-----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, CsJPLDzthav/QnF3je3u1aMKHTNKadjCibEmATbrEOG/vkXTY+rMYjppoKs+8ddy 744FkeeGl9OUE5ePYvqa7A== 0000946275-97-000509.txt : 19970929 0000946275-97-000509.hdr.sgml : 19970929 ACCESSION NUMBER: 0000946275-97-000509 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970926 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: REDWOOD FINANCIAL INC /MN/ CENTRAL INDEX KEY: 0000942895 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 411807233 STATE OF INCORPORATION: MN FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-25884 FILM NUMBER: 97686020 BUSINESS ADDRESS: STREET 1: 301 S WASHINGTON ST STREET 2: P O BOX 317 CITY: REDWOOD FALLS STATE: MN ZIP: 56283 BUSINESS PHONE: 5076378730 MAIL ADDRESS: STREET 1: 301 S WASHINGTON ST STREET 2: PO BOX 317 CITY: REDWOOD FALLS STATE: MN ZIP: 56283 10KSB 1 FORM 10KSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One): [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1997, ------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------------- --------------- Commission File No. 0-25884 REDWOOD FINANCIAL, INC. ---------------------------------------------- (Name of Small Business Issuer in Its Charter) Minnesota 41-1807233 - --------------------------------------------- -------------------- (State or Other Jurisdiction of Incorporation I.R.S. Employer or Organization) Identification No. 301 South Washington Street (P.O. Box 317), Redwood Falls, Minnesota 56283-0317 - -------------------------------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) Issuer's Telephone Number, Including Area Code: (507) 637-8730 -------------- Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.10 per share (Title of Class) Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]. Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] State issuer's revenues for its most recent fiscal year. $3,923,233 The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the average bid and asked price of the registrant's Common Stock on September 2, 1997, was $7,389,291 ($11.50 per share based on 642,547 shares of Common Stock held by non-affiliates). As of September 2, 1997, there were issued (1,125,000 shares) and outstanding 961,875 shares of the registrant's Common Stock. Transition Small Business Disclosure Format (check one) YES [ ] NO [X] DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Stockholders for the Fiscal Year ended June 30, 1997. (Part II) 2. Portions of the Proxy Statement for the Annual Meeting of Stockholders. (Part III) PART I Item 1. Business - ----------------- Business of the Company Redwood Financial, Inc. (the "Company") is a Minnesota corporation 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, 1997, the Company had total assets of $62.2 million, total deposits of $46.1 million, and stockholders' equity of $12.3 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 public and uses such deposits primarily to purchase investment securities and mortgage-backed and related securities and to originate loans secured by mortgages on single family residences in its market area. For this mortgage loan portfolio, the Association originates and retains fixed and adjustable rate loans, and 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 Association also participates in several commercial, commercial real estate, and agricultural 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 also obtains funds from FHLB Advances. The Association does not rely on brokered deposits, however, a substantial portion of the Association's deposits are funds from local government entities. Principal sources of income are interest on loans, mortgage-backed and related securities, and investment securities. The 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 2 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 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. 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 agricultural real estate loans and, agricultural operating and commercial loans not secured by real estate. Most of the Company's loan portfolio is secured by first mortgage loans on one- to four-family residences. For its mortgage loan portfolio, the Company originates and retains both fixed-rate and adjustable-rate loans. The Company does not sell mortgage loans into the secondary market. The Company's consumer loan portfolio consists primarily of savings account loans and to a lesser extent other consumer loans. The Company's commercial real estate loans are secured by multi-family residential apartment buildings, health care facilities, office buildings, and retail establishments. Agricultural loans include two participations with a local area bank secured by real estate and other farm related collateral. Analysis of Loan Portfolio. The following table sets forth information concerning the composition of the Company's loan portfolio in dollar amounts and in percentages of the loan portfolio (before deductions for loans in process, deferred loan fees and discounts, and allowance for loan losses) as of the dates indicated.
At June 30, --------------------------------------------------------------------- 1997 1996 -------------------------------- -------------------------------- Amount Percentage Amount Percentage (Dollars in thousands) Real estate loans: Residential (1-4 family).......... $18,577 89.46% $15,233 92.24% Residential construction.......... 502 2.42 220 1.33 Multi-family...................... 174 0.84 -- -- Multi-family construction......... 980 4.72 189 1.15 Commercial........................ 680 3.27 520 3.15 Agricultural...................... 150 0.72 -- -- Consumer loans: Other consumer loans.............. 21 0.10 -- -- Savings account................... 133 0.64 141 0.85 Commercial.......................... 715 3.44 775 4.69 Agricultural operating.............. 425 2.05 -- -- ------- ------- ------- ------- Total............................... 22,357 107.66 17,078 103.41 Less: Loans in process.................. (1,361) (6.56) (333) (2.01) Deferred loan fees and discounts.. (16) (0.08) (18) (0.11) Allowance for loan losses......... (213) (1.02) (213) (1.29) ------- ------- ------ ------ Total loans, net.................... $20,767 100.00% $16,514 100.00% ====== ======= ====== =======
3 The Company primarily originates loans for retention in its portfolio and has not purchased whole loans or sold loans during the past three years. 4 Loan Maturity Tables. The following table sets forth the maturity of Company's loan portfolio at June 30, 1997. The table does not include prepayments or scheduled principal repayments. Adjustable-rate mortgage loans are shown as maturing based on contractual maturities.
One- to Four- Multi- Family Family Residential Multi-Family Commercial Agricultural Residential Real Estate Construction Construction Real Estate Real Estate Consumer Commercial Agricultural Total ----------- ----------- ------------ ------------ ----------- ----------- -------- ---------- ------------ ----- (In thousands) Amounts Due: Within 1 year. $ 3,689 $ 123 $ -- $ -- $ 83 $ 150 $ 133 $ $ $ 4,178 1 to 5 years.. 12,060 51 -- -- 419 -- 21 12,551 After 5 years. 2,833 0 502 980 178 -- 710 425 5,628 ------ ---- ---- ---- ------ ----- ----- ----- ---- ------ Total amount due $18,582 $ 174 $ 502 $ 980 $ 680 $ 150 $ 154 $ 710 $ 425 $22,357 ====== ==== ==== ==== ====== ===== ===== ===== ==== =======
5 The following table sets forth the dollar amount of all loans due after June 30, 1998, which have pre-determined interest rates and which have floating or adjustable interest rates. Floating or Fixed-rates Adjustable Rates Total ----------- ---------------- ----- (In thousands) 1-4 Family residential.................. $8,518 $6,375 $14,893 Multi-family real estate................ 51 0 51 Residential construction................ 282 220 502 Multi-family construction............... -- 980 980 Commercial real estate.................. 385 212 597 Agricultural real estate................ 150 -- 0 Consumer................................ 21 -- 21 Commercial.............................. 417 293 710 Agricultural............................ 425 -- 425 ------ ------ ------ Total................................. $10,099 $8,080 $18,179 ====== ===== ====== One-to Four-Family Residential Loans. The Association's primary lending activity consists of the origination of one- to four-family residential mortgage loans secured by property located in the Association's primary market area. The Association generally originates one- to four-family residential first mortgage loans without private mortgage insurance in amounts up to 80% of the lesser of the appraised value or selling price of the mortgaged property. The 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 maintain interest-rate risk at acceptable levels, the Association originates primarily fixed-rate, balloon mortgage loans that provide for an amortization of up to 30 years, but which typically mature after 5 to 7 years. Provided the borrower demonstrates acceptable repayment ability, the Association will usually refinance the balloon mortgage loan at maturity at the then current market rate of interest. Among other factors, the Association's refinancing of these loans is dependent upon adequate collateral value. From time to time, the Association will originate fixed-rate loans with maturities of up to 30 years. The Association monitors the level of this type of long-term, fixed-rate lending in order to control interest-rate risk. Many of the existing loans that do not reprice within 5 years were originated more than 10 years ago, before the Association de-emphasized the origination of long-term, fixed-rate loans. The Association also offers adjustable-rate loans, although the majority of its recent loan production has been in fixed-rate balloon loans. The Association's adjustable-rate mortgage loans provide for periodic interest-rate adjustments of 1% to 2% with a maximum adjustment over the life of the loan of between 5% and 6%. Typically, the interest rate on these loans adjusts every 1, 3, or 5 years, and provides for amortization over a 15- to 30-year period. Indices used in the origination of adjustable-rate mortgage loans include both U.S. Treasury securities and a national cost of funds index. Interest rates charged on mortgage loans are competitively priced based on market conditions and the 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 6 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, 1997, the Association did not service loans for others. Consumer Loans. Consumer loans are primarily made when secured by a savings account in the Association. These loans generally have rates that adjust with the rate on the underlying account and are typically at least one percent above the rate on the underlying account. Savings account loans are offered subject to a 90% loan-to-value ratio. The Association is in the process of expanding its consumer loan program to include auto, unsecured, and other forms of consumer lending. At June 30, 1997, the Association's balance in these other consumer loans totaled $21,000. Although the Association also makes home equity loans, these loans are secured by liens on primary residences and are categorized as one- to four-family residential mortgage loans. Commercial Real Estate Loans. In order to serve its community and enhance the yield on its assets, the 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, 1997, the Association's largest commercial real estate loans to one borrower consisted of two participations totaling $148,000 that 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. Loans secured by commercial real estate generally involve a greater degree of risk than residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired. For the small total dollar amount of loans secured by church real estate that are originated by the 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 one- to four-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. 7 Multi-Family Loans. The Association also makes fixed-rate and adjustable-rate multi-family loans, including loans on apartment complexes. At June 30, 1997, the Association had no substantial multi-family real estate loans. However, in fiscal 1997, the Company has originated two multi-family loans totaling $500,000 and $480,000, respectively. Both loans are obligations of the various economic development authorities of the City of Redwood Falls and Olivia, respectively. The loans are originated by the Company due to regulatory limitations on the amount of non-rated municipal debt that the Association is permitted to hold. 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 $293,000 at June 30, 1997. 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 $422,000 at June 30, 1997, and is secured primarily by the revenues of the casino. Commercial loans generally involve a greater degree of risk than mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the lack of real estate as collateral, the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of commercial loans is typically dependent upon the successful operation of the related commercial enterprise. If the cash flow from the enterprise is reduced, the borrower's ability to repay the loan may be impaired. Agricultural Lending. In 1997, the Association commenced development of a program for agricultural lending. This program is intended to promote increased lending through agricultural lending opportunities found in the Association's lending area. The program is still in development. At June 30, 1997, the Association participated in a $150,000 agricultural loan secured by farm acreage with a local area bank. The Association also participated in a $425,000 loan secured by cooperative stock with the same bank. Both loans are to the same borrower. Agricultural lending, including both operating and real estate-secured agricultural lending generally involves a greater degree of risk than the Association's traditional residential mortgage lending efforts. This increased credit risk is a result of various factors, including higher loan balances, the concentration of principal in a limited number of loans and borrowers, the effects of general and farm- specific economic conditions, weather conditions, and the increased difficulty in monitoring these types of loans. Moreover, repayment is largely dependent upon the successful operation of the farm enterprise. If the cash flow from the farm enterprise is reduced, the borrower's ability to repay the loan may be impaired. 8 Loan Commitments. The Association issues written commitments to prospective borrowers on all real estate loans. Generally, the commitment requires acceptance within 45 days of the date of issuance. At June 30, 1997, the Association had $862,000 of commitments to cover originations and undisbursed funds for loans in process. The Association believes that most of the Association's commitments will be funded. At June 30, 1997, the Company had $902,000 of commitments to cover undisbursed funds for loans in process on the two multi-family construction loans to the economic development authorities of the City of Redwood Falls and the City of Olivia. 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 greater. The Association's maximum loan to one borrower limit was approximately $1,260,000 as of June 30, 1997. At June 30, 1997, the Association's largest amount of loans to one borrower was two agricultural loan participations in the amount of $575,000, secured by real estate and cooperative stock. Nonperforming and Problem Assets Loan Delinquencies. Loans are reviewed on a monthly basis and are placed on a non-accrual status when the loan becomes more than 90 days delinquent and, if, in the opinion of management, the collection of additional interest is doubtful. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent interest payments, if any, are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. 9 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 modified in a troubled debt restructuring.
June 30, ---------------------------- 1997 1996 -------- -------- (Dollars in thousands) Loans accounted for on a non-accrual basis: Mortgage loans: Permanent loans secured by 1-4 family residences........... $ -- $ 89 All other mortgage loans................................... -- -- Non-mortgage loans........................................... -- -- ------ ------- Total........................................................ $ -- $ 89 ====== ======= Accruing loans which are contractually past due 90 days or more: Mortgage loans: Permanent loans secured by 1-4 family residences........... $ 120 $ 46 All other mortgage loans................................... -- -- Non-mortgage loans........................................... -- -- --------- ------ Total........................................................ $ 120 $ 46 ======== ====== Total non-accrual and accrual loans.......................... $ 120 $ 135 ======== ====== Real estate.................................................. $ 14 $ -- ======== ====== Other non-performing assets.................................. $ -- -- ======== ====== Total non-performing assets.................................. $ 134 $ 135 ======== ====== Total non-accrual and accrual loans to net loans.................................................. .58 % 0.82% ======== ====== Total non-accrual and accrual loans to total assets............................................... .19 % 0.26% ======== ====== Total non-performing assets to total assets.................. .22 % 0.26% ======== ======
There was $296 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, 1997. Classified Assets. OTS regulations provide for a classification system for problem assets of insured institutions which covers all problem assets. Under this classification system, problem assets of insured institutions are classified as "substandard," "doubtful," or "loss." An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard, with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of current existing facts, conditions, and values, "highly questionable and improbable." Assets classified as loss are those considered "uncollectible" and of such little value that their continuance as assets without 10 the establishment of a specific loss reserve is not warranted. Assets may be designated "special mention" because of potential weaknesses that do not currently warrant classification in one of the aforementioned categories. When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as loss, it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which may order the establishment of additional general or specific loss allowances. A portion of general loss allowances established to cover possible losses related to assets classified as substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. At June 30, 1997, the Company's classified assets consisted of substandard loans of $121,000. At June 30, 1997, the Company also had $14,000 in loans designated as special mention. The Company had delinquent loans of 60 and 90 days or more of $0 and $121,000, 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, 1997. The Company does, however, have one loan for which foreclosure proceedings have commenced. The loan is considered Real Estate in Judgment for reporting purposes. The balance on the loan totals $14,000. No loss is anticipated upon the eventual disposition of this asset. 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. 11 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, --------------------------------------------------------------- 1997 1996 --------------------------------- -------------------------- Percent of Percent of Loans in Loans in each each Category to Category to Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- (Dollars in thousands) At end of period allocated to: Real estate mortgage: Residential construction.......... $ 1 2.2% $ 1 1.3% 1-4 family residential............ 198 83.1 202 89.3 Multi-family ..................... 2 0.8 2 1.1 Commercial........................ 3 3.0 5 3.0 Multi-family construction......... -- 4.4 -- -- Agricultural real estate.......... 2 0.7 -- -- Consumer loans...................... -- 0.7 -- 0.8 Commercial.......................... 3 3.2 3 4.5 Agricultural........................ 4 1.9 -- -- ----- ----- ----- ----- Total allowance for loan losses .................. $ 213 100.0% $ 213 100.0% ===== ===== ===== =====
12 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. -------------------------- 1997 1996 ----------- --------- (Dollars in thousands) Total loans outstanding (1)..................... $20,980 $16,727 ====== ====== Average loans outstanding....................... $18,284 $15,755 ====== ====== Allowance balances (at beginning of year)........................................... $ 213 $213 Charge-offs..................................... -- -- Recoveries...................................... -- -- ------- ------- Net charge-offs................................. -- -- Provision....................................... -- -- ------- ------- Allowance balance (at end of year).............. $ 213 $ 213 ====== ====== Allowance for loan losses as a percent of total loans outstanding.................... 1.02% 1.27% Net loans charged off as a percent of average loans outstanding..................... --% --% - -------------------------------- (1) Excludes allowance for loan losses. Mortgage-Backed and Related Securities. To supplement lending activities, the Company invests in residential mortgage-backed securities. Mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity. At June 30, 1997, the Company's mortgage-backed and related securities designated available-for- sale had a carrying value (and fair value) of $8.1 million, and an amortized cost of $8.1 million. At June 30, 1997, the Company's mortgage-backed and related securities designated held-to-maturity had a carrying value at amortized cost of $13.9 million and a fair value of $14.1 million. 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 13 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, 1997, had a carrying value at amortized cost of $59,000 and consisted of fixed-rate notes issued by FHLMC. The fair value of the CMO portfolio was $62,000 at June 30, 1997. The portfolio of CMOs held within the Association's mortgage-backed and related securities portfolio at June 30, 1997, did not include any residual interests in CMOs. Further, at June 30, 1997, 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 short-term demand for funds to be used in the Association's loan origination and other activities. The Company has also begun designating select new investment securities as available-for-sale. At June 30, 1997, the Company's investment securities designated available-for-sale had a carrying value (and fair value) of $7.0 million. At June 30, 1997, amortized cost also totalled $7.0 million. At June 30, 1997, the Company's investment securities designated held-to-maturity had a carrying value at amortized cost of $10.4 million and a fair value of $10.4 million. The Company's investment securities consisted primarily of U.S. Treasury securities and U.S. Government agency securities. To a lesser extent, the portfolio includes municipal bonds and interest-bearing deposits as permitted by regulation. Investment Portfolio. The following table sets forth the carrying value of the Company's investment securities portfolio, short-term investments, FHLB stock, and mortgage-backed and related securities at the dates indicated. 14 At June 30, ------------------------- 1997 1996 ------------ -------- (In thousands) Investment securities: U.S. Treasury notes............................. $ 5,502 $7,654 U.S. Government agency bonds.................... 10,725 6,093 Municipal bonds................................. 1,150 1,542 ---------- -------- Total investment securities................... 17,377 15,289 Interest-earning deposits in other institutions.............................. 748 2,858 FHLB stock........................................ 334 334 Mortgage-backed and related securities...................................... 22,023 15,805 --------- ------ Total investments........................... $ 40,482 $34,286 ========= ====== Portfolio Maturities. The following table sets forth certain information regarding the carrying values, weighted average yields, and contractual maturities of the Company's investment securities and mortgage-backed and related securities portfolio at June 30, 1997.
As of June 30, 1997 -------------------------------------------------------------------------------------------------------- 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...... $ 1,700 5.75% $ 3,802 5.44% $ -- --% $ -- --% U.S. Government Agency bonds........... 1,000 6.28 2,744 6.56 6,981 7.32 -- -- Municipal bonds (1)...... 400 4.66 615 4.25 135 4.55 -- -- -------- ---- ------- ---- ------ ---- ------- ------ Total investment securities........... 3,100 5.78 7,161 5.77 7,116 7.27 -- -- FHLB stock............... N/A N/A N/A N/A N/A N/A N/A N/A Mortgage-backed and related securities..... 561 5.83 5,816 6.55 13,979 6.98 1,667 8.08 ------ ---- ------- ---- ------ ---- ----- ---- Total investment portfolio(2)......... $ 3,661 5.79% $12,977 6.12% $21,095 7.08% $ 1,667 8.08% ====== ==== ====== ==== ====== ====== ====== ====
- -------------------------------- (1) Tax exempt income was not significant and thus has not been presented on a tax equivalent basis. (2) Excludes interest-bearing deposits and FHLB stock. 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. 15 Deposits. Deposits are attracted principally from within the Company's primary market area through the offering of a broad selection of deposit instruments including regular savings accounts, money market accounts, and term certificate accounts. The Company also offers IRA and, to a lesser extent, KEOGH accounts. Deposit account terms vary according to the minimum balance required, the time period the funds must remain on deposit, and the interest rate, among other factors. At June 30, 1997, passbook and money market accounts constituted $8.1 million, or 17.75% of the Company's deposit portfolio and certificates of deposit constituted $37.6 million or 82.25% of the deposit portfolio. The Company had no brokered deposits at that date, however, a substantial portion of the Association's deposits are funds from local government entities. The Association has a $1.0 million line of credit with the FHLB which was not drawn on at June 30, 1997. The Association has the ability to draw additional borrowings of approximately $3,170,000, based upon its current investment in FHLB stock and investment securities pledged. 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, 1997, including term certificate accounts separated by time remaining until maturity. Amount (In thousands) Term certificate accounts: Maturity Period - ----------------- Within three months.......................................... $ 2,182 Three through six months..................................... 5,594 Six through twelve months.................................... 3,986 Over twelve months........................................... 2,147 ------- Total...................................................... 13,909 Money market accounts.......................................... 3,983 ------- Total...................................................... $ 17,892 ======= Borrowings Deposits are the primary source of funds for the Company's lending and investment activities and for its general business purposes. The Association obtains advances from the FHLB of Des Moines to supplement its supply of lendable funds. Advances from the FHLB of Des Moines are typically secured by a pledge of the Association's stock in the FHLB of Des Moines and a portion of the Association's investment securities. At June 30, 1997, the Association had advances outstanding of $3.5 million. 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, 1997, the Company and the Association had no borrowings from the Federal Reserve Board. Personnel The Company has no employees other than executive officers. As of June 30, 1997, the Association had 9 full-time and 2 part-time employees. None of the Association's employees are represented by a collective bargaining group. 16 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. Regulation of the Company General. The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings association subsidiaries, should such subsidiaries be formed, which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. This regulation and oversight is intended primarily for the protection of the depositors of the Association and not for the benefit of stockholders of the Company. Qualified Thrift Lender Test. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions, provided the 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, depending upon the institution's risk classification. This risk classification is based on an institution's capital group and supervisory subgroup assignment. In addition, the FDIC is authorized to increase deposit insurance rates on a semi-annual basis if it determines that such action is necessary to cause the balance in the SAIF to reach the designated reserve ratio of 1.25% of SAIF-insured deposits within a reasonable period of time. The FDIC may impose special assessments of SAIF members to repay amounts borrowed from the U.S. Treasury or for any other reason deemed necessary by the FDIC. Prior to September 30, 1996, savings associations paid within a range of .23% to .31% of domestic deposits and the SAIF was substantially underfunded. By comparison, prior to September 30, 1996, members of the Bank Insurance Fund ("BIF"), predominantly commercial banks, were required to pay substantially lower, or virtually no, federal deposit insurance premiums. 17 Effective September 30, 1996, federal law was revised to mandate a one-time special assessment on SAIF members such as the Association of approximately .657% of deposits held on March 31, 1995. The Association recorded a $237,000 pre-tax expense for this assessment for the year ended June 30, 1997, recognized in the first fiscal quarter. Beginning January 1, 1997, deposit insurance assessments for SAIF members were reduced to approximately .064% of deposits on an annual basis; this rate may continue through the end of 1999. During this same period, BIF members are expected to be assessed approximately .013% of deposits. Thereafter, assessments for BIF and SAIF members should be the same and the SAIF and BIF may be merged. It is expected that these continuing assessments for both SAIF and BIF members will be used to repay outstanding Financing Corporation bond obligations. As a result of these changes, beginning January 1, 1997, the rate of deposit insurance assessed the Association declined by approximately 70% from rates in effect prior to September 30, 1996. Regulatory Capital Requirements. OTS capital regulations require savings institutions to meet three capital standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) a leverage ratio (core capital) equal to at least 3% of total adjusted assets, and (3) a risk-based capital requirement equal to 8.0% of total risk-weighted assets. The Association's regulatory capital exceeded all minimum regulatory capital requirements applicable to it as of June 30, 1997. Interest-Rate Risk (IRR). As a financial institution regulated by the OTS, the Association is required to measure and monitor its sensitivity to interest rate movements. OTS-regulated institutions meeting certain conditions have the option of utilizing the OTS-established IRR measurement model, or developing an in-house model. The Association has chosen to meet its IRR sensitivity modeling requirements through use of the OTS's Net Present Value (NPV) model. This model measures how the net present value of an institution's assets, liabilities and off-balance-sheet items would change in the event of a range of assumed changes in market interest rates. These computations estimate the effect on NPV of a permanent and instantaneous change in market interest rates of plus or minus 100, 200, 300, and 400 basis points (bps). The Board has established acceptable ranges for the NPV changes across these various scenarios. The following table sets forth the interest-rate risk measures, as calculated by the OTS's NPV model, for the Association at June 30, 1997 and 1996, given an instantaneous and permanent increase in market interest rates.
June 30, ------------------- 1997 1996 ------ ----- Risk Measures: -------------- 200 Basis point rate shock Pre-shock NPV ratio: NPV as % of present value of assets 15.48% 21.94% Exposure measure: Post-shock NPV ratio: 12.95% 20.39% Sensitivity measure: Change in NPV ratio: (253) bps (155) bps
Calculations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit run-off, and should not be relied upon as indicative of actual results. Further, the calculations do not contemplate any actions the Association may undertake in response to changes in interest rates. Nevertheless, the Association's IRR sensitivity has increased over the twelve months ended June 30, 1997, as a result of dividends paid from the Association to the Company and increased loan production and investment purchases funded by short- and intermediate-term deposits and FHLB advances. 18 Savings associations with a greater than "normal" level of interest rate exposure may, in the future, be subject to a deduction from capital for an interest rate risk ("IRR") component for purposes of calculating their risk-based capital requirement. Dividend and Other Capital Distribution Limitations. OTS regulations require the 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, 1997, 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. During the year ended June 30, 1997, the Association declared and paid a $2.0 million dividend to the Company. 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 20% of total assets). Certain assets are subject to a percentage limitation of 20% of portfolio assets. In addition, savings associations may include shares of stock of the FHLBs, FNMA and FHLMC as qualifying QTIs. As of June 30, 1997, the Association was in compliance with its QTL requirement with 74.50% of its assets invested in QTIs. Liquidity Requirements. All savings associations are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. Federal Home Loan Bank System. The 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 19 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, 1997, 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. In May 1997, the Association purchased two vacant lots in Redwood Falls for possible future expansion. (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" and "Item 1. Business - Regulation of the Association." (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, 1997. 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, 1997. 20 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, 1997 (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(a) of the Exchange Act ------------------------------------------------- The information contained under the section captioned "I -- Information with Respect to Nominees for Director, Directors Continuing in Office, and Executive Officers" in the proxy statement for the Annual Meeting of Stockholders of the Company to be held October 30, 1997, (the "Proxy Statement") is incorporated herein by reference. Item 10. Executive Compensation - ------------------------------- The information contained under the section captioned "Director and Executive Officer Compensation - Executive Compensation" in the Proxy Statement is incorporated herein by reference. Item 11. Security Ownership of Certain Beneficial Owners and Management - ----------------------------------------------------------------------- (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Voting Securities and Principal Holders Thereof" in the Proxy Statement. (b) Security Ownership of Management 21 Information required by this item is incorporated herein by reference to the section captioned "I -- Information with Respect to Nominees for Director, Directors Continuing in Office, and Executive Officers" in the Proxy Statement. (c) Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company. Item 12. Certain Relationships and Related Transactions - -------------------------------------------------------- The information required by this item is incorporated herein by reference to the sections captioned "Certain Relationships and Related Transactions" and "Voting Securities and Principal Holders Thereof" in the Proxy Statement. Item 13. Exhibits, List and Reports on Form 8-K - ------------------------------------------------ (a) The following documents are filed as a part of this report: 1. The following financial statements and the report of independent accountants of the Company included in the Annual Report to Stockholders of the Company for the fiscal year ending June 30, 1997, are incorporated herein by reference. Report of Independent Auditors Consolidated Statements of Financial Condition as of June 30, 1997 and 1996 Consolidated Statements of Earnings for the Years Ended June 30, 1997, 1996, and 1995 Consolidated Statements of Stockholders' Equity for the Years Ended June 30, 1997, 1996, and 1995 Consolidated Statements of Cash Flows for the Years Ended June 30, 1997, 1996, and 1995 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** 22 10.3 Management Stock Bonus Plan** 10.4 1997 Directors Stock Option Plan 13 Annual Report to Stockholders for the fiscal year ended June 30, 1997. 21 Subsidiaries of the Registrant*** 23 Consent of KPMG Peat Marwick LLP 27 Financial Data Schedule (b) Reports on Form 8-K. None. - ------------------- * Incorporated by reference to the Registrant's Registration Statement on Form S-1 (33-90560) declared effective by the Commission on May 15, 1995. ** Incorporated by reference to the 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). 23 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. REDWOOD FINANCIAL, INC. Dated: September 9, 1997 By: /s/ Paul W. Pryor ------------------ Paul W. Pryor President, Chief Executive Officer and Director (Duly Authorized Representative) In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Paul W. Pryor By: /s/ James P. Tersteeg ------------------ --------------------- Paul W. Pryor James P. Tersteeg President, Chief Executive Officer Chairman of the Board and Director (Principal Executive Officer) Date: September 9, 1997 Date: September 9, 1997 By: /s/ J. Scott Nelson By: /s/ Blaine C. Farnberg ------------------- ---------------------- J. Scott Nelson Blaine C. Farnberg Vice Chairman of the Board Director Date: September 9, 1997 Date: September 9, 1997 By: /s/ Thomas W. Stotesbery By: /s/ Donald C. Orth ------------------------ ------------------ Thomas W. Stotesbery Donald C. Orth Director Vice President and Director Date: September 9, 1997 Date: September 9, 1997 By: /s/ Anthony H. Acker -------------------- Anthony H. Acker Chief Financial Officer (Principal Accounting and Financial Officer) Date: September 9, 1997 EX-10.1 2 EXHIBIT 10.1 Exhibit 10.1 AMENDMENT TO EMPLOYMENT AGREEMENT WHEREAS, Redwood Falls Federal Savings and Loan Association (the "Association") and Paul W. Pryor (the "Employee") previously entered into an Employment Agreement (the "Agreement") dated February 15, 1995, and WHEREAS, Section 14 of the Agreement provides that amendments to this Agreement may be made in writing and signed by both parties, NOW THEREFORE, BE IT RESOLVED that this Agreement be amended by adoption and execution of this Amendment to the Agreement as follows. 1. Revision to Section 5 of the Agreement by inclusion of the following phrase at the end of Section 5 as follows: "Notwithstanding anything herein to the contrary, the expiration date of the term of this Agreement shall be as of February 15, 2000, except as may be extend beyond that date by future action of the Board within its sole discretion in accordance with this Agreement." 2. Revision to Section 2 of the Agreement by inclusion of the following phrase at the end of Section 2 as follows: "Notwithstanding anything herein to the contrary, effective February 15, 1997, the annual salary of the Employee shall be increased to $113,820.00, or as may be increased thereafter by the Board from time to time." As Secretary to the Association, I hereby certify that the foregoing Amendment was adopted and ratified by a majority vote of a meeting of the Board of Directors of the Association, held on February 13, 1997, a quorum being present. /s/Rebecca A. Olson ----------------------------- Rebecca A. Olson, Secretary SEAL IN WITNESS WHEREOF, the parties to the Agreement dated February 13, 1997, do hereby execute this Amendment to the Agreement on this 13th day of February, 1997 Redwood Falls Federal Savings and Loan Association By: /s/James P. Tersteeg ------------------------------ James P. Tersteeg /s/Paul W. Pryor ------------------------------ Paul W. Pryor, Employee ATTEST: /s/Rebecca A. Olson - --------------------------- Rebecca A. Olson, Secretary SEAL AMENDMENT TO EMPLOYMENT AGREEMENT WHEREAS, Redwood Falls Federal Savings and Loan Association (the "Association") and Donald C. Orth (the "Employee") previously entered into an Employment Agreement (the "Agreement") dated February 15, 1995, and WHEREAS, Section 14 of the Agreement provides that amendments to this Agreement may be made in writing and signed by both parties, NOW THEREFORE, BE IT RESOLVED that this Agreement be amended by adoption and execution of this Amendment to the Agreement as follows. 1. Revision to Section 5 of the Agreement by inclusion of the following phrase at the end of Section 5 as follows: "Notwithstanding anything herein to the contrary, the expiration date of the term of this Agreement shall be as of February 15, 2000, except as may be extend beyond that date by future action of the Board within its sole discretion in accordance with this Agreement." 2. Revision to Section 2 of the Agreement by inclusion of the following phrase at the end of Section 2 as follows: "Notwithstanding anything herein to the contrary, effective February 15, 1997, the annual salary of the Employee shall be increased to $57,576.00, or as may be increased thereafter by the Board from time to time." As Secretary to the Association, I hereby certify that the foregoing Amendment was adopted and ratified by a majority vote of a meeting of the Board of Directors of the Association, held on February 13, 1997, a quorum being present. /s/Rebecca A. Olson ----------------------------- Rebecca A. Olson, Secretary SEAL IN WITNESS WHEREOF, the parties to the Agreement dated February 13, 1997, do hereby execute this Amendment to the Agreement on this 13th day of February, 1997 Redwood Falls Federal Savings and Loan Association By: /s/James P. Tersteeg ------------------------------ James P. Tersteeg /s/Donald C. Orth ------------------------------ Donald C. Orth, Employee ATTEST: /s/Rebecca A. Olson - --------------------------- Rebecca A. Olson, Secretary SEAL EX-10.4 3 EXHIBIT 10.4 EXHIBIT 10.4 STOCK OPTION AGREEMENT ---------------------- FOR NON-INCENTIVE STOCK OPTIONS PURSUANT TO THE REDWOOD FINANCIAL, INC. 1997 DIRECTORS STOCK OPTION PLAN -------------------------------- STOCK OPTIONS for a total of 6,412 shares of Common Stock of Redwood Financial, Inc. (the "Company") is hereby granted to ________________________ (the "Optionee") at the price determined as provided in, and in all respects subject to the terms, definitions and provisions of the 1997 Directors Stock Option Plan (the "Plan") adopted by the Company which is incorporated by reference herein, receipt of which is hereby acknowledged. Such Stock Options do not comply with Options granted under Section 422 of the Internal Revenue Code of 1986, as amended. 1. Option Price. The Option price is $11.0625 for each Share, being 100% of the fair market value, in accordance with the Plan as determined by the Committee, of the Common Stock on the date of grant of this Option (August 1, 1997) ("Date of Grant"). 2. Exercise of Option. (a) Exercisability. Such Options awarded herein shall be immediately exercisable as of the Date of Grant in accordance with provisions of the Plan. Such Options shall continue to be exerciseable for a period of ten years from such Date of Grant without regard to the continued status as an employee, director or director's emeritus. (b) Method of Exercise. This Option shall be exercisable by a written notice which shall: (i) State the election to exercise the Option, the number of Shares with respect to which it is being exercised, the person in whose name the stock certificate or certificates for such Shares of Common Stock is to be registered, his address and Social Security Number (or if more than one, the names, addresses and Social Security Numbers of such persons); (ii) Contain such representations and agreements as to the holder's investment intent with respect to such shares of Common Stock as may be satisfactory to the Company's counsel; (iii) Be signed by the person or persons entitled to exercise the Option and, if the Option is being exercised by any person or persons other than the Optionee, be accompanied by proof, satisfactory to counsel for the Company, of the right of such person or persons to exercise the Option; and (iv) Be in writing and delivered in person or by certified mail to the Treasurer of the Company. Payment of the purchase price of any Shares with respect to which the Option is being exercised shall be by certified or bank cashier's or teller's check. The certificate or certificates for shares of Common Stock as to which the Option shall be exercised shall be registered in the name of the person or persons exercising the Option. (c) Restrictions on Exercise. This Option may not be exercised if the issuance of the Shares upon such exercise would constitute a violation of any applicable federal or state securities or other law or valid regulation. As a condition to the Optionee's exercise of this Option, the Company may require the person exercising this Option to make any representation and warranty to the Company as may be required by any applicable law or regulation. 3. Non-transferability of Option. This Option may not be transferred in any manner otherwise than by will or the laws of descent or distribution and may be exercised during the lifetime of the Optionee only by the Optionee. The terms of this Option shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee. 4. Term of Option. This Option may not be exercised more than ten (10) years from the date of grant of this Option, as set forth below, and may be exercised during such term only in accordance with the Plan and the terms of this Option. 5. Related Matters. Notwithstanding anything herein to the contrary, additional conditions or restrictions related to such Options may be contained in the Plan or the resolutions of the Plan Committee authorizing such grant of Options. 6. Dividend Equivalent Rights. The Stock Options represented by this Agreement shall include the right of the Optionee to receive payment of dividend equivalent rights. Such rights shall provide that upon the payment of a cash dividend on the Common Stock, the holder of such Options shall receive payment of cash in an amount equivalent to the cash dividend payable as if such Options had been exercised and such Common Stock held as of the dividend record date. Such rights shall expire upon the expiration or exercise of such underlying Options. Such rights are non-transferable and shall attach to Options represented by this Agreement whether or not such Options are immediately exercisable. 2 EX-13 4 EXHIBIT 13 EXHIBIT 13 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. 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 public and uses such deposits primarily to invest in residential lending on owner-occupied properties. The Association also originates consumer and commercial real estate 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 1997: First Quarter $ 10 8 3/4 Second Quarter 10 9 3/4 Third Quarter 11 3/8 10 Fourth Quarter 11 10 1/4 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 Quarter 9 1/4 9 1/4 The number of stockholders of record of common stock as of June 30, 1997, was approximately 106. This does not reflect the number of persons or entities who held stock in nominee or "street" name through various brokerage firms. At June 30, 1997, there were 961,875 shares outstanding. (Continued) 3 REDWOOD FINANCIAL, INC. The Company paid no dividends to holders of common stock during the fiscal year ended June 30, 1997 or 1996. The Company's ability to pay dividends to stockholders is subject to the requirements of Minnesota law. No dividend may be paid by the Company unless its board of directors determines that the Company will be able to pay its debts in the ordinary course of business after payment of the dividend. In addition, the Company's ability to pay dividends is dependent, in part, upon the dividends it receives from the Association. The Association may not declare or pay a cash dividend on any of its stock if the effect thereof would cause the Associations regulatory capital to be reduced below (1) the amount required for the liquidation account established in connection with the Associations 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 ---------------------------------------------------- 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------- Operating results: Interest income $ 3,870 3,487 3,023 3,048 3,268 Interest expense 2,186 1,883 1,683 1,448 1,637 - ------------------------------------------------------------------------------------------------------- Net interest income 1,684 1,604 1,340 1,600 1,631 Provision for loan losses 0 0 0 1 15 Noninterest income 57 61 40 54 56 Noninterest expense 1,352 992 775 690 653 Income tax expense 137 211 245 426 407 - ------------------------------------------------------------------------------------------------------- Earnings before cumulative effect of accounting change 252 462 360 537 612 Cumulative effect of accounting change 0 0 0 (45) 0 - ------------------------------------------------------------------------------------------------------- Net earnings $ 252 462 360 492 612 ======================================================================================================= Net earnings per common share $ 0.26 0.45 N/A N/A N/A ======================================================================================================= Balance sheet data: Total assets $62,169 51,515 55,002 42,660 40,026 Investment securities held to maturity 10,396 15,289 16,431 17,213 13,434 Mortgage-backed and related securities held to maturity 13,874 15,805 7,874 7,774 8,936 Investment securities available for sale 6,981 0 0 0 0 Mortgage-backed and related securities available for sale 8,150 0 0 0 0 Loans receivable, net 20,767 16,514 15,255 15,091 15,620 Deposits 46,093 38,043 35,825 37,114 35,064 Stockholders equity 12,342 13,157 5,656 5,295 4,804 Financial ratios: Return on average assets 0.46% 0.93% 0.74% 1.17% 1.49% Return on average equity 1.96 3.42 6.58 9.73 13.65 Average equity to average assets 23.36 27.18 11.21 12.03 10.95 Net yield on average interest- earning assets 3.11 3.27 3.18 3.87 4.05
(Continued) 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 public and investing these funds primarily in investment securities and loans. The investment securities consist of U.S. government treasury notes and agency securities, mortgage-backed 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, agricultural loans, construction loans, and consumer loans. Net earnings are dependent primarily on net interest income, which is the difference between interest income earned on the investment and loan portfolio and interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The interest rate spread is affected by regulatory, economic, and competitive factors that influence interest rates, loan demand, and deposit flows. To a lesser extent, net earnings also are affected by the level of noninterest income, which primarily consists of service charges and other fees. In addition, net earnings are affected by the level of noninterest (general and administrative) expenses. The operations of the 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, 1997, 1996, and 1995. 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. (Continued) 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. Average Balance Sheet The following table sets forth certain information relating to the Association's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily average balances has caused any material differences in the information presented.
For the 12 months ended June 30 --------------------------------------- 1997 ------------------------------------- Average Average yield/ balance Interest (5) cost - ----------------------------------------------------------------------------------------------------------------- Interest-earning assets: Loans receivable (1) $18,283,543 $ 1,563,605 8.55% Securities held to maturity: Mortgage-backed and related securities 14,947,287 1,044,024 6.98 Investment securities 12,689,898 749,059 5.90 Securities available for sale: Mortgage-backed and related securities 2,695,970 168,357 6.24 Investment securities 2,219,892 147,775 6.66 FHLB stock 333,500 23,522 7.05 Other interest-earning assets (4) 3,017,686 173,275 5.74 ---------- --------- Total interest-earning assets 54,187,776 3,869,617 7.14 ---------- --------- Noninterest-earning assets 610,413 ---------- Total assets $54,798,189 =========== Interest-bearing liabilities: Passbook savings accounts 987,693 25,130 2.54 Money market savings accounts 7,077,184 275,769 3.90 Certificates of deposit 32,394,479 1,846,365 5.70 FHLB advances 726,923 38,485 5.29 ---------- --------- Total interest-bearing liabilities 41,186,279 2,185,749 5.31 ---------- --------- Noninterest-bearing liabilities 785,044 ------- Total liabilities 41,971,323 Retained earnings 12,826,866 ---------- Total liabilities and retained earnings $54,798,189 =========== Net interest income $ 1,683,868 =========== Net interest rate spread (2) 1.83% ==== Net yield on interest-earning assets (3) 3.11% ==== Ratio of average interest-earning assets to average interest-bearing liabilities 131.57% ======
For the 12 months ended June 30 -------------------------------------- 1996 ----------------------------------- Average Average yield/ balance Interest (5) cost - ---------------------------------------------------------------------------------------------------------------- Interest-earning assets: Loans receivable (1) $15,754,753 $ 1,376,334 8.74% Securities held to maturity: Mortgage-backed and related securities 11,410,198 784,869 6.88 Investment securities 18,055,614 1,090,543 6.04 Securities available for sale: Mortgage-backed and related securities 0 0 0.00 Investment securities 0 0 0.00 FHLB stock 330,792 23,765 7.18 Other interest-earning assets (4) 3,550,681 211,640 5.96 ---------- --------- Total interest-earning assets 49,102,038 3,487,151 7.10 ---------- --------- Noninterest-earning assets 698,754 ---------- Total assets $49,800,792 =========== Interest-bearing liabilities: Passbook savings accounts 1,394,964 33,968 2.44 Money market savings accounts 5,550,747 196,842 3.55 Certificates of deposit 28,561,491 1,652,027 5.78 FHLB advances 0 0 0.00 ---------- --------- Total interest-bearing liabilities 35,507,202 1,882,837 5.30 ---------- --------- Noninterest-bearing liabilities 758,718 ------- Total liabilities 36,265,920 Retained earnings 13,534,872 ---------- Total liabilities and retained earnings $49,800,792 Net interest income =========== $ 1,604,314 =========== Net interest rate spread (2) 1.80% ==== Net yield on interest-earning assets (3) 3.27% ==== Ratio of average interest-earning assets to average interest-bearing liabilities 138.29% ======
For the 12 months ended June 30 ------------------------------------- 1995 ------------------------------------ Average Average yield/ balance Interest (5) cost - ---------------------------------------------------------------------------------------------------------------- Interest-earning assets: Loans receivable (1) $15,128,730 $ 1,300,846 8.60% Securities held to maturity: Mortgage-backed and related securities 7,847,474 573,656 7.31 Investment securities 16,746,430 1,017,232 6.07 Securities available for sale: Mortgage-backed and related securities 0 0 0.00 Investment securities 0 0 0.00 FHLB stock 327,000 25,363 7.76 Other interest-earning assets (4) 2,084,790 105,947 5.08 ---------- --------- Total interest-earning assets 42,134,424 3,023,044 7.18 ---------- --------- Noninterest-earning assets 767,940 ---------- Total assets $42,902,364 =========== Interest-bearing liabilities: Passbook savings accounts 1,212,276 30,978 2.56 Money market savings accounts 6,469,209 214,906 3.32 Certificates of deposit 28,544,639 1,437,363 5.04 FHLB advances 0 0 0.00 ---------- --------- Total interest-bearing liabilities 36,226,124 1,683,247 4.65 ---------- --------- Noninterest-bearing liabilities 1,164,783 --------- Total liabilities 37,390,907 Retained earnings 5,511,457 --------- Total liabilities and retained earnings $42,902,364 Net interest income =========== $ 1,339,797 =========== Net interest rate spread (2) 2.53% ==== Net yield on interest-earning assets (3) 3.18% ==== Ratio of average interest-earning assets to average interest-bearing liabilities 116.31% ======
(1) Average balances include nonaccrual loans. (2) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (3) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets. (4) Includes interest-bearing deposits in other financial institutions. (5) Tax-exempt income was not significant and thus has not been presented on a tax equivalent basis. Tax exempt income of $67,546, $60,213, and $10,380 was recognized during the years ended June 30, 1997, 1996, and 1995, respectively. (Continued) 7 REDWOOD FINANCIAL, INC. Rate/Volume Analysis
Twelve months ended June 30, Twelve months ended June 30, -------------------------------------------- ---------------------------------------- 1997 versus 1996 1996 versus 1995 increase/(decrease) due to changes in increase/(decrease) due to changes in -------------------------------------------- ---------------------------------------- Rate/ Rate/ Volume Rate volume Total Volume Rate volume Total - ------------------------------------------------------------------------------------------------------------------------------------ Interest income: Loans receivable $ 220,915 (28,990) (4,654) 187,271 54,714 22,057 (1,283) 75,488 Securities held to maturity: Mortgage-backed and related securities 243,304 12,100 3,751 259,155 260,438 (33,855) (15,370) 211,213 Investment securities (324,085) (24,756) 7,358 (341,483) 78,944 (7,222) 1,589 73,311 Securities available for sale: Mortgage-backed and related securities 168,357 0 0 168,357 0 0 0 0 Investment securities 147,775 0 0 147,775 0 0 0 0 FHLB stock 195 (434) (5) (244) 294 (1,870) (22) (1,598) Other interest-earning assets (31,769) (7,761) 1,165 (38,365) 74,495 18,318 12,880 105,693 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest earning assets 424,692 (49,841) 7,615 382,466 468,885 (2,572) (2,206) 464,107 - ------------------------------------------------------------------------------------------------------------------------------------ Interest expense: Passbook savings accounts (9,917) 1,524 (445) (8,838) 4,668 (1,458) (220) 2,990 Money market savings accounts 54,131 19,448 5,348 78,927 (30,511) 14,507 (2,060) (18,064) Certificates of deposit 221,704 (24,128) (3,238) 194,338 849 213,689 126 214,664 FHLB advances 38,485 0 0 38,485 0 0 0 0 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest bearing liabilities 304,403 (3,156) 1,665 302,912 (24,994) 226,738 (2,154) 199,590 - ------------------------------------------------------------------------------------------------------------------------------------ Net change in interest income $ 120,289 (46,685) 5,950 79,554 493,879 (229,310) (52) 264,517 ====================================================================================================================================
(Continued) 8 REDWOOD FINANCIAL, INC. Comparison of Operating Results for the Years Ended June 30, 1997 and 1996 In recent years, significant new federal legislation has imposed numerous new legal and regulatory requirements on financial institutions. In addition to the uncertainties posed by possible legislative change, there are many other uncertainties that may make the Company's historical performance an unreliable indicator of its future performance, and forward-looking information, including projections of future performance, is subject to numerous possible adverse developments, including but not limited to the possibility of adverse economic developments which may increase default and delinquency risks in the Company's loan portfolios; shifts in interest rates which may result in shrinking interest margins; deposit outflows; interest rates on competing investments; demand for financial services and loan products; increases generally in competitive pressure in the banking and financial services industry; changes in accounting policies or guidelines, or monetary and fiscal policies of the federal government; changes in the quality or composition of the Company's loan and investment portfolios; or other significant uncertainties. Net Earnings Net earnings were $252,000 for the year ended June 30, 1997, as compared to $462,000 for the year ended June 30, 1996. This represented a decrease of $210,000, or 45.45%. The decrease was primarily attributable to a pre-tax $237,000 one-time assessment by the Federal Deposit Insurance Corporation to recapitalize the Savings Association Insurance Fund (SAIF). The decrease was also affected by various expenses incurred with the Company's unsuccessful acquisition attempt of a financial institution. The decrease was partially offset by an $80,000, or 4.99% increase in net interest income and a $74,000, or 35.07% decrease in income tax expense. Net Interest Income Net interest income increased by $80,000, or 4.99% from $1,604,000 for the year ended June 30, 1996 to $1,684,000 for the year ended June 30, 1997. The increase is primarily due to increased deposits and funds from advances invested in loans, investment securities, and mortgage-backed and related securities. The increase was also attributable to a modest improvement in the Company's overall net interest spread. The increase was partially offset by a decrease in the Company's interest-earning assets relative to its interest-bearing liabilities. Average interest-earning assets increased by $5,086,000, or 10.36% from $49,102,000 for the year ended June 30, 1996, to $54,188,000 for the year ended June 30, 1997. Average interest-bearing liabilities increased by $5,679,000, or 15.99% from $35,507,000 for the year ended June 30, 1996, to $41,186,000 for the year ended June 30, 1997. While the Company's asset base increased in the year ended June 30, 1997, the level of average-interest-earning assets to average interest-bearing liabilities decreased from 138.29% for the year ended June 30, 1996 to 131.57% for the year ended June 30, 1997. This decrease is attributed to the Company's common stock repurchases during the 1997 fiscal year. Funds used to repurchase stock totaled $1,227,000. The increase in net interest income was also affected by an increase in the Company's net interest spread from 1.80% for the year ended June 30, 1996, to 1.83% for the year ended June 30, 1997. (Continued) 9 REDWOOD FINANCIAL, INC. Interest Income Interest income increased by $383,000, or 10.98% from $3,487,000 for the year ended June 30, 1996 to $3,870,000 for the year ended June 30, 1997. The increase in interest income is primarily a result of the aforementioned increase in the Company's average interest earning assets. The increase was also attributable to a slight increase in the yield on average interest earning assets, from 7.10% for the year ended June 30, 1996 to 7.14% for the year ended June 30, 1997. Interest on loans receivable increased by $188,000, or 13.66% from $1,376,000 for the year ended June 30, 1996 to $1,564,000 for the year ended June 30, 1997. The increase is a result of a $2,529,000, or 16.05% increase in the average balance of loans from $15,755,000 to $18,284,000 for the years ended June 30, 1996 and 1997, respectively. The increase was partially offset by a decrease in the average yield on loans from 8.74% for the year ended June 30, 1996, to 8.55% for the year ended June 30, 1997. Interest on mortgage-backed and related securities increased by $427,000, or 54.39%, from $785,000 for the year ended June 30, 1996 to $1,212,000 for the year ended June 30, 1997. The increase was due to a $6,233,000, or 54.63% increase in the average balance of mortgage-backed and related securities from $11,410,000 for the year ended June 30, 1996 to $17,463,000 for the year ended June 30, 1997. The yield on the Company's mortgage-backed and related securities was nearly unchanged. The yield was 6.88% for the year ended June 30, 1996 as compared to 6.87% for the year ended June 30, 1997. Since January 1997, the Company has designated its mortgage-backed and related securities purchases as available for sale. Interest on investment securities, including FHLB stock decreased by $194,000, or 17.41%, from $1,114,000 for the year ended June 30, 1996 to $920,000 for the year ended June 30, 1997. The decrease was due to a $3,146,000, or 17.42% decrease in the average balance of investment securities from $18,056,000 for the year ended June 30, 1996 to $14,910,000 for the year ended June 30, 1997. The decrease in investment securities is a result of the Company's decision to reallocate funds from investment security maturities into loans and mortgage-backed and related securities. The yield on the Company's investment securities, 6.04% for the year ended June 30, 1996 as compared to 6.02% for the year ended June 30, 1997, was nearly unchanged. Since January 1997, the Company has designated all investment security purchases as available for sale. Interest Expense Interest expense increased by $303,000, or 16.09% from $1,883,000 for the year ended June 30, 1996 to $2,186,000 for the year ended June 30, 1997. The increase was a result of the increase in the average balance of interest-bearing liabilities. The increase was minimally affected by a slight increase in the cost of average interest-bearing liabilities from 5.30% to 5.31% for the years ended June 30, 1996 and 1997, respectively. Interest on deposits increased by $264,000 or 14.02% from $1,883,000 for the year ended June 30, 1996, to $2,147,000 for the year ended June 30, 1997. The increase was due to a $4,952,000, or 13.95% increase in the average balance of deposits. There was no material change in the cost of the Company's deposits in comparison of the two years. Interest on FHLB advances totaled $38,000. At June 30, 1997, the Company had FHLB advances totaling $3,500,000. There were no advances or other borrowings at June 30, 1996. The Company utilizes FHLB advances as an alternative source of loan and investment funding. (Continued) 10 REDWOOD FINANCIAL, INC. Provision for Loan Losses The Company's provision for loan losses was $0 for the year ended June 30, 1997. Due to lack of substantive problem loans during the period and stable real estate values in the Company's market area, management believed that the allowance for loan losses was adequate throughout these periods. The allowance for loan losses was maintained at $213,000 at June 30, 1997 and 1996. The Company's net loan charge-offs were $0 and $0 for the years ended June 30, 1997 and 1996, respectively. At June 30, 1997 and 1996, the allowance for loan losses represented 1.02% and 1.27%, respectively, of loans receivable. Nonaccrual loans totaled $14,000 and $89,000 at June 30, 1997 and 1996, respectively. Noninterest Income Noninterest income decreased by $5,000, or 8.20% from $61,000 for the year ended June 30, 1996 to $56,000 for the year ended June 30, 1997. The decrease was primarily due to $12,000 in gains resulting from the disposition of various assets in the year ended June 30, 1996. The decrease was partially offset by a $9,000 increase in fee and service charge income for the year ended June 30, 1997. In addition, the decrease was also affected by a $3,000 gain on the sale of investments available for sale in 1997. Noninterest Expense Noninterest expense increased by $360,000, or 36.29% from $992,000 for the year ended June 30, 1996, to $1,352,000 for the year ended June 30, 1997. The increase in noninterest expense was primarily due to the aforementioned $237,000 one-time deposit insurance fund assessment and the $102,000 in expenses, primarily professional fees, as a result of the Company's unsuccessful acquisition attempt. The increase was also due to a $64,000, or 9.86% increase in compensation costs from $649,000 for the year ended June 30, 1996 to $713,000 for the year ended June 30, 1997. The increase in compensation costs was due primarily to increased staffing. The increase in noninterest expense was partially offset by a $29,000, or 35.80% decrease in federal deposit insurance premiums from $81,000 to $52,000 for the years ended June 30, 1996 and 1997, respectively. As a result of the one-time $237,000 deposit insurance fund assessment, the Association currently pays substantially lower federal deposit insurance premiums. Excluding the $102,000 aforementioned professional fees incurred with the unsuccessful acquisition, professional fees declined by $33,000 in comparison of the two years. Income Taxes The Company's income tax expense decreased by $74,000, or 35.07% from $211,000 for the year ended June 30, 1996, to $137,000 for the year ended June 30, 1997. The decrease was a result of decreased earnings before taxes. For the years ended June 30, 1996 and 1997, earnings before taxes totaled $673,000 and $388,000, respectively. Financial Condition The Company's total assets decreased by $3,487,000 or 6.34%, from $55,002,000 at June 30, 1995 to $51,515,000 at June 30, 1996, and increased by $10,654,000, or 20.68% to $62,169,000 at June 30, 1997. Changes in the Company's level of assets from June 30, 1995 to 1996 reflect a decrease in funds held for stock subscriptions. For the year ended June 30, 1997, this increase is a result of increased deposit growth and use of FHLB advances to fund increased loan production and purchases of investment securities, including mortgage-backed securities. (Continued) 11 REDWOOD FINANCIAL, INC. The Company's loans receivable, net, increased by $1,259,000, or 8.25% from $15,255,000 at June 30, 1995 to $16,514,000 at June 30, 1996, and increased by $4,253,000, or 25.75% to $20,767,000 at June 30, 1997. For the year ended June 30, 1997, this increase primarily reflects increased residential mortgage lending. The increased loan portfolio will result in increased credit risk exposure. The increased loan portfolio was funded through short and intermediate term deposits and FHLB advances, which may result in an increase in the Company's interest-rate risk exposure. The Company's securities, which include investment securities and mortgage-backed and related securities, increased by $6,789,000, or 27.93%, from $24,305,000 at June 30, 1995 to $31,094,000 at June 30, 1996, and increased by $8,306,000 or 26.71%, to $39,400,000 at June 30, 1997. The increase in the Company's level of securities during the year ended June 30, 1996 reflects increased cash flows resulting from deposits and investment of a portion of the proceeds from the stock conversion. The increase in the Company's level of securities during the year ended June 30, 1997 reflects increased cash flows from deposits and FHLB advances. Commencing in January 1997, the Company has chosen to designate select new investments as available for sale. The Company had previously designated all securities held to maturity. At June 30, 1997, securities designated as available for sale totaled $15,131,000. Cash and cash equivalents decreased by $11,220,000, or 79.61%, from $14,093,000 at June 30, 1995 to $2,873,000 at June 30, 1996, and then decreased $2,109,000, or 73.41%, to $764,000 at June 30, 1997. For the years ended June 30, 1995 to 1996, the Company's cash and cash equivalents fluctuated primarily as a result of funds held at June 30, 1995 for stock subscriptions. For the year ended June 30, 1997, the Company's cash and cash equivalents fluctuated depending upon changes in deposits, maturity and purchases of securities, loan originations and principal and interest payments on loans and mortgage-backed and related securities. The Company's deposits increased by $2,218,000, or 6.19%, from $35,825,000 at June 30, 1995 to $38,043,000 at June 30, 1996, and increased by $8,050,000, or 21.16% to $46,093,000 at June 30, 1997. The increase in deposits is primarily a result of increased public deposits in each year. FHLB advances totaled $0, $0, and $3,500,000 at June 30, 1995, 1996, and 1997, respectively. During the year ended June 30, 1997, the Company utilized FHLB advances to fund increased loan growth and purchases of investment securities and mortgage-backed and related securities. Stockholders' equity increased during the year ended June 30, 1996 by $7,501,000 or 132.62%, from $5,656,000 at June 30, 1995 to $13,157,000 at June 30, 1996. The increase was due primarily to the $8,549,000 in net proceeds from the sale of the Company's common stock, and the Company's net earnings of $462,000 for the year ended June 30, 1996. The increase was partially offset by $541,000 in proceeds used to repurchase the Company's common stock and $596,000 and $393,000 as a result of unearned employee stock ownership plan shares and unearned management stock bonus plan shares at June 30, 1996, respectively. (Continued) 12 REDWOOD FINANCIAL, INC. Stockholders' equity decreased during the year ended June 30, 1997 by $815,000, or 6.19%, from $13,157,000 at June 30, 1996 to $12,342,000 at June 30, 1997. The decrease was due primarily to the repurchase of 106,875 shares of the Company's common stock. As a result, the Company's treasury stock increased by $1,227,000, or 226.80% from $541,000 at June 30, 1996, to $1,768,000 at June 30, 1997. The decrease in stockholder's equity was also affected by a $3,000 adjustment due to valuation of the Company's available for sale securities. The decrease in stockholder's equity was partially offset by net earnings for the year ended June 30, 1997 of $252,000, an $86,000 decrease in unearned management stock bonus plan shares, and a $66,000 decrease in unearned employee stock ownership plan shares from June 30, 1996 to June 30, 1997. 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, and an $218,000 or 28.17% increase in noninterest expense. The effects of these items were offset, in part, by 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. (Continued) 13 REDWOOD FINANCIAL, INC. 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. 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. (Continued) 14 REDWOOD FINANCIAL, INC. 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. 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. (Continued) 15 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 modified in a troubled debt restructuring. 1997 1996 - -------------------------------------------------------------------------------- Loans accounted for on a nonaccrual basis: Mortgage loans: Loan secured by 1-4 dwelling units $ 0 89,153 All other mortgage loans 0 0 Nonmortgage loans 0 0 - -------------------------------------------------------------------------------- Total $ 0 89,153 ================================================================================ Accruing loans which are contractually past due 90 days or more: Mortgage loans: Loans secured by 1-4 dwelling units 120,902 45,352 All other mortgage loans 0 0 0 0 - ------------------------------------------------------------------------------- Total $ 120,902 45,352 =============================================================================== Total nonaccrual and accrual loans $ 120,902 134,505 =============================================================================== Real estate $ 13,520 0 =============================================================================== Other nonperforming assets $ 0 0 =============================================================================== Total nonperforming assets $ 134,422 134,505 =============================================================================== Total nonaccrual and accrual loans to net loans 0.58% 0.81% =============================================================================== Total nonaccrual and accrual loans to total assets 0.19% 0.26% =============================================================================== Total nonperforming assets to total assets 0.22% 0.26% =============================================================================== 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, 1997 and 1996 was $296 and $2,946, respectively. (Continued) 16 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 --------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Allowance (at beginning of year) $ 213,034 213,034 213,034 Charge-offs 0 0 0 Recoveries 0 0 0 - ------------------------------------------------------------------------------- Net charge-offs 0 0 0 Provision 0 0 0 - ------------------------------------------------------------------------------- Allowance (at end of year) $ 213,034 213,034 213,034 =============================================================================== Allowance for loan losses as a percent of total loans outstanding 1.02% 1.27% 1.38% Net loans charged off as a percent of average loans outstanding 0.00 0.00 0.00 Liquidity and Capital Resources The Company's primary sources of funds are deposits 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. A substantial portion of the Company's deposits are funds from local government entities. The primary investing activities of the Company are the origination of loans and the purchase of investment and mortgage-backed and related securities. During the twelve months ended June 30, 1997 and 1996, the Company purchased investment and mortgage-backed and related securities in the amounts of $16,233,355 and $12,824,899, respectively. 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 additional advances from the Federal Home Loan Bank of Des Moines. In addition, the Company's designation of selected new investments as available for sale is intended to increase liquidity and overall operational flexibility. 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%. (Continued) 17 REDWOOD FINANCIAL, INC. The Company's most liquid assets are cash and cash equivalents. In addition, the Company maintains a portfolio of readily marketable investment securities, including mortgage-backed and related securities which are designated available for sale. If necessary, these investment securities may be sold to increase cash; however, the disposition of such may result in the recognition of a gain or loss. The levels of cash and investment securities, including mortgage-backed and related securities, are dependent on the Company's operating, financing, and investing activities during any given period. At June 30, 1997 and 1996, cash and cash equivalents totaled $764,000 and $2,873,000, respectively. Investment securities, including mortgage-backed and related securities designated available for sale totaled $15,131,000 and $0 at June 30, 1997 and 1996, 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, 1997, 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 (1) Automated Data Processing System During the quarter ended June 30, 1997, the Association began implementation of a conversion from its present manual data processing system to an automated in-house data processing system. The lack of such an automated data processing system had been previously disclosed in the Company's initial prospectus. The Association intends to utilize the automated data processing system for enhancing revenues through the development of new loan and deposit products. The Association expects to complete its conversion to the automated in-house data processing system in October 1997. It is expected that the automated in-house data processing system will cost approximately $9,000 per quarter. (2) Elimination of the Thrift Charter Recent legislation now in debate in Congress could lead to the elimination of the thrift charter, and the resulting conversation of all thrifts to state or national banks. Other elements of the proposed legislation would also combine the deposit insurance fund of the commercial banking industry with that insuring the thrift industry. It is unknown how this proposed legislation would affect the Association or the Company at this time. (Continued) REDWOOD FINANCIAL, INC. Consolidated Financial Statements June 30, 1997, 1996, and 1995 18 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, 1997 and 1996 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, 1997. 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, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1997 in conformity with generally accepted accounting principles. /s/KPMG Peat Marwick LLP August 8, 1997 19 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Balance Sheets June 30, 1997 and 1996
Assets 1997 1996 - -------------------------------------------------------------------------------------------------------------- Cash $ 15,314 15,345 Interest bearing deposits with banks 748,478 2,857,818 - -------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 763,792 2,873,163 Securities available for sale: Mortgage-backed and related securities (amortized cost $8,143,694 8,149,752 0 and $0, respectively) Investment securities (amortized cost $6,992,534 and $0, respectively) 6,981,250 0 - -------------------------------------------------------------------------------------------------------------- Total securities available for sale 15,131,002 0 Securities held to maturity: Mortgage-backed and related securities (market value $14,082,280 and $15,772,242, respectively) 13,873,801 15,805,305 Investment securities (market value $10,399,446 and $15,192,588, respectively 10,395,659 15,288,913 - -------------------------------------------------------------------------------------------------------------- Total securities held to maturity 24,269,460 31,094,218 Loans receivable, net 20,766,539 16,513,727 Federal Home Loan Bank stock, at cost 333,500 333,500 Accrued interest receivable 613,357 553,856 Premises and equipment, net 212,067 52,187 Real estate, net 13,520 0 Other assets 65,679 93,992 - -------------------------------------------------------------------------------------------------------------- Total assets $ 62,168,916 51,514,643 ============================================================================================================== Liabilities and Stockholders Equity - -------------------------------------------------------------------------------------------------------------- Deposits 46,093,213 38,042,529 Federal Home Loan Bank advances 3,500,000 0 Advance payments by borrowers for taxes and insurance 69,744 55,686 Accrued expenses and other liabilities 163,926 259,392 - -------------------------------------------------------------------------------------------------------------- Total liabilities 49,826,883 38,357,607 - -------------------------------------------------------------------------------------------------------------- Common stock ($.10 par value). Authorized and issued 1,125,000 shares; outstanding 961,875 shares at June 30, 1997; 1,068,750 at June 30, 1996 112,500 112,500 Additional paid-in capital 8,467,833 8,457,017 Retained earnings, subject to certain restrictions 6,369,591 6,118,091 Net unrealized loss on securities available for sale (3,135) 0 Unearned employee stock ownership plan shares (529,504) (595,744) Unearned management stock bonus plan shares (306,797) (393,422) Treasury stock, at cost, 163,125 shares at June 30, 1997; 56,250 at June 30, 1996 (1,768,455) (541,406) - -------------------------------------------------------------------------------------------------------------- Total stockholders equity 12,342,033 13,157,036 - -------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders equity $ 62,168,916 51,514,643 ==============================================================================================================
See accompanying notes to consolidated financial statements. (Continued) 20 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Earnings Years ended June 30, 1997, 1996, and 1995
1997 1996 1995 - ---------------------------------------------------------------------------------------------------------- Interest income: Loans receivable $1,563,605 1,376,334 1,300,846 Securities held to maturity: Mortgage-backed and related securities 1,044,024 784,869 573,656 Investment securities 772,581 1,114,308 1,042,595 Securities available for sale: Mortgage-backed and related securities 168,357 0 0 Investment securities 147,775 0 0 Cash equivalents 173,275 211,640 105,947 - ---------------------------------------------------------------------------------------------------------- Total interest income 3,869,617 3,487,151 3,023,044 Interest expense on Federal Home Loan Bank advances 38,485 0 0 Interest expense on deposits 2,147,264 1,882,837 1,683,247 - ---------------------------------------------------------------------------------------------------------- 2,185,749 1,882,837 1,683,247 - ---------------------------------------------------------------------------------------------------------- Net interest income 1,683,868 1,604,314 1,339,797 - ---------------------------------------------------------------------------------------------------------- Provision for losses on loans 0 0 0 - ---------------------------------------------------------------------------------------------------------- Net interest income after provision for losses on loans 1,683,868 1,604,314 1,339,797 - ---------------------------------------------------------------------------------------------------------- Noninterest income: Gain on sale of securities available for sale 2,863 0 0 Fees and service charges 45,231 36,197 18,947 Other 8,384 24,314 20,656 - ---------------------------------------------------------------------------------------------------------- Total noninterest income 56,478 60,511 39,603 - ---------------------------------------------------------------------------------------------------------- Noninterest expense: Compensation and employee benefits 713,001 648,859 511,502 Advertising 19,210 16,411 16,525 Occupancy 31,746 28,181 27,976 Federal deposit insurance premiums 51,851 80,769 84,370 Professional fees 195,493 126,781 34,054 Deposit insurance fund assessment 237,085 0 0 Other 103,792 90,880 99,948 - ---------------------------------------------------------------------------------------------------------- Total noninterest expense 1,352,178 991,881 774,375 - ---------------------------------------------------------------------------------------------------------- Earnings before income taxes 388,168 672,944 605,025 Income tax expense 136,668 210,512 244,720 - ---------------------------------------------------------------------------------------------------------- Net earnings $ 251,500 462,432 360,305 ========================================================================================================== Net earnings per common share $ 0.26 0.45 N/A Weighted average number of shares outstanding 962,193 1,018,267 N/A
See accompanying notes to consolidated financial statements. (Continued) 21 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Stockholders' Equity Years ended June 30, 1997, 1996, and 1995
Net Unearned unrealized Employee Unearned loss on Stock management Additional securities Ownership stock Total Common paid-in Retained available Plan bonus Treasury stockholders stock capital earnings for sale Shares plan shares stock equity - ------------------------------------------------------------------------------------------------------------------------------------ Balance on June 30, 1994 $ 0 0 5,295,354 0 0 0 0 5,295,354 0 Net earnings 0 0 360,305 0 0 0 360,305 - ------------------------------------------------------------------------------------------------------------------------------------ Balance on June 30, 1995 0 0 5,655,659 0 0 0 0 5,655,659 Net earnings 0 0 462,432 0 0 0 0 462,432 Sale of common stock 112,500 8,436,861 0 0 0 0 0 8,549,361 Adoption of employee stock ownership plan 0 0 0 0 (661,984) 0 0 (661,984) Earned employee stock ownership plan shares, net 0 10,781 0 0 66,240 0 0 77,021 Repurchase of common stock 0 0 0 0 0 0 (965,156) (965,156) Adoption of management stock bonus plan 0 9,375 0 0 0 (433,125) 423,750 0 Earned management stock bonus plan shares 0 0 0 0 0 39,703 0 39,703 - ------------------------------------------------------------------------------------------------------------------------------------ Balance on June 30, 1996 112,500 8,457,017 6,118,091 0 (595,744) (393,422) (541,406) 13,157,036 Net earnings 0 0 251,500 0 0 0 0 251,500 Repurchase of common stock 0 0 0 0 0 0 (1,227,049) (1,227,049) Net unrealized loss on securities available for sale, net 0 0 0 (3,135) 0 0 0 (3,135) Earned employee stock ownership plan shares, net 0 10,816 0 0 66,240 0 0 77,056 Earned management stock bonus plan shares 0 0 0 0 0 86,625 0 86,625 - ------------------------------------------------------------------------------------------------------------------------------------ Balance on June 30, 1997 $112,500 8,467,833 6,369,591 (3,135) (529,504) (306,797) (1,768,455) 12,342,033 ====================================================================================================================================
See accompanying notes to consolidated financial statements. 22 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows Years ended June 30, 1997, 1996, and 1995
1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Operating activities: Net earnings $ 251,500 462,432 360,305 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 16,742 16,992 17,354 Amortization of premiums and discounts, net (36,232) (40,057) (34,683) (Increase) decrease in other assets 28,313 15,440 (28,655) (Increase) decrease in accrued interest receivable (59,501) (144,272) 40,345 Increase (decrease) in accrued interest payable 221,379 (50,453) 69,452 Gain on sale of securities available for sale (2,863) 0 0 Amortization of unearned ESOP shares 66,240 66,240 0 Earned ESOP shares priced above original cost 10,816 10,781 0 Earned Management Stock Bonus Plan shares 86,625 39,703 0 Change in deferred income taxes (56,854) 45,726 57,281 (Decrease) increase in accrued expenses and other liabilities .. (36,522) (34,617) 78,542 Federal Home Loan Bank stock dividend 0 (6,500) 0 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 489,643 381,415 559,941 - ------------------------------------------------------------------------------------------------------------------------------------ Investing activities: Proceeds from maturities of investment securities held to maturity 4,895,000 4,000,200 1,200,000 Purchases of investment securities held to maturity 0 (2,860,069) (430,000) Purchases of mortgage-backed and related securities held to maturity 0 (9,964,830) (1,510,000) Principal collected on mortgage-backed and related securities held to maturity 1,927,523 2,075,679 1,456,544 Purchases of investment securities available for sale (7,988,700) 0 0 Proceeds from sales of investment securities available for sale 999,376 0 0 Purchases of mortgage-backed and related securities available for sale (8,244,655) 0 0 Principal collected on mortgage-backed and related securities available for sale 135,675 0 0 Increase in loans receivable, net (4,262,925) (1,350,152) (164,075) Purchases of premises and equipment (176,622) (5,268) (14,855) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash (used) provided by investing activities (12,715,328) (8,104,440) 537,614 - ------------------------------------------------------------------------------------------------------------------------------------ Financing activities: (Decrease) increase in funds held for stock subscriptions 0 (13,127,630) 13,127,630 (Decrease) increase in deferred stock conversion costs 0 439,015 (439,015) Increase (decrease) in deposits, net 7,829,305 2,267,713 (1,358,372) Increase in advance payments by borrowers for taxes and insurance 14,058 2,204 6,513 Proceeds from sale of common stock 0 8,549,361 0 Adoption of ESOP 0 (661,984) 0 Proceeds from Federal Home Loan Bank advances 5,500,000 0 0 Repayment of Federal Home Loan Bank advances (2,000,000) 0 0 Repurchase of common stock (1,227,049) (965,156) 0 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash (used) provided by financing activities 10,116,314 (3,496,477) 11,336,756 - ------------------------------------------------------------------------------------------------------------------------------------ (Decrease) increase in cash and cash equivalents (2,109,371) (11,219,502) 12,434,311 Cash and cash equivalents, beginning of year 2,873,163 14,092,665 1,658,354 - ------------------------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents, end of year $ 763,792 2,873,163 14,092,665 ==================================================================================================================================== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 1,964,370 1,933,290 1,613,795 Income taxes 272,505 175,101 224,979 Supplemental noncash flow disclosures: Transfer of loans to real estate $ 13,520 0 0
See accompanying notes to consolidated financial statements. (Continued) 23 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements June 30, 1997 (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 18). 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 statement of earnings included herein for the year ended June 30, 1995 is 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 Theaccompanying consolidated financial statements include the accounts of the Company and the 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) 24 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. Reclassifications Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current year presentation. 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. There was no impact of adoption on the Association's financial statements as the Association's entire portfolio of securities was classified as held to maturity upon adoption. Trading securities are bought and held principally for the purpose of selling them in the near term. The Company had no securities classified as trading for the years ended June 30, 1997, 1996 and 1995. Securities available for sale are carried at market value. Net unrealized gains and losses, net of tax effect, are included as a separate component of stockholders' equity. Securities held to maturity are carried at amortized cost, as management has the ability and positive intent to hold them to maturity. Discounts and premiums on securities are amortized to income using the level yield method over the estimated life of the security. Gains and losses on the sale of securities, are determined using the specific identification method. 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. (Continued) 25 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Interest income is recognized on an accrual basis except when collectibility is in doubt as determined on a loan by loan basis. When interest accruals are suspended, interest previously accrued is reversed. Interest is subsequently recognized as income to the extent cash is received when, in management's judgment, principal is collectible. 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, agriculture, 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 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 using the effective interest method over the life of the loan. Discounts and premiums on loans originated or purchased are deferred and amortized to income using the level-yield method over the estimated average loan life. Real Estate Real estate owned or expected to be acquired in settlement of loans is carried at the lower of the unpaid loan balance plus settlement costs or estimated fair value less selling costs. After acquisition, costs of capital improvements made to facilitate sales are capitalized as incurred. Costs incurred for holding properties after the redemption period are expensed currently. The carrying value of individual properties is periodically evaluated and reduced to the extent cost exceeds estimated fair value less selling costs. Gains on the sales of such real estate are recorded at the time of closing. 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) 26 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of Effective July 1, 1996, the Company adopted SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The effect of adopting SFAS No. 121 on July 1, 1996 did not have a material impact on the Company's financial condition or the results of its operations. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Stock-Based Compensation Effective July 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation. It elected to continue using the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25 and related interpretations which measure compensation cost using the intrinsic value method. The Company has included in note 12, Employee Benefits the impact of the fair value of employee stock-based compensation plans on net income and earnings per share on a pro forma basis for awards granted after July 1, 1995. New Accounting Standards Effective July 1, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, not deferred by SFAS No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125. The adoption of SFAS No. 125 did not impact the Company's financial condition or results of operations. (Continued) 27 REDWOOD FINANCIAL, INC. AND SUBSIDIARY In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, Earnings per Share. SFAS No. 128 establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. SFAS No. 128 supersedes the standards for computing EPS previously found in Accounting Principles Board (APB) Opinion No. 15, Earnings per Share. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier application is not permitted. SFAS No. 128 requires restatement of all prior-period EPS data presented. Management is currently determining what effect SFAS No. 128 will have on the Company's results of operations. In February 1997, the FASB issued SFAS No. 129, Disclosure of Information about Capital Structure, which codifies existing disclosure requirements regarding capital structure. SFAS No. 129 is not expected to have a significant impact on the Company's current capital structure disclosures. In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Management is currently determining what effect adoption of this statement will have on the reporting of its financial information. (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. Under this method unallocated employee stock ownership plan shares are not considered outstanding for purposes of calculating earnings per share. Earnings per share amounts for the year ended June 30, 1995 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 and 962,193 shares as the weighted average number of shares outstanding for the years ended June 30, 1996 and 1997, respectively. (Continued) 28 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (4) Securities Held to Maturity Securities held to maturity at June 30, 1997 and 1996 are summarized as follows:
June 30, 1997 ------------------------------------------------------------------ Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ------------------------------------------------------------------------------------------------------- Investment securities: U.S. Government agency bonds $ 3,743,759 34,800 (4,388) 3,774,171 U.S. Treasury notes 5,502,262 4,234 (28,441) 5,478,055 Municipal bonds 1,149,638 2,353 (4,771) 1,147,220 ------------------------------------------------------------------------------------------------------- Total investment securities $ 10,395,659 41,387 (37,600) 10,399,446 ========================================================================================================= Mortgage-backed and related securities: GNMA certificates 205,122 94,839 0 299,961 FHLMC certificates 9,358,524 121,853 (16,893) 9,463,484 FHLMC collateralized mortgage obliga- tions 58,548 3,297 0 61,845 FNMA certificates 4,251,607 12,100 (6,717) 4,256,990 ------------------------------------------------------------------------------------------------------- Total mortgage-backed and related securities $ 13,873,801 232,089 (23,610) 14,082,280 =========================================================================================================
(Continued) 29 REDWOOD FINANCIAL, INC. AND SUBSIDIARY
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 =========================================================================================================
There were no sales of securities held to maturity for the years ended June 30, 1997, 1996, or 1995. Accrued interest receivable on securities held to maturity aggregated $270,226 and $452,492 at June 30, 1997 and 1996, respectively. The carrying amount and approximate market value of investment securities and mortgage-backed and related securities held to maturity at June 30, 1997 and 1996, by contractual maturity, are shown below:
June 30, 1997 June 30, 1996 ---------------------------------- ---------------------------------- Carrying Approximate Carrying Approximate amount market value amount market value - ----------------------------------------------------------------------------------------- Due within one year $ 3,661,102 3,665,190 4,308,546 4,327,575 Due after one year through five years 12,976,574 12,989,956 18,296,351 18,067,792 Due after five years through ten years 5,964,539 6,068,667 6,527,826 6,531,162 Due after ten years 1,667,245 1,757,913 1,961,495 2,038,301 - ----------------------------------------------------------------------------------------- $ 24,269,460 24,481,726 31,094,218 30,964,830 =========================================================================================
(Continued) 30 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (5) Securities Available for Sale Securities available for sale at June 30, 1997 are summarized as follows:
June 30, 1997 ------------------------------------------------------------------ Gross Gross Amortized unrealized unrealized Approximate cost gains losses market value ------------------------------------------------------------------------------------------------------- Investment securities: U.S. Government agency bonds $ 6,992,534 10,000 (21,284) 6,981,250 ------------------------------------------------------------------------------------------------------- Total investment securities $ 6,992,534 10,000 (21,284) 6,981,250 ======================================================================================================= Mortgage-backed and related securities: FHLMC certificates 8,143,694 9,939 (3,881) 8,149,752 ------------------------------------------------------------------------------------------------------- Total mortgage-backed and related securities $ 8,143,694 9,939 (3,881) 8,149,752 =======================================================================================================
Proceeds from the sale of securities available for sale during the years ended June 30, 1997, 1996, and 1995, were $999,376, $0, and $0, respectively. Gross realized gains from the sale of securities for the years ended June 30, 1997, 1996, and 1995 were $2,863, $0, and $0, respectively. There were no gross realized losses from the sale of securities for the years ended June 30, 1997, 1996, and 1995. Accrued interest receivable on securities available for sale aggregated $212,930 and $0 at June 30, 1997 and 1996, respectively. The carrying amount and approximate market value of investment securities and mortgage-backed and related securities available for sale at June 30, 1997 and 1996, by contractual maturity, are shown below:
June 30, 1997 June 30, 1996 ---------------------------------- ---------------------------------- Amortized Approximate Amortized Approximate cost market value cost market value - ----------------------------------------------------------------------------------- Due within one year $ 0 0 0 0 Due after one year through five years 1,998,189 1,990,938 0 0 Due after five years through ten years 13,138,039 13,140,064 0 0 Due after ten years 0 0 0 0 - ----------------------------------------------------------------------------------- $ 15,136,228 15,131,002 0 0 ===================================================================================
Nontaxable interest income on securities available for sale and securities held to maturity was $67,546, $60,213, and $10,380 for the years ended June 30, 1997, 1996, and 1995, respectively. (Continued) 31 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (6) Loans Receivable 1997 1996 --------------------------------------------------------------------- Loans secured by real estate: Residential one-to-four family $ 18,577,418 15,232,656 Multifamily 173,594 189,266 Commercial 679,968 519,543 Agricultural 150,000 0 Residential construction 502,000 220,000 Multifamily construction 980,000 0 Other consumer loans 21,000 140,802 Loans on deposits 133,033 775,358 Commercial 714,869 775,358 Agricultural operating line of credit 425,000 0 --------------------------------------------------------------------- Total 22,356,882 17,077,625 --------------------------------------------------------------------- Deferred loan fees and discounts (15,765) (18,019) Loans in process (1,361,544) (332,845) Allowance for losses (213,034) (213,034) --------------------------------------------------------------------- Net loans $ 20,766,539 16,513,727 ===================================================================== Accrued interest receivable on loans receivable at June 30, 1997 and 1996 was $125,682 and $101,364, respectively. The following is a summary of nonperforming loans as of and for the years ended June 30: 1997 1996 1995 ----------------------------------------------------------------------- Impaired loans: Nonaccrual $ 0 0 0 Restructured 0 0 0 ----------------------------------------------------------------------- 0 0 0 ----------------------------------------------------------------------- Other nonperforming loans: Nonaccrual 0 89,153 0 Restructured 0 0 0 ----------------------------------------------------------------------- 0 89,153 0 ----------------------------------------------------------------------- Total nonperforming loans $ 0 89,153 0 ======================================================================= Scheduled interest under original terms 0 2,946 0 Actual interest recognized 0 0 0 ----------------------------------------------------------------------- Net interest lost on nonperforming loans $ 0 2,946 0 ======================================================================= (Continued) 32 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The average balance of impaired loans during each of the fiscal years ended June 30, 1997 and 1996 was $13,520 and $0, respectively. There was no allowance for losses on impaired loans at June 30, 1997 and 1996. The aggregate amount of loans to directors and executive officers of the Company was $231,803, $237,177, and $254,139, at June 30, 1997, 1996, and 1995, respectively. Activity with respect to these loans during fiscal 1997 included loan originations of $33,000 and loan repayments of $59,842. 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. Such loans were made in the ordinary course of business on normal credit terms, including interest rate and collateralization, and do not represent more than normal risk of collection. Included in total commitments to originate loans are fixed rate loans aggregating $402,000 and $751,400 as of June 30, 1997 and 1996, respectively. The interest rates on these commitments ranged from 8% to 9% for both June 30, 1997 and 1996. There were no material commitments to lend additional funds to customers whose loans were classified as nonaccrual at June 30, 1997. There were no loans at June 30, 1997 and 1996 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. (6) Allowance for Losses on Loans Receivable Activity in the allowance for losses on loans receivable is summarized as follows: Balance at June 30, 1994 $ 213,034 Provision for losses 0 Charge-offs and recoveries 0 ----------------------------------------------------------------------- Balance at June 30, 1995 213,034 Provision for losses 0 Charge-offs and recoveries 0 ----------------------------------------------------------------------- Balance at June 30, 1996 213,034 Provision for losses 0 Charge-offs and recoveries 0 ----------------------------------------------------------------------- Balance at June 30, 1997 $ 213,034 ======================================================================= (Continued) 33 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (7) Real Estate Real estate owned, representing real estate expected to be acquired in settlement of loans, totaled $13,520 and $0 at June 30, 1997 and 1996, respectively. The allowance for losses on real estate was $0 at June 30, 1997 and 1996. There were no charge-offs, recoveries, or provisions for losses for the years ended June 30, 1997, 1996, or 1995. (8) Premises and Equipment A summary of premises and equipment at June 30, 1997 and 1996 is as follows: 1997 1996 ------------------------------------------------------------------------ Land and office buildings $ 310,927 155,476 Furniture and equipment 192,375 171,204 ------------------------------------------------------------------------ 503,302 326,680 Less accumulated depreciation (291,235) (274,493) ------------------------------------------------------------------------ $ 212,067 52,187 ======================================================================== (9) Deposits Deposits and weighted-average interest rates at June 30 are summarized as follows:
1997 1996 --------------------------- ------------------------------ Amount Rate Amount Rate - ------------------------------------------------------------------------------------------ Passbook $ 922,487 2.65% $ 985,658 2.65% Money market accounts 7,187,340 4.23 7,104,387 3.89 - ----------------------------------------- --------------- 8,109,827 8,090,045 - ----------------------------------------- --------------- Certificates of deposit: 4.01 - 5.00% 421,418 2,069,519 5.01 - 6.00 18,099,518 16,334,358 6.01 - 7.00 18,749,835 10,766,128 7.01 - 8.00 306,992 598,235 - ----------------------------------------- --------------- 37,577,763 5.83% 29,768,240 5.83% - ----------------------------------------- --------------- Accrued interest payable 405,623 184,244 - ----------------------------------------- --------------- $ 46,093,213 $ 38,042,529 ========================================= ===============
(Continued) 34 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Interest expense on deposits is summarized as follows: 1997 1996 1995 ----------------------------------------------------------------------- Passbook $ 25,130 33,968 30,978 Money market accounts 275,769 196,842 214,906 Certificates of deposit 1,846,365 1,652,027 1,437,363 ----------------------------------------------------------------------- $ 2,147,264 1,882,837 1,683,247 ======================================================================= Certificates of deposit had the following remaining maturities at June 30: 1997 1996 ---------------------------- ------------------------------ Weighted Weighted average average Amount rate Amount rate - ------------------------------------------------------------------------------ 0-6 months $ 16,655,355 5.70% $ 11,533,143 5.86% 7-12 months 11,031,181 5.84 6,857,760 5.72 13-36 months 9,174,681 6.04 10,852,065 5.84 Over 36 months 716,543 6.00 525,272 6.41 - ----------------------------- --------------- $ 37,577,763 5.83% $ 29,768,240 5.83% ============================= =============== The Company had $13,909,498 and $9,698,164 of certificates of deposit with balances of $100,000 or more at June 30, 1997 and 1996, respectively. At June 30, 1997 investment securities and mortgage-backed securities with an approximate book value of $20,353,000 were pledged as collateral for certain deposits, including approximately $17,969,000 of public deposits. At June 30, 1997 and 1996, the aggregate amount of deposits by directors and executive officers totaled $322,029 and $234,298, respectively. Such deposits were accepted in the ordinary course of business with normal interest rates, interest payment terms, and maturities. (Continued) 35 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (10) Federal Home Loan Bank Advances The Company had no Federal Home Loan Bank (FHLB) advances outstanding as of June 30, 1996. At June 30, 1997, the Company's FHLB advances consisted of the following: Year of maturity Amount Rate ------------------------------------------------------------------------- 1998 $ 2,500,000 6.08% 1999 0 0.00 2000 1,000,000 6.33 ----------------------------------------------------------- 3,500,000 6.15 Open line of credit 0 0.00 ----------------------------------------------------------- $ 3,500,000 6.15% =========================================================== At June 30, 1997, the advances and open line of credit were collateralized by the Association's FHLB stock and investments with a carrying value of approximately $333,500 and $7,423,851, respectively. The Company has a $1,000,000 line of credit with the FHLB which was not drawn on at June 30, 1997. The Company has the ability to draw additional borrowings of approximately $3,170,000 based upon its current investment in FHLB stock and investment securities pledged. (11) Income Taxes Income tax expense (benefit) for the years ended June 30 is composed of the following: 1997 1996 1995 --------------------------------------------------------------------- Current: Federal $ 141,694 120,844 140,579 State 51,828 43,942 46,860 --------------------------------------------------------------------- Total current 193,522 164,786 187,439 --------------------------------------------------------------------- Deferred: Federal (43,066) 34,295 42,961 State (13,788) 11,431 14,320 --------------------------------------------------------------------- Total deferred (56,854) 45,726 57,281 --------------------------------------------------------------------- $ 136,668 210,512 244,720 ===================================================================== (Continued) 36 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The reasons for the difference between the effective income tax rate and the statutory federal income tax rate are as follows:
1997 1996 1995 --------------------------------------------------------------------------------------------------- Federal "expected" income tax rate 34.0% 34.0% 34.0% State income taxes, net of federal income tax benefit 6.5 6.5 6.7 (Increase) decrease in base year tax bad debt reserve 0.0 (6.3) (0.4) Tax-exempt interest income (5.3) (3.0) (0.1) Other, net 0.0 0.1 0.3 --------------------------------------------------------------------------------------------------- Effective income tax rate 35.2% 31.3% 40.5% ===================================================================================================
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at June 30, 1997 and 1996 are as follows: 1997 1996 - -------------------------------------------------------------------------------- Deferred tax assets: Discounts on mortgage-backed and related securities 26,175 32,005 Allowance for losses on loans receivable 2,651 2,651 Unrealized loss on available for sale securities 2,090 0 Other 0 4,365 - -------------------------------------------------------------------------------- Gross deferred tax assets 30,916 39,021 Valuation allowance 0 0 - -------------------------------------------------------------------------------- Deferred tax assets, net 30,916 39,021 Deferred tax liabilities: Accrual to cash conversion 95,564 159,421 FHLB stock 50,500 50,478 Premises and equipment 10,109 13,323 - -------------------------------------------------------------------------------- Gross deferred tax liabilities 156,173 223,222 - -------------------------------------------------------------------------------- Net deferred tax liability $ 125,257 184,201 ================================================================================ No valuation allowance was required for deferred tax assets at June 30, 1997 or 1996. Retained earnings at June 30, 1997 included approximately $1,155,957 for which no provision for federal income tax has been made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of the amount so allocated for purposes other than to absorb losses will create income for tax purposes, which will be subject to the then current corporate income tax rate. In August 1996, federal legislation was enacted that repealed the favorable bad debt method for savings and loan associations. Subsequent to this repeal, the Company continues to be subject to the potential tax liability to the extent payments or distributions of these appropriated earnings occurs. (Continued) 37 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (12) 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. Net periodic pension expense for the years ended June 30 includes the following components:
1997 1996 1995 --------------------------------------------------------------------------------------------------- Service cost--benefits earned during the period $ 28,076 26,494 26,927 Interest cost on projected benefit obligation 57,824 51,730 48,474 Actual return on plan assets (63,728) (55,934) (45,183) Net amortization and deferral 438 438 907 =================================================================================================== Net periodic pension expense $ 22,610 22,728 31,125 ===================================================================================================
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:
1997 1996 1995 --------------------------------------------------------------------------------------------------- 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
(Continued) 38 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The following table sets forth the Plan's funded status and the amounts recognized in the Company's balance sheet at June 30:
1997 1996 - ---------------------------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Vested accumulated benefit obligation $ 676,571 624,568 Nonvested accumulated benefit obligation 133 43 - ---------------------------------------------------------------------------------------------------- Total accumulated benefit obligation 676,704 624,611 Effect of projected future salary increases 137,234 104,247 - ---------------------------------------------------------------------------------------------------- Projected benefit obligation 813,938 728,858 Plan assets at fair value 889,838 780,740 - ---------------------------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation 75,900 51,882 Unrecognized prior service cost 15,875 17,638 Unrecognized gain from past experience different from that assumed (77,515) (47,254) Unrecognized net transition asset being amortized over 15 years (5,307) (6,632) - ---------------------------------------------------------------------------------------------------- Prepaid pension cost $ 8,953 15,634 ====================================================================================================
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 1997, 1996, or 1995. Employee Stock Ownership Plan Effective July 7, 1995, the Company adopted an Employee Stock Ownership Plan (the ESOP). The ESOP borrowed $661,984 from the Company to purchase 82,748 shares of common stock of the Company on the date of the conversion. The Company paid principal and interest of $117,125 and $123,086 to the ESOP during the fiscal year 1997 and 1996, respectively. As the debt is repaid, ESOP shares which were initially pledged as collateral for its debt are released from collateral and allocated to active employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be 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 $84,650 and $77,021 for fiscal year 1997 and 1996, respectively. (Continued) 39 REDWOOD FINANCIAL, INC. AND SUBSIDIARY 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 calendar year ended: 1997 1996 ----------------------------------------------------------------------- Shares allocated beginning of year $ 4,140 0 Shares allocated during year 8,280 4,140 Unreleased shares 70,328 78,608 ----------------------------------------------------------------------- Total ESOP shares 82,748 82,748 ======================================================================= Fair value of unreleased shares at June 30 $ 694,974 688,829 ======================================================================= 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 1997 and 1996 compensation and employee benefits expense is $86,625 and $39,703, respectively, related to the MSBP. Stock Option Plan On January 17, 1996, stockholders of the Company approved the Company's 1995 Stock Option Plan. The plan was subsequently approved by the OTS. The plan provides for the granting of options for the purpose of attracting and retaining key personnel and facilitating their purchase of a stock interest in the Company. The plan provided for the total allocation of 112,500 options of which 92,500 options were granted to directors, management, and employees of the Company at an exercise price of $9.8125 per share. On April 9, 1997, the Company granted 5,400 options of the remaining unawarded options at an exercise price of $11.375 per share. All options granted under this plan vest pro rata over five years from the grant date. In addition, vested options are exercisable for a period ending 10 years after the grant date. (Continued) 40 REDWOOD FINANCIAL, INC. AND SUBSIDIARY As of June 30, 1997, no stock options have been exercised or forfeited. A summary of stock option activity is detailed as follows:
Weighted Options average available Options exercise for grant outstanding price - ----------------------------------------------------------------------------------------- June 30, 1995 0 0 0 1995 stock option plan adopted 112,500 0 0 Granted January 17, 1996 (weighted average fair value $4.34 per option) (92,500) 92,500 $ 9.8125 - ----------------------------------------------------------------------------------------- June 30, 1996 20,000 92,500 9.8125 Granted April 9, 1997 (weighted average fair value $5.74 per option) (5,400) 5,400 11.3750 - ----------------------------------------------------------------------------------------- June 30, 1997 14,600 97,900 9.8987
The number of options exerciseable at June 30, 1997 was 18,500 options with a weighted average exercise price of $9.8125. The Company uses the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock option plans. Accordingly, no compensation cost has been recognized for the plans. There are no charges or credits to expense with respect to the granting or exercise of options since the options were issued at fair value on the respective grant dates. Had compensation cost for the 1995 Stock Option Plan been determined based on the fair value method as established in SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts as indicated in the following table:
Fiscal Year Ending June 30, 1997 June 30, 1996 --------------------------------------------------------------------------------------------------- Net Income: As reported $ 251,500 $ 462,432 Pro forma 202,396 442,360 Earnings per common share and common share equivalent: As reported 0.26 0.45 Pro forma 0.21 0.43
The above disclosed pro forma effects of applying SFAS No. 123 to compensation costs may not be representative of the effects on reported pro forma net income for future years. (Continued) 41 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The fair value for each option granted is estimated based on a Black-Scholes option pricing model. The model incorporates the following weighted average assumptions:
For options granted in accordance with 1995 Stock Option Plan granted in the fiscal year ending June 30, 1997 June 30, 1996 - ----------------------------------------------------------------------------------------------- Risk-free interest rate 7.07% 5.78% Expected life 10 years 10 years Expected volatility 12.00% 12.00% Expected dividends None None
On June 10, 1997, the Company approved a stock option plan to grant 38,472 options to its executive officers and directors at an exercise price of $11.0625 per share on August 1, 1997. These stock options are exercisable at grant date in full commencing August 1, 1997, through a period no later than 10 years after the grant date. For purposes of disclosing the effect of the 1997 Stock Option Plan in pro forma earnings statements as required by SFAS No. 123, the compensation costs of this plan will effect only pro forma net income and earnings per share in the fiscal year ended June 30, 1998. (13) 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, 1997, that the Association meets all capital adequacy requirements to which it is subject. As of June 30, 1997, the most recent notification from the OTS categorized the Company as `well capitalized.' There are no conditions or events since that notification that management believes have changed the Company's category. (Continued) 42 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The Association's actual capital amounts and ratios are also presented in the table (dollars in thousands):
To be Well Capitalized Under Prompt Corrective Actions Provisions Actual Requirement Excess Capital ---------------------- --------------------- ------------------------- -------------------- Percent Percent Percent Percent of of of of Amount assets Amount assets Amount assets Amount assets(1) (1) (1) (1) ----------------------------------------------------------------------------------------------------------------------- Association's net worth (3) $ 8,391 Add back: AFS market valuation 3 Tangible capital 8,394 13.91% $ 905 1.50% $ 7,489 12.41% N/A N/A --------- Core capital (2) 8,394 13.91 1,811 3.00 6,583 10.91 3,018 5.00% --------- Plus: Allowable portion of general allowance for loan losses 213 --------- Risk-based capital $ 8,607 44.76% $ 1,538 8.00% $ 7,069 36.76% $ 1,923 10.00% =========
(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. (2) Pursuant to Prompt Corrective Action regulations, the Association is also required to hold core capital equal to or greater than 6.00% of its risk-weighted assets, or $1,154 at June 30, 1997. (3) The Association's net worth excludes $18,000 in post period adjustments reportable in subsequent periods in accordance with regulatory capital instructions. (14) Recent Legislation and Regulatory Developments The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996. DIFA addressed the inadequate funding of the Savings Association Insurance Fund (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift institutions. The Bank's assessment was a pretax charge of $237,085 and was recognized in the first quarter of fiscal 1997. (Continued) 43 REDWOOD FINANCIAL, INC. AND SUBSIDIARY DIFA also addressed the funding for the Financing Corp. (FICO) bonds. Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1, 2000 until the FICO bonds are retired in 2019, the estimated assessment to retire the FICO bonds is expected to be 2.5 basis points per $100 of deposits. DIFA proposed that the Bank Insurance Fund (BISF) and SAIF be merged on January 1, 1999, provided no insurance depository institution is a savings association on that date. DIFA also directed the Secretary of the Treasury to present recommendations to Congress for establishment of a common depository institution charter. (15) Stock Repurchases During the fiscal year ended June 30, 1997, the Company purchased 106,875 shares of its outstanding common stock at an average price of $11.48 per share, or 10% of its previously outstanding common stock. For the fiscal year ended June 30, 1996, the Company repurchased 101,250 shares, including 45,000 shares allocated to the management recognition plan, at an average price of $9.53 per share. As a result of the stock repurchase program, the Company has now outstanding 961,875 shares of common stock. The following summarizes the Company's common stock repurchases during the fiscal year: Shares Price Date Purchased Purchased per share --------------------------------------------------------------- January 15, 1997 3,000 $ 10.3750 January 28, 1997 4,600 10.7500 January 30, 1997 600 11.0000 January 31, 1997 10,000 11.0000 February 4, 1997 37,500 11.0000 February 19, 1997 51,175 12.0625 Repurchased shares are considered treasury shares and will be utilized for general corporate and other purposes, including the issuance of shares in connection with stock option plans, the management stock bonus plan, and other purposes. (16) Financial Instruments With Off-Balance-Sheet Risk The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying balance sheets. The contract amounts of these instruments reflect the extent of involvement by the Company. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. (Continued) 44 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The contract amount of these financial instruments at June 30, 1997 and 1996 is as follows: Contract amount --------------------------- 1997 1996 - ----------------------------------------------------------------------------- Financial instruments whose contract amount represents risk: Commitments to extend credit $ 402,000 751,400 ============================================================================= 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. (17) Fair Value of Financial Instruments SFAS No. 107, Disclosures about Fair Values of Financial Instruments, requires disclosure of estimated fair values of the Company's financial instruments, including assets, liabilities, and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of June 30, 1997 and 1996, based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based only on existing financial instruments without attempting to estimate the value of anticipated future business or the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates. (Continued) 45 REDWOOD FINANCIAL, INC. AND SUBSIDIARY The estimated fair value of the Company's financial instruments are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.
June 30 ------------------------------------------------------------------------------------------ 1997 1996 -------------------------------------------- -------------------------------------------- Carrying Estimated Contract Carrying Estimated Contract amount fair value amount amount fair value amount -------------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $ 763,792 763,792 2,873,163 2,873,163 Securities held to maturity 24,269,460 24,481,726 31,094,218 30,964,830 Securities available for sale 15,131,002 15,131,002 0 0 Loans receivable, net 20,766,539 21,248,657 16,513,727 16,949,767 Stock in Federal Home Loan Bank of Des Moines, at cost 333,500 333,500 333,500 333,500 Accrued interest receivable 613,357 613,357 553,856 553,856 Financial liabilities: Deposits 45,687,590 45,864,695 37,858,285 38,010,952 Federal Home Loan Bank advances 3,500,000 3,496,847 0 0 Accrued interest payable 405,623 405,623 184,244 184,244 Off-balance sheet financial instruments: Commitments to extend credit 0 8,479 402,000 0 13,466 751,400
Cash and Cash Equivalents The carrying amount of cash and cash equivalents approximates their fair value. Securities Held to Maturity and Securities Available for Sale The fair values of securities held to maturity and securities available for sale are based upon quoted market prices. (Continued) 46 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Loans Receivable, Net The fair value of the loan receivable portfolio, with the exception of the 1 to 4 family adjustable rate mortgage loan portfolio and the consumer, agriculture, commercial and commercial real estate portfolios, was calculated by comparison of the loan portfolio to observed secondary market prices for loans and mortgage-backed securities with similar characteristics. For consumer, commercial, and commercial real estate loans, the fair value was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect credit and interest rate risk inherent in each loan portfolio. The fair value of the 1 to 4 family adjustable rate mortgage loan portfolio was estimated using the carrying value of the portfolio due to its repricing frequency and comparison to observed secondary market loans with similar characteristics. Stock in Federal Home Loan Bank of Des Moines, at Cost The carrying amount of FHLB stock approximates its fair value. 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, 1997 and 1996 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. Federal Home Loan Bank Advances The fair value of FHLB advances is based upon the discounted value of contractual cash flows using as discount rates the rates offered by the FHLB on advances with maturities similar to the remaining maturities of the existing advances. Accrued Interest Payable The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature. (Continued) 47 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Commitments to Extend Credit The fair value of commitments to extend credit is estimated based on comparison of the committed rate to observed secondary market rates and prices and adjusted for expected fallout. (18) Stock Conversion The Association converted from a federally-chartered mutual savings and loan association to a federally-chartered stock savings and loan association pursuant to its Plan of Conversion. The conversion was effected on July 7, 1995, and resulted in the issuance of 1,125,000 shares of common stock (par value $0.10) at $8.00 per share for a gross sales price of $9,000,000. Costs related to conversion (primarily underwriters' commission, printing, and professional fees) aggregated $450,639 and were deducted to arrive at the net proceeds of $8,549,361. The Company established an employee stock ownership trust which purchased 82,748 shares of common stock of the Company at the issuance price of $8.00 per share from funds borrowed from the Company. Funds held for stock subscriptions in excess of common stock issued were refunded to the subscribers at the time of conversion . Subsequent to conversion, savings account holders and borrowers do not have voting rights in the Association. Voting rights of the Association are vested exclusively with the Company. For the purpose of granting eligible members of the Association a priority in the event of future liquidation, the Association, at the time of conversion, established a liquidation account equal to its regulatory capital as of December 31, 1994. In the event (and only in such event) of future liquidation of the converted Association, an eligible savings accountholder who continues to maintain a savings account shall be entitled to receive a distribution from the liquidation account, in the proportionate amount of the then-current adjusted balance of the savings deposits then held, before any distributions may be made with respect to capital stock. Present regulations provide that the Association may not declare or pay a cash dividend on or repurchase any of its capital stock if the result thereof would be to reduce the regulatory capital of the Association below the amount required for the liquidation account or the regulatory capital requirement. Further, any dividend declared or paid on, or repurchase of, the Association's capital stock shall be in compliance with the rules and regulations of the OTS, or other applicable regulations. (19) 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, 1997 and 1996. (Continued) 48 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Condensed Balance Sheet
June 30, June 30, Assets 1997 1996 - -------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 2,122,649 101,019 Securities held to maturity 1,274,607 2,488,579 Loans receivable, net 500,269 475,358 Investment in subsidiary 8,372,837 10,040,701 Accrued interest receivable 35,479 66,784 Other assets 36,192 0 - -------------------------------------------------------------------------------------------------------- Total assets $ 12,342,033 13,172,441 ======================================================================================================== Liabilities and Stockholders Equity - -------------------------------------------------------------------------------------------------------- Accrued expenses and other liabilities 0 15,405 - -------------------------------------------------------------------------------------------------------- Total liabilities 0 15,405 - -------------------------------------------------------------------------------------------------------- Common stock 112,500 112,500 Additional paid-in capital 8,467,833 8,457,017 Retained earnings, subject to certain restrictions 6,369,591 6,118,091 Unearned employee stock ownership plan shares (529,504) (595,744) Net unrealized loss on securities available for sale (3,135) 0 Unearned management stock bonus plan shares (306,797) (393,422) Treasury stock, at cost (1,768,455) (541,406) - -------------------------------------------------------------------------------------------------------- Total stockholders equity 12,342,033 13,157,036 - -------------------------------------------------------------------------------------------------------- Total liabilities and stockholders equity $ 12,342,033 13,172,441 ========================================================================================================
Condensed Statement of Income
1997 1996 - -------------------------------------------------------------------------------------------------------- Gain on sale of investments available for sale $ 2,863 0 Interest income 201,007 200,739 Equity in earnings of subsidiary 335,271 433,884 Compensation and employee benefits (171,275) (116,725) Other (193,533) (62,936) - -------------------------------------------------------------------------------------------------------- Earnings before income tax benefit 174,333 454,962 Income tax benefit 77,167 7,470 - -------------------------------------------------------------------------------------------------------- Net earnings $ 251,500 462,432 ========================================================================================================
(Continued) 49 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Condensed Statement of Cash Flows
12 months ended June 30, ---------------------------- 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ Operating activities: Net earnings $ 251,500 462,432 Adjustments to reconcile net earnings to cash provided by operating activities: Equity in earnings of subsidiary (335,271) (433,884) Amortization of premiums (discounts), net (1,028) (1,092) (Increase) decrease in accrued interest receivable 31,305 (66,784) Gain on sale of investments available for sale (2,863) 0 Amortization of unearned ESOP shares 66,240 66,240 Earned ESOP priced above original cost 10,816 10,781 Earned management stock bonus plan shares 86,625 39,703 Increase (decrease) in accrued expenses and other liabilities (15,405) 15,405 Increase in other assets (36,192) (7,470) - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 55,727 85,331 - ----------------------------------------------------------------------------------------------------------------------------- Investing activities: Proceeds from maturities of investment securities held to maturity 1,215,000 0 Purchases of investment securities available for sale (996,513) (2,487,487) Proceeds from sales of investment securities available for sale 999,376 0 Increase in loans receivable, net (24,911) (475,358) - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by investing activities 1,192,952 (2,962,845) - ----------------------------------------------------------------------------------------------------------------------------- Financing activities: Adoption of ESOP 0 (661,984) Dividend from Association 2,000,000 0 Proceeds from sale of common stock 0 8,549,361 Repurchase of common stock (1,227,049) (965,156) Purchase of Association stock 0 (3,943,688) - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 772,951 2,978,533 - ----------------------------------------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 2,021,630 101,019 Cash and cash equivalents, beginning of year 101,019 0 - ----------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 2,122,649 101,019 =============================================================================================================================
(Continued) 50 REDWOOD FINANCIAL, INC. AND SUBSIDIARY (20) Quarterly Financial Data (Unaudited) Summarized quarterly financial data for fiscal 1997 are as follows:
Three months ended ----------------------------------------------------- June 30, March 31, December 31, September 30, Selected Operations Data 1997 1997 1996 1996 - -------------------------------------------------------------------------------------------------------- Interest income $1,078,635 972,178 909,043 909,761 Interest expense 623,269 553,189 502,095 507,196 - -------------------------------------------------------------------------------------------------------- Net interest income 455,366 418,989 406,948 402,565 Provision for loan losses 0 0 0 0 Non-interest income 13,910 14,923 12,712 14,933 Non-interest expense 258,223 232,074 366,713 495,168 Income tax expense (benefit) 84,566 74,986 17,239 (40,123) - -------------------------------------------------------------------------------------------------------- Net earnings (loss) $ 126,487 126,852 35,708 (37,547) ======================================================================================================== Earnings per common share $ .13 .13 .04 (.04)
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
(Continued) 51 REDWOOD FINANCIAL, INC. AND SUBSIDIARY Selected Financial June 30, March 31, December 31, September 30, Condition Data 1997 1997 1996 1996 - ----------------------------------------------------------------------------- Total assets $62,168,916 55,730,838 53,526,359 51,058,275 Securities 39,400,462 35,592,367 26,318,389 30,081,878 Net loans 20,766,539 18,878,902 18,171,579 17,229,712 Deposits 46,093,213 42,561,895 40,077,112 37,410,421 Stockholders equity 12,342,033 12,109,742 13,238,271 13,160,293 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 52 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 Tony Acker Chief Financial Officer ---------------------------------------- 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, 1997 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 30, 1997 at 10:00 a.m. at the office of the Company at 301 South Washington Street, Redwood Falls, Minnesota. EX-23 5 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 8, 1997, relating to the consolidated balance sheets of Redwood Financial, Inc. and subsidiary as of June 30, 1997 and 1996, 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, 1997, which report appears in the June 30, 1997 annual report on Form 10-KSB of Redwood Financial, Inc. /s/KPMG Peat Marwick LLP September 26, 1997 EX-27 6 FDS DEF14A
9 1 YEAR JUN-30-1997 JUN-30-1997 15,314 748,478 0 0 15,131,002 24,269,460 24,481,726 20,766,539 213,034 62,168,916 46,093,213 2,500,000 233,670 1,000,000 0 0 112,500 12,229,533 62,168,916 1,563,605 2,132,737 173,275 3,869,617 2,147,264 2,185,749 1,683,868 0 2,863 1,352,178 388,168 388,168 0 0 251,500 .26 .26 3.11 0 120,902 0 120,902 213,034 0 0 213,034 213,034 0 213,034
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