Item 1. Business
The Company
HF Financial Corp. (the "Company") was formed in November 1991, for the purpose of owning all of the outstanding stock of Home Federal Savings Bank ("Home Federal" or the "Bank") issued in the mutual to stock conversion of Home Federal (the "Conversion"). The Company acquired all of the outstanding stock of the Bank on April 8, 1992. In October 1994, the Company acquired and began operating a mortgage subsidiary as HomeFirst Mortgage Corp. ("Mortgage Corp."). This subsidiary ceased operations in fiscal year 1998. In May, 1996, the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of this entity. The Company became the owner of 100% of HF Card Services effective as of July 1998. At June 30, 2000, the Company had total assets of $725.0 million and consolidated stockholders' equity of $46.9 million (or 6.47% of assets).
The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law. The activities of the Company itself have no significant impact on the results of operations on a consolidated basis. Unless otherwise indicated, all matters discussed herein relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank, Mortgage Corp. and HF Card Services.
The executive offices of the Company, the Bank, the Mortgage Corp. and HF Card Services are located at 225 South Main Avenue, Sioux Falls, South Dakota 57104. The Company's telephone number at that address is (605) 333-7556.
The Bank
Home Federal is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota. Its deposits are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF"), administered by the Federal Deposit Insurance Corporation ("FDIC"). Originally chartered in 1929, Home Federal serves 20 cities in eastern South Dakota through its network of 27 retail banking offices located throughout eastern South Dakota and one internet branch which is located at www.homefederal.com. In August 2000, the Bank opened an additional branch in Marshall, Minnesota.
The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one- to four-family residential, consumer, multi-family, commercial real estate, construction, agricultural and commercial business loans. The Bank's consumer loan portfolio includes, among other things, mobile home loans, automobile loans, home equity loans, credit card loans, loans secured by deposit accounts and student loans.
The Bank also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. Home Federal does not rely on any brokered deposits and does not hold any non-investment grade bonds (i.e., "junk bonds"). The Bank also receives loan servicing income on loans serviced for others and commission income from credit-life. The Bank, through its wholly-owned subsidiaries, offers annuities, health, life, hazard and other insurance products and appraisal services.
At June 30, 2000, the Bank's loan portfolio totalled $577.0 million, which consisted of $134.0 million of one- to four-family residential mortgage loans, $44.8 million of multi-family real estate loans, $68.6 million of commercial real estate loans, $35.5 million of construction and development loans, $173.7 million of consumer loans, $33.3 million of agricultural loans and $87.1 million of commercial business loans. On such date, the Bank had $53.0 million of mortgage-backed securities and $60.1 million of investment securities.
Mortgage Corp.
HomeFirst Mortgage Corp. was a mortgage banking operation that originated one- to four-family residential loans which were sold into the secondary market and to the Bank. The Mortgage Corp. had no activity during fiscal year 2000.
The Mortgage Corp. resumed activity in August 2000 through the acquisition of Mid America Capital Services, Inc., a company specializing in equipment leasing. This acquisition expands the Company's servicing options for commercial and municipal customers.
HF Card Services
HF Card Services was established to provide secured, partially-secured and unsecured credit cards nationwide to sub-prime credit customers who have either an insufficient credit history or a negative credit history and are unable to obtain a credit card from more traditional credit card issuers. The Company ceased processing subprime credit card applications in March 1999.
Other Subsidiaries
Home Federal, through its wholly-owned subsidiaries, Hometown Insurors, Inc. and Mid-America Service Corporation, offers mortgage life, hazard and other insurance products and appraisal services. See "Subsidiary Activities." In addition, Home Federal's subsidiary, PMD, Inc., engages in the business of buying, selling and managing repossessed real estate properties of Home Federal. PMD, Inc. had no activity during fiscal year 2000.
Segments
The Company's reportable segments are banking, credit card and other. The "banking" segment is conducted through the Bank and the "credit card" segment is conducted through HF Card Services. The "other" segment is composed of smaller nonreportable segments, the Company and inter-segment eliminations. See Note 15 of the "Notes to Consolidated Financial Statements".
Market Area
Based on total assets at June 30, 2000, Home Federal is the largest thrift institution headquartered in South Dakota. During its 71-year existence, among its other lending activities, Home Federal served its customers located in eastern and central South Dakota, including the cities of Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Hartford, Canton, Parker, Lennox, Aberdeen, Mobridge, Brookings, Redfield, Dakota Dunes, Colman, Crooks, Chester, Wentworth and Watertown, and the communities surrounding such communities through its network of 27 full service offices and one internet branch. During August 2000, the Bank expanded its market area to include a branch in Marshall, Minnesota. The Bank's immediate market area features a variety of agri-business, banking, financial services, health care and light manufacturing firms.
HF Card Services provides services to customers nationwide.
Lending Activities
General. Historically, the Bank has originated fixed-rate one- to four-family mortgage loans. Since 1984, however, the Bank has emphasized the origination of adjustable-rate mortgage ("ARM") loans and short-term loans for retention in its portfolio in order to increase the percentage of loans in its portfolio with more frequent repricing or shorter maturities, and in some cases higher yields, than fixed-rate mortgage loans. The Bank has continued to originate fixed-rate mortgage loans in response to customer demand. While the Bank sold fixed-rate loans with maturities of 15 years or greater and
conventional ARM loans into the secondary market, during fiscal 2000 the Bank sold the majority of the loans with servicing released.
While the Bank primarily focuses its lending activities on the origination of loans secured by first mortgages on owner-occupied one- to four-family residences as well as consumer loans, the Bank also originates multi-family residential and commercial real estate, construction, agricultural and commercial business loans in its primary market area. The Bank originates residential and non-owner occupied construction loans that are presold to borrowers or held for sale by local builders and, on few occasions, makes land acquisition and development loans. The Bank's one- to four-family loans are primarily secured by homes located in its market area in South Dakota. At June 30, 2000, the Bank's net loan portfolio totalled $550.8 million.
Loan Portfolio Composition. The following table sets forth information concerning the composition of the Bank's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.
(1)Includes primarily second mortgage loans.
The following table shows the composition of the Bank's loan portfolio by fixed- and adjustable-rate loans at the dates indicated.
The following schedule illustrates the scheduled principal contractual repayments of the Bank's loan portfolio at June 30, 2000. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule 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)Includes construction loans. The total amount of loans due after June 30, 2001 which have predetermined interest rates is $236.1 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $218.3 million.
Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their average contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgages are substantially higher than current mortgage loan rates.
One- to Four-Family Residential Mortgage Lending. Residential loan originations of this type are generated by the Company's marketing efforts, its present customers, walk-in customers and referrals from real estate brokers and builders. Historically, the Bank has focused its lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences. At June 30, 2000, the Company's one- to four-family residential mortgage loans totalled $134.0 million, or approximately 23.2% of the Company's gross loan portfolio.
Historically, the Company has emphasized the origination of conventional ARM loans for retention in its portfolio and fixed-rate conforming loans suitable for sale in the secondary market. However, during fiscal 2000 the Company sold conventional ARM loans into the secondary market. Presently, the Company follows the practice of generally selling fixed rate conventional mortgage loans with maturities of 15 years or greater. See "Originations, Purchases, Sales and Servicing of Loans and Mortgage-Backed Securities." During the year ended June 30, 2000, the Company originated $57.0 million of adjustable-rate real estate loans, of which $22.6 million were secured by one- to four-family residential real estate. During the same period, the Company originated $85.3 million of fixed-rate real estate loans, of which $69.9 million were secured by one- to four-family residential real estate. The Bank's one- to four-family residential mortgage originations are primarily in its market area.
The Company currently makes 15- and 30-year fixed- and adjustable-rate one- to four-family residential mortgage loans in amounts up to 95% of the appraised value of the collateral property provided that private mortgage insurance is obtained in an amount sufficient to reduce the Company's exposure at or below the 80% level. The Company currently offers an ARM loan which has a fixed rate for the initial three years and converts to a one-year ARM loan for the remainder of the life of the loan. The Company also offers a one-year ARM loan with a rate below the Company's then current fixed-rate loan for a comparable 15- or 30-year term loan. These loans provide for up to a 2.0% annual cap and a lifetime cap of 6.0% over the fully-indexed rate. These ARM products have an interest rate margin generally 2.9% over the one-year Treasury Bill rate. As a consequence of using caps, the interest rates on these loans are not as rate sensitive as is the Company's cost of funds. The initial rate used for the loan is usually below the fully-indexed rate and is determined by the Company in accordance with market and competitive factors.
In addition, the Company offers a 30-year balloon loan which has a fixed-rate for the first five or seven years of the loan term. At the end of the five- or seven-year period, the loan converts to a 23- or 25-year fixed-rate loan at the then current market rate provided that the borrower qualifies at the new rate. If the borrower fails to qualify at the new rate, the loan becomes payable in full. These loans are underwritten to conform to the Federal Home Loan Mortgage Corporation's ("FHLMC") secondary market standards.
The Company also offers fixed-rate 15- through 30-year mortgage loans that conform to secondary market standards (i.e., Federal National Mortgage Bank ("FNMA"), Government National Mortgage Bank ("GNMA") and FHLMC standards). Interest rates charged on these fixed-rate loans are competitively priced on a daily basis according to market conditions. Residential loans generally do not include prepayment penalties. Most of these loans with maturities of 30 years are held for sale or sold in the secondary market. While the Company has generally retained servicing rights on such loans whenever possible, during fiscal 2000 the Company sold the majority of its loans with servicing released.
The Bank also originates fixed-rate one- to four-family mortgage loans through the South Dakota Housing Development Authority ("SDHDA") program. These loans generally have terms not to exceed 30 years and are either insured by the FHA/VA or private mortgage insuror or must have no more than a 80% loan to value ratio. The Bank receives an origination fee of one percent of the loan amount from the borrower and a servicing fee generally three-eighths of one percent from the SDHDA for these services. The Bank is the largest servicer of loans for the SDHDA. At June 30, 2000, the Bank serviced $391.5 million of mortgage loans for the SDHDA.
In underwriting one- to four-family residential real estate loans, Home Federal evaluates both the borrower's ability to make monthly payments and the value of the property securing the loan. These criteria are also applied to loans purchased. Most property securing real estate loans made by Home Federal is appraised by an appraiser employed by Mid-America Service Corporation, Home Federal's wholly-owned subsidiary. Other appraisals are performed by independent appraisers selected by Home Federal. Home Federal requires borrowers to obtain title, fire and casualty insurance in an amount not less than the amount of the loan. Real estate loans originated by the Bank contain a "due-on-sale" clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the collateral property.
Multi-Family and Commercial Real Estate Lending. The Bank engages in multi-family and commercial real estate lending primarily in South Dakota and the adjoining mid-western states. These lending activities may include existing property or new construction development.
Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent
on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired.
The Bank presently originates adjustable-rate, short-term balloon payment, fixed-rate multi-family and commercial real estate loans. The Bank's multi-family and commercial real estate loan portfolio is secured primarily by apartment buildings and, to a lesser extent, churches, motels, office buildings, strip shopping centers and nursing homes. The terms of such loans are negotiated on a case by case basis. Commercial real estate loans generally have terms that do not exceed 25 years. The Bank has a variety of rate adjustment features, call provisions and other terms in its multi-family and commercial real estate loan portfolio. Generally, the loans are made in amounts up to 75% of the appraised value of the collateral property and with debt service coverage ratios of 115% or higher. The debt service coverage is the ratio of net cash from operations before payment of debt service. However, these percentages may vary depending on the type of security and the guarantor. Such loans provide for a negotiated margin over a designated index which is generally the one-year Treasury Bill Rate. Fixed-rate loans are generally made when advances from the Federal Home Loan Bank ("FHLB") of Des Moines can be used to fund the loan. The Bank analyzes the financial condition of the borrower, the borrower's credit history, the borrower's prior record for producing sufficient income from similar loans, references and the reliability and predictability of the net income generated by the property securing the loan. The Bank generally requires personal guarantees of borrowers. Depending on the circumstances of the security of the loan or the relationship with the borrower, the Bank may decide to sell participations in the loan. The sale of participation interests in a loan are necessitated by the amount of the loan or the Loans to One Borrower requirements which would require the sale of the loan. In return for servicing these loans for the participants, the Bank generally receives a fee of one-fourth to three-eighths of one percent. Also, income is received at loan closing from loan fees and discount points. Appraisals on properties securing multi-family and commercial real estate loans originated by the Bank are performed by independent appraisers selected by Home Federal and reviewed by Bank employees.
At June 30, 2000, the Bank had $44.8 million of multi-family and $68.6 million of commercial real estate loans, which represented 7.8% and 11.9%, respectively, of the Bank's gross loan portfolio. See "Nonperforming Assets and Classified Loans" for a discussion of the Bank's largest nonperforming assets and items of concern and the allowance established for each.
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") includes a provision that limits the Bank's non-residential real estate lending (i.e., commercial real estate lending, other than lending on certain multi-family residences) to no more than four times its total capital. This maximum limitation, which at June 30, 2000 was $180.4 million, has not materially limited the Bank's lending practices. See "Regulation-Regulatory Capital Requirements."
Under FIRREA, the maximum amount which Home Federal may lend to any one borrower is 15% of Home Federal's unimpaired capital and surplus or $7.3 million at June 30, 2000. Loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to the same borrower if such loans are fully secured by readily marketable collateral. See "Regulation" for a discussion of the Loans to One Borrower rule. On June 30, 2000, the Bank did not have any loans exceeding the Loans to One Borrower requirements.
At June 30, 2000, Home Federal had no loans in excess of its present legal lending limit. On such date, the Bank had loans in excess of $1.0 million to 56 borrowers or groups of affiliated borrowers.
Construction and Development Lending. The Bank makes construction loans to individuals for the construction of their residences as well as to builders and, to a lesser extent, developers for the
construction of one- to four-family residences and condominiums and the development of one- to four-family lots in the Bank's primary market area.
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 6 to 12 months. These construction loans have rates and terms which match the one- to four-family permanent loans offered by the Bank. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans. At June 30, 2000, the Bank had $13.7 million of residential construction loans to borrowers intending to live in the properties upon completion of construction.
The Bank has lines of credit for qualified builders. This product provides the builder flexibility while the Bank maintains its credit standards. The lines of credit do not advance more than 75% of the approved value or cost on a construction project and a mortgage is filed on each construction project and interest is collected monthly. These lines provide for the payment of interest and loan fees, with interest rates of 1% to 2.5% over the prime rate adjusted on a monthly basis.
The Bank also makes loans to developers for the purpose of developing one- to four-family lots. These loans typically have terms of one year and carry interest rates which float monthly based on a national designated index such as the prime rate. Loan commitment and partial release fees are charged. These loans generally provide for the payment of interest and loan fees from loan proceeds. The principal balance of these loans is typically paid down as lots are sold. At June 30, 2000, the Bank had $10.5 million of development loans, included in the $13.7 million residential construction loans above.
Builder construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from the Bank as well as broker referrals and direct solicitations of developers and builders. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed or developed. 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 and/or the cost of construction (land plus building).
The Bank makes loans for the construction of multi-family residential properties. Such loans are generally made at adjustable rates which adjust annually based upon a national designated index. At June 30, 2000, the Bank had $8.4 million of multi-family residential construction loans. At June 30, 2000, all of the Bank's construction loans were performing in accordance with their terms.
Construction loans are generally originated with a maximum loan-to-value ratio of 75% and land development loans are generally originated with a maximum loan-to-value ratio of 60%, based upon an independent appraisal. Because of the uncertainties inherent in estimating development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. Construction and development loans to borrowers other than owner occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.
Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property, or for larger projects, both an appraisal and a study of the feasibility of the proposed project. The Bank's construction loan policy provides for the inspection of properties by in-house and independent inspectors at the commencement of construction and prior to disbursement of funds during the term of the construction loan.
Consumer Lending. Management considers its consumer loan products to be an important component of its lending strategy. Specifically, consumer loans generally have shorter terms to maturity and carry higher rates of interest than do one-to four-family residential mortgage loans. In addition,
management believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base, by increasing the number of customer relationships and providing cross-marketing opportunities. For these reasons, Home Federal has continued to focus on the origination of consumer loans.
Home Federal offers a variety of secured consumer loans, including home improvement and second mortgage loans, loans secured by savings deposits, home equity loans, mobile home loans and automobile loans. In addition, Home Federal offers student loans, boat and vacation loans and other secured and unsecured consumer loans. All secured consumer loans over $100,000 must be approved by the Bank's loan committee except for loans over $250,000 which must be approved by the Bank's Board of Directors. The Bank originates consumer loans on both a direct and indirect basis. Direct loans are made when the Bank extends credit directly to the borrower. Indirect loans are obtained when the Bank purchases loan contracts from retailers of goods or services which have extended credit to their customers. The only indirect lending by Home Federal, described below, is with selected automobile dealers located in the Bank's lending area.
Most of the Bank's mobile home loans have been originated with fixed rates of interest and are generally made in amounts of up to a maximum of the lesser of 125% of the net invoice or 90% of the buyer's cost. The buyer's cost can include such items as freight, itemized set-up charges, physical damage insurance, sales tax and filing and recording fees. Home Federal is permitted by regulation to make mobile home loans for terms of up to 20 years, although most of the Bank's mobile home loans are for terms of 15 years or less. At June 30, 2000, mobile home loans amounted to $5.7 million or 1.0% of the Bank's gross loan portfolio.
Home Federal currently purchases automobile conditional sales contracts from selected dealers within its market area as well as originating automobile loans directly. At June 30, 2000, automobile loans amounted to $81.1 million or 14.1% of the Bank's gross loan portfolio.
Loans secured by second mortgages, together with loans secured by all prior liens, are limited to 100% or less of the appraised value of the property securing the loan and generally have maximum terms that do not exceed seven to ten years. As of June 30, 2000, such loans amounted to $56.2 million or 9.8% of the Bank's gross loan portfolio.
The student loans originated by Home Federal are guaranteed as to principal and interest by the South Dakota Education Assistance Corporation. Upon the student nearing graduation, Home Federal sells such student loans with servicing rights released. At June 30, 2000, student loans amounted to $7.1 million or 1.2% of the Bank's gross loan portfolio.
At June 30, 2000, the Bank's consumer loan portfolio totalled $173.7 million, or 30.1% of its gross loan portfolio. Of the consumer loan portfolio at June 30, 2000, 24.7% were adjustable-rate loans.
Consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower. Home Federal offers both open-and closed-end credit. Overdraft lending is extended through lines of credit that are tied to a negotiated order of withdrawal ("NOW") account. The credit lines generally bear interest at 18% and are generally limited to no more than $5,000. Loans secured by deposit accounts at the Bank are currently originated for up to 90% of the account balance (although historically the Bank has loaned up to 100% of the account balance), with a hold placed on the account restricting the withdrawal of the account balance. The interest rate on such loans is typically equal to 2% above the contract rate.
The underwriting standards employed by the Bank for consumer loans, including mobile home loans, include an application, a determination of the applicant's payment history on other debts, and an assessment of the ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as mobile homes, automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At June 30, 2000, the Bank had $1.4 million consumer loans, including mobile home loans, delinquent more than 30 days. Not included in this amount was $82,000 of repossessed consumer and mobile home collateral. Although management believes that the level of delinquencies in the Bank's consumer loan portfolio, including mobile home loans, has generally been low and only 0.3% of the consumer loan portfolio was nonperforming, there can be no assurance that delinquencies will not increase in the future. See "Nonperforming Assets and Classified Loans" for further discussion.
Credit Card Lending. During fiscal year 1991, the Bank began offering VISA/Mastercard card credit card services on an agency basis to its customers. The Bank does not retain or have any credit liability related to the credit which is extended in connection with such cards. The Bank is paid a fee for each card issued and receives a fee for each transaction completed on these cards. During fiscal 1997, the Company made a strategic decision to enter the credit card business more directly and took a 51% majority position in a newly formed subsidiary, HF Card Services. The Company became the owner of 100% of HF Card Services effective as of July 1998. The target market for credit cards in this line of business was sub-prime credit customers who have either an insufficient credit history or a negative credit history and were unable to obtain a credit card from more traditional card issuers. Credit card processing is being provided by independent third parties. The Company had approximately $9.6 million in credit card loans at June 30, 2000. The Company ceased processing subprime credit card applications in March 1999.
Commercial Business Lending. In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates commercial loans to local businesses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Asset/Liability and Risk Management." At June 30, 2000, approximately $87.1 million or 15.1% of the Bank's total loan portfolio was comprised of commercial business loans. Home Federal's commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory, equipment and business expansion within the Bank's market area. Virtually all of Home Federal's commercial business loans have been to borrowers in its primary lending areas. The Bank originates commercial business loans directly and through programs sponsored by the Small Business Administration ("SBA") of which a portion of such loans are also guaranteed in part by the SBA. The Bank generally originates commercial business loans for its portfolio and retains the servicing with respect to such loans. In the future, Home Federal anticipates continued expansion of its commercial business lending, subject to market conditions. Interest rates on commercial business loans adjust or float with a designated national index plus a specified margin.
Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, is likely to be dependent upon the general economic environment). The Bank's commercial business loans are sometimes, but not always, secured by business assets, such as accounts receivable, equipment and inventory. However,
the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Virtually all of the Bank's commercial business loans include personal guarantees. At June 30, 2000, seven of the Bank's commercial business loans totaling $971,000 were nonperforming.
Agricultural Loans. In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Company established an agricultural lending department in fiscal year 1996. The Company employed experienced lenders to establish this department and to ensure a high quality portfolio. The agricultural division offers four types of loans to its consumers: (1) operating loans which are used to fund operating expenses which typically have a one year term and are indexed to the national prime rate; (2) term loans on machinery, equipment and breeding stock that may have a term up to seven years and require annual payments; (3) agricultural farmland term loans which are used to fund land purchases or refinances; and (4) specialized livestock loans to fund facilities and equipment for confinement enterprises. These loans typically will have personal guarantees, a first lien on the real estate, interest rates adjustable to the national prime rate, and quarterly or monthly payments. All loans are secured by the operating assets of the borrower. The Bank had approximately $33.3 million of its loan portfolio in agricultural loans which was 5.8% of its loan portfolio at June 30, 2000.
Loan customers are required to supply current financial statements, tax returns for the past three to five years, and cash flow projections which are updated on an annual basis. In addition, on major loans the loan officer will perform an annual farm visit, obtain financial statements and perform a financial review of the loan.
At June 30, 2000, four of the Bank's agricultural loans totaling $31,000 were nonperforming.
Originations, Purchases, Sales and Servicing of Loans and Mortgage-Backed Securities
Real estate loans are originated by Home Federal's staff of salaried loan officers working in the Bank's retail banking offices. Loan applications are taken in each office, submitted to the main office for processing, for underwriting, and then, if the amount requested requires, to the loan committee for approval. Walk-in customers and referrals from real estate brokers and builders are important sources of loan originations.
The Company originates both adjustable-rate and fixed-rate loans. Its ability to originate loans is dependent upon the relative customer demand for fixed-rate or ARM loans in its market, which is affected by the term structure (short-term compared to long-term) of interest rates as well as the current and expected future level of interest rates. Virtually all newly originated fixed-rate residential mortgage loans with maturities of 15 years or greater are originated pursuant to prior commitments for immediate sale in the secondary market. The Company sells loans to private investors as well as to FNMA and FHLMC. At June 30, 2000, the Company had $8.3 million of loans secured by one- to four-family residential real estate which were held for sale. See Notes 3 and 4 of the "Notes to Consolidated Financial Statements." These loans are originated to satisfy customer demand and to generate fee income and are sold to achieve the goals in the Bank's asset/liability management program. During fiscal 2000 the Bank sold the majority of these fixed-rate mortgage loans with servicing released. The Bank also occasionally sells loan participations in order to diversify risk and to comply with Loans to One Borrower requirements.
Home Federal has had a substantial portfolio of fixed-rate and adjustable-rate mortgage-backed securities which it uses for investment and liquidity management. During fiscal 2000, the Bank purchased $23.2 million of mortgage-backed securities. At June 30, 2000, mortgage-backed securities totalled $53.0 million, or 8.4% of Home Federal's gross loans and mortgage-backed securities portfolio. Such mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity. For information regarding the carrying and market values of Home Federal's
mortgage-backed securities portfolio, see Note 2 of the "Notes to Consolidated Financial Statements." Under the risk-based capital requirement, GNMA mortgage-backed securities have a risk-weighting of 0% and FNMA and FHLMC mortgage-backed securities and mortgage-backed securities issued by U.S. Government sponsored agencies have a risk weighting of 20%, in contrast to the 50% risk weight carried by residential loans. While the Bank could exchange its long-term, fixed-rate mortgage loans for FHLMC participation certificates in order to achieve the same benefit of increased liquidity, to date, it has not elected to do so because of adequate liquidity.
Since 1982, the Bank has purchased mortgage servicing rights from other originators on loans of the SDHDA, a state agency that provides low-interest residential housing financing for first time home buyers in South Dakota. In return for servicing such portfolio, the Bank generally receives a fee of three-eighths of one percent from the SDHDA. At June 30, 2000, the Bank serviced $460.8 million in loans for others (primarily the SDHDA).
The contractual right to service mortgage loans has an economic value. The value results from the future income stream of the servicing fees, the availability of the cash balances associated with escrow funds collected monthly for real estate taxes and insurance, the availability of the cash from monthly principal and interest payments from the collection date to the remittance date, and the ability of the servicer to cross-sell other products and services. The actual value of a servicing portfolio is dependent upon such factors as the age and maturity of the loans in the portfolio, the average dollar balance of the loans, the location of the collateral property, the average amount of escrow funds held, the interest rates and delinquency experience on the loans, the types of loans and other factors.
The unamortized cost of loan servicing rights was $2.2 million at June 30, 2000. Home Federal had no long-term capitalized excess servicing fees receivable as of that date. Home Federal is amortizing these rights in proportion to and over the period of estimated net servicing income. Management reviews its amortization schedules at least quarterly to assure that the carrying value of mortgage servicing is fairly stated.
From time to time, Home Federal has purchased whole loans and loan participations in accordance with its ongoing asset/liability management objectives.
The following table shows the loan and mortgage-backed securities origination, purchase and repayment activities of the Company for the years indicated.
Nonperforming Assets and Classified Loans
Nonperforming Assets. See "Asset Quality" under Management's Discussion and Analysis found on page 51 of this report for discussion.
Classified Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by the Office of Thrift Supervision ("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 savings association will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently
expose the thrift institution to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses, are required to be designated "Special Mention" by management.
When a thrift institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in amounts deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When a thrift institution classifies problem assets as "loss, "it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the association's Regional Director at the regional OTS office, who may order the establishment of additional 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 Bank regularly reviews problem loans in its portfolio to determine whether any loans require classification in accordance with applicable regulations. On the basis of management's monthly review of its assets, at June 30, 2000, the Bank had classified $7.9 million of its assets as special mention (including certain loans discussed herein), $8.5 million as substandard (including certain loans discussed herein), and approximately $715,000 as doubtful. Classified assets at June 30, 2000 consisted of the $2.9 million of nonperforming assets, and the $14.2 million of other loans of concern. See "Asset Quality" under Management's Discussion and Analysis found on page 51 of this report for further discussion.
The Company includes all loans considered impaired in nonaccrual loans. The amount of impaired loans was not significant at June 30, 2000.
The following table sets forth information concerning delinquent mortgage and other loans at June 30, 2000. The amounts presented represent the total remaining principal balances of the related loans, rather than the actual amounts which are overdue.
There were no construction and development loans delinquent at June 30, 2000.
There were no multi-family loans delinquent at June 30, 2000.
The following table sets forth the amounts and categories of the Bank's nonperforming assets. Loans are placed on nonaccrual status when the collection of principal and/or interest become doubtful. Foreclosed assets include assets acquired in settlement of loans. The Bank did not have any material troubled debt restructurings at any of the dates presented.
(1)Consists of nonperforming consumer loans exclusive of mobile home loans and credit card loans.
(2)Nonperforming assets include nonaccruing loans, accruing loans delinquent more than 90 days and foreclosed assets.
(3)Percentage is calculated based upon total assets of the Company, the Bank, HF Card Services L.L.C. and the Mortgage Corp. on a consolidated basis.
(4)Nonperforming loans includes nonaccruing loans and accruing loans delinquent more than 90 days.
Allowance for Loan Losses. See "Asset Quality" under Management's Discussion and Analysis found on page 51 of this report for discussion.
The following table sets forth information with respect to activity in the Bank's allowance for loan losses during the periods indicated.
(1)Nonperforming loans include nonaccruing loans and accruing loans delinquent more than 90 days.
The distribution of the Bank's allowance for loan losses at the dates indicated is summarized as follows:
(1)Includes construction loans.
(2)Excludes allowance for loan losses relating to mobile home loans and credit card loans. Mortgage-Backed Securities
The Bank maintains a substantial portfolio of mortgage-backed securities which it holds for investment and liquidity purposes. Such mortgage-backed securities can serve as collateral for borrowings and, through repayments and sales, as a source of liquidity. During fiscal year 2000, the Bank had $3.2 million of sales and repayments of $7.9 million. The Bank had $23.2 million of purchases of mortgage-backed securities during fiscal year 2000. For information regarding the carrying and market values of the Bank's mortgage-backed securities portfolio, see Note 2 of the "Notes to Consolidated Financial Statements." Under the Bank's risk-based capital requirement, mortgage-backed securities have a risk weight of 20% (or 0% in the case of GNMA securities) in contrast to the 50% risk weight carried by residential loans. See "Regulation." In order to reduce its risk-based capital requirement, the Bank may consider securitizing a portion of its fixed-rate mortgage loan portfolio. However, securitizing mortgage loans may result in a reduction in yield.
The following table sets forth the contractual maturities (without any prepayment assumptions) of the Bank's mortgage-backed securities at June 30, 2000, at amortized cost.
Based on historical experience, Home Federal believes that its mortgage-backed securities will be prepaid significantly in advance of the date of maturity as reflected in the table above. For information regarding prepayment assumptions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations and Asset/Liability and Risk Management."
Investment Activities
Home Federal is required under OTS regulation to maintain minimum levels of investments that qualify as liquid assets. 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 Bank has maintained its liquid assets above the minimum requirements imposed by the OTS regulations and at a level believed by management adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. As of June 30, 2000, the Bank's liquidity ratio (liquid assets as a percentage of net withdrawable savings deposits and current borrowings) was 4.8%. See "Regulation-Liquidity."
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 Bank is to invest funds among various categories of investments and maturities based upon the Bank's asset/liability management policies, investment quality and marketability, liquidity needs and performance objectives.
At June 30, 2000, the Company had $5.0 million in interest-bearing deposits, and investment securities totalled $55.8 million, or 7.7% of its total assets. As of such date, the Bank also had a $6.1 million investment in the stock of the FHLB of Des Moines in order to satisfy the FHLB of Des Moines' requirement for membership. It is the Bank's general policy to purchase investment securities which are U.S. Government securities and federal agency obligations and other issues rated investment grade. At June 30, 2000, the average term to maturity or repricing of the investment securities portfolio was 2.83 years.
The following table sets forth the composition of the Company's and the Bank's investment portfolio at the dates indicated.
The composition and maturities of the investment securities portfolio, excluding equity securities are indicated in the following table.
The Company's investment securities portfolio at June 30, 2000 contained no securities in excess of 10% of the Company's stockholders' equity, excluding those issued by the United States Government or its agencies. The Company's investment securities portfolio also contained no non-investment grade or other corporate debt securities (i.e., "junk bonds"). In addition, the Company does not invest in derivatives as defined by the Financial Accounting Standards Board.
Home Federal's investment security portfolio is managed in accordance with a written investment policy adopted by the Board of Directors. Investments may be made by the Bank's officers within specified limits and approved in advance by the Board of Directors for transactions over these limits. At the present time, the Bank does not have any investments that are held for trading purposes. At June 30, 2000, the Company has $60.4 million of securities available for sale, including FHLB stock of $6.1 million. See Note 2 in the "Notes to Consolidated Financial Statements."
Sources of Funds
General. The Bank's primary sources of funds are deposits, amortization and repayments of loan principal (including mortgage-backed securities), and, to a lesser extent, sales of mortgage loans, sales or maturities of investment securities, mortgage-backed securities, and short term investments.
Borrowings, presently all from the FHLB of Des Moines, may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels, and may be used on a longer-term basis to support expanded lending activities. The Bank in recent years has not relied on outside borrowings other than FHLB borrowings. The availability of funds from loan sales is influenced by general interest rates.
In August 2000, the Company entered into a $3.0 million revolving note agreement with an unrelated bank, primarily to fund the acquisition of Mid America Capital Services, Inc. The note is secured by substantially all assets of the Company, including the Bank stock held by the Company and bears interest at a variable rate and is due August 13, 2001.
Deposits. The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of statement savings accounts, NOW and checking accounts, money market and certificate accounts ranging in terms from 30 days to five years. The Bank's deposit products also include IRA certificates and Keogh plan retirement certificates. The Bank only solicits deposits from its market area and does not use brokers to obtain deposits. The Bank relies primarily on competitive pricing policies, advertising, and customer service to attract and retain these deposits.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition.
The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. In recent years, the Bank has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience, the Bank believes that its statement savings, money market, NOW and checking accounts are stable sources of deposits. However, the ability of the Bank to attract and maintain 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 dollar amount of deposits in the various types of deposit accounts offered by the Company as of the dates indicated.
The following table sets forth the savings flows at the Company during the periods indicated. Net increase refers to the amount of deposits during a period less the amount of withdrawals during the period. The net deposits (withdrawals) before interest credited during the years ended June 30, 2000, 1999, and 1998 reflect management's strategy of pricing deposits to control the Bank's cost of funds. The Bank generally prices its deposits to remain competitive with other financial institutions, but does not necessarily seek to match the highest rates paid by competing institutions in its market area. Deposit flows at savings associations, however, may also be influenced by external factors such as
governmental credit policies and, particularly in recent periods, depositors' perceptions of the adequacy of federal insurance of accounts.
The following table shows rate and repricing information for the Company's certificates of deposit as of June 30, 2000.
The following table sets forth the amount of the Company's certificates of deposit and other deposits by time remaining until maturity as of June 30, 2000.
(1)Includes certificates of deposit of $100,000 or more from governmental and other public entities.
The Bank solicits certificates of deposit of $100,000 or greater ("jumbo certificates") from various state, county and local government units which carry rates which are negotiated at the time of deposit. See Note 6 of "Notes to Consolidated Financial Statements." Deposits at June 30, 2000 and 1999 include $45.2 million and $46.8 million, respectively of deposits from one local governmental entity, the majority of which are demand accounts.
Borrowings. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings when they are a less costly source of funds or can be invested at a positive rate of return.
The Bank's borrowings consist primarily of advances from the FHLB of Des Moines upon the security of its capital stock of the FHLB of Des Moines and certain of its mortgage loans and mortgage-backed securities. Such advances can be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. At June 30, 2000, the Bank's FHLB advances totalled $111.5 million, representing 16.4% of total liabilities.
The Company's other borrowings primarily consist of a contract for deed in the amount of $968,000 due to the purchase of land held for future development during the first quarter of fiscal 1999. See Note 7 of "Notes to Consolidated Financial Statements."
The following table sets forth the maximum month-end balances and average balances of FHLB advances and other borrowings at the dates indicated.
The following table sets forth certain information as to the Bank's FHLB advances and other borrowings of the Company at the dates indicated.
Subsidiary Activities
As a federally chartered thrift institution, Home Federal is permitted by OTS regulations to invest up to 2% of its assets, or $14.5 million at June 30, 2000, in the stock of, or loans to, service corporation subsidiaries. As of such date, the net book value of Home Federal's investment in and loans to its service corporations was approximately $289,000. Home 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. In addition to investments in service corporations, federal
associations are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a federal association may engage in directly.
Home Federal has three subsidiary corporations, Hometown Insurors, Inc. ("Hometown"), Mid-America Service Corporation ("Mid-America") and PMD, Inc. ("PMD").
Hometown, located in Sioux Falls, South Dakota, provides a full line of insurance products to customers of Home Federal and members of the general public in Home Federal's market area. Insurance products offered by Hometown include annuities and life, health, homeowners, and auto insurance and, to a lesser extent, certain commercial-related insurance products. Home Federal had an investment in Hometown of $168,000 at June 30, 2000. Hometown had a loss before tax of $116,000 for the 2000 fiscal year. During fiscal year 2000, Home Federal infused capital of $400,000 into Hometown.
Mid-America is an appraisal company located in Sioux Falls, South Dakota, that provides residential appraisal services to Home Federal and other lenders in the Bank's market area. At June 30, 2000, the Bank had a $120,000 investment in Mid-America. Mid-America had income before tax of $2,000 for the 2000 fiscal year.
PMD, located in Sioux Falls, South Dakota, is engaged in the business of buying, selling and managing repossessed real estate properties. At June 30, 2000, the Bank had a $1,000 investment in PMD. PMD had no activity during fiscal year 2000.
In May, 1996 the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of the membership interest of this entity. The Company became the owner of 100% of HF Card Services effective as of July 1998. HF Card Services was established to provide secured, partially-secured and unsecured credit cards nationwide. At June 30, 2000, the Company had a negative investment in HF Card Services of $6.9 million. HF Card Services had a net loss of $994,000 for the 2000 fiscal year. Based upon lack of performance, the Company ceased processing subprime credit card applications in March 1999.
HomeFirst Mortgage Corp. is a South Dakota Corporation which had an office in Omaha, Nebraska. The Mortgage Corp. was a mortgage banking operation that originated one- to four-family residential loans which were sold into the secondary market. At June 30, 2000, the Company had a $1,000 investment in the Mortgage Corp. The Company ceased operations of the Mortgage Corp. during the first quarter of fiscal 1998. The Mortgage Corp. had no activity during fiscal year 2000.
The Mortgage Corp. resumed activity in August 2000 through the acquisition of Mid America Capital Services, Inc., a company specializing in equipment leasing. This acquisition expands the Company's servicing options for commercial and municipal customers.
Competition
Home Federal faces strong competition, both in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other commercial banks, credit unions and mortgage bankers making loans secured by real estate located in the Bank's market areas. Commercial banks and finance companies provide vigorous competition in consumer lending. The Bank competes for real estate and other loans principally on the basis of the quality of services it provides to borrowers, interest rates and loan fees it charges and the types of loans it originates.
The Bank 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 other commercial banks and credit unions located in the same communities. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, and convenient branch locations with interbranch deposit and withdrawal
privileges at each. There are approximately 25 financial institutions which compete for deposits in Minnehaha County. According to information contained in reports prepared by the FDIC, the Bank is the third largest financial institution based on total deposits in Minnehaha County, excluding Citibank. Management estimates that its deposit market share in Minnehaha County, where the majority of its deposits are located, is approximately 11%, excluding Citibank.
Employees
At June 30, 2000, the Bank had a total of 328 employees including 25 employees of the Bank's service corporations.
The Bank's employees are not represented by any collective bargaining group. Management considers its relations with its employees to be good.
Regulation
General. The Bank is a federally chartered thrift institution, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations. The Bank is a member of the FHLB of Des Moines and is subject to certain limited regulation by the Federal Reserve Board. As the savings and loan holding company of the Bank, the Company also is subject to federal regulation and oversight. The purpose of the regulation of the Company and other holding companies is to protect subsidiary savings associations where deposits are federally insured.
The Bank is a member of the Savings Association Insurance Fund (the "SAIF") and the deposits of the Bank are insured by the FDIC. Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document. The following discussion is intended to be a summary of the material statutes, regulations and policies applicable to savings associations and their holding companies, and it does not purport to be a comprehensive discussion of such statutes, regulations and policies.
Regulation of Federal Savings Associations. As an office of the Department of the Treasury, the OTS has extensive authority over the operations of federal savings associations, such as the Bank. Pursuant to this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last examination of the Bank by the OTS concluded on September 1, 1999. Examiners may require a federal savings association to provide for higher general or specific loan loss-reserves.
Assessments. The OTS has established a schedule for the assessment of fees upon all savings associations to fund the operations of the OTS. A schedule of fees has also been established for the various types of applications and filings made by savings associations with the OTS. In addition, the general assessment, paid on a semi-annual basis, is computed based upon the savings association's total assets, including consolidated subsidiaries, as reported in the association's latest quarterly thrift financial report. Savings associations (unlike the Bank) that are classified as "troubled" are required to pay a 50% premium over the standard assessment. The Bank's OTS assessment (standard assessment) for the fiscal year ended June 30, 2000 was approximately $122,000.
The OTS has proposed amendments to its regulations that are intended to assess savings associations on a more equitable basis. The proposed regulations would base the assessment for an individual savings association on three components: the size of the association, on which the basic assessment would be based; the association's supervisory condition, which would result in percentage increases for any savings institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination; and the complexity of the association's operations, which would result in percentage increases for a savings association that managed over $1 billion in trust assets, serviced for
others loans aggregating more than $1 billion, or had certain off-balance sheet assets aggregating more than $1 billion. In order to avoid a disproportionate impact on the smaller savings institutions, the OTS is proposing to permit the portion of the assessment based on assets size either under the current regulations or under the amended regulations. Management believes that, assuming the proposed regulations are adopted as proposed, any change in its rate of OTS assessments will not be material.
Enforcement. Under the Federal Deposit Insurance Act (the "FDI Act"), the OTS has primary enforcement responsibility over savings associations and has the authority to bring enforcement action against all "institution-affiliated parties," including any controlling stockholder or any stockholder, attorney, appraiser or accountant who knowingly or recklessly participates in any violation of applicable law or regulation or breach of fiduciary duty or certain other wrongful actions that causes or is likely to cause a more than a minimal loss or other significant adverse effect on an insured savings association. Civil penalties cover a wide range of violations and actions and range from $5,000 for each day during which violations of law, regulations, orders, and certain written agreements and conditions continue, up to $1 million per day for such violations if the person obtained a substantial pecuniary gain as a result of such violation or knowingly or recklessly caused a substantial loss to the institution. Criminal penalties for certain financial institution crimes include fines of up to $1 million and imprisonment for up to 30 years. In addition, regulators have substantial discretion to take enforcement action against an institution that fails to comply with its regulatory requirements, particularly with respect to its capital requirements. Possible enforcement actions range from the imposition of a capital plan and capital directive to receivership, conservatorship, or the termination of deposit insurance. Under the FDI Act, the FDIC has the authority to recommend to the Director of OTS that enforcement action be taken with respect to a particular savings association. If action is not taken by the Director of the OTS, the FDIC has authority to take such action under certain circumstances.
Business Activities. The Bank derives its lending and investment powers from the Home Owners' Loan Act, as amended (the "HOLA"), and the regulations of the OTS thereunder. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage. These investment powers are subject to various limitations, including (a) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories; (b) a limit of 400% of an association's capital on the aggregate amount of loans secured by non-residential real estate property; (c) a limit of 20% of an association's assets on the aggregate amount of commercial loans, with the amount of commercial loans in excess of 10% of assets being limited to small business loans; (d) a limit of 35% of an association's assets on the aggregate amount of consumer loans and acquisitions of certain debt securities; (e) a limit of 5% of assets on non-conforming loans (loans in excess of the specific limitations of the HOLA); and (f) a limit of the greater of 5% of assets or an association's capital on certain construction loans made for the purpose of financing what is or is expected to become residential property.
Under the HOLA, savings associations are generally subject to the same limits on Loans to One Borrower as are imposed on national banks. Generally, under these limits, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the association's unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily-marketable collateral. Such collateral is defined to include certain debt and equity securities and bullion, but generally does not include real estate. At June 30, 2000, the Bank's lending limit under this restriction was $7.3 million. In addition, the Bank may provide purchase money financing for the sale of any asset without regard to the Loans to One Borrower limitation so long as no new funds are
advanced and the Bank is not placed in a more detrimental position than if it had held the asset. Home Federal is in compliance with the loans-to-one-borrower limitation.
Safety and Soundness Standards. Pursuant to the FDI Act, as amended by FDICIA and the Riegle Community Development and Regulatory Improvement Act of 1994 (the "Community Development Act"), the OTS and the federal bank regulatory agencies have adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice by the OTS that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of FDICIA. If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Accounting Standards. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") requires the OTS to establish accounting standards to be applicable to all savings associations for purposes of complying with regulations, except to the extent otherwise specified in the capital standards. Such standards must incorporate generally accepted accounting standards to the same degree as is prescribed by federal banking agencies for banks, or may be more stringent than such requirements.
Insurance of Accounts and Regulation by the FDIC. The Bank is a member of the SAIF, which is administered by the FDIC. Savings deposits are insured up to $100,000 per insured member (as defined by law and regulation) 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.
On September 30, 1996, Congress passed and President Clinton signed into law The Deposit Insurance Funds Act of 1996 ("Funds Act") to resolve the deposit insurance premium disparity. The Funds Act also included extensive regulatory relief for banks and thrifts. The Funds Act included a one-time special assessment on SAIF deposits to be imposed to bring the fund's reserve ratio to the statutory required 1.25 percent. The assessment rate was 65.7 basis points on deposits as of March 31, 1995 resulting in an assessment of $2.6 million on the Bank's deposits as recorded of March 31, 1995 which was paid on November 29, 1996. In addition, the Funds Act includes the following items which affect SAIF members: (1) Pro-rata sharing of the Financing Corporation ("FICO") obligation among Bank Insurance Fund ("BIF") and SAIF members began January 1, 2000. From 1997 through 1999, partial sharing occurred, with SAIF deposits assessed 6.44 basis points and BIF deposits 1.29 basis points (2) The FDIC is prohibited from setting the semi-annual assessment at a rate in excess of that
needed to maintain or meet the required reserve ratio. Until the funds are merged, the FDIC is permitted to rebate or credit excess premiums to BIF members only (3) For a three-year period, the banking regulators are authorized to prevent SAIF insured institutions from "facilitating or encouraging" customers to shift their deposits to BIF-insured affiliates for the purpose of evading the SAIF premium and (4) Pro-rata FICO sharing began and the ban on deposit shifting ended on January 1, 2000. As a result of these changes in the Funds Act, the Bank's deposit assessment was decreased.
FDICIA also authorizes the FDIC to implement a risk-based deposit insurance assessment system. Pursuant to this requirement, the FDIC adopted a transitional risk-based assessment system, effective January 1, 1993, under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. The permanent system, adopted in June 1993 and effective January 1, 1994, continues the risk classification system established under the transitional rule. Under this 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. Assessments currently range from 0.0% of deposits for institutions in the highest category to 0.27% of deposits for institutions in the lowest category. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period.
The financing corporations created by FIRREA and the Competitive Equality Banking Act of 1987 are also empowered to assess premiums on savings associations to help fund the liquidation or sale of troubled savings associations. Such premiums cannot, however, exceed the amount of SAIF assessments and are paid in lieu thereof.
The FDIC has adopted regulations that generally prohibit payments to directors, officers and employees contingent upon termination of their affiliation with an FDIC-insured institution or its holding company (i.e., "golden parachute payments") if the payment is received after or in contemplation of, among other things, insolvency, or a determination that the institution or holding company is in "troubled condition." Certain types of employee benefit plans are not subject to the prohibition. The regulations would also generally prohibit certain indemnification payments for civil money penalties or other enforcement action.
Regulatory Capital Requirements. Federally insured savings associations, such as the Bank, 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 in excess of these standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital not less than 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 earnings on withdrawable accounts and deposits that qualify as core capital. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights and other categories must be deducted from tangible capital. At June 30, 2000, Home Federal had $2.2 million of unamortized loan servicing rights, none of which were required to be deducted from tangible capital.
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 such as mortgage banking activities 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. All subsidiaries of the Bank are includable subsidiaries.
At June 30, 2000, the Bank had Tier I (Core) capital equal to $42.0 million, or 5.83% of adjusted total assets, which is $20.4 million above the minimum leverage ratio requirement of 3% as 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, and up to 25% of other intangibles which meet certain separate salability and market valuation tests. At June 30, 2000, the Bank had $4.8 million in intangible assets which were subject to these tests. The amount of servicing rights includable as core capital is limited to 50% of such capital.
Effective December 31, 1990, national banks were required to maintain a ratio of core capital to adjusted total assets not less than 3%. Only those national banks that receive a composite rating of one (the highest rating) under the "CAMELS" rating system for commercial banks and that, in general, are considered strong banking organizations will qualify for the 3% requirement. All other national banks must maintain a core capital ratio of 3% plus an additional 100 to 200 basis points that would be established on a case-by-case basis. As required by federal law, the OTS has proposed a rule revising its minimum core capital requirement to be no less stringent than that imposed on national banks. The OTS has proposed that only those savings associations rated a composite one (the highest rating) under the MACRO rating system for savings associations will be permitted to operate at or near the regulatory minimum leverage ratio of 3%. All other savings associations will be required to maintain a minimum leverage ratio of 3% plus at least an additional 100 to 200 basis points. The OTS will assess each individual savings association through the supervisory process on a case-by-case basis to determine the applicable requirement. No assurance can be given as to the final form of any such regulation, the date of its effectiveness or the requirement applicable to the Bank.
The OTS risk-based capital 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% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital up to 100% of core capital. At June 30, 2000, Home Federal had no capital instruments that qualified as supplementary capital and $8.5 million of general loss reserves, which was in excess of 1.25% of risk-weighted assets by $2.1 million.
Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core 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 and reciprocal holdings of qualifying capital instruments. Home Federal had no such exclusions from capital and assets at June 30, 2000.
In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by the appropriate risk weight based on the risks inherent in the type of assets. The risk weights assigned by the OTS for principal categories of assets are (i) 0% for cash and securities issued by the U.S. Government or unconditionally backed by the full faith and credit of the
U.S. Government, (ii) 20% for securities (other than equity securities) issued by U.S. Government sponsored agencies, high quality mortgage-backed securities and mortgage-backed securities issued by, or fully guaranteed as to principal and interest by, the FNMA or the FHLMC except for those classes with residual characteristics or stripped mortgaged-related securities, (iii) 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 FNMA or FHLMC, and (iv) 100% for all other loans and investments, including consumer loans, commercial loans, repossessed and loans more than 90 days past due.
On June 30, 2000, the Bank had total risk based capital of $48.4 million (including $42.0 million in core capital and $6.4 million in qualifying supplementary capital) and risk-weighted assets of $509.0 million (including $1.5 million in converted off-balance sheet assets), or total capital of 9.5% of risk-weighted assets. This amount was $7.7 million above the 8.0% requirement in effect on that date.
The following table sets forth Home Federal's compliance with its capital requirements at June 30, 2000.
(1)Tier I (Core) capital figures are determined as a percentage of total adjusted assets; risk-based capital figures are determined as a percentage of risk-weighted assets.
(2)The Bank's investment in its subsidiaries is included for purposes of calculating regulatory capital.
(3)The OTS is expected to adopt a core capital requirement for savings associations comparable to the requirement for national banks that became effective December 31, 1990. The OTS core capital requirement is anticipated to be at least 3% of total adjusted assets for thrifts that receive the highest supervisory rating for safety and-soundness, with a 4% to 5% core capital requirement for all other thrifts. No prediction can be made as to the exact nature of any new OTS core capital regulation, or the date of its effectiveness, and the core capital requirement to be applicable to the Bank under such regulation.
(4)Includes qualifying supplementary capital of $6.4 million. Under FDICIA all the Federal banking agencies, including the OTS, must revise their risk-based capital requirements to ensure that such requirements account for interest rate risk, concentration of credit risk and the risks of non-traditional activities, and that they reflect the actual performance of and expected loss on multi-family loans.
The OTS has adopted a final rule which requires every savings association with more than normal interest rate risk to deduct from total capital an amount equal to 50% of its interest-rate risk exposure multiplied by the market value of its assets. This exposure is a measure of the potential decline in the market value of portfolio equity of a savings association greater than 2%, based upon a hypothetical
200 basis point increase or decrease in interest rates (whichever results in a greater decline) affecting on- and off-balance sheet assets and liabilities. Given Home Federal's capital position, this rule is not expected to have a material impact on its financial condition or results of operations. The OTS has delayed implementation of this Rule as of June 30, 2000.
Pursuant to FDICIA, the Federal banking agencies, including the OTS, have also proposed regulations authorizing the agencies to require a depository institution to maintain additional total capital to account for concentration of credit risk and the risk of non-traditional activities. No assurance can be given as to the final form of any such regulation.
Prompt Corrective Action Standards. The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against any association that fails to meet its 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 ratio, a 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 subject to one or more of the 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 restrictions on its activities in addition to those applicable to significantly undercapitalized associations. The FDIC must restrict the activities of a critically undercapitalized association and, among other things, prohibit any material transaction outside the ordinary course of business or engaging in certain transactions with affiliates, without the approval of the FDIC. 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 grounds for appointment of a conservator or receiver include substantially insufficient capital and losses or likely losses that will deplete substantially all capital with no reasonable prospect for replenishment of capital without federal assistance.
If the OTS determines that an association is in an unsafe or unsound condition or is engaged in an unsafe or unsound practice it is authorized to reclassify a well-capitalized association as an adequately capitalized association and if the association is adequately capitalized, to impose the restrictions applicable to an undercapitalized association.
The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on the Bank's and the Company's operations and profitability and the value
of the Company's Common Stock. The Company's shareholders do not have preemptive rights, and therefore, if the 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 Company of those persons owning shares of the Company's Common Stock.
Limitations on Dividends and Other Capital Distributions. OTS regulations 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 I 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.
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 written prior to making such distribution. 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. The Bank is classified as a Tier I association.
As a subsidiary of the Company, the Bank is 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.
The OTS has proposed regulations that would simplify the existing procedures governing capital distributions by savings associations. Under the proposed regulations, the approval of the OTS would be required only for capital distributions by an association that is deemed to be in troubled condition or that is undercapitalized or would be undercapitalized after the capital distribution. A savings association would be able to make a capital distribution without notice to or approval of the OTS if it is not held by a savings association holding company, is not deemed to be in troubled condition, has received either of the two highest composite supervisory ratings and would continue to be adequately capitalized after such distribution. Notice would have to be given to the OTS by any association that is held by a savings association holding company or that had received a composite supervisory rating below the highest two composite supervisory ratings. An association's capital rating would be determined under the prompt corrective action regulations.
Liquidity. All savings associations, including Home Federal, are required to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, specified United States Government, state or federal agency obligations, shares of certain mutual funds and certain corporate debt securities and commercial paper) in each calendar quarter 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. Furthermore, every savings association must maintain sufficient liquidity to ensure its safe and sound operation. For a discussion of what the Bank 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 4%.
Monetary penalties may be imposed upon associations for violations of the liquid asset ratio requirement. At June 30, 2000, the Bank was in compliance with the liquidity requirements, with the overall liquid asset ratio at 4.8%.
Accounting For Investments. 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 Generally Accepted Accounting Principles "GAAP." Under the policy statement, management must support its classification of and accounting for loans and securities (i.e., whether held for investment, sale or trading) with appropriate documentation. The Bank is in compliance with these rules.
The OTS has adopted an amendment to its accounting regulations, which may be made more stringent than 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.
Branching. Subject to certain limitations, the HOLA and the OTS regulations permit federally chartered savings associations to establish branches in any state of the United States. The authority to establish such branches is available (a) in states that expressly authorize branches of savings associations located in another state or (b) to an association that qualifies as a "domestic building and loan association" under the Internal Revenue Code of 1986, which imposes qualification requirements similar to those for a "qualified thrift lender" under the HOLA. See "QTL Test." The authority for a federal savings association to establish an interstate branch network would facilitate a geographic diversification of the association's activities. This authority under the HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings associations.
Community Reinvestment. Under the Community Reinvestment Act (the "CRA"), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation 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 its examination of a savings association, to assess the association's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Association received an "Outstanding" CRA rating in its most recent examination.
The CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the rating system focuses on three tests: (a) a lending test, to evaluate the
institution's record of making loans in its assessment areas; (b) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (c) a service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices. The amended CRA regulations also clarify how an institution's CRA performance would be considered in the application process.
Qualified Thrift Lender Test. All savings associations, including the Bank, 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 (which consists of total assets less the sum of goodwill and other intangible assets, properties used to conduct the savings association's business and specified liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. At June 30, 2000, the Bank maintained 78.06% of its portfolio assets in qualified thrift investments, and thus met the test. The Bank has always met the QTL test since its inception.
Loans and mortgage-backed securities secured by domestic residential housing, FHLB stock, credit card loans, educational loans and certain small business loans as well as certain obligations of the Federal Savings and Loan Insurance Corporation ("FSLIC"), the FDIC and certain other related entities may be included in qualifying thrift investments without limit. FHLMC and FNMA stock and certain other housing-related and non-residential real estate loans and investments, including loans to develop churches, nursing homes, hospitals and schools, and consumer loans and investments in subsidiaries engaged in housing-related activities may also be included, in varying amounts, not to exceed 20% of portfolio assets.
Any savings association that fails to meet the QTL test must either convert to a national bank charter or operate under certain restrictions on its activities, 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 and dispose of any investments not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. A savings association that has failed the QTL test may requalify under the QTL test and be free of such limitations, but it may do so only once. If any association that fails the QTL test is controlled by a holding company, then 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."
Transactions with Affiliates. The Bank's authority to engage in transactions with its "affiliates" is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act (the "FRA"). In general, an affiliate of the Association is any company that controls the Association or any other company that is controlled by a company that controls the Association, excluding the Association's subsidiaries other than those that are insured depository institutions. The OTS regulations prohibit a savings association (a) from lending to any of its affiliates that is engaged in activities that are not permissable for bank holding companies under Section 4(c) of the BHC Act and (b) from purchasing the securities of any affiliate other than a subsidiary. Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings association and also limits the aggregate amount of transactions with all affiliates to 20% of the savings association's capital and surplus. Extensions of credit to affiliates are required to be secured by
collateral in an amount and of a type described in Section 23A, and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the association as those prevailing at the time for comparable transactions with non-affiliated companies. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards, that in good faith would be offered to or would apply to non-affiliated companies.
The Association's authority to extend credit to its directors, executive officers, and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of the association's capital. In addition, extensions of credit in excess of certain limits must be approved by the association's board of directors.
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 those for loans to unaffiliated individuals.
Real Estate Lending Standards. The OTS and the other federal banking agencies adopted regulations to prescribe standards for extensions of credit that (a) are secured by real estate or (b) are made for the purpose of financing the construction of improvements on real estate. The OTS regulations require each savings association to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying OTS guidelines, which include loan-to-value ratios for the different types of real estate loans. Associations are also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending situations in which exceptions to the loan-to-value standards are justified.
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 registered with and files reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings association subsidiaries 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 Bank 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 Bank 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, within 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."
Federal Securities Law. The stock of the Company is registered with the Securities and Exchange Commission ("SEC") under the Securities Exchange 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 (FRB) 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). The FRB regulations generally require that reserves be maintained in the amount of 3% of the aggregate of transaction accounts up to $39.3 million. The amount of aggregate transaction accounts in excess of $39.3 million are currently subject to a reserve ratio of 10%, which ratio the FRB may adjust between 8% and 12%. The FRB regulations currently exempt $5.0 million of otherwise reservable balances from the reserve requirements, which exemption is adjusted by the FRB at the end of each year. At June 30, 2000, the Bank 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 ("FRB") "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the FRB.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs, that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. 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, Home Federal is required to purchase and maintain stock in the FHLB of Des Moines. At June 30, 2000, Home Federal had $6.1 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB stock. Over the past five fiscal years such dividends have averaged 6.81% and were 6.55% for fiscal year 2000.
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 advances 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. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in Home Federal's capital.
For the fiscal year ended June 30, 2000, dividends paid by the FHLB of Des Moines to Home Federal totalled approximately $387,000, which constitute a $116,000 increase in the amount of dividends received in fiscal 1999. The $105,000 dividend received for the quarter ended June 30, 2000 reflects an annualized rate of 6.86% or 9.90% increase from the rate for the same period in fiscal 1999.
Federal and State Taxation
The Company and subsidiaries file a consolidated federal income tax return on a fiscal year basis. The Bank is allowed bad debt deductions based on actual charge-offs.
In addition to the regular income tax, corporations, including savings associations such as the Bank, 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.
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 shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). As of June 30, 2000, the Bank's Excess for tax purposes totalled approximately $4.8 million.
The Bank and its consolidated subsidiaries have been audited by the IRS with respect to consolidated federal income tax returns through 1985. 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 Bank) would not result in a deficiency which could have a material adverse effect on the financial condition of the Bank and its consolidated subsidiaries.
South Dakota Taxation. The Bank is subject to the South Dakota franchise tax to the extent that such corporations are engaged in business in the state of South Dakota. South Dakota does not have a corporate income tax. The franchise tax will be imposed at a rate of 6% on franchise taxable income which is computed in the same manner as federal taxable income with some minor variations to comply with South Dakota law, other than the carryover of net operating losses which is not permitted under South Dakota law. A South Dakota return of franchise tax must be filed annually.
Nebraska Taxation. The Mortgage Corp. is subject to the Nebraska Corporate Income tax to the extent that such corporations are engaged in business in the state of Nebraska. The Corporate Income tax is imposed at rates of 5.58% to 7.81% on corporate taxable income which is computed in the same manner as federal taxable income with some minor variations to comply with Nebraska law. A Nebraska return of Corporate Income tax must be filed annually.
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.
Executive Officers of the Company
The following information as to the business experience during the past five years is supplied with respect to executive officers of the Company and the Bank.
Curtis L. Hage-Mr. Hage, age 54, is Chairman, President and Chief Executive Officer of the Bank. He was elected Chairman of the Board of Directors of the Bank in September 1996 and has held the position of President and Chief Executive Officer of the Bank since February 1991. Prior to such time, Mr. Hage served as Executive Vice President of the Bank since 1986. Since joining the Association in 1968, he served in various capacities prior to being elected Executive Vice President. Mr. Hage received his M.B.A. from the University of South Dakota and attended the Graduate School of Savings Institution Management at the University of Texas.
Gene F. Uher-Mr. Uher, age 52, is Executive Vice President/Chief Operations Officer and Secretary, a position he has held since March 1997. He was employed as Executive Vice President for Packers Bank, Omaha, Nebraska from 1996 until joining Home Federal. Prior to that time, he was employed as Executive Vice President/Chief Operating Officer for Conservative Savings Bank, F.S.B., Omaha, Nebraska from 1989 to 1996. Mr. Uher received his B.A. degree from Lincoln School of Commerce, Lincoln, Nebraska. He is a graduate of the School of Executive Development at University of Connecticut.
Brent E. Johnson-Mr. Johnson, age 38, is Senior Vice President/Chief Financial Officer and Treasurer, a position he has held since November 1998. Mr. Johnson served as Chief Financial Officer and Cashier with Mercantile Bank of Western Iowa and as Chief Financial Officer of Hawkeye Bancorporation in Des Moines, Iowa, from 1986 to 1998. Mr. Johnson received his B.S. degree from Northwest Missouri State University, and is also a Certified Public Accountant.
David A. Brown-Mr. Brown, age 38, is Senior Vice President/Senior Commercial Lending Officer, a position he has held since November 1999. Prior to joining Home Federal, Mr. Brown served as Vice President/Manager Commercial Banking at Firstar Bank, Sioux City, Iowa, a position he held since December 1998. Mr. Brown received his Masters of Business Administration and a B.S. in Business Administration from University of South Dakota.
Mary F. Hitzemann-Ms. Hitzemann, age 47, is Senior Vice President/Human Resources, a position she has held since October 1993. Ms. Hitzemann joined Home Federal in January 1993. Prior to that time, she was employed as Vice President of Human Resources for Rapid City Regional Hospital from May 1989 to May 1992. Ms. Hitzemann received her B.A. degree from Augustana College.
Terry L. Kappes-Mr. Kappes, age 46, is Senior Vice President/Retail Banking, a position he has held since June 1998. Prior to that time, he was employed with Bank One-Colorado, Grand Junction, Colorado from 1993 until joining Home Federal with his most recent position being Senior Vice President/Retail Market Manager. Mr. Kappes served as Senior Vice President for First Bank System, Billings, Montana from 1988 to 1991 and First Bank of South Dakota, Sioux Falls, South Dakota from 1977 to 1988. Mr. Kappes received his B.A. degree from Oral Roberts University, Tulsa, Oklahoma.
John E. Roers-Mr. Roers, age 53, is Senior Vice President/Agricultural Lending, a position he has held since joining Home Federal on October 31, 1995. Prior to that time, he was employed as Agricultural Loan Officer and Department Manager for Western Bank, Sioux Falls (then First Bank) from June 1981 to October 1996 and for Western Bank, Marshall, Minnesota from February 1974 to May 1981. Mr. Roers received his Bachelor of Science and Masters of Science from North Dakota State University.
Mark S. Sivertson-Mr. Sivertson, age 42, is Senior Vice President/Trust Officer, a position he has held since July 1996. He joined Home Federal in February 1995 as Vice President/Trust Officer. Prior to joining Home Federal, Mr. Sivertson was Vice President and Trust Officer in charge of the
Investment Management and Trust Department at Western Bank. He holds a law degree from the University of North Dakota and the Certified Trust Financial Advisor designation from the American Bankers Association.
Gary L. Smith-Mr. Smith, age 46, is Senior Vice President/Information Systems, a position he has held since July 1998. Mr. Smith joined Home Federal in 1979 and was promoted to Vice President in 1988. He received his B.S. from the University of South Dakota.
Michael H. Zimmerman-Mr. Zimmerman, age 47, is Senior Vice President/Senior Retail Lending Officer, a position he has held since joining Home Federal in August 1996. Prior to that time, he was employed as Vice President/Mortgage Loan Manager for First Trust and Savings Bank, Cedar Rapids, Iowa from October 1995 to August 1996 and as Vice President/Eastern Regional Manager for Homeland Savings Bank FSB, Waterloo, Iowa from May 1995 to October 1995; and as Vice President/ Manager Real Estate Lending for Homeland Bank, N.A., Waterloo, Iowa from August 1992 to April 1995. Mr. Zimmerman received his B.A. from Dana College, Blair, Nebraska.
M. Jay Beasley-Mr. Beasley, age 59, is Vice President/Trust Officer, a position he has held since joining the Bank in March 2000. He was employed by Norwest Banks as Assistant Vice President and Trust Officer in their Trust and Investment Management Department from 1990 to March 2000. He holds a B.A. from the University of Minnesota-Duluth and Certified Trust Financial Advisor designation from the American Bankers Association.
Roxanne R. Bobolz-Ms. Bobolz, age 44, is Vice President/Market Manager for the Bank. She joined Home Federal in January 1999 as Bank Market Manager and was promoted to her current position in March 1999. Ms. Bobolz is responsible for the Dakota Dunes market area.
Terry J. Cleberg-Mr. Cleberg, age 36, is Vice President/Commercial Business Lending. He joined the Bank in June 1998 as a Commercial Loan Officer and was promoted to his current position in March 1999. Prior to joining the Bank, he was Assistant Vice President/Commercial Lending for F&M Bank in Watertown from 1995 to 1998; and as Commercial Loan Officer for National Bank of Commerce, Lincoln, Nebraska from 1993 to 1995. Mr. Cleberg received his B.S. in Finance from the University of Wisconsin-Lacrosse.
Cristie M. Lawson-Ms. Lawson, age 31, is Vice President/Controller for the Bank. Ms. Lawson joined the Bank in March 1995 as Staff Accountant. She has held various positions of increasing responsibility within the Accounting Department and was promoted to her current position in July 2000. Ms. Lawson received her B.A. from Augustana College and is also a Certified Public Accountant (CPA).
Michael J. Echols-Mr. Echols, age 56, is Vice President/Loan Service, a position he has held since joining the Bank in June 1996. Prior to that time he was employed by South Dakota Housing Development Authority as Executive Director from 1974 to 1996.
Theodore R. "Ted" Ellinger-Mr. Ellinger, age 52, is Vice President/Market Manager. He joined Home Federal in July 1974 and was promoted to his present position in October 1993. Mr. Ellinger is responsible for the Canton, Freeman, Lennox and Parker branches.
Randall D. Fink-Mr. Fink, age 46, is Vice President/Mortgage Loan Production Manager, a position he has held since October 1995. In January 1983, Mr. Fink joined Home Federal and in 1989 was promoted to Vice President/Single Family Lending.
Theresa L. "Terry" Flamboe-Ms. Flamboe, age 48, is Vice President/Market Manager. She joined Home Federal in September 1998 and was promoted to her present position in March 1999. Ms. Flamboe is responsible for the Aberdeen Downtown, Aberdeen East and Redfield market areas. Ms. Flamboe received her B.A. from the University of Wyoming.
Anne M. Fuehrer-Ms. Fuehrer, age 39, is Vice President/Marketing, a position she has held since joining the Bank in October 1998. She was employed by First National Bank in Sioux Falls as Marketing/ Compliance Officer from 1988 to 1998. Ms. Fuehrer received her B.S. from St. Cloud State University.
LaVonne R. Grassel-Ms. Grassel, age 49, is Vice President/Market Manager for the Bank. She joined the Bank in January 1994 and was promoted to her current position in July 1999. She is responsible for the branches located in the Sioux Falls market area. Prior to that time, she was employed for 19 years with US Bank, Minnesota, and held the position of Vice President Retail Banking. Ms. Grassel received her B.A. from Bethel College, St. Paul, Minnesota.
Jack P. Hearst-Mr. Hearst, age 48, is Vice President/Credit Cards, a position he has held since March 1999. He was employed by Citicorp-Corporate Control and Risk Assessment as the Audit Director for Citicorp. Bankcards. Mr. Hearst received a B.S. from the University of Missouri.
Diane K. Hovda-Ms. Hovda, age 55, is Vice President/Financial Management, a position she has held since June of 1997. She joined Home Federal in May 1995 as Vice President/Bank Coordinator. Prior to that time, she was employed by Western Bank, Sioux Falls from 1974 to 1995, and for First National Bank and National Bank of South Dakota from 1966 to 1974.
Paul S. Jordahl-Mr. Jordahl, age 51, is Vice President/Commercial Business Lending. He joined Home Federal in December 1993 and was promoted to his present position in March 1999. He was employed by First Savings Bank as Senior Credit Officer from 1983 to 1993. From 1973 to 1983, Mr. Jordahl was a Farm Real Estate Lender for the Federal Land Bank. Mr. Jordahl received his B.S. from South Dakota State University.
David C. Kalil-Mr. Kalil, age 44, is Vice President/Market Manager. He joined Home Federal in March 1997 and was promoted to his present position in March 1999. Mr. Kalil is responsible for the Pierre, Mobridge and Winner market areas. He received his B.S. from North Dakota State University.
Faye A. Lee-Ms. Lee, age 42, is Vice President/Loan Operations. She joined Home Federal in 1984, and has held various positions within the Bank during that time. Ms. Lee most recently served as Vice President/Retail Loan Processing.
Sharon A. Manuel-Ms. Manuel, age 50, is Vice President/Electronic Banking. She joined Home Federal in April 1994. Ms. Manuel is responsible for managing technology-oriented projects such as automated telephone banking, debit card, bill payment services and home banking. Prior to joining Home Federal, she was employed by Citibank for 13 years.
Gary G. Sieverding-Mr. Sieverding, age 42, is Vice President/Commercial Business Lending. He joined Home Federal in 1996 and was promoted to his present position in 1997. Prior to joining Home Federal, he was with First Savings Bank-Sioux Falls, First Bank of South Dakota, N.A. and Western Bank in various management capacities. Mr. Sieverding received his education from South Dakota State University, Brookings, SD and his ABA from the National Commercial Lending School, Norman, OK.
Natalie A. Solberg-Ms. Solberg, age 37, is Vice President/ Retail Support, a position she has held since 1997. She joined Home Federal in February 1994 and was promoted to Vice President/In-Touch Banking in October 1995. Prior to joining Home Federal, she was the Customer Service Manager and various other positions for Bank of New York from October 1989 to October 1993. She received her B.S. from Northern State University.
Jacob M. Stahl-Mr. Stahl, age 32, is Vice President/Market Manager, a position he has held since joining Home Federal in January 2000. He is responsible for the Dell Rapids, Brookings, Watertown, Crooks, Chester, Colman and Wentworth market areas. He was employed as Assistant Vice President and Compliance Officer for First National Bank of Freeman, Freeman, South Dakota, from July 1994
to December 1999. Prior to that time, he was a commissioned bank examiner for the Federal Deposit Insurance Corporation from June 1990 to July 1994. Mr. Stahl received is B.S. in Business Administration and B.A. in History from Bethel College and also received his Masters in Banking from the University of Wisconsin Graduate School of Banking.
Mark S. Swenson-Mr. Swenson, age 36, is Vice President/Commercial Business Lending. Mr. Swenson joined Home Federal in May 1995 as Vice President/Bank Manager, and was promoted to his current position in April 2000. Prior to that time, he was employed as Managing Officer, Senior Personal Banking Officer, Marketing Specialist for Western Bank Northeast, Sioux Falls from 1986 to May 1996. Mr. Swenson received his B.S. from South Dakota State University and his M.B.A. from the University of South Dakota.
Kirk L. Waugh-Mr. Waugh, age 33, is Vice President/Mortgage Loan Operations. He joined Home Federal in June 1987, and has held various positions within the Bank during that time, most recently serving as Vice President/Secondary Market Manager.
Michael Westberg-Mr. Westberg, age 33, is Vice President/Market Manager, a position he has held since July 1999. He is responsible for the Brandon and North Cliff branches. Mr. Westberg joined Home Federal in February 1996 as a Branch Manager. Prior to that time, he was Assistant Vice President/ Branch Manager for First Savings Bank, Beresford from 1992 to 1996; and for The Associates, Dallas, Texas, from 1989 - 1992. Additionally, he attended the Illinois State University majoring in business.
Kent F. Wigg-Mr. Wigg, age 53, is Vice President/Financial Management, a position he has held since joining Home Federal in September 1995. Prior to that time, he was employed by Western Bank, Sioux Falls (then First Bank) from August 1985 to September 1995; and for First National Bank, Sioux City, Iowa from May 1974 to August 1985. He received his B.S. from Iowa State University and his MBA from University of South Dakota. Additionally, he is a Graduate of Colorado School of Banking, a Certified Trust Specialist (CTS), a Certified Investment Specialist (CIS) and a Certified Financial Planner (CFP).
Cheri L. Wolfe-Ms. Wolfe, age 42, is Vice President/General Auditor, a position she has held since joining the Bank in December 1999. She was employed as Controller for The Summit Group from November 1996 to November 1999. Prior to that time, she was employed as Finance Officer for First Premier Bank, Sioux Falls, South Dakota from March 1995 to November 1996. Ms. Wolfe received her B.A. degree from Augustana College. Additionally, she is a Certified Public Accountant (CPA) and Certified Internal Auditor (CIA).
Item 2.
Item 2. Properties
The Company and the Bank conduct their business at their main office located at 225 S. Main at 11th, Sioux Falls, South Dakota, 57104. Currently, the Bank also conducts business from 27 other retail banking locations located in its primary market area.
The Bank owns each of its branch offices, except for six offices that it leases. The total net book value of the Company's premises and equipment (including land, building and leasehold improvements and furniture, fixtures and equipment) at June 30, 2000 was $13.7 million. See Note 5 of "Notes to Consolidated Financial Statements."
Item 3.
Item 3. Legal Proceedings
The Company, Home Federal and its subsidiaries are involved 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 Home Federal and the Company in the proceedings, that the resolution of these proceedings should not have a material effect on the Company's consolidated financial position or results of operations.
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, 2000.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Stock Listing
The Company's Common stock is traded under the symbol "HFFC" on the NASDAQ National Market System.
The following table sets forth the range of high and low sale prices for the Company's Common Stock for each of the fiscal quarters of the two years ended June 30, 2000 and 1999. Quotations for such periods are as reported by NASDAQ for National Market System issues.
As of September 15, 2000, the Company had 567 holders of record of its Common Stock.
The transfer agent for the Company's Common Stock is ChaseMellon Shareholder Services, PO Box 3315, South Hackensack, New Jersey, 07606-1915.
Dividends
HF Financial Corp. paid quarterly cash dividends of $0.10 per share throughout fiscal year 2000. In addition, HF Financial Corp. paid quarterly cash dividends of $0.09 throughout fiscal year 1999. The Board of Directors intends to continue the payment of quarterly cash dividends, dependent on the results of operations and financial condition of HF Financial Corp., tax considerations, industry standards, economic conditions, general business practices and other factors the board of directors deems relevant. On July 26, 2000, the Board of Directors approved an increase in cash dividends to $0.105 per share and HF Financial Corp. paid the respective cash dividends on August 24, 2000 to shareholders of record on August 10, 2000. HF Financial Corp.'s ability to pay dividends is dependent on the dividend payments it receives from its subsidiary, Home Federal Savings Bank (the "Bank"), which are subject to federal and state regulations.
Sales of Unregistered Stock
The Company has had no sales of unregistered stock within the last three fiscal years.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected financial data with respect to the Company for the periods indicated. This information should be read in conjunction with the Financial Statements and related notes appearing elsewhere herein and "Management's Discussion and Analysis of Financial Condition and results of Operations." The Company's selected financial statement and operations data for each of
the years set forth below have been derived from financial statements which have been audited by McGladrey & Pullen, LLP, independent public accountants.
1)Net interest income divided by average interest-earning assets.
3)Nonperforming loans include nonaccruing loans and accruing loans delinquent more than 90 days.
4)Earnings per share are retroactively adjusted for the three-for-two stock split in the form of a stock dividend payable to shareholders of record on May 8, 1998.
5)Dividends per share are retroactively adjusted for the three-for-two stock split in the form of a stock dividend payable to shareholders of record on May 8, 1998. Item 7.
Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations
General
The Company's net income is primarily dependent upon the difference (or "spread") between the average yield earned on loans, mortgage-backed securities and investments and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. The interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. The Company, like other financial institutions, is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on a different basis, than its interest-earning assets. To better insulate itself from such risk, the Company has, over the last few years, attempted to increase both numerically and on a percentage basis its holding of consumer and commercial loans. The Company has also decreased its ratio of fixed-rate to
adjustable-rate loans. The Company's net income is also affected by, among other things, gains and losses on sales of foreclosed property, loans, mortgage-backed securities and securities available for sale, provisions for losses on loans, service charge fees, subsidiary activities, operating expenses and income taxes.
This Form 10-K and other reports issued by the Company, including reports filed with the Securities and Exchange Commission, may contain "forward-looking" statements that deal with future results, expectations, plans or performance. See "Forward-Looking Statement" under Management's Discussion and Analysis found on page 62 of this report for further discussion.
Financial Condition Data
At June 30, 2000, the Company had total assets of $725.0 million, an increase of $66.4 million from the level at June 30, 1999. The increase in assets was due primarily to an increase in loans receivable of $50.2 million, mortgage-backed securities available for sale of $11.4 million and cash and cash equivalents of $9.7 million. The increase in loans receivable, mortgage-backed securities available for sale and cash and cash equivalents was funded primarily by an increase in deposits of $34.8 million and an increase in advances from Federal Home Loan Bank ("FHLB") and other borrowings of $31.4 million from the levels at June 30, 1999. In addition, stockholders' equity decreased from $48.6 million at June 30, 1999 to $46.9 million at June 30, 2000, primarily due to the purchase of treasury stock of $4.9 million, the payment of cash dividends of $1.5 million and the change in net unrealized loss on securities available for sale of $715,000 which was partially offset by net income of $5.3 million.
The increase in loans receivable of $50.2 million was due primarily to purchases and originations of principal exceeding amortizations and prepayments of principal.
The increase in mortgage-backed securities available for sale of $11.4 million was primarily the result of purchases of $23.2 million exceeding sales, amortizations and prepayments of principal. The Bank's purchases of mortgage-backed securities available for sale were comprised primarily of thirty year, fixed-rate mortgage-backed securities.
The $34.8 million increase in deposits was primarily due to an increase in money market accounts of $34.4 million and an increase in certificates of deposit of $9.9 million offset by a reduction in saving accounts of $13.7 million. These increases were primarily the result of a focused marketing campaign in money market accounts during the fiscal year.
Advances from the FHLB and other borrowings increased $31.4 million for the year ended June 30, 2000 primarily due to the Company obtaining new advances in the amount of $288.1 million which were partially offset by payments of $256.7 million on advances and other borrowings during the fiscal year.
Analysis of Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.
Average Balances, Interest Rates and Yields. The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The table does not reflect any effect of income taxes. All average balances are monthly average balances and include the balances of nonaccruing loans. The yields and
costs for the years ended June 30, 2000, 1999 and 1998 include fees which are considered adjustments to yield.
(1)Includes interest on accruing loans past due 90 days or more.
(2)Includes primarily U.S. Government and agency securities.
(3)Net interest margin is net interest income divided by average interest-earning assets.
Rate/Volume Analysis of Net Interest Income
The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increases and decreases due to fluctuating outstanding balances that are due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
(1)Includes interest on loans past due 90 days or more.
(2)Includes primarily U.S. Government and agency securities. Asset Quality
In accordance with the Bank's internal classification of assets policy, management evaluates the loan portfolio on a monthly basis to identify loss potential and determine the adequacy of the
allowance for loan losses. The following table sets forth the amounts and categories of the Bank's nonperforming assets for the periods indicated.
(1)Nonperforming loans include nonaccruing loans and loans delinquent more than 90 days.
(2)Total foreclosed assets does not include land held for development. When a borrower fails to make a required payment on real estate secured loans within 10 to 15 days after the payment is due, the Bank generally institutes collection procedures by issuing a late notice. The customer is contacted again when the payment is 30 days past due. In the case of consumer loans, the borrower is sent a notice when a loan is 10 days past due and is contacted by telephone when a loan is 30 days past due. In most cases, delinquencies are cured promptly; however, if a loan has been delinquent for more than 30 days, the Bank attempts additional written as well as verbal contacts and, if necessary, personal contact with the borrower in order to determine the reason for the delinquency and to effect a cure, and, where appropriate, reviews the condition of the property and the financial circumstances of the borrower. Based upon the results of any such investigation, the Bank may: (i) accept a repayment program which under appropriate circumstances could involve an extension in the case of consumer loans for the arrearage from the borrower, (ii) seek evidence, in the form of a listing contract, of efforts by the borrower to sell the property if the borrower has stated that he is attempting to sell, or (iii) initiate foreclosure proceedings. When a loan payment is delinquent for 90 days, the Bank generally will initiate foreclosure proceedings unless management is satisfied the credit problem is correctable.
When a loan becomes 90 days delinquent, except for credit card loans, the Bank places the loan on a nonaccrual status and, as a result, accrued interest income on the loan is taken out of income. Income is subsequently recognized only to the extent cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is no longer in doubt, in which case the loan is returned to accrual status. Credit card loans remain in accrual status until 120 days, when accrued interest income on the loan is taken out of income.
Nonperforming assets decreased from $3.2 million at June 30, 1999 to $2.9 million at June 30, 2000, a decrease of $269,000. In addition, the ratio of nonperforming assets to total assets, which is one indicator of credit risk exposure, decreased from 0.48% at June 30, 1999 to 0.40% at June 30, 2000.
Nonaccruing loans increased to $2.1 million at June 30, 2000 from $1.0 million at June 30, 1999, an increase of $1.0 million. Included in nonaccruing loans at June 30, 2000 were eight loans totaling $551,000 secured by one- to four-family real estate, two loans in the amount of $165,000 secured by commercial real estate, four mobile home loans totaling $43,000, seven commercial business loans totaling $971,000, four agriculture loans totaling $31,000 and twenty consumer loans totaling $317,000. For the year ended June 30, 2000, gross interest income of $667,000 would have been recognized on loans accounted for on a nonaccrual basis had such loans been current in accordance with their original
terms. Gross interest income of $499,000 was recognized as income on loans accounted for on a nonaccrual basis.
Accruing credit card loans delinquent more than 90 days decreased from $1.6 million at June 30, 1999 to $514,000 at June 30, 2000. A total of $1.7 million of credit card loans were delinquent 30 days at June 30, 2000 as compared to $5.2 million at June 30, 1999. Net credit card loan charge-offs for the year ended June 30, 2000 were $8.4 million as compared to $6.5 million for the same period in fiscal 1999. Using historical stratification data on the current product, management expects credit card loan write-offs not to exceed $2.8 million in the next six months. Of this amount about 77% will be a charge-off against allowance for credit card loan losses, of which the Company currently maintains an allowance for credit card loan losses equal to 31% of the outstanding credit card loan balance, or about $3.0 million. The remaining 23% will be charged against credit card fee income, interest income and credit card fee income in future periods. Based upon lack of performance, the Company ceased processing subprime credit card applications in March 1999.
As of June 30, 2000, the Bank had $296,000 of foreclosed assets. The balance of foreclosed assets at June 30, 2000 consisted of $67,000 in consumer collateral (excluding mobile home loans), $15,000 in mobile homes and $214,000 in single-family residences.
At June 30, 2000, the Bank had approximately $14.2 million of other loans of concern that management has determined need to be closely monitored because of possible credit problems of the borrowers or the cash flows of the secured properties. These loans were considered in determining the adequacy of the allowance for possible loan losses. The allowance for possible loan losses is established based on management's evaluation of the risks inherent in the loan portfolio and changes in the nature and volume of loan activity. Such evaluation, which includes a review of all loans for which full collectability may not be reasonably assured, considers the estimated fair market value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an adequate loan loss allowance. Although the Bank's management believes that the June 30, 2000 recorded allowance for loan losses was adequate to provide for potential losses on the related loans, there can be no assurance that the allowance existing at June 30, 2000 will be adequate in the future.
The following table sets forth information with respect to activity in the Bank's allowance for loan losses during the periods indicated.
The allowance for loan losses was $8.5 million at June 30, 2000 as compared to $12.0 million at June 30, 1999. The ratio of the allowance for loan losses to total loans was 1.52% at June 30, 2000 and 2.32% at June 30, 1999. The Bank's management has considered nonperforming assets and other assets of concern in establishing the allowance for loan losses. The Bank continues to monitor its allowance for possible loan losses and make future additions or reductions in light of the level of loans in its portfolio and as economic conditions dictate. The current level of the allowance for loan losses is a result of management's assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on all commercial business, agricultural, construction and multi-family and commercial real estate loans, including purchased loans, that exceed $250,000. A monthly credit review is performed on all types of loans to establish the necessary reserve based on the estimated risk within the portfolio. This assessment of risk takes into account the composition of the loan portfolio, historical loss experience for each loan category, previous loan experience, concentrations of credit, current economic conditions and other factors that in management's judgment deserve recognition. In regard to credit card loans, the Company is providing a reserve of 31% of the loan balance until the credit card portfolio becomes seasoned. As of June 30, 2000, $3.0 million of the $8.5 million allowance for loan losses was reserved for the credit card loan portfolio. Regulators have reviewed the Company's methodology for determining allowance requirements on the Company's loan portfolio and have made no recommendations for increases in the allowances during the three year period ended June 30, 2000.
Real estate properties acquired through foreclosure are recorded at the lower of cost or fair value (less a deduction for disposition costs). Valuations are periodically updated by management and a specific provision for losses on such properties is established by a charge to operations if the carrying values of the properties exceed their estimated net realizable values.
Although management believes that it uses the best information available to determine the allowances, unforeseen market conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations. Future additions to the Bank's allowances result from periodic loan, property and collateral reviews and thus cannot be predicted in advance. At June 30, 2000, the Bank had a total allowance for loan losses of $8.5 million, or 1.5% of total loans. See Note 1 of the "Notes to Consolidated Financial Statements" for a description of the Bank's policy regarding the provision for losses on loans.
Comparison of the Years Ended June 30, 2000 and June 30, 1999
General. The Company's net income increased $4.2 million to $5.3 million for the year ended June 30, 2000 as compared to $1.1 million for the year ended June 30, 1999. As discussed in more detail below, this increase was due primarily to an increase in interest income of $7.0 million, a decrease in provision for losses on loans of $6.5 million and a decrease in noninterest expense of $1.4 million. These increases to income were partially offset by an increase in interest expense of $4.9 million, a decrease in noninterest income of $3.8 million and an increase in income tax expense of $2.0 million.
Interest Income. Interest income increased $7.0 million from $46.1 million for the year ended June 30, 1999 to $53.1 million for the year ended June 30, 2000. The $85.6 million increase of average earning assets resulted in a $6.9 million increase in interest income. Average loan balances increased $65.7 million due to originations and purchases exceeding amortizations, prepayments and sales and from loans acquired in new branch acquisitions and openings during the last half of fiscal 1999 and fiscal 2000. The Company continues to manage yields by changing the types of loans that comprise the portfolio to loans that have a higher yield than single-family real estate loans. Commercial business loans and agricultural loans comprise 20.87% of the total loan portfolio at June 30, 2000 as compared to 17.52% at June 30, 1999. In addition, one-to four-family loans comprise 23.23% of the total loan
portfolio at June 30, 2000 as compared to 26.35% at June 30, 1999. The yield on average earning assets remained stable at 8.25% as compared to 8.26% one year ago.
Interest Expense. Interest expense increased $4.9 million from $24.7 million for the year ended June 30, 1999 to $29.6 million for the year ended June 30, 2000. The $96.1 million increase of average interest-bearing liabilities resulted in a $4.1 million increase in interest expense. The average balance of deposits increased $65.6 million primarily due to deposits acquired in new branch acquisitions and openings during the last half of fiscal 1999 and fiscal 2000. The average rate paid on deposits remained stable at 4.65% as compared to 4.64% one year ago. The average balance of FHLB advances and other borrowings increased $30.5 million during fiscal year 2000. The average rate paid on FHLB advances and other borrowings increased to 5.62% at June 30, 2000 from 5.46% at June 30, 1999. See "Financial Condition Data" for further discussion.
Net Interest Income. The Company's net interest income for the year ended June 30, 2000 increased $2.1 million, or 9.64%, to $23.5 million compared to $21.5 million for the same period ended June 30, 1999. The increase in net interest income reflects an overall increase in net earning assets offset by a reduction in the net interest spread on average earning assets to 3.43% for the period ended June 30, 2000 from 3.50% for the same period in 1999. The decrease in the net interest spread is due primarily to funding other noninterest-earning assets and purchases of treasury stock.
Provision for Losses on Loans. The allowance for possible losses on loans is maintained at a level which is considered by management to be adequate to absorb possible loan losses on existing loans that may become uncollectible, based on an evaluation of the collectability of loans and prior loan loss experience. The evaluation takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. The allowance for possible loan losses is established through a provision for possible loan losses charged to expense.
During the year ended June 30, 2000, the Company recorded a provision for losses on loans of $5.6 million compared to $12.1 million for the year ended June 30, 1999, a decrease of $6.5 million. A majority of the decrease is related to reduction of the subprime credit card loan portfolio from $18.1 million for the year ended June 30, 1999 to $9.6 million at June 30, 2000. See "Asset Quality" for further discussion.
The allowance for loan losses at June 30, 2000 was $8.5 million. The allowance decreased from the June 30, 1999 balance primarily as a result charge-offs exceeding recoveries by $9.1 million offset by the provision for losses on loans of $5.6 million. The ratio of allowance for loan losses to nonperforming loans at June 30, 2000 was 326.97% compared to 445.27% at June 30, 1999. The allowance for loan losses to total loans at June 30, 200 was 1.52% compared to 2.32% at June 30, 1999. The Bank's management believes that the June 30, 2000 recorded allowance for loan losses was adequate to provide for potential losses on the related loans, based on its evaluation of the collectability of loans and prior loss experience.
Noninterest Income. Noninterest income was $15.3 million for the year ended June 30, 2000 as compared to $19.0 million for the year ended June 30, 1999.
The decrease in credit card fee income of $5.1 million for the year ended June 30, 2000 as compared to the same period in fiscal 1999 is primarily due to a decrease in fees received on unsecured credit cards. This is a result of the credit card loan portfolio decreasing from $18.1 million at June 30, 1999 to $9.6 million at June 30, 2000. The fee income represents processing fees, interchange fees, annual fees, late fees and other miscellaneous fees. This credit card program was initiated in fiscal 1997. The Company ceased credit card applications in March 1999. This decreased the level of these fees. Interest income on credit card loans is included in interest income on loans.
Fees on deposits increased $604,000 due to an increase in volume from deposits acquired in new branch acquisitions/openings during the last half of fiscal 1999 and fiscal 2000.
Insurance and commission from the sale of financial and insurance products increased $467,000 primarily due to a greater emphasis on the production of non-interest income revenue.
Gain on sale of securities increased $184,000 for the year ended June 30, 2000 as compared to the same period in the prior fiscal year. This increase was due to current market prices being higher than amortized cost at the time of sale as compared to sales in the prior year.
Noninterest Expense. Noninterest expense decreased $1.4 million from $26.4 million for the year ended June 30, 1999 to $25.0 million for the year ended June 30, 2000. This decrease was primarily from a decrease in credit card processing expense of $3.7 million which was partially offset by an increase in compensation and employee benefits of $1.3 million, an increase in other general and administrative expenses (not including advertising) of $579,000 and amortization of intangible assets of $329,000.
There was a decrease of $3.7 million in the cost of third party processors of credit cards. This expense represents costs for processing of applications, collecting loans, and marketing costs for the acquisition of credit cards for the unsecured credit card program. The decrease in expense is due primarily to a decrease of credit card loans from $18.1 million as of June 30, 1999 to $9.6 million as of June 30, 2000. The Company began offering credit cards in the second quarter of fiscal 1997 and ceased credit card applications in March 1999.
The increase in compensation and employee benefits was due primarily to an increase in employee compensation of $1.0 million paid to employees from new bank branches opened or acquired since the last quarter of fiscal 1999.
The increase in other general and administrative expenses was due primarily due to an increases in consulting expense of $214,000, TTL expense of $79,000, dues and subscriptions of $77,000, office supplies of $52,000 and contributions of $51,000.
Income tax expense. The Company's income tax expense for the year ended June 30, 2000 was $2.9 million compared to $924,000 for the year ended June 30, 1999, an increase of $2.0 million. This increase was primarily due to the increase in the Company's income before income tax.
Comparison of the Years Ended June 30, 1999 and June 30, 1998
General. The Company's net income decreased $5.4 million to $1.1 million for the year ended June 30, 1999 as compared to $6.5 million for the year ended June 30, 1998. As discussed in more detail below, this decrease was due primarily to an increase in noninterest expense of $6.4 million and an increase in provision for losses on loans of $7.4 million. These increases were partially offset by an increase in noninterest income of $5.4 million and a reduction in income tax expense of $2.3 million.
Interest Income. Interest income decreased $82,000 from $46.2 million for the year ended June 30, 1998 to $46.1 million for the year ended June 30, 1999. This decrease was primarily due to the falling interest rate environment during the first quarter of fiscal 1999. The decrease in interest earned on investment securities was primarily due to a decrease in the average balance of investment securities of $18.6 million. During this period the average yield on investment securities decreased from 5.86% to 5.79% due to current market rates being at a lower rate on new purchases as compared to the rates of matured investment securities. The decrease in the average balance of investment securities was primarily due to the call, maturity and sales of U.S. Government securities and tax exempt municipals in the amount of $30.6 million during fiscal 1999. The decrease in interest earned on investment securities was partially offset by an increase in interest earned on loans and mortgage-backed securities. The average balance of loans increased $19.5 million during this period due to originations and
purchases exceeding amortizations, prepayments and sales and the acquisition of DSB during the year ended June 30, 1999 while the average yield on loans decreased from 9.01% to 8.73%. The Company continues to manage yields by changing the types of loans that comprise the portfolio to loans that have a higher yield than single-family real estate loans. Commercial business loans and agricultural loans comprise 17.52% of the total loan portfolio at June 30, 1999 as compared to 12.76% at June 30, 1998. In addition, one-to four-family loans comprise 26.35% of the total loan portfolio at June 30, 1999 as compared to 29.13% at June 30, 1998. The decrease in the average yield on loans was due to lower market rates than in the prior fiscal year. The increase in interest earned on mortgage-backed securities was primarily due to an increase of the average balance of $12.5 million from the prior fiscal year resulting from purchases exceeding sales and repayments.
Interest Expense. Interest expense decreased $791,000 from $25.4 million for the year ended June 30, 1998 to $24.7 million for the year ended June 30, 1999. This decrease was largely attributable to a decrease in the average rate paid on savings, certificates of deposit and FHLB advances and other borrowings and due to an increase in the average balance of demand, NOW and money market accounts and FHLB advances and other borrowings. The average balance of demand, NOW and money market accounts increased $22.5 million during the year ended June 30, 1999 while the average balance of FHLB advances and other borrowings increased $14.4 million during fiscal year 1999. The increase in average balances of demand, NOW and money market accounts and FHLB advances and other borrowings was used to offset the decrease in average balances of savings by $4.3 million and certificates of deposit by $16.5 million from the levels at June 30, 1998. In addition, the average rate paid on savings accounts decreased from 3.57% for the year ended June 30, 1998 to 3.13% for the year ended June 30, 1999. The average rate paid on certificates of deposit decreased from 5.95% for the year ended June 30, 1998 to 5.71% for the year ended June 30, 1999 while the average rate paid on FHLB advances and other borrowings decreased from 5.07% to 4.76% for the years ended June 30, 1998 and 1999 respectively. See "Financial Condition Data" for further discussion.
Net Interest Income. The Company's net interest income for the year ended June 30, 1999 increased $709,000, or 3.42%, to $21.5 million compared to $20.8 million for the same period ended June 30, 1998. The increase in net interest income reflects an overall increase in the net interest spread on average interest-earning assets to 3.50% for the period ended June 30, 1999 from 3.40% for the same period in 1998. The increase in the net interest spread is due primarily to a decrease in the rates paid on interest-bearing liabilities from 5.07% for the year ended June 30, 1998 to 4.76% for the year ended June 30, 1999.
During the fiscal years ended June 30, 1999 and 1998, the Company increased its average balances of commercial, agricultural and credit card loans. The Company anticipates activity in this type of lending to continue in future years subject to market demand except for subprime credit card loans which the Company ceased processing applications in March 1999. In addition, the Company sells the majority of conventional single-family residential real estate loan originations into the secondary market. Net interest income is expected to trend upward as a result of this lending activity as interest rate yields are generally higher on these types of loans compared to the yield provided by conventional single-family residential real estate loans. This lending activity is considered to carry a higher level of risk due to the nature of the collateral and the size of the individual loans. As such, the Company anticipates continued increases in its allowance for loan losses.
Provision for Losses on Loans. The allowance for possible losses on loans is maintained at a level which is considered by management to be adequate to absorb possible loan losses on existing loans that may become uncollectible, based on an evaluation of the collectability of loans and prior loan loss experience. The evaluation takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. The allowance for possible loan losses is established through a provision for possible loan losses charged to expense.
During the year ended June 30, 1999, the Company recorded a provision for losses on loans of $12.1 million compared to $4.7 million for the year ended June 30, 1998, an increase of $7.4 million. A majority of the increase is related to growth of the subprime credit card loan portfolio from $12.3 million for the year ended June 30, 1998 to $18.1 million at June 30, 1999. The provision for losses on loans of $12.1 million for the year ended June 30, 1999 compared to the same period in fiscal 1998 is primarily to provide for future expected write-offs on credit card loans and due to management's continued evaluation of the loan portfolio in light of general economic conditions. See "Asset Quality" for further discussion.
The allowance for loan losses at June 30, 1999 was $12.0 million. The allowance increased from the June 30, 1998 balance primarily as a result of the provision for losses on loans of $12.1 million which was reduced by charge-offs exceeding recoveries by $7.8 million. In addition, an additional $464,000 allowance for loan losses was acquired as a result of the purchase of DSB. The ratio of allowance for loan losses to nonperforming loans at June 30, 1999 was 445.27% compared to 258.86% at June 30, 1998. The allowance for loan losses to total loans at June 30, 1999 was 2.32% compared to 1.62% at June 30, 1998. The Bank's management believes that the June 30, 1999 recorded allowance for loan losses was adequate to provide for potential losses on the related loans, based on its evaluation of the collectability of loans and prior loss experience.
Noninterest Income. Noninterest income was $19.0 million for the year ended June 30, 1999 as compared to $13.6 million for the year ended June 30, 1998.
The increase in credit card fee income of $5.9 million for the year ended June 30, 1999 as compared to the same period in fiscal 1998 is primarily due to an increase in fees received on unsecured credit cards. This is a result of the credit card loan portfolio increasing from $12.3 million at June 30, 1998 to $18.1 million at June 30, 1999. The fee income represents processing fees, interchange fees, annual fees, late fees and other miscellaneous fees. This credit card program was initiated in fiscal 1997. The Company ceased credit card applications in March 1999. This will decrease the level of these fees. Interest income on credit card loans is included in interest income on loans.
Gain on the sale of loans decreased $412,000 to $673,000 for the year ended June 30, 1999 from $1.1 million for the year ended June 30, 1998. Loans originated for resale and sales of participation interest in loans that were sold during the year ended June 30, 1999 were $82.5 million as compared to $106.4 million in the year ended June 30, 1998.
Gain on sale of securities decreased $225,000 for the year ended June 30, 1999 as compared to the same period in the prior fiscal year. This decrease was due to current market rates being lower than amortized cost at the time of sale as compared to sales in the prior year.
Noninterest Expense. Noninterest expense increased $6.4 million from $20.0 million for the year ended June 30, 1998 to $26.4 million for the year ended June 30, 1999. This increase was primarily from an increase in compensation and employee benefits of $896,000, an increase in other general and administrative expenses of $491,000, and an increase in credit card processing expense of $5.1 million which were partially offset by a decrease in losses and provision for losses and expenses on foreclosed real estate and other properties of $167,000.
The increase in compensation and employee benefits was due primarily to an increase in employee compensation of $1.0 million due to merit raises, an increase in health insurance of $116,000, an increase in pension costs of $81,000, an increase in payroll taxes of $71,000 and an increase in recruiting costs of $71,000, which were partially offset by a reduction in incentive compensation of $566,000.
The increase in other general and administrative expenses was due primarily due to an increase in check and data processing costs of $265,000, an increase in consultant services of $86,000, an increase in legal services of $71,000 and an increase in postage of $93,000.
There was an increase of $5.1 million in the cost of third party processors of credit cards. This included $1.4 million of nonrecurring expenses associated with the decision to stop marketing subprime credit cards. This expense represents costs for processing of applications, collecting loans, and marketing costs for the acquisition of credit cards for the unsecured credit card program. The increase in expense is due primarily to an increase of credit card loans from $12.3 million as of June 30, 1998 to $18.1 million as of June 30, 1999. The Company began offering credit cards in the second quarter of fiscal 1997 and ceased credit card applications in March 1999.
Income tax expense. The Company's income tax expense for the year ended June 30, 1999 was $924,000 compared to $3.2 million for the year ended June 30, 1998, a decrease of $2.3 million. This decrease was primarily due to the decrease in the Company's income before income tax.
Liquidity and Capital Resources
The Bank's primary sources of funds are deposits, FHLB advances, amortization and prepayments of loan principal (including mortgage-backed securities) and, to a lesser extent, sales of mortgage loans, sales and/or maturities of securities, mortgage-backed securities, and short-term investments. While scheduled loan payments and maturing securities are relatively predictable, deposit flows and loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Bank attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight funds.
Federal regulations have historically required the Bank to maintain minimum levels of liquid assets. The required percentage has varied from time to time based upon economic conditions and savings flows and is currently 4% of net withdrawable savings deposits and current borrowings. Liquid assets for purposes of this ratio include cash, certain time deposits, U.S. Government and corporate securities and other obligations generally having remaining maturities of less than five years. The Bank has historically maintained its liquidity ratio at a level in excess of that required by these regulations. At June 30, 2000, the Bank's regulatory liquidity ratio was 4.78%.
Liquidity management is both a daily and long-term responsibility of management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) the objectives of its asset/liability management program. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. During fiscal 2000, the Bank required funds beyond its ability to generate funds internally. Thus it used its borrowing capacity with the FHLB by obtaining advances, which increased its borrowings with the FHLB by $31.5 million.
The Bank anticipates that it will have sufficient funds available to meet current loan commitments. At June 30, 2000, the Bank had outstanding commitments to originate or purchase loans of $21.5 million and to sell loans of $11.6 million. The Bank had no commitments to purchase or sell securities.
Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings where the funds can be invested in either loans or securities at a positive rate of return or to use the funds for short term liquidity purposes. See "Financial Condition Data" for further analysis.
The Company currently has in effect a stock buy back program in which up to 10% of the common stock of the Company outstanding on March 26, 2000 may be acquired through March 31, 2001. No shares of common stock have been purchased pursuant to this current program. Pursuant to a series of stock buy back programs initiated by the Company since 1996 the Company has purchased an aggregate of 1,105,209 shares of common stock through June 30, 2000, including 421,637 shares during the fiscal year ended June 30, 2000.
On April 24, 1998, the Company declared a three-for-two stock split in the form of a stock dividend of one-half share of common stock for each one share outstanding, payable to shareholders of record on May 8, 1998. Earnings and dividends per share have been retroactively adjusted based upon the new shares outstanding after the effect of the three-for-two stock split for all periods presented. The stockholders' equity of the Company was adjusted for the effect of the three-for-two stock split and $16,000 was transferred from additional paid-in capital to common stock.
Savings institutions insured by the Federal Deposit Insurance Corporation are required by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") to meet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure. Institutions not in compliance may apply for an exemption from the requirements and submit a recapitalization plan. Under these capital requirements, at June 30, 2000, the Bank met all current capital requirements.
The Office of Thrift Supervision ("OTS") has adopted a core capital requirement for savings institutions comparable to the requirement for national banks. The OTS core capital requirement is 3% of total adjusted assets for thrifts that receive the highest supervisory rating for safety and soundness. The Bank had core capital of 5.83% at June 30, 2000.
Pursuant to the Federal Deposit Insurance Corporation Insurance Act ("FDICIA"), the federal banking agencies, including the OTS, have also proposed regulations authorizing the agencies to require a depository institution to maintain additional total capital to account for concentration of credit risk and the risk of non-traditional activities. No assurance can be given as to the final form of any such regulation.
At June 30, 2000 and 1999, securities with a fair value of $104.2 million and $78.0 million, respectively, were pledged as collateral for public deposits and other purposes. Deposits at June 30, 2000 and 1999 include $45.2 million and $46.8 million, respectively, of deposits from one local governmental entity, the majority of which are demand accounts.
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 Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Effect of New Accounting Standards
The Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 138. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The effective date of this Statement was deferred by SFAS No. 137 to require its application for all fiscal quarters of fiscal years beginning after June 15, 2000. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Earlier application of all of the provisions of this Statement is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance of this Statement. This Statement should not be applied retroactively to financial statements of prior periods. Management has evaluated the impact of this Statement on the Company's consolidated financial statements and believes the impact will not be significant.
Year 2000
During the four years prior to fiscal year 2000, substantial time and resources were dedicated in preparation for the issues pertaining to calendar year-end 1999. The potential year-end issue with Y2K proved uneventful.
Asset/Liability and Risk Management
Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. The Bank, like other thrift institutions, is subject to interest rate risk to the extent that its interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.
As a continuing part of its financial strategy, the Bank considers methods of managing this asset/ liability mismatch consistent with maintaining acceptable levels of net interest income. In order to properly monitor interest rate risk, the Board of Directors has created an Asset/Liability Committee whose principal responsibilities are to assess the Bank's asset/liability mix and recommend strategies to the Board that will enhance income while managing the Bank's vulnerability to changes in interest rates.
In managing market risk and the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. The effect of this policy will generally be to reduce the Bank's one-year gap and sensitivity to interest rate changes. The goal of this policy is to provide a relatively consistent level of net interest income in varying interest rate cycles and to minimize the potential for significant fluctuations from period to period.
One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of the liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. The following table sets forth, at June 30, 2000, an analysis of the Company's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (+ or -300 basis points, measured in 100 basis point increments).
The data in the following tables is based on assumptions utilized by the OTS in assessing interest rate risk of thrift institutions and published in "Selected Asset and Liability Price Tables as of June 30, 2000". Even if interest rates change in the designated amounts, there can be no assurance that the Company's assets and liabilities would perform as set forth below. In addition, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause significantly different changes to the NPV than indicated below.
The following table sets forth the scheduled repricing or maturity of the Bank's assets and liabilities which mature or reprice within one year. In preparing the following table, it has been assumed, consistent with the assumptions used by the OTS, that: (i) adjustable-rate first mortgage loans will prepay at a rate of 10% per year; (ii) fixed-maturity deposits will not be withdrawn prior to maturity; and (iii) escrow accounts are assumed to reprice or be withdrawn in the first three month period. Savings accounts and transaction accounts are expected to reprice 100% within the first year.
Using these classifications, fixed-rate mortgage loans and mortgage-backed securities are assumed to prepay annually as follows:
The effect of these assumptions is to quantify the dollar amount of items that are interest-sensitive and can be repriced within each of the periods specified. Such repricing can occur in one of three ways: (i) the rate of interest to be paid on an asset or liability may adjust periodically on the basis of an index; (ii) an asset or liability such as a mortgage loan may amortize, permitting reinvestment of cash flows at the then-prevailing interest rates; or (iii) an asset or liability may mature, at which time the proceeds can be reinvested at current market rates. The following table does not necessarily indicate the impact of general interest rate movements on the Bank's net interest yield because the repricing of certain categories of assets and liabilities is subject to competitive and other pressures beyond the Bank's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period, may, in fact, mature or reprice at different times and at different volumes. The
table does not include redeployment of funds from contractual amortization and the possible impact of annual ceilings on adjustable-rate loans and securities.
At June 30, 2000, the Bank's cumulative one-year gap as a percentage of total assets was a negative 17.37% and its one- to three-year gap as a percentage of total assets was a negative 14.88%.
Forward-Looking Statement
This Form 10-K and other reports issued by the Company, including reports filed with the Securities and Exchange Commission, may contain "forward-looking" statements that deal with future results, expectations, plans or performance. In addition, the Company's management may make such statements orally to the media, securities analysts, investors or others. Forward-looking statements deal with matters that do not relate strictly to historical facts. These forward-looking statements might include one or more of the following:
•Projections of income, revenues, earnings per share, dividends, capital expenditures, capital structure or other financial items.
•Descriptions of plans or objectives of management for future operations, products or services.
•Forecasts of future economic performance.
•Descriptions of assumptions underlying or relating to such matters.
Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "believe," "expect," "anticipate," "intend," "plan," "estimate," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may."
The Company's future results may differ materially from historical performance, and forward-looking statements about the Company's expected financial results or other plans are subject to a number of risks and uncertainties. These include but are not limited to possible legislative changes and adverse economic, business and competitive developments such as shrinking interest margins; deposit outflows; reduced demand for financial services and loan products; changes in accounting policies or guidelines, or in monetary and fiscal policies of the federal government; changes in credit and other risks posed by the Company's loan portfolios; technological, computer-related or operational difficulties; adverse changes in securities markets; results of litigation; or other significant uncertainties.
Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk Management
The Company's net income is largely dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.
In an attempt to manage its exposure to change in interest rates, management monitors the Company's interest rate risk. Since 1991, management's Asset-Liability Committee has met monthly to review the Company's interest rate risk position and profitability, and to recommend adjustments for consideration by the Board of Directors. Management also reviews the Bank's securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company's asset/liability position, the Board and management attempt to manage the Company's interest rate risk while enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates.
Consistent with the asset/liability management philosophy described above, the Company has taken several steps to manage its interest rate risk. First, the Company has structured the security portfolio to shorten the lives of its interest-earning assets. The Company's recent purchases of mortgage-backed securities and securities available for sale have had either short or medium terms to maturity or adjustable interest rates. At June 30, 2000, the Company had securities available for sale of $51.1 million with contractual maturities of five years or less and adjustable rate mortgage-backed securities of $5.6 million. Mortgage-backed securities amortize and experience prepayments of principal; the Company has received average cash flows from principal paydowns, maturities, sales and calls of securities of $46.4 million annually over the past three fiscal years. The Company also controls interest rate risk reduction by emphasizing non-certificate depositor accounts. The Board and management believe that such accounts carry a lower cost than certificate accounts, and that a material portion of such accounts may be more resistant to changes in interest rates than are certificate
accounts. At June 30, 2000, the Company had $54.5 million of regular savings accounts, $113.3 million of money market accounts and $78.1 million of NOW and demand accounts, representing 45.1% of total depositor accounts.
One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations-Asset/Liability and Risk Management" for further discussion.
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements of the Company as of June 30, 2000 and 1999, together with the Independent Auditor's Report are included in this Form 10-K on the pages indicated below.
HF FINANCIAL CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Contents
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
HF Financial Corp.
Sioux Falls, South Dakota
We have audited the accompanying consolidated statements of financial condition of HF Financial Corp. and subsidiaries as of June 30, 2000 and 1999, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HF Financial Corp. and subsidiaries as of June 30, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2000, in conformity with generally accepted accounting principles.
Sioux Falls, South Dakota
August 11, 2000
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2000 and 1999
(Dollars in Thousands)
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2000, 1999 and 1998
(Dollars in Thousands, Except Per Share Data)
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30, 2000, 1999 and 1998
(Dollars in Thousands, Except Per Share Data)
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2000, 1999 and 1998
(Dollars in Thousands)
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands)
Note 1. Summary of Significant Accounting Policies
The accounting and reporting policies of HF Financial Corp. (the Company) and subsidiaries conform to generally accepted accounting principles and to general practice within the industry. The following is a description of the more significant of those policies that the Company follows in preparing and presenting its consolidated financial statements.
Principles of consolidation: The accompanying consolidated financial statements include the accounts of the Company, HF Card Services, L.L.C. (HF Card) (a wholly-owned subsidiary of the Company at June 30, 2000 and 1999 and a 51% owned subsidiary at June 30, 1998), and the Company's wholly-owned subsidiaries, HomeFirst Mortgage Corp. and Home Federal Savings Bank (the Bank) and the Bank's wholly-owned subsidiaries, Hometown Insurors, Inc., Mid-America Service Corporation and PMD, Inc. All intercompany balances and transactions have been eliminated in consolidation.
The Company ceased operations of HomeFirst Mortgage Corp. during the first quarter of 1998, with no material affect on the consolidated financial statements (Note 19).
Basis of financial statement presentation: The financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the year. Actual results could differ significantly from those estimates. A material estimate that is particularly susceptible to significant change in the near-term relates to the determination of the allowance for loan losses.
Management believes that the allowance for loan losses is adequate. While management uses available information to recognize possible losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Cash and cash equivalents: For purposes of reporting the statements of cash flows, the Company includes as cash equivalents all cash accounts, which are not subject to withdrawal restrictions or penalties and time deposits with original maturities of 90 days or less. The Company had $5,000 of cash equivalents at June 30, 2000 and $2,000 at June 30, 1999.
Trust assets: Assets of the trust department, other than trust cash on deposit at the Bank, are not included in these financial statements because they are not assets of the Bank.
Securities: Management determines the appropriate classification of securities at the date individual securities are acquired and evaluates the appropriateness of such classifications at each statement of financial condition date.
Securities available for sale are those debt or equity securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified
as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value and unrealized gains or losses are reported as increases or decreases in other comprehensive income, net of the related deferred tax effect.
Premiums and discounts on securities are amortized over the contractual lives of those securities, except for mortgage-backed securities, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of securities are determined using the specific identification method.
Loans held for sale: Loans receivable which the Bank may sell or intends to sell prior to maturity are carried at the lower of net book value or fair value on an aggregate basis. Such loans held for sale include loans receivable that management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk or other similar factors.
Loans receivable: Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, and net of deferred loan origination fees, costs and discounts.
Discounts and premiums on loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for prepayments.
Uncollectible interest on loans that are impaired or contractually past due is charged off based on management's periodic evaluation. The charge to interest income is equal to all interest previously accrued, and income is subsequently recognized only to the extent cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is no longer in doubt, in which case the loan is returned to accrual status.
The Company includes all loans considered impaired in its evaluation of the adequacy of the allowance for loan losses. A loan is impaired when it is probable the Bank will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans was not significant at June 30, 2000 and 1999.
The allowance for loan losses is increased by provisions charged to income and reduced by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the allowance for loan losses is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions.
Loan origination fees and related discounts: Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for prepayments.
Credit card fees include acceptance, annual/monthly, late, over limit, returned check, cash advance, and other miscellaneous fees. These fees are assessed according to agreements with customers. Accrued credit card fees on charged-off accounts are deducted from credit card fee income. Annual credit card fees and acceptance fees, net of loan origination costs, are deferred and amortized on a straight-line basis over the one-year period to which they pertain. Unearned annual fees are included in other liabilities in the consolidated financial statements of financial condition, while unearned acceptance fees (net of loan origination costs) are net against the related loan balances in the consolidated financial statements of financial condition.
Commitment fees and costs relating to commitments, the likelihood of exercise of which is remote, are recognized over the commitment period on a straight-line basis. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield.
Loan servicing: The cost allocated to mortgage servicing rights purchased or retained has been recognized as a separate asset and is being amortized in proportion to and over the period of estimated net servicing income. Mortgage servicing rights are periodically evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the rights are stratified by one or more predominant risk characteristics of the underlying loans. The Bank stratifies its capitalized mortgage servicing rights based on the interest rate of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed their fair value.
Cost in excess of net assets acquired: During the year ended June 30, 2000, the Bank acquired the assets and liabilities of a branch of another financial institution. The Bank received cash of $775 in settlement of the purchase, as the liabilities assumed exceeded the assets acquired. Also during 2000, Hometown Insurors, Inc. paid $300 to acquire the customer base of a local insurance agency, with another $150 payment possible under contingency provisions of the purchase agreement. These acquisitions were treated as purchases for accounting purposes, and a total of $442 was allocated to goodwill.
On May 27, 1999, the Bank acquired 100% of the outstanding capital stock of a local commercial bank for cash consideration of $9,540, and accounted for the acquisition under the purchase method of accounting. Accordingly, the results of operations of the acquired bank since the date of acquisition are included in the consolidated financial statements. The excess of cash paid and fair value of liabilities assumed over the fair value of net assets acquired of $4,973 is being amortized to expense by the straight-line method over 15 years.
Unaudited proforma consolidated results of operations for the years ended June 30, 1999 and 1998 as though the bank had been acquired as of July 1, 1997 follows (in thousands, except per share data):
Foreclosed real estate and other properties: Real estate and other properties acquired through, or in lieu of, loan foreclosure are initially recorded at lower of cost or fair value less estimated costs to sell at the date of foreclosure. Costs relating to improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management, and charge-offs to operations are made if the carrying value of a property exceeds its estimated fair value less estimated costs to sell.
Land held for development is carried at the lower of cost, including cost of improvements and amenities incurred subsequent to acquisition, or fair value less cost to sell. Costs relating to development and improvement of property are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. The carrying amount of land held for development was $1,298 at June 30, 2000 and 1999.
Office properties and equipment: Land is carried at cost. All other office properties and equipment are carried at cost, less accumulated depreciation and amortization. Buildings and improvements and leasehold improvements are depreciated primarily on the straight-line method over the estimated useful lives of the assets which is five to fifty years. Furniture, fixtures, equipment and automobile are depreciated using both the straight-line and declining balance methods over the estimated useful lives of the assets which is three to twelve years.
Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Earnings per share: Earnings per share has been computed on the basis of the weighted-average number of common shares outstanding during each period presented. On April 24, 1998, the Company declared a three-for-two stock split in the form of a stock dividend of one-half share of common stock for each one share outstanding, payable to shareholders of record on May 8, 1998. All data related to common shares has been retroactively adjusted based upon the new shares outstanding after the effect of the three-for-two stock split for all periods presented. The stockholders' equity of the Company was
adjusted for the effect of the three-for-two stock split and $16 was transferred from additional paid-in capital to common stock.
Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate their fair values.
Securities: Fair values for investment securities are based on quoted market prices, except for stock in the Federal Home Loan Bank for which fair value is assumed to equal cost.
Loans: Approximately 50% and 48% of loans at June 30, 2000 and 1999, respectively, are variable-rate loans that reprice frequently and have no significant change in credit risk. Fair values on these loans are based on carrying values. The fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality or from quoted market prices of similar loans sold, adjusted for differences in loan characteristics.
Accrued interest receivable: The carrying value of accrued interest receivable approximates its fair value.
Mortgage servicing rights: Fair values are estimated using discounted cash flows based on current market rates of interest.
Off-statement-of-financial-condition instruments: Fair values for the Company's off-statement-of- financial-condition instruments (unused lines of credit and letters of credit), which are based upon fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and counterparties' credit standing, are not significant.
Deposits: The fair values for deposits with no defined maturities equal their carrying amounts which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on certificates of deposit.
Borrowed funds: The carrying amounts reported for variable rate advances approximate their fair values. Fair values for fixed-rate advances and other borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances and borrowings with corresponding maturity dates.
Accrued interest payable and advances by borrowers for taxes and insurance: The carrying values of accrued interest payable and advances by borrowers for taxes and insurance approximate their fair values.
Stock-based compensation: The Company accounts for stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25.
Recent accounting pronouncements: The Financial Accounting Standards Board has issued certain Statements of Financial Accounting Standards which have required effective dates occurring after the Company's June 30, 2000 year end. The Company's financial statements, including the disclosures therein, are not expected to be materially affected by those accounting pronouncements.
Note 2. Investments in Securities
The amortized cost and fair values of investments in securities at June 30, 2000, all of which are classified as available for sale according to management's intent, are as follows:
The amortized cost and fair values of debt securities as of June 30, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Equity securities have been excluded from the maturity table above because they do not have contractual maturities associated with debt securities. The Bank, as a member of the Federal Home Loan Bank system, is required to maintain an investment in capital stock of the Federal Home Loan Bank. No ready market exists for the Bank stock, and it has no quoted market value. For disclosure purposes, such stock is assumed to have a fair value which is equal to cost.
The components of other comprehensive income (loss)-net change in unrealized (loss) on securities available for sale are as follows:
Proceeds from the sale of securities available for sale in 2000 were $5,386 and resulted in gross gains of $201 and gross losses of $(16). Proceeds from the sale of securities during 1999 and 1998 were $4,678 and $7,436, respectively, and resulted in gross gains of $76 and $226, respectively, and gross losses of $(75) and $0, respectively.
At June 30, 2000 and 1999, securities with a fair value of $104,245 and $78,029, respectively, were pledged as collateral for public deposits and other purposes.
The amortized cost and fair values of investments in securities at June 30, 1999, all of which are classified as available for sale according to management's intent, are as follows:
Note 3. Loans Receivable and Loans Held for Sale
Loans receivable at June 30, 2000 and 1999 consist of the following:
Loans held for sale totaling $8,257 and $11,755 at June 30, 2000 and 1999, respectively, consist of one-to-four family fixed-rate loans.
Activity in the allowance for loan losses is summarized as follows for the years ended June 30:
Nonaccrual loans for which interest has been reduced totaled approximately $2,078, $1,045 and $2,251 at June 30, 2000, 1999 and 1998, respectively. Interest income that would have been recorded
under the original terms of such loans and the interest income actually recognized for the years ended June 30 are summarized below:
Note 4. Loan Servicing
Mortgage loans serviced for others (primarily the South Dakota Housing Development Authority) are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of mortgage loans serviced for others was $460,786 and $408,078 at June 30, 2000 and 1999, respectively.
Custodial balances maintained in connection with the foregoing loan servicing, and included in deposits and advances by borrowers for taxes and insurance, were approximately $1,397 and $1,580 at June 30, 2000 and 1999, respectively.
The carrying values of mortgage servicing rights were $2,171 and $1,739 at June 30, 2000 and 1999, respectively. The fair values of these rights were $5,064 and $4,330 at June 30, 2000 and 1999, respectively. The fair values of the mortgage servicing rights were estimated as the present value of the expected future cash flows using a discount rate of 15.0% for both periods. The Company recognized expense for amortization of the cost of mortgage servicing rights in the amount of $297 and $277 for the years ended June 30, 2000 and 1999, respectively.
No valuation allowances were provided for mortgage servicing rights capitalized during the years ended June 30, 2000 and 1999.
Note 5. Office Properties and Equipment
Office properties and equipment at June 30, 2000 and 1999 consist of the following:
In addition, the Bank leases several branch facilities under operating lease agreements which require minimum rentals totaling $984 through the year ending June 30, 2006.
Note 6. Deposits
Deposits at June 30, 2000 and 1999 consist of the following:
Scheduled maturities of savings certificates are as follows:
Eligible savings accounts are insured up to $100 by the Savings Association Insurance Fund (SAIF) under management of the Federal Deposit Insurance Corporation (FDIC). The aggregate amount of jumbo certificates of deposit with a minimum denomination of $100 was approximately $69,428 and $54,384 at June 30, 2000 and 1999, respectively. Deposits at June 30, 2000 and 1999 include $45,213 and $46,827, respectively, of deposits from one local governmental entity, the majority of which are demand accounts.
Note 7. Advances From Federal Home Loan Bank and Other Borrowings
Advances from the Federal Home Loan Bank of Des Moines at June 30, 2000 and 1999 are summarized as follows:
Aggregate maturities of advances are as follows: 2001 $20,814; 2002 $18,280; 2003 $4,936; 2004 $10,962; 2005 $1,090; and thereafter $55,446. Advances totaling $44,500 are callable at the discretion of the Federal Home Loan Bank, with first call dates ranging from July 2000 to September 2004. Prepayment of the callable advances results in a prepayment fee as negotiated between the Bank and the Federal Home Loan Bank.
Advances are secured by stock in the Federal Home Loan Bank of Des Moines, one-to-four family first mortgage loans with balances exceeding 135% of the amount of the advances and multi-family first mortgage loans with balances exceeding 175% of the amount of the advances.
Other borrowings consist of the following at June 30, 2000 and 1999:
During fiscal year 1994, the South Dakota Housing Development Authority loaned $600 to the Bank at 0% interest rate per annum to be used by the Bank to originate $600 in qualified home improvement loans. The note had a balance of $524 at June 30, 2000 and 1999, and is due on August 31, 2000.
On August 20, 1998, the Company entered into a Real Estate Purchase Agreement to purchase land for future development for $1,298, with a down payment of $261, and the remainder financed under a contract for deed requiring monthly payments of $9, plus interest at 7.0%, to October 2013. The contract for deed had a balance of $968 and $1,011 at June 30, 2000 and 1999, respectively. Aggregate maturities of the contract for deed are as follows: 2001 $46; 2002 $49; 2003 $52; 2004 $56; 2005 $60; and thereafter $705.
Note 8. Income Tax Matters
The Company and subsidiaries file a consolidated federal income tax return on a fiscal year basis. The Bank is allowed bad debt deductions based on actual charge-offs.
The consolidated provision for income taxes consists of the following for the years ended June 30:
Income tax expense is different from that calculated at the statutory federal income tax rate. The reasons for this difference in the tax expense are as follows:
The components of the net deferred tax asset as of June 30, 2000 and 1999 are as follows:
Retained earnings at June 30, 2000 and 1999, include approximately $4,805 related to the pre-1987 allowance for loan losses for which no deferred federal income tax liability has been recognized. These amounts represent an allocation of income to bad debt deductions for tax purposes only. If the Bank no longer qualifies as a bank, or in the event of a liquidation of the Bank, income would be created for tax purposes only, which would be subject to the then current corporate income tax rate. The unrecorded deferred income tax liability on the above amounts for financial statement purposes was approximately $1,634 at June 30, 2000 and 1999.
Note 9. Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier I capital (as defined) to total
assets (as defined). Management believes, as of June 30, 2000, that the Bank meets all capital adequacy requirements to which it is subject.
As of June 30, 2000, the most recent notification from the Office of Thrift Supervision (OTS) categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I (core) capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category.
The following table summarizes the Bank's compliance with its regulatory capital requirements at June 30, 2000 and 1999:
Note 10. Stockholders' Equity
The Company has continued a stock buy back program in which up to 10% of the common stock of the Company may be acquired in each series of buy-backs. The current program is in effect through March 31, 2001. Since inception of the program through June 30, 2000, a total of 1,105,209 shares of common stock have been purchased. A total of 421,637 shares of common stock were purchased pursuant to this program during the year ended June 30, 2000.
During 1996, the Company approved the creation of 50,000 shares of Preferred Stock, designated as "Series A Junior Participating Preferred Stock" with a stated value of $1.00 per share. Outstanding shares of the Junior Preferred Stock are entitled to cumulative dividends. Such shares have voting
rights of 100 votes per share and a preference in liquidation. The shares are not redeemable after issuance.
During 1996, the Company also declared a dividend of one preferred share purchase right (Right) for each outstanding share of common stock of the Company. The dividend was paid on November 13, 1996 to the stockholders of record on such date. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock at a price of $65 per one-hundredth of a preferred share, subject to the complete terms as stated in the Rights Agreement. The Rights become exercisable immediately after the earlier of (i) ten business days following a public announcement that a person or group has acquired beneficial ownership of 20% or more of the outstanding common shares of the Company (subject to certain exclusions), (ii) ten business days following the commencement or announcement of an intention to make a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person or group of 20% or more of such outstanding common shares. The Rights expire on October 22, 2006, which date may be extended subject to certain additional conditions.
Under current regulations, the Bank is not permitted to pay dividends on its stock if its regulatory capital would reduce below (i) the amount required for the liquidation account established to provide a limited priority claim to the assets of the Bank to qualifying depositors (Eligible Account Holders) at March 31, 1992 who continue to maintain deposits at the Bank after its conversion from a Federal mutual savings and loan association to a Federal stock savings bank pursuant to its Plan of Conversion adopted August 21, 1991, or (ii) the Bank's regulatory capital requirements. As a "Tier 1" institution (an institution with capital in excess of its capital requirements, both immediately before the proposed capital distribution and after giving effect to such distribution), the Bank may make capital distributions without the prior consent of the OTS in any calendar year. The capital distribution is equal to the greater of 100% of net income for the year to date plus 50% of the amount by which the lesser of the institution's tangible, core or risk-based capital exceeds its capital requirement for such capital commitment, as measured at the beginning of the calendar year or up to 75% of net income over the most recent four quarter period. On August 9, 2000, the Bank mailed written notification to the OTS of its intention to pay up to 75% of the Bank's net income for the quarter ending September 30, 2000, to the Company.
Note 11. Earnings Per Share
A reconciliation of the income and common stock share amounts used in the calculation of basic and diluted earnings per share (EPS) for the fiscal years ended June 30, 2000, 1999 and 1998 follow.
Options outstanding of approximately 128,000 shares of common stock at a weighted average share price of $15.54 during the year ended June 30, 2000 were not included in the computation of diluted earnings per share because the exercise price of those instruments exceeded the average market price of the common shares during the year. There were no options excluded from the computation of diluted earnings per share for the years ended June 30, 1999 and 1998.
Note 12. Defined Benefit Plan
The Company has a noncontributory (cash balance) defined benefit pension plan covering all employees of the Company and its wholly-owned subsidiaries who have attained the age of twenty-one and have completed one year of service. The benefits are based on 6% of each eligible participant's annual compensation, plus income earned in the accounts at a rate determined annually based on 30-year Treasury Bill rates. The Company's funding policy is to make the minimum annual required contribution plus such amounts as the Company may determine to be appropriate from time to time. One hundred percent vesting occurs after five years, and retirement with age 65.
Information relative to the Company's defined benefit plan is presented below:
The components of pension cost for the years ended June 30 consist of the following:
The weighted-average post-retirement and pre-retirement discount rates used in determining the actuarial present value of the benefit obligations were 6.0% and 7.5% respectively, for both fiscal years 2000 and 1999. The rate of increase in future compensation levels used to determine the actuarial
present value of the benefit obligations was 5.5% for both fiscal years 2000 and 1999. The expected long-term rate of return on plan assets was 8.0% for both fiscal years 2000 and 1999.
Note 13. Employee Stock Ownership Plan
The Company has an employee stock ownership plan (ESOP) covering all full-time employees of the Company who have attained age 21 and completed one year of service during which they worked at least 1,000 hours. The ESOP includes an employee savings plan feature which provides for voluntary contributions by eligible employees on a tax-deferred basis with no matching contribution by the Company. All shares owned by the ESOP are included in earnings per share computations, with shares being allocated to eligible employees as the corresponding ESOP debt is repaid. At June 30, 2000, the ESOP holds 262,310 shares comprised of 226,526 shares which have been allocated to eligible employees and 35,784 shares remaining unallocated. Dividends on unallocated shares are used to fund the release of unallocated shares annually. Annual contributions are limited to the maximum tax-deductible amount and amounts necessary to ensure continued compliance with the Bank's regulatory capital requirements. During 1994, the Company made payments to the ESOP trust in the amount of $906 to enable the trust to pay off the ESOP debt. The Company recorded a receivable equal to the amounts paid which is reflected as a deduction from stockholders' equity (unearned compensation) in the accompanying consolidated statements of financial condition. The receivable is reduced as the Bank makes contributions to the Plan which in turn are used to repay the Company and the corresponding compensation expense is recorded.
For financial statement purposes, expense for the ESOP is determined on the percentage of shares allocated to participants each period (allocations are based on principal and interest payments) times the original amount of the debt plus the interest incurred. The compensation cost charged to expense was $110, $112 and $121 for 2000, 1999 and 1998, respectively.
The Company has elected not to adopt the accounting treatment for the ESOP shares provided by AICPA Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans", as all ESOP shares were held by the ESOP as of December 31, 1992 and are allowed to be accounted for under previously existing accounting standards.
Note 14. Stock-Based Compensation Plans
The Company has stock-based compensation plans which are described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for grants under the fixed stock option plan. Had compensation cost for the Company's stock-based compensation plans been determined based on the grant date fair values of awards (the method described in Statement No. 123), reported net income and earnings per common share would have been reduced to the pro forma amounts shown below:
Under the Company's stock option and incentive plan (Option Plan), stock options of 828,000 common shares may be granted to directors and officers of the Bank. Options granted under the Option Plan may be either options that qualify as Incentive Stock Options, as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the Code), or options that do not qualify. The Option Plan also provides for the award of stock appreciation rights, limited stock appreciation rights and restricted stock.
At June 30, 2000, 606,368 shares of common stock were reserved for issuance under the Option Plan. The options granted under the Option Plan expire ten years from the date of grant.
The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model. No options were granted during fiscal year 2000. The following weighted average assumptions were used for grants in fiscal years 1999 and 1998, respectively: a dividend rate as a percentage of stock price of 2.69% and 1.30%; price volatility of 28.00% and 18.00%, risk-free interest rates of 5.09% and 6.34% and expected lives of seven years for both years.
A summary of the status of the plan and changes during the years ended June 30 are as follows:
Options for 193,780, 174,373 and 157,298 were exercisable at June 30, 2000, 1999 and 1998, respectively. The weighted average fair value of options granted was $4.00 and $5.21 for the fiscal years ended June 30, 1999 and 1998, respectively.
Fixed options outstanding at June 30, 2000 are summarized as follows:
The Company has a Director Restricted Stock Plan (Plan) which provides that awards of restricted shares of the Company's common stock be made to outside directors of the Company. The Plan is designed to allow for payment of the annual retainer fee in shares of the Company's common stock, with the inclusion of an annual cost of living adjustment based on the Consumer Price Index. Each outside director is entitled to all voting, dividend and distribution rights during the restriction period. The effective date of the Plan is July 1, 1997. The Plan has 75,000 shares allocated to it and is in effect for a period of ten years. During fiscal years 2000 and 1999, 7,252 and 4,046 shares were awarded and $98 and $95 of expense was incurred under the Plan as the annual retainer for the Company's Board of
Directors for the years ending June 30, 2000 and 1999, respectively. On July 31, 2000, 11,249 shares were awarded under the Plan as the annual retainer for the year ended June 30, 2001.
Note 15. Segment Information
The management approach is used as the conceptual basis for identifying reportable segments and is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and monitoring performance.
The Company's reportable segments are banking, credit card, and other. The "banking" segment is conducted through the subsidiary, Home Federal Savings Bank, and the "credit card" segment is conducted through the subsidiary, HF Card Services, L.L.C. The "other" segment is composed of smaller nonreportable segments, the parent company, and inter-segment eliminations.
For expense allocation purposes, income tax expense is allocated only to the Company and the Bank.
Note 16. Financial Instruments
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Unless noted otherwise, the Bank does not require collateral or other security to support financial instruments with credit risk.
Estimated fair values of the Company's financial instruments are as follows:
Note 17. Commitments, Contingencies and Credit Risk
The Bank originates first mortgage, consumer and other loans primarily in eastern South Dakota and holds residential and commercial real estate loans which were purchased from other originators of loans located throughout the United States. The Bank has primarily unsecured credit card loans which were issued through third parties nationwide to a target customer market consisting of sub-prime credit customers who have either an insufficient credit history or a negative credit history. The Bank issued no new credit cards in fiscal year 2000. Collateral for substantially all noncredit card consumer loans are security agreements and/or Uniform Commercial Code (UCC) filings on the purchased asset. At
June 30, 2000 and 1999, the Bank has approximately $143 and $209 of loans sold with recourse to the Federal National Mortgage Association (FNMA). The collateral securing these loans are one-to-four family mortgage loans which are seasoned. Unused lines of credit amounted to $59,421 and $66,720 at June 30, 2000 and 1999, respectively. Unused letters of credit amounted to $1,410 and $2,571 at June 30, 2000 and 1999, respectively. The lines of credit and letters of credit are collateralized in substantially the same manner as loans receivable.
The Bank had outstanding commitments to originate or purchase loans of $21,494 and to sell loans of approximately $11,637 at June 30, 2000. The portion of commitments to originate or purchase fixed rate loans totaled $17,812 with a range in interest rates of 5.4% to 10.0%. No losses are expected to be sustained in the fulfillment of any of these commitments.
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based upon consultation with legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position.
Note 18. Cash Flow Information
Changes in other assets and liabilities at June 30, 2000, 1999 and 1998 consist of:
Note 19. Subsequent Events
In July 2000, HomeFirst Mortgage Corp. entered into a stock purchase agreement under which it will purchase all outstanding shares of Mid America Capital Services, Inc. for cash consideration of approximately $2,850. The operations of Mid America Capital Services consist primarily of leasing business equipment.
In August 2000, the Company entered into a $3,000 revolving note agreement with an unrelated bank, primarily to fund the above acquisition. The note is secured by substantially all assets of the Company, including the Bank stock held by the Company, bears interest at a variable rate and is due August 13, 2001.
Note 20. Financial Information of HF Financial Corp. (Parent Only)
The Company's condensed balance sheets as of June 30, 2000 and 1999 and related condensed statements of income and cash flows for each of the years in the three year period ended June 30, 2000 are as follows:
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
CONDENSED STATEMENTS OF CASH FLOWS
Note 21. Quarterly Financial Information (Unaudited)
(Dollars in thousands except per share data)
*Includes additional provision charged to income of $3,500 for allowance for loan losses related to credit card loans.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
During the Company's two most recent fiscal years there have been no disagreements with our accountant on any matter of accounting principle or financial statement disclosure.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information regarding untimely filings pursuant to Section 16 of the Securities Exchange Act of 1934, as amended, is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 2000, a copy of which will be filed not later than 120 days after the close of the fiscal year.
Directors
Information concerning Directors of the Company is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 2000, a copy of which will be filed not later than 120 days after the close of the fiscal year.
Executive officers
Information regarding the business experience of the executive officers of the Company and the Bank contained in Part I of this Form 10-K is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 2000, except for information contained under the headings "Board Compensation Committee Report on Executive Compensation" and "Stockholder Return Performance Presentation", a copy of which will be filed not later than 120 days after the close of the fiscal year.
Item 12.
Item 12. 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 definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 2000, a copy of which will be filed not later than 120 days after the close of the fiscal year.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 2000, except for information contained under the headings "Board Compensation Committee Report on Executive Compensation" and "Stockholder Return Performance Presentation", a copy of which will be filed not later than 120 days after the close of the fiscal year.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)Documents filed with this report.
(1)See index to consolidated financial statements on page 64 of this report.
(2)All supplemental schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the Consolidated Financial Statements or notes thereto.
(a)(3) Exhibits
Regulation
S-K Exhibit
Number
Document
Reference to
Prior Filing
or Exhibit
Number
Attached
Hereto
Sequential Page
Number Where
Attached Exhibits
Are Located in This
Form 10-K
Report
3(i)
Articles of Incorporation
(1)
Not Applicable
3(ii)
By-Laws
(1)
Not Applicable
4.0
Rights Agreement
(5)
Not Applicable
10.1
Employment Contracts between the Bank and Curtis L. Hage
(1)
Not Applicable
10.2
Amendment to Employment Contract between the Bank and Curtis L. Hage
(4)
Not Applicable
10.4
1991 Stock Option and Incentive Plan
(2)
Not Applicable
10.5
Articles of Incorporation of HF Card Services L.L.C.
(4)
Not Applicable
10.6
Amendment to 1991 Stock Option and Incentive Plan
(6)
Not Applicable
10.7
1996 Director Restricted Stock Plan
(6)
Not Applicable
10.8
Employment Contract between the Bank and Gene F. Uher
(6)
Not Applicable
10.9
Employment Contract between the Bank and Mark S. Sivertson
(7)
Not Applicable
10.10
Employment Contract between the Bank and Michael H. Zimmerman
(7)
Not Applicable
10.11
Change in Control Contract between the Bank and Gene F. Uher
(7)
Not Applicable
10.12
Change in Control Contract between the Bank and Mark S. Sivertson
(7)
Not Applicable
10.13
Change in Control Contract between the Bank and Michael H. Zimmerman
(7)
Not Applicable
10.14
Amendment to Employment Contract between the Bank and Gene F. Uher
(8)
Not Applicable
10.15
Employment Contract between the Bank and Brent E. Johnson
(8)
Not Applicable
10.16
Change in Control Contract between the Bank and Brent E. Johnson
(8)
Not Applicable
Subsidiaries of Registrant
Consents of Experts and Counsel
27.1
Financial Data Schedule
27.1
27.2
Financial Data Schedule-Restated
27.2
(1)Filed as exhibits to the Company's Form S-1 registration statement filed on December 6, 1991 (File No. 33-44383) pursuant to Section 5 of the Securities Act of 1933.
(2)Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1993.
(3)Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1994.
(4)Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1996.
(5)Filed as Exhibit I to the Company's filing on Form 8-A, filed on October 28, 1996.
(6)Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1997.
(7)Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1998.
(8)Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1999. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K.
(b) Reports on Form 8-K
No current reports on Form 8-K were filed by the Company during the quarter ended June 30, 2000.
SIGNATURES
Pursuant to the requirements of Section 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.
HF FINANCIAL CORP.
By
/s/ CURTIS L. HAGE Curtis L. Hage, Chairman, 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 in the capacities and on the dates indicated.
Index to Exhibits
Exhibit
Number
Subsidiaries of Registrant
Consents of Experts and Counsel
27.1
Financial Data Schedule
27.2
Financial Data Schedule-Restated
DOCUMENTS INCORPORATED BY REFERENCE
PART I
PART II
HF FINANCIAL CORP. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITOR'S REPORT
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
CONDENSED STATEMENTS OF CASH FLOWS
PART III
PART IV
SIGNATURES
Index to Exhibits