Item 1. Description of Business
General.
Sobieski Bancorp, Inc.
Sobieski Bancorp, Inc. (the "Company") was incorporated under the laws of the State of Delaware in December 1994 by authorization of the Board of Directors of Sobieski Federal Savings and Loan Association of South Bend ("Sobieski Federal" or the "Association") for the purpose of becoming a unitary savings and loan holding company that acquired all of the outstanding stock of Sobieski Federal issued upon the conversion of Sobieski Federal from the mutual to the stock form of ownership (the "Conversion").
As a Delaware corporation, the Company is authorized to engage in any activity permitted by Delaware General Corporation Law. The Company is a unitary savings and loan holding company. Through the unitary holding company structure, it is possible to expand the size and scope of the financial services offered beyond those currently offered by the Association. The holding company structure also provides the Company with greater flexibility than the Association would have to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions or mergers of both mutual and stock thrift institutions as well as other companies. Although there are no current arrangements, understandings or agreements regarding any such acquisition, the Company is in a position to take advantage of any favorable acquisition opportunities that may arise. Future activities of the Company, other than the continuing operations of Sobieski Federal, will be funded through the portion of the net proceeds of the stock conversion retained by the Company, dividends from Sobieski Federal, principal and interest collections on loans purchased from Sobieski Federal and through borrowings from third parties. See "Regulation - Holding Company Regulation" and "-Federal and State Taxation." Activities of the Company may also be funded through sales of additional securities or income generated by other activities of the Company. At this time, there are no plans regarding such activities.
At June 30, 1997, the Company had assets of approximately $81.7 million, deposits of approximately $59.4 million and stockholders' equity of approximately $12.4 million.
The executive office of the Company is located at 2930 West Cleveland Road, South Bend, Indiana 46628, telephone (219) 271- 8300.
Sobieski Federal Savings and Loan Association of South Bend
Sobieski Federal is a federally chartered mutual savings and loan association headquartered in South Bend, Indiana. Sobieski Federal was originally chartered under the laws of the State of Indiana in 1893 and converted to a federally chartered mutual savings and loan association in 1936. Its deposits are insured up to the maximum allowable amount by the Federal Deposit Insurance Corporation (the "FDIC") under the Savings Association Insurance Fund (the "SAIF"). Through its main office and two branch offices, Sobieski Federal serves communities located in St. Joseph County, Indiana.
Sobieski Federal has been, and intends to continue to be, a community-oriented financial institution offering selected financial products and services to meet the needs of the communities it serves. The Association attracts deposits from the general public and uses such deposits, together with other funds, to originate primarily one-to-four family, fixed-rate and variable-rate residential mortgage loans for retention in its portfolio. In addition, the Association originates a limited number of construction loans, consumer loan, and real estate- backed small business commercial loans. During both fiscal 1997 and 1996, the Association purchased participation interests in commercial loans funded primarily by advances from the Federal Home Loan Bank ("FHLB") of Indianapolis.
Forward-Looking Statements
When used in this Form 10-KSB and in future filings by the Company with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or shareholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among other things, changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward- looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The Company does not undertake-and specifically declines any obligation-to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Lending Activities
General. The Association has historically originated primarily fixed-rate one- to four- family mortgage loans for retention in its portfolio. Since September 1994, the Association has begun to originate adjustable-rate mortgage loans for retention in its portfolio. However, in response to customer demand, the Association continues to originate fixed rate-rate mortgage loans. Such loans are primarily for terms of up to 20 years.
While the Association primarily focuses its lending activities on the origination of loans secured by first mortgages on owner-occupied one-to-four family residences, to a much lesser extent, it also originates construction and consumer loans. During fiscal 1997 and 1996 the Association purchased participation interests in commercial loans funded with short- term advances from the FHLB. The Association has in the past purchased participations of the Small Business Administration (the "SBA") and originated a limited number of commercial real estate loans. Substantially all of the Association's loans are originated in its market area. At June 30, 1997, the Association's net loan portfolio totaled $61.1 million.
The loan committee, comprised of three members of the Board on a three-month rotating basis, has authority to approve loans up to $250,000; any loans over $250,000 must be approved by the entire Board of Directors.
Under regulations of the Office of Thrift Supervision (the "OTS"), the Association's loans-to-one-borrower limit is generally limited to the greater of 15% of unimpaired capital and surplus or $500,000. See "Regulation - Federal Regulation of Savings Associations." At June 30, 1997, the maximum amount which the Association could loan to any one borrower and the borrower's related entities was $1,554,000. At June 30, 1997, the Association had no loans with aggregate outstanding balances in excess of this amount. At that date, the Association's largest lending relationship to a single borrower or group of related borrowers totaled $1,399,000.
All of the Association's lending is subject to its written underwriting standards and loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and property valuations. Properties securing real estate loans made by Sobieski Federal are generally appraised by Board-approved independent appraisers. In the loan approval process, Sobieski Federal assesses the borrower's ability to repay the loan, the adequacy of the proposed collateral, the employment stability of the borrower and the credit worthiness of the borrower.
The Association requires evidence of marketable title and lien position or appropriate title insurance (except on certain home equity loans) on all loans secured by real property. The Association also requires fire and extended coverage casualty insurance in amounts at least equal to the lesser of the principal amount of the loan or the value of improvements on the property, depending on the type of loan. As required by federal regulations, the Association also requires flood insurance to protect the property securing its interest if property is located in a designated flood area.
Loan Portfolio Composition. The following information presents the composition of the Company's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowances for loan losses) as of the dates indicated.
The following table shows the composition of the Company's loan portfolio by fixed- and adjustable-rate loans at the dates indicated.
The following schedule illustrates the amortization schedule by contractual maturity of the Company's loan portfolio at June 30, 1997. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does reflect scheduled principal amortization but does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
(1) Includes demand loans, loans having no stated maturity and overdraft loans. (2) Represents construction/permanent loans. The total amount of loans due after June 30, 1998 that have predetermined interest rates is $49.6 million. One- to-Four Family Residential Mortgage Lending. Residential loan originations are generated by the Association's marketing efforts, its present customers, walk-in customers and referrals from real estate brokers. Historically, the Association has focused its lending efforts primarily on the origination of fixed-rate loans secured by first mortgages on owner-occupied, single-family residences in its market area. In September 1994, the Association began to originate adjustable rate mortgage ("ARM") loans. At June 30, 1997, the Company's one-to-four family residential mortgage loan portfolio totaled $55.7 million, or 89.5% of the Company's gross loan portfolio.
The Association currently offers fixed-rate and ARM loans. For the year ended June 30, 1997, the Association originated $15.1 million of one-to-four family real estate loans. At June 30, 1997, the Association had $4.7 million of adjustable-rate mortgage loans, and $51.0 million of fixed-rate mortgage residential loans.
The Association currently originates fixed-rate loans with terms to maturity up to 30 years. Interest rates charged on these fixed-rate loans are priced on a regular basis according to market conditions. The Association has recently begun to offer adjustable-rate mortgage loans at rates and on terms determined in accordance with market and competitive factors. The Association currently originates one-year ARM loans, with up to 30-year amortization schedule, with a stated interest rate margin over the one-year Constant Maturity Treasury Index. These loans provide for a 2.0% maximum annual cap and a cap over the life of the loan of 6.0%. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as is the Association's cost of funds. Currently, all ARM loans originated provide for an interest rate floor below which the interest rate charged may not fall.
Borrowers with adjustable-rate mortgage loans are qualified at the fully indexed rate. Adjustable-rate loans decrease the risk to the Association associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower may rise to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the market value of the underlying property may be adversely affected by higher interest rates.
Currently, Sobieski Federal will loan up to 85% of the appraised value of the security property without private mortgage insurance ("PMI") on owner occupied one- to-four family loans and up to 95% with PMI on the sale price of such security properties. Residential loans do not include prepayment penalties, are not assumable and do not produce negative amortization. Real estate loans originated by the Association contain a "due on sale" clause allowing the Association to declare the unpaid principal balance due and payable upon the sale of the security property.
The loans currently originated by the Association are typically underwritten and documented pursuant to the guidelines of the Federal Home Loan Mortgage Corporation ("FHLMC"). The Association retains all loans originated in its portfolio.
The Association also originates a limited amount of second mortgage and home equity lines of credit. At June 30, 1997, the Association's second mortgage loans and home equity loans totaled $860,000 and $1.1 million, respectively. Second mortgage loans have fixed or variable rates of interest and have terms up to 15 years. Home equity loans have adjustable interest rates and terms of up to 12 years. These loans are underwritten using similar guidelines as for single family mortgage lending.
Residential Construction Lending. To a limited extent, the Association also originates loans for the construction of one- to- four family residences. At June 30, 1997, the Association's construction loan portfolio totaled $869,000, or 1.4% of its gross loan portfolio. As of that date, all of these loans were secured by property located within the Association's market area.
All of the construction loans to individuals for their residences are structured to be converted to permanent loans at the end of the construction phase, which typically runs from four to six months. These construction loans have rates and terms comparable to one- to-four family loans offered by the Association, except that during the construction phase, the borrower pays interest only. The maximum loan-to-value ratio of owner occupied single-family construction loans is 85% without PMI and 95% with PMI. Residential construction loans are generally underwritten pursuant to the same guidelines for originating permanent residential loans.
Construction loans are obtained primarily from walk-in customers and builder and realtor referrals. The application process includes submission to the Association of plans and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value or the cost of construction (land plus building).
The Association's construction loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. The Association periodically reviews the progress of the underlying dwelling before disbursements are made. Nevertheless, construction lending is generally considered to involve a higher level of credit risk than one- to four-family residential lending since the risk of loss on construction loans is dependent largely upon the accuracy of the initial estimate of the individual property's value upon completion of the project and the estimated cost (including interest) of the project.
Commercial Real Estate Lending. Commercial real estate loans at June 30, 1997 totaled $2.5 million. These loans consist of participation certificates guaranteed by the SBA. As of June 30, 1997, all of these participation certificates were performing in accordance with their terms and Sobieski Federal has not experienced any losses on these loans.
Consumer and Commercial Business Lending. To a much lesser extent, Sobieski Federal has engaged in both consumer and commercial business lending.
Consumer loans at June 30, 1997 totaled $147,000, or approximately .2% of its gross loan portfolio. These loans consisted of share loans secured by deposit accounts. Even though some of these loans are currently delinquent ($22,000 or 15.0% of total consumer loans at June 30, 1997), they do not entail great risk because they are fully secured by savings deposit accounts with balances exceeding the amount of the loan. Management believes the delinquencies primarily result from timing factors wherein borrowers are waiting for certificates to mature to repay the loans. Historically, losses from consumer loans have been non-existent.
Commercial business loans at June 30, 1997 totaled $3.1 million or 4.9% of the Company's gross loan portfolio. These loans are purchased participations originated by other financial institutions. The loans are secured by collateral consisting of autos, trucks and an airplane. All of these loans were performing in accordance with their terms at June 30, 1997. See "Business-Asset Quality".
Originations and Purchases of Loan and Mortgage-Backed Securities
Loan originations are developed from continuing business with depositors and borrowers, soliciting realtors, builders, walk-in customers and small business entities.
While the Association originates both adjustable-rate and fixed-rate loans, its ability to originate loans to a certain extent is dependent upon the relative customer demand for loans in its market, which is affected by the interest rate environment, among other factors. For the year ended June 30, 1997, the Association originated $16.2 million in loans. Originations consisted of $15.1 million in one-to-four family real estate loans, $22,000 of consumer loans and $1.1 million in nonresidential real estate loans.
Loan originations during the year ended June 30, 1997 were significantly higher than the prior year. The Association believes the increase is attributable to the lower interest level of refinancing as customers sought to take advantage of historically low interest rates on fixed rate loans. The Association retains its loan originations in its portfolio and has followed a policy of not selling loan originations in the secondary market.
During fiscal 1997, the Association purchased $3.0 million of participation interests in commercial loans funded by advances from the FHLB. These purchases were made to increase income, increase liquidity spread, and assist in short-term interest rate risk management.
In order to supplement its lending activities, the Association invests funds in mortgage-backed securities. See Notes B and C of the Notes to Consolidated Financial Statements. Virtually all of the mortgage-backed securities purchased by the Association have adjustable interest rate features. See "Business - Investment Activities."
The following table shows the loan origination and purchase activities of the Association for the periods indicated.
Asset Quality
General. When a borrower fails to make a required payment on a loan, the Association attempts to cause the delinquency to be cured by contacting the borrower. In the case of loans secured by real estate, a reminder notice is sent to the borrower on all loans over 15 days delinquent. When a loan becomes 15 days delinquent, late charges are assessed and a notice of late charges is sent to the borrower. An additional late notice is sent to the borrower if the delinquency is not cured within 30 days of the required payment date. If the loan becomes 60 days delinquent and the borrower has not attempted to contact the Association to arrange an acceptable plan to bring the loan current, the borrower is contacted by telephone. If the borrower contacts the Association with a reasonable explanation for the delinquency, the Association generally will attempt to reach workable accommodations with the borrower to bring the loan current. All proposed workout arrangements are evaluated on a case by case basis, based on the best judgment of the Association's management, considering, among other things, the borrower's past credit history, current financial status, cooperativeness, future prospects and the reason for the delinquency. If the loan is in excess of 90 days delinquent, the loan will be referred to the Association's legal counsel for collection. In all cases, if the Association believes that its collateral is at risk and added delay would place the collectibility of the balance of the loan in further question, management may refer loans for collection even sooner than the 90 days described below.
When a loan becomes delinquent 90 days or more, the Association will place the loan on non-accrual status. The loan will remain on a non-accrual status as long as the loan is 90 days delinquent.
The following table sets forth the Association's loan delinquencies by type, by amount and by percentage of type as of June 30, 1997
Non-Performing Assets. The table below sets forth the amounts and categories of non-performing assets in the Association's loan portfolio. Loans are placed on non-accrual status when the collection of principal and/or interest becomes doubtful. Foreclosed assets include assets acquired in settlement of loans. The Association had no accruing loans more than 90 days delinquent at the dates shown.
For the year ended June 30, 1997, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $8,000. At June 30, 1997, the Association had $126,000 of non- accruing loans consisting of four one-to-four family delinquent loans and one consumer loan.
Other Loans of Concern. At June 30, 1997, there were no loans not included in the table or discussed above where known information about the possible credit problems of borrowers caused management to have doubts as to the ability of the borrower to comply with present loan repayment terms and which may result in disclosure of such loans in the future.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the OTS to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard" with the added characteristic that the weaknesses present make "collection or liquidation in full" on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
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 recognized 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's 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 regulatory authorities, who may order the establishment of addition general or specific loss allowances.
In connection with the filing of its periodic reports with the OTS and in accordance with its classification of assets policy, the Association regularly reviews problem loans and real estate acquired through foreclosure to determine whether such assets require classification in accordance with applicable regulations. On the basis of management's review of its assets, at June 30, 1997, the Association had classified a total of $126,000 of its assets as substandard, $0 as doubtful, and $0 as loss. At June 30, 1997, total classified assets comprised $126,000 or 1.4% of the Association's capital, or 0.17% of the Association's total assets.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risk inherent in its loan portfolio and changes in the nature and volume of its loan activity, including those loans which are being specifically monitored by management. Such evaluation, which includes a review of loans for which full collectibility may not be reasonably assured, considers among other matters, the loan classifications discussed above, the estimated fair value of the underlying collateral, economic conditions, historical loan loss experience, the amount of loans outstanding and other factors that warrant recognition in providing for an adequate loan loss allowance. A significant factor considered in the unallocated allowance was the historically low level of loans other than one- to-four family real estate loans. Management recognizes that as loan growth continues additional provisions to the allowance may be required.
Real estate properties acquired through foreclosure are recorded at the lower of cost or fair value minus estimated cost to sell. If fair value at the date of foreclosure is lower than the balance of the related loan, the difference will be charged- off to the allowance for loan losses at the time of transfer. Valuations are periodically updated by management and if the value declines, a specific provisions for losses on such property is established by a charge to operations.
Although management believes that it uses the best information available to determine the allowance, unforeseen market conditions could result in adjustments and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. Future additions to the Association's allowance for loan losses will be the result of periodic loan, property and collateral reviews and thus cannot be predicted in advance. In addition, federal regulatory agencies, as an integral part of the examination process, periodically review the Association's allowance for loan losses. Such agencies may require the Association to recognize additions to the allowance level based upon their judgment of the information available to them at the time of their examination. At June 30, 1997, the Association had a total allowance for losses on loans of $200,000 representing 159% of total non-performing loans and .21% of the Association's loans, net. See Note D of the Notes to Consolidated Financial Statements.
The following table sets forth an analysis of the Association's allowance for loan losses.
(1) Excludes net gain on sale of real estate owned in the amount of $8,611 for the year ended June 30, 1995. These gains were included in other operating expenses or other noninterest income. The distribution of the Company's allowance for losses on loans at the dates indicated is summarized as follows:
(1) Total loans represent the amount before deducting the loan loss allowance.
Investment Activities
General. Sobieski Federal must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, the Association has generally maintained liquid assets at levels above the minimum requirements imposed by the OTS regulations and at levels believed adequate to meet the requirements of normal operations, including repayments of maturing debt and potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. At June 30, 1997, the Association's liquidity ratio (liquid assets as a percentage of net withdrawable savings deposits and current borrowings) was 6.07%.
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.
Generally, the investment policy of the Association, as established by the Board of Directors, is to invest funds among various categories of investments and maturities based upon the Association's liquidity needs, asset/liability management policies, investment quality, marketability and performance objectives. The Investment Committee consists of two outside directors, Robert J. Urbanski and Joseph F. Nagy, plus President and Chief Executive Officer Thomas F. Gruber and Vice President of Finance Arthur Skale. Subject to the policies established by the Board of Directors, President Gruber and Vice President Skale are authorized to purchase and sell securities. All securities transactions are disclosed to the Board of Directors at their next regular meeting.
Mortgage-Backed Securities. The Association purchases mortgage-backed securities to supplement residential loan production and as part of its asset/liability strategy. The type of securities purchased is based upon the Association's asset/liability management strategy and balance sheet objectives. For instance, substantially all of the mortgage-backed investments purchased by the Association over the last several years have had adjustable rates of interest. At June 30, 1997, the amortized cost of the Association's mortgage-backed securities was $13.7 million and the market value of these mortgage-backed securities was $13.4 million at that date.
At June 30, 1997, $11.9 million or 87% of the Association's mortgage-backed securities have been classified as held-to- maturity and, accordingly, are included in its financial statements at amortized cost. Mortgage-backed securities with an amortized cost of $1.8 million have been classified as available- for-sale and are included in the financial statements at fair value. The Association's investment securities portfolio was $2.3 million at June 30, 1997. Of that amount, $1.3 million or 56% was classified as available-for-sale and $1.0 million or 44% was classified as held-to-maturity. See Note C of the Notes to Consolidated Financial Statements for additional information regarding the amortized cost and approximate market value of the Association's mortgage-backed securities as of June 30, 1997.
As of June 30, 1997, all of the Association's mortgage- backed securities were backed by government sponsored agency programs. Accordingly, management believes that the Association's mortgage-backed securities are generally resistant to credit problems.
The Association's mortgage-backed securities portfolio consists of securities issued under government-sponsored agency programs, including those of the Federal National Mortgage Association ("FNMA"), FHLMC and the Government National Mortgage Association ("GNMA"). The FNMA, FHLMC and GNMA certificates are modified pass-through mortgage-backed securities that represent undivided interests in underlying pools of fixed-rate, or certain types of adjustable-rate, predominantly single-family and, to a lesser extent, multi-family residential mortgages issued by those government-sponsored entities. 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. FNMA and FHLMC generally provide the certificate holder a guarantee of timely payments of interest and ultimate collection of principal, whether or not collected. GNMA's guarantee to the holder is timely payments of principal and interest, backed by the full faith and credit of the U.S. Government.
Mortgage-backed securities generally yield less than the loans that underlie such securities, because of the cost of payment guarantees or credit enhancements that reduce credit risk to holders. Since federal agency mortgage-backed securities generally carry a yield approximately 50 to 100 basis points below that of the corresponding type of residential loan (due to the implied federal agency guarantee fee and the retention of a servicing spread by the loan servicer), in the event that the proportion of the Association's assets consisting of mortgage- backed investments increase in the future, the Association's assets yields would be adversely affected. Mortgage-backed securities are also more liquid than individual mortgage loans and may be used to collateralize obligations of the Association. In general, mortgage-backed securities issued or guaranteed by FNMA and FHLMC are weighted at no more than 20% for risk-based capital purposes, and mortgage-backed securities issued or guaranteed by GNMA are weighted at 0% for risk-based capital purposes, compared to an assigned risk weighing of 50% to 100% for whole residential mortgage loans.
While mortgage-backed securities carry a reduced credit risk as compared to whole loans, such securities remain subject to the risk that a fluctuating interest rate environment, along with other factors such as the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of such mortgage loans and so affect to the prepayment speed, and value, of such securities. Mortgage-backed securities involve a risk that actual prepayments will differ from estimated prepayments over the life of the security which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby reducing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities. In addition, the market value of such securities may be adversely affected by changes in interest rates. The adjustable rate and/or short maturity of the Association's portfolio is designed to minimize that risk.
Investment Securities and Other Interest-Earning Assets. At June 30, 1997, Sobieski Federal's interest-bearing deposits with financial institutions totaled $94,000, or .1% of total assets, and its investment securities, consisting of U.S. Treasury obligations totaled $2.3 million, or 2.8% of total assets. In addition, as of such date, the Association had a $636,000 investment in FHLB stock, satisfying its requirement for membership in the FHLB of Indianapolis. It is the Association's general policy to purchase securities which are U.S. Government securities or federal agency obligations or other issues that are rated investment grade. At June 30, 1997, the average term to maturity or repricing of the securities portfolio (excluding FHLB stock) was less than two years.
The Association's investment securities portfolio at June 30, 1997 contained neither tax-exempt securities nor securities of any issuer with an aggregate book value in excess of 10% of the Association's equity capital, excluding those issued by the United State Government or its agencies.
The following table sets forth the contractual maturities of the Association's mortgage-backed securities at June 30, 1997.
The following table sets forth the composition of the Association's investment and mortgage-backed securities at the dates indicated.
(1)The average remaining life of U.S. government securities June 30, 1997 was less than two years.
The composition and maturities of the investment securities portfolio, excluding FHLB stock, are indicated in the following table.
Sources of Funds
General. The Association's primary sources of funds are deposits, payment of principal and interest on loans, interest earned on mortgage-backed securities, investment securities, interest earned on interest-bearing deposits with other financial institutions, and other funds provided from operations.
Deposits. Sobieski Federal offers a variety of deposit accounts having a wide range of interest rates and terms. The Association's deposits consist of passbook, NOW, checking, money market deposit and certificate accounts. The certificate accounts currently range in terms from 91 days to four years.
The Association relies primarily on advertising (including television, radio, and newspaper), competitive pricing policies and customer service to attract and retain these deposits. Sobieski Federal solicits deposits from its market area only, does not use brokers to obtain deposits and currently, does not engage in any type of premium, gift or promotional programs beyond the advertising vehicles mentioned above. The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition.
The Association has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. The Association endeavors to manage the pricing of its deposits in keeping with its asset/liability management and profitability objectives. The ability of the Association to attract and maintain savings accounts and certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.
The following table sets forth the savings flows at the Association during the periods indicated.
(1) Includes interest credited to passbook, NOW and money market deposit accounts, but not certificates of deposit.
The following table set forth the dollar amount of savings deposits in the various types of deposit programs offered by the Association at the dates indicated.
The following table shows rate and maturity information for the Association's certificates of deposit as of June 30, 1997.
The following table indicates the amount of the Association's certificates of deposit by time remaining until maturity as of June 30, 1997.
Maturity (In Thousands) 3 months Over 3 to Over 6 to Over 12 or less 6 months 12 months months Total
Certificates of deposit less than $100,000 $ 6,266 $4,901 $6,647 $18,119 $35,933 Certificates of deposit of $100,000 or more 116 501 442 1,177 2,236 Total certificates of deposit ............. $ 6,382 $5,402 $7,089 $19,296 $38,169
Borrowings. Although deposits are the Association's primary source of funds, the Association may utilize FHLB advances or other borrowings to support lending activities and to assist the Association's asset/liability management strategy when they are a less costly source of funds and may be invested at a positive interest rate spread or when the Association desires additional capacity to fund loan demand. At June 30, 1997, the Association had borrowings of $9.5 million.
Service Corporation Activities
As a federally chartered savings bank, Sobieski Federal is permitted by OTS regulations to invest up to 2% of its assets, or approximately $1.5 million in the stock of, or loans to, service corporation subsidiaries. Sobieski Federal may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes and up to 50% of its total capital in conforming loans to service corporations in which it owns more than 10% of the capital stock. In addition to investments in service corporations, federal associations are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which a federal association may engage in directly. At June 30, 1997, Sobieski Federal had no active service corporation activities.
Competition
Sobieski Federal faces strong competition, both in originating real estate loans and in attracting deposits. Competition in originating real estate loans comes primarily from commercial banks, savings institutions, mortgage bankers and credit unions located in the Association's market area. Commercial banks, savings institutions and credit unions provide vigorous competition in consumer lending. The Association competes for real estate and other loans principally on the basis of the quality of services it provides to borrowers, the interest rates and loan fees it charges, and the types of loans it originates. See "Business - Lending Activities."
The Association attracts all of its deposits through its retail banking offices, primarily from the communities in which those retail banking offices are located. Therefore, competition for those deposits is principally from commercial banks, savings banks, brokerage firms and credit unions located in these communities. The Association competes for these deposits by offering a variety of account alternatives at competitive rates and by providing convenient business hours, branch locations and interbranch deposit and withdrawal privileges.
Employees
At June 30, 1997, the Association had a total of 20 full- time and 4 part-time employees. The Association's employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
Executive Officers Who Are Not Directors
The business experience of each executive officer of the Association and the Holding Company who is not also a director is set forth below.
Marsha Nafrady, age 43, Ms. Nafrady is secretary/treasurer of the Association. In that capacity she oversees teller operations of the Cleveland main branch facility. Ms. Nafrady joined the Association in 1973.
Arthur Skale, age 56. Mr. Skale is currently Chief Financial Officer. In that capacity, he is responsible for the investment, cash management and budget planning of the Association. Mr. Skale joined the Association in 1997.
REGULATION
General
Sobieski Federal is a federally chartered savings and loan association, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, Sobieski Federal is subject to broad federal regulation and oversight extending to all its operations. The Association is a member of the FHLB of Indianapolis and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). As the savings and loan holding company of the Association, the Holding Company also is subject to federal regulation and oversight. The purpose of the regulation of the Holding Company and other holding companies is to protect subsidiary savings associations. The Association is a member of the Savings Association Insurance Fund ("SAIF") and the deposits of the Association are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Association.
Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document.
Federal Regulation of Savings Associations
The OTS has extensive authority over the operations of savings associations. As part of this authority, the Association is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last regular OTS and FDIC examinations of the Association were as of July 1995 and February 1997, respectively. Under agency scheduling guidelines, it is likely that another examination will be initiated in the near future. When there examinations are conducted by the OTS and the FDIC, the examiners may require the Association to provide for higher general or specific loan loss reserves.
All savings associations are subject to a semiannual assessment, based upon the savings association total assets to fund the operations of the OTS. The Association's OTS assessment for the fiscal year ended June 30, 1997 was $26,000.
The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Association and the Holding Company. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease- and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulation and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required.
In addition, the investment, lending and branching authority of the Association is prescribed by federal laws and regulations, and it is prohibited from engaging in any activities not permitted by such laws and regulations. For instance, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal associations in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings associations are also generally authorized to branch nationwide. The Association is in compliance with the noted restrictions.
The Association's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At June 30, 1997, the Association's lending limit under this restriction was $1,554,000. The Association is in compliance with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution which fails to comply with these standards must submit a compliance plan. A failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action.
Insurance of Accounts and Regulation by the FDIC
Sobieski Federal is a member of the SAIF, which is administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from 0% to .27% of deposits, based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk- weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy would pay the lowest premium while institutions that are less than adequately capitalized (i.e., core and Tier 1 risk- based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern would pay the highest premium. Risk classification of all insured institutions will be made by the FDIC for each semi- annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to the designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, under FDICIA, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.
As is the case with the SAIF, the FDIC is authorized to adjust the insurance premium rates for banks that are insured by the Bank Insurance Fund (the "BIF") of the FDIC in order to maintain the reserve ratio of the BIF at 1.25% of BIF insured deposits. The FDIC has revised the premium schedule of BIF insured institutions to provide a range of .04% to .31% of deposits in anticipation of the BIF achieving its statutory reserve ratio. As a result, such institutions generally will pay lower insurance premiums than SAIF insured institutions. The revisions became effective in the third quarter of 1996.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.
For the first six months of 1995, the assessment schedule for members of the Bank Insurance Fund ("BIF") and SAIF members ranged from .23% to .31% of deposits. As is the case with the SAIF, the FDIC is authorized to adjust the insurance premium rates for banks that are insured by the BIF of the FDIC in order to maintain the reserve ratio of the BIF at 1.25% of BIF insured deposits. As a result of the BIF reaching its statutory reserve ratio the FDIC revised the premium schedule for BIF insured institutions to provide a range of .04% to .31% of deposits. The revisions became effective in the third quarter of 1995. In addition, the BIF rates were further revised, effective January 1996, to provide a range of 0% to .27%. The SAIF rates, however, were not adjusted. At the time the FDIC revised the BIF premium schedule, it noted that, absent legislative action (as discussed below), the SAIF would not attain its designated reserve ratio until the year 2002. As a result, SAIF insured members would continue to be generally subject to higher deposit insurance premiums than BIF insured institutions until, all things being equal, the SAIF attained its required reserve ratio.
In order to eliminate this disparity and any competitive disadvantage between BIF and SAIF member institutions with respect to deposit insurance premiums, legislation to recapitalize the SAIF was enacted in September 1996. The legislation provides for a one-time assessment to be imposed on all deposits assessed at the SAIF rates, as of March 31, 1995, in order to recapitalize the SAIF. It also provides for the merger of the BIF and the SAIF on January 1, 1999 if no savings associations then exist. The special assessment rate has been established at .657% of deposits by the FDIC and the resulting assessment of $414,000 was paid in November 1996. This special assessment significantly increased noninterest expense and adversely affected the Association's results of operations for the year ended June 30, 1997. As a result of the special assessment, the Association's deposit insurance premiums were reduced to $37,000 based upon its current insured institutions. These premiums are subject to change in future periods. Effective January 1, 1997, SAIF members have the same risk-based schedule as BIF members. The Association has effectively paid no assessment for deposit insurance coverage commencing January 1, 1997.
All SAIF-insured institutions are required to pay an assessment for the repayment of interest on obligations issued by a federally chartered corporation to provide financing ("FICO") for resolving the thrift crisis in the 1980s, in an amount equal to 6.48 basis points for each $100 in domestic deposits. As a result of the recent legislation discussed above, BIF-insured institutions are also required to pay an assessment for the repayment of interest on the FICO bonds, in an amount equal to 1.52 basis points for each $100 in domestic deposits. The assessment on SAIF-insured institutions is expected to be reduced to 2.43 basis points for each $100 in domestic deposits no later than January 1, 2000, by which point BIF-insured institutions will participate fully in the FICO bond interest repayment. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature in 2017.
Regulatory Capital Requirements
Federally insured savings associations, such as the Association, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by- case basis.
The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained income, and certain noncumulative perpetual preferred stock and related income and excludes unrealized appreciation or depreciation on securities available for sale. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital. At June 30, 1997, the Association did not have any intangible assets.
The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. Under these regulations certain subsidiaries are consolidated for capital purposes and others are excluded from assets and capital. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks or engaged in certain other activities solely as agent for its customers are "includable" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership, including the assets of includable subsidiaries in which the association has a minority interest that is not consolidated for GAAP purposes. For excludable subsidiaries the debt and equity investments in such subsidiaries are deducted from assets and capital. At June 30, 1997, the Association did not have any active subsidiaries.
At June 30, 1997 the Association had tangible capital of $9.0 million, or 11.4% of adjusted total assets, which is approximately $7.8 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of adjusted total assets (as defined by regulation). Core capital generally consists of tangible capital plus certain intangible assets, including supervisory goodwill (which is phased-out over a five-year period) and a limited amount of purchased credit card relationships. As a result of the prompt corrective action provisions of FDICIA discussed below, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio. At June 30, 1997, the Association had no intangibles which were subject to these tests.
At June 30, 1997, the Association had core capital equal to $9.0 million, or 11.4% of adjusted total assets, which is $6.6 million above the minimum leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% or risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is authorized to require a savings association to maintain an additional amount of capital for concentration of credit risk and the risk of non-traditional activities. At June 30, 1997, the Association had no capital instruments that qualify as supplementary capital and $200,000 of general loss reserves, which was less than 1.25% of risk-weighted assets.
Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio (these items are excluded on a sliding scale through June 30, 1994, after which they must be excluded in their entirety) and reciprocal holdings of qualifying capital instruments. The Association had no such exclusions from capital and assets at June 30, 1997.
In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one-to four-family first lien mortgage loans not more than 90 days delinquent and having a loan to value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by the FNMA or FHLMC.
OTS regulations also require that every savings association with more than normal interest rate risk exposure to deduct from its total capital, for purposes of determining compliance with such requirement, an amount equal to 50% of its interest-rate risk exposure multiplied by the present value of its assets. This exposure is a measure of the potential decline in the net portfolio value of a savings association, greater than 2% of the present value of its assets, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline). Net portfolio value is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The rule will not become effective until the OTS evaluates the process by which savings associations may appeal an interest rate risk deduction determination. It is uncertain as to when this evaluation may be completed. Any savings association with less than $300 million in assets and a total capital ratio in excess of 12% is exempt from this requirement unless the OTS determine otherwise.
On June 30, 1997, the Association had risk-based capital of $9.2 million (including $9.0 million in core capital and $200,000 in general loss reserves) and risk-weighted assets of $33.32 million or total capital of 27.68% of risk-weighted assets. This amount was $6.56 million above the 8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances required, to take certain actions against associations that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions, discussed below, that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions mandated by FDICIA. These actions and restrictions include requiring the issuance of additional voting securities; limitations on asset growth; mandated asset reduction; changes in senior management; divestiture, merger or acquisition of the association; restrictions on executive compensation; and any other action the OTS deems appropriate. An association that becomes "critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, the OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized.
Any undercapitalized association is also subject to other possible enforcement actions by the OTS or the FDIC. Such actions could include a capital directive, a cease-and-desist order, civil money penalties, the establishment of restrictions on all aspects of the association's operations or the appointment of a receiver or conservator or a forced merger into another institution.
The OTS is also generally authorized to reclassify an association into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on Sobieski Federal may have a substantial adverse effect on the Association's operations and profitability and the value of the Common Stock purchased in the Conversion. Holding Company shareholders do not have preemptive rights, and therefore, if the Holding Company is directed by the OTS or the FDIC to issue additional shares of Common Stock, such issuance may result in the dilution in the percentage of ownership of the Holding Company of those persons who purchased shares in the Conversion.
Limitations on Dividends and Other Capital Distributions
OTS regulation impose various restrictions or requirements on associations with respect to their ability to pay dividends or make other distributions of capital. OTS regulations prohibit an association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion.
The OTS utilizes a three-tiered approach to permit associations, based on their capital level and supervisory condition, to make capital distributions which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account (see "--Regulatory Capital Requirements").
Generally, Tier 1 associations, which are associations that before and after the proposed distribution meet their fully phased-in capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or the amount authorized for a Tier 2 association. However, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination. The Association meets the requirements for a Tier 1 association and has not been notified of a need for more than normal supervision. Tier 2 associations, which are associations that before and after the proposed distribution meet their current minimum capital requirements, may make capital distributions of up to 75% of net income over the most recent four quarter period.
Tier 3 associations (which are associations that do not meet current minimum capital requirements) that propose to make any capital distribution and Tier 2 associations that propose to make a capital distribution in excess of the noted safe harbor level must obtain OTS approval prior to making such distributions. Tier 2 associations proposing to make a capital distribution within the safe harbor provisions and Tier 1 associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. As a subsidiary of the Holding Company, the Association will also be required to give the OTS 30 days' notice prior to declaring any dividend on its stock. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. See "-Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital distribution restrictions. The proposal eliminates the current tiered structure and the safe-harbor percentage limitations. Under the proposal a savings association may make a capital distribution without notice to the OTS (unless it is a subsidiary of a holding company) provided that it has a CAMEL 1 or 2 rating, is not in troubled condition (as defined by regulation) and would remain adequately capitalized (as defined in the OTS prompt corrective action regulations) following the proposed distribution. Savings associations that would remain adequately capitalized following the proposed distribution but do not meet the other noted requirements must notify the OTS 30 days prior to declaring a capital distribution. The OTS stated it will generally regard as permissible that amount of capital distributions that do not exceed 50% of the institution's excess regulatory capital plus net income to date during the calendar year. A savings association may not make a capital distribution without prior approval of the OTS and the FDIC if it is undercapitalized before, or as a result of, such a distribution. As under the current rule, the OTS may object to a capital distribution if it would constitute an unsafe or unsound practice. No assurance may be given as to whether or in what form the regulations may be adopted.
Liquidity
All savings associations, including Sobieski Federal, 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. For a discussion of what the Association includes in liquid assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the minimum liquid asset ratio is 5%.
In addition, short-term liquid assets (e.g., cash, certain time deposits, certain bankers acceptances and short-term United States Treasury obligations) currently must constitute at least 1% of the association's average daily balance of net withdrawable deposit accounts and current borrowings. Penalties may be imposed upon associations for violations of either liquid asset ratio requirement. At June 30, 1997, the Association was in compliance with both requirements, with an overall liquid asset ratio of 6.07% and a short-term liquid assets ratio of 2.47%
Accounting
An OTS policy statement applicable to all savings associations clarifies and re-emphasizes that the investment activities of a savings association must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with GAAP. Under the policy statement, management must support its classification of an accounting for loans and securities (i.e., whether held for investment, sale or trading) with appropriate documentation. The Association is in compliance with this policy statement.
The OTS has adopted an amendment to its accounting regulations, which may be made more stringent then GAAP by the OTS, to require that transactions be reported in a manner that best reflects their underlying economic substance and inherent risk and that financial reports must incorporate any other accounting regulations or orders prescribed by the OTS.
Qualified Thrift Lender Test
All savings associations, including Sobieski Federal, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by regulation) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans and investments. Such assets primarily consist of residential housing related loans and investments. At June 30, 1997, the Association met the test and has always met QTL the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the Bank Insurance Fund. If an association that fails the test has not yet requalified and has not converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, than within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "- Holding Company Regulation."
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with the examination of the Association, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by Sobieski Federal. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS.
The federal banking agencies, including the OTS, have recently revised the CRA regulations and the methodology for determining an institution's compliance with the CRA. Due to the heightened attention being given to the CRA in the past few years, the Association may be required to devote additional funds for investment and lending in its local community. The Association was examined for CRA compliance in October 1994 and received a rating of satisfactory.
Transactions with Affiliates
Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions are restricted to a percentage of the association's capital. Affiliates of the Association include the Company and any company which is under common control with the Association. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The Association's subsidiaries are not deemed affiliates, however; the OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals.
Holding Company Regulation
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 Holding Company and its non-savings association subsidiary which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. 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 such restrictions unless such other associations each qualify as a QTL and were acquired in a supervisory acquisition.
If the Association fails the QTL test, the Company must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, with one year of such failure the Company must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See "--Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association.
Federal Securities Law
The stock of the Company is registered with the SEC under the Securities Exchanges Act of 1934, as amended (the "Exchange Act"). The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three- month period.
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). At June 30, 1997, the Association was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "-- Liquidity."
Savings associations are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System
The Association is a member of the FHLB of Indianapolis, which is one of 12 regional FHLBs that administer the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing.
As a member, the Association is required to purchase and maintain stock in the FHLB of Indianapolis. At June 30, 1997, the Association had $636,000 of FHLB stock, which was in compliance with this requirement. During fiscal 1997 and prior years the Association received substantial dividends on its FHLB stock. The dividends averaged 7.84% for fiscal year 1997. For both the years ended June 30, 1997 and 1996, dividends paid by the FHLB of Indianapolis to the Association totaled $50,000.
Under federal law the FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to low- and moderately priced housing programs through direct loans or interest subsidies on advantages targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. A reduction in value of the Association's FHLB stock may result in a corresponding reduction in the Association's capital.
Federal and State Taxation
Prior to the enactment of recent legislation (discussed below), savings associations such as the Association that met certain definitional test relating to the composition of assets and other conditions prescribed by the Interanl Revenue Code of 1986, as amended (the "Code"), had been permitted to establish reserves for bad debts and to make annual additions thereto which could, within specified formula limits, be taken as a deduction in computing taxable income for federla income tax purposes. The amount of the bad debt reserve deduction for "non-qualifying loans" was computed under the experience method. The amount of the bad debt reserve deduction for "qualifying real property loans" (generally loans secured by improved real estate) could be computed under either the experience method or the percentage of taxable income method (based on an annual election).
The Small Business Job Protection Act of 1996, signed into law on August 20, 1996, repealed the special thrift bad debt deductions provisions. This legislation eliminates the use of the percentage of taxable income method as a means of calculating deductions for bad debts, allows thrifts greater flexibility in diversifying their loan and investment portfolios and establishes requirements for the recapture of previously untaxed bad debt reserve accumulations. Bad debt reserve accumulations prior to fiscal 1988 are exempt from recapture unless the Association liquidates, pays a dividend in excess of earnings and profits or redeems stock. Post fiscal 1987 bad debt reserve accumulations will be taxed in equal amounts over six years beginning in fiscal 1997. The Association may defer the recapture tax in fiscal 1997 or 1998 if it originates the same principal amount of mortgage loans that it had originated in the six years before fiscal 1997. The Association does not expect the post fiscal 1987 recapture tax to have a material effect on the consolidated financial statements.
In addition to the regular income tax, corporations, including savings associations such as the Association, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. For taxable years beginning after 1986 and before 1996, corporations, including savings associations such as the Association, are also subject to an environmental tax equal to 0.12% of the excess of alternative minimum taxable income for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2 million.
To the extent earnings appropriated to a savings association's bad debt reserves for "qualifying real property loans" and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholders (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses).
The Association files federal income tax returns on a fiscal year basis using the accrual method of accounting. The Company files consolidated federal income tax returns with the Association and its subsidiaries. Savings associations, such as the Association, that file federal income tax returns as part of a consolidated group are required by applicable Treasury regulations to reduce their taxable income for purposes of computing the percentage bad debt deduction for losses attributable to activities of the non-savings association members of the consolidated group that are functionally related to the activities of the savings association member.
The Association has not been audited by the IRS with respect to federal income tax returns through June 30, 1997. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, the Association) would not result in a deficiency which could have a material adverse effect on the financial condition of the Association and its consolidated subsidiaries.
Indiana Taxation. The Company and the Association is subject to an 8.5% franchise tax, imposed by the State of Indiana, on the net income of financial (including thrift) institutions, exempting them from the current gross income, supplemental net income and intangible taxes. Net income for franchise tax purposes will constitute federal taxable income before net operating loss deductions and special deductions, adjusted for certain items, including Indiana income taxes, property taxes, charitable contributions, tax exempt interest and bad debt. Other applicable Indiana taxes include sales, use and property taxes.
Delaware Taxation. As a Delaware holding company, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. The Company is also subject to an annual franchise tax imposed by the State of Delaware.
Item 2.
Item 2. Description of Property
The Association conducts its business through its main office and two branch offices located in South Bend, Indiana. The following table sets forth information relating to each of the Association's offices as of June 30, 1997. The total net book value of the Association's premises and equipment (including land, buildings and leasehold improvements and furniture, fixtures and equipment) at June 30, 1997 was approximately $2,028,300. See Note E of the Notes to Consolidated Financial Statements.
Total Year Approximate Leased Square Net Book Value at Location or Acquired Footage June 30, 1997
Main Office: 2930 West Cleveland Road 1995 10,080 $1,457 South Bend, Indiana 46628
Branch Offices: 4606 Western Avenue 1978 1,600 $ 0 Belleville Shopping Center
740 S. Walnut Street 1952 1,900 $ 25
Sobieski Federal believes that its current facilities, including its new main office facilities are adequate to meet the present and foreseeable needs of the Association and the Company.
The Association maintains an on-line date base with a service bureau servicing financial institutions. The net book value of the data processing and computer equipment utilized by the Association at June 30, 1997 was $99,000.
Item 3.
Item 3. Legal Proceedings
The Company and Sobieski Federal are involved, from time to time, as plaintiff or defendant in various legal actions arising in the normal course of their businesses. While the ultimate outcome of these proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing Sobieski Federal and the Company in the proceedings, that the resolution of these proceedings should not have a material effect on the Company's results of operations on a consolidated basis.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended June 30, 1997.
PART II
Item 5.
Item 5. Market for the Issuer's Common Stock and Related Security Holder Matters
Page 47 of the attached 1997 Annual Report to Stockholders is herein incorporated by reference.
Item 6.
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations
Pages 10 to 21 of the attached 1997 Annual Report to Stockholders are herein incorporated by reference.
Item 7.
Item 7. Financial Statements
The following pages of the attached 1997 Annual Report to Stockholders are herein incorported by reference.
Report of Independent Accountants Page 22
Consolidated Statements of Financial Condition as of Page 23 June 30, 1997 and 1996
Consolidated Statements of Income for the years ended Page 24 June 30, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the Page 25 years ended June 30, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years Page 26 ended June 30, 1997, 1996 and 1995
Notes to Consolidated Financial Statements Pages 27-46
Item 8.
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable. PART III
Item 9.
Item 9. Directors, Executive Officers, Promoters, and Control Persons; Compliance with Section 16(a) of the Exchange Act
Directors
Information concerning directors of the Company is incorporated herein by reference from the Company's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders, a copy of which has been filed with the Securities and Exchange Commission.
Executive Officers
Information concerning the executive officers of the Company is incorporated herein by reference from "Executive Officers of the Company" contained in Part I of this form 10-KSB.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company's officers and directors, and persons owning more than 10% of a registered class of the Company's equity securities, to file periodic reports of ownership and changes in ownership with the Securities and Exchange Commisssion and to provide the Company with copies of such reports. Based solely upon information provided to the Company by the directors and officers subject to Section 16(a), all Section 16(a) filing requirements applicable to such persons were complied with during fiscal 1997, except for the inadvertent failure to timely file a Form 3 Initial Statement of Beneficial Ownership by Arthur Skale, the Vice President of Finance and Chief Financial Officer of the Company. Mr. Skale subsequently filed the required form with the Securities and Exchange Commission.
Item 10.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from the Company's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders, a copy of which has been filed with the Securities and Exchange Commission.
Item 11.
Item 11. Security Ownership of Certain Beneficial Owners and Management
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders, a copy of which has been filed with the Securities and Exchange Commission.
Item 12.
Item 12. Certain Relationship and Related Transactions
Information concerning certain relationships and transactions is incorporated herein by reference from the Company's definitive Proxy Statement for the 1997 Annual Meeting of Shareholders, a copy of which has been filed with the Securities and Exchange Commission.
Item 13.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits:
Reference to Prior Filing or Regulation S-B Exhibit Number Exhibit Number Document Attached Hereto
2 Plan of Acquisition, Reorganization, Arrangement, None Liquidation or Succession
4.1 Articles of Incorporation and amendments thereto **
4.2 Bylaws **
9 Voting Trust Agreement None
10 Executive Compensation Plans and Arrangements:
Employee Stock Ownership Plan ** Stock Option and Incentive Plan ** Recognition and Retention Plan **
11 Statement re computation of per share earnings None
13 Annual Report to Security Holders 13
16 Letter re change in certifying accountant None
18 Letter re change in accounting principles None 21 Subsidiaries of Registrant 21
22 Published report regarding matter submitted to vote None
23 Consent of Coopers & Lybrand LLP None
24 Power of Attorney Not Required
27 Financial Data Schedule 27
99 Additional Exhibits None
** Filed on December 30, 1994, as exhibits to the Company's Form S-1 registration statement (File number 3-88078). All of such previously filed documents are hereby reference in accordance with Item 601 of Regulation S-B.
(b) Reports on Form 8-K:
No current reports on Form 8-K were filed by the Company during the three months ended June 30, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SOBIESKI BANCORP, INC.
Date: September 23, 1997 By: /s/ Thomas F. Gruber Thomas F. Gruber President and Chief Executive Officer (Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Robert J. Urbanski /s/ Joseph A. Gorny Robert J. Urbanski, Chairman of the Board Joseph A. Gorny, Director
Date: September 23, 1997 Date: September 23, 1997
/s/ George J. Aranowski George J. Aranowski, Director Leonard J. Dobosiewicz, Director Date: September 23, 1997 Date: September 23, 1997
/s/ Joseph F. Nagy /s/ Arthur Skale Joseph F. Nagy, Director Arthur Skale, Chief Financial Officer (Principal Financial and Accounting Officer) Date: September 23, 1997 Date: September 23, 1997
/s/ Thomas F. Gruber Thomas F. Gruber President and Chief Executive Officer and Director (Principal Executive Officer)
Date: September 23, 1997
INDEX TO EXHIBITS
Exhibit Number
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant 27 Financial Data Schedule
Exhibit 13
1997 ANNUAL REPORT
SOBIESKI BANCORP, INC.
Management Letter . . . . . . . . . . . . . . . 3 Corporate Profile . . . . . . . . . . . . . . . 6 Selected Financial Information . . . . . . . . . 8 Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . 10 Report of Independent Accountants . . . . . . . . 22 Consolidated Financial Statements . . . . . . . . 23 Stockholder Information . . . . . . . . . . . . . 47 Corporate Information . . . . . . . . . . . . . 48
Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
When used in this Annual Report or in filings by the Company with the Securities and Exchange Commission, in the Company's press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "believe" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including, among other things, changes in economic conditions, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area, credit risks of lending activities and competition. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors noted above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
General
The principal business of Sobieski Federal consists of attracting deposits from the general public and investing those funds in the origination of one-to-four family residential mortgage loans, consumer loans, construction loans and commercial loans. The Company also invests in mortgage-backed securities, which are insured or guaranteed by federal agencies, investment securities, consisting primarily of obligations of the U.S. Government or agency obligations, financial institution certificates of deposit fully insured by the FDIC, and other liquid assets. The Company's profitability depends primarily on its net interest income, which is the difference between interest income earned on its loans, investments and mortgage-backed securities and the interest expense incurred on its deposits and FHLB borrowings. Net interest income is affected by rates received on and the amounts of interest-earning assets as contrasted to the rates paid on and the amounts of interest- bearing liabilities.
Sobieski Federal's profitability is also affected by its provision for loan losses, non-interest income and non-interest expense. Non-interest income principally consists of fees and service charges on deposit accounts and loan late payment fees. Non-interest expense is principally operating expense, including compensation and related benefits, federal deposit insurance premiums, advertising, service bureau data processing, and occupancy costs. Earnings of Sobieski Federal are also affected significantly by general economic and competitive conditions, particularly changes in general interest rate levels.
Business Strategy
Sobieski Federal has concentrated its lending efforts on the origination of one-to- four family mortgage loans along with home equity loans and mortgage-backed commercial loans for portfolio retention. In addition, the Association continues to purchase participation interests in commercial loans. The participation interests are purchased according to established underwriting standards. The loans underlying the participation interests are performing in accordance with their terms. At June 30, 1997, the ratio of Sobieski Federal's nonperforming assets to total assets was .15% and the ratio of its allowance for loan losses to nonperforming loans was 158.52%. Historically, the loans originated by Sobieski Federal were principally fixed-rate, one-to-four family mortgage loans, while the Association's investments in mortgage-backed securities have been principally in adjustable rate products. At June 30, 1997, $53.8 million, or 77.5%, of the Association's combined mortgage loans and mortgage- backed securities portfolio had fixed rates of interest and $15.6 million, or 22.5%, had adjustable interest rates. The Association's business strategy emphasizes retail deposits along with FHLB advances as its principal source of funds.
The Association's primary objective is to remain an independent, community oriented financial institution serving customers in its primary market area. The Board of Directors has sought to accomplish this objective through the adoption of a strategy designed to maintain profitability, a strong capital position and high asset quality. This strategy has been effected primarily by (i) emphasizing the origination of one-to-four family residential mortgage lending, home equity lending and mortgage- backed commercial lending, (ii) purchasing participation interests in commercial loans funded by advances from FHLB, (iii) maintaining a substantial portfolio of adjustable-rate mortgage-backed securities and short to intermediate term investment securities, (iv) controlling operating expenses and (v) increasing fee income.
Asset/Liability Management
Sobieski Federal, like other financial institutions, is vulnerable to increases in interest rates because interest- bearing liabilities reprice more quickly than interest-earning assets. Historically, Sobieski Federal has invested in fixed- rate, long-term mortgage loans secured by one-to-four family residences and its primary source of funds has been deposits with much shorter terms to maturity. This mismatched position generally produces lower net interest income through compressed spreads during periods of rising rates and improved net interest income resulting from larger spreads during periods of declining rates. Accordingly, increases in general market interest rates adversely impact the Association's interest rate spread and, therefore, have a negative impact on the Company's results of operations and financial condition.
To reduce interest rate risk through asset/liability management, Sobieski Federal has taken steps to mitigate the sensitivity of its interest-earning assets by investing in short to intermediate term investments and adjustable-rate mortgage- backed securities, which, although long-term in nature, adjust periodically in response to changes in general levels of interest rates. Additionally, to decrease interest rate sensitivity, Sobieski Federal originates variable-rate home equity products and adjustable mortgage-backed commercial loans along with purchased participation interests in adjustable rate commercial loans. The funding for these originations and purchases has come from short-term advances from the FHLB. At June 30, 1997, Sobieski Federal had $47.0 million in long-term fixed-rate mortgages and $4.5 million in adjustable-rate mortgages. The Association's ability to generate Adjustable-Rate Mortgage ("ARM") loans is dependent upon the current interest rate environment and customer preferences.
Net Portfolio Analysis. The OTS provides a Net Portfolio Value ("NPV") approach to the quantification of interest rate risk. This approach calculates the difference between the present value of expected cash flows from assets and the present value of expected cash flows from liabilities, as well as cash flows from off-balance sheet contracts.
In August 1993, the OTS issued new regulations to be effective beginning on January 1, 1994, which were going to add an interest-rate risk component to a bank's risk-based capital requirement. The OTS then delayed implementation of this new regulation pending action on the issue from the other banking agencies. In early 1996, the other regulators (the Federal Reserve Board, Federal Deposit Insurance Corp., and Office of the Comptroller of the Currency) announced that their approach to evaluating a financial institution's interest rate risk would not include a standard model to calculate a required capital component. While the OTS will likely review its approach to evaluating a bank's exposure to interest rate fluctuations as a result of the other regulators' conclusions, the OTS under any scenario will require that a Bank have adequate board and senior management oversight and a comprehensive process for managing interest rate risk.
Presented below, as of June 30, 1997, is an analysis of the Association's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up and down 400 basis points in accordance with OTS regulations. As illustrated in the table, NPV is more sensitive to rising rates than declining rates. This occurs principally because, as rates rise, the market value of fixed-rate loans decline due to the rate increase. When rates decline, the Association does not experience as significant a rise in market value for these loans because borrowers prepay at relatively high rates. The following table is based on assets and liabilities of the Association only.
Management reviews the NPV measurements on a quarterly basis. In addition to monitoring selected measures on NPV, management also monitors effects on net interest income resulting from increases or decreases in rates. This measure is used in conjunction with NPV measures to identify excessive interest rate risk.
The Association's change in its NPV, based on a rise in interest rates of 2.0%, was a 28% decrease representing a dollar decrease in equity value of approximately $2.77 million at June 30, 1997. In contrast, based on a decline in interest rates of 2.0%, the Association's NPV was estimated to increase 9% at June 30, 1997. The most significant factor contributing to its liability sensitive position was the Association's balance of fixed rate mortgage loans. At June 30, 1997, 91.3% of the Association's loan portfolio was comprised of long-term, fixed- rate mortgage loans.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumed in calculating the table.
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 due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations, Nearly all the assets and liabilities of the Company are financial, unlike most industrial companies. As a result, the Company's performance is directly impacted by changes in interest rates, which are indirectly influenced by inflationary expectations. The Company's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its financial liabilities in its asset/liability management may tend to minimize the effect of change in interest rates on the Company's performance. Changes in interest rates do not necessarily move to the same extent as changes in the price of goods and services. In the current interest rate environment, liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels.
(1) Calculated net of deferred loan fees, discounts and premiums, and loans in process.
Financial Condition
General. Total assets increased $2.87 million or 3.64%, from $78.86 million at June 30,1996 to $81.73 million at June 30, 1997. The increase in assets was primarily the result of a $8.02 million increase in net loans offset by reductions of $4.84 million in investment securities and mortgage-backed securities and $.31 million of other assets. Funding for the asset growth primarily came from $6.50 million of FHLB advances offset by $1.84 million in decreased deposits and common stock repurchases of $2.01 million.
Cash and Cash Equivalents. Cash and cash equivalents, consisting of cash, interest-bearing deposits and federal funds sold decreased $134,000 from $1.39 million at June 30, 1996 to $1.25 million at June 30, 1997.
Investment Securities. Investment securities, consisting of United States Government securities and an investment in a United States Government securities mutual fund, decreased $2.39 million or 51% from $4.69 million at June 30, 1996 to $2.30 million at June 30, 1997. The decrease resulted from the sale of the Company's $.89 million interest in a mutual fund, and maturities of $1.5 million of government securities. At June 30, 1997, $1.30 million or 56% of the Association's investment securities were available for sale.
Mortgage-backed Securities. Mortgage-backed securities decreased $2.44 million or 15%, from $16.15 million at June 30, 1996 to $13.71 million at June 30, 1997. The decrease was primarily the result of principal repayments. At June 30, 1997, $1.78 million or 13% of the mortgage-backed securities were classified as available for sale.
Loans Receivable, Net. Loans receivable increased $8.02 million, or 15%, from $53.11 million at June 30, 1996 to $61.13 million at June 30, 1997. This increase was primarily the result of increased demand and expanded market area for residential mortgages in conjunction with aggressive efforts in origination of home equity and mortgage-backed commercial loans along with continued participations in commercial loans.
Deposits. Deposits decreased $1.84 million, or 3.0%, from $61.23 million at June 30, 1996 to $59.39 million at June 30, 1997. The Association is actively pursuing a deposit retention program. The program, implemented during the fourth quarter of fiscal 1997, offers higher rate special short-term and long-term deposit certificates. Under the program, fourth quarter deposits increased by $390,000, a reversal of the outflow pattern experienced during fiscal 1996 and the first three quarters of fiscal 1997. Monitoring of local market rates, special certificate offerings and wholesale alternatives will continue to be utilized as management focuses on viable funding sources.
Stockholders' Equity. Stockholders' equity decreased $1.69 from $14.05 million at June 30, 1996 to $12.36 million at June 30, 1997. This decrease was primarily the result of the Company's stock repurchase program, partially offset by 1997 net income.
Results of Operations
General. Net income decreased $88,000, or 26.27%, from $335,000 for 1996 to $247,000 for 1997. The decrease in net income resulted primarily from the expense associated with the one-time special SAIF recapitalization assessment of $414,000. Adjusted for the SAIF recapitalization assessment, net of related federal and state income tax benefits, net income for 1997 would have been $497,000, an increase of 48.36% over net income for 1996.
Net interest income. Net interest income increased $136,000 from $2.44 million in 1996 to $2.57 million in 1997. The increase was due to $3.07 million of additional average interest-earning assets at an improved net four basis point yield. Net yield on average interest-earning assets in 1997 increased 1.19% to 3.40% from 3.36% in 1996.
Interest Income. Interest income increased $237,000, from $5.46 million for 1996 to $5.70 million for 1997. The increase was the result of $6.33 million of higher average balances in loans receivable during the year offset by $3.26 million of reduced investment and mortgage-backed securities average balances. The change due to net volume increases added $318,000 to interest income and was offset by lower rate precipitated decreases of $81,000. The yield on average interest-earning assets increased 1 basis point, from 7.53% for 1996 to 7.54% for
Interest Expense. Interest expense increased $101,000 from $3.03 million in 1996 to $3.13 million in 1997, primarily as a result of $336,000 of additional expense related to increased FHLB advances. The average rate paid for interest-bearing liabilities decreased 8 basis points from 4.84% in 1996 to 4.76% in 1997, a decrease of 1.65%. The average balance of interest- bearing liabilities for fiscal 1997 was $65.76 million, an increase of $3.18 million from $62.58 million for fiscal 1996.
Provision for Loan Losses. There was no provision for loan losses for the year ended June 30, 1997 and the year ended June 30, 1996. The Company maintains an allowance for loan losses based upon management's periodic evaluation of non-performing loans, inherent risks in the loan portfolio, economic conditions and past experience. Management does expect that as loan growth continues, provisions for loan losses may be required. The provisions, however, are not expected to have a material impact on earnings.
Noninterest Income. Noninterest income increased $54,000 from $172,000 in 1996 to $226,000 in 1997, primarily from gains on sales of securities.
Noninterest Expense. Noninterest expense increased $310,000, from $2.06 million in 1996 to $2.37 million in 1997. The primary increase was the result of the $414,000 one-time special assessment to recapitalize the SAIF fund. The expense recognition for the SAIF recapitalization occurred as of September 30, 1996. As a result of the special assessment, FDIC deposit insurance rates have decreased from $.23 per $100 of domestic deposits to $.064 per $100 of domestic deposits. Under the revised assessment rate, the Association expects to realize approximately $99,000 of reduced expenses at current deposit levels under existing regulatory ratings. Total compensation and related benefits as well as occupancy and equipment expense remained relatively unchanged from 1996 levels at $964,000 and $279,000, respectively. Advertising and promotion expense decreased by $10,000, the continued result of the 1996 reorganization of our advertising campaign. Additionally, service bureau expense decreased by $9,000 and other operating expense decreased by $25,000 over fiscal 1996 expenditures.
Income Taxes. Income tax expense decreased $31,000 from $213,000 in 1996 to $182,000 in 1997, principally as a result of a decrease in pretax income. The effective tax rate for 1997 was 42.34% versus 38.83% in 1996.
Liquidity and Capital Resources
The Association's primary sources of funds consist of deposits, repayment and prepayment of loans and mortgage-backed securities, maturities of investment securities and temporary cash investments, and funds provided by operations. While scheduled loan and mortgage-backed securities repayments and maturities of investments are predictable sources of funds, deposit flows and loan and mortgage-backed securities prepayments are significantly influenced by the general level of interest rates, economic conditions, and competition. Sobieski Federal uses it liquidity resources to fund existing and future loan commitments, purchase mortgage-backed securities, fund maturing certificates of deposit and other savings deposit withdrawals, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses. Management believes that loan and mortgage-backed securities repayments and other sources of funds will be adequate to meet Sobieski Federal's current liquidity needs.
As a federal savings association, the Association is required to maintain liquid assets of 5% of its withdrawable deposits plus short-term borrowings. At June 30, 1997, the Association was in compliance with Office of Thrift Supervision ("OTS") liquidity requirements, having a ratio of 6.07%.
The Association is required by OTS to meet minimum capital requirements, which include tangible capital, core capital and risk-based capital requirements. The Association's actual capital as reported to the OTS at June 30, 1997 exceeded all three requirements. The following chart sets forth the actual and required minimum levels of regulatory capital for the Association under applicable OTS regulations as to June 30, 1997(dollars in thousands):
Actual Percent Required Percent Excess Core $ 9,026 11.4 $ 2,380 3.0 $ 6,646 Tangible 9,026 11.4 1,190 1.5 7,836 Risk-based 9,226 27.7 2,666 8.0 6,560
The OTS has proposed to increase the minimum required core capital ratio from the current 3% level to a range of 4% to 5% for all but the most highly rated financial institutions. While the OTS has not taken final action on such proposal, it has adopted a prompt corrective action regulation that classifies any savings institution that maintains a core capital ratio of less than 4% (3% in the event the institution was assigned a composite 1 rating in its most recent report of examination) as "undercapitalized." As of June 30, 1997, the Association had a core capital ratio of 11.4% and met the requirement for a "well capitalized" institution.
Accounting And Regulatory Developments
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and Long- Lived Assets to be Disposed Of," was issued in March 1995 and requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The adoption of this statement during fiscal 1997 had no effect on the Company's consolidated financial statements.
SFAS No. 122, "Accounting for Mortgage Servicing Rights," was issued in May 1995 and requires the capitalization of mortgage servicing rights acquired through either purchase of mortgage loan servicing or origination and sale or securitization of mortgage loans with retention of servicing. SFAS No. 122 also requires an analysis of capitalized mortgage servicing rights for potential impairment based on the fair value of the rights. Currently, the Company does not purchase or originate to sell mortgage loans.
SFAS No. 123, "Accounting for Stock-Based Compensation," was issued in October 1995 and established a fair value based method of accounting for stock-based compensation plans. This statement also establishes fair value as the measurement basis for transactions in which an entity acquires goods or services from non-employees in exchange for equity instruments. There was no effect on the Company's 1997 consolidated financial statements as this statement was adopted in 1997 on a disclosure basis only.
SFAS No. 128, "Earnings Per Share," establishes new standards for computing and presenting earnings per share ("EPS") for publicly- held companies. The statement replaces the current presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and fully diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the fully diluted EPS computation. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. This statement requires restatement of all prior-period EPS data presented. Adoption of this statement by the Company in fiscal 1998 is not presently expected to have any significant impact on the Company's historical presentation of EPS data.
SFAS No. 129, "Disclosure of Information about Capital Structure," establishes standards for disclosing information about an entity's capital structure. Such information includes pertinent rights and privileges of securities outstanding. Examples of information that shall be disclosed are dividend and liquidation preferences, participation rights, call prices and dates, conversion or exercise prices or rates and significant terms of contracts to issue additional shares. Other disclosures include information regarding liquidation preferences of preferred stock and redemption requirements of redeemable stock. SFAS 129 is effective for financial statements issued for periods ending after December 15, 1997 and is not presently expected to have any significant impact on the Company's historical financial statements.
Impact of Deposit Insurance Funds Act of 1996
On September 30, 1996, President Clinton signed into law the Deposit Insurance Funds Act of 1996, which included provisions recapitalizing the SAIF. It provides for the eventual merger of the thrift fund with the Bank Insurance Fund ("BIF") on January 1, 1999, provided no savings associations are then in existence, and reallocates payment of the annual Financing Corp. ("FICO") bond obligation. As part of the legislation, the FDIC imposed a special one-time assessment of 65.7 basis points to be applied against all SAIF-insured deposits as of March 31, 1995, in order to restore the SAIF to the statutorily prescribed 1.25 percent reserve ratio. The special assessment, which was paid in November 1996, resulted in a $414,000 pretax charge to the Association during its first quarter of fiscal 1997. The assessment reduced the Company's 1997 net income by approximately $250,000, or $0.32 per share.
Effective January 1, 1997, SAIF members will have the same risk- based assessment schedule as BIF members. The Association has effectively paid no assessment for deposit insurance coverage commencing January 1, 1997. However, all SAIF and BIF institutions, including the Company, are responsible for sharing the cost of interest payments on the FICO bonds. The cost will be an annualized charge of 1.3 basis points for BIF deposits and 6.4 basis points for SAIF deposits.
REPORT OF INDEPENDENT ACCOUNTANTS Coopers & Lybrand L.L.P.
To the Stockholders and Board of Directors of Sobieski Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Sobieski Bancorp, Inc. and subsidiary as of June 30, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sobieski Bancorp, Inc. and subsidiary as of June 30, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1997, in conformity with generally accepted accounting principles.
South Bend, Indiana August 22, 1997
Sobieski Bancorp, Inc. and Subsidiary
Consolidated Statements Of Financial Condition as of June 30, 1997 and 1996
ASSETS 1997 1996 Cash, including interest- bearing deposits in other financial institutions of $94,477 and $334,793, respectively $ 1,251,373 $ 1,258,520 Federal funds sold - 127,000 Certificates of deposit 198,000 198,000 Investment securities, available-for-sale (amortized cost of $1,299,335 and $3,167,813, respectively) 1,297,148 3,193,784 Investment securities, held-to-maturity (market value of approximately $1,012,900 and $1,497,000, respectively) 1,000,000 1,500,000 Mortgage-backed securities, available-for-sale (amortized cost of $1,790,203 and $2,383,429, respectively) 1,780,210 2,344,925 Mortgage-backed securities, held-to-maturity (market value of approximately $11,617,500 and $13,424,600, respectively) 11,929,352 13,806,725 Loans receivable, net 61,134,644 53,114,094 Real estate owned 11,037 - Federal Home Loan Bank stock, at cost 636,000 636,000 Property and equipment, net 2,028,310 2,110,699 Other assets 466,672 557,044 Deferred income taxes - 15,960
Total assets $81,732,746 $ 78,862,751
LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits $59,386,630 $ 61,226,683 Federal Home Loan Bank advances 9,500,000 3,000,000 Advances from borrowers for taxes and insurance 260,439 264,531 Accrued income taxes 80,628 129,305 Accrued interest and other expenses 132,077 188,042 Deferred income taxes 12,177 -
Total liabilities 69,371,951 64,808,561
Commitments (Notes L )
Stockholders' equity: Preferred stock, $.01 par value: 500,000 shares authorized; none issued - - Common stock, $.01 par value: 3,500,000 shares authorized; 966,000 shares issued 9,660 9,660 Additional paid-in capital 9,147,176 9,099,156 Retained earnings, substantially restricted 6,670,543 6,538,602 Net unrealized depreciation of securities available-for-sale (7,356) (7,571) 15,820,023 15,639,847 Less: Treasury stock, at cost, 206,368 and 71,940 shares, respectively 2,879,878 909,457 Unallocated Employee Stock Ownership Plan shares;57,935 and 67,620 shares, respectively 579,350 676,200 Total stockholders' equity 12,360,795 14,054,190
Total liabilities and stockholders' equity $ 81,732,746 $ 78,862,751 See accompanying notes to consolidated financial statements. Sobieski Bancorp, Inc. and Subsidiary
Consolidated Statements Of Income for the years ended June 30, 1997, 1996 and 1995
1997 1996 1995 Interest income: Loans $ 4,433,288 $ 4,012,220 $ 4,079,101 Mortgage-backed securities 944,274 962,464 835,981 Interest-bearing deposits 43,665 267,071 179,173 Investments and other 281,103 222,913 200,800
Total interest income 5,702,330 5,464,668 5,295,055
Interest expense: Interest on deposits 2,782,319 3,016,692 2,798,112 Interest on borrowings 348,563 12,896 -
Total interest expense 3,130,882 3,029,588 2,798,112
Net interest income 2,571,448 2,435,080 2,496,943
Provision for loan losses - - 9,743
Net interest income after provision for loan losses 2,571,448 2,435,080 2,487,200
Non-interest income: Fees and service charges 156,443 162,303 139,361 Gain on sale of securities 63,535 - - Other income 5,567 9,247 30,469
Total non-interest income 225,545 171,550 169,830
Non-interest expenses: Compensation and benefits 964,207 962,655 775,672 Occupancy and equipment 278,747 278,576 173,084 Federal deposit insurance premiums 495,872 143,583 152,580 Advertising and promotion 30,666 41,349 120,967 Service bureau expense 98,555 107,575 92,929 Other operating expenses 500,257 524,813 419,263
Total non-interest expenses 2,368,304 2,058,551 1,734,495
Income before income taxes 428,689 548,079 922,535
Income taxes 181,500 212,800 372,400
Net income $ 247,189 $ 335,279 $ 550,135
Earnings per common share(1)$ .32 $ .39 $ .09
(1) For 1995, earnings per common share is for the period subsequent to the initial offering of common stock which was completed on March 30, 1995.
See accompanying notes to consolidated financial statements. Sobieski Bancorp, Inc. and Subsidiary
Consolidated Statements Of Stockholders' Equity for the years ended June 30, 1997, 1996 and 1995
See accompanying notes to consolidated financial statements. Sobieski Bancorp, Inc. and Subsidiary
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements
A. CONVERSION AND ISSUANCE OF COMMON STOCK.
On October 4, 1994, the Board of Directors of Sobieski Federal Savings and Loan Association of South Bend (the "Association") adopted a plan of conversion to convert the Association from a federally chartered mutual savings and loan association to a federally chartered stock savings and loan association (the "Conversion"). The Association obtained the required regulatory approval for the Conversion in February 1995 and on March 22, 1995 the plan of conversion was approved by a majority of the votes eligible to be cast by the members of the Association.
Sobieski Bancorp, Inc. (the "Company") was organized as a Delaware corporation in December 1994 for the purpose of acquiring all of the issued and outstanding capital stock of the Association to be issued in the Conversion.
In connection with the Conversion, on March 30, 1995 the Company sold 966,000 shares of its common stock, par value $.01 per share, including 77,280 shares acquired by the newly formed Employee Stock Ownership Plan ("ESOP"), for $10 per share. Net proceeds from the sale, after deducting direct issuance costs and expenses of $571,000, aggregated $9,089,000 of which $4,542,500 was used to purchase all of the capital stock of the Association and $772,800 was used to fund the purchase of 77,280 shares of the Company's common stock by the ESOP.
The Company's Articles of Incorporation authorize the issuance of 4,000,000 shares of capital stock, consisting of 3,500,000 shares of common stock, par value $.01 per share, and 500,000 shares of preferred stock, par value $.01 per share. As of June 30, 1996 and 1995, 966,000 shares of the Company's common stock were issued and all of the Company's preferred stock is unissued.
At the time of the Conversion, the Association established a liquidation account in an amount equal to the Association's retained earnings as of September 30, 1994. The liquidation account will be maintained for the benefit of depositors, as of the eligibility record date and supplemental eligibility record date, who continue to maintain their deposits with the Association after the Conversion. In the event of a complete liquidation (and only in such event), each eligible depositor will be entitled to receive a liquidation distribution from the liquidation account, in the proportionate amount of the then current adjusted balance for deposits then held, before any liquidation distribution may be made with respect to the stockholders.
Current regulations allow the Company to pay dividends on its common stock if its regulatory capital would not thereby be reduced below the amount then required for the aforementioned liquidation account. Also, capital distribution regulations limit the Company's ability to make capital distributions which include dividends, stock redemptions, repurchases and other transactions charged to the capital account based on its capital level and supervisory condition. Federal regulations also preclude any repurchase of the stock of the Company for three years after conversion except for Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
A. CONVERSION AND ISSUANCE OF COMMON STOCK, Concluded.
purchases of qualifying shares of a director and repurchases pursuant to an offer made on a pro-rata basis to all stockholders and with prior approval of the Office of Thrift Supervision or pursuant to an open-market stock repurchase program with certain regulatory criteria.
B. ACCOUNTING POLICIES.
Organization
The Association is a federally chartered stock savings and loan association and as a member of the Federal Home Loan Bank System ("FHLB") is required to maintain an investment in the capital stock of the FHLB.
Deposit accounts are insured by the Federal Deposit Insurance Corporation ("FDIC") within certain limitations. An annual premium is required by the FDIC for the insurance of such deposit accounts.
On September 30, 1996, Congress passed into law a recapitalization plan for the Savings Association Insurance Fund, the insurance fund covering deposits of savings institutions. The recapitalization plan provided for a special one-time assessment of .66% on certain deposits of savings institutions as of March 31, 1995. The Association's special assessment amounted to approximately $414,000 and is included in federal deposit insurance premiums in the consolidated statement of income for the year ended June 30, 1997. Future deposit insurance premiums decreased to approximately .06% from the .23% of deposits previously paid by the Association.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and the Association, collectively referred to herein as "Sobieski". All significant intercompany accounts and transactions have been eliminated. The initial capitalization of the Company and its acquisition of the Association took place on March 30, 1995 as more fully described in Note A. The acquisition of the Association has been accounted for at historical cost in a manner similar to that utilized in a pooling of interest.
Securities
Securities are classified as either held-to-maturity and reported at amortized cost, trading and reported at fair value (with unrealized holding gains and losses included in current earnings), or available-for-sale and reported at fair value (with unrealized holding gains and losses excluded from current earnings and reported as a separate
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
B. ACCOUNTING POLICIES, Continued.
component of stockholders' equity). The Association had no trading securities at June 30, 1997 and 1996.
Gains and losses on all securities transactions are recognized when sold as determined by the identified certificate method.
Loans Receivable
Loans receivable are stated at the unpaid principal balances, less deferred loan fees and an allowance for loan losses. Sobieski follows the policy of charging estimated losses on loans to the provision for loan losses in the period in which such losses become evident.
The allowance for loan losses is an estimate used by management in the preparation of Sobieski's financial statements. The allowance is maintained at a level considered by management to be adequate to provide for probable loan losses inherent in the portfolio. Management's evaluation is based on a continuing review of the loan portfolio and includes consideration of its actual loan loss experience, the present and prospective financial condition of the borrowers, balance of the loan portfolio, and general economic conditions. An economic slow- down in the geographic area could adversely effect the ability of borrowers to make scheduled monthly payments and the duration of such an economic slow-down would increase the possibility of credit losses.
Revenue Recognition
Interest on loans is included in interest income on the accrual method over the terms of the loans based upon principal balances outstanding. Sobieski discontinues the accrual of interest income on loans when payment of interest is more than 90 days delinquent. Loan origination and commitment fees and direct loan origination costs are deferred, and the net deferred amount is amortized to interest income over the contractual life of the related loans as an adjustment to the yield.
Property And Equipment
Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are determined using the straight-line method based on the estimated useful lives of the applicable assets which range from 3 to 39 years.
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
B. ACCOUNTING POLICIES, Continued.
Real Estate Owned
Real estate acquired in settlement of loans is recorded at the lower of cost (the unpaid principal balance of the loan at the date of acquisition plus foreclosure and other related costs) or fair market value at the date of acquisition and is subsequently carried at the lower of cost or net realizable value. Costs of improvements made to facilitate sale are capitalized; costs of holding the property are charged to expense. It is Sobieski's policy to provide valuation allowances for estimated losses whenever, based upon management's evaluation, a significant and permanent decline in value occurs.
Income Taxes
The Company and the Association file consolidated federal and state income tax returns.
The Small Business Job Protection Act of 1996 (the "Act") repealed the special tax bad debt deduction available to savings institutions. The Association was required to change its tax bad debt reserve method to the specific charge-off method under Internal Revenue Code Section 585 effective for its taxable year ended June 30, 1997. This change in method will result in taxable income of approximately $295,000, representing the excess of the Association's tax bad debt reserve at June 30, 1996 over the reserve that arose in tax years beginning before July 1, 1988 (base year amount). This additional taxable income is reportable for income tax purposes ratably over a six-year period. There was no effect of this change on the Company's net income for the year ended June 30, 1997 as a deferred tax liability had previously been established for the tax effect of the excess tax bad debt reserve over the base year amount.
The Association's retained earnings as of June 30,1997 includes the income tax benefit of approximately $875,000 of tax bad debt deductions, representing the base year amount, for which no deferred income taxes have been provided.
Earnings Per Common Share
Earnings per common share for periods subsequent to the completion of the Company's initial stock offering on March 30, 1995 is calculated by dividing net income for the period by the weighted average number of common shares outstanding. The Company accounts for the shares of common stock acquired by the ESOP and the restricted shares awarded under the Recognition and Retention Plan ("RRP") in accordance with Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans," which prescribes that shares held by the ESOP and the restricted shares awarded under the RRP are not considered in the weighted average number of shares outstanding until such shares are committed for Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued.
B. ACCOUNTING POLICIES, Concluded.
allocation to an ESOP participant's individual account or vested, in the case of the RRP. Accordingly, the weighted average number of common shares outstanding for the year ended June 30, 1997 was 770,098 (864,621 shares for the year ended June 30, 1996 and 888,755 shares for the period March 30, 1995 through June 30, 1995). No adjustment has been made to the weighted average number of common shares outstanding to reflect outstanding stock options since the effect is not material.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
Statements Of Cash Flows
For purposes of the consolidated statements of cash flows, Sobieski considers cash and federal funds sold to be cash and cash equivalents.
Supplemental disclosures of cash flow information and noncash investing and financing activities for the years ended June 30, 1997, 1996 and 1995 are as follows:
1996 1995
Supplemental disclosures of cash flow information: Cash paid during the years for: Interest $ 3,154,873 $3,033,648 $2,784,152 Income taxes 202,177 59,060 582,000
Noncash investing and financing activities: Loans transferred to real estate owned 11,037 - 32,696 Common stock issued to ESOP - - 772,800
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
C. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES.
The amortized cost and estimated aggregate fair value of investment securities and mortgage-backed securities at June 30, 1997 are as follows: Available-For-Sale Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Aggregate Cost Gains Losses Fair Value
Debt securities: U.S. Treasury obligations $ 1,299,335 $ 111 $ (2,298) $1,297,148 Mortgage-backed securities 1,790,203 10,609 (20,602) 1,780,210
Total $ 3,089,538 $10,720 $ (22,900) $ 3,077,358
Held-To-Maturity Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Aggregate Cost Gains Losses Fair Value
Debt securities: U. S. Treasury obligations $ 1,000,000 $ 12,900 $ - $ 1,012,900 Mortgage-backed securities 11,929,352 27,288 (339,140) 11,617,500
Total $12,929,352 $ 40,188 $ (339,140) $ 12,630,400
The amortized cost and estimated aggregate fair value of debt securities and mortgage-backed securities at June 30, 1997, by contractual maturity (except for mortgage-backed securities), are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available-For-Sale Held-To-Maturity Estimated Estimated Amortized Aggregate Amortized Aggregate Cost Fair Value Cost Fair Value
Due in one year or less $ 801,253 $ 799,938 $ - $ - Due after one year through five years 498,082 497,210 - - Due after five years - - 1,000,000 1,012,900 Mortgage-backed securities 1,790,203 1,780,210 11,929,352 11,617,500
Total $ 3,089,538 $ 3,077,358 $12,929,352 $12,630,400
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
C. INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES, Concluded.
The amortized cost and estimated aggregate fair value of investment securities and mortgage-backed securities at June 30, 1996 are as follows:
Available-For-Sale Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Aggregate Cost Gains Losses Fair Value
Debt securities: U.S. Treasury obligations $2,308,353 $ - $ (23,283) $ 2,285,070 Mortgage- backed securities 2,383,429 1,618 (40,122) 2,344,925
Other securities: Federated Intermediate Government Trust Fund #47 859,460 49,254 - 908,714
Total $5,551,242 $ 50,872 $ (63,405) $ 5,538,709
Held-To-Maturity Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Aggregate Cost Gains Losses Fair Value
Debt securities: U. S. Treasury obligations$ 1,500,000 $ 3,323 $ (6,323) $ 1,497,000 Mortgage-backed securities 13,806,725 - (382,125) 13,424,600
Total $15,306,725 $ 3,323 $(388,448) $ 14,921,600
Purchases of available-for-sale securities for the years ended June 30, 1997, 1996 and 1995 totaled $12,415, $2,621,645 and $49,650, respectively. Purchases of held-to-maturity securities for the years ended June 30, 1997, 1996 and 1995 totaled $0, $2,546,969 and $1,270,445, respectively. Proceeds from the sales of available-for-sale securities for the year ended June 30, 1997 totaled $1,227,149, with gross gains of $63,535 realized on those sales. There were no sales of investment securities or mortgage- backed securities during the years ended June 30, 1996 and 1995.
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
D. LOANS RECEIVABLE.
Loans receivable consisted of the following: June 30, 1997 1996
One-to-four family mortgage loans $ 55,714,150 $ 48,748,883 Construction and commercial mortgage loans 3,928,023 2,580,066 Share loans 146,561 176,379 Small Business Administration pass-through certificates 2,454,856 2,781,500 62,243,590 54,286,828 Less: Undisbursed portion of loans in process 882,268 801,524 Allowance for loan losses 200,000 200,000 Deferred loan fees 26,678 171,210
Loans receivable, net $ 61,134,644 $ 53,114,094
Certain directors, executive officers and their families have loans with Sobieski. Such loans, exclusive of those not exceeding $60,000 in the aggregate to any such persons, aggregated approximately $145,000 at June 30, 1997 (none at June 30, 1996).
The following is a summary of activity in the allowance for loan losses:
Years Ended June 30, 1997 1996 1995
Balance, beginning of year $ 200,000 $ 200,000 $ 200,000 Provision charged to expense - - 9,743 Charge-offs - - (9,743)
Balance, end of year $ 200,000 $ 200,000 $ 200,000
Nonaccrual loans totaled approximately $126,000, $90,000 and $41,000 at June 30, 1997, 1996 and 1995, respectively.
E. PROPERTY AND EQUIPMENT.
Property and equipment and related accumulated depreciation and amortization consisted of the following:
June 30, 1997 1996
Land $ 169,518 $ 162,893 Office buildings 1,696,031 1,686,978 Leasehold improvements 66,927 68,396 Furniture and equipment 580,622 800,672 2,513,098 2,718,939 Less, Accumulated depreciation and amortization 484,788 608,240
Property and equipment, net $ 2,028,310 $ 2,110,699
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
F. OTHER ASSETS.
Other assets consisted of the following: June 30, 1997 1996
Accrued interest receivable: Loans $ 300,583 $ 290,589 Mortgage-backed securities 92,092 110,308 Investment securities 23,004 42,057 Interest-bearing deposits 963 945 Prepaid expenses and other 50,030 113,145
Total $ 466,672 $ 557,044
G. DEPOSITS.
Deposits consisted of the following: June 30, 1997 1996 Percent Percent Amount of Total Amount of Total
NOW accounts, 2.75% $ 3,875,715 6.5% $ 2,453,936 4.0%
Money market accounts, 2.75-3.00% 2,171,804 3.7 2,271,719 3.7
Passbook accounts, 2.50% 15,170,287 25.5 15,908,610 26.0
Certificates of deposit and IRA accounts:
3.51-5.00% 9,039,019 15.2 8,941,931 14.6 5.01-6.00% 18,774,255 31.6 17,936,185 29.3 6.01-8.00% 10,355,550 17.5 13,714,302 22.4 38,168,824 64.3 40,592,418 66.3
Total $ 59,386,630 100.0% $61,226,683 100.0%
The weighted average interest rates on certificates of deposit and IRA accounts were 5.62% and 5.74% at June 30, 1997 and 1996, respectively.
The aggregate amount of certificates of deposit and IRA accounts with a minimum denomination of $100,000 was approximately $2,235,600 and $1,856,000 at June 30, 1997 and 1996, respectively. Deposits in denominations greater than $100,000 are in excess of federally insured limits.
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
G. DEPOSITS, Concluded.
At June 30, 1997, scheduled maturities of certificates of deposit and IRA accounts for the years ending on June 30 are as follows: 1998 1999 2000 2001 2002
3.51-5.00%$ 9,039,019 $ - $ - $ - $ - 5.01-6.00% 8,832,677 4,711,613 3,334,284 1,801,268 94,413 6.01-8.00% 1,000,489 8,748,320 606,741 - -
$18,872,185 $13,459,933 $ 3,941,025 $1,801,268 $94,413
At June 30, 1996, scheduled maturities of certificates of deposit and IRA accounts for the years ending on June 30 are as follows: 1997 1998 1999 2000 2001 2002
3.51-5.00%$7,263,637 $1,670,354 $ - $ - $ - $7,940 5.01-6.00% 9,733,202 4,638,156 646,265 2,918,562 - - 6.01-8.00% 5,488,889 1,204,287 6,410,646 610,480 - -
$22,485,728 $7,512,797 $7,056,911 $3,529,042 $- $7,940
Interest expense on deposits is summarized as follows:
Years Ended June 30, 1997 1996 1995
NOW and money market accounts$ 117,653 $ 128,385 $ 146,196 Passbook accounts 373,848 456,114 507,356 Certificates of deposit and IRA accounts 2,290,818 2,432,193 2,144,560
Total $ 2,782,319 $ 3,016,692 $ 2,798,112
H. FEDERAL HOME LOAN BANK ADVANCES.
At June 30, 1997 and 1996, Sobieski had advances from the Federal Home Loan Bank of Indianapolis totaling $9,500,000 and $3,000,000, respectively, with variable and fixed interest rates ranging from 5.75% to 6.97%, respectively, as of June 30, 1997. Advances outstanding at June 30, 1997 mature from July 1997 through June 1998.
The advances are collateralized by all mortgage loans and mortgage-backed securities issued or guaranteed by the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association or the Government National Mortgage Association.
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
I. INCOME TAXES.
Income taxes consist of the following: Years Ended June 30, 1997 1996 1995
Federal: Current $ 106,500 $ 132,300 $260,400 Deferred 28,000 39,500 24,000
134,500 171,800 284,400 State 47,000 41,000 88,000
Total $ 181,500 $ 212,800 $ 372,400
The provision for income taxes differs from the expected amounts (computed by applying the federal statutory corporate income tax rate of 34% to income before income taxes) as follows :
Years Ended June 30, 1997 1996 1995
Computed statutory tax provision $ 145,800 $ 186,400 $ 313,700 State income taxes, net of federal income tax benefit 31,000 27,100 58,100 Non-deductible portion of ESOP contributions 14,100 7,200 700 (Gain) loss on sale of real estate owned, net - 1,300 (2,900) Business meals and entertainment 5,300 5,600 9,600 Other, net (14,700) (14,800) (6,800) $181,500 $212,800 $372,400 Effective tax rate 42.3% 38.8% 40.4%
The components of the net deferred tax asset(liability) at June 30, 1997 and 1996 were as follows :
June 30, 1997 1996
Deferred tax asset (liability): Deferred loan fees $ 4,600 $ 51,000 Allowance for loan losses 68,000 68,000 Special tax bad debt deductions (83,700) (100,000) Depreciation and amortization (11,500) 4,000 Net unrealized depreciation of securities available-for-sale 4,823 4,960 Other, net 5,600 (12,000)
Net deferred tax asset(liability) $ (12,177) $ 15,960
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
J. EMPLOYEE BENEFIT PLANS.
The Association has a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code. Substantially all employees of the Association are eligible to participate in the plan. Under the plan, the Association matches a percentage of participating employee contributions and may also provide an additional annual discretionary contribution. Retirement plan expense for the years ended June 30, 1997, 1996 and 1995 was $10,312, $13,383 and $9,262, respectively.
Effective March 30, 1995, the Association established the ESOP for the benefit of the Association's employees who meet certain eligibility requirements including having completed 1,000 hours of credited service within a twelve-month period with the Association. The ESOP trust acquired 77,280 shares of the Company's common stock in the Company's initial public offering with proceeds from a loan from the Company. The Association makes cash contributions to the ESOP on a semi-annual basis sufficient to enable the ESOP trust to make its required debt service payments to the Company.
The promissory note payable to the Company by the ESOP trust bears interest at 7.78% with interest and principal payments due in twenty-four (24) consecutive semi-annual installments on the last day of June and December commencing June 30, 1995 and continuing until December 31, 2006. The promissory note is collateralized by the unallocated shares of the Company's common stock held by the ESOP.
As the ESOP promissory note is repaid, shares of the Company's common stock are released from collateral and allocated to qualified ESOP participants based on the proportion of debt service paid during the period. The Company accounts for the ESOP in accordance with Statement of Position 93-6. Accordingly, the unallocated shares pledged as collateral are reported as a reduction of stockholders' equity in the consolidated statements of financial condition. As shares are committed for release from collateral, the Association records contribution expense equal to the average market value of the released shares, and the released shares become outstanding for earnings per common share computations. Contribution expense related to the ESOP was $138,345, $82,513 and $34,000 for the years ended June 30, 1997, 1996 and 1995, respectively.
Following is a summary of shares held by the ESOP trust as of June 30, 1997:
Allocated shares 19,345 Unreleased shares 57,935
Total ESOP shares 77,280
Fair value of unreleased shares at June 30, 1997 $ 854,541
On October 25, 1995, the stockholders of the Company ratified the Company's adoption of the Recognition and Retention Plan ("RRP") and the 1995 Stock Option and Incentive Plan (the "Stock Option Plan").
Under the RRP, an aggregate of 38,640 shares of the Company's common stock have been reserved for the awarding of restricted shares to the Company's directors, officers and employees. Awards of common stock granted under the RRP vest in five equal annual installments beginning on the first anniversary of stockholder approval of the RRP and are subject to forfeiture in the event the recipient terminates employment with the Company for any reason other than death or disability. RRP shares become free of all restrictions and are distributed to recipients on the date on which they vest. As of June 30, 1997 and 1996, an aggregate of 21,452 and 19,162 shares, respectively, of the Company's common stock, with a market value of $249,714 and $208,600, respectively, at the respective dates of grant, have been
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
J. EMPLOYEE BENEFIT PLANS, Concluded.
awarded under the RRP. Contribution expense recognized for the years ended June 30, 1997 and 1996 related to the award of RRP shares was $48,295 and $31,095, respectively.
Pursuant to the Stock Option Plan, an aggregate of 96,600 shares of the Company's common stock have been reserved for the granting of stock options and other long-term incentive awards to the Company's directors, officers and employees. Incentive and non- qualified stock options may be granted under the Stock Option Plan at exercise prices of not less than the fair market value of the Company's common stock at the date of grant, become exercisable at the rate of 20% per year commencing on the first anniversary of the date of grant and have terms not exceeding ten years.
The following is a summary of the activity with respect to Sobieski's stock option plan for the years ended June 30, 1996 and 1997.
Weighted- Average Exercise Number of Price Shares Per Share
Outstanding, July 1, 1995 - $ - Granted 42,480 12.75
Outstanding, June 30, 1996 42,480 12.75 Granted 19,320 12.50 Canceled (9,000) 12.75
Outstanding, June 30, 1997 52,800 12.65
At June 30, 1997, options exercisable under the Company's Stock Option Plan totaled 3,348 shares and had a weighted-average exercise price per share of $12.75. There were no options exercisable at June 30, 1996. For options outstanding at June 30, 1997, the exercise price per share ranged from $12.50 to $12.75 and the weighted-average remaining contractual life of the options was 8.6 years. As of June 30, 1997, 43,800 shares of common stock were reserved for future option grants under the Company's Stock Option Plan compared to 54,120 shares of June 30, 1996.
Sobieski adopted the disclosure only provisions of Statement of Financial Accounting Standards No. 123, "Accounting For Stock- Based Compensation" ("SFAS No. 123"), effective July 1, 1996. For the years ended June 30, 1997 and 1996, pro forma net income and earnings per share, reported as if compensation expense had been recognized under the fair value provisions of SFAS No. 123, would have been approximately $225,000, or $.29 per share, and $319,000, or $.37 per share, respectively. The significant assumptions used in the calculation of the Black-Scholes value of Sobieski's stock options were as follows:
Risk free interest rate 6.25% Volatility rate 20% Expected life 7 years Expected dividends 2%
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
K. REGULATORY CAPITAL.
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 of total and Tier I capital, as defined in the regulations, to risk-weighted assets, as defined, and of Tier I capital to average assets, as defined. As of June 30, 1997, the most recent notification from the Office of Thrift Supervision categorized the Association as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Association must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios. There are no conditions or events since that notification that management believes have changed the Association's category.
The following represents a reconciliation between the Association's stockholder's equity under generally accepted accounting principles to regulatory capital at June 30, 1997:
Stockholder's equity $ 9,018,312 Add: Net unrealized depreciation of securities available-for-sale 7,356 Tangible and Tier I capital 9,025,668
Add: Allowance for loan losses 200,000
Total risk-based capital $ 9,225,668
The following are details of the Association's regulatory capital position and the related capital requirements as of June 30, 1997. Sobieski's consolidated amounts and ratios do not differ materially from the Association's capital amounts and ratios.
To Be Well Capitalized Under For Capital Prompt Corrective Actual AdequacyPurposes Action Provisions Amount Ratio Amount Ratio Amount Ratio (Dollars in Thousands)
Total Capital $9,226 27.68 $ 2,666 > 8.0% $3,332 > 10% (to Risk-Weighted Assets) Tier I Capital 9,026 27.08 1,333 > 4.0% 1,999 > 6.0% (to Risk-Weighted Assets) Tier I Capital 9,026 11.37 3,173 > 4.0% 3,966 > 5.0% (to Adjusted Assets) Tangible Capital9,026 11.37 2,380 > 3.0% N/A N/A (to Tangible Assets)
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
L. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK.
Sobieski is a party to loan commitments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. The loan commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition.
Sobieski's exposure to credit loss in the event of nonperformance by the parties to the loan commitments is represented by the contractual dollar amounts of those commitments ($1,769,000 and $712,000 at June 30, 1997 and 1996, respectively). Sobieski uses the same credit policies in making loan commitments as it does for on-balance-sheet instruments.
Loan commitments are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Sobieski evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Sobieski upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held consists primarily of the real estate being financed.
M. CONCENTRATION OF CREDIT RISK.
Substantially all of Sobieski's loan activity is with customers located in St. Joseph County in Northern Indiana with a major concentration in single-family residential lending.
Generally, loans are collateralized by real estate. The loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrowers. Sobieski's policy for requiring collateral is dependent upon management's credit evaluation of the borrower.
The mortgage-backed securities held by Sobieski consist primarily of FNMA, GNMA and FHLMC pass-through certificates which are issued by those respective agency programs, as sponsored by the United States Government.
Interest-bearing deposits in other financial institutions consist principally of deposits with the Federal Home Loan Bank of Indianapolis.
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
N. FAIR VALUE OF FINANCIAL INSTRUMENTS.
Fair value disclosures of financial instruments are made to comply with the requirements of Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments."
The estimated fair values of Sobieski's financial instruments as of June 30, 1997 and 1996 are as follows:
Carrying Estimated Amount Fair Value 1997 1996 1997 1996 Assets: Cash and cash equivalents $ 1,251,373 $ 1,385,520 $ 1,251,373 $1,385,520 Certificates of deposit 198,000 198,000 198,000 198,000 Investment securities 2,297,148 4,693,784 2,310,048 4,690,784 Mortgage- backed securities 13,709,562 16,151,650 13,397,710 15,769,525 Loans receivable, net 61,134,644 53,114,094 61,521,000 53,095,000 Federal Home Loan Bank stock 636,000 636,000 636,000 636,000
Liabilities: Deposits 59,386,630 61,226,683 59,508,000 61,442,000 Federal Home Loan Bank advances 9,500,000 3,000,000 9,511,000 3,000,000
Contract or Estimated Notional Unrealized Amount Gain 1997 1996 1997 1996
Off-balance-sheet financial instruments: Loan commitments - fixed rate $1,331,000 $ 610,000 $ 13,000 $ - Loan commitments - adjustable rate 438,000 102,000 - -
The following methods and assumptions were used to estimate the fair value of Sobieski's financial instruments.
Cash and cash equivalents, certificates of deposit and Federal Home Loan Bank stock:
The carrying amounts of cash and cash equivalents, certificates of deposit and Federal Home Loan Bank stock are reasonable estimates of their respective fair values.
Investment securities and mortgage-backed securities:
Estimated fair values of investment securities and mortgage- backed securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated using quoted market prices for similar instruments.
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
N. FAIR VALUE OF FINANCIAL INSTRUMENTS, Concluded.
Loans receivable:
Fair values are estimated for portfolios with similar financial characteristics. Loans are segregated by type, such as residential mortgages, nonresidential mortgages, commercial and consumer loans. Each loan category is further segmented into fixed and variable interest categories, with residential mortgage loans (Sobieski's largest category) further segregated by similar note rates and maturities. Future cash flows of these loans are discounted using the current rates at which similar loans would be made to borrowers with similar credit rating for the same remaining maturities.
Deposits:
The estimated fair values of passbook and money market accounts and negotiable orders of withdrawal are determined by discounting estimated future cash flows using the market rates for similar deposits. Certificates of deposit and IRA accounts are segregated by original and remaining term and estimated future cash flows are discounted using rates currently offered for certificate and IRA accounts of similar remaining maturity.
Federal Home Loan Bank advances:
The estimated fair values of advances from the Federal Home Loan Bank of Indianapolis are determined by discounting the future cash flows of outstanding advances using rates currently available on advances from the Federal Home Loan Bank of Indianapolis with similar characteristics.
Loan commitments - fixed rate:
The estimated fair value of commitments to originate fixed-rate loans is determined based on the difference between current levels of interest rates and the committed rates. Because Sobieski's loan commitments expire within 45-60 days of commitment, the effect of market rate changes on the fair value of these commitments is not significant.
Loan commitments - adjustable rate:
There is no estimated unrealized gain or loss attributable to adjustable rate loan commitments due to their adjustable interest rate feature.
The fair value estimates presented herein are based on pertinent information available to management as of June 30, 1997 and 1996. Estimated fair value amounts have been determined by Sobieski using available market information and a selection from appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amount Sobieski could realize in a current market exchange. The use of different market assumptions and estimation methodologies may have a material effect on the estimated fair value amounts.
O. PARENT COMPANY FINANCIAL INFORMATION.
The Company was organized to serve as the holding company for the Association and began operations on March 30, 1995 in conjunction with the Association's mutual-to-stock conversion and the Company's initial public offering of its common stock. The Company's statements of financial condition as of June 30, 1997 and 1996, and its related statements of income and cash flows for the years ended June 30, 1997 and 1996 and the period from March 30, 1995 through June 30, 1995 are as follows:
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
O. PARENT COMPANY FINANCIAL INFORMATION, Continued.
STATEMENTS OF FINANCIAL CONDITION As of June 30, 1997 and 1996
ASSETS 1997 1996
Cash and cash equivalents $ 24,566 $ 24,573 Loans receivable 3,089,198 3,292,723 Note receivable from subsidiary 611,800 676,200 Investment in subsidiary 9,018,312 10,100,080 Other assets 144,179 32,726
Total assets $ 12,888,055 $ 14,126,302
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES: Note payable to subsidiary $ 500,000 $ - Accrued income taxes 14,173 65,829 Other liabilities 13,087 6,283
Total liabilities 527,260 72,112
STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value: 500,000 shares authorized; none issued - - Common stock, $.01 par value: 3,500,000 shares authorized; 966,000 shares issued 9,660 9,660 Additional paid-in capital 9,147,176 9,099,156 Retained earnings, substantially restricted 6,670,543 6,538,602 Net unrealized depreciation of securities available-for-sale (7,356) (7,571) 15,820,023 15,639,847
Less: Treasury stock, at cost, 206,368 and 71,940 shares, respectively 2,879,878 909,457 Unallocated Employee Stock Ownership Plan shares; 57,935 and 67,620 shares, respectively 579,350 676,200
Total stockholders' equity 12,360,795 14,054,190
Total liabilities and stockholders' equity $12,888,055 $ 14,126,302
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Continued
O. PARENT COMPANY FINANCIAL INFORMATION, Continued.
STATEMENTS OF INCOME for the years ended June 30,1997 and 1996 and for the period from March 30, 1995 through June 30, 1995
1997 1996 1995
Income: Interest income on loans $ 231,082 $ 260,652 $ 67,422 Dividends received from subsidiary 1,449,000 217,350 - Interest on note receivable from subsidiary 51,356 56,366 15,031 Other interest income - 266 11,689
Total income 1,731,438 534,634 94,142
Expenses: Compensation and benefits 57,900 63,900 5,475 Occupancy and equipment 6,000 6,000 1,500 Professional fees 37,349 76,098 10,988 Interest on note payable to subsidiary 24,006 - - Other operating expenses 48,159 65,800 16,019
Total expenses 173,414 211,798 33,982
Income before income taxes and equity in undistributed earnings of subsidiary 1,558,024 322,836 60,160
Income taxes 43,000 42,000 23,830
Income before equity in undistributed earnings of subsidiary 1,515,024 280,836 36,330
Equity in undistributed earnings (losses) of subsidiary (1,267,835) 54,443 513,805
Net income $ 247,189 $ 335,279 $ 550,135
Sobieski Bancorp, Inc. and Subsidiary Notes To Consolidated Financial Statements, Concluded
O. PARENT COMPANY FINANCIAL INFORMATION, Concluded.
STATEMENTS OF CASH FLOWS for the years ended June 30, 1997 and 1996 and for the period from March 30, 1995 through June 30, 1995 1997 1996 1995
Cash flows from operating activities: Net income $ 247,189 $ 335,279 $ 550,135 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed losses (earnings) of subsidiary 1,267,835 ( 54,443) (513,805) Decrease (increase) in other assets (111,453) 2,597 (35,323) Increase (decrease) in accrued income taxes (51,656) 41,999 23,830 Increase (decrease) in other liabilities 6,804 (4,334) 10,615
Net cash provided by operating activities 1,358,719 321,098 35,452
Cash flows from investing activities: Investment in common stock of subsidiary - - (4,542,500) Payments received on note receivable from subsidiary 64,400 96,600 - Net (increase) decrease in loans purchased from subsidiary and principal collections on loans 203,525 282,983 (3,575,706)
Net cash provided by (used in)investing activities 267,925 379,583 (8,118,206)
Cash flows from financing activities: Proceeds from note payable to subsidiary 500,000 - - Proceeds from issuance of common stock, net - - 8,316,103 Purchase of treasury stock (2,011,403) (909,457) - Cash dividends (115,248) - -
Net cash provided by (used in) financing activities (1,626,651) (909,457) 8,316,103
Net increase (decrease) in cash and cash equivalents (7) (208,776) 233,349
Cash and cash equivalents: Beginning of period 24,573 233,349 -
End of period $ 24,566 $ 24,573 $ 233,349
These financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto.
SOBIESKI BANCORP, INC. STOCKHOLDER INFORMATION
ANNUAL MEETING
The Annual Meeting of Stockholders will be held at 2:00 p.m., South Bend, Indiana, time on October 27, 1997 at the office of Sobieski Bancorp, Inc., 2930 W. Cleveland Road, South Bend, Indiana 46628.
STOCK LISTING
Sobieski Bancorp, Inc. common stock is traded on the NASDAQ System under the symbol "SOBI".
MARKET AND DIVIDEND INFORMATION
The Company's ability to pay dividends to its stockholders is substantially dependent upon the dividends it receives from Sobieski Federal. Under current regulations, the Association is not permitted to pay dividends if its regulatory capital would thereby be reduced below (1) the amount then required for the liquidation account established in connection with the Association's conversion from mutual to stock form, or (2) the regulatory capital requirements imposed by the Office of Thrift Supervision. Capital distributions are also subject to certain limitations based on Sobieski Federal's net income. See Note A of Notes to Consolidated Financial Statements. The Association's total capital at June 30, 1997 exceeded the amounts of its liquidation account and regulatory capital requirements.
The following table sets forth, for the periods shown, the per share price range of the common stock and dividends paid for each quarter since the common stock began trading on March 30, 1995. The prices reflect interdealer quotations without retail markup, markdown or commissions, and do not necessarily represent actual transactions. 1997 1996 1995 HIGH LOW Dividends HIGH LOW Dividends HIGH LOW Dividends First Quarter $12.75 $11.75 $ - $12.19 $11.00 $ - $ - $ - $ - Second Quarter 17.00 12.75 - 13.25 12.00 - - - - Third Quarter(1) 15.50 14.00 0.07 13.00 12.00 - 10.25 10.00 - Fourth Quarter 15.25 14.50 0.07 13.00 12.00 - 11.13 10.00 -
(1) For 1995, reflects the period from March 30, 1995 through March 31, 1995.
The stock price information set forth in the table above was provided by the National Association of Securities Dealers, Inc. Automated Quotation System. The average of the bid and asked prices of Sobieski Bancorp, Inc.'s common stock on August 29, 1997 was $16.4375.
At August 29, 1997, there were 759,632 shares of Sobieski Bancorp, Inc. common stock issued and outstanding and there were approximately 399 holders of record.
STOCKHOLDER AND GENERAL INQUIRIES: TRANSFER AGENT: Thomas F. Gruber Registrar and Transfer Co. President and Chief Executive Officer 10 Commerce Drive Sobieski Bancorp, Inc. Cranford, NJ 07016 2930 W. Cleveland Road South Bend, Indiana 46628 (219) 271-8300
ANNUAL AND OTHER REPORTS A copy of Sobieski Bancorp, Inc.'s Annual Report on Form 10-KSB for the year ended June 30, 1997, as filed with the Securities and Exchange Commission, may be obtained without charge by contacting Thomas F. Gruber, President and Chief Executive Officer, Sobieski Bancorp, Inc., 2930 W. Cleveland Road, South Bend, Indiana (219) 271-8300.
SOBIESKI BANCORP, INC. CORPORATE INFORMATION
COMPANY AND BANK ADDRESS
2930 W. Cleveland Road South Bend, Indiana 46628 Telephone: (219) 271-8300 Fax: (219) 271-3269
BOARD OF DIRECTORS
Thomas F. Gruber Robert J. Urbanski President and Chief Executive Officer President and Co-owner, of Sobieski Bancorp, Inc. and Trans-Tech Electric,Co. Sobieski Federal Savings and Loan and Chairman of the Association Board Sobieski Bancorp, Inc. and Sobieski Federal Savings and Loan Association
Joseph F. Nagy Leonard J. Dobosiewicz Auditor, St. Joseph Maintenance Professional County
Joseph A. Gorny George J. Aranowski Owner, Liquor Store Public Accountant
EXECUTIVE OFFICERS
Thomas F. Gruber Marsha Nafrady President and Chief Executive Secretary and Treasurer Officer
Arthur Skale Sharon Mrozek Chief Financial Officer Vice President of Operations
INDEPENDENT AUDITORS GENERAL COUNSEL SPECIAL COUNSEL
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
State of Percentage Parent Subsidiary Incorporation of Ownership
Sobieski Bancorp, Inc. Sobieski Federal Savings and Loan United States 100% Association