-----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, Nq3oyr1xikzLSxCdPTpvsqTm4LW/1wn3iV5ZB/3FvOi42CELUQuXo+kRIXd3+9KD qfb/nM3/yyfXg+2EAWTIYg== 0000946275-96-000278.txt : 19960930 0000946275-96-000278.hdr.sgml : 19960930 ACCESSION NUMBER: 0000946275-96-000278 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960927 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: 10KSB40 SEC ACT: 1934 Act SEC FILE NUMBER: 000-25884 FILM NUMBER: 96635414 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 10KSB40 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One): [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended June 30, 1996, [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to . Commission File No. 0-25884 REDWOOD FINANCIAL, INC. (Name of Small Business Issuer in Its Charter) Minnesota 41-1807233 (State or Other Jurisdiction I.R.S. Employer of Incorporation 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. [X] State issuer's revenues for its most recent fiscal year. $3,547,662 As of September 3, 1996, there were issued and outstanding 1,068,750 shares of the registrant's Common Stock. 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 3, 1996, was $7,495,294 ($9.25 per share based on 810,302 shares of Common Stock held by non-affiliates). 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, 1996. (Parts I, II, and IV) 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 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. 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 Association retains a specified amount of its assets in housing-related investments. At June 30, 1996, the Company had total assets of $51.5 million, total deposits of $38.0 million, and stockholders' equity of $13.2 million. The primary activity of the Company is to hold all of the outstanding capital stock of the Association, however, the Company maintains a small investment and loan portfolio separate from its investment in the Association. Business of the Association The Association is a federally chartered stock savings and loan association headquartered in Redwood Falls, Minnesota. The Association was founded in 1924 under the name Redwood Falls Building and Loan Association. The Association changed its name to Redwood Falls Savings and Loan Association in 1948. The Association obtained a federal charter in 1982 and changed its name to Redwood Falls Federal Savings and Loan Association. The Association 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 Association 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. The Association attracts deposits from the general public and uses such deposits primarily to purchase investment securities and mortgage-backed and related securities and to originate loans secured by first mortgages on single family residences in its market area. For this mortgage loan portfolio, the Association originates and retains adjustable rate loans as well as fixed-rate balloon loans. The Association also originates commercial real estate loans and consumer loans. The Association originates a limited number of multi-family and residential construction loans. The principal sources of funds for the Association's lending activities are deposits and the amortization, repayment, and maturity of loans and investment securities. The Association does not rely on brokered deposits. Principal sources of income are interest on loans and investment securities. The Association's principal expense is interest paid on deposits. Market Area and Competition The Association'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 Association'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 Association's market area has been dependent on agriculture and agriculture related industries. However, one of the largest employers in 2 this area is a manufacturer of 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. Although the surrounding area is largely economically based on agriculture, the Association does not make loans secured by farm real estate or make farm operating loans. Lending Activities General. The Company's loan portfolio predominantly consists of mortgage loans secured by single family residences. The Company also makes commercial real estate, consumer, residential construction, and multi-family real estate loans. From time to time, the Company will participate in unsecured commercial loans 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 fixed rate and adjustable rate loans. The Company does not sell mortgage loans into the secondary market. The Company's consumer loan portfolio consists of savings account loans. The vast majority of commercial real estate loans are secured by health care facilities, office buildings and, to a lesser extent, retail establishments. 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, ------------------------------------------------- 1996 1995 --------------------- ---------------------- Amount Percentage Amount Percentage ----- ---------- ------ ---------- (Dollars in Thousands) Real Estate Loans: Residential construction........ $ 220 1.33% $ 242 1.59% Single-family residentia1....... 15,233 92.24 14,618 95.83 Multi-family residential........ 189 1.15 204 1.34 Commercial ..................... 520 3.15 474 3.11 Consumer loans: Savings account ................ 141 0.85 165 1.08 Commercial ....................... 775 4.69 0 0.00 Less: Loans in process ............... (333) (2.01) (216) (1.42) Deferred loan fees and discounts (18) (0.11) (19) (0.13) Allowance for loan losses....... (213) (1.29) (213) (1.40) ------ ----- ------ ----- Total loans, net ................. $ 16,514 100.00% $ 15,255 100.00% ====== ====== ====== ======
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, 1996. The table does not include prepayments or scheduled principal repayments. Adjustable rate mortgage loans are shown as maturing based on contractual maturities.
Single Multi- Family Family Commercial Residential Residential Residential Real Estate Construction Consumer Commercial Total ----------- ----------- ----------- ------------ -------- ---------- ----- (In Thousands) Amounts Due: Within 1 year... $ 655 $ 0 $ 0 $ 0 $ 141 $ 0 $ 796 1 to 5 years.... 4,621 97 5 0 0 0 4,723 After 5 years... 9,958 92 514 220 0 775 11,559 ------ ---- ---- ---- --- ---- ------- Total amount due.. $ 15,234 $ 189 $ 519 $ 220 $ 141 $ 775 $ 17,078 ====== ==== ==== ==== ==== ==== =======
The following table sets forth the dollar amount of all loans due after June 30, 1996, which have pre-determined interest rates and which have floating or adjustable interest rates. Floating or Fixed Rates Adjustable Rates Total ----------- ---------------- ----- (In Thousands) Single-family residential... $8,109 $7,124 $15,233 Multi-family real estate.... 150 40 190 Commercial real estate...... 223 296 519 Residential construction.... 0 220 220 Consumer.................... 141 0 141 Commercial.................. 475 300 775 ----- ------ ------ Total..................... $9,098 $ 7,980 $17,078 ===== ====== ====== Single-Family Residential Loans. The Association's primary lending activity consists of the origination of single-family residential mortgage loans secured by property located in the Association's primary market area. The Association generally originates single-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 Association 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 Association 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 reduce interest rate risk, the Association offers primarily adjustable rate loans and balloon loans. For its adjustable-rate loans, the Association may offer low initial interest rates (i.e., teaser rates) but requires for all adjustable-rate mortgage loans that the borrower qualify at the fully indexed rate. The Association's adjustable-rate loans provide for periodic interest rate adjustments of 1% to 2% with a maximum adjustment over the term of the loan of between 5% and 6%. Adjustable-rate loans typically reprice every 1, 3, or 5 years, and typically provide for amortization over a 15 to 30 year period. Currently, the Association sets adjustable-rate loan interest rates based on a national cost of funds index. In the past, the Association used a one-year U.S. Treasury securities index. The Association does not permit adjustable-rate loans to be converted to fixed rate loans. 4 The Association also offers fixed rate, single-family mortgage balloon loans that provide for an amortization of up to 30 years, but which typically mature after 5 to 7 years. The Association usually refinances the balloon loans at the then current market rate of interest. Refinancing matured balloon loans is dependent on certain factors including, but not limited to, the borrower's payment history and the value of the collateral. The Association is not legally bound to refinance a balloon loan. The Association does not generally offer long-term fixed rate single-family mortgage loans, although the Association does, on occasion, originate long-term loans (up to 30 years) with the first adjustment due at either 7, 8, or 15 years. Many of the existing loans that do not reprice within five years were originated more than 10 years ago, before the Association de-emphasized the origination of long-term, fixed rate loans. Interest rates charged on mortgage loans are competitively priced based on market conditions and the Association's cost of funds. The origination fees for loans are generally 1% of the loan amount. Generally, the Association's standard underwriting guidelines for fixed rate mortgage loans conform to Federal Home Loan Mortgage Corporation ("FHLMC") guidelines. It is the current policy of the Association to originate loans solely for its loan portfolio. However, if favorable market conditions exist, the Association may originate long-term, fixed rate loans for sale in the secondary mortgage market. The Association will continue to emphasize short-term or adjustable-rate mortgage loans consistent with its asset/liability management strategy. At June 30, 1996, the Association did not service loans for others. Consumer Loans. Consumer loans are only made when secured by a savings account in the Association and 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. Although the Association also makes home equity loans, these loans are secured by liens on primary residences and are categorized as single-family residential loans. Commercial Real Estate Loans. In order to serve its community and enhance the yield on its assets, the Association 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, 1996, the Association's largest commercial real estate loans to one borrower consisted of two participations totaling $160,000 discussed below and were performing loans, secured by a health care facility in Redwood Falls, Minnesota. All commercial real estate loans require prior approval by the Association's Board of Directors. As part of its underwriting, the Association requires that borrowers qualify for a commercial real estate loan at the fully indexed interest rate rather than at the origination interest rate. The Association has a one-half interest in a participation loan with a commercial bank for a home in Redwood Falls that will house handicapped adults. The Association also has a one third participation with two commercial banks for a loan for a home in Redwood Falls that will also house handicapped adults. At June 30, 1996, the Association's interest in both loans totalled $160,000. Both loans are with the same borrower. 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 5 dollar amount of loans secured by church real estate that are originated by the Association, 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 Association, these loans are made on terms similar to those of the Association's single-family residential loans and may be amortized over terms of up to 30 years. The Association 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 assumable by ultimate purchasers. In underwriting such loans, the Association takes into consideration the number of units that the builder has on a speculative basis that remain unsold. Multi-Family Loans. The Association also makes fixed rate and adjustable rate multi-family loans, including loans on apartment complexes. The only multi-family real estate loan at June 30, 1996 was secured by a six unit apartment building located within the primary market area of the Association. 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. The Association does not actively originate commercial loans. However, the Association participates in a loan on a 35-unit housing complex designed to assist elderly and low-to-moderate income persons. The loan is an obligation of the City of Redwood Falls, Minnesota, and is secured by the general taxing authority of the City. The Association's participation in the loan totalled $300,000 at June 30, 1996. While the Company does not regularly engage in lending activities outside of the lending activities of the Association, the Company participates in a commercial loan used for the improvement and operation of a hotel and convention center on a local gaming casino. The Company's participation in the loan totalled $475,000 at June 30, 1996, and is secured primarily by the revenues of the casino. The loan is the only loan receivable of the Company. 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. Loan Commitments. The Association issues written commitments to prospective borrowers on all real estate approved loans. Generally, the commitment requires acceptance within 45 days of the date of issuance. At June 30, 1996, the Association had $1,084,000 of commitments to cover originations 6 and undisbursed funds for loans in process. The Association believes that most of the Association's commitments will be funded. Loans to One Borrower. Savings associations 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 higher. The Association's maximum loan-to-one borrower limit was approximately $1,531,000 as of June 30, 1996. At June 30, 1996, the Association's largest amount of loans to one borrower was a commercial loan participation in the amount of $300,000, secured by the general taxing authority of the City of Redwood Falls, Minnesota. Nonperforming and Problem Assets Loan Delinquencies. Loans are reviewed on a monthly basis and are generally placed on a non-accrual status when the loan becomes more than 90 days delinquent and, in the opinion of management, the collection of additional interest is doubtful. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent interest payments, if any, are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. 7 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 Association had no loans categorized as troubled debt restructuring within the meaning of Statement of Financial Accounting Standards ("SFAS") No. 15.
June 30, --------------------- 1996 1995 --------- ---------- (Dollars in Thousands) Loans accounted for on a non-accrual basis: Mortgage loans: Permanent loans secured by 1-4 dwelling units ................ $ 89 $ 0 All other mortgage loans ..................................... 0 0 Non-mortgage loans ............................................. 0 0 ---- ---- Total .......................................................... $ 89 $ 0 ==== ==== Accruing loans which are contractually past due 90 days or more: Mortgage loans: Permanent loans secured by 1-4 dwelling units ................ 46 $ 0 All other mortgage loans ..................................... 0 0 Non-mortgage loans ............................................. 0 0 --- --- Total .......................................................... $ 46 $ 0 ==== ==== Total non-accrual and accrual loans ............................ $ 135 $ 0 ==== ==== Real estate owned .............................................. $ 0 $ 0 ==== ==== Other non-performing assets .................................... $ 0 $ 0 ==== ==== Total non-performing assets .................................... $ 135 $ 0 ==== ==== Total non-accrual and accrual loans to net loans .................................................... 0.82% 0.00% ==== ==== Total non-accrual and accrual loans to total assets ................................................. 0.26% 0.00% ==== ==== Total non-performing assets to total assets .................... 0.26% 0.00% ==== ====
There was $3,000 in interest income that would have been recorded on loans placed on a non-accrual basis under the original terms of such loans during the year ended June 30, 1996. 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 currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified 8 as loss are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets may be designated "special mention" because of potential weakness that do not currently warrant classification in one of the aforementioned categories. When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as loss, it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which may order the establishment of additional general or specific loss allowances. A portion of general loss allowances established to cover possible losses related to assets classified as substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. At June 30, 1996, the Company's classified assets consisted of substandard loans of $89,000. At June 30, 1996, the Company also had $115,000 in loans designated as special mention. The Company had delinquent loans of 60 and 90 days or more of $46,000 and $135,000, respectively, and a general valuation allowance of $213,000. 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, 1996. 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. 9 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.
At June 30, -------------------------------------------------- 1996 1995 ---------------------- ---------------------- Percent of Percent of Loans to Loans to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (Dollars in Thousands) At end of period allocated to: Real estate mortgage: Residential construction.. $ 1 0.47% $ 1 1.54% Single-family residential. 202 94.83 206 93.09 Multi-family residential.. 2 0.94 2 1.30 Commercial................ 5 2.35 4 3.02 Savings account............. 0 0.00 0 1.05 Commercial.................. 3 1.41 0 0.00 ---- ------ ---- ------ Total allowance for loan losses ...... $ 213 100.00% $ 213 100.00% ==== ====== ==== ======
10 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 ---------------------- 1996 1995 ----------- --------- (Dollars in Thousands) Total loans outstanding ................................... $16,727 $15,468 ====== ====== Average loans outstanding ................................. $15,755 $15,129 ====== ====== Allowance balances (at beginning of year) ..................................................... $ 213 $ 213 Charge-offs ............................................... 0 0 Recoveries ................................................ 0 0 ------ ------ Net charge-offs ........................................... 0 0 Provision ................................................. 0 0 ------ ------ Allowance balance (at end of year) ........................ $ 213 $ 213 ====== ====== Allowance for loan losses as a percent of total loans outstanding .............................. 1.27% 1.38% Net loans charged off as a percent of average loans outstanding ............................... 0.00% 0.00%
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 (although the Company has not used them as such) and, through repayments, as a source of liquidity. In May 1993, the Financial Accounting Standards Board ("FASB") issued SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. This statement addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. SFAS No. 115 is effective for fiscal years beginning after December 15, 1993 as of the beginning of the fiscal year (i.e., July 1, 1994 for the Company). SFAS No. 115 requires classification of investments into three categories. Debt securities that the Company has the positive intent and ability to hold to maturity must be reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term must be reported at fair value, with unrealized gains and losses included in earnings. All other debt and equity securities must be considered available for sale and must be reported at fair value, with unrealized gains and losses excluded from earnings but reported as a separate component of stockholders' equity (net of tax effects). The Company adopted SFAS No. 115 as of July 1, 1994. The implementation of SFAS No. 115 had no impact on the financial statements of the Company as the Company's entire portfolio of securities is classified as held to maturity. At June 30, 1996, the mortgage-backed and related securities portfolio had a fair value of $15.8 million and an amortized cost of $15.8 million. Because the entire portfolio is classified as held to maturity (the Company had no mortgage-backed or related securities classified as available for sale at June 30, 1996), the portfolio is recorded at amortized cost. The Board of Directors, however, has approved an investment policy that will permit management to purchase investment 11 securities and place these securities in an available for sale portfolio should market conditions favor such a classification. 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 Association. Such quasi-governmental agencies, which guarantee the payment of principal and interest to investors, primarily include FHLMC, Government National Mortgage Association ("GNMA"), and Federal National Mortgage Association ("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. The collateralized mortgage obligations ("CMOs") (in the form of real estate mortgage investment conduits) held by the Association at June 30, 1996 totalled $78,000 and consisted of fixed rate notes issued by FHLMC. The portfolio of CMOs held within the Association's mortgage-backed and related securities portfolio at June 30, 1996 did not include any residual interests in CMOs. Further, at June 30, 1996, the Company's mortgage-backed and related securities portfolio did not include any "stripped" CMOs (i.e., CMOs that pay interest only and do not repay principal or CMOs that repay principal only and do not pay interest). Investment Activities. The Association is required under federal regulations to maintain a minimum amount of liquid assets which may be invested in specified short-term securities and certain other investments. See "Regulation - Regulation of the Association - Federal Home Loan Bank System." The Association has maintained a liquidity portfolio in excess of regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of future yield levels, as well as management's projections as to the 12 short-term demand for funds to be used in the Association's loan origination and other activities. At June 30, 1996, the Company had an investment portfolio of approximately $34.3 million, consisting primarily of U.S. Treasury securities, U.S. Government Agency securities, and mortgage-backed and related securities. To a lesser extent, the portfolio includes municipal bonds and interest-bearing deposits as permitted by regulation. The Company classifies its investments as held to maturity in accordance with SFAS No. 115. See the discussion of SFAS No. 115 under "- Mortgage-backed and Related Securities." 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, ----------------------- 1996 1995 --------- --------- (In Thousands) Investment securities: U.S. Treasury Notes............. $ 7,654 $ 8,963 U.S. Government Agency Bonds.... 6,093 6,946 Municipal bonds................. 1,542 522 ------ ------ Total Investment Securities... 15,289 16,431 Interest-bearing deposits in other institutions.............. 2,858 898 Interest-bearing deposits - stock subscriptions............. 0 13,128 FHLB stock........................ 334 327 Mortgage-backed and related securities...................... 15,805 7,874 ------ ------ Total Investments........... $ 34,286 $ 38,658 ====== ====== 13 Investment Portfolio Maturities. The following table sets forth certain information regarding the carrying values, weighted average yields, and maturities of the Company's investment securities portfolio at June 30, 1996.
As of June 30, 1996 ---------------------------------------------------------------------------------- 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 $ 2,150 6.21% $ 5,504 5.54% $ 0 0.00% $ 0 0.00% U.S. Government Agency bonds ..... 1,350 7.49 4,743 6.45 0 0.00 0 0.00 Municipal bonds .... 393 4.78 949 4.22 200 4.50 0 0.00 ----- ------ ----- ----- Total Investment Securities ..... 3,893 6.51 11,196 5.81 200 4.50 0 0.00 FHLB stock ......... N/A N/A N/A N/A N/A N/A N/A N/A Mortgaged-backed and related securities 416 7.32 7,100 6.26 6,328 6.89 1,961 8.08 ----- ------ ----- ----- Total Investment Portfolio(1).... $ 4,309 6.59% $18,296 5.99% $ 6,528 6.82% $ 1,961 8.08% ====== ==== ====== ==== ====== ==== ===== ====
- -------------------------------- (1) Excludes interest bearing deposits and FHLB stock. Sources of Funds General. Deposits 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. The Company may also use FHLB advances as an additional source of funds. Deposits. Consumer and commercial deposits are attracted principally from within the Company's primary market area through the offering of a broad selection of deposit instruments including regular savings accounts, 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. Passbook and money market accounts constituted $8.1 million, or 21.27%, of the Company's deposit portfolio at June 30, 1996. Certificates of deposit constituted $29.8 million or 78.25% of the deposit portfolio. At June 30, 1996, the Company had no brokered deposits. 14 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, 1996, including term certificate accounts separated by time remaining until maturity. Amount (In Thousands) Term certificate accounts: Maturity Period Within three months.............................. $1,269 Three through six months......................... 1,440 Six through twelve months........................ 1,617 Over twelve months............................... 1,900 ----- Total.......................................... 6,226 Money market accounts.............................. 3,472 ----- Total.......................................... $9,698 ===== Borrowings Deposits are the primary source of funds of the Company's lending and investment activities and for its general business purposes. The Association may obtain advances from the FHLB of Des Moines to supplement its supply of lendable funds. Advances from the FHLB of Des Moines are typically secured by a pledge of the Association's stock in the FHLB of Des Moines and a portion of the Association's first mortgage loans and certain other assets. The Association, 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, 1996, the Company and the Association had no borrowings. Personnel The Company has no employees other than executive officers. As of June 30, 1996, the Association had 10 full-time and no part-time employees. None of the Association'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 Association. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations. Company Regulation 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 Association and not for the benefit of stockholders of the Company. 15 Qualified Thrift Lender Test. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions, provided the Association 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 Association 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 Association - Qualified Thrift Lender Test." Regulation of the Association General. As a federally chartered, SAIF-insured savings association, the Association 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 Association is also subject to certain reserve requirements promulgated by the Federal Reserve Board. Insurance of Deposit Accounts. The Association'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. Under this system, SAIF members pay within a range of 23 cents to 31 cents per $100 of domestic deposits, 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 such 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 also may impose special assessments on SAIF members to repay amounts borrowed from the U.S. Treasury or for any other reason deemed necessary by the FDIC. By comparison, most members of the Bank Insurance Fund ("BIF") (e.g., commercial banks) pay a substantially lower insurance premium. The Association expects a one-time assessment of approximately 68 basis points on every $100 of deposits. If the assessment was applied to the Association's deposits at June 30, 1996, the Association would experience a one time cost of approximately $156,000 (net of taxes). If the Association is required to pay the proposed special assessment, future deposit insurance premiums are expected to be reduced. Based upon the Association's deposits as of June 30, 1996, the Association's deposit insurance expense would decrease by approximately $51,000 per year after taxes. Management of the Association is unable to predict whether this proposal or any similar proposal will be enacted or whether ongoing SAIF premiums will be reduced to a level comparable to that of BIF premiums. 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 Association's regulatory capital exceeded all minimum regulatory capital requirements applicable to it as of June 30, 1996. 16 Savings associations with a greater than "normal" level of interest rate exposure will, 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 Association 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, 1996, the Association was a Tier 1 institution. In the event the Association'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 Association'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 Association 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 Association below the amount required for the liquidation account to be established pursuant to the Association's plan of conversion. Qualified Thrift Lender Test. Savings institutions must meet a QTL test. If the Association 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 10% 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. An association must be in compliance with the QTL test on a monthly basis in nine out of every 12 months. As of June 30, 1996, the Association was in compliance with its QTL requirement with 87.99% of its assets invested in QTIs. There can be no assurance that the Association will continue to meet the QTL requirements in future periods. 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. 17 Federal Home Loan Bank System. The Association 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, 1996, the Association 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 Association. The Association 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 Association also owns a building adjacent to the branch office and two lots in Redwood Falls, Minnesota. (b) Investment Policies. See "Item 1. Business" above for a general description of the Association'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 Association," 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 Association." (3) Investments in Securities of or Interests in Persons Primarily Engaged in Real Estate Activities. See "Item 1. Business - Lending Activities," "Item 1. Business - Regulation of the Association," and "Item 1. Business - Subsidiary Activity." (c) Description of Real Estate and Operating Data. Not Applicable. Item 3. Legal Proceedings The Company and the Association, 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 Association 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 Association. No claims or lawsuits were pending or threatened at June 30, 1996. 18 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, 1996. 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, 1996 (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 The Association's consolidated financial statements required 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. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(b) 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 Corporation's definitive proxy statement for the Corporation's Annual Meeting of Stockholders to be held October 22, 1996 (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. 19 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 Corporation knows of no arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the Registrant. 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. 20 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 Registrant included in the Registrant's Annual Report to Stockholders for the fiscal year ending June 30, 1996 are incorporated herein by reference. Report of Independent Auditors Consolidated Statements of Financial Condition as of June 30, 1996 and 1995 Consolidated Statements of Earnings for the Years Ended June 30, 1996, 1995, and 1994 Consolidated Statements of Stockholders' Equity for the Years Ended June 30, 1996, 1995, and 1994 Consolidated Statements of Cash Flows for the Years Ended June 30, 1996, 1995, and 1994 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** 13 Annual Report to Stockholders for the fiscal year ended June 30, 1996. 21 Subsidiaries of the Registrant*** 23 Consent of KPMG Peat Marwick LLP 21 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 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). *** Incorporated by reference to the Annual Report on Form 10-KSB for the fiscal year ended June 30, 1995 (File No. 0-25884). 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. REDWOOD FINANCIAL, INC. Dated: September 27, 1996 By: /s/ Paul W. Pryor ----------------- Paul W. Pryor President, Chief Executive Officer and Director (Duly Authorized Representative) Pursuant to the requirement of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities 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 27, 1996 Date: September 27, 1996 By: /s/ J. Scott Nelson By: /s/ Blaine C. Farnberg ------------------- ---------------------- J. Scott Nelson Blaine C. Farnberg Vice Chairman of the Board Director Date: September 27, 1996 Date: September 27, 1996 By: /s/ Thomas W. Stotesbery By: /s/ Donald C. Orth ------------------------ ------------------ Thomas W. Stotesbery Donald C. Orth Director Vice President (Principal Financial Officer) Date: September 27, 1996 Date: September 27, 1996 By: /s/ Ardella J. Schlapkohl ------------------------- Ardella J. Schlapkohl Comptroller (Principal Accounting Officer) Date: September 27, 1996 EX-13 2 EXHIBIT 13 EXHIBIT 13 R E D W O O [PICTURE OF AN EAGLE] D F I N A N C I 1 9 9 6 A N N U A L R E P O R T A L I N C Redwood Financial, Inc. P.O. Box 317; 301 S. Washington St. Redwood Falls, MN 56283-0317 507-637-8730 Fax 507-637-5825 To Our Stockholders: We are happy to present to you our second annual stockholders' report. Redwood Falls Federal Savings and Loan Association (the Association) successfully completed the conversion from a federally chartered mutual savings association to a federally chartered stock savings association. Redwood Financial, Inc., (the Company) acquired all of the issued and outstanding capital stock of the Association in July 1995. We are pleased to report to you the results of our first year of operations. We believe the Company and the Association are well positioned to meet tomorrow's challenges and demands, and we look forward to the future with enthusiasm and optimism. We will continue striving to provide quality financial services to the communities we serve. We have a loyal customer base, a dedicated board of directors, and an excellent staff who recognize the importance of quality customer service. We will continue to focus on what we do best. Your board of directors and management team are committed to protecting and enhancing the value of your investment in the Company. To do so, we are challenged to continue delivering high quality services to our customers and communities and build upon our past accomplishments. We appreciate the confidence, support, and loyalty of our customers, employees, and stockholders. Sincerely, /s/Paul W. Pryor Paul W. Pryor President and Chief Executive Officer 2 REDWOOD FINANCIAL, INC. Profile and Related Information Redwood Financial, Inc. (the Company) is a Minnesota corporation organized at the direction of the board of directors of the Redwood Falls Federal Savings and Loan Association (the Association) to acquire all of the capital stock that the Association 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 Association 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 Association but utilizes the support staff of the Association from time to time. The Association is a federally chartered mutual savings and loan association headquartered in Redwood Falls, Minnesota. The Association has two full-service offices located in Redwood and Renville Counties, Minnesota. The Association was founded in 1924 and obtained its current name in 1982. The Association'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, and the Association is a member of the Federal Home Loan Bank (FHLB) System. The Association is a community oriented, retail savings institution offering traditional mortgage loan products. It is the Association's intent to remain an independent community savings and loan association serving the local banking needs of Redwood and Renville Counties, Minnesota. The Association attracts deposits from the general public and uses such deposits primarily to invest in residential lending on owner-occupied properties. The Association also makes consumer, commercial real estate, and multi-family 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 1996: First Quarter $ 9-1/2 8-3/4 Second Quarter 9-3/4 9-1/2 Third Quarter 9-3/4 9-1/4 Fourth 9-1/4 9-1/4 Quarter The number of stockholders of record of common stock as of June 30, 1996, was approximately 113. 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, 1996, there were 1,068,750 shares outstanding. The Company paid no dividends to holders of common stock during the fiscal year ended June 30, 1996. 3 REDWOOD FINANCIAL, INC. The Company's ability to pay dividends to stockholders is subject to the requirements of Minnesota law. No dividend may be paid by the Company unless its board of directors determines that the Company will be able to pay its debts in the ordinary course of business after payment of the dividend. In addition, the Company's ability to pay dividends is dependent, in part, upon the dividends it receives from the Association. The Association may not declare or pay a cash dividend on any of its stock if the effect thereof would cause the Association's regulatory capital to be reduced below (1) the amount required for the liquidation account established in connection with the Association's 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 ------------------------------------------------------------------ 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------------- Operating results: Interest income $ 3,487 3,023 3,048 3,268 3,417 Interest expense 1,883 1,683 1,448 1,637 2,148 - -------------------------------------------------------------------------------------------------------------------- Net interest income 1,604 1,340 1,600 1,631 1,269 Provision for loan losses 0 0 1 15 27 Noninterest income 61 40 54 56 66 Noninterest expense 992 775 690 653 617 Income tax expense 211 245 426 407 276 - -------------------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting change 462 360 537 612 415 Cumulative effect of accounting change 0 0 (45) 0 0 - -------------------------------------------------------------------------------------------------------------------- Net earnings $ 462 360 492 612 415 ==================================================================================================================== Net earnings per common share $ 0.45 N/A N/A N/A N/A ==================================================================================================================== Balance sheet data: Total assets $ 51,515 55,002 42,660 40,026 39,046 Investment securities 15,289 16,431 17,213 13,434 8,352 Mortgage-backed and related securities 15,805 7,874 7,774 8,936 12,027 Loans receivable, net 16,514 15,255 15,091 15,620 15,957 Deposits 38,043 35,825 37,114 35,064 34,526 Stockholders' equity 13,157 5,656 5,295 4,804 4,192 Financial ratios: Return on average assets 0.93% 0.74% 1.17% 1.49% 1.07% Return on average equity 3.42 6.58 9.73 13.65 10.51 Average equity to average assets 27.18 11.21 12.03 10.95 10.15 Net yield on average interest- earning assets 3.27 3.18 3.87 4.05 3.32
4 REDWOOD FINANCIAL, INC. 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 Redwood Falls Federal Savings and Loan Association (the Association). 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 as a result, the following discussion as it describes information prior to this relates to the Association. The principal business of the Company through the Association consists of accepting deposits from the general public and investing these funds primarily in investment securities and loans. The investment securities consist of U.S. government treasury notes and agency securities, mortgaged-backed and related securities, and, to a lesser extent, collateralized mortgage obligations, municipal bonds, and FHLB stock. 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, and loans secured by deposit accounts. 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 Association 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 Association'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, 1996, 1995, and 1994. 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. 5 REDWOOD FINANCIAL, INC. 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. 6 REDWOOD FINANCIAL, INC.
For the year ended June 30 ----------------------------------------------------------------------------------------------------- 1996 1995 1994 ------------------------------- ----------------------------- --------------------------------- Interest Interest Interest Average earned/ Yield/ Average earned/ Yield/ Average earned/ Yield/ balance paid cost balance paid cost balance paid cost - ------------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets: Loans receivable, net (1) $15,754,753 $1,376,334 8.74% $15,128,730 $1,300,846 8.60% $15,415,696 $1,345,427 8.73% Securities held to maturity: Mortgage-backed and related securities 11,410,198 784,869 6.88 7,847,474 573,656 7.31 7,902,192 615,114 7.78 Investment securities 18,055,614 1,090,543 6.04 16,746,430 1,017,232 6.07 16,083,304 996,845 6.20 FHLB stock 330,792 23,765 7.18 327,000 25,363 7.76 327,000 26,630 8.14 Other interest- earning assets (2) 3,550,681 211,640 5.96 2,084,790 105,947 5.08 1,649,067 64,383 3.90 ----------- --------- ----------- ---------- ----------- ---------- Total interest- earning assets 49,102,038 3,487,151 7.10 42,134,424 3,023,044 7.18 41,377,259 3,048,399 7.37 ----------- --------- ----------- ---------- ----------- ---------- Noninterest-earning assets 698,754 767,940 636,591 ----------- ----------- ---------- Total assets $49,800,792 $42,902,364 $42,013,850 =========== =========== =========== Interest-bearing liabilities: Passbook savings accounts 1,394,964 33,968 2.44 1,212,276 30,978 2.56 1,272,972 56,344 4.43 Money market savings accounts 5,550,747 196,842 3.55 6,469,209 214,906 3.32 8,267,024 220,825 2.67 Certificates of deposit 28,561,491 1,652,027 5.78 28,544,639 1,437,363 5.04 26,908,121 1,171,590 4.35 ----------- --------- ----------- --------- ----------- ---------- Total interest- bearing liabilities 35,507,202 1,882,837 5.30 36,226,124 1,683,247 4.65 36,448,117 1,448,759 3.97 ----------- --------- ----------- --------- ----------- ---------- Noninterest- bearing liabilities 758,718 1,164,783 513,485 ----------- ----------- ----------- Total liabilities 36,265,920 37,390,907 36,961,602 Stockholders' equity 13,534,872 5,511,457 5,052,248 ----------- ----------- ----------- Total liabilities and stockholders' equity $49,800,792 $42,902,364 42,013,850 =========== =========== =========== Net interest income $1,604,314 $1,339,797 $1,599,640 ========== ========== ========== Net interest rate spread (3) 1.80% 2.53% 3.40% ====== ====== ====== Net yield on interest-earning assets (4) 3.27% 3.18% 3.87% ====== ====== ====== Ratio of average interest-earning assets to average interest- bearing liabilities 138.29% 116.31% 113.52% ====== ====== ======
(1) Average balances include nonaccrual loans. (2) Includes interest-bearing deposits in other financial institutions. (3) Net 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. 7 REDWOOD FINANCIAL, INC. Rate/Volume Analysis The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate); (ii) changes in rates (changes in rate multiplied by old average volume); and (iii) changes in rate-volume (changes in rate multiplied by the change in average volume).
For the years ended June 30 --------------------------------------------------------------------------------- 1996 versus 1995 1995 versus 1994 increase/(decrease) due to increase/(decrease) due to -------------------------------------- ---------------------------------------- Rate/ Rate/ Volume Rate volume Total Volume Rate volume Total - ----------------------------------------------------------------------------------------- ---------------------------------------- Interest income: Loans receivable ...................... $ 54,714 22,057 (1,283) 75,488 (25,045) (19,906) 370 (44,581) Securities held to maturity: Mortgage-backed and related securities .................... 260,438 (33,855) (15,370) 211,213 (4,259) (37,458) 259 (41,458) Investment securities ............. 78,944 (7,222) 1,589 73,311 41,100 (19,893) (820) 20,387 FHLB stock ............................ 294 (1,870) (22) (1,598) 0 (1,267) 0 (1,267) Other interest-earning assets ......... 74,495 18,318 12,880 105,693 17,012 19,421 5,131 41,564 --------- -------- ------- ------- ------- -------- ------- -------- Total interest earning assets .... 468,885 (2,572) (2,206) 464,107 28,808 (59,103) 4,940 (25,355) --------- -------- ------- ------- ------- -------- ------- -------- Interest expense: Passbook savings accounts ............. 4,668 (1,458) (220) 2,990 (2,687) (23,815) 1,136 (25,366) Money market savings accounts ......... (30,511) 14,507 (2,060) (18,064) (48,022) 53,803 (11,700) (5,919) Certificates of deposit ............... 849 213,689 126 214,664 71,255 183,366 11,152 265,773 --------- -------- ------- ------- ------- -------- ------- -------- Total interest bearing liabilities (24,994) 226,738 (2,154) 199,590 20,546 213,354 588 234,488 --------- -------- ------- ------- ------- -------- ------- -------- Net change in net interest income .......... $ 493,879 (229,310) (52) 264,517 8,262 (272,457) 4,352 (259,843) ========= ======== ======= ======= ======= ======== ======= ========
8 REDWOOD FINANCIAL, INC. Comparison of Operating Results for the Years Ended June 30, 1996 and 1995 Net Earnings Net earnings were $462,000 for the year ended June 30, 1996, as compared to $360,000 for the year ended June 30, 1995. This represented an increase of $102,000, or 28.33%. The increase was attributable to a $464,000, or 15.35% increase in total interest income, a $200,000, or 11.88% increase in interest expense on deposits, a $21,000, or 52.50% increase in non-interest income, a $218,000 or 28.17% increase in noninterest expense and a $34,000, or 13.88% decrease in income tax expense. Net Interest Income Net interest income increased by $264,000, or 19.70%, from $1,340,000 for the year ended June 30, 1995 to $1,604,000 for the year ended June 30, 1996. The increase in net interest income primarily reflects an increase in the ratio of average interest-earning assets to average interest-bearing liabilities from 116.31% for the year ended June 30, 1995 to 138.29% for the year ended June 30, 1996. However, this was offset by a decrease in the Company's interest rate spread from 2.53% for the year ended June 30, 1995 to 1.80% for the year ended June 30, 1996. The decrease in the Company's interest rate spread primarily was caused by increases in interest rates during fiscal 1996, as the Company's liabilities repriced more quickly than did its assets. Interest Income Interest income was $3,487,000 for the year ended June 30, 1996, as compared to $3,023,000 for the year ended June 30, 1995, representing an increase of $464,000, or 15.35%. The increase in interest income was caused primarily by an increase in the average balance of interest-earning assets by $6,968,000, or 16.54%, from $42,134,000 for the year ended June 30, 1995 to $49,102,000 for the year ended June 30, 1996, primarily because of the funds raised in the conversion to stock form. This was offset in part by a decrease between the periods in the average yield on interest-earning assets from 7.18% for the year ended June 30, 1995 to 7.10% for the year ended June 30, 1996. Interest on loans receivable increased by $75,000, or 5.75% during the year ended June 30, 1996, as compared to the year ended June 30, 1995. Such increase was due to a increase in the average yield on loans receivable from 8.60% for the year ended June 30, 1995 to 8.74% for the year ended June 30, 1996, as well as a $626,000, or 4.14%, increase in the average balance of loans receivable from $15,129,000 for the year ended June 30, 1995 to $15,755,000 for the year ended June 30, 1996. Interest on mortgage-backed and related securities increased by $211,000, or 36.76% during the year ended June 30, 1996, as compared to the year ended June 30, 1995. Such increase was due to an increase in the average balance of mortgage-backed and related securities by $3,563,000, or 45.41%, from $7,847,000 for the year ended June 30, 1995 to $11,410,000 for the year ended June 30, 1996. This was offset in part by a decrease in the average yield on mortgage-backed and related securities from 7.31% for the year ended June 30, 1995 to 6.88% for the year ended June 30, 1996. The increase in the average balance of mortgage-backed and related securities primarily reflected a decision to invest a portion of the proceeds obtained from the stock offering in mortgage-backed and related securities. 9 REDWOOD FINANCIAL, INC. Interest on investment securities, including FHLB stock, increased by $71,000, or 6.81%, during the year ended June 30, 1996, as compared to the year ended June 30, 1995. Such increase was due primarily to a $1,313,000 or 7.69% increase in the average balance of investment securities, as the Company purchased investment securities during fiscal 1996 with funds received from the stock offering, principal payments on mortgage-backed and related securities and repayments of loans. The effect of the increase in the average balance of securities was offset, in part, by a decrease in the average yield on investment securities from 6.11% for the year ended June 30, 1995 to 6.06% for the year ended June 30, 1996, as maturing investment securities were replaced with lower yielding investment securities. Interest Expense Interest expense increased by $200,000, or 11.88%, from $1,683,000 for the year ended June 30, 1995 to $1,883,000 for the year ended June 30, 1996. The increase in interest expense resulted from an increase in the average cost of deposits from 4.65% for the year ended June 30, 1995 to 5.30% for the year ended June 30, 1996, resulting from increased prevailing market interest rates during fiscal 1996. The effect of the increase in the average cost of deposits was partially offset by a $719,000, or 1.98% decrease in the average balance of deposits from $36,226,000 for the year ended June 30, 1995 to $35,507,000 for the year ended June 30, 1996. Provision for Loan Losses The Company's provision for loan losses was $0 for the year ended June 30, 1996. Because of the consistency in the size of the loan portfolio and lack of significant nonaccruing loans during fiscal 1996 and stabilizing real estate markets in the Company's market area, management believed that the allowance for loan losses was adequate throughout fiscal 1996. The allowance for loan losses was maintained at $213,000 at June 30, 1995 and 1996. The Company's net loan charge-offs were $0 in fiscal 1995 and $0 in fiscal 1996. At June 30, 1996 and 1995, the allowance for loan losses represented 1.27% and 1.38%, respectively, of loans receivable. Nonaccrual loans at June 30, 1996 and 1995 were $89,000 and $0, respectively. Noninterest Income Noninterest income increased by $21,000, or 52.50%, from $40,000 for the year ended June 30, 1995 to $61,000 for the year ended June 30, 1996. The increase in noninterest income was primarily due to a $17,000 or 89.47% increase in fee and service charge income as a result of increased loan originations for the year ended June 30, 1996. Noninterest Expense Noninterest expense increased by $218,000, or 28.17%, from $774,000 for the year ended June 30, 1995 to $992,000 for the year ended June 30, 1996. The increase in total noninterest expense was primarily due to a $137,000, or 26.76%, increase in compensation and employee benefits from $512,000 for the year ended June 30, 1995 to $649,000 for the year ended June 30, 1996 as a result of expense from the Employee Stock Ownership Plan and Management Stock Bonus Plan, and an increase in professional fees from $34,000 for the year ended June 30, 1995 to $127,000 for the year ended June 30, 1996. The increase in professional fees was due to the increased costs associated with being a public company. 10 REDWOOD FINANCIAL, INC. Income Taxes The Company's income tax expense was $245,000 for the year ended June 30, 1995 and $211,000 for the year ended June 30, 1996, resulting from an increase in the base year tax bad debt reserve as a result of the increase in the Company's level of mortgage loans and mortgage-backed and related securities during 1996. Financial Condition The Company's total assets increased by $12,342,000, or 28.93%, from $42,660,000 at June 30, 1994 to $55,002,000 at June 30, 1995, and decreased by $3,487,000, or 6.34%, to $51,515,000 at June 30, 1996. Changes in the Company's level of assets from June 30, 1994 to 1995, reflects funds held for stock subscriptions. For the year ended June 30, 1996, this decrease reflects funds held for stock subscriptions that were refunded to subscribers due to the stock offering being over-subscribed. The Company's loans receivable, net, increased by $164,000, or 1.09%, from $15,091,000 at June 30, 1994 to $15,255,000 at June 30, 1995, and increased by $1,259,000, or 8.25%, to $16,514,000 at June 30, 1996 due to increased consumer demand. The Company's securities, which include investment securities and mortgage-backed and related securities, decreased by $682,000, or 2.73%, from $24,987,000 at June 30, 1994 to $24,305,000 at June 30, 1995 and increased by $6,789,000, or 27.93%, to $31,094,000 at June 30, 1996. The increase in the Company's level of securities during the year ended June 30, 1996 reflects increased cash flows resulting from deposits and investing a portion of the proceeds from the stock conversion. Cash and cash equivalents increased by $12,435,000, or 750.00%, from $1,658,000 at June 30, 1994 to $14,093,000 at June 30, 1995, and then decreased by $11,220,000, or 79.61%, to $2,873,000 at June 30, 1996. For the years ended June 30, 1994, 1995, and 1996, the Company's cash and cash equivalents fluctuated primarily as a result of the funds held at June 30, 1995 for the stock subscriptions and, depending on liquidity needs, the timing of purchases of securities. The Company's deposits decreased by $1,289,000, or 3.47%, from $37,114,000 at June 30, 1994 to $35,825,000 at June 30, 1995, and increased by $2,218,000, or 6.19%, to $38,043,000 at June 30, 1996 due to an increase in public deposits at the fiscal year end. 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. This increase was due primarily to the $8,549,000 in net proceeds from the sale of the Company's common stock. In addition, there was an increase of $462,000 from net earnings for the year ended June 30, 1996. Stockholders' equity was reduced by $596,000 and $393,000, respectively, as a result of unearned employee stock ownership plan shares and unearned management stock bonus plan shares at June 30, 1996. Stockholders' equity was also reduced by $541,000 as a result of the Company repurchasing shares of its outstanding common stock during the year ended June 30, 1996. 11 REDWOOD FINANCIAL, INC. Comparison of Operating Results for the Years Ended June 30, 1995 and 1994 Net Earnings Net earnings were $360,000 for the year ended June 30, 1995, as compared to $492,000 for the year ended June 30, 1994. This represented a decrease of $132,000, or 26.8%. The decrease was attributable to a $25,000, or 0.82% decrease in total interest income, a $234,000, or 16.15% increase in interest expense on deposits, a $14,000, or 25.93% decrease in non-interest income, and an $84,000 or 12.17% increase in noninterest expense. The effects of these items were offset, in part, by a $181,000, or 42.49% decrease in income tax expense. Also contributing to the change in net earnings was the reduction to net earnings for fiscal 1994 of $45,000 representing the cumulative effect of change in accounting principle resulting from the implementation of Statement of Financial Accounting Standards (SFAS) No. 109. Net Interest Income Net interest income decreased by $260,000, or 16.25%, from $1,600,000 for the year ended June 30, 1994 to $1,340,000 for the year ended June 30, 1995. The decrease in net interest income primarily reflects a decrease in the Association's interest rate spread from 3.40% for the year ended June 30, 1994 to 2.53% for the year ended June 30, 1995. The decrease in the Association's interest rate spread primarily was caused by increases in interest rates during the first half of fiscal 1995, as the Association's liabilities repriced more quickly than did its assets. This was partially offset by an increase in the ratio of average interest-earning assets to average interest-bearing liabilities from 113.52% for the year ended June 30, 1994 to 116.31% for the year ended June 30, 1995. Interest Income Interest income was $3,023,000 for the year ended June 30, 1995, as compared to $3,048,000 for the year ended June 30, 1994, representing a decrease of $25,000, or 0.82%. The decrease in interest income was caused primarily by a decrease between the periods in the average yield on interest-earning assets from 7.37% for the year ended June 30, 1994 to 7.18% for the year ended June 30, 1995. This was offset in part by a $757,000, or 1.83%, increase in the average balance of interest-earning assets. Interest on loans receivable decreased by $44,000, or 3.27% during the year ended June 30, 1995, as compared to the year ended June 30, 1994. Such decrease was due to a decrease in the average yield on loans receivable from 8.73% for the year ended June 30, 1994 to 8.60% for the year ended June 30, 1995, as well as a $287,000, or 1.86%, decrease in the average balance of loans receivable from $15,416,000 for the year ended June 30, 1994 to $15,129,000 for the year ended June 30, 1995. Interest on mortgage-backed and related securities decreased by $41,000, or 6.74% during the year ended June 30, 1995, as compared to the year ended June 30, 1994. Such decrease was due to a decrease in the average yield on mortgage-backed and related securities from 7.78% for the year ended June 30, 1994 to 7.31% for the year ended June 30, 1995, as well as a $55,000, or 0.69%, decrease in the average balance of mortgage-backed and related securities from $7,902,000 for the year ended June 30, 1994 to $7,847,000 for the year ended June 30, 1995. The decrease in the average balance of mortgage-backed and related securities primarily reflected an increase in prepayments of the underlying mortgages and a decision to reinvest payments in investment securities. 12 REDWOOD FINANCIAL, INC. Interest on investment securities, including FHLB stock, increased by $20,000, or 1.96%, during the year ended June 30, 1995, as compared to the year ended June 30, 1994. Such increase was due primarily to a $663,000 or 4.04% increase in the average balance of investment securities, as the Association purchased investment securities during fiscal 1995 with funds received from principal payments on mortgage-backed and related securities and repayments of loans. The effect of the increase in the average balance of securities was offset, in part, by a decrease in the average yield on investment securities from 6.24% for the year ended June 30, 1994 to 6.11% for the year ended June 30, 1995, as maturing investment securities were replaced with lower yielding investment securities. Interest Expense Interest expense increased by $234,000, or 16.15%, from $1,449,000 for the year ended June 30, 1994 to $1,683,000 for the year ended June 30, 1995. The increase in interest expense resulted from an increase in the average cost of deposits from 3.97% for the year ended June 30, 1994 to 4.65% for the year ended June 30, 1995, resulting from increased prevailing market interest rates during fiscal 1995. The effect of the increase in the average cost of deposits was partially offset by a $222,000, or 0.61% decrease in the average balance of deposits from $36,448,000 for the year ended June 30, 1994 to $36,226,000 for the year ended June 30, 1995. Provision for Loan Losses The Association's provision for loan losses was $0 for the year ended June 30, 1995. Because of the consistency in the size of the loan portfolio and in nonaccruing loans during fiscal 1995 and stabilizing real estate markets in the Association's market area, management believed that the allowance for loan losses was adequate throughout fiscal 1995. Therefore, the provision for loan losses was decreased from the $1,000 provision made for the year ended June 30, 1994, while the allowance for loan losses was maintained at $213,000 at June 30, 1994 and 1995. The Association's net loan charge-offs were $5,000 in fiscal 1994 and $0 in fiscal 1995. At June 30, 1995, the allowance for loan losses represented 1.38% of loans receivable. There were no nonaccrual loans at June 30, 1995 and 1994. Noninterest Income Noninterest income decreased by $14,000, or 25.93%, from $54,000 for the year ended June 30, 1994 to $40,000 for the year ended June 30, 1995. The decrease in noninterest income was primarily due to a $16,000 or 45.71% decrease in fee and service charge income as a result of fewer loan originations for the year ended June 30, 1995. Noninterest Expense Noninterest expense increased by $84,000, or 12.17%, from $690,000 for the year ended June 30, 1994 to $774,000 for the year ended June 30, 1995. The increase in total noninterest expense was primarily due to a $79,000, or 18.24%, increase in compensation and employee benefits from $433,000 for the year ended June 30, 1994 to $512,000 for the year ended June 30, 1995, and an increase in other expense from $81,000 for the year June 30, 1994 to $100,000 for the year ended June 30, 1995. These were partially offset by a $20,000 loss on investment securities sold during the year ended June 30, 1994 compared to a $0 loss for the year ended June 30, 1995. 13 REDWOOD FINANCIAL, INC. Cumulative Effect of Change in Accounting Principle In February 1992, the Financial Accounting Standards Board (FASB) issued SFAS No. 109, Accounting for Income Taxes. The Association adopted SFAS No. 109 as of July 1, 1993. Prior to adopting SFAS No. 109, the Association accounted for income taxes in accordance with Accounting Principles Board (APB) Opinion No. 11, Accounting for Income Taxes. SFAS No. 109 requires a change from the deferred method of accounting for income taxes of APB No. 11 to the asset and liability method of SFAS No. 109. Under the asset and liability method, 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. Under SFAS No. 109, 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. The cumulative effect of the application of SFAS No. 109 decreased net earnings for the year ended June 30, 1994 by $45,000. Income Taxes The Association's income tax expense was $426,000 for the year ended June 30, 1994 and $245,000 for the year ended June 30, 1995, resulting from decreased earnings before income tax expense during the year ended June 30, 1995. 14 REDWOOD FINANCIAL, INC. 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 categorized as troubled debt restructuring within the meaning of SFAS 15. 1996 1995 - -------------------------------------------------------------------------------- Loan accounted for on a nonaccrual basis: Mortgage loans: Loans secured by 1-4 dwelling units $ 89,153 0 All other mortgage loans 0 0 Nonmortgage loans 0 0 - -------------------------------------------------------------------------------- Total $ 89,153 0 ================================================================================ Accruing loans which are contractually past due 90 days or more: Mortgage loans: Loans secured by 1-4 dwelling units 45,352 0 All other mortgage loans 0 0 Nonmortgage loans 0 0 - -------------------------------------------------------------------------------- Total $ 45,352 0 ================================================================================ Total nonaccrual and accrual loans $ 134,505 0 ================================================================================ Real estate owned $ 0 0 ================================================================================ Other nonperforming assets $ 0 0 ================================================================================ Total nonperforming assets $ 134,505 0 ================================================================================ Total nonaccrual and accrual loans to net loans 0.81% 0.00% ================================================================================ Total nonaccrual and accrual loans to total assets 0.26% 0.00% ================================================================================ Total nonperforming assets to total assets 0.26% 0.00% ================================================================================ 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, 1996 and 1995 was $2,946 and $0, respectively. 15 REDWOOD FINANCIAL, INC. 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 --------------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------------- Allowance (at beginning of year) $ 213,034 213,034 217,534 Charge-offs: Residential 0 0 5,500 Recoveries 0 0 0 - -------------------------------------------------------------------------------- Net charge-offs 0 0 5,500 Provision 0 0 1,000 - -------------------------------------------------------------------------------- Allowance (at end of year) 213,034 213,034 213,034 ================================================================================ Allowance for loan losses as a percent of total loans outstanding 1.27% 1.38% 1.39% Net loans charged off as a percent of average loans outstanding 0.00 0.00 0.03 Liquidity and Capital Resources The Company's primary sources of funds are deposits and proceeds from maturing investment securities and principal and interest payments on loans and mortgage-backed 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. The primary investing activity of the Company is the purchase of investment and mortgage-backed and related securities. During the years ended June 30, 1996 and 1995, the Company purchased investment and mortgage-backed and related securities in the amounts of $12,824,899 and $1,940,000, respectively. Other investing activities include originations of loans and investment in FHLB of Des Moines stock. The primary financing activity of the Company is the attraction of savings deposits. The Company has other sources of liquidity if there is a need for funds. The Association has the ability to obtain advances from the FHLB of Des Moines. In addition, the Association maintains a significant portion of its investments in FHLB overnight funds that will be available when needed. The Association 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 5.0%. Management of the Association seeks to maintain a relatively high level of liquidity in order to retain flexibility in terms of investment opportunities and deposit pricing. Because liquid assets generally provide for lower rates of return, the Association's relatively high liquidity will, to a certain extent, result in lower rates of return on assets. 16 REDWOOD FINANCIAL, INC. The Company's most liquid assets are cash and cash equivalents, which are short-term, highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash, and include interest-bearing deposits. The levels of these assets are dependent on the Company's operating, financing, and investing activities during any given period. At June 30, 1996 and 1995, cash and cash equivalents totaled $2,873,000 and $14,093,000 (including $13,128,000 related to stock subscriptions), respectively. Federal savings institutions are required to satisfy three capital requirements: (i) a requirement that "tangible capital" equal or exceed 1.5% of adjusted total assets, (ii) a requirement that "core-capital" equal or exceed 3.0% of adjusted total assets, and (iii) a risk-based capital standard currently of 8.0% of "risk-adjusted" assets. At June 30, 1996, the Association met each of the 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 Recent action by the Federal Deposit Insurance Corporation (FDIC) has created an inequity in deposit insurance rates applicable to commercial banks and the rates applicable to savings associations. Generally, commercial banks are insured by and pay their premiums to the Bank Insurance Fund (BIF), and savings associations are insured by and pay their premiums to the Savings Association Insurance Fund (SAIF), with both the BIF and SAIF administered by the FDIC. Commercial banks and savings associations both previously paid a deposit insurance premium to the FDIC based upon the same rate schedule, which ranged, in 1995, from 0.23% to 0.31% of deposits. On August 8, 1995, the FDIC voted to lower the minimum insurance premiums charged to BIF-insured institutions, with the best-rated BIF-insured institutions paying only an annual assessment of $2,000, while leaving the level of premiums unchanged for SAIF-insured institutions. As a result of this premium disparity, BIF-insured institutions could have a competitive advantage and/or comparably better results of operations over SAIF insured institutions. Among the proposals being considered by the FDIC and Congress to eliminate this premium disparity is a similar reduction in premium rates charged to SAIF-insured institutions. Such a reduction would be accompanied by, and follow, a one-time additional assessment of SAIF-insured institutions of approximately 0.68% of deposits to increase the SAIF reserve level to 1.25% of SAIF-insured deposits, which is the same level attained by the BIF prior to the reduction of BIF premium rates. If such a special assessment were required, it would result in an after tax charge to the Association of approximately $156,000. Assuming such an assessment were made and, as a result, the SAIF was fully recapitalized, it could have the effect of reducing the Association's future deposit insurance premiums paid to the SAIF. The Company cannot predict at this time if any of the foregoing proposals will be adopted in their current form. [Letterhead of KPMG Peat Marwick LLP] 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, 1996 and 1995 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, 1996. 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, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1996 in conformity with generally accepted accounting principles. As discussed in note 2 to the consolidated financial statements, the Company changed its method of accounting for securities during the year ended June 30, 1995 to adopt the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Also, as discussed in note 2 to the consolidated financial statements, the Company changed its method of accounting for income taxes during the year ended June 30, 1994 to adopt the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. /s/KPMG Peat Marwick LLP August 16, 1996 18 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Balance Sheets June 30, 1996 and 1995
Assets 1996 1995 - --------------------------------------------------------------------------------------------------------------------- Cash $ 15,345 66,735 Interest bearing deposits with banks 2,857,818 898,300 Interest bearing deposits--stock subscriptions 0 13,127,630 - --------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 2,873,163 14,092,665 Securities held to maturity: Investment securities (market value approximates $15,192,588 and $16,445,048, respectively) 15,288,913 16,431,265 Mortgage-backed and related securities (market value approximates $15,772,242 and $8,117,065, respectively) 15,805,305 7,873,876 Loans receivable, net 16,513,727 15,255,027 Stock in Federal Home Loan Bank of Des Moines, at cost 333,500 327,000 Accrued interest receivable 553,856 409,584 Premises and equipment, net 52,187 63,911 Other assets 93,992 109,432 Deferred stock conversion costs 0 439,015 - --------------------------------------------------------------------------------------------------------------------- $ 51,514,643 55,001,775 ===================================================================================================================== Liabilities and Stockholders' Equity - --------------------------------------------------------------------------------------------------------------------- Deposits 38,042,529 35,825,269 Advance payments by borrowers for taxes and insurance 55,686 53,482 Deferred income tax liability, net 184,201 229,927 Accrued expenses and other liabilities 75,191 109,808 Funds held for stock subscriptions 0 13,127,630 - --------------------------------------------------------------------------------------------------------------------- Total liabilities 38,357,607 49,346,116 Common stock ($.10 par value). Authorized and issued 1,125,000 shares in 1996; outstanding 1,068,750 shares in 1996 112,500 0 Additional paid-in capital 8,457,017 0 Retained earnings, subject to certain restrictions 6,118,091 5,655,659 Unearned employee stock ownership plan shares (595,744) 0 Unearned management stock bonus plan shares (393,422) 0 Treasury stock, at cost, 56,250 shares in 1996 (541,406) 0 - --------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 13,157,036 5,655,659 - --------------------------------------------------------------------------------------------------------------------- $ 51,514,643 55,001,775 =====================================================================================================================
See accompanying notes to consolidated financial statements. 19 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Earnings Years ended June 30, 1996, 1995, and 1994
1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- Interest income: Loans receivable $ 1,376,334 1,300,846 1,345,427 Mortgage-backed and related securities 784,869 573,656 615,114 Investment securities 1,114,308 1,042,595 1,023,475 Cash equivalents 211,640 105,947 64,383 - --------------------------------------------------------------------------------------------------------------------------- Total interest income 3,487,151 3,023,044 3,048,399 Interest expense on deposits 1,882,837 1,683,247 1,448,759 - --------------------------------------------------------------------------------------------------------------------------- Net interest income 1,604,314 1,339,797 1,599,640 Provision for losses on loans 0 0 1,000 - --------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for losses on loans 1,604,314 1,339,797 1,598,640 - --------------------------------------------------------------------------------------------------------------------------- Noninterest income: Fees and service charges 36,197 18,947 35,043 Other 24,314 20,656 18,499 - --------------------------------------------------------------------------------------------------------------------------- Total noninterest income 60,511 39,603 53,542 - --------------------------------------------------------------------------------------------------------------------------- Noninterest expenses: Compensation and employee benefits 648,859 511,502 432,594 Advertising 16,411 16,525 15,460 Occupancy 28,181 27,976 26,917 Federal deposit insurance premiums 80,769 84,370 81,060 Professional fees 126,781 34,054 32,601 Loss on sale of investment securities 0 0 20,428 Other 90,880 99,948 80,615 - --------------------------------------------------------------------------------------------------------------------------- Total noninterest expenses 991,881 774,375 689,675 - --------------------------------------------------------------------------------------------------------------------------- Earnings before income taxes and cumulative effect of accounting change 672,944 605,025 962,507 Income tax expense 210,512 244,720 425,847 - --------------------------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting change 462,432 360,305 536,660 Cumulative effect of accounting change 0 0 (45,000) - --------------------------------------------------------------------------------------------------------------------------- Net earnings $ 462,432 360,305 491,660 =========================================================================================================================== Net earnings per common share $ 0.45 N/A N/A Weighted average number of shares outstanding 1,018,267 N/A N/A
See accompanying notes to consolidated financial statements. 20 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Stockholders' Equity Years ended June 30, 1996, 1995, and 1994
Unearned shares Unearned Employee management Additional Stock stock Total Common paid-in Retained Ownership bonus Treasury stockholders' stock capital earnings Plan plan shares stock equity - ---------------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1993 $ 0 0 4,803,694 0 0 0 4,803,694 Net earnings 0 0 491,660 0 0 0 491,660 - ---------------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1994 0 0 5,295,354 0 0 0 5,295,354 Net earnings 0 0 360,305 0 0 0 360,305 - ---------------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1995 0 0 5,655,659 0 0 0 5,655,659 Net earnings 0 0 462,432 0 0 0 462,432 Sale of common stock 112,500 8,436,861 0 0 0 0 8,549,361 Adoption of employee stock ownership plan 0 0 0 (661,984) 0 0 (661,984) Earned employee stock ownership plan shares 0 10,781 0 66,240 0 0 77,021 Repurchase of common stock 0 0 0 0 0 (965,156) (965,156) Adoption of management stock bonus plan 0 9,375 0 0 (433,125) 423,750 0 Earned management stock bonus plan shares 0 0 0 0 39,703 0 39,703 - ---------------------------------------------------------------------------------------------------------------------------------- Balance on June 30, 1996 $ 112,500 8,457,017 6,118,091 (595,744) (393,422) (541,406) 13,157,036 ==================================================================================================================================
See accompanying notes to consolidated financial statements. 21 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows Years ended June 30, 1996, 1995, and 1994
1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------------------- Operating activities: Net earnings $ 462,432 360,305 491,660 Adjustments to reconcile net earnings to net cash provided by operating activities: Provision for loan losses 0 0 1,000 Depreciation 16,992 17,354 18,020 Amortization of premiums and discounts on investment securities, mortgage-backed and related securities, and loans receivable, net (40,057) (34,683) (47,539) Loss on sale of investment securities 0 0 20,428 Federal Home Loan Bank stock dividend (6,500) 0 0 Amortization of unearned ESOP shares 66,240 0 0 Earned ESOP shares priced above original cost 10,781 0 0 Earned management stock bonus plan shares 39,703 0 0 Deferred income taxes (45,726) 57,281 92,646 Decrease (increase) in other assets 15,440 (28,655) (36,246) (Increase) decrease in accrued interest receivable (144,272) 40,345 (59,499) (Decrease) increase in accrued interest payable (50,453) 69,452 99,606 (Decrease) increase in accrued expenses and other liabilities (34,617) 78,542 (3,932) Other, net 0 0 4,609 - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 289,963 559,941 580,753 - -------------------------------------------------------------------------------------------------------------------------------- Investing activities: Proceeds from maturities of investment securities held to maturity 4,000,200 1,200,000 0 Proceeds from sales of investment securities (mutual funds) 0 0 3,994,142 Purchases of investment securities held to maturity (2,860,069) (430,000) (7,809,599) Purchases of mortgage-backed and related securities held to maturity (9,964,830) (1,510,000) (1,980,106) Principal collected on mortgage-backed and related securities held to maturity 2,075,679 1,456,544 3,206,431 Decrease in loans receivable, net (1,258,700) (164,075) 522,850 Decrease in real estate, net 0 0 12,000 Purchases of premises and equipment (5,268) (14,855) (1,158) - -------------------------------------------------------------------------------------------------------------------------------- Net cash (used) provided by investing activities (8,012,988) 537,614 (2,055,440) - -------------------------------------------------------------------------------------------------------------------------------- Financing activities: Adoption of ESOP (661,984) 0 0 Proceeds from sale of common stock 8,549,361 0 0 (Decrease) increase in funds held for stock subscriptions (13,127,630) 13,127,630 0 (Decrease) increase in deferred stock conversion costs 439,015 (439,015) 0 Increase (decrease) in deposits, net 2,267,713 (1,358,372) 1,950,379 Increase in advance payments by borrowers for taxes and insurance 2,204 6,513 3,635 Repurchase of common stock (965,156) 0 0 - -------------------------------------------------------------------------------------------------------------------------------- Net cash (used) provided by financing activities (3,496,477) 11,336,756 1,954,014 - -------------------------------------------------------------------------------------------------------------------------------- (Decrease) increase in cash and cash equivalents (11,219,502) 12,434,311 479,327 Cash and cash equivalents, beginning of year 14,092,665 1,658,354 1,179,027 - -------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 2,873,163 14,092,665 1,658,354 ================================================================================================================================ Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 1,933,290 1,613,795 1,349,153 Income taxes 175,101 224,979 380,572
See accompanying notes to consolidated financial statements. 22 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements June 30, 1996 (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 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 16). The Company had not transacted any material business activities through June 30, 1995 other than those associated with the preparations for the issuance of stock. Accordingly, the consolidated financial statements included herein as of June 30, 1995 and for the years ended June 30, 1995 and 1994 are for the Association. (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: Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and Redwood Falls Federal Savings and Loan Association. All significant intercompany account balances and transactions have been eliminated in consolidation. 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. (Continued) 23 REDWOOD FINANCIAL, INC. AND SUBSIDIARY 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. Investment Securities and Mortgage-Backed Securities In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. This statement addresses the accounting and reporting for securities by classifying them into three categories: securities held to maturity, trading securities, and securities available for sale. The Association adopted SFAS No. 115 as of July 1, 1994. Management has the ability and intent to hold all of its securities to maturity. There was no impact of adoption on the Association's financial statements as the Association's entire portfolio of securities are classified as held to maturity. Prior to July 1, 1994, marketable equity securities (mutual funds) were carried at the lower of cost or market determined on an aggregate basis. Unrealized losses were recorded as a valuation allowance against retained earnings. Securities held to maturity are carried at amortized cost. Gains and losses on sales of securities are recognized at the time of sale and are calculated based on the specific identification method. Discounts and premiums on securities are amortized to income using the level yield method over the estimated life of the security. 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. 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. (Continued) 24 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Effective July 1, 1995, the Association adopted SFAS No. 114, Accounting by Creditors for Impairment of a Loan and SFAS No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures. Under the Company's credit policies and practices, all nonaccrual and restructured construction and commercial real estate loans meet the definition of impaired loans under SFAS No. 114 and SFAS No. 118. Impaired loans as defined by SFAS No. 114 and SFAS No. 118 exclude certain consumer loans and residential real estate loans classified as nonaccrual. 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. The adoption of SFAS No. 114 and SFAS No. 118 did not have a material effect on the Company's financial position or results of operation. Loan origination fees and certain related direct costs are deferred and amortized to interest income 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. 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 market 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 less selling costs value. Gains on the sales of such real estate are recorded at the time of closing. Cash Equivalents 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. 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. (Continued) 25 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Income Taxes In February 1992, the FASB issued SFAS No. 109, Accounting for Income Taxes. The Company adopted SFAS No. 109 as of July 1, 1993. Prior to adopting SFAS No. 109, the Association accounted for income taxes in accordance with Accounting Principles Board Opinion (APB) No. 11, Accounting for Income Taxes and APB No. 23, Accounting for Income Taxes--Special Areas. SFAS No. 109 requires a change from the deferred method of accounting for income taxes of APB No. 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of SFAS No. 109, 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. Under SFAS No. 109, 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. The cumulative effect of the application of SFAS No. 109 decreased net earnings for the year ended June 30, 1994 by $45,000. New Accounting Standard In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation. This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. This statement defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value base method of accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. The statement requires pro forma disclosures of net income and earnings per share computed as if the fair value based method had been applied in financial statements of companies that continue to follow current practice in accounting for such arrangements under Opinion 25. The changes required by the new statement could affect employers' financial statements in a number of ways. Companies that historically have provided fixed stock options to employees or have established broad-based plans will generally experience a negative earnings impact (either in the basic income statement or in the required pro forma net income disclosures). Conversely, compensation cost will generally be reduced for companies that rely predominantly on performance-based or other variable plan awards. The effect on net income (or pro forma net income), whether positive or negative, will be amplified for companies that rely heavily on stock-based compensation awards as a critical element in their overall compensation strategy. The accounting requirements of this statement are effective for transactions entered into in fiscal years that begin after December 15, 1995, although they may be adopted on issuance. The disclosure requirements of this statement are effective for financial statements for fiscal years beginning after December 15, 1995, or for an earlier fiscal year for which this statement is initially adopted for recognizing compensation cost. The adoption of this statement will not have a significant impact on the Company's financial condition or results of operations. (Continued) 26 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (3) Earnings Per Share Earnings per share are based upon the weighted average number of common shares and common stock equivalents, if dilutive, outstanding during the period. The only common stock equivalents are stock options. The weighted average number of common stock equivalents is calculated using the treasury stock method. Earnings per share amounts for the years ended June 30, 1995 and 1994 have not been presented in the consolidated statements of earnings because the Association did not convert to stock form until July 7, 1995. Net earnings per common share were calculated using 1,018,267 shares as the weighted average number of shares outstanding for the year ended June 30, 1996. (4) Securities Held to Maturity Securities held to maturity at June 30, 1996 and 1995 are summarized as follows:
June 30, 1996 ------------------------------------------------------------------ Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ------------------------------------------------------------------------------------------------------- Investment securities: U.S. government agency bonds $ 6,092,875 24,627 (19,049) 6,098,453 U.S. Treasury notes 7,654,214 7,245 (90,068) 7,571,391 Municipal bonds 1,541,824 918 (19,998) 1,522,744 ------------------------------------------------------------------------------------------------------- Total investment securities $ 15,288,913 32,790 (129,115) 15,192,588 ======================================================================================================= Mortgage-backed and related securities: GNMA certificates 252,258 101,952 0 354,210 FHLMC certificates 10,847,779 75,606 (148,227) 10,775,158 FHLMC collateralized mortgage obliga- tions 78,194 1,519 0 79,713 FNMA certificates 4,627,074 0 (63,913) 4,563,161 ------------------------------------------------------------------------------------------------------- Total mortgage-backed and related securities $ 15,805,305 179,077 (212,140) 15,772,242 =======================================================================================================
(Continued) 27 REDWOOD FINANCIAL, INC. AND SUBSIDIARY
June 30, 1995 ------------------------------------------------------------------ Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ------------------------------------------------------------------------------------------------------- Investment securities: U.S. government agency bonds $ 6,945,933 83,222 (20,588) 7,008,567 U.S. Treasury notes 8,962,904 38,860 (94,008) 8,907,756 Municipal bonds 522,428 43,873 (37,576) 528,725 ------------------------------------------------------------------------------------------------------- Total investment securities $ 16,431,265 165,955 (152,172) 16,445,048 ======================================================================================================= Mortgage-backed and related securities: GNMA certificates 321,328 137,842 0 459,170 FHLMC certificates 7,457,818 140,650 (36,446) 7,562,022 FHLMC collateralized mortgage obliga- tions 94,730 1,143 0 95,873 ------------------------------------------------------------------------------------------------------- Total mortgage-backed and related securities $ 7,873,876 279,635 (36,446) 8,117,065 =======================================================================================================
Proceeds from the sale of securities during the years ended June 30, 1996, 1995, and 1994, were $0, $0, and $3,994,142, respectively. Such sales consisted entirely of mutual funds. There were no sales of investment securities or mortgage-backed and related securities other than mutual funds. Gross realized losses from the sale of securities for the years ended June 30, 1996, 1995, and 1994 were $0, $0, and $20,428, respectively. Accrued interest receivable on securities held to maturity aggregated $452,492 and $344,843 at June 30, 1996 and 1995, respectively. (Continued) 28 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The carrying amount and approximate market value of investment securities held to maturity at June 30, 1996 and 1995, by contractual maturity, are shown below:
June 30, 1996 June 30, 1995 ---------------------------------- --------------------------------- Carrying Approximate Carrying Approximate amount market value amount market value - -------------------------------------------------------------------------------------------- Due within one year $ 3,892,474 3,904,481 3,707,509 3,721,357 Due after one year through five 11,196,439 11,099,647 12,423,756 12,419,941 years Due after five years through ten years 200,000 188,460 0 0 Due after ten years 0 0 300,000 303,750 - -------------------------------------------------------------------------------------------- $15,288,913 15,192,588 16,431,265 16,445,048 ============================================================================================
(5) Loans Receivable Loans receivable at June 30, 1996 and 1995 are summarized as follows: 1996 1995 ---------------------------------------------------------------------- Loans secured by real estate: Residential one-to-four family $15,232,656 14,618,727 Multifamily 189,266 203,673 Commercial 519,543 474,121 Residential construction 220,000 242,021 Loans on deposit accounts 140,802 165,182 Commercial loans 775,358 0 ---------------------------------------------------------------------- 17,077,625 15,703,724 Deferred loan fees and discounts (18,019) (19,253) Loans in process (332,845) (216,410) Allowance for losses (213,034) (213,034) ---------------------------------------------------------------------- $16,513,727 15,255,027 ================================================================================ Accrued interest receivable on loans receivable at June 30, 1996 and 1995 was $101,364 and $64,741, respectively. (Continued) 29 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The following is a summary of nonperforming loans as of and for the years ended June 30: 1996 1995 1994 - -------------------------------------------------------------------------------- Impaired loans: Nonaccrual $ 0 0 0 Restructured 0 0 0 - -------------------------------------------------------------------------------- 0 0 0 - -------------------------------------------------------------------------------- Other nonperforming loans: Nonaccrual 89,153 0 0 Restructured 0 0 0 - -------------------------------------------------------------------------------- 89,153 0 0 - -------------------------------------------------------------------------------- Total nonperforming loans $ 89,153 0 0 ================================================================================ Scheduled interest under original terms 2,946 0 0 Actual interest recogized 0 0 0 - -------------------------------------------------------------------------------- Net interest lost on nonperforming loans $ 2,946 0 0 ================================================================================ The average balance of impaired loans during each of the fiscal years ended June 30, 1996, 1995, and 1994 was $0. There was no allowance for losses on impaired loans at June 30, 1996, 1995, and 1994. The aggregate amount of loans to directors and executive officers of the Company was $237,177, $254,139, and $271,757, at June 30, 1996, 1995, and 1994, respectively. Activity with respect to these loans during fiscal 1996 included loan originations of $0 and loan repayments of $16,962. Activity with respect to these loans in fiscal 1995 included new loans of $0 and loan repayments of $17,618. Activity with respect to these loans during fiscal 1994 included loan originations of $64,660 and loan repayments of $81,700. 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. There were no material commitments to lend additional funds to customers whose loans were classified as nonaccrual at June 30, 1996. There were no loans at June 30, 1996 and 1995 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) 30 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (6) Allowance for Losses on Loans Receivable Activity in the allowance for losses on loans receivable is summarized as follows: Balance at June 30, 1993 $ 217,534 Provision for losses 1,000 Charge-offs (5,500) -------------------------------------------------------------------------- Balance at June 30, 1994 213,034 Provision for losses 0 Charge-offs 0 -------------------------------------------------------------------------- Balance at June 30, 1995 213,034 Provision for losses 0 Charge-offs 0 -------------------------------------------------------------------------- Balance at June 30, 1996 $ 213,034 ========================================================================== (7) Real Estate Owned or in Judgment Realestate owned or in judgment totaled $0 at June 30, 1996 and 1995. The allowance for losses on real estate owned or in judgment was $0 at June 30, 1996 and 1995. There were no charge-offs, recoveries, or provisions for losses for the years ended June 30, 1996, 1995, or 1994. (8) Premises and Equipment A summary of premises and equipment at June 30, 1996 and 1995 is as follows: 1996 1995 ------------------------------------------------------------------------- Land and office buildings $ 155,476 154,436 Furniture and equipment 171,204 166,761 ------------------------------------------------------------------------- 326,680 321,197 Less accumulated depreciation (274,493) (257,286) ------------------------------------------------------------------------- $ 52,187 63,911 ========================================================================= (Continued) 31 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (9) Deposits Deposits and weighted-average interest rates at June 30 are summarized as follows:
1996 1995 ------------------------------ ---------------------------- Average Average Amount rate Amount rate - -------------------------------------------------------------------------------------------------------------------- Passbook $ 985,658 2.65% $ 1,601,776 2.75% Money market accounts 7,104,387 3.89 4,598,343 3.02 - ------------------------------------------------------------------------------------------------------------------- 8,090,045 6,200,119 - -------------------------------------------------------------------------------------------------------------------- Certificates of deposit: 3.01%-4.00% 0 1,766,350 4.01 -5.00 2,069,519 8,005,177 5.01 -6.00 16,334,358 8,318,200 6.01 -7.00 10,766,128 8,709,118 7.01 -8.00 598,235 2,531,608 8.01 -9.00 0 60,000 - -------------------------------------------------------------------------------------------------------------------- 29,768,240 5.83 29,390,453 5.72 - -------------------------------------------------------------------------------------------------------------------- Accrued interest payable 184,244 234,697 - -------------------------------------------------------------------------------------------------------------------- $ 38,042,529 $ 35,825,269 ====================================================================================================================
Interest expense on deposits is summarized as follows: 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------- Passbook $ 33,968 30,978 32,757 Money market 196,842 214,906 244,412 Certificates 1,652,027 1,437,363 1,171,590 - ----------------------------------------------------------------------------------------------------------------------- $ 1,882,837 1,683,247 1,448,759 =======================================================================================================================
Certificates of deposit had the following remaining maturities at June 30:
1996 1995 ---------------------------- ---------------------------- Average Average Amount rate Amount rate - ----------------------------------------------------------------------------------------------------------------------- 0-6 months $ 11,533,143 5.86% $ 11,444,590 5.29% 7-12 months 6,857,760 5.72 6,920,593 5.91 13-36 months 10,852,065 5.84 9,893,433 6.05 Over 36 months 525,272 6.41 1,131,837 5.90 - ----------------------------------------------------------------------------------------------------------------------- $ 29,768,240 $ 29,390,453 ========================================================================================================================
(Continued) 32 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The Company had $9,698,164 and $6,352,859 of certificates of deposit with balances of $100,000 or more at June 30, 1996 and 1995, respectively. At June 30, 1996 investment securities and mortgage-backed securities with an approximate book value of $16,635,589 were pledged as collateral for certain deposits, including approximately $10,027,362 of public deposits. (10) Income Taxes Income tax expense for the years ended June 30 is composed of the following:
1996 1995 1994 ---------------------------------------------------------------------------------------------------- Current: Federal $ 120,844 140,579 286,521 State 43,942 46,860 91,680 ---------------------------------------------------------------------------------------------------- Total current 164,786 187,439 378,201 ---------------------------------------------------------------------------------------------------- Deferred: Federal 34,295 42,961 35,736 State 11,431 14,320 11,910 ---------------------------------------------------------------------------------------------------- Total deferred 45,726 57,281 47,646 ---------------------------------------------------------------------------------------------------- $ 210,512 244,720 425,847 ====================================================================================================
The reasons for the difference between the effective income tax rate and the statutory federal income tax rate are as follows:
1996 1995 1994 --------------------------------------------------------------------------------------------------- Federal "expected" income tax rate 34.0% 34.0% 34.0% State income taxes, net of federal income tax benefit 6.5 6.7 7.1 (Increase) decrease in base year tax bad debt reserve (6.3) (0.4) 3.5 Tax-exempt interest income (3.0) (0.1) (0.1) Other, net 0.1 0.3 (0.3) --------------------------------------------------------------------------------------------------- Effective income tax rate 31.3% 40.5% 44.2% ===================================================================================================
(Continued) 33 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at June 30, 1996 and 1995 are as follows: 1996 1995 - -------------------------------------------------------------------------------- Deferred tax assets: Discounts on mortgage-backed and related securities $ 32,005 39,717 Allowance for losses on loans receivable 2,651 0 Other 4,365 3,534 - ------------------------------------------------------------------------------- Gross deferred tax assets 39,021 43,251 Valuation allowance 0 0 - -------------------------------------------------------------------------------- Deferred tax assets, net 39,021 43,251 Deferred tax liabilities: Accrual to cash conversion 159,421 168,481 FHLB stock 50,478 47,846 Allowance for losses on loans receivable 0 41,226 Premises and equipment 13,323 15,625 - -------------------------------------------------------------------------------- Gross deferred tax liabilities 223,222 273,178 - -------------------------------------------------------------------------------- Net deferred tax liability $184,201 229,927 ================================================================================ No valuation allowance was required for deferred tax assets at June 30, 1996 or 1995. Retained earnings at June 30, 1996 included approximately $1,156,000 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. (11) Employee Benefits 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) 34 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Net periodic pension expense for the years ended June 30 includes the following components:
1996 1995 1994 --------------------------------------------------------------------------------------------------- Service cost--benefits earned during the period $ 26,494 26,927 29,011 Interest cost on projected benefit obligation 51,730 48,474 43,979 Actual return on plan assets (55,934) (45,183) (43,781) Net amortization and deferral 438 907 438 --------------------------------------------------------------------------------------------------- Net periodic pension expense $ 22,728 31,125 29,647 ===================================================================================================
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:
1996 1995 1994 --------------------------------------------------------------------------------------------------- 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:
1996 1995 - ---------------------------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Vested accumulated benefit obligation $ 624,568 565,307 Nonvested accumulated benefit obligation 43 1,096 - ---------------------------------------------------------------------------------------------------- Total accumulated benefit obligation 624,611 566,403 Effect of projected future salary increases 104,247 117,621 - ---------------------------------------------------------------------------------------------------- Projected benefit obligation 728,858 684,024 Plan assets at fair value 780,740 639,505 - ---------------------------------------------------------------------------------------------------- Plan assets in excess of (less than) projected benefit obligation 51,882 (44,519) Unrecognized prior service cost 17,638 19,401 Unrecognized (gain) loss from past experience different from that assumed (47,254) 57,970 Unrecognized net transition asset being amortized over 15 years (6,632) (7,957) - ---------------------------------------------------------------------------------------------------- Prepaid pension cost $ 15,634 24,895 ====================================================================================================
(Continued) 35 REDWOOD FINANCIAL, INC. AND SUBSIDIARY 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 1996, 1995, or 1994. 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 contributed $123,086 to the ESOP during the fiscal year 1996. 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 ratably 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 $77,021 for fiscal year 1996. 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 year ended: 1996 ----------------------------------------------------------------------- Shares allocated beginning of year 0 Shares allocated during year 8,280 Unreleased shares 74,468 ----------------------------------------------------------------------- Total ESOP shares 82,748 ======================================================================= Fair value of unreleased shares at June 30 $ 688,829 ======================================================================= 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 1996 compensation and employee benefits expense is $39,703 related to the MSBP. (Continued) 36 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Stock Option Plan On January 17, 1996, stockholders approved the Company's Stock Option Plan, which was subsequently also approved by the OTS. The Plan provides for the granting of options for the purpose of attracting and retaining key personnel and to facilitate their purchase of a stock interest in the Company. Options on 112,500 shares were granted at an exercise price of $9.8125 per share. The options become exercisable over a five year period at the rate of 20% per year. If unused, the options expire in 2006. (12) Retained Earnings and Regulatory Capital The Association, 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 Association is required to maintain cash and other liquid assets in an amount equal to 5% of its deposit accounts and other obligations due within one year. The Association has met these requirements. The Association is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Association's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Association must meet specific capital guidelines that involve quantitative measures of the Association's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Association's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Association to maintain minimum amounts and ratios (set forth in the 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, 1996, that the Association meets all capital adequacy requirements to which it is subject. As of June 30, 1996, the most recent notification from the OTS categorized the Association as "well capitalized". There are no conditions or events since that notification that management believes have changed the Association's category. (Continued) 37 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The Association's actual capital amounts and ratios are also presented in the table:
Actual Requirement Excess Capital ---------------------------- --------------------------- --------------------------- Percent Percent Percent of of of Amount assets (1) Amount assets (1) Amount assets (1) - ------------------------------------------------------------------------------------------------------ Association's retained earnings $10,033,000 Tangible capital 10,033,000 20.72% $ 726,000 1.50% $ 9,307,000 19.22% ----------- Core capital 10,033,000 20.72 1,452,000 3.00 8,581,000 17.72 ----------- Plus: Allowable portion of general allowance for loan losses 172,000 ----------- Risk-based capital $10,205,000 73.26% $ 1,114,000 8.00% $ 9,091,000 65.26% ===========
(1) Based on the Association'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. (13) Stock Repurchases On March 4, 1996, the Company purchased 56,250 shares of its outstanding common stock at $9.625 per share. Repurchased shares are considered treasury shares and will be utilized for general corporate and other purposes, including the issuance of shares in connection with the exercise of stock options. On March 15, 1996, the Company repurchased 15,000 shares of its outstanding common stock at $9.50 per share and on March 18, 1996, the Company repurchased 30,000 shares of its outstanding common stock at $9.375 per share. Repurchased shares are considered treasury shares and will be utilized for the management stock bonus plan and other purposes. (14) 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. (Continued) 38 REDWOOD FINANCIAL, INC. AND SUBSIDIARY 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. The contract amount of these financial instruments at June 30, 1996 and 1995 is as follows: Contract amount ------------------------- 1996 1995 - ------------------------------------------------------------------------------ Financial instruments whose contract amount represents risk: Commitments to extend credit $ 751,400 130,000 ============================================================================== Commitments to extend credit 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. (15) 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, 1996 and 1995, 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. 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. (Continued) 39 REDWOOD FINANCIAL, INC. AND SUBSIDIARY
June 30 ------------------------------------------------------------------------------------------ 1996 1995 -------------------------------------------- -------------------------------------------- Carrying Estimated Contract Carrying Estimated Contract amount fair value amount amount fair value amount -------------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 2,873,163 2,873,163 14,092,665 14,092,665 Securities held to maturity 31,094,218 30,964,830 24,305,141 24,562,113 Loans receivable, net 16,513,727 16,949,767 15,255,027 15,615,945 Stock in Federal Home Loan Bank of Des Moines, at cost 333,500 333,500 327,000 327,000 Accrued interest receivable 553,856 553,856 409,584 409,584 Financial liabilities: Deposits 37,858,285 38,010,952 35,590,572 35,705,268 Accrued interest payable 184,244 184,244 234,697 234,697 Off-balance sheet financial instruments: Commitments to extend credit 0 13,466 751,400 0 2,794 130,000
Cash and Cash Equivalents The carrying amount of cash and cash equivalents approximates their fair value. Securities Held to Maturity The fair values of securities held to maturity are based upon quoted market prices. Loans Receivable, Net The fair values of loans receivable were estimated for groups of loans with similar characteristics. The fair value of the loan portfolio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market. Stock in Federal Home Loan Bank of Des Moines, at Cost The carrying amount of FHLB stock approximates its fair value. (Continued) 40 REDWOOD FINANCIAL, INC. AND SUBSIDIARY 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. 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, 1996 and 1995 for deposits with maturities 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. Accrued Interest Payable The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature. Commitments to Extend Credit The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. (16) 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 . 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. (Continued) 41 REDWOOD FINANCIAL, INC. AND SUBSIDIARY 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. (17) Redwood Financial, Inc. Financial Information (Parent Company Only) The parent company's principal assets are its investment in the Association and securities. The following are the condensed financial statements for the parent company only as of and for the year ended June 30, 1996. (Continued) 42 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Condensed Balance Sheet
June 30, Assets 1996 ---------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 101,019 Securities held to maturity 2,488,579 Loans receivable, net 475,358 Investment in subsidiary 10,033,231 Accrued interest receivable 66,784 Other assets 7,470 ---------------------------------------------------------------------------------------------------------- Total assets $ 13,172,441 ========================================================================================================== Liabilities and Stockholders' Equity ---------------------------------------------------------------------------------------------------------- Accrued expenses and other liabilities 15,405 ---------------------------------------------------------------------------------------------------------- Total liabilities 15,405 ---------------------------------------------------------------------------------------------------------- Common stock 112,500 Additional paid-in capital 8,457,017 Retained earnings, subject to certain restrictions 6,118,091 Unearned employee stock ownership plan shares (595,744) Unearned management stock bonus plan shares (393,422) Treasury stock, at cost (541,406) ---------------------------------------------------------------------------------------------------------- Total stockholders' equity 13,157,036 ---------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 13,172,441 ==========================================================================================================
Condensed Statement of Income 1996 ---------------------------------------------------------------------------------------------------------- Interest income $ 200,739 Equity in earnings of subsidiary 433,884 Compensation and employee benefits (116,725) Other (62,936) ---------------------------------------------------------------------------------------------------------- Earnings before income tax benefit 454,962 Income tax benefit 7,470 ---------------------------------------------------------------------------------------------------------- Net earnings $ 462,432 ==========================================================================================================
(Continued) 43 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Condensed Statement of Cash Flows
1996 ---------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net earnings $ 462,432 Adjustments to reconcile net earnings to cash provided by operating activities: Equity in earnings of subsidiary (433,884) Amortization of premiums (discounts), net (1,092) Amortization of unearned ESOP shares 66,240 Earned ESOP priced above original cost 10,781 Earned management stock bonus plan shares 39,703 Increase in accrued interest receivable (66,784) Increase in accrued expenses and other liabilities 15,405 Increase in other assets (7,470) ---------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 85,331 ---------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchases of securities (2,487,487) Increase in loans receivable, net (475,358) ---------------------------------------------------------------------------------------------------------- Net cash used by investing activities (2,962,845) ---------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Adoption of ESOP (661,984) Repurchase of Company common stock (965,156) Proceeds from sale of common stock 8,549,361 Purchase of Association stock (3,943,688) ---------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 2,978,533 ---------------------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 101,019 Cash and cash equivalents, beginning of year 0 ---------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 101,019 ==========================================================================================================
(Continued) 44 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (18) Quarterly Financial Data (Unaudited) Summarized quarterly financial data for fiscal 1996 are as follows:
Three months ended ------------------------------------------------------------------- June 30, March 31, December 31, September 30, Selected Operations Data 1996 1996 1995 1995 ----------------------------------------------------------------------------------------------------------- Interest income $ 888,592 860,909 864,851 872,799 Interest expense 470,402 474,621 463,819 473,995 ----------------------------------------------------------------------------------------------------------- Net interest income 418,190 386,288 401,032 398,804 Provision for loan losses 0 0 0 0 Non-interest income 12,395 14,681 17,867 15,568 Non-interest expense 259,503 238,277 289,247 204,854 Income tax expense 59,608 60,328 54,496 36,080 ----------------------------------------------------------------------------------------------------------- Net earnings $ 111,474 102,364 75,156 173,438 =========================================================================================================== Earnings per common share $ .11 .10 .07 .17
Three months ended ------------------------------------------------------------------- June 30, March 31, December 31, September 30, Selected Operations Data 1995 1995 1994 1994 ----------------------------------------------------------------------------------------------------------- Interest income $ 767,054 734,153 770,553 751,284 Interest expense 437,878 456,473 394,687 394,209 ----------------------------------------------------------------------------------------------------------- Net interest income 329,176 277,680 375,866 357,075 Provision for loan losses 0 0 0 0 Non-interest income (2,071) 10,216 21,224 10,234 Non-interest expense 209,283 173,556 230,143 161,393 Income tax expense 64,818 36,440 49,547 93,915 ----------------------------------------------------------------------------------------------------------- Net earnings $ 53,004 77,900 117,400 112,001 ===========================================================================================================
(Continued) 45 REDWOOD FINANCIAL, INC. AND SUBSIDIARY
Selected Financial June 30, March 31, December 31, September 30, Condition Data 1996 1996 1995 1995 ------------------------------------------------------------------------------------------------------------ Total assets $ 51,514,643 50,697,495 48,686,408 48,495,677 Securities 31,094,218 27,572,272 29,854,684 29,294,283 Net loans 16,513,727 15,883,903 15,307,707 15,368,895 Deposits 38,042,529 37,371,536 34,633,047 34,488,104 Stockholders' equity 13,157,036 13,004,368 13,830,097 13,735,104
Selected Financial June 30, March 31, December 31, September 30, Condition Data 1995 1995 1994 1994 ------------------------------------------------------------------------------------------------------------ Total assets $ 55,001,775 42,435,348 42,713,770 42,103,643 Securities 24,305,141 24,696,290 24,984,872 24,134,405 Net loans 15,255,027 15,196,359 15,153,331 15,170,397 Deposits 35,825,269 36,551,035 36,878,825 36,390,303 Stockholders' equity 5,655,659 5,602,655 5,524,755 5,407,355
46 CORPORATE OFFICE Redwood Financial, Inc. 301 South Washington Street, P.O. Box 317 Redwood Falls, Minnesota 56283-0317 Board of Directors of Redwood Financial, Inc. James P. Tersteeg, Grocer, Owner-- J. Scott Nelson, Doctor of Pharmacy, Tersteeg's Inc. Sward-Kemp Drug, Inc. Paul W. Pryor, Executive Officer Donald C. Orth, Executive Officer Blaine C. Farnberg, Retired Thomas W. Stotesbery, Certified Public Accountant Executive Officers of Redwood Financial, Inc. Paul W. Pryor Donald C. Orth President and Chief Executive Officer Vice President ---------------------------------------- Corporate Counsel: Independent Auditors: Ebbesen & Sarrazin KPMG Peat Marwick LLP 301 East Third Street 4200 Norwest Center Redwood Falls, Minnesota 56283-0127 90 South 7th Street Minneapolis, Minnesota 55402 Special Counsel: Transfer Agent and Registrar: Malizia, Spidi, Sloane & Fisch, P.C. American Securities Transfer, Inc. One Franklin Square 1825 Lawrence Street, Suite 444 1301 K Street, N.W., Suite 700 East Denver, Colorado 80202-1817 Washington, D.C. 20005 -------------------- The Company's Annual Report for the Year Ended June 30, 1996 filed with the Securities and Exchange Commission on Form 10-KSB is available without charge upon written request. For a copy of the Form 10-KSB or any other investor information, please write or call the Secretary of the Company, at the Company's corporate office in Redwood Falls, Minnesota. The annual meeting of stockholders will be held on October 22, 1996 at 10:00 a.m. at the office of the Company at 301 South Washington Street, Redwood Falls, Minnesota. EX-23 3 EXHIBIT 23 EXHIBIT 23 [Letterhead of KPMG Peat Marwick LLP] 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 August 16, 1996, relating to the consolidated balance sheets of Redwood Financial, Inc. and subsidiary as of June 30, 1996 and 1995, 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, 1996, which report appears in the June 30, 1996 annual report on Form 10-KSB of Redwood Financial, Inc. /s/KPMG Peat Marwick LLP KPMG Peat Marwick LLP September 24, 1996 EX-27 4 FDS FOR 10-KSB
9 YEAR JUN-30-1996 JUN-30-1996 15,345 2,857,818 0 0 0 31,094,218 30,964,830 17,077,625 213,034 51,514,643 38,042,529 0 75,191 0 0 0 112,500 13,044,536 51,514,643 1,376,334 1,899,177 211,640 3,487,151 1,882,837 1,882,837 1,604,314 0 0 991,881 672,944 462,432 0 0 462,432 0.45 0.45 3.27 89,513 45,513 115,000 0 213,034 0 0 213,034 0 0 213,034
-----END PRIVACY-ENHANCED MESSAGE-----