: The Company has entered into transactions with its executive officers, directors, significant shareholders, and their affiliates (related parties). The aggregate amounts of loans to such related parties at December 31, 1998 and 1997 were $294 and $452, respectively. During 1998, new loans to such related parties were $104 and repayments were $262. 31 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 5. Loans Receivable and Loans Held for Sale (Continued) Loans held for sale: As of December 31, 1998 and 1997, the Company's loans held for sale were $6,097 and $2,012, respectively, and consisted of one to four family residential real estate loans. Loans held for sale have been reduced by estimated unrealized market losses of $-0- and $14 at December 31, 1998 and 1997, respectively. Outstanding commitments to sell loans at December 31, 1998 were $6,097. Note 6. 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, 1998 and 1997 were $136,336 and $72,192, respectively, and consist of one-to-four family residential real estate loans. These loans are serviced primarily for the Federal Home Loan Mortgage Corporation. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in advances from borrowers for taxes and insurance, were $636 and $387 at December 31, 1998 and 1997, respectively. Effective January 1, 1996, the Company adopted FASB Statement No. 122, Accounting for Mortgage Servicing Rights. this Statement requires that a mortgage banking enterprise that acquires mortgage servicing rights through either the purchase or origination of mortgage loans and then sells or securitizes those loans with servicing rights retained should allocate the total cost of the mortgage loans to the mortgage servicing rights and the loans based on their relative fair values if it is practicable to estimate those fair values. Effective January 1, 1997, the Company adopted FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement establishes the basic principles 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. Statement No. 125 also continues the recognition of mortgage servicing rights on loans sold and supersedes Statement No. 122 for transactions after January 1, 1997. Mortgage servicing rights in the amounts of $662 and $107 were capitalized during the years ended December 31, 1998 and 1997, respectively. The fair values of capitalized mortgage servicing rights were $722 and $166 at December 31, 1998 and 1997, respectively. The fair values of the mortgage servicing rights were estimated as the present value of the expected future cash flows using a discount rate of 15%. The Company recognized amortization of the cost of mortgage servicing rights in the amounts of $125 and $30 for the years ended December 31, 1998 and 1997, respectively. The effect of adopting Statements No. 122 and 125 was to increase net income by $77 and $88 for the years ended December 31, 1997 and 1996, respectively. 32 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 7. Foreclosed Real Estate The Company had investment in real estate acquired through foreclosure or deeded to the Company in lieu of foreclosure of $-0- and $35 as of December 31, 1998 and 1997, respectively. No allowances for losses on foreclosed real estate were required at these dates. Note 8. Premises and Equipment Premises and equipment are summarized as follows: December 31, --------------------- 1998 1997 - ------------------------------------------------------------------------- Cost: Land $ 71 $ 71 Buildings and improvements 1,075 1,075 Leasehold improvements 330 537 Furniture, fixtures and equipment 2,005 1,861 --------------------- 3,481 3,544 Less accumulated depreciation and amortization 2,232 2,119 --------------------- $ 1,249 $ 1,425 ===================== Note 9. Deposits Composition of deposits: December 31, ---------------------- 1998 1997 - ------------------------------------------------------------------------ Demand and NOW accounts $ 24,781 $ 20,940 Savings accounts 18,377 16,117 Certificates of deposit 115,283 108,321 ---------------------- $ 158,441 $ 145,378 ====================== The aggregate amount of certificates of deposit over $100 was $10,524 and $10,387 at December 31, 1998 and 1997, respectively. 33 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 9. Deposits (Continued) A summary of scheduled maturities of certificates of deposits is as follows: Years Ending December 31, - -------------------------------------------------------------------------------- 1999 $ 78,785 2000 19,242 2001 13,583 2002 3,673 ----------- $ 115,283 =========== 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 10. Borrowed Funds Borrowed funds consisted of advances from Federal Home Loan Bank (FHLB), as follows: December 31, ---------------------------------- 1998 1997 - -------------------------------------------------------------- Due Date Interest Rate - --------------------------- 01/16/08 5.34% $ 5,000 $ -- 04/08/98 6.13% -- 3,000 05/04/98 5.46% -- 5,000 05/26/98 5.61% -- 6,000 06/23/98 5.86% -- 10,500 ---------------------------------- $ 5,000 $ 24,500 ================================== The advance due on January 16, 2008 has a fixed interest rate and is callable beginning January 16, 2003. Prepayment of the advance will result in a prepayment penalty. The advances are collateralized by FHLB stock and first mortgage loans with balances exceeding 125% of the amount of the advances. 34 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 11. Income Tax Matters The Company and its subsidiary file consolidated federal income tax returns. For years prior to 1996, the Company was allowed a special bad debt deduction based on a percentage of taxable income (8 percent) or on specified experience formulas. 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 only allow bad debt deductions based on actual charge-offs. The Company is required to recapture into income the excess of its December 31, 1995 loan loss reserves for "qualifying" and "nonqualifying" loans over its December 31, 1987 loan loss reserves for "qualifying" and "nonqualifying" loans. This excess, which is $177, is required to be recaptured ratably over a six year period. At December 31, 1998, the Company recorded a deferred tax liability of $36 to provide for the remaining recapture of the loan loss reserves and it is netted against the deferred tax asset. The components of income tax expense are as follows: Years Ended December 31, -------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------- Federal: Current $ 1,181 $ 1,186 $ 690 Deferred (credit) 143 (36) (6) -------------------------------------------------- 1,324 1,150 684 -------------------------------------------------- State: Current 383 387 230 Deferred (credit) 45 (12) (2) -------------------------------------------------- 428 375 228 -------------------------------------------------- Total $ 1,752 $ 1,525 $ 912 ================================================== 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, --------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------- Statutory rate applied to income before income taxes taxes $ 1,480 $ 1,311 $ 739 State income taxes, net of federal benefit 273 242 137 Effect of graduated rates (42) (37) (21) Other 41 9 57 --------------------------- Income tax expense $ 1,752 $ 1,525 $ 912 ===========================
35 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 11. Income Tax Matters (Continued) 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, --------------------------- 1998 1997 - --------------------------------------------------------------- Deferred tax assets: Allowance for loan losses $ 310 $ 261 Management stock bonus plan 63 71 Accrued vacation 39 33 Other 21 24 --------------------------- 433 389 Less valuation allowance --------------------------- 433 389 --------------------------- Deferred tax liabilities: Premises and equipment 155 165 Securities available for sale 622 399 FHLB stock dividends 217 217 Mortgage servicing rights 284 67 Deferred loan origination fees 10 Other 30 15 --------------------------- 1,318 863 --------------------------- $ (885) $ (474) =========================== Retained earnings at December 31, 1998 includes 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, 1998. Note 12. Stockholders' Equity, Regulatory Capital and Dividend Restrictions In April 1996, the Company initiated a stock buy back program. Shares totaling 307,200, 64,500 and 163,640 were purchased during the years ended December 31, 1998, 1997 and 1996, respectively. On January 20, 1999, the Company declared a dividend of $.15 per common share payable on February 12, 1999 to stockholders of record as of February 1, 1999. The scheduled dividend is $247,824. 36 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 12. Stockholders' Equity, Regulatory Capital and Dividend Restrictions (Continued) 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, 1998, that the Bank meets all capital adequacy requirements to which it is subject. The most recent examination by the Office of Thrift Supervision, as of December 29, 1997, 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. The following table summarizes the Bank's compliance with its regulatory capital requirements:
Bank's Capital Required Capital Excess Capital -------------------------------------------------------- As of December 31, 1998: Amount Percent Amount Percent Amount Percent -------------------------------------------------------- Tier 1 (leverage) capital $15,896 8.70 % $ 5,480 3.00 % $10,416 5.70 % Risk-based capital 16,745 14.78 % 9,066 8.00 % 7,679 6.78 % Bank's Capital Required Capital Excess Capital ----------------------------------------------------------------------------- As of December 31, 1997: Amount Percent Amount Percent Amount Percent ----------------------------------------------------------------------------- Tier 1 (leverage) capital $22,790 11.41 % $ 5,990 3.00 % $16,800 8.41 % Risk-based capital 23,544 20.00 % 9,417 8.00 % 14,127 12.00 %
37 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 12. Stockholders' Equity, Regulatory Capital and Dividend Restrictions (Continued) 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 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. The Bank paid dividends of $9 million to the Company during the year ended December 31, 1998. Note 13. Earnings Per Share Earnings per share (EPS) are calculated and presented in accordance with FASB Statement No. 128, Earnings per Share. The Statement requires the presentation of earnings per share by all entities that have common stock or potential common stock, such as options, warrants and convertible securities, outstanding that trade in a public market. Those entities that have only common stock outstanding are required to present basic earnings per-share amounts. All other entities are required to present basic and diluted earnings per-share amounts. Diluted per-share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce a loss or increase the income per common share from continuing operations. 38 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 13. Earnings Per Share (Continued) A reconciliation of the numerators and denominators of the basic and diluted earnings per-share computations follows: For the Year Ended December 31, 1998 --------------------------------- Income Shares Per-Share (Numerator) (Denominator) Amount - ------------------------------------------------------------------------ Basic EPS Net income $ 2,476 1,747,325 $ 1.42 ========= Effect of Dilutive Securities Stock options -- 49,966 ---------------------- Diluted EPS Net income plus assumed conversions $ 2,476 1,797,291 $ 1.38 =============================== For the Year Ended December 31, 1997 --------------------------------- Income Shares Per-Share (Numerator) (Denominator) Amount - ------------------------------------------------------------------------ Basic EPS Net income $ 2,220 1,873,499 $ 1.18 ========= Effect of Dilutive Securities Stock options -- 37,016 ------------------------------- Diluted EPS Net income plus assumed conversions $ 2,220 1,910,515 $ 1.16 =============================== For the Year Ended December 31, 1996 Income Shares Per-Share (Numerator)(Denominator) Amount - ------------------------------------------------------------------------ Basic EPS Net income $ 1,200 1,960,731 $ 0.61 ========= Effect of Dilutive Securities Stock options -- 6,454 ---------------------- Diluted EPS Net income plus assumed conversions $ 1,200 1,967,185 $ 0.61 =============================== 39 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 14. Employee Benefit Plans 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. There were no contributions made by the Bank for the years ended December 31, 1998, 1997 and 1996. 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. 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 additional principal on the debt. 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 $312, $218 and $163 for the years ended December 31, 1998, 1997 and 1996, respectively. Shares of the Company held by the ESOP at December 31, 1998 and 1997 are as follows: 1998 1997 - -------------------------------------------------------------------------------- Shares released for allocation 62,991 42,248 Unreleased (unearned) shares 73,897 94,640 ---------------------------------- 136,888 136,888 ---------------------------------- Fair value of unreleased (unearned) shares $ 1,164 $ 1,692 ---------------------------------- 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. 40 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 14. 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, 1998, 1997 and 1996 as the option price is the quoted market price of the shares at the date of the award. 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 $61, $100 and $176 for the years ended December 31, 1998, 1997 and 1996, respectively. Reported net income and earnings per common share would have been reduced to the pro forma amounts shown below: Years Ended December 31, --------------------------------------------- 1998 1997 1996 - ---------------------------------------------------------------------------- Net income: As reported $ 2,476 $ 2,220 $ 1,200 Pro forma 2,440 2,161 1,095 Basic earnings per share: As reported $ 1.42 $ 1.18 $ 0.61 Pro forma 1.40 1.15 0.56 Diluted earnings per share: As reported $ 1.38 $ 1.16 $ 0.61 Pro forma 1.36 1.14 0.56 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. 41 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 14. Employee Benefit Plans (Continued) The status of the Company's fixed stock option plan as of December 31, 1998 and 1997, and changes during the years ended on those dates are presented below: Years Ended December 31, ---------------------------------------------------------- 1998 1997 ---------------------------------------------------------- Weighted-Average Weighted-Average Fixed Options Shares Exercise Shares Exercise Price Price - -------------------------------------------------------------------------------- Outstanding at beginning of year 125,405 $ 11 125,405 $ 11 Granted -- -- -- -- Exercised -- -- -- -- Forfeited -- -- -- -- ---------------------------------------------------------- Outstanding at end of year 125,405 $ 11 125,405 $ 11 ========================================================== As of December 31, 1998, there were 125,405 options outstanding, all options had an exercise price of $11 per share, and their remaining contractual life was 6.8 years. As of December 31, 1998 and 1997, 75,243 and 50,162 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, 1998 and 1997 and the changes during the years ended on those dates is presented below: Years Ended December 31, -------------------------- 1998 1997 - --------------------------------------------------------------- Outstanding at beginning of year 28,785 38,380 Granted -- -- Vested and distributed (11,345) (9,595) Forfeited -- -- -------------------------- Outstanding at end of year 17,440 28,785 ========================== The Bank recorded expense of $84 relating to this Plan for the year ended December 31, 1998 and $129 for the year ended December 31, 1997. 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. 42 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 15. 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, 1998 are as follows: Years Ending - --------------------------------- 1998 $ 183 1999 129 2000 129 2001 118 2002 80 ---------------- $ 639 ================ Total rental expense related to operating leases was approximately $206, $174 and $162 for the years ended December 31, 1998, 1997 and 1996, respectively. 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 $22,685 and $12,512 at December 31, 1998 and 1997, respectively. The portion of commitments to extend credit that related to fixed rate loans is $7,280 and $3,201 as of December 31, 1998 and 1997, respectively. 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. 43 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 17. 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 taken into consideration by management in determining the allowance for loan losses. Concentration by institution: As of December 31, 1998 the Company had $18,523 on deposit with the FHLB of Des Moines. Note 18. Fair Values of Financial Instruments The estimated fair values of the Company's financial instruments are as follows:
Years Ended December 31, ----------------------------------------- 1998 1997 - ----------------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------------------------------------------- Financial assets Cash $ 19,446 $ 19,446 $ 5,971 $ 5,971 Certificates of deposit 500 500 1,850 1,850 Securities and mortgage backed securities available for sale 2,968 2,968 2,726 2,726 Securities held to maturity 5,539 5,542 3,198 3,201 Loans receivable, net 154,305 155,650 182,724 184,336 Loans held for sale 6,097 6,097 2,012 2,012 Accrued interest receivable 843 843 1,106 1,106 Financial liabilities Deposits 158,441 158,509 145,378 145,443 Borrowed funds 5,000 4,930 24,500 24,496 Advances from borrowers for taxes and insurance 1,220 1,220 1,080 1,080 Accrued interest payable 100 100 139 139 ==============================================
44 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 19. Financial Information of Wells Financial Corp. (Parent Only) The Company's condensed statements of financial condition as of December 31, 1998 and 1997 and related condensed statements of income and cash flows for each of the years in the three year period ended December 31, 1998 are as follows:
Condensed Statements of Financial Condition 1998 1997 - -------------------------------------------------------------------------------------- Assets Cash, including deposits with Wells Federal Bank, fsb 1998 $195; 1997 $318 $ 5,081 $ 387 Certificates of deposit 200 350 Securities held to maturity 2,499 750 Investment in Wells Federal Bank, fsb 18,091 24,148 Loan to Wells Federal Bank, fsb 4,000 Accrued interest receivable and other assets 21 12 ---------------------------------- Total assets $ 25,892 $ 29,647 ================================== Liabilities and Stockholders' Equity Liabilities $ $ 6 Stockholders' equity 25,892 29,641 ---------------------------------- Total liabilities and stockholders' equity $ 25,892 $ 29,647 ==================================
Condensed Statements of Income 1998 1997 1996 - ------------------------------------------------------------------------ Interest income $ 261 $ 402 $ 466 Other expenses 125 52 73 --------------------------------- Income before income taxes 136 350 393 Income tax expense 55 87 169 --------------------------------- Net income before equity in net income of subsidiary 81 263 224 Equity in net income of subsidiary 2,395 1,957 976 --------------------------------- Net income $ 2,476 $ 2,220 $ 1,200 --------------------------------- 45 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 19. Financial Information of Wells Financial Corp. (Parent Only) (Continued)
Condensed Statements of Cash Flows 1998 1997 1996 - --------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 2,476 $ 2,220 $ 1,200 Adjustment to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiary (2,395) (1,957) (976) (Increase) decrease in accrued interest receivable (10) 3 (5) Increase (decrease) in other liabilities (6) (55) 59 ---------------------------------- Net cash provided by operating activities 65 211 278 ---------------------------------- Cash Flows From Investing Activities Purchase of certificates of deposit (100) (350) (200) Purchase of securities held to maturity (2,499) (1,750) (1,999) Proceeds from the maturities of certificates of deposit 250 200 800 Proceeds from maturity of securities held to maturity 750 1,499 1,700 Dividends from subsidiaries 9,000 Decrease in loan to Wells Federal Bank, sb 4,000 1,000 ---------------------------------- Net cash provided by (used in investing activities 11,401 (401) 1,301 ---------------------------------- Cash Flows From Financing Activities Payments relating to ESOP stock 166 139 112 Purchase of treasury stock (5,937) (921) (1,362) Dividends paid (1,001) (470) ---------------------------------- Net cash (used in) financing activities (6,772) (1,252) (1,250) ---------------------------------- Net increase in cash 4,694 (1,442) 329 Cash: Beginning of period 387 1,829 1,500 ---------------------------------- End of period $ 5,081 $ 387 $ 1,829 ==================================
46 Wells Financial Corp. and Subsidiary Notes to consolidated financial statements (dollars in thousands) - -------------------------------------------------------------------------------- Note 20. Selected Quarterly Financial Data (Unaudited) (dollars in thousands, except per share data) Year Ended December 31, 1998 - ---------------------------------------------------------------------- First Second Third Fourth ------------------------------------------- Interest income $ 3,942 $ 3,806 $ 3,592 $ 3,550 Net interest income 1,751 1,683 1,640 1,638 Provision for loan losses 30 30 30 30 Net income 658 622 576 620 Earnings per share Basic 0.35 0.34 0.34 0.39 Diluted 0.34 0.33 0.33 0.38 Year Ended December 31,1997 - -------------------------------------------------------------------- First Second Third Fourth ---------------------------------------- Interest income $ 3,756 $ 3,817 $ 3,862 $ 3,890 Net interest income 1,716 1,701 1,689 1,697 Provision for loan losses 45 45 45 45 Net income 560 539 561 560 Earnings per share Basic 0.29 0.29 0.30 0.30 Diluted 0.29 0.28 0.30 0.29 47 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 David Buesing President, Wells Federal Bank President, Wells Concrete Products, Inc. Gerald D. Bastian Randel I. Bichler Branch Manager, Wells Federal Bank Attorney, Bichler 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, CPA President and Chief Executive Officer Treasurer and Principal Financial and Accounting Officer Gerald D. Bastian Wallace J. Butson Vice President Secretary -------------------- Corporate Counsel: Independent Auditors: Randel I. Bichler, 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 & 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, 1998, filed with the Securities and Exchange Commission on Form 10 KSB is available without charge upon written request. For a copy of the Form 10 KSB 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 21, 1998 at 4:00 p.m. at eh corporate Office, wells, Minnesota. EX-23 4 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-3520 of Wells Financial Corp. on Form S-8 (filed with the Securities and Exchange Commission on April 12, 1996) of our report, dated February 8, 1999, included in this Annual Report on Form 10-KSB of Wells Financial Corp. for the year ended December 31, 1998. /s/ MCGLADREY & PULLEN, LLP ------------------------------- Rochester, Minnesota March 23, 1999 EX-27 5 FDS
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION DERIVED FROM THE ANNUAL REPORT ON FORM 10-KSB AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL INFORMATION. 1000 year Dec-31-1998 Dec-31-1998 923 19,023 0 0 2,968 5,539 5,542 160,402 853 191,876 158,441 5,000 2,543 0 0 0 219 25,673 191,876 13,888 1,002 0 14,890 7,339 839 6,712 120 0 4,769 4,228 4,228 0 0 2,476 1.42 1.38 3.49 260 360 0 356 763 46 16 853 853 0 0
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