-----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, Wq8XiB60+HRMv1haRf2O5hmr4V96KBj1BQO8LDjVfuIB2W8YcCw/nWmw3Mv5xnz7 x/Tu7VsxUyv5XD6EkDty3A== 0000946275-98-000562.txt : 19980928 0000946275-98-000562.hdr.sgml : 19980928 ACCESSION NUMBER: 0000946275-98-000562 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980925 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: REDWOOD FINANCIAL INC /MN/ CENTRAL INDEX KEY: 0000942895 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 411807233 STATE OF INCORPORATION: MN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-25884 FILM NUMBER: 98715350 BUSINESS ADDRESS: STREET 1: 301 S WASHINGTON ST STREET 2: P O BOX 317 CITY: REDWOOD FALLS STATE: MN ZIP: 56283 BUSINESS PHONE: 5076378730 MAIL ADDRESS: STREET 1: 301 S WASHINGTON ST STREET 2: PO BOX 317 CITY: REDWOOD FALLS STATE: MN ZIP: 56283 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 For the fiscal year ended June 30, 1998, [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File No. 0-25884 REDWOOD FINANCIAL, INC. ---------------------------------------------- (Name of Small Business Issuer in Its Charter) Minnesota 41-1807233 - --------------------------------------------- ------------------ (State or Other Jurisdiction of Incorporation I.R.S. Employer or Organization) Identification No. 301 South Washington Street (P.O. Box 317), Redwood Falls, Minnesota 56283-0317 - -------------------------------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) Issuer's Telephone Number, Including Area Code: (507) 637-8730 -------------- 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) Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]. Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the 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. [ ] State issuer's revenues for its most recent fiscal year $4.9 million. ------------ The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the average bid and asked price of the registrant's Common Stock on September 2, 1998, was $6.6 million ($13.0 per share based on 510,221 shares of Common Stock held by non-affiliates). As of September 2, 1998, there were issued and outstanding 800,611 shares of the registrant's Common Stock. Transition Small Business Disclosure Format (check one) YES [ ] NO [X] DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Stockholders for the Fiscal Year ended June 30, 1998. (Part II) 2. Portions of the Proxy Statement for the Annual Meeting of Stockholders. (Part III) PART I Item 1. Business - ----------------- Business of the Company Redwood Financial, Inc. (the "Company") is a Minnesota corporation. It was organized in January 1995 at the direction of Redwood Falls Federal Savings and Loan Association (the "Association") in connection with the Association's conversion from the mutual to stock form (the "Conversion"). On July 7, 1995, the Association completed its conversion and became a wholly owned subsidiary of the Company. Subsequently, in May 1998, the Association changed its corporate title to HomeTown Bank (the "Bank"). 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 the Bank retains a specified amount of its assets in housing-related investments. At June 30, 1998, the Company had total assets of $77.3 million, total deposits of $48.1 million, and stockholders' equity of $11.9 million. The primary activity of the Company is to hold all of the outstanding capital stock of the Bank, however, the Company maintains a small loan portfolio separate from its investment in the Bank. Business of the Bank The Bank attracts deposits from the public and uses such deposits primarily to purchase investment securities and mortgage-backed and related securities and to originate loans in its market area. For its loan portfolio, the Bank originates and retains fixed and adjustable rate loans, and fixed rate balloon loans. The Bank is primarily a 1-4 family residential mortgage lender; however, the Bank has actively begun origination of commercial and agricultural loans, including both real estate secured and operating and term loans secured by non-real estate collateral. The Bank also originates various consumer loans and a limited number of multi-family and residential construction loans. The Bank also participates in several commercial, commercial real estate, and agricultural loans. The principal sources of funds for the Bank's lending activities are deposits and the amortization, repayment, and maturity of loans and investment securities. The Bank also obtains funds from Federal Home Loan Bank ("FHLB") advances. The Bank does not rely on brokered deposits, however, a substantial portion of the Bank's deposits are funds from local government entities. Principal sources of income are interest on loans, mortgage-backed and related securities, and investment securities. The Bank's principal expenses are interest expense on deposits and noninterest expense and, to a lesser extent, interest expense on FHLB advances. The Bank is subject to examination and comprehensive regulation by the Office of Thrift Supervision ("OTS") 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 1958. The Bank is a member of, and owns capital stock in, the Federal Home Loan Bank ("FHLB") of Des Moines, which is one of the 12 regional banks in the FHLB System. Market Area and Competition The Bank's market area consists of a major portion of Renville County and northern Redwood County, Minnesota. This area is primarily rural with a large amount of agri-business. The primary lending concentration is in the Bank's market area, an area mainly comprised of the cities of Redwood Falls and Olivia, both of which are county seats and have populations of approximately 5,000 and 2,800, respectively. Historically, the economy in the Bank's market area has been dependent on agriculture and agriculture related industries. However, one of the largest employers in this area is a manufacturer of 2 peripheral parts for computers. In recent years, a casino has had an important economic impact on the area providing employment and promoting tourism. Employment is also provided by city and county governments, through their need for administrative and hospital workers. Lending Activities General. The Company's loan portfolio predominantly consists of mortgage loans secured by single family residences. The Company also makes agricultural and commercial real estate, consumer, residential construction, multi-family real estate loans, and agricultural and commercial non-real estate loans. From time to time, the Company will participate in agricultural and commercial real estate loans and, agricultural operating and commercial loans not secured by real estate. Most of the Company's loan portfolio is secured by first mortgage loans on one- to four-family residences. For its mortgage loan portfolio, the Company originates and retains both fixed-rate and adjustable-rate loans. The Company does not sell mortgage loans into the secondary market. The Company's consumer loan portfolio consists primarily of savings account loans and to a lesser extent other consumer loans. The Company's commercial real estate loans are secured by multi-family residential apartment buildings, office buildings, and retail establishments. Agricultural loans are secured by real estate and/or other farm related collateral. Analysis of Loan Portfolio. The following table sets forth information concerning the composition of the Company's loan portfolio in dollar amounts and in percentages of the loan portfolio (before deductions for loans in process, deferred loan fees and discounts, and allowance for loan losses) as of the dates indicated.
At June 30, -------------------------------------------------- 1998 1997 ------------------------ ---------------------- Amount Percentage Amount Percentage ------ ---------- ------ ---------- (Dollars in thousands) Real estate loans: Residential (1-4 family) ......... $ 24,261 83.67% $ 18,577 89.46% Residential construction ......... 464 1.60 502 2.42 Multi-family ..................... 1,472 5.08 174 0.84 Multi-family construction ........ 0 0 980 4.72 Commercial ....................... 1,375 4.74 680 3.27 Agricultural ..................... 113 0.39 150 0.72 Consumer loans: Other consumer loans ............. 182 0.63 21 0.10 Loans on deposits ................ 256 0.88 133 0.64 Commercial ......................... 1,236 4.26 715 3.44 Agricultural operating ............. 2,793 9.64 425 2.05 -------- ------ -------- ------ Total .............................. 32,152 110.89 22,357 107.66 Less: Loans in process ................. (2,877) (9.92) (1,361) (6.56) Deferred loan fees and discounts . (29) (0.10) (16) (0.08) Allowance for loan losses ........ (251) (0.87) (213) (1.02) -------- ------ -------- ------ Total loans, net ................... $ 28,995 100.00% $ 20,767 100.00% ======== ====== ======== ======
The Company primarily originates loans for retention in its portfolio and has not purchased whole loans or sold loans during the past three years. 3 Loan Maturity Tables. The following table sets forth the maturity of Company's loan portfolio at June 30, 1998. The table does not include prepayments or scheduled principal repayments. Adjustable-rate mortgage loans are shown as maturing based on contractual maturities.
One- to Four- Multi- Family Family Residential Multi-Family Commercial Agricultural Residential Real Estate Construction Construction Real Estate Real Estate Consumer Commercial Agricultural Total ----------- ----------- ------------ ------------ ----------- ----------- -------- ---------- ------------ ----- (In thousands) Amounts Due: Within 1 year $ 830 $ 45 $ 0 $ 0 $ 7 $ 0 $ 153 $ 105 $ 1 $ 1,141 1 to 5 years . 8,150 416 0 0 560 113 88 324 2,174 11,825 After 5 years 15,281 1,011 464 0 808 0 197 807 618 19,186 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Total amount due $24,261 $ 1,472 $ 464 $ 0 $ 1,375 $ 113 $ 438 $ 1,236 $ 2,793 $32,152 ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
4 The following table sets forth the dollar amount of all loans due after June 30, 1999, which have pre-determined interest rates and which have floating or adjustable interest rates. Floating or Fixed Adjustable Rates Rates Total (In thousands) 1-4 Family residential............ $18,349 $5,082 $23,431 Multi-family real estate.......... 416 1,011 1,427 Residential construction.......... 464 -- 464 Multi-family construction......... -- -- -- Commercial real estate............ 1,334 34 1,368 Agricultural real estate.......... 113 -- 113 Consumer.......................... 285 -- 285 Commercial........................ 1,131 -- 1,131 Agricultural...................... 2,792 -- 2,792 ------- ------- ------- Total........................... $ 24,884 $ 6,127 $ 31,011 ======= ======= ======= One-to Four-Family Residential Loans. The Bank's primary lending activity consists of the origination of one- to four-family residential mortgage loans secured by property located in the Bank's primary market area. The Bank generally originates one- to four-family residential first 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 Bank generally will not originate any loan which exceeds 95% of the lesser of the appraised value or the selling price of the property and typically requires private mortgage insurance on any loans in excess of 80% of the value of the mortgaged property. The Bank also originates home equity loans (e.g., second mortgage loans) up to 90% of the appraised value on an aggregate basis with all other mortgages without private mortgage insurance. In order to maintain interest-rate risk at acceptable levels, the Bank originates primarily fixed-rate, balloon mortgage loans that provide for an amortization of up to 30 years, but which typically mature after 5 to 7 years. Provided the borrower demonstrates acceptable repayment ability, the Bank will usually refinance the balloon mortgage loan at maturity at the then current market rate of interest. Among other factors, the Bank's refinancing of these loans is dependent upon adequate collateral value. The Bank will originate fixed-rate loans with maturities of up to 30 years. The Bank monitors the level of this type of long-term, fixed-rate lending in order to control interest-rate risk. In addition, the Bank attempts to fund long-term, fixed-rate loans with long-term deposits and FHLB advances. The Bank also offers adjustable-rate loans, although the majority of its recent loan production has been in fixed-rate balloon loans. The Bank's adjustable-rate mortgage loans provide for periodic interest-rate adjustments of 1% to 2% with a maximum adjustment over the life of the loan of between 5% and 6%. Typically, the interest rate on these loans adjusts every 1, 3, or 5 years, and provides for amortization over a 15- to 30-year period. Indices used in the origination of adjustable-rate mortgage loans include both U.S. Treasury securities and a national cost of funds index. Interest rates charged on mortgage loans are competitively priced based on market conditions and the Bank's cost of funds. The origination fees for loans are generally 1% of the loan amount. Generally, the Bank's standard underwriting guidelines for fixed-rate mortgage loans conform to Federal Home Loan 5 Mortgage Corporation ("FHLMC") guidelines. It is the current policy of the Bank to originate loans solely for its loan portfolio. However, if certain market conditions exist, the Bank may originate long-term, fixed-rate loans for sale in the secondary mortgage market. The Bank will continue to emphasize short-term or adjustable-rate mortgage loans consistent with its asset/liability management strategy; however, recent declines in interest rates have resulted in a higher level of origination of long-term, fixed-rate loans. At June 30, 1998, the Bank did not service loans for others. Consumer Loans. Consumer loans are primarily made when secured by a savings account in the Bank. These loans generally have rates that adjust with the rate on the underlying account and are typically at least one percent above the rate on the underlying account. Savings account loans are offered subject to a 90% loan-to-value ratio. The Bank is in the process of expanding its consumer loan program to include auto, unsecured, and other forms of consumer lending. At June 30, 1998, the Bank's balance in these other consumer loans totaled $182,000. Although the Bank also makes home equity loans, these loans are secured by liens on primary residences and are categorized as one- to four-family residential mortgage loans. Commercial Real Estate Loans. In order to serve its community and enhance the yield on its assets, the Bank originates loans secured by commercial real estate. Loans secured by commercial real estate are generally originated in amounts up to 80% of the appraised value of the property. Commercial real estate loans are either adjustable-rate loans that reprice after 1, 3, or 5 years or fixed-rate balloon loans due after 1, 3, or 5 years. Commercial real estate loans typically amortize over a 25- to 30-year period. At June 30, 1998, the Bank's largest commercial real estate loan to one borrower consisted of a loan totaling $328,000, secured by several retail properties in Redwood Falls, Minnesota. All commercial real estate loans require approval by the Bank's Board of Directors. As part of its underwriting, the Bank requires that borrowers qualify for adjustable rate commercial real estate loans 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 the small total dollar amount of loans secured by church real estate that are originated by the Bank, repayment is dependent upon the continuing financial support of the church's members. Residential Construction Loans. Residential construction loans are generally made on single-family residential property to the individuals who will be the owners and occupants upon completion of construction. These loans are made on a long-term basis and are classified as construction permanent loans, usually with no principal payments required during the first six months, after which the payments are set at an amount that will amortize over a 15- to 30-year period. The maximum loan-to-value ratio is 80%. For loans with private mortgage insurance, the maximum loan to value ratio is 95%. Because residential construction loans are not rewritten if permanent financing is obtained from the Bank, these loans are made on terms similar to those of the Bank's one- to four-family residential loans and may be amortized over terms of up to 30 years. The Bank originates a limited number of speculative loans to builders and limits the loan to value ratio to 80% with a balloon maturity based on an amortization of up to 30 years on terms that are 6 assumable by ultimate purchasers. In underwriting such loans, the Bank takes into consideration the number of units that the builder has on a speculative basis that remain unsold. Multi-Family Loans. The Bank also makes fixed-rate and adjustable-rate multi-family loans, including loans on apartment complexes. At June 30, 1998, the Company's largest multi-family loans consisted of two loans to the economic development authorities of the cities of Redwood Falls and Olivia, Minnesota totaling $498,000 and $480,000, respectively. The loans are secured by mortgage liens on the respective multi-family properties. Multi-family loans generally provide higher origination fees and interest rates than can be obtained from single-family mortgage loans. Multi-family lending, however, entails significant additional risks compared with one- to four-family residential lending. Commercial Loans. During fiscal 1998, the Bank began to actively originate commercial loans not secured by real estate. In this period, the Bank hired a local experienced loan officer to expand its commercial and agricultural lending programs. As such, the Bank's portfolio of commercial non-real estate loans increased by $695,000 to $1,236,000 from June 30, 1997 to June 30, 1998. The Company's largest commercial loans to one borrower consist of two participation loans, totaling $737,000 to a local casino secured primarily by the casino's revenues. Commercial loans generally involve a greater degree of risk than mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the lack of real estate as collateral, 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 commercial loans is typically dependent upon the successful operation of the related commercial enterprise. If the cash flow from the enterprise is reduced, the borrower's ability to repay the loan may be impaired. Agricultural Lending. As with the Bank's commercial lending activities, during fiscal 1998, the Bank began to actively originate agricultural loans secured by real estate or by other non real estate collateral. As a result, the Bank's portfolio of agricultural loans secured by non-real estate collateral increased by $2,368,000 to $2,793,000 from June 30, 1997 to June 30, 1998. The Bank's portfolio of agricultural loans secured by real estate declined modestly by $37,000 to $113,000 from June 30, 1997 to June 30, 1998. The Company's largest agricultural loans to one borrower consist of an agricultural term loan totaling $537,000 secured by cooperative stock. Agricultural lending, including both operating and real estate-secured agricultural lending generally involves a greater degree of risk than the Bank's traditional residential mortgage lending efforts. This increased credit risk is a result of various factors, including higher loan balances, the concentration of principal in a limited number of loans and borrowers, the effects of general and farm-specific economic conditions, weather conditions, and the increased difficulty in monitoring these types of loans. Moreover, repayment is largely dependent upon the successful operation of the farm enterprise. If the cash flow from the farm enterprise is reduced, the borrower's ability to repay the loan may be impaired. Loan Commitments. The Bank issues written commitments to prospective borrowers on all real estate loans. Generally, the commitment requires acceptance within 45 days of the date of issuance. At June 30, 1998, the Bank had $2,198,000 of commitments to cover originations, undisbursed funds for loans in process, and unused lines of credit. The Bank believes that most of the Bank's commitments will be funded. 7 Nonperforming and Problem Assets Loan Delinquencies. Loans are reviewed on a monthly basis and are placed on a non-accrual status when the loan becomes more than 90 days delinquent and, if, 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. Nonperforming Assets. The following table sets forth information regarding non-accrual loans, real estate owned, and certain other repossessed assets and loans. As of the dates indicated, the Bank had no loans modified in a troubled debt restructuring.
June 30, --------------------------- 1998 1997 ------- ------- (Dollars in thousands) Loans accounted for on a non-accrual basis: Mortgage loans: Permanent loans secured by 1-4 family residences........... $ -- $ -- All other mortgage loans................................... -- -- Non-mortgage loans........................................... -- -- ------ ------ Total........................................................ $ -- $ -- ===== ====== Accruing loans which are contractually past due 90 days or more: Mortgage loans: Permanent loans secured by 1-4 family residences........... $ 75 $ 120 All other mortgage loans................................... -- -- Non-mortgage loans........................................... 15 -- ----- ------ Total........................................................ $ 90 $ 120 ==== ====== Total non-accrual and accrual loans.......................... $ 90 $ 120 ==== ====== Real estate.................................................. $ -- 14 ===== ====== Other non-performing assets.................................. $ -- -- ===== ====== Total non-performing assets.................................. $ 90 $ 134 ===== ====== Total non-accrual and accrual loans to net loans.................................................. 0.31% 0.58% ==== ==== Total non-accrual and accrual loans to total assets............................................... 0.12% 0.19% ==== ==== Total non-performing assets to total assets.................. 0.12% 0.22% ==== ====
There was no interest income that would have been recorded on loans placed on a non-accrual basis under the original terms of such loans as there were no loans on a nonaccrual basis during the year ended June 30, 1998. 8 Classified Assets. 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 current 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 weaknesses 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. At June 30, 1998, the Company's classified assets consisted of substandard loans of $37,000. At June 30, 1998, the Company also had $427,000 in loans designated as special mention. The Company had delinquent loans of 60 and 90 days or more of $138,000 and $90,000, respectively, and a general valuation allowance of $251,000. 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 fair value at the date of acquisition less estimated costs of disposition. The Company had no real estate owned at June 30, 1998. Allowance for Loan Losses. Management performs an analysis to identify the inherent risk of loss in its portfolio. A provision for loan losses is charged to operations based on management's analysis, 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. 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 that may occur within the loan category because the total loan loss allowance is a valuation reserve applicable to the entire loan portfolio. 9
At June 30, ------------------------------------------------------------ 1998 1997 --------------------------- ------------------------ Percent of Percent of Loans in each Loans in each Category to Category to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (Dollars in thousands) At end of period allocated to: Real estate mortgage: 1-4 family residential............ 56 76.9 68 85.3 Multi-family ..................... 5 4.5 1 5.2 Commercial........................ 31 4.3 6 3.0 Agricultural...................... 1 0.4 1 0.7 Consumer............................ 2 1.4 -- 0.7 Commercial.......................... 8 3.8 -- 3.2 Agricultural........................ 18 8.7 7 1.9 Unallocated allowance for loans losses...................... 130 N/A 130 N/A ----- ----- ----- ----- Total allowance for loan losses .................. $ 251 100.0% $ 213 100.0% ===== ===== ===== =====
Analysis of the Allowance for Loan Losses. The following table sets forth information with respect to the Company's allowance for loan losses at the dates and for the periods indicated:
At or For the Year Ended June 30, ---------------------------- 1998 1997 ---- ---- (Dollars in thousands) Total loans outstanding (1)..................... $29,246 $20,980 ====== ====== Average loans outstanding....................... $24,131 $18,284 ====== ====== Allowance balances (at beginning of year)........................................... $ 213 $213 Charge-offs..................................... -- -- Recoveries...................................... -- -- -------- ------- Net charge-offs................................. -- -- Provision....................................... 38 -- -------- ------- Allowance balance (at end of year).............. $ 251 $ 213 ======== ======= Allowance for loan losses as a percent of total loans outstanding.................... 0.86% 1.02% Net loans charged off as a percent of average loans outstanding..................... --% --%
- -------------------------------- (1) Excludes allowance for loan losses. 10 Mortgage-Backed and Related Securities. To supplement lending activities, the Company invests in residential mortgage-backed securities. Mortgage-backed securities can serve as collateral for borrowings and, through repayments and/or sales, as a source of liquidity. At June 30, 1998, the Company's mortgage-backed and related securities designated available-for- sale had a carrying value (and fair value) of $33.9 million, and an amortized cost of $33.7 million. In January 1998, the Company redesignated all mortgage-backed and related securities held to maturity as available for sale. As such, at June 30, 1998, the Company had no mortgage-backed and related securities designated held to maturity. The Company doe not intend to designate any mortgage-backed and related securities as held to maturity in the foreseeable future. Mortgage-backed securities represent a participation interest in a pool of single-family mortgages, the principal and interest payments on which are passed from the mortgage originators, through intermediaries (generally quasi-governmental agencies) that pool and repackage the participation interests in the form of securities, to investors such as the Bank. Such quasi-governmental agencies, which guarantee the payment of principal and interest to investors, primarily include FHLMC, Government National Mortgage Bank ("GNMA"), and Federal National Mortgage Bank ("FNMA"). FHLMC is a publicly-owned corporation chartered by the United States Government. FHLMC issues participation certificates backed principally by conventional mortgage loans. FHLMC guarantees the timely payment of interest and the ultimate return of principal within one year. FHLMC securities are indirect obligations of the United States Government. FNMA is a private corporation chartered by Congress with a mandate to establish a secondary market for conventional mortgage loans. FNMA guarantees the timely payment of principal and interest, and FNMA securities are indirect obligations of the United States Government. GNMA is a government agency within the Department of Housing and Urban Development ("HUD") which is intended to help finance government assisted housing programs. GNMA guarantees the timely payment of principal and interest, and GNMA securities are backed by the full faith and credit of the United States Government. Because FHLMC, FNMA, and GNMA were established to provide support for low- and middle-income housing, there are limits to the maximum size of loans that qualify for these programs. To accommodate larger-sized loans, and loans that, for other reasons, do not conform to the agency programs, a number of private institutions have established their own home-loan origination and securitization programs. Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages can be composed of either fixed-rate mortgages or adjustable-rate mortgage loans. Mortgage-backed securities are generally referred to as mortgage participation certificates or pass-through certificates. As a result, the interest rate risk characteristics of the underlying pool of mortgages, (i.e., fixed-rate or adjustable-rate) as well as prepayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgages. Mortgage-backed securities issued by FHLMC, FNMA, and GNMA make up a majority of the pass-through certificates market. At June 30, 1998, the Company had no collateralized mortgage obligations or other mortgage derivative products. Investment Activities. In order to maintain operational flexibility and meet regulatory liquidity requirements, the Bank maintains an investment securities portfolio. See Regulation of the Bank Liquidity Requirements. Investment securities can serve as collateral for borrowings and, through maturities and/or sales, as a source of liquidity. At June 30, 1998, the Company's investment securities designated available-for-sale had a carrying value (and fair value) of $9.8 million. At June 30, 1998, amortized cost also totalled $9.8 million. In January 1998, the Company redesignated all investment securities held to maturity as 11 available for sale. As such, at June 30, 1998, the Company had no investment securities designated held to maturity. The Company does not intend to designate any investment securities as held to maturity in the foreseeable future. The Company's investment securities consisted primarily of U.S. Treasury securities and U.S. Government agency securities. To a lesser extent, the portfolio includes municipal bonds and interest-bearing deposits as permitted by regulation. Investment Portfolio. The following table sets forth the carrying value of the Company's investment securities portfolio, short-term investments, FHLB stock, and mortgage-backed and related securities at the dates indicated. At June 30, ------------------------- 1998 1997 ------- ------- (In thousands) U.S. Treasury notes.................... $3,798 $ 5,502 U.S. Government agency securities...... 10,725 5,166 Municipal bonds........................ 830 1,150 ------- ------ Total investment securities.......... 9,794 17,377 Interest-earning deposits in other institutions..................... 1,989 748 FHLB stock............................... 835 334 Mortgage-backed and related securities............................. 33,937 22,023 ------- ------ Total investments.................. $46,555 $40,482 ======= ====== Portfolio Maturities. The following table sets forth certain information regarding the carrying values, weighted average yields, and contractual maturities of the Company's investment securities and mortgage-backed and related securities portfolio at June 30, 1998.
As of June 30, 1998 -------------------------------------------------------------------------------------------------------- One Year or Less One to Five Years Five to Ten Years More than Ten Years ----------------------- --------------------- ------------------- --------------------- Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield ------- ------- ------- ------- ------- ------- ------- ------ (Dollars in thousands) U.S. Treasury notes...... $3,798 5.44% $ -- --% $ -- --% $ -- --% U.S. Government Agency bonds........... 1,753 6.48 1,913 6.64 1,500 6.48 -- -- Municipal bonds (1)...... 430 4.19 250 4.35 150 4.57 -- -- ------ ----- ------ ----- ------ ---- ------ ----- Total investment securities........... 5,981 5.65 2,163 6.38 1,650 6.31 -- -- Mortgage-backed and related securities..... 1,965 6.34 9,811 6.55 20,173 6.50 1,988 7.19 ----- ----- ------ ----- ------- ---- ----- ----- Total investment portfolio(2)......... $7,946 5.82% $11,974 6.52% $21,823 6.49% $1,988 7.19% ===== ===== ====== ===== ====== ===== ===== =====
- -------------------------------- (1) Tax exempt income was not significant and thus has not been presented on a tax equivalent basis. (2) Excludes interest-bearing deposits and FHLB stock. 12 Sources of Funds General. Deposits and, to a lesser extent, FHLB advances are the major source of the Company's funds for lending and other investment purposes. The Company derives funds from the amortization and prepayment of loans and, to a much lesser extent, the maturities of investment securities, mortgage-backed, and related securities 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. Deposits. 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, money market accounts, and term certificate accounts. The Company also offers IRA and, to a lesser extent, 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. At June 30, 1998, passbook and money market accounts constituted $7.6 million, or 15.80% of the Company's deposit portfolio and certificates of deposit constituted $40.5 million or 84.20% of the deposit portfolio. The Company had no brokered deposits at that date, however, a substantial portion of the Bank's deposits are funds from local government entities. Deposits of $100,000 or More. The following table indicates the amount of the Company's deposit accounts of $100,000 or more as of June 30, 1998, including term certificate accounts separated by time remaining until maturity. Amount ------ (In thousands) Term certificate accounts: Maturity Period Within three months..................... $ 2,660 Three through six months................ 4,254 Six through twelve months............... 3,878 Over twelve months...................... 4,976 ------- Total................................. 15,768 Money market accounts..................... 3,531 ------- Total................................. $19,299 ====== Borrowings Deposits are the primary source of funds for the Company's lending and investment activities and for its general business purposes. The Bank obtains 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 blanket pledge of its 1-4 family mortgage loan portfolio, a pledge of the Bank's stock in the FHLB of Des Moines, and a portion of the Bank's investment securities. At June 30, 1998, the Bank had advances outstanding of $16.2 million. The Bank also has a $1.0 million line of credit with the FHLB which was not drawn on at June 30, 1998. The Bank's advances include $5.0 million in advances with various call features. If called, the FHLB has pledged to provide alternative funding albeit at then current market terms. The Bank, if the need arises, may also access the discount window of the Board of Governors of the Federal Reserve System ("Federal Reserve Board") to supplement its supply of lendable funds and to meet deposit withdrawal requirements. At June 30, 1998, the Company and the Bank had no borrowings from the Federal Reserve Board. 13 Personnel The Company has no employees other than executive officers. As of June 30, 1998, the Bank had 12 full-time and 2 part-time employees. None of the Bank's employees are represented by a collective bargaining group. Regulation Set forth below is a brief description of certain laws which related 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. 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 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 of SAIF members to repay amounts borrowed from the U.S. Treasury or for 14 any other reason deemed necessary by the FDIC. Prior to September 30, 1996, savings associations paid within a range of .23% to .31% of domestic deposits and the SAIF was substantially underfunded. By comparison, prior to September 30, 1996, members of the Bank Insurance Fund ("BIF"), predominantly commercial banks, were required to pay substantially lower, or virtually no, federal deposit insurance premiums. Effective September 30, 1996, federal law was revised to mandate a one-time special assessment on SAIF members such as the Bank of approximately .657% of deposits held on March 31, 1995. The Bank recorded a $237,000 pre-tax expense for this assessment for the year ended June 30, 1997, recognized in the first fiscal quarter. Beginning 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, BIF members are expected to be 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 declined by approximately 70% from rates in effect prior to September 30, 1996. Regulatory Capital Requirements. OTS capital regulations require savings institutions to meet three capital standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) a leverage ratio (core capital) equal to at least 3% of total adjusted assets, and (3) a risk-based capital requirement equal to 8.0% of total risk-weighted assets. The Bank's regulatory capital exceeded all minimum regulatory capital requirements applicable to it as of June 30, 1998. Interest-Rate Risk (IRR). As a financial institution regulated by the OTS, the Bank is required to measure and monitor its sensitivity to interest rate movements. OTS-regulated institutions meeting certain conditions have the option of utilizing the OTS-established IRR measurement model, or developing an in-house model. The Bank has chosen to meet its IRR sensitivity modeling requirements through use of the OTS's Net Present Value (NPV) model. This model measures how the net present value of an institution's assets, liabilities and off-balance-sheet items would change in the event of a range of assumed changes in market interest rates. These computations estimate the effect on NPV of a permanent and instantaneous change in market interest rates of plus or minus 100, 200, 300, and 400 basis points (bps). The Board has established acceptable ranges for the NPV changes across these various scenarios. The following table sets forth the interest-rate risk measures, as calculated by the OTS's NPV model, for the Bank at June 30, 1998 and 1997, given an instantaneous and permanent increase in market interest rates.
Risk Measures: At June 30, At June 30, 1998 1997 ----------- ----------- 200 Basis point rate shock Pre-shock NPV ratio: NPV as % of present value of assets 13.14% 15.48% Exposure measure: Post-shock NPV ratio: 11.29% 12.95% Sensitivity measure: Change in NPV ratio: (185) bps (253) bps
Calculations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit run-off, and should not be relied upon as indicative of actual results. Further, the calculations do not contemplate any actions the Bank may undertake in response to changes in interest rates. Nevertheless, the Bank's interest-rate risk exposure has decreased over the 12 months ended June 30, 1998, primarily as a result of the Company's use of long-term, fixed-rate FHLB advances. These advances were obtained as part 15 of management's strategy to fund a substantial portion of its long-term, fixed-rate loan portfolio with long-term, fixed-rate sources of funds in order to minimize interest-rate risk. Savings associations with a greater than "normal" level of interest rate exposure may, in the future, be subject to a deduction from capital for an interest rate risk ("IRR") component for purposes of calculating their risk-based capital requirement. Dividend and Other Capital Distribution Limitations. OTS regulations require the Bank to give the OTS 30 days advance notice of any proposed declaration of dividends to the Company, and the OTS has the authority under its supervisory powers to prohibit the payment of dividends to the Company. 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 June 30, 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. 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 to be established pursuant to the Bank's plan of conversion. During the year ended June 30, 1998, the Bank declared and paid a $500,000 dividend to the Company. Loans to One Borrower. Savings institutions are subject to the same limits as those applicable to national banks, which under current regulations limit loans to one borrower in an amount equal to 15% of unimpaired capital and unimpaired surplus, or $500,000, whichever is greater. The Bank's maximum loan to one borrower limit was approximately $1,275,000 as of June 30, 1998. At June 30, 1998, the Bank's largest loan amount to one borrower was an agricultural term loan in the amount of $537,000, secured by co-operative stock. 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 June 30, 1998, the Bank was in compliance with its QTL requirement with 84.71% of its assets invested in QTIs. 16 Liquidity Requirements. All savings associations are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. 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. 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. At June 30, 1998, the Bank was in compliance with these requirements. Item 2. Description of Property - -------------------------------- (a) Properties. The Company owns no real property but utilizes the offices of the Bank. The Bank owns its main office located at 301 South Washington Street, Redwood Falls, Minnesota and one full- service branch office located at 824 East Lincoln Street, Olivia, Minnesota. The Bank also owns a building adjacent to the branch office and two lots in Redwood Falls, Minnesota. In May 1997, the Bank purchased two vacant lots in Redwood Falls for possible future expansion. Subsequently, in April 1998, the Bank announced that it was proceeding with construction of a new main office building for the Bank on the east side of Redwood Falls. The new facility will be completed in early 1999 with occupancy shortly thereafter. The Bank intends to continue operating its downtown Redwood Falls office as a branch office. In December 1997, the Bank also purchased a lot in Olivia for possible future expansion of its Olivia branch office. The Bank has made no decision if or when to construct a branch office building on this lot. (b) Investment Policies. See "Item 1. Business" above for a general description of the Bank's investment policies and any regulatory or Board of Directors' percentage of assets limitations regarding certain investments. (1) Investments in Real Estate or Interests in Real Estate. See "Item 1. Business - Lending Activities," "Item 1. Business - Regulation of the Bank," and "Item 2. Description of Property. (a) Properties" above. (2) Investments in Real Estate Mortgages. See "Item 1. Business - Lending Activities" and "Item 1. Business - Regulation of the Bank." 17 (3) Investments in Securities of or Interests in Persons Primarily Engaged in Real Estate Activities. See "Item 1. Business - Lending Activities" and "Item 1. Business - Regulation of the Bank." (c) Description of Real Estate and Operating Data. Not Applicable. Item 3. Legal Proceedings - -------------------------- The Company and the Bank, from time to time, are parties to ordinary routine litigation, which arises in the normal course of business, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans, and other issues incident to the business of the Company and the Bank. No claims or lawsuits were pending or threatened at June 30, 1998. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 1998. PART II Item 5.Market for the Registrant's Common Equity and Related Stockholder Matters - -------------------------------------------------------------------------------- The information contained under the section captioned "Stock Market Information" in the Company's Annual Report to Stockholders for the fiscal year ended June 30, 1998 (the "Annual Report"), is incorporated herein by reference. Item 6. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations - ------------- 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 - ----------------------------- Consolidated financial statements are contained in the Annual Report and are incorporated herein by reference. Item 8. Changes in and Disagreements With Accountants on Accounting and - -------------------------------------------------------------------------------- Financial Disclosure - -------------------- Not Applicable. 18 PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance - -------------------------------------------------------------------------------- with Section 16(a) of the Exchange Act - -------------------------------------- The information contained under the section captioned "I -- Information with Respect to Nominees for Director, Directors Continuing in Office, and Executive Officers" in the proxy statement for the Annual Meeting of Stockholders of the Company to be held October 29, 1998, (the "Proxy Statement") is incorporated herein by reference. Item 10. Executive Compensation - -------------------------------- The information contained under the section captioned "Director and Executive Officer Compensation - Executive Compensation" in the Proxy Statement is incorporated herein by reference. Item 11. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the section captioned "I -- Information with Respect to Nominees for Director, Directors Continuing in Office, and Executive Officers" in the Proxy Statement. (c) Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company. Item 12. Certain Relationships and Related Transactions - -------------------------------------------------------- The information required by this item is incorporated herein by reference to the sections captioned "Certain Relationships and Related Transactions" and "Voting Securities and Principal Holders Thereof" in the Proxy Statement. Item 13. Exhibits, List and Reports on Form 8-K - ------------------------------------------------ (a) The following documents are filed as a part of this report: 1. The following financial statements and the report of independent accountants of the Company included in the Annual Report to Stockholders of the Company for the fiscal year ending June 30, 1998, are incorporated herein by reference. Report of Independent Auditors Consolidated Statements of Financial Condition as of June 30, 1998 and 1997 Consolidated Statements of Earnings for the Years Ended June 30, 1998, 1997, and 1996 19 Consolidated Statements of Stockholders' Equity for the Years Ended June 30, 1998, 1997, and 1996 Consolidated Statements of Cash Flows for the Years Ended June 30, 1998, 1997, and 1996 Notes to Consolidated Financial Statements. 2. Financial Statement Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission ("SEC") are not required under the related instructions or are inapplicable and therefore have been omitted. 3. The following exhibits are included in this Report or incorporated herein by reference: (a) List of Exhibits: 3.1 Articles of Incorporation of Redwood Financial, Inc.* 3.2 Bylaws of Redwood Financial, Inc.* 10.1 Employment contract with Paul W. Pryor ** 10.2 1995 Stock Option Plan*** 10.3 Management Stock Bonus Plan*** 10.4 1997 Directors Stock Option Plan** 13 Annual Report to Stockholders for the fiscal year ended June 30, 1998. 21 Subsidiaries of the Registrant 23 Consent of KPMG Peat Marwick LLP 27 Financial Data Schedule (b) Reports on Form 8-K. None. - -------------------- * Incorporated by reference to the Registrant's Registration Statement on Form S-1 (33-90560) declared effective by the Commission on May 15, 1995. ** Incorporated by reference to the Annual Report on Form 10-KSB for the fiscal year ended June 30, 1997 (File No. 0-25884). *** Incorporated by reference to the proxy statement for the special meeting of stockholders held on January 17, 1996, and filed with the SEC on December 5, 1995 (File No. 0-25884). 20 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. REDWOOD FINANCIAL, INC. Dated: September 16, 1998 By: /s/ Paul W. Pryor -------------------------------- Paul W. Pryor President, Chief Executive Officer and Director (Duly Authorized Representative) In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Paul W. Pryor By: /s/ James P. Tersteeg ---------------------------------- --------------------------- Paul W. Pryor James P. Tersteeg President, Chief Executive Officer Chairman of the Board and Director (Principal Executive Officer) Date: September 16, 1998 Date: September 16, 1998 By: /s/ J. Scott Nelson By: /s/ Blaine C. Farnberg ---------------------------------- --------------------------- J. Scott Nelson Blaine C. Farnberg Vice Chairman of the Board Director Date: September 16, 1998 Date: September 16, 1998 By: /s/ Thomas W. Stotesbery By: /s/ Donald C. Orth ---------------------------------- --------------------------- Thomas W. Stotesbery Donald C. Orth Director Vice President and Director Date: September 16, 1998 Date: September 16, 1998 By: /s/ Anthony H. Acker ---------------------------------- Anthony H. Acker Chief Financial Officer (Principal Accounting and Financial Officer) Date: September 16, 1998 EX-13 2 EXHIBIT 13 EXHIBIT 13 [REDWOOD FINANCIAL, INC. LETTER TO STOCKHOLDERS] [REDWOOD FINANCIAL, INC. LETTER TO STOCKHOLDERS CONTINUED] REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Financial Statements June 30, 1998, 1997, and 1996 REDWOOD FINANCIAL, INC. AND SUBSIDIARY TABLE OF CONTENTS - -------------------------------------------------------------------------------- Page(s) Independent Auditors' Report....................................... 1 Annual Report...................................................... 2-19 Financial Statements: Consolidated Balance Sheets................................... 20 Consolidated Statements of Earnings........................... 21 Consolidated Statements of Stockholders' Equity............... 22 Consolidated Statements of Cash Flows......................... 23-24 Notes to Financial Statements...................................... 25-54 Independent Auditors' Report The Board of Directors Redwood Financial, Inc.: We have audited the accompanying consolidated balance sheets of Redwood Financial, Inc. and subsidiary (the Company) as of June 30, 1998 and 1997 and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the years in the three-year period ended June 30, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Redwood Financial, Inc. and subsidiary at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1998 in conformity with generally accepted accounting principles. /s/KPMG Peat Marwick LLP Minneapolis, Minnesota July 31, 1998, except for note 21, which is as of September 15, 1998 1 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report June 30, 1998 - -------------------------------------------------------------------------------- Profile and Related Information Redwood Financial, Inc. (the Company) is a Minnesota corporation organized at the direction of the Board of Directors of the HomeTown Bank (the Bank, formerly Redwood Falls Federal Savings and Loan Association) to acquire all of the capital stock that the Bank issued upon its conversion from the mutual to stock form of ownership. The Company is a unitary savings and loan holding company which generally, under existing laws, 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 significant 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 mutual savings and loan association headquartered in Redwood Falls, Minnesota. The Bank has two full-service offices located in Redwood and Renville Counties, Minnesota. The Bank was founded in 1924 and obtained its current name in 1998. 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 1958. The Bank is a member of the Federal Home Loan Bank (FHLB) System. The Bank is a community-oriented, retail savings institution offering traditional mortgage loan products. It is the Bank's intent to remain an independent community savings and loan association serving the local banking needs of Redwood and Renville Counties, Minnesota. The Bank attracts deposits from the public and uses such deposits primarily to invest in residential lending on owner-occupied properties. The Bank also originates consumer, commercial, and agricultural loans. Stock Market Information Since its issuance on July 7, 1995, the Company's common stock has been traded in the over-the-counter market. The following table reflects the stock price as published by the OTC Bulletin Board. The quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not represent actual transactions. - -------------------------------------------------------------------------------- High bid Low bid - -------------------------------------------------------------------------------- Fiscal 1998: First Quarter $ 11 1/8 10 3/4 Second Quarter 12 1/2 11 1/8 Third Quarter 13 1/4 12 1/2 Fourth Quarter 14 1/2 13 Fiscal 1997: First Quarter 10 8 3/4 Second Quarter 10 9 3/4 Third Quarter 11 3/8 10 Fourth Quarter 11 10 1/4 - ----------------------------------------------------------------------------- The number of stockholders of record of common stock as of June 30, 1998, was approximately 106. This does not reflect the number of persons or entities who held stock in nominee or "street" name through various brokerage firms. At June 30, 1998, there were 868,093 shares outstanding. 2 (Continued) REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations General At the present time, Redwood Financial, Inc. (the Company) does not conduct any significant business outside of serving as a unitary savings and loan holding company for the HomeTown Bank. The Bank converted from a federally-chartered mutual savings and loan association to a federally-chartered stock savings and loan association, pursuant to its Plan of Conversion. The conversion was effected on July 7, 1995. The principal business of the Company through the Bank consists of accepting deposits from the public and investing these funds primarily in investment securities and loans. The investment securities consist of U.S. government treasury notes and agency securities, mortgage-backed securities, and municipal bonds. Loans consist primarily of loans secured by residential real estate located in its market area and, to a lesser extent, commercial real estate loans, commercial loans, agricultural loans, construction loans, and consumer loans. Net earnings are dependent primarily on net interest income, which is the difference between interest income earned on the investment and loan portfolio 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 interest rate spread is affected by regulatory, economic, and competitive factors that influence interest rates, loan demand, and deposit flows. To a lesser extent, net earnings also are affected by the level of noninterest income, which primarily consists of service charges and other fees. In addition, net earnings are affected by the level of noninterest (general and administrative) expenses. The operations of the Bank, and the entire thrift industry, are significantly affected by prevailing economic conditions, competition, and the monetary and fiscal policies of the federal government and governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates, and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities, and the levels of personal income and savings in the Bank's market area. Average Balance Sheet The following table sets forth certain information relating to the Company's average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods ended June 30, 1998, 1997, and 1996. Such yields and costs are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily balances has caused any material difference in the information presented. The table also presents information for the periods indicated with respect to the difference between the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities, or net interest rate spread, which savings institutions have traditionally used as an indicator of profitability. Another indicator of an institution's net interest income is its net yield on interest-earning assets, which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. (Continued) 3 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- The Company paid no dividends to holders of common stock during the fiscal years ended June 30, 1998 and 1997. The Companys 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 Companys 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 Banks regulatory capital to be reduced below (1) the amount required for the liquidation account established in connection with the Banks conversion from mutual stock form, or (2) the regulatory capital requirements imposed by the Office of Thrift Supervision (OTS).
FIVE-YEAR SELECTED FINANCIAL SUMMARY (dollars in thousands, except per share data) Year ended June 30 ---------------------------------------------------- 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------- Operating results: Interest income $ 4,748 3,870 3,487 3,023 3,048 Interest expense 2,999 2,186 1,883 1,683 1,448 - ---------------------------------------------------------------------------------------------------------------------------- Net interest income 1,749 1,684 1,604 1,340 1,600 Provision for loan losses 38 - - - 1 Noninterest income 131 57 61 40 54 Noninterest expense 1,174 1,352 992 775 690 Income tax expense 243 137 211 245 426 - ---------------------------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting change 425 252 462 360 537 Cumulative effect of accounting change - - - - (45) - ---------------------------------------------------------------------------------------------------------------------------- Net earnings $ 425 252 462 360 492 - ---------------------------------------------------------------------------------------------------------------------------- Net earnings per common sharebasic $ 0.52 0.27 0.46 Net earnings per common sharediluted 0.49 0.26 0.45 N/A N/A - ---------------------------------------------------------------------------------------------------------------------------- Balance sheet data: Total assets $ 77,287 62,169 51,515 55,002 42,660 Investment securities held to maturity - 10,396 15,289 16,431 17,213 Mortgage-backed and related securities held to maturity - 13,874 15,805 7,874 7,774 Investment securities available for sale 9,794 6,981 - - - Mortgage-backed and related securities available for sale 33,937 8,150 - - - Loans receivable, net 28,995 20,767 16,514 15,255 15,091 Deposits 48,102 45,688 38,043 35,825 37,114 Stockholders' equity 11,938 12,342 13,157 5,656 5,295 Financial ratios: Return on average assets 0.62% 0.46% 0.93% 0.74% 1.17% Return on average equity 3.48 1.96 3.42 6.58 9.73 Average equity to average assets 17.95 23.36 27.18 11.21 12.03 Net yield on average interest-earning assets 2.68 3.11 3.27 3.18 3.87
(Continued) 4 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report
- ------------------------------------------------------------------------------------------------------------------------------ For the year ended June 30 ---------------------------------------------------------------------------------------------- 1998 1997 1996 ------------------------- ------------------------- -------------------------------- Average Average Average Average yield/ Average Yield/ Average yield/ balance Interest cost balance Interest cost balance Interest cost - ------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets: Loans receivable (1) $24,130,515 $2,071,506 8.58% $18,283,543 $1,563,605 8.55% $15,754,753 $1,376,334 8.74% Securities held to maturity: Mortgage-backed and related securities 7,226,040 453,033 6.27 14,947,287 1,044,024 6.98 11,410,198 784,869 6.88 Investment securities 5,164,420 295,402 5.72 12,689,898 749,059 5.90 18,055,614 1,090,543 6.04 Securities available for sale: Mortgage-backed and related securities 17,876,631 1,233,835 6.90 2,695,970 168,357 6.24 0 0 0.00 Investment securities 8,984,208 584,221 6.50 2,219,892 147,775 6.66 0 0 0.00 FHLB stock 408,007 28,060 6.88 333,500 23,522 7.05 330,792 23,765 7.18 Other interest-earning assets (2) 1,378,145 81,864 5.94 3,017,686 173,275 5.74 3,550,681 211,640 5.96 ---------- --------- ---------- --------- ---------- --------- Total interest-earning assets 65,167,966 4,747,921 7.29 54,187,776 3,869,617 7.14 49,102,038 3,487,151 7.10 ---------- --------- ---------- --------- ---------- --------- Noninterest-earning assets 1,521,245 610,413 698,754 ---------- ---------- ---------- Total assets $66,689,211 $54,798,189 $49,800,792 ---------- ---------- ---------- Interest-bearing liabilities: Passbook savings accounts 867,074 23,696 2.73 987,693 25,130 2.54 1,394,964 33,968 2.44 Money market savings accounts 6,153,126 221,899 3.61 7,077,184 275,769 3.90 5,550,747 196,842 3.55 Certificates of deposit 39,580,590 2,333,739 5.90 32,394,479 1,846,365 5.70 28,561,491 1,652,027 5.78 FHLB advances 7,012,335 419,138 5.98 726,923 38,485 5.29 0 0 0.00 ---------- --------- --------- -------- ---------- --------- Total interest-bearing liabilities 53,613,125 2,998,472 5.59 41,186,279 2,185,749 5.31 35,507,202 1,882,837 5.30 --------- --------- --------- -------- ---------- --------- Noninterest-bearing liabilities 1,093,901 785,044 758,718 ---------- --------- --------- Total liabilities 54,707,026 41,971,323 36,265,920 Retained earnings 11,982,185 12,826,866 13,534,872 ---------- --------- ---------- Total liabilities and retained earnings $66,689,211 $54,798,189 $49,800,792 ---------- --------- ---------- Net interest income $1,749,449 $1,683,868 $1,604,314 -------- --------- --------- Net interest rate spread (3) 1.70% 1.83% 1.80% ----- ----- ------ Net yield on average interest- earning assets(4) 2.68% 3.11% 3.27% ----- ------ ------ Ratio of average interest- earning average interest- bearing liabilities 121.55% 131.57% 138.29% ------ ------ -------
(1) Average balances include non-accrual loans. (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. (5) Tax exempt income was not significant and thus is not presented on tax equivalent basis.
(Continued) 5 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ Rate/Volume Analysis Year ended June 30, Year ended June 30, ------------------------------------------ -------------------------------------- 1998 versus 1997 1997 versus 1996 increase/(decrease) due to changes in increase/(decrease) due to changes in ------------------------------------------ -------------------------------------- Rate/ Rate/ Volume Rate volume Total Volume Rate volume Total - ------------------------------------------------------------------------------------------------------------------------------------ Interest income: Loans receivable $ 500,032 5,962 1,907 507,901 220,915 (28,990) (4,654) 187,271 Securities held to maturity: Mortgage-backed and related securities (539,307) (106,911) 55,227 (590,991) 243,304 12,100 3,751 259,155 Investment securities (444,214) (23,204) 13,761 (453,657) (324,085) (24,756) 7,358 (341,483) Securities available for sale: Mortgage-backed and related securities 947,997 17,717 99,764 1,065,478 168,357 - - 168,357 Investment securities 450,291 (3,421) (10,424) 436,446 147,775 - - 147,775 FHLB stock 5,255 (586) (131) 4,538 195 (434) (5) (244) Other interest-earning assets (94,142) 5,980 (3,249) (91,411) (31,769) (7,761) 1,165 (38,365) - ----------------------------------------------------------------------------------------------------------------------------------- Total interest earning assets 825,912 (104,463) 156,855 878,304 424,692 (49,841) 7,615 382,466 - ----------------------------------------------------------------------------------------------------------------------------------- Interest expense: Passbook savings accounts (3,069) 1,862 (227) (1,434) (9,917) 1,524 (445) (8,838) Money market savings accounts (36,007) (20,546) 2,683 (53,870) 54,131 19,448 5,348 78,927 Certificates of deposit 409,581 63,669 14,124 487,374 221,704 (24,128) (3,238) 194,338 FHLB advances 332,765 4,964 42,924 380,653 38,485 - - 38,485 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 703,270 49,949 59,504 812,723 304,403 (3,156) 1,665 302,912 - ----------------------------------------------------------------------------------------------------------------------------------- Net change in interest income $ 122,642 (154,412) 97,351 65,581 120,289 (46,685) 5,950 79,554 - -----------------------------------------------------------------------------------------------------------------------------------
(Continued) 6 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Comparison of Operating Results for the Years Ended June 30, 1998 and 1997 In recent years, significant new federal legislation has imposed numerous new legal and regulatory requirements on financial institutions. In addition to the uncertainties posed by possible legislative change, there are many other uncertainties that may make the Company's historical performance an unreliable indicator of its future performance, and forward-looking information, including projections of future performance, is subject to numerous possible adverse developments, including but not limited to the possibility of adverse economic developments which may increase default and delinquency risks in the Company's loan portfolios; shifts in interest rates which may result in shrinking interest margins; deposit outflows; interest rates on competing investments; demand for financial services and loan products; increases generally in competitive pressure in the banking and financial services industry; changes in accounting policies or guidelines, or monetary and fiscal policies of the federal government; changes in the quality or composition of the Company's loan and investment portfolios; or other significant uncertainties. Net Earnings Net earnings were $425,000 for the year ended June 30, 1998, as compared to $252,000 for the year ended June 30, 1997. This represented an increase of $173,000, or 68.65%. The increase in net earnings was primarily attributable to lower noninterest expense during the year ended June 30, 1998. In the fiscal year ended June 30, 1997, the Company incurred a pretax $237,000, one-time special assessment required by the Federal Deposit Insurance Corporation and levied on thrift institutions to recapitalize the Savings Association Insurance Fund (SAIF). In addition, in the fiscal year ended June 30, 1997, the Company incurred an additional $102,000 in professional fees as a result of an unsuccessful acquisition attempt. The increase in net earnings was also attributable to a $75,000 increase, or 133.93% in noninterest income. The increase in noninterest income was primarily a result of an increase in net gains on the sale of securities available for sale and increased fees and service charges. The increase in net earnings was also attributable to a $65,000, or 3.86% increase in net interest income. The increase in net earnings was also impacted by a $127,000 increase, or 17.81% in compensation and employee benefits, a $106,000 increase, or 77.37% in income tax expense, and a $38,000, or 100.00% increase in provision for loan losses. Net Interest Income Net interest income increased by $65,000, or 3.86%, from $1,684,000 for the year ended June 30, 1997 to $1,749,000 for the year ended June 30, 1998. The increase in net interest income is primarily due to increased net interest earnings generated through growth of the Company over the past fiscal year. The increase in net interest income was also adversely impacted by a decrease in the net interest spread in comparison of the two fiscal years. The Company's average interest-earning assets increased $10,980,000, or 20.26% from $54,188,000 at June 30, 1997, to $65,168,000 at June 30, 1998. Similarly, the Company's average interest-bearing liabilities increased $12,427,000, or 30.17% from $41,186,000 at June 30, 1997 to $53,613,000 at June 30, 1998. While the Company's interest-bearing liabilities increased at a faster rate than its interest-earning assets due primarily to the use of investable funds to repurchase the Company's common stock over the previous 12 months, the net interest earnings generated by the growth exceeded the interest income lost through use of the funds for stock repurchases and other uses. During the fiscal year ended June 30, 1998, stock repurchases totaled $1,140,000. The Company's net interest income was also impacted by a decline in its net interest spread. The Company's net interest spread was 1.70% and 1.83% for the years ended June 30, 1998 and 1997, respectively. The decrease in the net interest spread is the result of cost of liabilities rising more rapidly than interest earning assets. (Continued) 7 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Interest Income Interest income was $4,748,000 for the year ended June 30, 1998, as compared to $3,870,000 for the year ended June 30, 1997, representing an increase of $878,000, or 22.69%. The increase in interest income was primarily due to the aforementioned increase in interest-earning assets. The increase in interest income was also affected by an increase in the overall yield on interest-earning assets. For the year ended June 30, 1998, the yield on interest-earning assets was 7.29%, as compared to 7.14% for the year ended June 30, 1997. The increase in yield on interest-earning assets was due primarily to the larger loan portfolio in the year ended June 30, 1998. Interest on loans receivable increased by $508,000, or 32.48%, to $2,072,000 for the year ended June 30, 1998, as compared to $1,564,000 for the year ended June 30, 1997. Such increase was due to a $5,847,000, or 31.98% increase in the average balance of loans receivable from $18,284,000 for the year ended June 30, 1997 to $24,131,000 for the year ended June 30, 1998. The increase in interest on loans receivable was also affected by an increase in the average yield on loans receivable from 8.55% for the year ended June 30, 1997, to 8.58% for the year ended June 30, 1998. In January 1997, management began designating all purchases of mortgage-backed and related securities as available for sale. Subsequently, in January 1998, management redesignated all mortgage-backed and related securities as available for sale. As a result of this strategy, interest income on mortgage-backed and related securities held to maturity declined $591,000, or 56.61% from $1,044,000 for the year ended June 30, 1997 to $453,000 for the year ended June 30, 1998. The decrease in interest income on mortgage-backed and related securities held to maturity is a result of a $7,721,000 decrease, or 51.66% in the average balance of mortgage-backed and related securities held to maturity in comparison of the years ended June 30, 1998 and 1997, respectively. This decrease was also affected by a decrease in the yield on the mortgage-backed and related securities held to maturity from 6.98% for the year ended June 30, 1997, to 6.27% for the year ended June 30, 1998. Interest income on mortgage-backed and related securities available for sale increased $1,066,000, or 634.52% from $168,000 for the year ended June 30, 1997 to $1,234,000 for the year ended June 30, 1998. The increase in interest income on mortgage-backed and related securities available for sale was due to a $15,181,000, or 563.09% increase in the average balance of mortgage-backed and related securities available for sale, primarily as a result of the aforementioned portfolio redesignation. The increase was also impacted by an increase in yield on the mortgage-backed and related securities available for sale from 6.24% to 6.90% for the years ended June 30, 1997 and 1998, respectively. As with the Company's mortgage-backed and related securities purchases, in January 1997, management began designating all purchases of investment securities as available for sale. In January 1998, management also redesignated all investment securities available for sale. As a result of this strategy, interest income on investment securities held to maturity declined $454,000, or 60.61% from $749,000 for the year ended June 30, 1997 to $295,000 for the year ended June 30, 1998. The decrease in interest income on investment securities held to maturity is a result of a $7,526,000 decrease, or 59.31% in the average balance of investment securities held to maturity in comparison of the years ended June 30, 1998 and 1997, respectively. This decrease was also affected by a decline in the yield on the investment securities held to maturity from 5.90% for the year ended June 30, 1997, to 5.72% for the year ended June 30, 1998. Interest income on investment securities available for sale increased $436,000, or 294.59% from $148,000 for the year ended June 30, 1997 to $584,000 for the year ended June 30, 1998. The increase in interest income on investment securities available for sale was due to a $6,764,000, or 304.68% increase in the average balance of investment securities available for sale, primarily as a result of the aforementioned portfolio redesignation. The increase was partially offset by a slight decrease in yield on the investment securities available for sale from 6.66% to 6.50% for the years ended June 30, 1997 and 1998, respectively. (Continued) 8 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Interest income on cash and cash equivalents decreased by $91,000, or 52.60% for the years ended June 30, 1998 and 1997, respectively. The decrease is a result of management's decision to decrease its average balance in cash on hand in order to enhance overall yield. Interest income on FHLB stock increased $4,000, or 16.67%, owing to higher investment in FHLB stock during the fiscal year ended June 30, 1998. Interest Expense Interest expense increased by $812,000, or 37.15%, from $2,186,000 for the year ended June 30, 1997 to $2,998,000 for the year ended June 30, 1998. The increase in interest expense resulted from a $12,427,000, or 30.17% increase in the average balance of interest-bearing liabilities from $41,186,000 for the year ended June 30, 1997, to $53,613,000 for the year ended June 30, 1998. The increase in interest expense was also impacted by an increase in the average cost of interest-bearing liabilities to 5.59% during the year ended June 30, 1998, as compared to 5.31% for the year ended June 30, 1997. The increase in the Company's interest-bearing liabilities was a result of a $6,142,000, or 15.18% increase in the average balance of deposits and a $6,285,000, or 864.51% increase in the average balance of FHLB advances. The increase in deposits was largely a result of increased public deposits (i.e. deposits from local governmental entities) which typically are more volatile and costly than traditional retail deposits. The increase in FHLB advances was primarily to fund increases in loan production and mortgage-backed securities purchases. Provision for Loan Losses The Company's provision for loan losses was $38,000 and $0 for the years ended June 30, 1998 and 1997, respectively. The Company has experienced substantial loan growth including commercial, agricultural, and 1-4 family residential mortgage loans. While no known loan losses are identified, the provision was in response to inherent losses as a result of growth in the loan portfolio. As such, the Company intends to regularly provide for loan losses. The level of this provision is dependent on loan growth, delinquencies, economic conditions, and other various factors used by management in the assessment of its loan portfolio and overall level of loan loss reserves. The Company is committed to maintaining adequate allowances for loan losses, regardless of the impact on reported earnings. At June 30, 1998 and 1997, the allowance for loan losses totaled $251,000 and $213,000, respectively. The Company's net charge-offs were $0 and $0 for the fiscal years ended June 30, 1998 and 1997, respectively. At June 30, 1998 and 1997, the allowance for loan losses represented 0.86% and 1.02% of total loans receivable, respectively. Nonaccrual loans totaled $0 and $0 for the fiscal years ended June 30, 1998 and 1997, respectively. At June 30, 1998 and 1997, classified assets totaled $37,000 and $121,000, respectively. Noninterest Income Noninterest income increased $76,000, or 135.71% for the fiscal year ended June 30, 1998 in comparison to the fiscal year ended June 30, 1997. The increase is attributable to a $40,000 increase in net gains realized on the sale of securities available for sale. In addition, the increase was also impacted by a $36,000, or 80.00% increase in fees and service charges. The increase is largely a result of a one-time, $20,000 commercial loan prepayment fee. (Continued) 9 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Noninterest Expense Noninterest expense decreased by $178,000, or 13.17%, from $1,352,000 for the year ended June 30, 1997 to $1,174,000 for the year ended June 30, 1998. The decrease in total noninterest expense was primarily due to the aforementioned pretax $237,000 one-time special deposit insurance fund assessment in the fiscal year ended June 30, 1997. In addition, the decrease was also due to a $95,000, or 48.72% decrease in professional fees, and a $23,000 or 44.23% decrease in federal deposit insurance premiums. During the fiscal year ended June 30, 1997, the Company incurred higher professional fees as a result of an unsuccessful acquisition attempt. The decrease in federal deposit insurance premiums is due to lower deposit insurance fund assessments as a result of federal legislation enacted in 1996. The decrease in noninterest expense was partially offset by a $127,000, or 17.81% increase in compensation and employee benefits expense, an $11,000, or 10.58% increase in other expenses, and an $8,000, or 42.11% increase in advertising expense. The increase in compensation and employee benefits is primarily due to an increase in staff. As a result of its October 1997 automated data processing conversion, the Company now reports data processing expense separately. During the fiscal year ended June 30, 1998, data processing expense totaled $32,000. In previous periods, data processing expense was not material. Income Taxes The Company's income tax expense increased by $106,000, or 77.37%, from $137,000 for the year ended June 30, 1997, to $243,000 for the year ended June 30, 1998. The change in income taxes was due primarily to an increase in pre-tax earnings of $280,000, or 72.16%, from $388,000 for the year ended June 30, 1997 to $668,000 for the year ended June 30, 1998. The effective tax rates for fiscal 1998, 1997 and 1996 were 36.4%, 35.2% and 31.3%. The effective rate was higher in fiscal 1998 than in 1997 because th Bank had fewer tax exempt investments. The effective rate in 1996 was lower because of a benefit recognized for bad debt reserves. Financial Condition The Company's total assets increased by $15,118,000, or 24.32%, from $62,169,000 at June 30, 1997 to $77,287,000 at June 30, 1998. The increase in the Company's size primarily reflected an increase in the level of FHLB advances during the fiscal year ended June 30, 1998. These advances were used primarily to fund increased loan production and purchases of mortgage-backed securities. Cash and cash equivalents increased by $1,245,000, or 162.96%, from $764,000 at June 30, 1997 to $2,009,000 at June 30, 1998. The increase in cash was primarily due to the procurement of FHLB advances in late June 1998 in order to fund loan and security purchases commitments. The Company continues to maintain lower levels of cash and cash equivalents in order to enhance overall yield. The Company's average cash balance declined $1,640,000, or 54.34% in comparison of the fiscal years ended June 30, 1998 and 1997, respectively. The Company's loans receivable, net, increased $8,228,000, or 39.62% over the year ended June 30, 1997. The increase in loans was primarily due to expansion in the Company's agricultural and commercial lending programs as previously announced. During the fiscal year ended June 30, 1998, the Company announced the hiring of an experienced agricultural and commercial loan officer to expand the Company's lending programs. As a result, during the fiscal year ended June 30, 1998, the Company originated $5.2 million in agricultural and commercial loans. These loans primarily included agricultural operating and term loans, but also included agricultural real estate and commercial operating and real estate loans. Large concentrations of credit include two participation loans to a local casino totaling $737,000 at June 30, 1998, secured by the casino's revenues, and an agricultural operating loan with a June 30, 1998 balance of $537,000, secured by agricultural cooperative stock. The Company also increased its 1 family residential loan portfolio by approximately $4.1 million since June 30, 1997. (Continued) 10 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- The continued increase in the Company's loan portfolio and changes in loan portfolio mix will increase the Company's credit risk exposure. Furthermore, in conjunction with this increase in loans receivable, the Company is increasing its allowance for loan losses. As previously noted, effective January 1, 1998, the Company designated all investment securities, including mortgage-backed and related securities as available for sale. Previously, the Company maintained a portfolio of investment securities and mortgage-backed and related securities purchased before January 1997 as held to maturity. The purpose of the designation is to enhance operational flexibility and liquidity. To this extent, $20,596,000 in investment securities, including mortgage-backed and relate securities were specifically redesignated available for sale. The Company will not maintain any investments, including mortgage-backed and related securities as held to maturity for the foreseeable future. Overall, the Company's mortgage-backed and related securities available for sale increased $25,787,000, or 316.40% from June 30, 1997 to June 30, 1998. The increase in mortgage-backed and related securities available for sale is due to the aforementioned redesignation of $12,101,000 in mortgage-backed securities previously designated held to maturity and $19,626,000 in purchases of mortgage-backed and related securities available for sale. No mortgage-backed and related securities designated held to maturity were purchased during the year ended June 30, 1998. The carrying value of mortgage-backed and related securities reflected an increase of $211,000 due to market appreciation. Mortgage-backed and related securities previously designated held to maturity reflected net market appreciation of $140,000 at redesignation to available for sale. The Company's investment securities available for sale increased $2,813,000, or 40.30% from June 30, 1997 to June 30, 1998. The increase in investment securities available for sale is due to the aforementioned redesignation of $8,495,000 in investment securities previously designated held to maturity and $2,490,000 in purchases of investment securities available for sale. No investment securities designated held to maturity were purchased during the year ended June 30, 1998. The carrying value of investment securities reflected an increase of $9,000 due to market appreciation. Investment securities previously designated held to maturity reflected net market appreciation of $10,000 at redesignation to available for sale. The Company's deposits increased by $2,414,000, or 5.28%, from $45,688,000 at June 30, 1997 to $48,102,000 at June 30, 1998. At June 30, 1998, the Company's Federal Home Loan Bank (FHLB) advances totaled $16,200,000, an increase of $12,700,000, or 362.86% from $3,500,000 at June 30, 1997. The advances were primarily utilized to fund increased loan production and mortgage-backed securities purchases during the fiscal year. The Company's advances include $8,000,000 in 15 year amortizing advances which are utilized to fund the retention of long term 1-4 family residential mortgage loans as part of the Company's interest-rate risk management strategies. The advances also include $5,000,000 in advances that may be called by the FHLB. Should these advances be called, the FHLB has committed to provide replacement advances, at the then current market interest rate. In order to productively leverage its capital, the Company may continue to seek additional deposits through traditional deposit products and new deposit products, as well as increased utilization of FHLB advances, to fund loan growth and securities purchases. FHLB advances provide an alternative source of funds for the Company, at costs substantially equivalent to, or lower than its retail deposit products. Stockholders' equity decreased $404,000, or 3.27% from $12,342,000 at June 30, 1997 to $11,938,000 at June 30, 1998. The decrease was primarily due to the repurchase of the Company's common stock. Repurchases of common stock totaled $1,140,000 during the fiscal year ended June 30, 1998. The decrease was also impacted by the Company's $425,000 in net earnings, a $135,000 after tax market change in appreciation of the Company's available for sale securities portfolio, an $87,000 decrease in unearned management stock bonus plan shares, and a $66,000 decrease in unearned employee stock ownership plan shares. (Continued) 11 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Comparison of Operating Results for the Years Ended June 30, 1997 and 1996 Net Earnings Net earnings were $252,000 for the year ended June 30, 1997, as compared to $462,000 for the year ended June 30, 1996. This represented a decrease of $210,000, or 45.45%. The decrease was primarily attributable to a pre-tax $237,000 one-time assessment by the Federal Deposit Insurance Corporation to recapitalize the Savings Bank Insurance Fund (SAIF). The decrease was also affected by various expenses incurred with the Company's unsuccessful acquisition attempt of a financial institution. The decrease was partially offset by an $80,000, or 4.99% increase in net interest income and a $74,000, or 35.07% decrease in income tax expense. Net Interest Income Net interest income increased by $80,000, or 4.99% from $1,604,000 for the year ended June 30, 1996 to $1,684,000 for the year ended June 30, 1997. The increase is primarily due to increased deposits and funds from advances invested in loans, investment securities, and mortgage-backed and related securities. The increase was also attributable to a modest improvement in the Company's overall net interest spread. The increase was partially offset by a decrease in the Company's interest-earning assets relative to its interest-bearing liabilities. Average interest-earning assets increased by $5,086,000, or 10.36% from $49,102,000 for the year ended June 30, 1996, to $54,188,000 for the year ended June 30, 1997. Average interest-bearing liabilities increased by $5,679,000, or 15.99% from $35,507,000 for the year ended June 30, 1996, to $41,186,000 for the year ended June 30, 1997. While the Company's asset base increased in the year ended June 30, 1997, the level of average-interest-earning assets to average interest-bearing liabilities decreased from 138.29% for the year ended June 30, 1996 to 131.57% for the year ended June 30, 1997. This decrease is attributed to the Company's common stock repurchases during the 1997 fiscal year. Funds used to repurchase stock totaled $1,227,000. The increase in net interest income was also affected by an increase in the Company's net interest spread from 1.80% for the year ended June 30, 1996, to 1.83% for the year ended June 30, 1997. Interest Income Interest income increased by $383,000, or 10.98% from $3,487,000 for the year ended June 30, 1996 to $3,870,000 for the year ended June 30, 1997. The increase in interest income is primarily a result of the aforementioned increase in the Company's average interest earning assets. The increase was also attributable to a slight increase in the yield on average interest earning assets, from 7.10% for the year ended June 30, 1996 to 7.14% for the year ended June 30, 1997. Interest on loans receivable increased by $188,000, or 13.66% from $1,376,000 for the year ended June 30, 1996 to $1,564,000 for the year ended June 30, 1997. The increase is a result of a $2,529,000, or 16.05% increase in the average balance of loans from $15,755,000 to $18,284,000 for the years ended June 30, 1996 and 1997, respectively. The increase was partially offset by a decrease in the average yield on loans from 8.74% for the year ended June 30, 1996, to 8.55% for the year ended June 30, 1997. Interest on mortgage-backed and related securities increased by $427,000, or 54.39%, from $785,000 for the year ended June 30, 1996 to $1,212,000 for the year ended June 30, 1997. The increase was due to a $6,233,000, or 54.63% increase in the average balance of mortgage-backed and related securities from $11,410,000 for the year ended June 30, 1996 to $17,463,000 for the year ended June 30, 1997. The yield on the Company's mortgage-backed and related securities was nearly unchanged. The yield was 6.88% for the year ended June 30, 1996 as compared to 6.87% for the year ended June 30, 1997. Since January 1997, the Company has designated its mortgage-backed and related securities purchases as available for sale. (Continued) 12 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Interest on investment securities, including FHLB stock decreased by $194,000, or 17.41%, from $1,114,000 for the year ended June 30, 1996 to $920,000 for the year ended June 30, 1997. The decrease was due to a $3,146,000, or 17.42% decrease in the average balance of investment securities from $18,056,000 for the year ended June 30, 1996 to $14,910,000 for the year ended June 30, 1997. The decrease in investment securities is a result of the Company's decision to reallocate funds from investment security maturities into loans and mortgage-backed and related securities. The yield on the Company's investment securities, 6.04% for the year ended June 30, 1996 as compared to 6.02% for the year ended June 30, 1997, was nearly unchanged. Since January 1997, the Company has designated all investment security purchases as available for sale. Interest Expense Interest expense increased by $303,000, or 16.09% from $1,883,000 for the year ended June 30, 1996 to $2,186,000 for the year ended June 30, 1997. The increase was a result of the increase in the average balance of interest-bearing liabilities. The increase was minimally affected by a slight increase in the cost of average interest-bearing liabilities from 5.30% to 5.31% for the years ended June 30, 1996 and 1997, respectively. Interest on deposits increased by $264,000 or 14.02% from $1,883,000 for the year ended June 30, 1996, to $2,147,000 for the year ended June 30, 1997. The increase was due to a $4,952,000, or 13.95% increase in the average balance of deposits. There was no material change in the cost of the Company's deposits in comparison of the two years. Interest on FHLB advances totaled $38,000. At June 30, 1997, the Company had FHLB advances totaling $3,500,000. There were no advances or other borrowings at June 30, 1996. The Company utilizes FHLB advances as an alternative source of loan and investment funding. Provision for Loan Losses The Company's provision for loan losses was $0 for the year ended June 30, 1997. Due to lack of substantive problem loans during the period and stable real estate values in the Company's market area, management believed that the allowance for loan losses was adequate throughout these periods. The allowance for loan losses was maintained at $213,000 at June 30, 1997 and 1996. The Company's net loan charge-offs were $0 and $0 for the years ended June 30, 1997 and 1996, respectively. At June 30, 1997 and 1996, the allowance for loan losses represented 1.02% and 1.27%, respectively, of loans receivable. Nonaccrual loans totaled $14,000 and $89,000 at June 30, 1997 and 1996, respectively. Noninterest Income Noninterest income decreased by $5,000, or 8.20% from $61,000 for the year ended June 30, 1996 to $56,000 for the year ended June 30, 1997. The decrease was primarily due to $12,000 in gains resulting from the disposition of various assets in the year ended June 30, 1996. The decrease was partially offset by a $9,000 increase in fee and service charge income for the year ended June 30, 1997. In addition, the decrease was also affected by a $3,000 gain on the sale of investments available for sale in 1997. (Continued) 13 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Noninterest Expense Noninterest expense increased by $360,000, or 36.29% from $992,000 for the year ended June 30, 1996, to $1,352,000 for the year ended June 30, 1997. The increase in noninterest expense was primarily due to the aforementioned $237,000 one-time deposit insurance fund assessment and the $102,000 in expenses, primarily professional fees, as a result of the Company's unsuccessful acquisition attempt. The increase was also due to a $64,000, or 9.86% increase in compensation costs from $649,000 for the year ended June 30, 1996 to $713,000 for the year ended June 30, 1997. The increase in compensation costs was due primarily to increased staffing. The increase in noninterest expense was partially offset by a $29,000, or 35.80% decrease in federal deposit insurance premiums from $81,000 to $52,000 for the years ended June 30, 1996 and 1997, respectively. As a result of the one-time $237,000 deposit insurance fund assessment, the Bank currently pays substantially lower federal deposit insurance premiums. Excluding th $102,000 aforementioned professional fees incurred with the unsuccessful acquisition, professional fees declined by $33,000 in comparison of the two years. Income Taxes The Company's income tax expense decreased by $74,000, or 35.07% from $211,000 for the year ended June 30, 1996, to $137,000 for the year ended June 30, 1997. The decrease was a result of decreased earnings before taxes. For the years ended June 30, 1996 and 1997, earnings before taxes totaled $673,000 and $388,000, respectively. Financial Condition The Company's total assets decreased by $3,487,000 or 6.34%, from $55,002,000 at June 30, 1995 to $51,515,000 at June 30, 1996, and increased by $10,654,000, or 20.68% to $62,169,000 at June 30, 1997. Changes in the Company's level of assets from June 30, 1995 to 1996 reflect a decrease in funds held for stock subscriptions. For the year ended June 30, 1997, this increase is a result of increased deposit growth and use of FHLB advances to fund increased loan production and purchases of investment securities, including mortgage-backed securities. The Company's loans receivable, net, increased by $1,259,000, or 8.25% from $15,255,000 at June 30, 1995 to $16,514,000 at June 30, 1996, and increased by $4,253,000, or 25.75% to $20,767,000 at June 30, 1997. For the year ended June 30, 1997, this increase primarily reflects increased residential mortgage lending. The increased loan portfolio will result in increased credit risk exposure. The increased loan portfolio was funded through short and intermediate term deposits and FHLB advances, which may result in an increase in the Company's interest-rate risk exposure. The Company's securities, which include investment securities and mortgage-backed and related securities, increased by $6,789,000, or 27.93%, from $24,305,000 at June 30, 1995 to $31,094,000 at June 30, 1996, and increased by $8,306,000 or 26.71%, to $39,400,000 at June 30, 1997. The increase in the Company's level of securities during the year ended June 30, 1996 reflects increased cash flows resulting from deposits and investment of a portion of the proceeds from the stock conversion. The increase in the Company's level of securities during the year ended June 30, 1997 reflects increased cash flows from deposits and FHLB advances. Commencing in January 1997, the Company has chosen to designate select new investments as available for sale. The Company had previously designated all securities held to maturity. At June 30, 1997, securities designated as available for sale totaled $15,131,000. (Continued) 14 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Cash and cash equivalents decreased by $11,220,000, or 79.61%, from $14,093,000 at June 30, 1995 to $2,873,000 at June 30, 1996, and then decreased $2,109,000, or 73.41%, to $764,000 at June 30, 1997. For the years ended June 30, 1995 to 1996, the Company's cash and cash equivalents fluctuated primarily as a result of funds held at June 30, 1995 for stock subscriptions. For the year ended June 30, 1997, the Company's cash and cash equivalents fluctuated depending upon changes in deposits, maturity and purchases of securities, loan originations and principal and interest payments on loans and mortgage-backed and related securities. The Company's deposits increased by $2,218,000, or 6.19%, from $35,825,000 at June 30, 1995 to $38,043,000 at June 30, 1996, and increased by $8,050,000, or 21.16% to $46,093,000 at June 30, 1997. The increase in deposits is primarily a result of increased public deposits in each year. FHLB advances totaled $0, $0, and $3,500,000 at June 30, 1995, 1996, and 1997, respectively. During the year ended June 30, 1997, the Company utilized FHLB advances to fund increased loan growth and purchases of investment securities and mortgage-backed and related securities. Stockholders' equity increased during the year ended June 30, 1996 by $7,501,000 or 132.62%, from $5,656,000 at June 30, 1995 to $13,157,000 at June 30, 1996. The increase was due primarily to the $8,549,000 in net proceeds from the sale of the Company's common stock, and the Company's net earnings of $462,000 for the year ended June 30, 1996. The increase was partially offset by $541,000 in proceeds used to repurchase the Company's common stock and $596,000 and $393,000 as a result of unearned employee stock ownership plan shares and unearned management stock bonus plan shares at June 30, 1996, respectively. Stockholders' equity decreased during the year ended June 30, 1997 by $815,000, or 6.19%, from $13,157,000 at June 30, 1996 to $12,342,000 at June 30, 1997. The decrease was due primarily to the repurchase of 106,875 shares of the Company's common stock. As a result, the Company's treasury stock increased by $1,227,000, or 226.80% from $541,000 at June 30, 1996, to $1,768,000 at June 30, 1997. The decrease in stockholders' equity was also affected by a $3,000 adjustment due to valuation of the Company's available for sale securities. The decrease in stockholders' equity was partially offset by net earnings for the year ended June 30, 1997 of $252,000, an $86,000 decrease in unearned management stock bonus plan shares, and a $66,000 decrease in unearned employee stock ownership plan shares from June 30, 1996 to June 30, 1997. (Continued) 15 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Nonperforming Assets The following table sets forth information regarding nonaccrual loans, real estate owned, and certain other repossessed assets, and loans. As of the dates indicated, there were no loans modified in a troubled debt restructuring.
- -------------------------------------------------------------------------------------------------------------------- 1998 1997 - -------------------------------------------------------------------------------------------------------------------- Loans accounted for on a nonaccrual basis: Mortgage loans: Loan secured by 1-4 dwelling units $ - - All other mortgage loans - - Nonmortgage loans - - - -------------------------------------------------------------------------------------------------------------------- Total $ - - - -------------------------------------------------------------------------------------------------------------------- Accruing loans which are contractually past due 90 days or more: Mortgage loans: Loans secured by 1-4 dwelling units 75,292 120,902 All other mortgage loans - - Non-mortgage loans 15,414 - - -------------------------------------------------------------------------------------------------------------------- Total $90,706 120,902 - -------------------------------------------------------------------------------------------------------------------- Total nonaccrual and accrual loans $90,706 120,902 - -------------------------------------------------------------------------------------------------------------------- Real estate $ - 13,520 - -------------------------------------------------------------------------------------------------------------------- Other nonperforming assets $ - - - -------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $90,706 134,422 - -------------------------------------------------------------------------------------------------------------------- Total nonaccrual and accrual loans to net loans 0.31% 0.58% - -------------------------------------------------------------------------------------------------------------------- Total nonaccrual and accrual loans to total assets 0.12% 0.19% - -------------------------------------------------------------------------------------------------------------------- Total nonperforming assets to total assets 0.12% 0.22% - --------------------------------------------------------------------------------------------------------------------
Interest income that would have been recorded on loans accounted for on a nonaccrual basis under the original terms of such loans for the year ended June 30, 1998 and 1997, was $0 and $296, respectively. (Continued) 16 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- Analysis of the Allowance for Loan Losses The following table sets forth information with respect to the Company's allowance for loan losses at the dates and for the periods indicated:
- ---------------------------------------------------------------------------------------------- At or for the year ended June 30 ----------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------------------------- Allowance (at beginning of year) $213,034 213,034 213,034 Charge-offs - - - Recoveries - - - - ----------------------------------------------------------------------------------------------- Net charge-offs - - - Provision 38,000 - - - ----------------------------------------------------------------------------------------------- Allowance (at end of year) $251,034 213,034 213,034 - ----------------------------------------------------------------------------------------------- Allowance for loan losses as a percent of total loans outstanding 0.86% 1.02% 1.27% Net loans charged off as a percent of average loans outstanding 0.00 0.00 0.00 - -----------------------------------------------------------------------------------------------
Liquidity and Capital Resources The Company's primary sources of funds are deposits, FHLB advances, proceeds from maturing investment securities, and principal and interest payments on loans and mortgage-backed securities and related securities. While maturities and scheduled amortization of mortgage-backed and related securities and loans are a predictable source of funds, deposit flows and mortgage prepayments are generally influenced by general interest rates, economic conditions, competition, and other factors. A substantial portion of the Company's deposits are funds from local government entities. The primary investing activities of the Company are the origination of loans and the purchase of investment and mortgage-backed and related securities. During the twelve months ended June 30, 1998 and 1997, the Company's loan portfolio, net, increased $8,228,000 and $4,253,000, respectively. During the same periods, the Company purchased investment securities and mortgage-backed and related securities in the amounts of $22,117,000 and $16,233,355, respectively. The primary financing activity of the Compan is the attraction of savings deposits and utilization of FHLB advances. The Company has other sources of liquidity if there is a need for funds. The Bank has the ability to obtain additional advances from the Federal Home Loan Bank of Des Moines. During the twelve months ended June 30, 1998 and 1997, the Bank utilized advances of $23,500,000 and $5,500,000, respectively. The Company's advances include $5,000,000 which include call provisions. In the event that these advances are called, the FHLB has committed to providing an alternative funding, at market rates and terms. In addition, commencing in January 1998, the Company's redesignation of all investment securities, including mortgage-backed and related securities as available for sale, is intended to increase liquidity and overall operational flexibility. The Bank is required to maintain minimum levels of liquid assets as defined by OTS regulations. This requirement, which may be changed at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The required minimum ratio is currently 4.0%. (Continued) 17 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- The Company's most liquid assets are cash and cash equivalents. In addition, the Company maintains a portfolio of readily marketable investment securities, including mortgage-backed and related securities which are designated available for sale. The levels of cash and investment securities, including mortgage-backed and related securities, are dependent on the Company's operating, financing, and investing activities during any given period. At June 30, 1998 and 1997, cash and cash equivalents totaled $2,009,000 and $764,000, respectively. Investment securities, including mortgage-backed and related securities designated available for sale totaled $43,731,000 and $15,131,000 at June 30, 1998 and 1997, respectively. Federal savings institutions are required to satisfy three capital requirements: (i) a requirement that "tangible capital" equal or excess 1.5% of tangible assets, (ii) a requirement that "core capital" equal or excess 3.0% of adjusted tangible assets, and (iii) a risk-based capital requirement currently of 8.0% of "risk-adjusted" assets. The Bank currently meets all three capital requirements. 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 Company's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Recent Developments (1) Bank Corporate Title Change In June 1998, Redwood Financial, Inc. announced that it had approved a change in the corporate title of the Redwood Falls Federal Savings and Loan Association (the Association) to the "HomeTown Bank". The Company stated that the purpose of the change in the corporate title of the Association is to reflect changes in its banking operations and the banking products that it offers and plans to offer. Since the conversion of the Association from a federally chartered mutual savings and loan association to a federally chartered stock savings and loan association in July 1995, the Association has endeavored to become a community bank offering additional lending and deposit products and services. The Company believes that the name change reflects this effort and will assist in attracting new customers and further strengthening its relationships with its current customers. (2) Year 2000 Consideration The Company's primary exposure to the Year 2000 issue is its automated data processing system which had been determined to be Year 2000 noncompliant. On August 4, 1998, the Company received its Year 2000 compliant release from its data processing provider. Management has begun testing the release to ensure that the software properly addresses all pertinent risks identified by the Federal Financial Institutions Examination Council and its data processing vendor. The company expects to have its testing substantially completed by December 31, 1998. (Continued) 18 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Annual Report - -------------------------------------------------------------------------------- The Company has also recently begun using various telecommunication services provided by the Federal Reserve Bank of Minneapolis. The Company has begun the testing of this service with assistance from the Federal Reserve Bank. Also, as part of the construction of its new office building, the Company is in process of updating its telephone network, which is currently not Year 2000 compliant. The Company also has several lesser Year 2000 issues (i.e., various non-mission critical applications) that are also being addressed. The Company has lessor exposure to borrower delinquencies arising after Year 2000 due to its 1-4 family residential lending emphasis. However, as the Company broadens its lending activities to include commercial lending, as part of its credit underwriting, the Company is prudently assessing Year 2000 sensitivity of all commercial loan applicants. At this time, the Company expects that its Year 2000 compliance efforts will have no material financial effect (i.e., less than $5,000). However, a substantial amount of current staff time is being expended on Year 2000 assessment and testing. Should the Company fail to correct its Year 2000 deficiencies by December 31, 1999, the Company could expect a substantial disruption to daily operations. Such disruption could have a material effect on the Company's financial position and future earnings. To this extent, the Company's contingency plan is to re-commence manual data processing operations. As the Company only recently converted from manual to automated data processing in October 1997, the Company still retains the equipment and trained staff necessary to re-commence manual data processing operations. The Company plans to re-assess its contingency plan pending the results of on-going testing. (3) New Facility Update On April 28, 1998, the Company announced its intention to construct a new bank facility on the east side of Redwood Falls, Minnesota. Construction commenced shortly thereafter. The building is currently scheduled for completion in January 1999 with occupancy shortly thereafter. The building will permit the Company to provide several new deposit and banking services that are not currently being offered. Development of these services is currently being addressed. The Company estimates that the new facility will decrease earnings by approximately $120,000 per year. This estimate does not reflect any additional staffing or other indirect costs which may be incurred, nor any additional revenues which may be generated. The Company expects to continue utilizing its existing downtown Redwood Falls location. 19 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Balance Sheets June 30, 1998 and 1997
- --------------------------------------------------------------------------------------------------------------------------- Assets 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Cash $ 20,448 15,314 Interest bearing deposits with banks 1,988,780 748,478 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 2,009,228 763,792 Securities available for sale: Mortgage-backed and related securities (amortized cost $33,726,372 and $8,143,694) 33,937,175 8,149,752 Investment securities (amortized cost $9,784,454 and $6,992,534) 9,793,500 6,981,250 - --------------------------------------------------------------------------------------------------------------------------- Total securities available for sale 43,730,675 15,131,002 Securities held to maturity: Mortgage-backed and related securities (market value $0 and $14,082,280) - 13,873,801 Investment securities (market value $0 and $10,399,446) - 10,395,659 - --------------------------------------------------------------------------------------------------------------------------- Total securities held to maturity - 24,269,460 Loans receivable, net 28,994,750 20,766,539 Federal Home Loan Bank stock, at cost 835,000 333,500 Accrued interest receivable 547,898 613,357 Premises and equipment, net 596,867 212,067 Real estate, net - 13,520 Investment in limited partnership 484,024 - Other assets 88,163 65,679 - --------------------------------------------------------------------------------------------------------------------------- Total assets $ 77,286,605 62,168,916 - --------------------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity - --------------------------------------------------------------------------------------------------------------------------- Deposits 48,101,806 45,687,590 Federal Home Loan Bank advances 16,200,000 3,500,000 Accrued interest payable 631,168 405,623 Advance payments by borrowers for taxes and insurance 75,463 69,744 Accrued expenses and other liabilities 340,142 163,926 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities 65,348,579 49,826,883 - --------------------------------------------------------------------------------------------------------------------------- Common stock ($.10 par value). Authorized and issued 1,125,000 shares; outstanding 868,093 shares at June 30, 1998; 961,875 at June 30, 1997 112,500 112,500 Additional paid-in capital 8,490,163 8,467,833 Retained earnings, subject to certain restrictions 6,794,926 6,369,591 Net unrealized gain (loss) on securities available for sale 131,909 (3,135) Unearned employee stock ownership plan shares (463,264) (529,504) Unearned management stock bonus plan shares (220,172) (306,797) Treasury stock, at cost, 256,907 and 163,125 shares in 1998 and 1997, respectively (2,908,036) (1,768,455) - --------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 11,938,026 12,342,033 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 77,286,605 62,168,916 - ---------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 20 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Earnings Years ended June 30, 1998, 1997, and 1996
- ---------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------- Interest income: Loans receivable $ 2,071,506 1,563,605 1,376,334 Securities held to maturity: Mortgage-backed and related securities 453,033 1,044,024 784,869 Investment securities 295,402 749,059 1,090,544 Securities available for sale: Mortgage-backed and related securities 1,233,835 168,357 - Investment securities 584,221 147,775 - Cash equivalents and other 109,924 196,797 235,404 - ---------------------------------------------------------------------------------------------------------------------------- Total interest income 4,747,921 3,869,617 3,487,151 Interest expense on deposits 2,579,334 2,147,264 1,882,837 Interest expense on Federal Home Loan Bank advances 419,138 38,485 - ---------------------------------------------------------------------------------------------------------------------------- Total interest expense 2,998,472 2,185,749 1,882,837 Net interest income 1,749,449 1,683,868 1,604,314 - ---------------------------------------------------------------------------------------------------------------------------- Provision for losses on loans 38,000 - - - ---------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for losses on loans 1,711,449 1,683,868 1,604,314 - ---------------------------------------------------------------------------------------------------------------------------- Noninterest income: Fees and service charges 81,344 45,231 36,197 Gain on sale of securities available for sale, net 41,741 2,863 Other 8,168 8,384 24,314 - ---------------------------------------------------------------------------------------------------------------------------- Total noninterest income 131,253 56,478 60,511 - ---------------------------------------------------------------------------------------------------------------------------- Noninterest expense: Compensation and employee benefits 839,660 713,001 648,859 Professional fees 99,773 195,493 126,781 Advertising 26,828 19,210 16,411 Occupancy 31,874 31,746 28,181 Data processing expense 31,954 - - Federal deposit insurance premiums 29,313 51,851 80,769 Deposit insurance fund assessment - 237,085 - Other 115,056 103,792 90,880 - ---------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 1,174,458 1,352,178 991,881 - ---------------------------------------------------------------------------------------------------------------------------- Earnings before income taxes 668,244 388,168 672,944 Income tax expense 242,909 136,668 210,512 - ---------------------------------------------------------------------------------------------------------------------------- Net earnings $ 425,335 251,500 462,432 - ---------------------------------------------------------------------------------------------------------------------------- Net earnings per common share-basic $ .52 .27 .46 Net earnings per common share-diluted .49 .26 .45
See accompanying notes to consolidated financial statements. 21 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Stockholders' Equity Years ended June 30, 1998, 1997, and 1996
- --------------------------------------------------------------------------------------------------------------------------- Net Unearned unrealized Employee Unearned gain (loss) Stock management Additional on securities Ownership stock Total Common paid-in Retained available Plan bonus Treasury stockholders' stock capital earnings for sale Shares plan shares stock equity - --------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1995 $ - - 5,655,659 - - - - 5,655,659 Net earnings - - 462,432 - - - - 462,432 Sale of common stock 112,500 8,436,861 - - - - - 8,549,361 Adoption of employee stock ownership plan - - - - (661,984) - - (661,984) Earned employee stock ownership plan shares, net - 10,781 - - 66,240 - - 77,021 Repurchase of common stock - - - - - - (965,156) (965,156) Adoption of management stock bonus plan - 9,375 - - - (433,125) 423,750 - Earned management stock bonus plan shares - - - - - 39,703 - 39,703 - --------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1996 112,500 8,457,017 6,118,091 - (595,744) (393,422) (541,406) 13,157,036 Net earnings - - 251,500 - - - - 251,500 Repurchase of common stock - - - - - - (1,227,049) (1,227,049) Net unrealized loss on securities available for sale, net - - - (3,135) - - - (3,135) Earned employee stock ownership plan shares, net - 10,816 - - 66,240 - - 77,056 Earned management stock bonus plan shares - - - - - 86,625 - 86,625 - --------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1997 112,500 8,467,833 6,369,591 (3,135) (529,504) (306,797) (1,768,455) 12,342,033 Net earnings - - 425,335 - - - - 425,335 Repurchase of common stock - - - - - - (1,139,581) (1,139,581) Net unrealized gain on securities available for sale, net - - - 135,044 - - - 135,044 Earned employee stock ownership plan shares, net - 22,330 - - 66,240 - - 88,570 Earned management stock bonus plan shares - - - - - 86,625 - 86,625 - --------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1998 $ 112,500 8,490,163 6,794,926 131,909 (463,264) (220,172) (2,908,036) 11,938,026 - ---------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 22 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows Years ended June 30, 1998, 1997, and 1996
- --------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Operating activities: Net earnings $ 425,335 251,500 462,432 Adjustments to reconcile net earnings to net cash provided by operating activities: Provision for loan losses 38,000 - - Depreciation 28,384 16,742 16,992 Amortization of premiums and discounts, net (15,832) (36,232) (40,057) (Increase) decrease in other assets (22,484) 28,313 15,440 (Increase) decrease in accrued interest receivable 65,459 (59,501) (144,272) Increase (decrease) in accrued interest payable 225,545 221,379 (50,453) Gain on sale of securities available for sale, net (41,741) (2,863) Amortization of unearned ESOP shares 66,240 66,240 66,240 Earned ESOP shares priced above original cost 22,330 10,816 10,781 Earned Management Stock Bonus Plan shares 86,625 86,625 39,703 Change in deferred income taxes (5,178) (56,854) 45,726 Increase (decrease) in accrued expenses and other liabilities 176,216 (36,522) (34,617) Federal Home Loan Bank stock dividend - - (6,500) - --------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 1,048,899 489,643 381,415 - --------------------------------------------------------------------------------------------------------------------------- Investing activities: Proceeds from maturities of investment securities held to maturity 500,000 4,895,000 4,000,200 Purchases of investment securities held to maturity - - (2,860,069) Purchases of mortgage-backed and related securities held to maturity - - (9,964,830) Principal collected on mortgage-backed and related securities held to maturity 2,034,858 1,927,523 2,075,679 Proceeds from maturities of investment securities available for sale 9,600,000 - - Purchases of investment securities available for sale (2,490,093) (7,988,700) - Proceeds from sales of investment securities available for sale - 999,376 - Proceeds from sales of mortgage-backed and related securities available for sale 1,011,469 - - Purchases of mortgage-backed and related securities available for sale (19,626,386) (8,244,655) - Principal collected on mortgage-backed and related securities available for sale 4,916,656 135,675 - Purchase of investment in limited partnership (500,000) - - Purchases of Federal Home Loan Bank stock (501,500) - - Increase in loans receivable, net (8,315,637) (4,262,925) (1,350,152) Purchases of premises and equipment (413,184) (176,622) (5,268) - --------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (13,783,817) (12,715,328) (8,104,440) - ---------------------------------------------------------------------------------------------------------------------------
(Continued) 23 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows, Continued
- --------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Financing activities: Decrease in funds held for stock subscriptions $ - - (13,127,630) Increase in deferred stock conversion costs - - 439,015 Increase in deposits, net 2,414,216 7,829,305 2,267,713 Increase in advance payments by borrowers for taxes and insurance 5,719 14,058 2,204 Proceeds from sale of common stock - - 8,549,361 Adoption of ESOP - - (661,984) Proceeds from Federal Home Loan Bank advances 23,500,000 5,500,000 - Repayment of Federal Home Loan Bank advances (10,800,000) (2,000,000) - Repurchase of common stock (1,139,581) (1,227,049) (965,156) - --------------------------------------------------------------------------------------------------------------------------- Net cash (used) provided by financing activities 13,980,354 10,116,314 (3,496,477) - --------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents 1,245,436 (2,109,371) (11,219,502) Cash and cash equivalents, beginning of year 763,792 2,873,163 14,092,665 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 2,009,228 763,792 2,873,163 - --------------------------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 2,772,927 1,964,370 1,933,290 Income taxes 281,559 272,505 175,101 Supplemental noncash flow disclosures: Transfer of loans to real estate $ - 13,520 - Transfer of real estate to loans 13,520 - - Transfer of investment and mortgage-backed and related securities from held to maturity to available for sale 20,596,006 - - Loss on limited partnership recorded using the equity method (15,976) - -
See accompanying notes to consolidated financial statements. 24 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements June 30, 1998 - -------------------------------------------------------------------------------- (1) Redwood Financial, Inc. Redwood Financial, Inc. (the Company) was incorporated under the laws of the State of Minnesota for the purpose of becoming the savings and loan holding company of HomeTown Bank (the Bank), formerly known as Redwood Falls Federal Savings and Loan Association (the Association), in connection with the Association's conversion from a federally-chartered mutual savings and loan association to a federally-chartered stock savings and loan association, pursuant to its Plan of Conversion. The Company commenced on May 22, 1995, a Subscription and Community Offering of its shares in connection with the conversion of the Association (the Offering). The Offering was closed on June 22, 1995, and final approval for the conversion was received from the Office of Thrift Supervision on July 7, 1995 (see note 18). (2) Summary of Significant Accounting Policies The accounting and reporting policies of the Company and its subsidiary conform to generally accepted accounting principles. The following summarizes the more significant accounting policies the Company follows in preparing and presenting its consolidated financial statements. (a) Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and the Bank. All significant intercompany account balances and transactions have been eliminated in consolidation. (b) Material Estimates 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 balance sheet and revenues and expenses for the period. Actual results could differ significantly 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 allowance for losses on loans is adequate. While management uses available information to recognize losses on loans, future additions to the allowance 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 allowance for losses on loans. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination. (c) Reclassifications Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current year presentation. (d) Cash and Cash Equivalents Cash and cash equivalents primarily represent amounts on deposit at other financial institutions and highly liquid financial instruments with original maturities at the date of purchase of three months or less. (Continued) 25 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (e) Investment Securities, Mortgage-Backed Securities, and Investment in Limited Partnership The Company classifies its debt and equity securities in one of three categories: trading, available for sale or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. The Company had no securities classified as trading for the years ended June 30, 1998, 1997, and 1996. Securities available for sale include securities that management intends to use as part of its asset/liability strategy or that may be sold in response to changes in interest rate, changes in prepayment risk, or similar factors. Securities available for sale are carried at market value. Net unrealized gains and losses, net of tax effect, are included as a separate component of stockholders' equity. Securities held to maturity are carried at amortized cost, as management has the ability and positive intent to hold them to maturity. Discounts and premiums on securities are amortized to income using the level yield method over the estimated life of the security. Gains and losses on the sale of securities are determined using the specific identification method on trade date. The investment in limited partnership is recorded using the equity method of accounting. (f) Loans Receivable Loans are considered long-term investments and, accordingly, are carried at historical cost. The allowance for loan losses is maintained at an amount considered adequate to provide for probable losses. The allowance for loan losses is based on periodic analysis of the loan portfolio by management. In this analysis, management considers factors including, but not limited to, specific occurrences, general economic conditions, loan portfolio composition, and historical experience. Loans are charged off to the extent they are deemed to be uncollectible. Interest income is recognized on an accrual basis except when collectibility is in doubt as determined on a loan by loan basis. When interest accruals are suspended, interest previously accrued is reversed. Interest is subsequently recognized as income to the extent cash is received when, in management's judgment, principal is collectible. Under the Company's credit policies and practices, all nonaccrual and restructured loans, excluding consumer loans and residential real estate loans classified as nonacrrual, are considered impaired loans. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loan impairment is 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 observable market price of the loan or the fair value of the collateral if the loan is collateral dependent. Loan origination fees and certain related direct costs are deferred and amortized to interest income using the effective interest method over the life of the loan. Discounts and premiums on loans originated or purchased are deferred and amortized to income using the level-yield method over the estimated average loan life. (Continued) 26 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (g) Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over the estimated useful lives of 35 to 40 years for buildings, 20 to 25 years for building improvements, and 2 to 11 years for furniture and equipment. (h) Real Estate Real estate owned or expected to be acquired in settlement of loans is carried at the lower of the unpaid loan balance plus settlement costs or estimated fair value less selling costs. After acquisition, costs of capital improvements made to facilitate sales are capitalized as incurred. Costs incurred for holding properties after the redemption period are expensed currently. The carrying value of individual properties is periodically evaluated and reduced to the extent cost exceeds estimated fair value less selling costs. Gains on the sales of such real estate are recorded at the time of closing. (i) Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. (j) Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (k) Stock-Based Compensation As permitted by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, the Company elected to continue using the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25 and related interpretations which measure compensation cost using the intrinsic value method. The Company has included in note 12, the impact of the fair value of employee stock-based compensation plans on net income and earnings per share on a pro forma basis for awards granted after July 1, 1995. (l) New Accounting Standards In July 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income (SFAS 130), which establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be disclosed in the financial statements. Comprehensive Income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income. Other comprehensive income is anticipated to be primarily comprised of unrealized gains and losses on securities available for sale. SFAS 130 is effective for fiscal years beginning after December 15, 1997. Management adopted SFAS 130 on July 1, 1998 and will report comprehensive income in statements issued for financial reporting periods occurring during the year ended June 30, 1999. (Continued) 27 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- In February 1998, the FASB issued SFAS No. 132, Employers' Disclosures about Pension and Other Postretirement Benefits (SFAS 132), which revises current disclosure requirements for employers' pensions and other retiree benefits. SFAS 132 will have no effect on the financial position or results of operations of the Company, however, it will impact disclosures in the financial statements in future periods. SFAS 132 is effective for fiscal years beginning after December 15, 1997. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Management is currently studying the impact of adopting SFAS 133. (m) Earnings Per Share In February 1997, the FASB issued SFAS No. 128, Earnings per Share (SFAS 128). SFAS 128 establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. SFAS 128 supersedes the standards for computing EPA previously found in Accounting Principles Board (APB) Opinion No. 15, Earnings per Share. The Company adopted SFAS 128 effective for periods ending December 31, 1997. All prior period earnings per share have been restated in accordance with SFAS 128. The following tables illustrate the calculation of basic and diluted earnings per share for the twelve months ended June 30, 1998, 1997, and 1996:
- --------------------------------------------------------------------------------------------------------------------------- For the year ended: June 30, 1998 June 30, 1997 June 30, 1996 -------------------------------- -------------------------------- -------------------------------- Weighted Per Weighted Per Weighted Per average share average share average share Income shares amount Income shares amount Income shares amount ---------------------------------------------------------------------------------------------------------------------------- Net income: $ 425,335 $ 251,500 $ 462,432 Basic EPS: Income available to common stockholders 425,335 817,109 .52 251,500 933,377 .27 462,432 1,015,053 .46 Effect on Dilutive Securities: Options on common stock 23,173 4,070 - Unvested restricted 19,159 24,559 12,450 stock awards ---------------------------------------------------------------------------------------------------------------------------- 42,332 28,629 12,450 Dilutive EPS Income available to common stock-holders plus assumed con- $ 425,335 859,441 .49 $ 251,500 962,432 .26 $ 462,432 1,027,503 .45 versions ----------------------------------------------------------------------------------------------------------------------------
(Continued) 28 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (3) Securities Available for Sale Securities available for sale at June 30, 1998 and 1997 are summarized as follows:
- ------------------------------------------------------------------------------------------------------------------------------ June 30, 1998 -------------------------------------------------------------------- Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ---------------------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Government agency securities $ 5,152,897 13,665 (937) 5,165,625 U.S. Treasury notes 3,799,561 2,290 (3,976) 3,797,875 Municipal bonds 831,996 - (1,996) 830,000 ---------------------------------------------------------------------------------------------------------------------------- Total investment securities $ 9,784,454 15,955 (6,909) 9,793,500 ---------------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities: GNMA certificates 1,171,238 41,920 (112) 1,213,046 FHLMC certificates 29,060,047 154,355 (37,600) 29,176,802 FNMA certificates 3,495,087 52,240 - 3,547,327 ---------------------------------------------------------------------------------------------------------------------------- Total mortgage-backed securities $ 33,726,372 248,515 (37,712) 33,937,175 ----------------------------------------------------------------------------------------------------------------------------
June 30, 1997 -------------------------------------------------------------------- Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ---------------------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Government agency securities $ 6,992,534 10,000 (21,284) 6,981,250 ---------------------------------------------------------------------------------------------------------------------------- Total investment securities $ 6,992,534 10,000 (21,284) 6,981,250 ---------------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities: FHLMC certificates 8,143,694 9,939 (3,881) 8,149,752 ---------------------------------------------------------------------------------------------------------------------------- Total mortgage-backed securities $ 8,143,694 9,939 (3,881) 8,149,752 ----------------------------------------------------------------------------------------------------------------------------
Proceeds from the sale of securities available for sale during the years ended June 30, 1998, 1997, and 1996, were $1,011,469, $999,376, and $0, respectively. Gross realized gains from the sale of securities for the years ended June 30, 1998, 1997, and 1996 were $42,652, $2,863, and $0, respectively. Gross realized losses from the sale of securities for the years ended June 30, 1998, 1997, and 1996, were $911, $0, and $0, respectively. Accrued interest receivable on securities available for sale aggregated $355,164 and $212,930 at June 30, 1998 and 1997, respectively. (Continued) 29 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The carrying amount and approximate market value of investment securities and mortgage-backed and related securities available for sale at June 30, 1998 and 1997, by contractual maturity, are shown below:
- ----------------------------------------------------------------------------------------------------------------- June 30, 1998 June 30, 1997 ---------------------------------- ---------------------------------- Amortized Approximate Amortized Approximate cost market value cost market value - ----------------------------------------------------------------------------------------------------------------- Due within one year $ 7,940,686 7,945,510 - - Due after one year through five years 11,876,970 11,973,559 1,998,189 1,990,938 Due after five years through ten years 21,718,570 21,823,030 13,138,039 13,140,064 Due after ten years 1,974,600 1,988,576 - - - ----------------------------------------------------------------------------------------------------------------- $43,510,826 43,730,675 15,136,228 15,131,002 - -----------------------------------------------------------------------------------------------------------------
Nontaxable interest income on securities available for sale and securities held to maturity was $41,998, $67,546, and $60,213 for the years ended June 30, 1998, 1997, and 1996, respectively. (4) Securities Held to Maturity Securities held to maturity at June 30, 1997, are summarized as follows:
---------------------------------------------------------------------------------------------------------------------------- June 30, 1997 ------------------------------------------------------------------ Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ---------------------------------------------------------------------------------------------------------------------------- Investment securities: U.S. Government agency bonds $ 3,743,759 34,800 (4,388) 3,774,171 U.S. Treasury notes 5,502,262 4,234 (28,441) 5,478,055 Municipal bonds 1,149,638 2,353 (4,771) 1,147,220 ---------------------------------------------------------------------------------------------------------------------------- Total investment securities $ 10,395,659 41,387 (37,600) 10,399,446 ---------------------------------------------------------------------------------------------------------------------------- Mortgage-backed and related securities: GNMA certificates 205,122 94,839 - 299,961 FHLMC certificates 9,358,524 121,853 (16,893) 9,463,484 FHLMC collateralized mortgage obligations 58,548 3,297 - 61,845 FNMA certificates 4,251,607 12,100 (6,717) 4,256,990 ---------------------------------------------------------------------------------------------------------------------------- Total mortgage-backed and related securities $ 13,873,801 232,089 (23,610) 14,082,280 ----------------------------------------------------------------------------------------------------------------------------
(Continued) 30 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- During the third quarter of fiscal 1998, the Company determined that it no longer had the intent to hold its securities classified as held to maturity to the actual maturity date of the securities. Therefore, it transferred all the remaining securities in the held to maturity portfolio to the available for sale portfolio. The fair value of securities transferred to "available for sale" at the date of transfer was $20,848,776 with amortized cost of $20,596,006 and unrealized holding gains, gross and net of taxes, of $249,044 and $149,426, respectively. The Company does not intend to hold securities classified as "held to maturity" in the foreseeable future. There were no sales of securities held to maturity for the years ended June 30, 1998, 1997, or 1996. Accrued interest receivable on securities held to maturity aggregated $270,226 at June 30, 1997. (5) Loans Receivable Loans receivable at June 30, 1998 and 1997 are summarized as follows: - -------------------------------------------------------------------------------- 1998 1997 - -------------------------------------------------------------------------------- Loans secured by real estate: Residential one-to-four family $24,261,342 18,577,418 Multifamily 1,471,862 173,594 Commercial 1,375,388 679,968 Agricultural 112,500 150,000 Residential construction 463,500 502,000 Multifamily construction - 980,000 Other consumer loans 182,405 21,000 Loans on deposits 255,494 133,033 Commercial 1,236,260 714,869 Agricultural operating line of credit 2,793,024 425,000 - -------------------------------------------------------------------------------- Total 32,151,775 22,356,882 - -------------------------------------------------------------------------------- Deferred loan fees and discounts (29,043) (15,765) Loans in process (2,876,948) (1,361,544) Allowance for losses (251,034) (213,034) - -------------------------------------------------------------------------------- Net loans $28,994,750 20,766,539 - -------------------------------------------------------------------------------- Accrued interest receivable on loans receivable at June 30, 1998 and 1997 was $192,734 and $125,682, respectively. (Continued) 31 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- There were no nonperforming loans for the years ended June 30, 1998 and 1997. The following is a summary of nonperforming loans as of and for the year ended June 30, 1996: - -------------------------------------------------------------------------------- 1996 - -------------------------------------------------------------------------------- Impaired loans: Nonaccrual $ - Restructured - - -------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------- Other nonperforming loans: Nonaccrual 89,153 Restructured - - -------------------------------------------------------------------------------- 89,153 - -------------------------------------------------------------------------------- Total nonperforming loans $ 89,153 - -------------------------------------------------------------------------------- Scheduled interest under original terms 2,946 Actual interest recognized - - -------------------------------------------------------------------------------- Net interest lost on nonperforming loans $ 2,946 - -------------------------------------------------------------------------------- The average balance of impaired loans during each of the fiscal years ended June 30, 1998 and 1997 was $0. There was no allowance for losses on impaired loans at June 30, 1998 and 1997. The aggregate amount of loans to directors and executive officers of the Company was $244,602, $231,803, and $237,177, at June 30, 1998, 1997, and 1996, respectively. Activity with respect to these loans during fiscal 1998 included loan originations of $159,349 and repayments of $137,417, including both principal and interest. Activity with respect to these loans during fiscal 1997 included loan originations of $33,000 and loan repayments of $59,842, including both principal and interest. Activity with respect to these loans during fiscal 1996 included loan originations of $0 and loan repayments of $16,962, including both principal and interest. Such loans were made in the ordinary course of business on normal credit terms, including interest rate and collateralization, and do not represent more than normal risk of collection. Included in total commitments to originate loans are fixed rate loans aggregating $2,197,996 and $402,000 as of June 30, 1998 and 1997, respectively. The interest rates on these commitments ranged from 7.25% to 8.8% and 8% to 9% for June 30, 1998 and 1997, respectively. There were no material commitments to lend additional funds to customers whose loans were classified as nonaccrual at June 30, 1998, as there were no nonaccrual loans at June 30, 1998. There were no loans at June 30, 1998 and 1997, which had terms modified in troubled debt restructurings. The Company grants loans to customers who live primarily in southwestern Minnesota. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon local economic conditions. (Continued) 32 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (6) Allowance for Losses on Loans Receivable Activity in the allowance for losses on loans receivable is summarized as follows: - -------------------------------------------------------------------------------- Balance at June 30, 1995 $ 213,034 Provision for losses - Charge-offs and recoveries - - -------------------------------------------------------------------------------- Balance at June 30, 1996 213,034 Provision for losses - Charge-offs and recoveries - - -------------------------------------------------------------------------------- Balance at June 30, 1997 213,034 Provision for losses 38,000 Charge-offs and recoveries - - -------------------------------------------------------------------------------- Balance at June 30, 1998 $ 251,034 - -------------------------------------------------------------------------------- (7) Premises and Equipment A summary of premises and equipment at June 30, 1998 and 1997, is as follows: - -------------------------------------------------------------------------------- 1998 1997 - -------------------------------------------------------------------------------- Land and office buildings $ 620,976 310,927 Furniture and equipment 295,510 192,375 - -------------------------------------------------------------------------------- 916,486 503,302 Less accumulated depreciation (319,619) (291,235) - -------------------------------------------------------------------------------- $ 596,867 212,067 - -------------------------------------------------------------------------------- (8) Real Estate Real estate owned, representing real estate expected to be acquired in settlement of loans, totaled $0 and $13,520 at June 30, 1998 and 1997, respectively. The allowance for losses on real estate was $0 at June 30, 1998 and 1997. There were no provisions for losses on real estate, charge-offs, or recoveries for the years ended June 30, 1998, 1997, or 1996. (Continued) 33 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (9) Deposits Deposits and weighted-average interest rates at June 30, 1998 and 1997 are summarized as follows: - -------------------------------------------------------------------------------- 1998 1997 ------------------------ -------------------- Amount Rate Amount Rate - -------------------------------------------------------------------------------- Passbook $ 868,463 2.64% $ 922,487 2.65% Money market accounts 6,743,864 3.83% 7,187,340 4.23 7,612,327 8,109,827 - --------------------------------------- ---------- Certificates of deposit: 4.01-5.00% 2,577,293 421,418 5.01-6.00 24,147,498 18,099,518 6.01-7.00 13,604,445 18,749,835 7.01-8.00 160,243 306,992 - --------------------------------------- ---------- 40,489,479 5.90% 37,577,763 5.83% Total deposits $48,101,806 5.55% $45,687,590 5.51% - -------------------------------------------------------------------------------- Interest expense on deposits is summarized as follows: - -------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------- Passbook $ 23,696 25,130 33,968 Money market accounts 221,899 275,769 196,842 Certificates of deposit 2,333,739 1,846,365 1,652,027 - -------------------------------------------------------------------------------- $ 2,579,334 2,147,264 1,882,837 - -------------------------------------------------------------------------------- Certificates of deposit had the following remaining maturities at June 30, 1998 and 1997: - -------------------------------------------------------------------------------- 1998 1997 ----------------------- ----------------------------- Weighted Weighted average average Amount rate Amount rate - -------------------------------------------------------------------------------- 0-6 months $16,822,782 5.82% $16,655,356 5.70% 7-12 months 9,467,884 5.87 11,031,181 5.84 13-36 months 13,175,201 6.01 9,174,681 6.04 Over 36 months 1,023,612 6.21 716,545 6.00 - ------------------------------------ ---------- $40,489,479 5.90 $37,577,763 5.83% - ------------------------------------ ---------- The Company had $15,767,539 and $13,909,498 of certificates of deposit with balances of $100,000 or more at June 30, 1998 and 1997, respectively. (Continued) 34 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- At June 30, 1998 and 1997, investment securities and mortgage-backed securities with an approximate carrying value of $23,244,000 and $20,353,000, respectively, were pledged as collateral for certain deposits, including approximately $17,147,000 and $17,969,000, respectively, of public deposits. At June 30, 1998 and 1997, the aggregate amount of deposits by directors and executive officers totaled $243,621 and $322,029, respectively. Such deposits were accepted in the ordinary course of business with normal interest rates, interest payment terms, and maturities. (10) Federal Home Loan Bank Advances At June 30, 1998 and 1997, the Bank's Federal Home Loan Bank (FHLB) advances consisted of the following: - -------------------------------------------------------------------------------- 1998 1997 ---------------------- -------------------- Year of maturity Amount Rate Amount Rate - -------------------------------------------------------------------------------- 1998 $ 2,366,401 5.87% 2,500,000 6.08% 1999 348,257 6.05 - - 2000 1,369,929 6.25 1,000,000 6.33 2001 392,950 6.05 2002 417,404 6.05 2003 443,379 6.05 2004 470,971 6.05 2005 500,281 6.05 2006 531,414 6.05 2007 564,486 6.05 2008 5,599,615 5.42 2009 636,931 6.05 2010 676,570 6.05 2011 718,675 6.05 2012 763,401 6.05 2013 399,336 6.05 - --------------------------------------------- --------- 16,200,000 5.83% 3,500,000 6.15% Open line of credit - - - - - -------------------------------------------------------------------------------- At June 30, 1998 and 1997, the advances and open line of credit were collateralized by the Bank's FHLB stock and investments with a carrying value of approximately $835,000 and $10,942,000 and $333,500 and $7,424,000, respectively. At June 30, 1998, the Bank has also pledged its portfolio of 1-4 family non-delinquent loans as additional collateral for advances with an unpaid principal balance of approximately $17,218,000. The Bank has a $1,000,000 line of credit with the FHLB which was not drawn on at June 30, 1998 and 1997. The Bank has the ability to borrow additional amounts given the availability of collateral available for pledging to the FHLB. The Bank's advances include $5 million in advances with various call features. If called, the FHLB will provide alternative funding at the then current market interest rates and terms. (Continued) 35 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (11) Income Taxes Income tax expense (benefit) for the years ended June 30, 1998, 1997, and 1996, is composed of the following: - -------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------- Current: Federal $ 181,345 141,694 120,844 State 66,742 51,828 43,942 - -------------------------------------------------------------------------------- Total current 248,087 193,522 164,786 - -------------------------------------------------------------------------------- Deferred: Federal (3,924) (43,066) 34,295 State (1,254) (13,788) 11,431 - -------------------------------------------------------------------------------- Total deferred (5,178) (56,854) 45,726 - -------------------------------------------------------------------------------- $ 242,909 136,668 210,512 - -------------------------------------------------------------------------------- The reasons for the difference between the effective income tax rate and the statutory federal income tax rate are as follows: - -------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------- Federal "expected" income tax rate 34.0% 34.0% 34.0% State income taxes, net of federal income tax benefit 6.5 6.5 6.5 Increase in base year tax bad debt reserve 0.0 0.0 (6.3) Tax-exempt interest income (4.1) (5.3) (3.0) Other, net 0.0 0.0 0.1 - -------------------------------------------------------------------------------- Effective income tax rate 36.4% 35.2% 31.3% - -------------------------------------------------------------------------------- (Continued) 36 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at June 30, 1998 and 1997, are as follows: - -------------------------------------------------------------------------------- 1998 1997 - -------------------------------------------------------------------------------- Deferred tax assets: Discounts on mortgage-backed and related securities $ 20,856 26,175 Allowance for losses on loans receivable 2,651 2,651 Unrealized loss on available for sale securities 0 2,090 Other 1,599 - - -------------------------------------------------------------------------------- Gross deferred tax assets 25,106 30,916 Valuation allowance - - - -------------------------------------------------------------------------------- Deferred tax assets, net 25,106 30,916 Deferred tax liabilities: Unrealized gain on available for sale securities 87,940 - Accrual to cash conversion 82,695 95,564 FHLB stock 43,216 50,500 Premises and equipment 21,364 10,109 - -------------------------------------------------------------------------------- Gross deferred tax liabilities 235,215 156,173 - -------------------------------------------------------------------------------- Net deferred tax liability $210,109 125,257 - -------------------------------------------------------------------------------- No valuation allowance was required for deferred tax assets at June 30, 1998 or 1997. Retained earnings at June 30, 1998, included approximately $1,155,957 for which no provision for federal income tax has been made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of the amount so allocated for purposes other than to absorb losses will create income for tax purposes, which will be subject to the then current corporate income tax rate. In August 1996, federal legislation was enacted that repealed the favorable bad debt method for savings and loan associations. Subsequent to this repeal, the Company continues to be subject to the potential tax liability to the extent payments or distributions of these appropriated earnings occurs. (12) Employee Benefits (a) Retirement Plan The Company has a defined benefit retirement plan (the Plan) that covers substantially all full-time employees. The Plan provides for retirement benefits beginning at age 65 based on each employee's years of qualifying service and the average of the highest five consecutive annual salaries of the ten years prior to retirement. The benefits are reduced by a specific percentage of the employee's Social Security benefit. The Plan also provides for early retirement beginning at age 55 with reduced benefits determined by using an early retirement factor. An employee becomes fully vested upon completion of five years of qualifying service. (Continued) 37 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Net periodic pension expense for the years ended June 30 includes the following components: - -------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------- Service cost-benefits earned during the period $ 31,734 28,076 26,494 Interest cost on projected benefit obligation 63,131 57,824 51,730 Actual return on plan assets (76,688) (63,728) (55,934) Net amortization and deferral (4,324) 438 438 - -------------------------------------------------------------------------------- Net periodic pension expense $ 13,853 22,610 22,728 - -------------------------------------------------------------------------------- The weighted average discount rate and rate of increase in future compensation level used in determining the actuarial present value of the projected benefit obligation and the expected long-term rate of return on assets were as follows: - -------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------- Discount rate 7.5% 7.5% 7.5% Future compensation increase rate 6.0 6.0 6.0 Long-term rate of return on assets 7.5 7.5 7.5 - -------------------------------------------------------------------------------- The following table sets forth the Plan's funded status and the amounts recognized in the Company's balance sheet at June 30: - -------------------------------------------------------------------------------- 1998 1997 - -------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Vested accumulated benefit obligation $ 732,406 676,571 Nonvested accumulated benefit obligation 910 133 - -------------------------------------------------------------------------------- Total accumulated benefit obligation 733,316 676,704 Effect of projected future salary increases 155,302 137,234 - -------------------------------------------------------------------------------- Projected benefit obligation 888,618 813,938 Plan assets at fair value 1,057,116 889,838 - -------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation 168,478 75,900 Unrecognized prior service cost 14,112 15,875 Unrecognized gain from past experience different from that assumed (174,284) (77,515) Unrecognized net transition asset being amortized over 15 years (3,982) (5,307) - -------------------------------------------------------------------------------- Prepaid pension cost $4,344 8,953 - -------------------------------------------------------------------------------- (Continued) 38 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (b) 401(k) Plan All employees are eligible to participate in the Company's 401(k) plan. Participating employees may contribute up to 15% of gross wages earned. Contributions to the Plan by the Company are made at the discretion of the Board of Directors. The Company made no contributions to the Plan in 1998, 1997, or 1996. (c) Employee Stock Ownership Plan Effective July 7, 1995, the Company adopted an Employee Stock Ownership Plan (the ESOP). The ESOP borrowed $661,984 from the Company to purchase 82,748 shares of common stock of the Company on the date of the conversion. The Company paid principal and interest of $111,163, $117,125, and $123,086 to the ESOP during the fiscal years 1998, 1997 and 1996, respectively. As the debt is repaid, ESOP shares which were initially pledged as collateral for its debt are released from collateral and allocated to active employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be committed to be 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. ESOP compensation expense was $103,457, $84,650, and $77,021 for fiscal years 1998, 1997 and 1996, respectively. All employees of the Company are eligible to participate in the ESOP after they attain age 21 and complete one year of service. A summary of the ESOP share allocation is as follows for the years ended June 30: - -------------------------------------------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------- Shares allocated beginning of year 12,420 4,140 - Shares allocated during year 8,280 8,280 4,140 Unreleased shares 62,048 70,328 78,608 Total ESOP shares 82,748 82,748 82,748 Fair value of unreleased shares at June 30 $ 810,502 694,974 688,829 - -------------------------------------------------------------------------------- (d) Management Stock Bonus Plan On January 17, 1996, stockholders approved the Company's Management Stock Bonus Plan (MSBP), which was subsequently also approved by the Office of Thrift Supervision (OTS). The plan provides for the grant of shares of stock to executive employees and directors of the Company in the form of restricted stock, which vest over a five year period at the rate of 20% per year. Under the plan, 45,000 shares of restricted stock were granted. Included in 1998, 1997, and 1996, were compensation and employee benefits expense of $86,625, $86,625, and $39,703, respectively, related to the MSBP. (Continued) 39 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (e) Stock Option Plan On January 17, 1996, stockholders of the Company approved the Company's 1995 Stock Option Plan. The plan was subsequently approved by the OTS. The plan provides for the granting of options for the purpose of attracting and retaining key personnel and facilitating their purchase of a stock interest in the Company. The plan provided for the total allocation of 112,500 options of which 92,500 options were granted to directors, management, and employees of the Company at an exercise price of $9.8125 per share. On April 9, 1997, the Company granted 5,400 options of the remaining unawarded options at an exercise price of $11.375 per share. All options granted under this plan vest pro rata over five years from the grant date. In addition, vested options are exercisable for a period ending 10 years after the grant date. On June 10, 1997, the Board of Directors of the Company approved the 1997 Director's Stock Option Plan. The Plan granted 38,472 shares or 4% of its then 961,875 outstanding shares to the directors of the Company at an exercise price of $11.0625 per share. Each director received an award of 6,412 shares. The awards vested in entirety on August 1, 1997. In addition, vested options are exerciseable for a period ending 10 years after the grant date. As of June 30, 1998, no stock options have been exercised or forfeited. A summary of stock option activity is detailed as follows: - -------------------------------------------------------------------------------- Weighted Options average available Options exercise for grant outstanding price - -------------------------------------------------------------------------------- June 30, 1995 - - - 1995 stock option plan adopted 112,500 - - Granted January 17, 1996 (weighted average fair value $4.34 per option) (92,500) 92,500 $9.8125 - -------------------------------------------------------------------------------- June 30, 1996 20,000 92,500 9.8125 Granted April 9, 1997 (weighted average fair value $5.74 per option) (5,400) 5,400 11.3750 1997 Director's stock option plan adopted 38,472 - - Granted June 10, 1997 (weighted average fair value $5.26 per option) (38,472) 38,472 11.0625 - -------------------------------------------------------------------------------- June 30, 1997 14,600 136,372 10.2270 (No activity) - - - June 30, 1998 14,600 136,372 10.2270 - -------------------------------------------------------------------------------- The number of options exerciseable at June 30, 1998 was 76,552 options with a weighted average exercise price of $10.4627. (Continued) 40 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The Company uses the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock option plans. Accordingly, no compensation cost has been recognized for the plans. There are no charges or credits to expense with respect to the granting or exercise of options since the options were issued at fair value on the respective grant dates. Had compensation cost for the 1995 Stock Option Plan and 1997 Director's Stock Option Plan been determined based on the fair value method as established in SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts as indicated in the following table: - -------------------------------------------------------------------------------- Fiscal year Fiscal year Fiscal year ending ending ending June 30, 1998 June 30, 1997 June 30, 1996 - -------------------------------------------------------------------------------- Net income: As reported $ 425,335 251,500 462,432 Pro forma 252,023 202,396 442,360 Basic earnings per share: As reported .52 .27 .46 Pro forma .31 .22 .44 - -------------------------------------------------------------------------------- The above disclosed pro forma effects of applying SFAS No. 123 to compensation costs may not be representative of the effects on reported pro forma net income for future years. The fair value for each option granted is estimated based on a Black-Scholes option pricing model. The model incorporates the following weighted average assumptions:
- ------------------------------------------------------------------------------------------------------ For options granted in For options granted in For options granted in accordance with 1997 accordance with 1995 accordance with 1995 Director's Stock Option Stock Option Plan Stock Option Plan Plan granted on granted on granted on June 10, 1997 April 9, 1997 January 17, 1996 - ------------------------------------------------------------------------------------------------------ Risk-free interest rate 6.46% 7.07% 5.78% Expected life 10 years 10 years 10 years Expected volatility 12.00% 12.00% 12.00% Expected dividends None None None - ------------------------------------------------------------------------------------------------------
(Continued) 41 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (13) Federal Home Loan Bank Investment, Retained Earnings and Regulatory Capital Requirements The Bank, as a member of the Federal Home Loan Bank System, is required to hold a specified number of shares of capital stock, which is carried at cost, in the Federal Home Loan Bank of Des Moines. In addition, the Bank is required to maintain cash and other liquid assets in an amount equal to 4% of its deposit accounts and other obligations due within one year. The Bank has met these requirements. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatoryand possibly additional discretionaryactions 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 (set forth in the following table) of Tangible, Core and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of June 30, 1998, that the Bank meets all capital adequacy requirements to which it is subject. As of June 30, 1998 and 1997, the most recent notification from the OTS categorized the Bank as 'well capitalized.' There are no conditions or events since that notification that management believes have changed the Bank's category. (Continued) 42 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The Bank's actual capital amounts and ratios are also presented in the table (dollars in thousands):
- ----------------------------------------------------------------------------------------------------------------- To be Well Capitalized Upon Prompt Corrective Actual Requirement Excess Capital Actions Provisions ------------------------ ----------------------- ----------------------- ------------------------- Percent Percent of Percent Percent of of assets assets (1) of assets assets (1) Amount (1) Amount Amount (1) Amount - ----------------------------------------------------------------------------------------------------------------- Bank's net worth $ 8,502 Less: AFS market valuation 132 ---------- Tangible capital 8,370 11.19% 1,122 1.50% 7,248 9.69% N/A N/A ---------- Core capital (2) 8,370 11.19% 2,244 3.00% 6,126 8.19% 3,751 5.00% ---------- Plus: Allowable portion of general allowance for loan losses 251 ---------- Risk-based capital $ 8,621 31.66% $ 2,179 8.00% $ 6,442 23.66% 2,723 10.00% ----------
(1) Based on the Bank's adjusted total assets for the purpose of the tangible and core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio. (2) Pursuant to Prompt Corrective Action regulations, the Bank is also required to hold core capital equal to or greater than 6.00% of its risk-weighted assets, or $1,634 at June 30, 1998. - -------------------------------------------------------------------------------- (14) SAIF Assessment The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996. DIFA addressed the inadequate funding of the Savings Association Insurance Fund (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift institutions. The Bank's assessment was a pretax charge of $237,085 and was recognized in the first quarter of fiscal 1997. DIFA also addressed the funding for the Financing Corp. (FICO) bonds. Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1, 2000 until the FICO bonds are retired in 2019, the estimated assessment to retire the FICO bonds is expected to be 2.5 basis points per $100 of deposits. (Continued) 43 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on January 1, 1999, provided no insurance depository institution is a savings association on that date. DIFA also directed the Secretary of the Treasury to present recommendations to Congress for establishment of a common depository institution charter. (15) Stock Repurchases During the fiscal year ended 1998, the Company repurchased a total of 93,782 shares, or 9.75%, of its 961,875 shares outstanding as of June 30, 1997, at an average price of $12.15 per share. During the fiscal year ended June 30, 1997, the Company repurchased 106,875 of its outstanding common stock at an average price of $11.48 per share. During the fiscal year ended June 30, 1996, the Company repurchased 101,250 shares of its outstanding common stock, at an average price per share of $9.53. As a result of these stock repurchase programs, the Company has now outstanding 868,093 shares of common stock. The following summarizes the Company's common stock repurchases during the twelve months ended June 30, 1998: - -------------------------------------------------------------------------------- Shares Price Settlement date Purchased per share - -------------------------------------------------------------------------------- September 11, 1997 28,000 $11.75 September 12, 1997 20,093 11.75 November 28, 1997 24,707 12.1250 December 4, 1997 2,000 12.1250 January 6, 1998 6,500 13.0000 January 12, 1998 12,482 13.3125 - -------------------------------------------------------------------------------- Average price per share: $12.1514 - -------------------------------------------------------------------------------- Repurchased shares are considered treasury shares and will be utilized for general corporate and other purposes, including the issuance of shares in connection with stock option plans, the management stock bonus plan, and other purposes. (16) Financial Instruments With Off-Balance-Sheet Risk The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to -- meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount -- recognized in the accompanying balance sheets. The contract amounts of these instruments reflect the extent of -- involvement by the Company. 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 is represented by the contract amount of these commitments. The -- Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. (Continued) 44 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The contract amount of these financial instruments at June 30, 1998 and 1997, is as follows: - -------------------------------------------------------------------------------- Contract amount ----------------------------- 1998 1997 - -------------------------------------------------------------------------------- Financial instruments whose contract amount represents risk: Commitments to extend credit $ 2,197,996 402,000 Letter of credit 20,000 - - -------------------------------------------------------------------------------- Commitments to extend credit and the letter of credit, collectively referred to as commitments, are agreements to lend to a customer provided 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 a portion of the commitments may expire without being drawn upon, the total commitment amount does 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 deemed necessary by the Company upon extension of credit, is based on the loan type and on management's evaluation of the borrower. Collateral consists primarily of residential real estate and personal property. (17) Fair Value of Financial Instruments SFAS No. 107, Disclosures about Fair Values of Financial Instruments, requires disclosure of estimated fair values of the Company's financial instruments, including assets, liabilities, and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of June 30, 1998 and 1997, based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based only on existing financial instruments without attempting to estimate the value of anticipated future business or the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates. (Continued) 45 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- The estimated fair value of the Company's financial instruments are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.
- ------------------------------------------------------------------------------------------------------------------------------------ June 30 --------------------------------------------------------------------------------------- 1998 1997 ------------------------------------------- ------------------------------------------ Carrying Estimated Contract Carrying Estimated Contract amount fair value amount amount fair value amount - ------------------------------------------------------------------------------------------------------------------------------------ Financial assets: Cash and cash equivalents $ 2,009,228 2,009,228 763,792 763,792 Securities available for sale 43,730,675 43,730,675 15,131,002 15,131,002 Securities held to maturity - - 24,269,460 24,481,726 Loans receivable, net (1) 28,994,750 29,500,683 20,766,539 21,248,657 FHLB stock 835,000 835,000 333,500 333,500 Accrued interest receivable 547,898 547,898 613,357 613,357 Financial liabilities: Deposits 48,101,806 48,333,647 45,687,590 45,864,695 FHLB Advances 16,200,000 15,912,088 3,500,000 3,496,847 Accrued interest payable 631,168 631,168 405,623 405,623 Off-balance sheet financial instruments: Commitments to extend credit - 2,217,996 2,217,996 - 8,479 402,000 ------------------------------------------------------------------------------------------------------------------------------
(1) The carrying amount of loans receivable is reported net of $251,034 and $213,034 in allowance for losses on loans at June 30, 1998, and June 30, 1997, respectively - -------------------------------------------------------------------------------- (a) Cash and Cash Equivalents The carrying amount of cash and cash equivalents approximates their fair value. (b) Securities Held to Maturity and Securities Available for Sale The fair values of securities held to maturity and securities available for sale are based upon quoted market prices. (c) Loans Receivable, Net The fair value of the loan receivable portfolio, with the exception of the 1 to 4 family adjustable rate mortgage loan portfolio and the consumer, agriculture, commercial and commercial real estate portfolios, was calculated by comparison of the loan portfolio to observed secondary market prices for loans and mortgage-backed securities with similar characteristics. For consumer, agriculture, commercial, and commercial real estate loans, the fair value was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect credit and interest rate risk inherent in each loan portfolio. The fair value of the 1 to 4 family adjustable rate mortgage loan portfolio was estimated using the carrying value of the portfolio due to its repricing frequency and comparison to observed secondary market loans with similar characteristics. (Continued) 46 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (d) FHLB Stock The carrying amount of FHLB stock approximates its fair value. (e) Accrued Interest Receivable The carrying amount of accrued interest receivable approximates its fair value since it is short-term in nature and does not present unanticipated credit concerns. (f) Deposits Under SFAS No. 107, the fair value of deposits with no stated maturity such as savings and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using as discount rates the rates that were offered by the Company as of June 30, 1998 and 1997, for deposits with maturates similar to the remaining maturities of the existing certificates of deposit. The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Company's existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit is commonly referred to as the core deposit intangible. (g) FHLB Advances The fair value of FHLB advances is based upon the discounted value of contractual cash flows using as discount rates the rates offered by the FHLB on advances with maturities similar to the remaining maturities of the existing advances. (h) Accrued Interest Payable The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature. (i) Commitments to Extend Credit The fair value of commitments to extend credit is based on the proposed carrying value. All loan commitments are made at current market interest rates. Therefore, the proposed carrying value approximates fair value. (18) Stock Conversion The Association converted from a federally-chartered mutual savings and loan association to a federally-chartered stock savings and loan association pursuant to its Plan of Conversion. The conversion was effected on July 7, 1995, and resulted in the issuance of 1,125,000 shares of common stock (par value $0.10) at $8.00 per share for a gross sales price of $9,000,000. Costs related to conversion (primarily underwriters' commission, printing, and professional fees) aggregated $450,639 and were deducted to arrive at the net proceeds of $8,549,361. The Company established an employee stock ownership trust which purchased 82,748 shares of common stock of the Company at the issuance price of $8.00 per share from funds borrowed from the Company. Funds held for stock subscriptions in excess of common stock issued were refunded to the subscribers at the time of conversion . (Continued) 47 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Subsequent to conversion, savings account holders and borrowers do not have voting rights in the Association. Voting rights of the Association are vested exclusively with the Company. For the purpose of granting eligible members of the Association a priority in the event of future liquidation, the Association, at the time of conversion, established a liquidation account equal to its regulatory capital as of December 31, 1994. In the event (and only in such event) of future liquidation of the converted Association, an eligible savings accountholder who continues to maintain a savings account shall be entitled to receive a distribution from the liquidation account, in the proportionate amount of the then-current adjusted balance of the savings deposits then held, before any distributions may be made with respect to capital stock. Present regulations provide that the Association may not declare or pay a cash dividend on or repurchase any of its capital stock if the result thereof would be to reduce the regulatory capital of the Association below the amount required for the liquidation account or the regulatory capital requirement. Further, any dividend declared or paid on, or repurchase of, the Association's capital stock shall be in compliance with the rules and regulations of the OTS, or other applicable regulations. (19) Business Segment Performance Disclosure SFAS No. 131, Disclosures about Segments of an Operation and Related Information, requires the disclosure of financial and descriptive information about the operating segments of a public business enterprise. For purposes of this disclosure, Redwood Financial, Inc. has deemed its operating segments to follow its corporate structure. The rationale for this segmentation is a result of the differing operational purposes of its corporate entities as well as the simplicity of the Company's corporate structure. To this extent, the Company has determined that it has three operating segments. These include (1) the parent holding company, Redwood Financial, Inc., (2) the insured financial institution, HomeTown Bank, and (3) a subsidiary of the Bank, Redwood Falls Federal Services, Inc. (the Service Corporation). Following is a brief description of the three operating segments: Holding Company: Redwood Financial, Inc. was organized in 1995 primarily to acquire and hold the common stock of the Association. This continues to be the Holding Company's primary purpose. The Holding Company also contributes to the operational performance of the consolidated Company through (1) retention and servicing of three loans which were not eligible for investment within the Bank's operating segment due to regulatory restrictions, (2) management of a small investment portfolio, including an investment in a limited partnership, and (3) providing and incurring expense as a result of employee benefits available to Bank personnel for the remuneration and retention of Bank personnel. The Bank: HomeTown Bank provides standard banking services to communities in Redwood and Renville Counties, Minnesota, including lending and deposit products services. The Bank is the largest of the consolidated Company's operating segments. The Service Corporation: Redwood Falls Federal Services, Inc. is a Minnesota corporation organized in 1993 for the sole purpose of providing insurance sales separate from the Bank as a result of previous federal regulatory requirements. These requirements have since been lifted and the Service Corporation has been inactive since June 1996. The Service Corporation provided no contribution to the consolidated Company's operating performance for the fiscal years ended June 30, 1998 and 1997. The following table summarizes the contribution of each segment to the operating performance of the consolidated Company for the fiscal years ended June 30, 1998, 1997, and 1996. (Continued) 48 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------------------------------------------------------------ For the year ended June 30, 1998 For the year ended June 30, 1997 ------------------------------------------------ --------------------------------------------- Unconsolidated Intercompany Consolidated Unconsolidated Intercompany Consolidated segment results eliminations segment results segment results eliminations segment results ----------------------------------------------------------------------------------------------------------------------------------- Holding Company Interest income: Loans 78,133 78,133 48,784 48,784 Investment and mortgage- backed and related securities 26,778 26,778 100,520 100,520 Other (1) 45,602 (45,602) - 51,703 (24,578) 27,125 ----------------------------------------------------------------------------------------------------------------------------------- Subtotal 150,513 (45,602) 104,911 201,007 (24,578) 176,429 Noninterest income: Gain on sale of investments - - 2,863 2,863 Other noninterest income - - - - ----------------------------------------------------------------------------------------------------------------------------------- Subtotal - - - 2,863 - 2,863 Noninterest expense: Compensation and employee benefits 190,282 190,282 171,275 171,275 Income tax benefit (78,829) (78,829) (77,167) (77,167) Other (2) 107,872 (48,000) 59,872 193,534 (48,000) 145,534 ----------------------------------------------------------------------------------------------------------------------------------- Subtotal 219,325 (48,000) 171,325 287,642 (48,000) 239,642 ----------------------------------------------------------------------------------------------------------------------------------- Segment total (68,812) 2,398 (66,414) (83,772) 23,422 (60,350) ----------------------------------------------------------------------------------------------------------------------------------- Total assets-segment 11,759,177 11,759,177 12,308,976 12,308,976 ----------------------------------------------------------------------------------------------------------------------------------- Bank Interest income: Loans 1,993,373 1,993,373 1,514,821 1,514,821 Investment and mortgage- backed and related securities 2,567,773 2,567,773 2,032,217 2,032,217 Other 81,865 81,865 146,150 146,150 ----------------------------------------------------------------------------------------------------------------------------------- Subtotal 4,643,011 - 4,643,011 3,693,188 - 3,693,188 Interest expense: Deposits 2,624,936 (45,602) 2,579,334 2,171,842 (24,578) 2,147,264 Borrowings 419,138 419,138 38,485 38,485 ----------------------------------------------------------------------------------------------------------------------------------- Subtotal 3,044,074 (45,602) 2,998,472 2,210,327 (24,578) 2,185,749 Noninterest income: Gain on sale of investments 42,652 42,652 - - Other noninterest income 137,512 (48,000) 89,512 101,616 (48,000) 53,616 ----------------------------------------------------------------------------------------------------------------------------------- Subtotal 180,164 (48,000) 132,164 101,616 (48,000) 53,616 Noninterest expense: Compensation and employee benefits 649,378 649,378 553,458 553,458 Provision for loan losses 38,000 38,000 - - Loss on sale of investments 911 911 - - Income tax expense 321,738 321,738 213,835 213,835 Other 274,927 274,927 481,912 481,912 ----------------------------------------------------------------------------------------------------------------------------------- Subtotal 1,284,954 - 1,284,954 1,249,205 - 1,249,205 ----------------------------------------------------------------------------------------------------------------------------------- Segment total 494,147 (2,398) 491,749 335,272 (23,422) 311,850 ----------------------------------------------------------------------------------------------------------------------------------- Total assets-segment 75,022,442 75,022,442 60,331,501 60,331,501 ----------------------------------------------------------------------------------------------------------------------------------- Service Corporation (3) Interest income: Other (4) - - ----------------------------------------------------------------------------------------------------------------------------------- Subtotal - - - - - - Noninterest income: Other noninterest income - - ----------------------------------------------------------------------------------------------------------------------------------- Subtotal - - - - - - Noninterest expense: Other (5) - - ----------------------------------------------------------------------------------------------------------------------------------- Subtotal - - - - - - ----------------------------------------------------------------------------------------------------------------------------------- Segment total - - - - - - ----------------------------------------------------------------------------------------------------------------------------------- Total assets-segment - - - - ----------------------------------------------------------------------------------------------------------------------------------- Total 425,335 - 425,335 251,500 - 251,500 ----------------------------------------------------------------------------------------------------------------------------------- Total assets 86,781,619 - 86,781,619 72,640,477 - 72,640,477 -----------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------- For the year ended June 30, 1996 ---------------------------------------------- Unconsolidated Intercompany Consolidated segment results eliminations segment results ------------------------------------------------------------------------------------- Holding Company Interest income: Loans 30,519 30,519 Investment and mortgage- backed and related securities 130,826 130,826 Other (1) 39,394 (959) 38,435 ------------------------------------------------------------------------------------- Subtotal 200,739 (959) 199,780 Noninterest income: Gain on sale of investments - - Other noninterest income 959 959 ------------------------------------------------------------------------------------- Subtotal 959 - 959 Noninterest expense: Compensation and employee benefits 116,725 116,725 Income tax benefit - Other (2) 63,895 (44,000) 19,895 ------------------------------------------------------------------------------------- Subtotal 180,620 (44,000) 136,620 ------------------------------------------------------------------------------------- Segment total 21,078 43,041 64,119 ------------------------------------------------------------------------------------- Total assets-segment 13,172,441 13,172,441 ------------------------------------------------------------------------------------- Bank Interest income: Loans 1,333,064 1,333,064 Investment and mortgage- backed and related securities 1,781,102 1,781,102 Other 172,246 172,246 ------------------------------------------------------------------------------------- Subtotal 3,286,412 - 3,286,412 Interest expense: Deposits 1,884,432 (1,595) 1,882,837 Borrowings - ------------------------------------------------------------------------------------- Subtotal 1,884,432 (1,595) 1,882,837 Noninterest income: Gain on sale of investments - - Other noninterest income 108,950 (45,800) 63,150 ------------------------------------------------------------------------------------- Subtotal 108,950 (45,800) 63,150 Noninterest expense: Compensation and employee benefits 532,134 532,134 Provision for loan losses - Loss on sale of investments - Income tax expense 210,512 210,512 Other 326,933 326,933 ------------------------------------------------------------------------------------- Subtotal 1,069,579 - 1,069,579 ------------------------------------------------------------------------------------- Segment total 441,351 (44,205) 397,146 ------------------------------------------------------------------------------------- Total assets-segment 48,415,372 48,415,372 ------------------------------------------------------------------------------------- Service Corporation (3) Interest income: Other (4) 636 (636) ------------------------------------------------------------------------------------- Subtotal 636 (636) - Noninterest income: Other noninterest income 1,941 1,941 ------------------------------------------------------------------------------------- Subtotal 1,941 - 1,941 Noninterest expense: Other (5) 2,574 (1,800) 774 ------------------------------------------------------------------------------------- Subtotal 2,574 (1,800) 774 ------------------------------------------------------------------------------------- Segment total 3 1,164 1,167 ------------------------------------------------------------------------------------- Total assets-segment - - ------------------------------------------------------------------------------------- Total 462,432 - 462,432 ------------------------------------------------------------------------------------- Total assets 61,587,813 - 61,587,813 -------------------------------------------------------------------------------------
Footnotes: (1) The Holding Company maintains substantially all of its cash in an interest bearing account at the Bank. The elimination reflects interest earned and paid on this account. (2) The Holding Company pays the Bank $4,000 per month for management services provided by the Bank to the Holding Company. (3) The Service Corporation has been inactive since June 1996 and has no assets as of June 30, 1996. (4) The Service Corporation maintained substantially all of its cash in an interest bearing account at the Bank. The elimination reflects interest earned and paid on this account. (5) The Service Corporation paid the Bank $1,800 per year for management services provided by the Bank to the Service Corporation.
(Continued) 49 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (20) Redwood Financial, Inc. Finanical Information (Parent Company Only) The parent companys principal assets are its investment in the Bank and securities. The following are the condensed financial statements for the parent company only as of and for the years ended June 30, 1998 and 1997. Condensed Balance Sheet
June 30, June 30, Assets 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 1,172,127 2,122,649 Securities held to maturity - 1,274,607 Securities available for sale 375,000 - Loans receivable, net 1,340,118 500,269 Investment in subsidiary 8,502,030 8,372,837 Accrued interest receivable 17,789 35,479 Other assets 542,383 36,192 - --------------------------------------------------------------------------------------------------------------------------- Total assets $ 11,949,447 12,342,033 - --------------------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity - --------------------------------------------------------------------------------------------------------------------------- Accrued expenses and other liabilities 11,421 - - --------------------------------------------------------------------------------------------------------------------------- Total liabilities 11,421 - - --------------------------------------------------------------------------------------------------------------------------- Common stock 112,500 112,500 Additional paid-in capital 8,490,163 8,467,833 Retained earnings, subject to certain restrictions 6,794,926 6,369,591 Net unrealized gain (loss) on securities available for sale 131,909 (3,135) Unearned employee stock ownership plan shares (463,264) (529,504) Unearned management stock bonus plan shares (220,172) (306,797) Treasury stock, at cost (2,908,036) (1,768,455) - --------------------------------------------------------------------------------------------------------------------------- Total stockholders equity 11,938,026 12,342,033 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders equity $ 11,949,447 12,342,033 - ---------------------------------------------------------------------------------------------------------------------------
Condensed Statement of Income
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Gain on sale of investments available for sale $ - 2,863 - Interest income 150,513 201,007 200,739 Equity in earnings of subsidiary 494,147 335,271 433,884 Compensation and employee benefits (250,181) (171,275) (116,725) Other (47,973) (193,533) (62,936) - --------------------------------------------------------------------------------------------------------------------------- Earnings before income tax benefit 346,506 174,333 454,962 Income tax benefit 78,829 77,167 7,470 - --------------------------------------------------------------------------------------------------------------------------- Net earnings $ 425,335 251,500 462,432 - ---------------------------------------------------------------------------------------------------------------------------
(Continued) 50 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements
- ---------------------------------------------------------------------------------------------------------------------------- Condensed Statement of Cash Flows Years ended June 30, ----------------------------------------------- 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------- Operating activities: Net earnings $ 425,335 251,500 462,432 Adjustments to reconcile net earnings to cash provided by operating activities: Equity in earnings of subsidiary (494,147) (335,271) (433,884) Amortization of premiums (discounts), net (395) (1,028) (1,092) (Increase) decrease in accrued interest receivable 17,690 31,305 (66,784) Gain on sale of investments available for sale - (2,863) - Amortization of unearned ESOP shares 66,240 66,240 66,240 Earned ESOP priced above original cost 22,330 10,816 10,781 Earned management stock bonus plan shares 86,625 86,625 39,703 Increase (decrease) in accrued expenses and other liabilities 11,421 (15,405) 15,405 Increase in other assets (506,191) (36,192) (7,470) - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by operating activities (371,092) 55,727 85,331 - ---------------------------------------------------------------------------------------------------------------------------- Investing activities: Proceeds from maturities of investment securities held to maturity 900,000 1,215,000 - Purchases of investment securities available for sale - (996,513) (2,487,487) Proceeds from sales of investment securities available for sale - 999,376 - Increase in loans receivable, net (839,849) (24,911) (475,358) - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided by investing activities 60,151 1,192,952 (2,962,845) - ---------------------------------------------------------------------------------------------------------------------------- Financing activities: Adoption of ESOP - - (661,984) Dividend from Bank 500,000 2,000,000 - Proceeds from sale of common stock - - 8,549,361 Purchase of Association stock - - (3,943,688) Repurchase of common stock (1,139,581) (1,227,049) (965,156) - ---------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities (639,581) 772,951 2,978,533 - ---------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (950,522) 2,021,630 101,019 Cash and cash equivalents, beginning of year 2,122,649 101,019 - - ---------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 1,172,127 2,122,649 101,019 - ----------------------------------------------------------------------------------------------------------------------------
51 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (21) Subsequent Event From July 1, 1998, through August 31, 1998, the investment in the limited partnership had incurred losses. The Company's share of these losses was approximately $120,000. Depending on the performance of the limited partnership, the losses may be recognized in the fiscal 1999 financial statements. 52 REDWOOD FINANCIAL, INC. AND SUBSIDIARY
- ------------------------------------------------------------------------------------------------------------------------- Summarized quarterly financial data for fiscal 1998 and 1997 are as follows: - ------------------------------------------------------------------------------------------------------------------------- Three months ended --------------------------------------------------------------- June 30, March 31, December 31, September 30, Selected Operations Data 1998 1998 1997 1997 - ------------------------------------------------------------------------------------------------------------------------- Interest income $ 1,233,154 1,202,259 1,158,230 1,154,278 Interest expense 788,140 758,725 752,020 699,587 - ------------------------------------------------------------------------------------------------------------------------- Net interest income 445,014 443,534 406,210 454,691 Provision for loan losses 24,000 14,000 - - Non-interest income 50,123 35,054 33,536 13,451 Non-interest expense 301,884 287,441 318,496 267,548 Income tax expense 60,838 65,270 42,097 74,704 - ------------------------------------------------------------------------------------------------------------------------- Net earnings $ 108,415 111,877 79,153 125,890 - ------------------------------------------------------------------------------------------------------------------------- Earnings per common sharebasic $ .13 .14 .10 .15 Earnings per common sharediluted .13 .13 .09 .14
Three months ended --------------------------------------------------------------- June 30, March 31, December 31, September 30, Selected Operations Data 1997 1997 1996 1996 - ------------------------------------------------------------------------------------------------------------------------- Interest income $ 1,078,635 972,178 909,043 909,761 Interest expense 623,269 553,189 502,095 507,196 - ------------------------------------------------------------------------------------------------------------------------- Net interest income 455,366 418,989 406,948 402,565 Provision for loan losses - - - - Non-interest income 13,910 14,923 12,712 14,933 Non-interest expense 258,223 232,074 366,713 495,168 Income tax expense (benefit) 84,566 74,986 17,239 (40,123) - ------------------------------------------------------------------------------------------------------------------------- Net earnings (loss) $ 126,487 126,852 35,708 (37,547) - ------------------------------------------------------------------------------------------------------------------------- Earnings per common sharebasic $ .13 .14 .04 (.04) Earnings per common sharediluted .13 .13 .04 (.04)
53 REDWOOD FINANCIAL, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------------------------------------------------- Selected Financial June 30, March 31, December 31, September 30, Condition Data 1998 1998 1997 1997 - --------------------------------------------------------------------------------------------------------------------------- Total assets $ 77,286,605 69,687,671 67,147,038 64,651,177 Securities 43,730,675 38,332,752 39,997,129 40,510,502 Net loans 28,994,750 26,905,925 23,374,423 22,356,259 Deposits 48,101,806 48,668,957 46,979,232 45,780,689 Stockholders' equity 11,938,026 11,824,419 11,801,405 11,985,092
Selected Financial June 30, March 31, December 31, September 30, Condition Data 1997 1997 1996 1996 - --------------------------------------------------------------------------------------------------------------------------- Total assets $ 62,168,916 55,730,838 53,526,359 51,058,275 Securities 39,400,462 35,592,367 26,318,389 30,081,878 Net loans 20,766,539 18,878,902 18,171,579 17,229,712 Deposits 46,093,213 42,561,895 40,077,112 37,410,421 Stockholders' equity 12,342,033 12,109,742 13,238,271 13,160,293 - ---------------------------------------------------------------------------------------------------------------------------
54 EX-21 3 EXHIBIT 21 EXHIBIT 21 Subsidiaries of the Registrant HomeTown Bank is a federally chartered savings association that is a wholly owned subsidiary of the registrant. Redwood Falls Federal Services, Inc. is a wholly-owned subsidiary of HomeTown Bank that was chartered by the State of Minnesota. Both subsidiaries conduct business with their chartered names. EX-23 4 EXHIBIT 23 EXHIBIT 23 [KPMG Peat Marwick LLP, Minneapolis, Minnesota Letterhead] Consent of Independent Public Accountants The Board of Directors Redwood Financial, Inc.: We consent to incorporation by reference in the registration statement (No. 333-4204) on Form S-8 of Redwood Financial, Inc. of our report dated July 31, 1998, except for note 21, which is as of September 15, 1998, relating to the consolidated balance sheets of Redwood Financial, Inc. and subsidiary as of June 30, 1998 and 1997, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 1998, which report appears in the June 30, 1998 annual report on Form 10-KSB of Redwood Financial, Inc. /s/KPMG Peat Marwick LLP September 25, 1998 EX-27 5 FDS
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION DERIVED FROM THE QUARTERLY REPORT ON FORM 10-KSB AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL INFORMATION. 1 12-MOS JUN-30-1998 JUN-30-1998 20,448 1,988,780 0 0 43,730,675 43,730,675 43,730,675 29,245,784 251,034 77,286,605 48,101,806 2,366,401 1,046,773 13,833,599 0 0 112,500 11,825,526 77,286,605 2,071,506 2,566,491 109,924 4,747,921 2,579,334 2,998,472 1,749,449 38,000 41,741 1,174,458 668,244 668,244 0 0 425,335 .52 .49 2.68 0 983,151 0 0 213,031 0 0 251,031 251,031 0 130,000
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