Item 1. Business
General
MAF Bancorp, Inc. ("Company"), was incorporated under the laws of the state of Delaware in 1989. The Company is a registered savings and loan holding company primarily engaged in the consumer banking business through its wholly-owned subsidiary, Mid America Bank, fsb ("Bank") and secondarily, in the residential real estate development business through MAF Developments, Inc. ("MAF Developments").
The Bank is a consumer-oriented financial institution offering various financial services to its customers through 24 retail banking offices. The Bank's market area is generally defined as the western suburbs of Chicago, including DuPage County, which has the second highest per capita income in Illinois, as well as the northwest side of Chicago. It is principally engaged in the business of attracting deposits from the general public and using such deposits, along with other borrowings, to make loans secured by real estate, primarily one-to four-family residential mortgage loans. To a lesser extent, the Bank also makes multi-family mortgage, residential construction, land acquisition and development and a variety of consumer loans. The Bank also has a small portfolio of commercial real estate. Through three wholly-owned subsidiaries, MAF Developments, Mid America Development Services, Inc. ("Mid America Developments"), and NW Financial, Inc. ("NW Financial"), the Company and the Bank are also engaged in primarily residential real estate development activities. Additionally, the Bank operates an insurance agency, Mid America Insurance Agency, Inc., which provides general insurance services, a title agency, Centre Point Title Services, Inc., which provides general title services for the Bank's loan customers, and an investment brokerage operation through its affiliation with INVEST, a registered broker-dealer.
On December 31, 1998, the Company successfully completed its acquisition of Westco Bancorp, Inc. ("Westco"), which was the sole shareholder of First Federal Savings and Loan of Westchester ("Westchester"). The Company acquired $245.2 million in loans, $259.5 million in deposits, a full service branch along with a satellite drive-up facility. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for a more detailed review of the acquisition.
On May 30, 1996, the Company acquired N.S. Bancorp, Inc. ("Northwestern"), which was the sole shareholder of Northwestern Savings Bank. At acquisition, Northwestern had $749.7 million in loans receivable, which were primarily one-to four-family residential mortgage loans, and $872.0 million in deposits, which were serviced from six branch locations. All but one of the branches are in markets which the Bank did not service in the past.
As a federally chartered savings bank, the Bank's deposits are insured up to the applicable limits by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is a member of the Federal Home Loan Bank ("FHLB") of Chicago, which is one of the twelve regional banks for federally insured savings institutions comprising the FHLB system. The Bank is regulated by the Office of Thrift Supervision ("OTS") and the FDIC. The Bank is further regulated by the Board of Governors of the Federal Reserve System as to reserves required to be maintained against deposits and certain other matters.
The Company's executive offices are located at 55th Street and Holmes Avenue, Clarendon Hills, Illinois 60514-1596. The telephone number is (630) 325-7300.
Market Data
Based on total assets at December 31, 1998, the Bank is one of the largest financial institutions headquartered in the Chicago metropolitan area, with its home office located in Clarendon Hills, Illinois in the southeastern portion of DuPage County. Through its network of 24 retail banking offices, the Bank serves the residential, commercial and high technology sector west of Chicago, including western Cook County, northern Will County, eastern Kane County and DuPage County, as well as the northwest side of the City of Chicago.
Competition
The Bank is faced with increasing competition in attracting retail customer business, including deposit accounts and loan originations. Competition for deposit accounts comes primarily from other savings institutions, commercial banks, money market mutual funds, and insurance companies (primarily in the form of annuity products). Factors affecting the attraction of customers include interest rates offered, convenience of branch locations, ease of business transactions, and office hours. Competition for loan products comes primarily from other mortgage brokers, savings institutions, commercial banks and mortgage banking companies. Factors affecting business include interest rates, terms, fees, and customer service.
Regulatory Environment
The Bank is subject to extensive regulation, supervision and examination by the OTS, as its chartering authority and primary federal regulator, and by the FDIC, which insures its deposits up to applicable limits. Such regulation and supervision establish a comprehensive framework of activities in which the Bank can engage and is designed primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities. Any change in such regulation, whether by the OTS, the FDIC or Congress could have a material impact on the Bank and its operations. See "Regulation and Supervision - Federal Savings Institution Regulation - Recent Federal Legislative Initiatives" for more information.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
This report, in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere, contains, and other periodic reports and press releases of the Company may contain, certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of invoking these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," "plan," or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and the subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the Company's loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market area, the possible short-term dilutive effect of potential acquisitions, the effectiveness of the Company's compliance review and implementation plan to identify and resolve Year 2000 issues, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
Executive Officers of the Registrant
The following executive officers were employed by the Company and the Bank as of January 1, 1999.
Biographical Information
Set forth below is certain information with respect to executive officers of the Company and the Bank. Unless otherwise indicated, the principal occupation listed for each person below has been their principal occupation for the past five years.
Allen H. Koranda has been Chairman of the Board and Chief Executive Officer of the Company since August, 1989, and of the Bank since May, 1984. He joined the Bank in 1972. He is also Senior Vice President and a director of Mid America Developments, a wholly-owned subsidiary of the Bank. Mr. Koranda holds Bachelor of Arts and Juris Doctor degrees from Northwestern University. Mr. Koranda is the brother of Kenneth Koranda.
Kenneth Koranda has been President of the Company since August, 1989, and of the Bank since July 1984. He joined the Bank in 1972. He is also Chairman of Mid America Developments. Mr. Koranda holds a Bachelor of Arts degree from Stanford University and a Juris Doctor degree from Northwestern University. Mr. Koranda is the brother of Allen Koranda.
David C. Burba joined the Company as Executive Vice President on January 1, 1999 in conjunction with the acquisition of Westco. He had previously served as Chairman of the Board and President of Westco since 1992 and President of First Federal Savings and Loan of Westchester since 1978. Mr. Burba holds a Bachelor of Arts degree from Carthage College.
Jerry A. Weberling has been Executive Vice President and Chief Financial Officer of the Company and the Bank since July 1993. Prior to that, he was Senior Vice President of the Company since August, 1989, and Senior Vice President and Chief Financial Officer of the Bank from March 1990 to July 1993. He was Senior Vice President and Controller from 1986 to March 1990. He joined the Bank in 1984. He is a certified public accountant. Mr. Weberling holds a Bachelor of Science degree from Northern Illinois University.
Gerard J. Buccino has been Senior Vice President and Controller of the Company and the Bank since July 1996. Prior to that he was First Vice President and Controller of the Company and the Bank from July 1993 to July 1996 and Vice President and Controller of the Company and the Bank from March 1990 to July 1993. He is a certified public accountant. Mr. Buccino holds a Bachelor of Science degree from Marquette University and a Master of Business Administration degree from the University of Chicago Graduate School of Business.
William Haider has been Senior Vice President of the Company and the Bank since July 1996. Prior to that he was Vice President of the Company since April 1993 and of the Bank since 1987. He is President of Mid America Developments, MAF Developments, and NW Financial, managing the real estate development activities of the Company. Mr. Haider holds a Bachelor of Science degree from Southern Illinois University. He joined the Bank in 1984.
Michael J. Janssen has been Senior Vice President - Investor Relations and Taxation of the Company and the Bank since July 1996. Prior to that he was First Vice President - Investor Relations and Taxation of the Company and the Bank from July 1993 to July 1996, and Vice President of the Company from March 1990 to July 1993. He is a certified public accountant. Mr. Janssen holds a Bachelor of Business Administration degree from the University of Notre Dame, and a Master of Science of Taxation degree from DePaul University.
David W. Kohlsaat has been Senior Vice President - Administration since July 1996. Prior to that he was First Vice President - Administration of the Company from July 1993 to July 1996, and is responsible for retail deposit administration and Human Resources. He has been Vice President of the Company since April 1993 and of the Bank since 1980. Mr. Kohlsaat holds a Bachelor of Science degree from Southern Methodist University. He joined the Bank in 1976.
Thomas Miers has been Senior Vice President of the Company since April 1993 and Senior Vice President-Retail Banking of the Bank since January 1992. Prior to that he was Senior Vice President - Marketing. Mr. Miers holds a Bachelor of Science degree from George Williams College. He joined the Bank in 1979.
Kenneth Rusdal has been Senior Vice President of the Company since April 1993 and Senior Vice President-Operations and Information Systems since January 1992. Prior to that he was Senior Vice President-Information Systems from 1987 through 1991. He also served as Vice President of Software Development for FISERV, Inc., where he was employed from 1983 to 1987.
Sharon Wheeler has been Senior Vice President of the Company since April 1993 and has been Senior Vice President - Residential Lending of the Bank since July 1986. She joined the Bank in 1971.
Gail Brzostek has been First Vice President - Check Operations and VISA services since July 1996. Prior to that she was Vice President - Check Operations since 1985. She joined the Bank in 1967.
Alan W. Schatz has been First Vice President - Secondary Marketing of the Bank since July 1996. Prior to that he was Vice President - Secondary Marketing of the Bank from September 1992 to July 1996. Prior to that he served as the Director of Trading and Risk Management at First Illinois Mortgage Corporation where he was employed from 1987 until 1992. Mr. Schatz holds a Bachelor of Science degree from the University of Illinois at Chicago and a Master of Business Administration degree from Rosary College.
Diane Stutte has been First Vice President - Teller Operations since July 1996. Prior to that, she was Vice President - Teller Operations of the Bank since 1985. She joined the Bank in 1970.
Carolyn Pihera has been Vice President since 1979 and Corporate Secretary to the Board of Directors of the Company since August 1989 and of the Bank since 1980. She joined the Bank in 1959.
Employees
The Bank employs a total of 921 full time equivalent employees as of December 31, 1998. Management considers its relationship with its employees to be excellent.
Item 2.
Item 2. Properties
The Company neither owns nor leases any real property. For the time being, it utilizes the property and equipment of the Bank without payment to the Bank.
The Bank conducts its business through 24 retail banking offices, including its executive office location in Clarendon Hills, Illinois, and a 30,000 square foot loan processing and servicing center located in Naperville, Illinois, which it leases. The Bank has its own data processing equipment. The data processing equipment primarily consists of mainframe hardware, network servers, personal computers and ATMs. At December 31, 1998, the data processing equipment owned has a net book value of $2.6 million.
The following table sets forth information regarding the Bank's executive office and its 24 branches. At December 31, 1998, the net book value of the Bank's premises and related equipment was $40.7 million.
- ------------------------- (1) Land lease expires in 2006 (2) Land lease expires in 2007.
Item 3.
Item 3. Legal Proceedings
The Bank was the named defendant in an action filed on June 29, 1998, in the Circuit Court of Lake County, Illinois, in which the plaintiffs were seeking certification of a plaintiff class. The plaintiffs claimed certain alleged violations under the Real Estate Settlement Practices Act in connection with a residential mortgage loan made to the plaintiffs and certain disclosure violations under Illinois state consumer protection law. The Bank removed the suit to Federal District Court of the Northern District of Illinois on July 22, 1998. This matter has since been resolved and the lawsuit dismissed with no material adverse effect to the Company.
As of December 31, 1998, there are no outstanding legal proceedings against the Company. There are various actions pending against the Bank but, in the opinion of management, the probable liability resulting from these suits is unlikely, individually or in the aggregate, to have a material effect on the Bank's or the Company's financial statements.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Stockholders Matters
The Company's common stock trades on the Nasdaq Stock market under the symbol "MAFB." As of March 5, 1999, the Company had 2,244 shareholders of record. The table below shows the reported high and low sales prices of the common stock during the periods indicated as well as the period end closing sales prices.
The Company declared $0.257 per share in dividends during the year ended December 31, 1998, and $0.18 per share in dividends for the year ended December 31, 1997. The Company's ability to pay cash dividends primarily depends on cash dividends received from the Bank. Dividend payments from the Bank are subject to various restrictions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulation and Supervision - Federal Savings Institution Regulation - Limitation on Capital Distributions."
All amounts in this Form 10-K have been adjusted for the 3-for-2 stock split announced by the Company on April 29, 1998, which was paid on July 10, 1998 to shareholders of record on June 18, 1998.
Item 6.
Item 6. Selected Financial Data
The following table sets forth certain summary consolidated financial data at or for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements and notes thereto included herein. See "Item 8. Financial Statements and Supplementary Data."
(1) The extraordinary items in the years ended December 31, 1998 and June 30, 1996 represent charges for the early extinguishment of debt, net of tax benefits.
(2) Ratios for the six months ended December 31, 1996 are annualized.
(3) Excludes the effect of the special SAIF assessment of $14.2 million ($8.7 million after tax) for the six months ended December 31, 1996. Including the impact of the special SAIF assessment, the Company's actual ratios were as follows: Return on average assets of .56%; Return on average equity of 7.12%; Non-interest expense to average assets of 2.60%; Non-interest expense to average assets and average loans serviced for others of 1.95%; Efficiency ratio of 73.09%; Ratio of earnings to fixed charges including interest on deposits of 1.20x; and Ratio of earnings to fixed charges excluding interest on deposits of 1.67x.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
As of December 31, 1996, the Company changed its fiscal year to coincide with the calendar year, compared to the June 30 fiscal year it followed in the past. Management's discussion and analysis of financial condition and results of operations will discuss the years ended December 31, 1998 and 1997, the six month transition period ended December 31, 1996, and the fiscal year ended June 30, 1996.
Overview
Net income for the Company was $38.2 million, or $1.65 per diluted share ($1.70 per basic share) for the year ended December 31, 1998, compared to $37.9 million, or $1.59 per diluted share ($1.64 per basic share) for the year ended December 31, 1997. Net income in 1998 includes a $456,000, or $.02 extraordinary charge for the early extinguishment of the Company's $27.6 million of 8.32% subordinated capital notes. Net income was $8.8 million, or $.36 per diluted share ($.37 per basic share) for the six months ended December 31, 1996. The six month period included an after-tax charge of $8.7 million, or $.35 per diluted share for the one-time special SAIF assessment, which was assessed to all SAIF- insured savings institutions. Without this charge, operating earnings were $17.4 million, or $.71 per share. For the year ended June 30, 1996, net income was $17.2 million, or $1.23 per diluted share ($1.31 per basic share), which included a $474,000, or $.03 per diluted share extraordinary charge for the early extinguishment of $20.9 million of 10% subordinated capital notes.
Results in 1998 are a reflection of the Company's approach to consumer banking, namely its asset generation capability and the increased emphasis on transaction type deposit accounts to generate fee income. The Company maintained earnings during a year where a flat yield curve hampered its ability to grow its balance sheet internally at a desired rate. Highlights include the following items:
. The Company successfully completed its acquisition of Westco Bancorp, Inc. on December 31, 1998, as reflected in the year-end balance sheet. In addition, the Company successfully completed the data processing conversion related to this transaction as of February 17, 1999.
. The Bank originated $1.8 billion in mortgage loans, far surpassing any previous year's volume. Despite the challenges of the current interest rate environment, loans receivable grew 13.5% (exclusive of the impact of Westco) due to record loan origination volume in 1998 and the Bank's retaining of prepayment protected fixed-rate mortgage loans in portfolio. Higher levels of fixed-rate originations enabled the Bank to increase gain on sale of loans and mortgage-backed securities to $3.2 million, compared to $432,000 in 1997.
. Deposit account service charges, mainly earned from checking accounts, grew 19.5% to $8.6 million due to continued success from the Bank's direct mail strategy and further growth in its debit card program.
. The Company's efficiency ratio was 48.54% in 1998, compared in 47.07% in 1997, despite the large increase in loan volume and additional accounts serviced. In addition, the Company's 1998 non-interest expense to average assets ratio of 1.65% remained stable compared to 1997.
Acquisitions and Expansion Activity
On December 31, 1998, the Company completed its acquisition of Westco Bancorp. Westco had $312.9 million of assets, $245.2 million of loans receivable, $259.5 million of deposits and $46.7 million of equity on the closing date. The loans are primarily single-family residential mortgage loans that complement the Bank's loans receivable portfolio. The deposit accounts consisted of 33.3% core deposits, namely passbook savings, money market and checking accounts.
Under the terms of the agreement, the Company issued 3,305,129 shares of its common stock from treasury at a rate of 1.395 shares of the Company's stock for each share of Westco. The transaction was accounted for as a purchase. As of December 31, 1998, the Company recorded purchase accounting discounts and premiums of $2.6 million and $3.7 million, respectively, a core deposit intangible of $1.7 million, and goodwill of $31.6 million. The Westco transaction had no impact on the Company's 1998 income statement.
On May 30, 1996, the Company completed its acquisition of Northwestern, for cash and stock totaling $269.7 million. The Company paid $41.18 per share of Northwestern in the form of $20.1799 cash and .8549 shares of the Company's common stock. The Company issued 11.7 million shares in the acquisition. The cash portion of the purchase was made from existing cash, as well as funds from Northwestern due to their excess capital position as of the acquisition date. Additionally, the Company obtained a $35.0 million unsecured term bank loan with a local commercial bank. The transaction was accounted for as a purchase. As such, the Company valued the assets and liabilities of Northwestern at fair value, and created goodwill and core deposit intangible assets aggregating $35.9 million as a result of the transaction.
The banking industry has and continues to experience consolidation both nationally and in the local Chicago area. As it has in recent years, the Company expects to continue to search for and evaluate potential acquisition opportunities that will enhance franchise value and may periodically be presented with opportunities to acquire other institutions, branches or deposits in the market it serves, or which allow the Company to expand outside its current primary market areas of DuPage County and the City of Chicago. Management intends to review acquisition opportunities across a variety of parameters, including the potential impact on its financial condition as well as its financial performance in the future. It is anticipated that future acquisitions, if any, will likely be valued at a premium to book value, and many times at a premium to current market value. As such, management anticipates that acquisitions made by the Company may include some book value per share dilution and earnings per share dilution depending on the Company's success in integrating the operations of businesses acquired and the level of cost savings and revenue enhancements that may be achieved.
Net Interest Income
Net interest income is the principal source of earnings for the Company, and consists of interest income on loans receivable and mortgage-backed and investment securities, offset by interest expense on deposits and borrowed funds. Net interest income fluctuates due to a variety of reasons, most notably due to the size of the balance sheet, changes in interest rates, and to a lesser extent asset quality. The Company seeks to increase net interest income without materially mismatching maturities of the interest-earning assets it invests in compared to the interest-bearing liabilities which fund such investments.
Net interest income before the provision for loan losses was $96.5 million, $93.7 million, $44.2 million and $49.9 million for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996 and year ended June 30, 1996, respectively. The net interest margin (net interest income divided by average interest-earning assets) for the same periods were 2.85%, 2.98%, 2.96%, and 2.62%, respectively.
Over the past 18 months, the treasury yield curve has undergone a dramatic change. For a variety of economic reasons, the yield curve has shifted from a somewhat positively sloped shape, where shorter-term rates are lower than longer-term rates, to a flatter one, where the difference between short and long-term rates has been quite narrow, non-existent, and periodically inverted. In addition, this flattening effect has occurred in tandem with an approximately 175 basis point decrease in long-term (10 Year) Treasury bond rates. These changes to the yield curve have greatly impacted the Bank's loan volume and loan origination mix during 1998, have resulted in the repricing of interest sensitive assets and liabilities, and have influenced the Bank's funding strategies.
Borrowers generally favor long-term fixed-rate mortgage loans in falling interest rate environments. This is exacerbated in a flat yield curve environment, where the premium for long-term loans is small compared to shorter- termed adjustable-rate loans. The impact of both of these changes in Treasury yields caused a 46% decrease in adjustable-rate loan originations in 1998 compared to 1997. Traditionally, the Bank has relied on adjustable-rate loan originations to grow its loans receivable held for investment purposes, choosing to sell its conforming fixed-rate loan originations into the secondary market to maintain acceptable interest-rate risk levels. In 1998, however, the growth in loans receivable was achieved primarily by holding in portfolio long-term fixed- rate loans that have associated prepayment penalties throughout the first five years of the loans. Management believes that the inclusion of the prepayment protection feature will cause these loans to have more stable average lives in both falling and rising interest environments, and accordingly the Bank has funded these loans with longer-term fixed-rate FHLB advances. As a result of this strategy, the Bank was able to achieve some growth in its balance sheet and partially offset the impact of the decrease in its net interest margin during the current year.
Interest rates were relatively stable for the year ended December 31, 1997 and the six months ended December 31, 1996, and this was reflected in the net interest margin remaining relatively constant between these periods. The small decrease in the net interest spread was offset by a slight increase in net interest earning assets. The large increase in the net interest margin for the six months ended December 31, 1996 is due to the Northwestern acquisition that dramatically decreased the average cost of deposits. This led to an increase in the net interest margin of 34 basis points compared to the 2.62% margin for the year ended June 30, 1996.
Rate/Volume Analysis
The table below describes the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Bank's interest income and interest expense on a fully taxable equivalent basis during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rates multiplied by prior volume), and (iii) the net change. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
The average yield on interest-earning assets decreased by 30 basis point to 7.27% during the year ended December 31, 1998. During the current year, the Federal Reserve Board decreased its target federal funds rate by .75%. This impact, along with a large decrease in long-term Treasury rates, led to higher prepayments of loans receivable and mortgage-backed securities, as well as lower repricing for short-term investment securities and liquidity.
Interest income on loans receivable increased a net $13.5 million in the current year. The average yield on loans receivable decreased 32 basis points to 7.41%. As discussed above, the decrease is a function of lower long-term interest rates, increased prepayments and modifications of higher yielding loans, as well as a decrease in earnings on prime-rate indexed equity line of credit loans. Offsetting the decrease due to a decline in average yield was a $294.2 million increase in average loans receivable. The decrease in interest income on mortgage-backed securities of $8.1 million is primarily a function of lower average balances due to prepayments and amortization, reduced purchase activity as proceeds were redeployed in loans receivable and investment securities, and the elimination of $30.2 million of fixed-rate mortgage-backed securities as a result of the sale of the Bank's 100% beneficial interests in two special purpose finance subsidiaries. The average yield on mortgage-backed securities declined 49 basis points. Because of the difficulty of originating adjustable-rate loans, the average balance of investment securities increased $66.1 million in the current year, as proceeds from the sale of loans were invested in shorter-term investment securities. The impact of newer investments at current lower yields led to a 75 basis point decrease in average yields on investment securities.
Interest expense on deposits decreased by $2.8 million during the current year, primarily due to a decrease of 18 basis points in the average cost of deposits. The decrease in the cost of deposits was attributable to lower repricing on maturing certificates of deposits, a decrease of 29 basis points on the Bank's passbook accounts, and an 8 basis point decrease in checking accounts. The average balance of deposits increased $29.4 million. Interest expense on borrowed funds increased a net $8.2 million, of which $11.2 million was due to increased average balances, offset by a $3.1 million decrease due to a decrease in average cost of 34 basis points. Growth in the Bank's interest- earning assets in 1998 was funded almost solely by increases in FHLB advances. The decrease in average cost was due to maturing higher-rate advances offset by new longer-term fixed-rate advances at lower rates. The decline in the average cost on borrowed funds was also influenced by the decrease in CMO bonds payable which carried an average cost of 9.46% resulting from the sale of the bank's 100% beneficial interests in two special-purpose finance subsidiaries.
The average yield on interest-earning assets increased for the year ended December 31, 1997 to 7.57% compared to 7.53% for the six months ended December 31, 1996. The average yield on loans receivable decreased 1 basis point, however, the average balance increased 8.3% to $2.6 billion for the year ended December 31, 1997. The average yield on investment securities increased 37 basis points primarily due to accelerated amortization of purchase accounting discounts on investment securities called prior to maturity.
The average cost of deposits increased 6 basis points to 4.44% for the year ended December 31, 1997 compared to the six months ended December 31, 1996. Average deposits increased $47.7 million, of which $37.9 million was attributable to certificates of deposit which carry average rates in excess of the overall cost of deposits. The average balance of borrowed funds increased $97.4 million, with a 15 basis point decline in average cost of borrowings due to generally lower interest rates during the current year. The increase in the average balance of borrowed funds is primarily due to funding for the increase in mortgage loans held for investment purposes.
Average Balance Sheets
The following table sets forth certain information relating to the Company's consolidated statements of financial condition and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense, on a tax equivalent basis, by the average balance of assets or liabilities. Average balances are derived from average daily balances, and include non-performing loans. The yield/cost at December 31, 1998 includes fees which are considered adjustments to yield.
(1) Includes $39.4 million, $28.9 million, $30.7 million, $18.7 million, and $50.9 million of Stock in Federal Home Loan Bank of Chicago for the year ended December 31, 1998, 1997, the six months ended December 31, 1996, year ended June 30, 1996, and at December 31, 1998, respectively. Income on a tax equivalent basis is computed assuming an effective tax rate of 40.0%.
The average yield on interest-earning assets increased 4 basis points for the six months ended December 31, 1996 from the year ended June 30, 1996 with a $1.1 billion increase in net interest-earning assets primarily due to the acquisition of Northwestern. The yield on loans receivable decreased 3 basis points offset by a 58 basis point increase in mortgage-backed securities and a 20 basis point increase in investment securities. These increases are attributable to the longer term maturities of the mortgage-backed securities and investment securities acquired from Northwestern.
The average cost of deposits decreased 31 basis points accompanying a $819.7 million increase in average balance for the six months ended December 31, 1996 compared to the year ended June 30, 1996. The significant change is due to the addition of low cost deposits from the Northwestern acquisition. The average cost of borrowed funds decreased 33 basis points although the average balance increased $180.6 million. The increase in the average balance is primarily due to borrowings for the acquisition, as well as funding for the increase in loan originations.
Since December 31, 1998, long-term interest rates have increased approximately 70 basis points, while short-term interests have increased approximately 20 basis points. Management expects that if this rise in long-term interest rates and steepening of the yield curve persists, the pressure on the Bank's net interest margin caused by the flat yield curve environment experienced over the last 18 months should moderate.
Provision for loan losses
The provision for loan losses is recorded to provide coverage for losses inherent in the Bank's loan portfolio. The Company recorded a provision for loan losses of $800,000 for the year ended December 31, 1998, compared to $1.2 million for the year ended December 31, 1997, and $700,000 for the six months ended December 31, 1996. The allowance for loan losses is based on management's continuous evaluation of the risk inherent in the Bank's loan portfolio, including its composition of loans and economic conditions that may affect the borrower's ability to make payments. In assessing its provision for loan losses in 1998, management took into account the continued increase of one-to-four family loans as a percentage of total outstanding loans in its portfolio. This is a result of the Bank's current origination strategy, which continues to stress single-family lending, as well as the impact of the Westco acquisition, which had a vast majority of its loan portfolio consisting of single-family loans receivable. At December 31, 1998, the Bank's allowance for loan losses was $16.7 million, or 119.37% of non-performing loans, and .52% of total loans.
Non-interest income
Non-interest income is another significant source of revenue for the Company. It consists of fees earned on products and services, gains and losses from loan sale activity and income from real estate operations. Although changes in interest rates can have an impact on earnings from these sources, the impact is generally not nearly as dramatic as the impact on net interest income. Non- interest income was $25.7 million for the year ended December 31, 1998, compared to $22.7 million for the year ended December 31, 1997, $12.0 million for the six months ended December 31, 1996, and $17.1 million year ended June 30, 1996.
The table below shows the composition of non-interest income for the periods indicated.
Gain on sale of loans and mortgage-backed securities. The Bank recorded a net gain on the sale of loans receivable and mortgage-backed securities for the year ended December 31, 1998 of $3.2 million, compared to $432,000 for the year ended December 31, 1997. During 1998, the Bank experienced an increase of fixed-rate loan originations, due to lower overall interest rates, and a relatively flat yield curve. This led to sales of $437.5 million in the current year compared to $105.8 million during the year ended December 31, 1997. The loss during the six months ended December 31, 1996 was primarily due to the sale of $16.9 million of adjustable-rate and fixed-rate CMOs, which were classified as available for sale, at a loss of $301,000. The Bank recorded a net gain on the sale of loans receivable and mortgage-backed securities of $198,000 for the year ended June 30, 1996. If the recent rise in long-term interest rates since December 31, 1998 persists, management would expect moderate reductions in the volume of conforming fixed-rate loan originations, the level of loan sales and the related gain on sale of loans receivable.
The gains and losses on mortgage-backed securities included in the above figures represent the sale of loans originated by the Bank and swapped into mortgage-backed securities prior to sale. The Bank swapped and sold $26.6 million, compared to $3.4 million for the year ended December 31, 1997, $8.2 million during the six months ended December 31, 1996 and $41.2 million for the year ended June 30, 1996. Sales of swaps versus whole loans to FNMA or FHLMC are primarily determined by price differences at the time of sale, and are executed in a manner to maximize profit to the Bank. The Bank has traditionally held few of its own swaps in portfolio.
Gain on sale of investment securities. The Company had net gains on the sale of investment securities during the year ended December 31, 1998 of $816,000 compared to $404,000 during the year ended December 31, 1997, $251,000 during the six months ended December 31, 1996, and $188,000 for the year ended June 30, 1996. Net gains in these periods have been primarily generated from the sale of marketable equity securities of national and regional bank and thrift companies. In addition, the current year is net of a $375,000 other than temporary impairment writedown on certain marketable equity securities and $76,000 in net gains from the sale of the Bank's 100% beneficial interests in its two
special purpose finance subsidiaries, Mid America Finance Corporation ("MAFC") and Northwestern Acceptance Corporation ("NWAC").
Income from real estate operations. Income from real estate operations was $4.5 million for the year ended December 31, 1998, $6.9 million for the year ended December 31, 1997, $4.1 million for the six months ended December 31, 1996 and $4.8 million for the year ended June 30, 1996. A summary of income from real estate operations is as follows:
During the year ended December 31, 1998, sales activity in the Harmony Grove continued at a pace that nearly sold this project out in 1998. Margins in this project expanded in 1998 due to the final lots of this subdivision being the most desirable. At December 31, 1998, seven lots remain in the project. Lot sale activity improved in the Reigate Woods subdivision, where 20 homesites were sold. At December 31, 1998, there are 21 homesites remaining in Reigate Woods, with five under contract. The Company expects to complete this project in mid- 2000, at the current pace of sales. The residential parcel of the Woodbridge subdivision was completed in 1998 with the sale of the final 15 homesites. The Woodbridge project currently contains approximately 48 acres of commercially zoned land, of which sites for a total of 46 acres are under contract at December 31, 1998. These parcels are expected to close in 1999.
In December 1998, the Company sold 20 lots in its newest subdivision, Tallgrass of Naperville. This project is planned to be a 926-lot development, augmented with a townhome unit, pending final plat approvals. At December 31, 1998, 161 lots are under contract. A second unit of 369 lots is expected to be developed in 1999 to meet the high builder demand in this project.
The current year marked the conclusion of four successful projects for the Company. The Ashbury profit of $297,000 represents the sale of a small commercial parcel adjacent to the previously sold 1,115-lot residential parcel of this project. The remaining six lots in the Clow Creek Farm subdivision were sold, completing this 260-lot subdivision. The final two lots of the Woods of Rivermist subdivision were sold, completing this 31-lot, upscale subdivision. In addition, the final six homesites were sold in the Fields of Ambria project. The loss is due to sale discounts on the remaining homesites, extended marketing costs, and additional expenses related to the completion of the project.
Deposit account service charges. Deposit account service charges totaled $8.6 million for the year ended December 31, 1998, $7.2 million for the year ended December 31, 1997, $3.2 million for the six months ended December 31, 1996, and $4.9 million for the year ended June 30, 1996. The primary source of these fees is from checking account charges for insufficient funds, service charges, sustained overdraft fees, debit card usage, and automated teller machine services. The results are primarily attributable to a net increase of 8,000 accounts, or a 9.2% increase in the number of checking accounts since December 31, 1997, increases to existing fee schedules for various services, new charges for services provided to the Bank's checking and deposit customer, as well as the new policy of surcharging non-customers' use of Bank ATMs.
Brokerage commissions. Through the Bank's affiliation with INVEST, the Bank offers non-traditional investment products to its customers such as mutual funds, annuities and other brokerage services. Commission revenue improved to $2.8 million for the year ended December 31, 1998, compared to $2.1 million for the year ended December 31, 1997, $924,000 for the six months ended December 31, 1996 and $1.7 million for the year ended June 30, 1996. The improvement in commissions is due to increased sales of mutual funds and other non-traditional products, an increased sales force, an increase in the number of locations which provide INVEST services, as well as sharing a greater percentage of current commission revenue and trailer fee income with INVEST than in the past.
Mortgage loan related fees. Mortgage loan related fees include late charge income on loans owned and serviced by the Bank, prepayment penalty income, inspection fee income for construction loans, and most recently, loan modification income for refinance transactions. During the year ended December 31, 1998, these fees increased $1.1 million, to $2.5 million. The primary reason for the increase was a $723,000 increase in fees from loan modifications. The Bank introduced a loan modification program for refinance customers whereby it allows the customer to lower the interest rate and/or modify other loan terms for a fee, in lieu of a processing a new loan. The Bank treats the modified loan as if it were paid off, and amortizes any remaining deferred fees or expenses into interest income. Modification income was minimal during the year ended December 31, 1997. The increase in loan modification fees was due to the lower long-term rates and heavy refinance opportunities in 1998. The recent rise in long-term interest rates causes management to expect that it will realize lower fee income from this program in 1999.
Loan servicing fee income. Loan servicing fee income is generated from loans that the Bank has originated and sold, or from purchased servicing, and includes fees for the collection and remittance of mortgage payments, insurance policies and real estate taxes. Typically, the Bank receives a servicing fee for performing the aforementioned services equal to at least 1/4 of 1% for fixed- rate mortgages and at least 3/8 of 1% for ARM loans on the outstanding principal balance of the sold loan being serviced. Loan servicing fee income is reduced by the amortization of capitalized mortgage servicing rights, and impairment valuations against recorded values of mortgage servicing rights. Since July 1, 1996, upon the adoption of SFAS No. 122, mortgage servicing rights are capitalized when a loan is sold. Prior to July 1, 1996, the Bank was only able to capitalize mortgage servicing rights on wholesale originations.
For the year ended December 31, 1998, loan servicing fee income, net of impairment writedowns, was $131,000, compared to $2.3 million for the year ended December 31, 1997, $1.2 million for the six months ended December 31, 1996, and $2.4 million for the year ended June 30, 1996. The following table shows the components of loan servicing fee income in dollars and as a percentage of loans serviced for others for the periods indicated:
The decline in long-term U.S. Treasury rates during 1998 increased prepayment activity in the loans serviced for others portfolio, that led to the large increase in amortization of capitalized mortgage servicing rights, when compared to the prior year. Although the Bank sold $437.5 million of loans in 1998, the average balance of loans serviced for others was flat compared to 1997 due to this prepayment activity. In addition, an analysis of the value of the Bank's mortgage servicing rights led to a $1.3 million impairment writedown due to the impact of higher expected prepayment speeds on the net present value of expected cash flows from these servicing rights. To the extent that actual prepayment speeds slow, the Bank may recover a portion of this impairment writedown in future periods. At December 31, 1998, 1997 and 1996, the weighted-average coupon rate on the loans serviced for others portfolio was 7.39%, 7.74% and 7.78%, respectively.
The average balance of loans serviced for others peaked during the six months ended December 31, 1996. The Bank's strategy in 1997 was to reduce sales activity to grow its loans receivable balances. This ability was primarily provided by its acquisition of Northwestern in May 1996, which greatly increased the Bank's capital levels.
The Bank also services its own portfolio of loans that it holds for investment purposes. The following table sets forth information as to the Bank's total loan servicing portfolio.
Income from Bank owned life insurance. During the current year, the Bank invested $20.0 million in bank owned life insurance ("BOLI") to help fund the cost of certain employee benefit plan expenses. The Bank's BOLI investment consists of the purchase of life insurance on the lives of certain employees from an insurance carrier with a Standard and Poors rating of AA+. The Company is the sole beneficiary of the life insurance policies. The primary source of income on this investment is the cash surrender value ("CSV") increase of the life insurance policies, which to the benefit of the Company is free from income taxes. Death benefits paid to the Company will be revenue in the periods received, if any. During the current year, CSV income recognized on these life insurance policies totaled $458,000.
Non-interest expense
Non-interest expense was $58.9 million for the year ended December 31, 1998, compared to $54.6 million for the year ended December 31, 1997, $41.1 million for the six months ended December 31, 1996, and $37.8 million for the year ended June 30, 1996. Included in the six months ended December 31, 1996 total is the impact of the one-time assessment to recapitalize the SAIF of $14.2 million. The table below shows the composition of non-interest expense for the periods indicated.
Compensation expense. Compensation expense was $26.9 million for the year ended December 31, 1998, compared to $23.9 million for the year ended December 31, 1997. Overall compensation levels rose during the year due to increased loan originations and refinance activity as it related to loan officer commissions, incentive pay and overtime compensation. In addition, the Bank's headcount rose by approximately 7.5%, related to new branch operations, as well as increased loan processing staff to meet record loan volume. Brokerage commissions paid to INVEST representatives increased due to the increase in brokerage commission income in the current year. Compensation expense in 1997 increased 2.5% on an annualized basis during the year ended December 31, 1997 compared to the six months ended December 31, 1996, primarily due to the addition of two new branch locations, normal salary increases and higher loan officer commissions resulting from increased loan volume.
Employee benefits expense. Employee benefits expense increased $1.0 million during the current year primarily due to an increased overall payroll, which led to a $310,000 increase in FICA taxes. In addition, medical insurance costs were higher in 1998 than in 1997 due to additional headcount, and slightly higher medical claims. The Bank's contributions to its ESOP and profit sharing plans increased by $150,000. Employee benefits expense increased 15.5% for the year ended December 31, 1997, compared to annualized results for the six months ended December 31, 1996, primarily due to increased medical insurance costs and a higher profit sharing contribution.
Occupancy and equipment expense. Occupancy expenses were relatively constant between the years ended December 31, 1998 and 1997, and increased 32.8% on an annualized basis during the year ended December 31, 1997 compared to the six months ended December 31, 1996, primarily due to the costs related to two new branch facilities. Equipment costs increased $347,000 during the year ended December 31, 1998 primarily due to increased depreciation from interior renovation work done at various branch locations.
FDIC insurance expense. FDIC insurance costs remained relatively constant between the year ended December 31, 1998 and 1997, as the Bank's average deposits were stable, and its insurance rate did not change. The Bank pays the lowest rate allowed by regulation for savings institutions. The decrease in FDIC premiums to $1.5 million during the year ended December 31, 1997 reflects the reduction in the premium rate the Bank pays on deposits as a result of legislation which recapitalized the SAIF. During the six months ended December 31, 1996, a one-time special assessment of 65.7 basis points on deposit balances as of March 31, 1995 was imposed on all savings institutions. This charge equaled $14.2 million for the Bank. Without this assessment, FDIC insurance premiums were $2.3 million for the six month period ended December 31, 1996.
Advertising and promotion expense. Advertising and promotion expenses decreased $456,000 to $2.3 million during the year ended December 31, 1998. The decrease reflects the elimination of certain forms of advertising traditionally used by the Bank. In addition, the level of direct mailing under the Bank's Totally Free checking campaign was analyzed and scaled back in areas where the Bank has already achieved higher levels of checking account penetration. Advertising costs increased to $2.7 million for the year ended December 31, 1997, a 33.5% increase compared to the annualized expense for the six months ended December 31, 1996. The increase was primarily due to the higher marketing costs expended in introducing the Bank's products and services in the Northwestern offices beginning in 1997 and costs related to the new Downers Grove, Super K-Mart and Ashbury branches which opened in 1997.
Data processing expense. Data processing expense was $2.3 million for the year ended December 31, 1998, compared to $2.1 million during the year ended December 31, 1997, an increase of 8.1%. The increase is a function of increased expenditures for the Bank's PC network, including a limited amount of costs related to upgrading systems to Year 2000 compliance. Data processing costs were relatively flat for the year ended December 31, 1997, compared to an annualized six months ended December 31, 1996.
Amortization of core deposit intangible. Amortization of core deposit intangibles totaled $1.1 million for the year ended December 31, 1998, compared to $1.3 million for the year ended December 31, 1997, $709,000 for the six months ended December 31, 1996 and $122,000 for the year ended June 30, 1996. The Bank is amortizing its core deposit intangible on an accelerated method over 10 years. Amortization to date is for the core deposit intangible identified in the Northwestern acquisition in May 1996. Amortization will include the impact of the Westco acquisition beginning in 1999.
Amortization of goodwill. Amortization of goodwill totaled $1.3 million for the years ended December 31, 1998 and 1997, $679,000 for the six months ended December 31, 1996, and $113,000 for the year ended June 30, 1996. The Bank has been amortizing the goodwill created in the Northwestern acquisition over a 20 year period, using the straight-line method. Amortization will include the impact of the Westco acquisition beginning in 1999.
Other non-interest expense. Other non-interest expense was relatively flat at $3.2 million for the year ended December 31, 1998 compared to 1997. Other expense increased to $3.2 million for the year ended December 31, 1997, compared to $1.3 million for the six months ended December 31, 1996. The increase was primarily due to a higher incidence of check losses incurred due to the increased checking account base and higher title, credit report and appraisal fees due to the higher loan volumes.
Income taxes
Income tax expense from continuing operations for the year ended December 31, 1998 was $23.8 million (effective income tax rate of 38.1%) compared to $22.7 million (effective income tax rate of 37.4%) for the year ended December 31, 1997. The increase in the effective income tax rate was primarily due to the recognition in 1997 of $1.0 million in income tax benefits related to the resolution of certain prior years' income tax issues compared to the recognition in 1998 of approximately $600,000 of such income tax benefits. Income tax expense from continuing operations was $5.6 million for the six months ended December 31, 1996 (effective income tax rate of 39.0%), and $10.8 million for the year ended June 30, 1996 (effective income tax rate of 37.9%).
Extraordinary Items
During the year ended December 31, 1998, the Company incurred an extraordinary charge of $456,000, or $.02 per diluted share, net of income tax benefits of $294,000, related to the early call of its $27.6 million 8.32% subordinated capital notes due September 2005. The call provision in the indenture allowed for early redemption at par plus accrued interest. The expense related to the early redemption represents the write-off of the remaining deferred transaction costs of the original offering in November 1995.
During the year ended June 30, 1996, the Company refinanced its $20.9 million, 10% subordinated capital notes due June 30, 2002, and incurred an extraordinary charge of $474,000, or $.03 per diluted share, net of income tax benefits of $300,000. The call provision in the indenture allowed for early redemption at par plus accrued interest. The expense related to the early redemption represents the write-off of the remaining deferred transaction costs of the original offering.
Review of Financial Condition
Total assets increased $663.4 million, or 19.2% to $4.12 billion at December 31, 1998, compared to $3.46 billion at December 31, 1997. The increase was primarily due to the acquisition of Westco, as well as an increase in loans receivable, primarily funded with borrowed funds.
Cash, interest-bearing deposits and federal funds sold increased a combined $10.8 million to $157.7 million at December 31, 1998. A total of $28.7 million is due to the closing of the acquisition of Westco as of December 31, 1998.
Investment securities classified as held to maturity decreased $14.2 million, to $11.1 million as of December 31, 1998. The Company has generally been classifying its new investment securities purchases as available for sale. The primary reason for the decrease is due to maturities and calls of investment securities of $15.0 million. The $17.9 million increase in FHLB of Chicago stock is due to $2.1 million assumed in the purchase of Westco, as well as growth in the Bank's FHLB of Chicago advance portfolio that required increased investments in FHLB of Chicago stock.
Investment securities available for sale increased $79.5 million to $199.0 million at December 31, 1998. Of this increase, $34.3 million was due to the purchase of Westco, and primarily included short-term U.S. Government securities. The Company purchased a total of $206.5 million of investment securities, which consisted of asset-backed securities, U.S. Government and Agency securities, and marketable equity securities, offset by maturities and calls of securities totaling $138.3 million. The Company also sold a total of $12.1 million of marketable equity securities, at a net gain of $740,000. At December 31, 1998, this portfolio had net unrealized gains of $912,000, compared to $2.6 million at December 31, 1997.
Mortgage-backed securities classified as held to maturity decreased $86.9 million to $128.5 million as of December 31, 1998. The decrease is primarily due to amortization and prepayments, as well as the elimination of $30.2 million of mortgage-backed securities that collateralized an equal amount of CMO bonds in the Bank's two special-purpose finance subsidiaries. This was accomplished through the sale of the Bank's 100% beneficial interests in these subsidiaries. The Bank no longer consolidates these entities in its consolidated statements of financial condition.
Mortgage-backed securities classified as available for sale decreased $12.5 million to $55.1 million at December 31, 1998. The decrease is due to amortization and prepayments of $24.7 million, offset by purchases of mortgage- backed securities of $12.4 million. At December 31, 1998, net unrealized losses in the available for sale portfolio were $(205,000), compared to an unrealized gain of $19,000 at December 31, 1997.
Included in total mortgage-backed securities at December 31, 1998 are $100.5 million of CMO's which have 3-5 year weighted average lives, and are primarily collateralized by the Federal National Mortgage Association ("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC") and the Government National Mortgage Association ("GNMA") mortgage-backed securities, and to a lesser extent by whole loans.
Investment securities and mortgage-backed securities acquired and classified as available-for-sale represent a secondary source of liquidity to the Bank and the Company. The market value of these securities fluctuates with interest rate movements. Net interest income in future periods may be adversely impacted to the extent interest rates increase and these securities are not sold with the proceeds reinvested at the higher market rates. The decision whether to sell the available for sale securities or not, is based on a number of factors, including but not limited to projected funding needs, reinvestment alternatives and the relative cost of alternative liquidity sources. Investments and mortgage-backed securities classified as held to maturity cannot be sold except under extraordinary and very restrictive circumstances. Generally, these investments are acquired for investment after taking into account the Bank's cash flow needs, the investment's projected cash flows, the Bank's overall interest rate and maturity structure of the liability base used to fund these investment's and the net interest spread obtained. To the extent the Bank is able to maintain funding costs below a market rate of interest, the potential negative impact from rising interest rates on investments and mortgage-backed securities held to maturity on net interest income in future periods will be substantially mitigated.
Loans receivable increased 19.6%, or $529.1 million to $3.23 billion at December 31, 1998. The acquisition of Westco is attributable for $245.2 million of this increase. The Bank originated $1.8 billion of mortgage loans during the current year, which were offset by amortization and prepayments of $942.1 million, as well as sales of $437.5 million. The loans sold represent long-term conforming fixed-rate mortgages, which are sold as a means of limiting interest- rate risk. Loans held for sale increased substantially to $89.4 million at December 31, 1998 compared to $6.5 million at December 31, 1997 due to increased sales activity due to the high level of fixed-rate originations during the current year.
The allowance for loan losses increased to $16.7 million as of December 31, 1998, due to a provision for loan losses of $800,000, an addition to the allowance of $846,000 from the acquisition of Westco, offset by net charge-offs of $351,000. As of December 31, 1998, the Bank's ratio of the allowance for loan losses to total non-performing loans was 119.4%, compared to 145.2% as of December 31, 1997. In addition, the ratio of the allowance for loan losses to total loans decreased to .52% at December 31, 1998, compared to .57% at December 31, 1997. During 1998, the Bank's loan portfolio continued to become more concentrated in single-family residential mortgage loans that management perceives to carry lower risk than other types of loans in its portfolio.
Real estate held for development or sale decreased $6.1 million to $25.1 million at December 31, 1998. A summary of real estate held for development or sale is as follows:
The Company completed four projects during the current year, all of which had sales of their remaining parcels. In addition, the Harmony Grove subdivision is nearly sold-out, with only seven lots available at December 31, 1998. A total of 184 lots were sold in 1998. Sales activity also continued in the Woodbridge project, with the Company selling its remaining residential homesites. The balance at December 31, 1998 primarily represents costs associated with 48 acres of commercial land, of which 46 acres are under contract at December 31, 1998. The Company sold 20 homesites in Reigate Woods in 1998, decreasing the investment in this project by $1.9 million. The Company's largest current project, Tallgrass of Naperville, had a net increase in investment of $3.5 million, due to the development of the first 181 lots. The Company sold 20 lots in the fourth quarter of 1998, and has contracts for the remaining 161 lots at December 31, 1998.
Premises and equipment increased $4.9 million to $40.7 million at December 31, 1998. The purchase of Westco added $2.5 million of net premises and equipment, including a $500,000 increase in the fair value of land and buildings. The remainder of the increase is due to purchases of $5.9 million, offset by depreciation and amortization of $3.5 million. Data processing upgrades, some of which relate to implementation of the Bank's Year 2000 plan, as well as costs associated with the building of a new branch, comprise the majority of purchases for the year ended December 31, 1998.
Foreclosed real estate increased to $8.4 million at December 31, 1998, compared to $489,000 at December 31, 1997. During the current year, the Bank foreclosed on a $500,000 second mortgage related to a commercial office park. In connection with the foreclosure, the Bank assumed the first mortgage on the property, which is a $6.0 million industrial revenue bond. The Bank continues to provide a letter of credit against this industrial revenue bond in the amount of $6.5 million. As a result of the foreclosure, the Bank recorded $6.5 million in foreclosed real estate, as well as borrowed funds in the amount of $6.0 million. The industrial revenue bond is assumable by any buyer of the property.
Other assets increased $18.8 million to $41.8 million at December 31, 1998. The primary reason for the increase is the Bank's investment in $20.0 million of BOLI to help fund the cost of certain future employee benefit plan expenses. The Bank's BOLI investment consists of the purchase of life insurance on the lives of certain employees from an insurance carrier with a Standard and Poors rating of AA+. The Company is the sole beneficiary of the life insurance policies. The primary source of revenue on this investment is the incremental increase in the cash surrender value of the life insurance policies, which are recorded over the term of the policies but to the benefit of the Company are free from income taxes. Death benefits paid to the Company will be tax-free revenue in the periods received.
Intangible assets increased a net $30.9 million, primarily due the acquisition of Westco. The transaction increased goodwill by $31.6 million, and also created a core deposit intangible of $1.7 million. Offsetting these increases was amortization of goodwill and core deposit intangibles of $2.4 million.
Deposits increased $319.9 million to $2.66 billion as of December 31, 1998. A large part of the increase was due to the purchase of Westco, which added $259.5 million of deposits as of December 31, 1998. During the year, the Bank had net savings outflows of $33.0 million, offset by interest credited to deposits of $90.7 million.
Borrowed funds increased $264.5 million, to $1.03 billion at December 31, 1998. The Bank funded its increase in loans receivable (other than the increase in loans from the Westco purchase) primarily with FHLB of Chicago advances, which increased a net $315.0 million during the current year. As of December 31, 1998, the Bank has $975.5 million of FHLB of Chicago advances at a weighted average rate and term to maturity of 5.83% and 4.6 years, respectively, compared to $660.5 million at a weighted average rate and term to maturity of 6.37%, and 2.4 years, respectively, as of December 31, 1997. At December 31, 1998, the Bank has $385.0 million of advances with a weighted average term to maturity of 8.7 years, that contain various call provisions, with a weighted average term to call of 3.9 years. The calls would most likely be exercised by the issuer in a period of rising interest rates. The Bank also assumed a $6.0 million industrial revenue bond obligation that is collateralized by a commercial office building the Bank received through foreclosure in January 1998. Offsetting these increases was a decrease in CMO bonds payable of $30.2 million due to the sales of the Bank's 100% residual interests in its two special purpose finance subsidiaries during 1998. In addition, reverse repurchase agreements decreased by $24.8 million to $20.0 million at December 31, 1998 due to a current year maturity.
The Company called its $27.6 million, 8.32% subordinated capital notes during the current year, and incurred an extraordinary loss of $456,000, or $.02 per diluted share. The Company did not replace this borrowing.
Stockholders' equity of the Company grew to $344.7 million at December 31, 1998, compared to $263.4 million at December 31, 1997, an increase of $81.3 million. Stockholders' equity increased due to comprehensive income of $37.1 million, as well as $72.4 million related to the common stock issued for the purchase of Westco, offset by dividends of $5.8 million, and $22.9 million for the repurchase of common stock.
Lending Activities
General. The Bank's lending activities reflect its focus as a consumer banking institution serving its local market area by concentrating on residential mortgage lending. The Bank is one of the largest originators of residential mortgages in its market area, and experienced record loan volume in 1998 due to a robust economy and high refinance activity attributable to falling long-term interest rates. In addition to traditional retail originations, the Bank operates a wholesale lending operation that purchases loans from brokers and correspondents. In connection with these activities, the Bank has traditionally emphasized the origination of adjustable-rate or shorter-term loans for its portfolio and sold a portion of its long-term fixed-rate loans directly into the secondary market. The Bank originates and purchases long-term fixed-rate mortgage loans in response to customer demand; however, the Bank sells selected conforming long-term fixed-rate mortgage loans and a limited amount of ARM loans in the secondary market, primarily to the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). The volume of current loan originations sold into the secondary market varies over time based on the Bank's available cash or borrowing capacity, as well as in response to the Bank's asset/liability management strategy.
During the year ended December 31, 1998, the Bank originated and purchased $1.20 billion in fixed-rate one- to four-family residential mortgage loans, of which $929.9 million, or 77.6%, conformed to the requirements for sale to FNMA and FHLMC and $269.1 million, or 22.4%, did not conform to the requirements of these agencies. During the year ended December 31, 1998, the Bank sold $437.5 million of these loans in the secondary market. The Bank's "nonconforming" loans are generally designated as such because the principal loan balance exceeds $227,150 ($240,000 as of January 1, 1999), which is the FHLMC and FNMA purchase limit, and not because the loans present increased risk of default to the Bank. Generally, nonconforming loans are held in the Bank's loan portfolio. Loans with such excess balances generally carry interest rates from one-eighth to three- eighths of one percent higher than similar, conforming fixed-rate loans.
In early 1997, the Bank started offering its loan products with prepayment penalties in an effort to mitigate interest rate and prepayment risks in a declining rate environment. The borrower receives a lower interest rate in return for accepting prepayment penalties based on the original loan balance. The penalty is 2% for the initial three years on ARM loans that are fixed for the initial three-year period. The penalty for 10, 15, 20 and 30 year fixed rate loans, seven year balloon loans and ARM loans that are fixed for the initial five-year period is 3% for the first three years, 2% in year four and 1% in year five. At December 31, 1998, the Bank had $617.3 million of prepayment penalty loans, or 18.5% of its loans receivable, compared to $111.0 million, or 4.1% as of December 31, 1997.
As a result of its acquisition of Northwestern, the Bank acquired a $749.7 million loan portfolio. Included in the portfolio as of the acquisition date was a $670.5 million nationwide portfolio of single-family residential mortgage loans that had been purchased through brokers as part of Northwestern's loan strategy. Collateral for this portfolio is spread throughout 41 states and Puerto Rico. Consistent with its strategy to focus primarily on the local market area, the Bank has allowed this portfolio to amortize and prepay and plans to hold the existing loans to maturity without replacement. Due to normal amortization and prepayments, this portfolio has a balance of $232.7 million at December 31, 1998.
While the Bank has primarily focused its lending activities on the origination of loans secured by first mortgages on owner-occupied one- to four-family residences, the Bank, to a lesser extent, also originates multi-family mortgage loans, residential construction loans, land acquisition and development loans, commercial real estate loans and a variety of consumer loans. At December 31, 1998, the Bank's net loans receivable amounted to $3.3 billion, excluding $183.6 million in mortgage-backed securities.
Loan Portfolio Composition. The following table sets forth the composition of the Bank's loan and mortgage-backed securities portfolio in dollar amounts and in percentages at the dates indicated:
The following table shows the composition of the Bank's fixed- and adjustable- rate loan portfolio as well as the Bank's mortgage-backed securities portfolio as of the dates indicated.
- ------------------ (1) See "Subsidiary activities - Mid America Finance Corporation and Northwestern Acceptance Corporation." (2) Excludes the fixed-rate mortgage-backed securities held by MAFC and NWAC, which are duration matched.
Loan Maturity
The following table shows the contractual maturity of the Bank's loan portfolio at December 31, 1998. The table does not include principal repayments. Principal repayments and prepayments on mortgage loans totaled $942.1 million, $706.6 million, $266.0 million and $394.3 million for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, respectively.
The following table sets forth at December 31, 1998 the dollar amount of gross loans receivable held for investment due after December 31, 1999, and whether such loans have fixed or adjustable interest rates.
Retail Residential Mortgage Lending. The Bank focuses its lending efforts primarily on the retail origination of loans secured by first mortgages on owner-occupied, one-to four-family residences. Residential loan originations are generated by the Bank's marketing efforts, its present customers, walk-in customers and referrals from real estate brokers and builders. The Bank's loan officers are compensated primarily through commissions, based on the level of loans originated in accordance with the Bank's lending standards. At December 31, 1998, the Bank's one-to four- family residential mortgage loans totaled $3.0 billion, or 88.7% of the Bank's total loans receivable. The Bank emphasizes the origination of conventional ARM loans and shorter-term to maturity or repricing and jumbo loans for retention in its portfolio and fixed-rate conforming loans for both portfolio purposes as well as for sale in the secondary market. The Bank's retail residential mortgage originations are predominantly in the Bank's market area. During the twelve months ended December 31, 1998, the Bank originated $213.0 million of residential ARM loans, representing 16.3% of the total loans originated by the Bank during that period. During the same period, the Bank originated $1.01 billion of fixed-rate residential mortgage loans, representing 77.5% of the total mortgage loans originated by the Bank during that period.
The Bank offers a number of ARM loan programs under which the interest rate may be fixed for the initial one-, three-, or five-year period. Most of the Bank's residential ARM loans adjust on an annual basis following the initial one-, three- or five-year fixed-rate period. The Bank also offered, until recently, ARM loans that are fixed for an initial five- or seven-year period that reprice once at the end of the initial period for the remaining 25 or 23 year term based on a spread above the weekly average of U.S. Treasury securities adjusted to a constant maturity of ten years (the "ten year Treasury constant maturity index"). The Bank's ARM loans generally carry an initial interest rate which is less than the fully indexed rate for the loan. The initial discount rate is determined by the Bank in accordance with market and competitive factors. After the initial fixed-rate period, the interest rates on the ARM loans that adjust annually reprice based on a spread above the published weekly average yield on United States Treasury securities, adjusted to a constant maturity of one year (the "one-year Treasury constant maturity index"). Interest rates and origination fees on ARM loans are priced to be competitive in the local market. These loans are subject to limitations on annual interest rate adjustments of 2%, as well as a lifetime interest rate cap adjustment of 6%, and are originated for terms of up to 40 years. At December 31, 1998, the weighted average term to repricing of the Bank's ARM loan portfolio was 2.80 years.
The Bank also offers fixed-rate mortgage loans with terms to maturity of 10, 15, 20 and 30 years and fixed-rate balloon loans that mature after seven years. The Bank's fixed-rate loan products generally offer a monthly repayment option. Interest rates charged on fixed-rate loans are competitively priced on a daily basis based on secondary market prices and market conditions. The Bank generally originates its fixed-rate and adjustable-rate mortgage loans in a form consistent with secondary market standards.
In an effort to streamline refinance activity, the Bank offers a mortgage loan modification program that allows the borrower to receive a reduced interest rate, change in term, or a change in loan program, in lieu of refinancing the original loan. The borrower is charged a fee that varies based upon the modifications made, including an appraisal fee when the Bank requires a reappraisal of the collateral. The program has been advantageous to the Bank during the most recent refinance boom in the current year, by limiting the disruption to its loan operations, as well as reducing the costs associated with refinance activity of existing borrowers.
The Bank's residential mortgage loans customarily include due-on-sale clauses giving the Bank the right to declare the loan immediately due and payable in the event, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage and the loan is not repaid. The Bank has enforced due-on-sale clauses in its mortgage contracts for the purpose of increasing its loan portfolio yield, often through the authorization of assumptions of existing loans at higher rates of interest and the imposition of assumption fees. ARM loans may be assumed provided home buyers meet the Bank's underwriting standards and the applicable fees are paid.
Loan applications are reviewed in accordance with the underwriting standards approved by the Bank's Board of Directors and which generally conform to FNMA standards. Loans in excess of $1.5 million must be approved by the Loan Committee of the Board of Directors. In underwriting residential real estate loans, the Bank evaluates both the borrower's ability to make monthly payments and the value of the property securing the loan. Potential borrowers are qualified for ARM loans and fixed-rate loans based on the initial or stated rate of the loan, except for one-year ARM loans with a loan-to-value ratio in excess of 70% and a term greater than 15 years, in which case the borrower is qualified at 2% above the initial note rate.
Upon receipt of a completed loan application from a prospective borrower, credit reports are ordered and income, employment and financial information is verified in accordance with underwriting standards. An appraisal of the real estate intended to secure the proposed loan is undertaken by a Bank appraiser or an independent appraiser previously approved by the Bank. It is the Bank's policy to obtain title insurance on all mortgage loans. Borrowers also must obtain hazard (including fire) insurance prior to closing. The Bank requires flood insurance on a property located in special flood hazard areas. Borrowers are generally required to advance funds on a monthly basis together with each payment of principal and interest through a mortgage escrow account from which the Bank makes disbursements for items such as real estate taxes and hazard insurance premiums as they become due. The Bank has adopted a policy of limiting the loan-to-value ratio on originated loans and refinanced loans to 97% and requiring that loans exceeding 80% of the appraised value of the property or its purchase price, whichever is less, generally be insured by a mortgage insurance company approved by the FNMA in an amount sufficient to reduce the Bank's exposure to no greater than the 75% level. Despite the benefits of ARM loans to the Bank's asset/liability management program, they do pose potential additional risks, primarily because as interest rates rise, the underlying payment requirements of the borrower rise, thereby increasing the potential risk of default.
Wholesale Residential Lending. The Bank's wholesale loan origination division that purchases loans from brokers and correspondents for a fee generally ranging from 1.25% to 1.50%. Generally, the Bank offers the same type of loan products, both fixed-rate and adjustable-rate loans, at interest rates similar to those it offers on retail originations. The purchase of these loans does not necessitate the Bank to incur the processing costs associated with its retail originations. The Bank acts as the supplier of funds for the mortgage broker who is responsible for the processing and closing of the loan. The Bank performs its normal underwriting procedures on wholesale-originated loans similar to retail loans, and can refuse to purchase any loan which does not meet its underwriting criteria. Wholesale originations were $346.2 million for the year ended December 31, 1998, compared to $254.2 million for the year ended December 31, 1997.
Purchased Loans. At December 31, 1998, the Bank had $232.7 million, compared to $437.2 million at December 31, 1997, of purchased residential mortgage loans, nearly all of that were acquired in the acquisition of Northwestern. The vast majority of purchased loans are adjustable-rate loans secured by properties which serve as the primary residence of the borrower, and which are located primarily in metropolitan areas located in 41 states and Puerto Rico. The decrease in the balance is primarily due to prepayments and amortization which have not been replaced with new purchases since the Bank's current policy is to not purchase loans outside of its market area. At December 31, 1998, purchased loans were being serviced by 95 companies, the largest of which serviced $46.3 million, or 19.9% of total purchased loans. The loans in this portfolio were underwritten with substantially the same underwriting standards as for loans originated by the Bank. One variation from these guidelines is that loans exceeding FNMA and FHLMC limits could be purchased up to $400,000 with a loan-to-value-ratio of 80% or less, and up to $300,000 with a loan-to-value ratio of 90% or less with private mortgage insurance. At December 31, 1998, $100.2 million, or 43.1% of the loans in the purchased loan portfolio are in excess of the current FNMA limit of $240,000. In addition to these underwriting guidelines, original executed promissory notes with proper endorsements are in the possession of the Bank.
Construction and Land Lending. The Bank originates loans to finance the construction of one-to four-family residences, primarily in its market area. At December 31, 1998, the Bank had $28.4 million of loans to finance the construction of one- to four-family residences. The Bank also originates loans for the acquisition and development of unimproved property to be used primarily for residential purposes in cases where the Bank is to provide the construction funds to improve the properties. At December 31, 1998, the Bank's construction and land loans totaled $53.2 million, or 1.6%, of total loans receivable.
The Bank finances the construction of primarily individual, owner-occupied houses where qualified contractors are involved and on the basis of underwriting and construction loan guidelines. Construction loans are structured either to be converted to permanent loans at the end of the construction phase or to be paid off upon receiving financing from another financial institution. Construction loans are based on the appraised value of the property, as determined by an independent appraiser, and an analysis of the potential marketability and profitability of the project. Construction loans generally have terms of up to 12 months, with extensions as needed. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant.
Land loans include loans to developers for the development of residential subdivisions in the Bank's market area. At December 31, 1998, the Bank had land loans to developers totaling $12.7 million. At December 31, 1998, the largest aggregate amount of land acquisition and development loans to a single developer amounted to $11.1 million. Loans to developers are generally short-term loans with terms of three to five years. The loan-to-value ratio may not exceed 80% and generally is less than 75%. The majority of such loans are based on the prime rate, or LIBOR. Loans generally are made to customers of the Bank and developers with whom the Bank has had long-standing relationships. The Bank requires an independent appraisal of the property and feasibility studies may be required to determine the profit potential of the development project.
Land loans are also made to local builders for the purchase of improved lots. At December 31, 1998, the Bank had land loans outstanding to local builders totaling $6.5 million. Such loans are generally for terms of up to three years and are generally granted at rates higher than rates quoted for 30-year fixed- rate residential mortgage loans. The loan-to-value ratio on such loans is limited to 75%. Land loans for the purchase of fully improved lots are also made to individuals. At December 31, 1998, the Bank had land loans to individuals totaling $5.5 million. Such loans are made for up to 15-year terms with adjustable or fixed interest rates which are made at the prevailing rates for one- to four-family residential loans.
Construction and land development loans afford the Bank the opportunity to increase the interest rate sensitivity of its loan portfolio and to receive yields higher than those obtainable on ARM loans secured by existing residential properties. These higher yields correspond to the higher risks associated with construction lending. Construction and land development loans involve additional risks attributable to the fact that loan funds are advanced upon the security of the project under construction, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan- to-value ratio. As a result of the foregoing, construction and land development lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank is forced to foreclose on a project prior to or at completion due to a default, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs. In addition, the Bank may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time. The Bank has attempted to address these risks through its underwriting procedures and its limited amount of construction lending on multi-family and commercial real estate properties.
Multi-family Lending. The Bank originates multi-family residential mortgage loans in its market area. At December 31, 1998, the Bank had multi-family loans of $137.3 million, including a portfolio of purchased participating interests of $2.1 million related to low-income housing. Multi-family loans represent 4.1% of total loans receivable at December 31, 1998. ARM loans represented 56.3% of the multi-family residential loan portfolio at December 31, 1998. Such loans are offered with initial fixed-rate periods of one, three, five, seven and ten years. Multi-family residential mortgage loans are made for terms to maturity of up to 25 years and carry a loan-to-value ratio not greater than 80%. The Bank requires a positive net operating income to debt service ratio for loans secured by multi-family residential property. Loans secured by properties of five or more units are qualified on the basis of rental income generated by the property.
Commercial Real Estate Lending. In connection with the Bank's policy of maintaining an interest-rate sensitive loan portfolio, the Bank has originated loans secured by commercial real estate, which generally carry a higher yield and are made for a shorter term than fixed-rate one- to four-family residential loans. At December 31, 1998, the Bank had $43.1 million of commercial real estate loans. The Bank's policy has been to originate additional commercial real estate loans on a limited basis. Commercial real estate loans are generally granted in amounts up to 80% of the appraised value of the property, as determined by an independent appraiser previously approved by the Bank. The Bank's commercial real estate loans are secured by improved properties located in the Chicago metropolitan area. The Bank often requires borrowers to provide their personal guarantees on loans made for commercial real estate.
Loans secured by commercial real estate properties are generally larger and involve a greater degree of risk than residential mortgage loans. Because payments on loans secured by 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. The Bank seeks to minimize these risks by lending primarily on existing income-producing properties and generally restricting such loans to properties in the Chicago area. The Bank analyzes the financial condition of the borrower and the reliability and predictability of the net income generated by the security property in determining whether to extend credit. In addition, the Bank generally requires a net operating income to debt service ratio of at least 1.15 times.
A loan with an outstanding balance of $5.9 million at December 31, 1998 represents the Bank's largest single commercial real estate loan to one borrower. The loan is on a shopping center located in Carol Stream, Illinois and is current as to the payment of principal and interest at December 31, 1998. At December 31, 1998, the Bank's ten largest commercial real estate loans totaled $30.2 million, all of which are current and performing in accordance with their original terms.
Other Lending. The Bank's other lending activities consist of consumer lending, primarily home equity loans, fixed-rate second mortgage loans, and to a lesser extent, commercial business lending. On December 31, 1998, outstanding balances on home equity lines represented $91.9 million or 2.8% of the Bank's total loan portfolio. Home equity lines of credit are generally extended up to 80% of the appraised value of the property, less existing liens, generally at interest rates which range from the designated prime rate minus .25% to plus .75%, based on balances drawn. To a lesser extent, the Bank offers home equity lines of credit at greater than 80% to 100% of the appraised value of the property. The interest rate on greater than 80% loan-to-value lines of credit is the designated prime rate plus 3.5%. The Bank uses the same underwriting standards for home equity lines of credit as it uses for residential mortgage loans. Other home equity loans consist of primarily $42.4 million of fixed- rate, second mortgage loans that generally amortize over a five year period.
Letters of Credit. At December 31, 1998, the Bank had $15.7 million in standby letters of credit, one of which totals $6.5 million to enhance a developer's industrial revenue bond financing of commercial real estate parcel located in the Bank's market area, and included in foreclosed real estate. See "Asset Quality and Allowance for Loan Losses."
Environmental Issues. The Bank encounters certain environmental risks in its lending activities. Under federal and state environmental laws, lenders may become liable for the costs of cleaning up hazardous materials found on security property. Although environmental risks are usually associated with industrial and commercial loans, risks may be substantial for residential lenders like the Bank if environmental contamination makes security property unsuitable for use. This could also have effect on nearby property values. In accordance with FNMA and FHLMC guidelines, appraisals for single-family residences on which the Bank lends include comments on environmental influences. The Bank attempts to control its risk by training its appraisers and underwriters to be cognizant of signs indicative of environmental hazards. No assurance can be given, however, that the values of properties securing loans in the Bank's portfolio will not be adversely affected by unforeseen environmental risks, although the Bank is unaware of any environmental issues which would subject it to liability at this time.
Originations, Purchases, Sales, Swaps of Mortgage Loans and Mortgage-Backed Securities. The Bank originates and purchases both ARM and fixed-rate loans. Its ability to originate loans is dependent upon the relative customer demand for fixed-rate or ARM loans in the origination and purchase 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. The Bank sells selected conforming fixed-rate mortgage loans in the secondary mortgage market to manage its interest rate risk exposure. Substantially all of these loans are sold without recourse. These loan sales also allow the Bank to continue to make loans when deposit flows decline or funds are not otherwise available for lending. Generally, the loans are sold for cash or securitized and sold in the secondary mortgage market to investors such as FNMA and FHLMC, as well as investment banks and other financial institutions.
The Bank has also exchanged or swapped loans out of its portfolio for mortgage-backed securities primarily with FNMA and FHLMC. Generally, the mortgage-backed securities are used to collateralize borrowings and deposits or are sold in the secondary market to raise additional funds. Swap activity by the Bank is governed by pricing levels in the secondary mortgage market for whole mortgage loans versus securitized mortgage loans, as well as the level of rates for collateralized borrowings. During the current year, the Bank swapped and sold $26.6 million, compared to $3.4 million for the year ended December 31, 1997, $8.2 million for the six months ended December 31, 1996, and $41.2 million during the year ended June 30, 1996.
The Bank has purchased mortgage-backed securities and collateralized mortgage obligations from time to time that coincide with its ongoing asset/liability management objectives. Purchases have been minimal during the last 2 1/2 years due to the Bank's ability to originate and hold mortgage loans for its portfolio.
All of the mortgage-backed securities and CMOs in the Bank's portfolio are issued by or have collateral backed by FNMA, FHLMC or GNMA, or are backed with whole loan collateral and have an investment grade rating. Coupon rates at December 31, 1998, ranged from 3.84% to 16.25%. At December 31, 1998, mortgage- backed securities, net, totaled $183.6 million, or 4.5% of total assets. At December 31, 1998, the Bank's mortgage-backed securities portfolio had a market value of $182.6 million.
The following table sets forth the Bank's originations, purchases, sales, swaps and principal repayments of loans receivable and mortgage-backed securities for the periods indicated.
Asset Quality and Allowance for Loan Losses
When a borrower fails to make a required payment by the end of the month in which the payment is due, the Bank generally institutes collection procedures. The Bank will send a late notice, and in most cases, delinquencies are cured promptly; however, if a loan has been delinquent for more than 60 days, the Bank contacts 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: (1) accept a repayment program for the arrearage from the borrower; (2) 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; (3) request a deed in lieu of foreclosure; or (4) initiate foreclosure proceedings. When a loan payment is delinquent for three or more monthly installments, the Bank will initiate foreclosure proceedings. Interest income on loans is reduced by the full amount of accrued and uncollected interest on loans which are in process of foreclosure or otherwise determined to be uncollectible.
Delinquent Loans. At December 31, 1998, 1997, and 1996, delinquencies in the Bank's portfolio were as follows:
(1) Percentage represents principal balance of delinquent loans to total loans outstanding.
Non-Performing Loans. On July 1, 1995, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures," which impose certain requirements on the identification and measurement of impaired loans. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan. For loans which are not individually significant (i.e. loans under $750,000), and represent a homogeneous population, the Bank evaluates impairment collectively based on management reports on the level and extent of delinquencies, as well as historical loss experience for these types of loans. The Bank uses this criteria on one-to four-family residential loans, consumer loans, multi-family residential loans, and land loans. Impairment for loans considered individually significant and commercial real estate loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. Charge-offs of principal occur when a loss has deemed to have occurred as a result of the book value exceeding the fair value.
The Company's policy for recognition of interest income on impaired loans is unchanged as a result of the adoption of SFAS No. 114 and 118. A loan (whether considered impaired or not) is classified as non-accrual when collectibility is in doubt, and is normally analyzed upon the borrower becoming 90 days past due on contractual principal or interest payments. When a loan is placed on non- accrual status, or in the process of foreclosure, previously accrued but unpaid interest is reversed against interest income. Income is subsequently recorded to the extent cash payments are received, or at a time when the loan is brought current in accordance with its original terms.
The following table sets forth information regarding non-accrual loans, loans which are 91 days or more delinquent but on which the Bank is accruing interest, non-accrual investment securities, and foreclosed real estate held by the Bank at the dates indicated.
(1) Consists of loans in the process of foreclosure or for which interest is otherwise deemed uncollectible.
For the years ended December 31, 1998, 1997, the six months ended December 31,1996, and the year ended June 30, 1996, the amount of interest income that would have been recorded on non-accrual loans amounted to $421,000, $663,000, $573,000, and $631,000, respectively, if the loans had been current. For the year ended December 31, 1998, interest income on non-accrual loans that was included in net income amounted to $229,000.
Non-performing loans increased $3.4 million to $14.0 million at December 31, 1998, primarily in one-to-four family residential loans. Non-performing commercial real estate, construction and land loans remained flat at $1.3 million as of December 31, 1998. Asset quality measured by non-performing loans to total loans receivable was excellent at .43% as of December 31, 1998.
Foreclosed real estate includes $6.5 million related to a previously non- performing $500,000 second mortgage on a commercial real estate loan the Bank took title to in January 1998. In conjunction with the foreclosure, the Bank assumed the first mortgage on this property, a $6.0 million industrial revenue bond. The industrial revenue bond is current as to interest payments as of December 31, 1998, and carries an interest rate of 3.35%. The industrial revenue bond is assumable by any purchaser of the underlying collateral. The Bank has issued a standby letter of credit against the industrial revenue bond. The property is currently being marketed for sale by a commercial real estate broker.
Classified Assets. The federal regulators have adopted a classification system for problem assets of insured institutions which covers all problem assets. Under this classification system, problem assets of insured institutions are classified as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified, "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or to charge off such an 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 institution's Principal Supervisory Agent of the OTS, who can order the establishment of additional general or specific loss allowances.
In connection with the filing of its periodic reports with the OTS, the Bank regularly reviews the problem loans in its portfolio to determine whether any loans require classification in accordance with applicable regulations. At December 31, 1998, all of the Bank's non-performing loans were classified as substandard, while at December 31, 1996, the Bank had classified $1.5 million of a $2.9 million commercial real estate loan as "loss" and allocated $1.5 million of its allowance for loan losses to a specific allowance against the loan.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risk inherent in its loan portfolio and changes in the nature and volume of its loan activity. Such evaluation, which includes a review of all loans of which full collectibility may not be reasonably assured, considers among other matters, the estimated fair 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.
The following table sets forth the Bank's allowance for loan losses at the dates indicated.
At December 31, 1998, the Bank maintained no specific reserves on its loan portfolio, and is unaware of any specifically identifiable charge-offs in its loan portfolio. The following table sets forth the Company's allocation of the allowance for loan losses. This allocation is based on management's subjective estimates. The amount allocated to a particular category should not be interpreted as the only amount available for future charge-offs that may occur within that category: it may not be indicative of future charge-off trends and it may change from year to year based on management's assessment of the risk characteristics of the loan portfolio.
At December 31, 1998, the Bank's loan portfolio consists of 88.7% of one-to four-family real estate loans, with an additional 4.0% being equity lines of credit or home equity loans on one-to four-family real estate. Based on the Bank's historical high asset quality, low charge-off experience and concentration on one-to four-family lending in its market area, management considers the risk of loss due to these loans as minimal. The remaining 7.3% of the Bank's portfolio, or $241.9 million, consists of multi-family mortgage, commercial real estate, construction, land, and other loans. These loans generally tend to exhibit greater risk of loss than do one-to four-family loans, primarily because such loans typically carry higher loan balances and repayment is dependent, in large part, on sufficient income to cover operating expenses. In addition, economic events and government regulations, which are outside the control of the Bank and the borrower, could impact the security of the loan or the future cash flow of affected properties. Management has addressed these risks through its underwriting standards.
With respect to multi-family loans, the Bank has traditionally limited its lending to small apartment buildings, which management believes have lower risk than larger properties. At December 31, 1998, in the Bank's $137.3 million multi-family portfolio, only six loans are on properties greater than 36 units and the average multi-family loan size is $270,000. In addition, almost all of the Bank's construction and land loans are on one- to four- family residential property. All of the Bank's multi-family, construction and land loans are secured by properties located in the Chicago metropolitan area.
Investment Activities
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.
The Bank is required to maintain liquid assets at minimum levels. See "Regulation and Supervision - Federal Savings Institution Regulation - Liquidity." The Bank's liquid investments include interest-bearing deposits, primarily at the Federal Home Loan Bank of Chicago, federal funds sold and U.S. Government and federal agency obligations. The Bank invests overnight federal funds with two large commercial banks in Chicago, based upon periodic review of these institutions' financial condition. The Bank generally limits overnight federal funds sold investments to $50.0 million at any one institution.
The table below sets forth information regarding the carrying value, weighted average yields and maturities of the Company's investment securities.
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(1) Marketable equity securities with no stated maturity are included in the "More than 10 Years" category.
The following table sets forth certain information regarding the book value of the Company's and the Bank's liquidity and investment securities portfolio at the dates indicated. At December 31, 1998 and December 31, 1997, the fair value of the investment securities portfolio was $211.3 million and $145.7 million, respectively.
The classification of investments as available for investment, available for sale, or for trading purposes is made at the time of purchase based upon management's intent at that time. At December 31, 1998, $199.0 million of investment securities were classified as available for sale and recorded at fair value (cost basis of $198.0 million). At December 31, 1997, $119.5 million were classified as available for sale (cost basis of $117.0 million), while at December 31, 1996, $69.0 million were classified as available for sale (cost basis of $68.5 million). All balances exclude the Bank's required investment of stock in the Federal Home Loan Bank of Chicago, which was $50.9 million, $33.0 million, $30.7 million, and $30.7 million at December 31, 1998, 1997, 1996 and June 30, 1996, respectively.
Sources of Funds
The Bank's primary sources of funds are deposits, amortization and prepayment of loan principal (including mortgage-backed securities), borrowings, sales of mortgage loans, sales or maturities of investment securities, mortgage-backed securities and short-term investments, and funds provided from operations.
Deposits. The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of passbook accounts, NOW and checking accounts, money market and certificate accounts. 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 net increase in deposits during the year ended December 31, 1998 is primarily due $259.5 million acquired from Westco, interest credited to deposits, offset by outflows during the period. The large increase in deposits during the year ended June 30, 1996 was primarily due to the acquisition of Northwestern, as well as the Bank generating net deposit inflows of $6.3 million.
Deposit Portfolio. The following table sets forth the distribution and the weighted average nominal interest rates of the Bank's average deposit accounts at the dates indicated.
The following table presents the deposit activity of the Bank for the periods indicated:
The following table presents, by various rate categories, the amount of certificate accounts outstanding at December 31, 1998, 1997, and 1996, and the periods to maturity of the certificate accounts outstanding at December 31, 1998.
At December 31, 1998, the Bank had outstanding $195.6 million in certificate accounts in amounts of $100,000 or more maturing as follows:
Borrowings. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings, such as advances from FHLB of Chicago, and reverse repurchase agreements, when they are a less costly source of funds or can be invested at a positive rate of return.
A summary of the Company's borrowed funds at December 31, 1998, 1997 and 1996 is as follows:
(1) See "Subsidiary Activities - Mid America Finance Corporation." (2) See "Subsidiary Activities - Northwestern Acceptance Corporation."
Federal Home Loan Bank of Chicago Advances
The Bank obtains advances from the FHLB of Chicago upon the security of its capital stock in the FHLB of Chicago and a blanket pledge of certain of its mortgage loans. See "Regulation and Supervision - Federal Home Loan Bank System." Such advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB of Chicago will advance to member institutions, including the Bank, for purposes other than meeting withdrawals, fluctuates from time to time in accordance with the policies of the OTS and the FHLB of Chicago. The maximum amount of FHLB of Chicago advances to a member institution generally is reduced by borrowings from any other source. At December 31, 1998, the Bank's FHLB of Chicago advances totaled $975.5 million, representing 23.7% of total assets.
Unsecured Term Bank Loan
The Company obtained a $35.0 million unsecured term bank loan in conjunction with its acquisition of Northwestern. The loan provides for an interest rate of the prime rate or 1% over one, two or three-month LIBOR at management's discretion adjustable and payable at the end of the repricing period. The loan currently carries an interest rate of 1% over three-month LIBOR. The loan is convertible all or in part, with certain limitations at the end of any repricing period, at management's election to a fixed rate at 1.25% over the U.S. Treasury rate with a maturity corresponding to the remaining term of the loan. The loan requires increasing annual principal payments starting in December 1997 with $9.2 million due at the final maturity of the loan on December 31, 2003. The Company made its scheduled principal payment on the loan on December 31, 1998 in the amount of $1.5 million. Prepayments of principal are allowed, but fixed-rate portions are subject to penalty. In conjunction with the term bank loan, the Company also maintains a $15.0 million one year unsecured revolving line of credit which matures on April 30, 1999, and is generally renewable annually thereafter. The interest rate on the line of credit is currently the prime rate or 1% over one, two, or three-month LIBOR, at management's discretion with interest payable at the end of the repricing period. At December 31, 1998, no balance is outstanding on the line of credit. The financing agreements contain covenants that, among other things, requires the Company to maintain a minimum stockholders' equity balance and to obtain certain minimum operating results, as well as requiring the Bank to maintain "well capitalized" regulatory capital levels and certain non-performing asset ratios. In addition, the Company has agreed not to pledge any stock of the Bank or MAF Developments for any purpose. At December 31, 1998, the Company was in compliance with these covenants.
Subordinated Capital Notes. In November, 1995, the Company refinanced its $20.9 million of 10% Subordinated Capital Notes due June 30, 2002 with $27.6 million of 8.32% Subordinated Notes due September 30, 2005. Costs incurred in the refinance transaction amounted to $1.0 million, and were being accreted over the life of the notes yielding an effective cost of 8.85%. The capital notes were callable at the discretion of the Company at any time after September 30, 1998, at par plus any accrued interest.
In November 1998, the Company called the entire balance of its Subordinated Capital Notes. Under the terms of the bond indenture, the call was made at par plus accrued interest, and resulted in an extraordinary charge to income of $456,000, or $.02 per diluted share, representing the after-tax impact of the remaining $750,000 of unamortized transaction costs, net of income tax benefits of $294,000.
Asset/Liability Management
The Bank's overall asset/liability management strategy is directed toward reducing the Bank's exposure to interest rate risk over time in changing interest rate environments. Asset/liability management is a daily function of the Bank's management due to continual fluctuations in interest rates and financial markets.
As part of its asset/liability strategy, the Bank has implemented a policy to maintain its cumulative one-year interest sensitivity gap ratio within a range of (15)% to 15% of total assets, which helps the Bank to maintain a more stable net interest rate spread in various interest rate environments. The gap ratio fluctuates as a result of market conditions and management's expectation of future interest rate trends. Under OTS Thrift Bulletin 13, the Bank is required to measure its interest rate risk assuming various increases and decreases in general interest rates, and the effect on net interest income and market value of portfolio equity. An interest rate risk policy has been approved by the Board of Directors setting the limits to changes in net interest income and market value of portfolio equity at the various rate scenarios required. In addition, the OTS has added an interest rate risk component to its regulatory capital requirements which could require an additional amount of capital based on the level of adverse change in a savings institution's market value of portfolio equity, resulting from changes in interest rates.
Management continually reviews its interest rate risk policies in light of potentially higher capital requirements that could result from the adoption of an interest rate risk component to the OTS capital requirements.
The Bank's asset/liability management strategy emphasizes the origination of one- to four-family adjustable-rate loans and other loans which have shorter terms to maturity or reprice more frequently than fixed-rate mortgage loans, yet, provide a positive margin over the Bank's cost of funds. In response to customer demand, the Bank originates fixed-rate mortgage loans, but has historically generally sold the conforming loans in the secondary market in order to maintain its interest rate sensitivity levels. During the last eighteen months, the Bank has been retaining the majority of the non-conforming, fixed- rate originations and all of the prepayment protected fixed-rate loan originations in portfolio for investment purposes to help utilize the Bank's higher capital base resulting from the merger with Northwestern. These fixed rate loans have been funded with intermediate to longer-term fixed rate FHLB advances.
In conjunction with the strategy discussed above, management has also hedged the Bank's exposure to interest rate risk primarily by committing to sell fixed- rate mortgage loans for future delivery. Under these commitments, the Bank agrees to sell fixed-rate loans at a specified price and at a specified future date. The sale of fixed-rate mortgage loans for future delivery has enabled the Bank to continue to originate new mortgage loans, and to generate gains on sale of these loans as well as loan servicing fee income, while maintaining its gap ratio within the parameters discussed above. Most of these forward sale commitments are conducted with FNMA and FHLMC with respect to loans that conform to the requirements of these government agencies. The forward commitment of mortgage loans presents a risk to the Bank if the Bank is not able to deliver the mortgage loans by the commitment expiration date. If this should occur, the Bank would be required to pay a fee to the buyer. The Bank attempts to mitigate this risk by charging potential retail borrowers a 1% fee to fix the interest rate, or by requiring the interest rate to float at market rates until shortly before closing. In its wholesale lending operation, there is more risk due to the competitive inability to charge a rate lock fee to the mortgage brokers, which the Bank tries to offset by using higher assumed fallout rates. In addition, the Bank uses U.S. Treasury bond futures contracts to hedge some of the mortgage pipeline exposure. These futures contracts are used to hedge mortgage loan production in those circumstances where loans are not sold forward as described above.
The table below sets forth the scheduled repricing or maturity of the Bank's assets and liabilities at December 31, 1998, based on the assumptions used by the FHLB of Chicago with respect to NOW, checking and passbook account withdrawals as well as loan and mortgage-backed securities prepayment percentages. Investment securities and FHLB advances that contain call provisions at the option of the issuer or lender are shown in the category relating to their respective final maturities at December 31, 1998.
The effect of these assumptions is to quantify the dollar amount of items that are interest-sensitive and may be repriced within each of the periods specified. The 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.
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(1) Includes $50.9 million of stock in FHLB of Chicago in 6 months or less. (2) Represents forward commitments to sell long-term fixed-rate mortgage loans.
Liquidity and Capital Resources
The Company's principal assets are its investment in the Bank and in MAF Developments. To the extent that it does not generate significant earnings outside of these two subsidiaries, the Company's liquidity position is primarily dependent on dividends from the Bank. To date, excess cash flow at MAF Developments has been used to fund new real estate projects.
The Bank's ability to pay dividends to the Company is dependent on its ability to generate earnings, and to meet regulatory restrictions. See "Regulation and Supervision - Limitation on Capital Distributions" for a detail of these restrictions. The Bank has not been restricted by these limitations to fund the necessary amounts needed by the Company for its operations. The Company received $50.0 million in dividends from the Bank during the year ended December 31, 1998, compared to $34.5 million for the year ended December 31, 1997, $-0-for the six months ended December 31, 1996 and $69.0 million during the year ended June 30, 1996. The large dividend for the six months ended June 30, 1996 was primarily related to the Northwestern acquisition, in which the purchase price was made up of 49% cash.
The primary uses for funds at the Company consist of principal and interest payments on borrowed funds, cash dividends, loans to and investments in MAF Developments, and stock repurchases. To the extent the Company has excess cash at any time, it will invest funds in investment securities, marketable equity securities or other interest-earning assets. During the year ended December 31, 1998, the Company made total interest payments of $4.4 million on its $27.6 million, 8.32% subordinated capital notes, and $33.0 million unsecured term bank loan (borrowed in conjunction with the acquisition of Northwestern). In addition, it made its scheduled payment on the unsecured term bank loan of $1.5 million, as well as called its $27.6 million of subordinated capital notes, at par plus accrued interest. The Company did not need to make any additional investments in MAF Developments during the current year.
The Company has used stock repurchase programs during the past few years as a means of providing for future acquisition activity, stock option exercises, and other general corporate purposes. During the year ended December 31, 1998, the Company repurchased 973,938 shares for a total of $22.9 million (average price of $23.32 per share). This total includes 66,460 shares purchased on October 23, 1998 from Allen Koranda, Chief Executive Officer of the Company, for approximately $1.5 million in a private transaction on terms approved by the disinterested members of the Board. The sale of shares was related to Mr. Koranda's marital dissolution agreement. For the year ended December 31, 1997, 1,179,617 shares were repurchased for a total of $22.7 million (average price of $19.12 per share). Subsequent to December 31, 1998, the Company announced it had purchased an additional 276,062 shares, completing its last announced buyback program, and announced a new 750,000 share stock buyback plan.
Cash dividends paid to common shareholders totaled $5.3 million ($.257 per share) for the year ended December 31, 1998, compared to $4.0 million ($.18 per share) for the year ended December 31, 1997. The increase is primarily due to a 50% increase in the cash dividend paid in July, 1998. The current dividend rate is $.07 per share. The payment of cash dividends is subject to the discretion of the Board of Directors and depends on a variety of factors, including operating results, financial position, and the ability for the Bank to pay dividends.
The Bank's principal sources of funds are deposits, advances from the FHLB of Chicago, reverse repurchase agreements, principal repayments on loans and mortgage-backed securities, proceeds from the sale of loans and funds provided by operations. While scheduled loan and mortgage-backed securities amortization and maturing interest-bearing deposits are a relatively predictable source of funds, deposit flows and loan and mortgage-backed securities prepayments are greatly influenced by economic conditions, the general level of interest rates and competition. The Bank utilizes particular sources of funds based on comparative costs and availability.
Cash flows from operating activities primarily includes net income for the year, adjusted for items in net income that did not impact cash, as well as cash flow activity from mortgage banking activity. During the current year, the net use of funds from operating activities is due to the high level of loans held for sale at the end of the period. The Bank originated and purchased $495.0 million of loans for sale, and received $438.5 million in proceeds from sales during the current year. The Bank had $89.4 million of loans held for sale at December 31, 1998, of which $89.2 million were sold under firm commitments. Cash flows from mortgage loan swap transactions are also accounted for as cash from operating activities.
Cash used in investing activities reflects the impact of loans and investments acquired for the Bank's interest-earning asset portfolios, as well as cash flows from asset sales, real estate held for development activity and the impact of business acquisitions. Cash used in investing activities totaled $350.6 million for the current year. During the current year, the Bank originated and purchased $1.26 billion of loans for investment, but experienced $942.1 million of loan amortization and prepayments, primarily due to declining long-term interest rates. Additionally, the Bank collected $85.0 million in amortization and
prepayments from mortgage-backed securities, which were primarily reinvested into loans held for investment purposes. The use of investment securities increased in 1998 due to the high level of prepayments in loans receivable. Investments purchased by the Company totaled $208.2 million, financed in part by maturities and sales of investments of $176.4 million, and loan prepayments. The Bank also purchased an additional $16.3 million of stock in the FHLB of Chicago due to growth in its borrowings from the FHLB of Chicago. Cash flow from the Company's land development operations was a net positive cash flow, as sales of property of $32.1 million was offset by costs of land acquisition and development of $13.9 million.
Cash provided from financing activities for Bank operations are primarily in the form of savings deposits, FHLB of Chicago advances and to a lesser extent, reverse repurchase agreements. Cash provided from financing activities totaled $368.3 million for the year ended December 31, 1998. During the current year, as a means to fund loan originations held for investment, the Company borrowed a total of $420.0 million of FHLB of Chicago advances, which were offset by $105.0 million of maturities. Net deposits increased $57.7 million, including the impact of interest credited. Interest credited is charged to cash from operating activities, but because it is not paid out, is reflected as a cash flow from financing. In the acquisition of Westco, the Company issued 3,305,129 shares of its common stock at a recorded value of $72.7 million. Offsetting these cash inflows was cash used to purchase treasury stock of $22.9 million. Additionally, the Company paid $.257 per share in common stock dividends, totaling $5.3 million. Due to improved capital levels at the Bank, and the decrease in overall interest rates, the Company was able to call its $27.6 million, 8.32% subordinated capital notes with a final maturity of September 2005 as of October 1, 1998. The debt was not replaced with a new borrowing at the Company.
At December 31, 1998, the Company believes it has sufficient cash to fund its outstanding commitments, or will be able to obtain the necessary funds from outside sources to meet its cash needs.
The Bank is required by regulation to maintain specific minimum levels of liquid investments. Regulations currently require the Bank to maintain liquid assets at least equal to 4.0% of the sum of its average daily balance of net withdrawable accounts and borrowed funds due in one year or less. This regulatory requirement may be changed from time to time to reflect current economic conditions. During the year ended December 31, 1998, the Bank's average liquidity ratio was 10.6%. At December 31, 1998, total liquidity was $276.1 million, or 11.3%, which was $178.0 million in excess of the 4.0% regulatory requirement. This excess liquidity has provided the Bank with the flexibility needed to maintain its short-term gap ratios within strategic limits, as well as most recently, to fund the increased loan volume.
Impact of Inflation and Changing Prices
The consolidated financial statements and related consolidated information are 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 changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant effect on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services.
Subsidiary Activities
Mid America Developments, NW Financial and MAF Developments. The Company engages in the business of purchasing unimproved land for development into residential subdivisions of single family lots through three wholly-owned subsidiaries. MAF Developments is a wholly-owned subsidiary of the Company, while Mid America Developments and NW Financial are wholly-owned subsidiaries of the Bank. The subsidiaries have been engaged in this activity since 1974, and since that time have developed and sold over 4,900 lots in 24 different subdivisions primarily in the western suburbs of Chicago. These subsidiaries acts as sole principal or as a joint venture partner in their developments. The subsidiaries historically have provided essentially all of the capital for a joint venture and receive in exchange an ownership interest in the joint venture which entitles it to a percentage of the profit or loss generated by the project, generally 50%, with the exact percentage based upon a number of factors, including characteristics of the venture, the perceived risks involved, and the time to completion. The net profits are generally defined in the joint venture agreement as the gross profits of the joint venture from sales, less all expenses, loan repayments and capital contributions.
In the acquisition of Northwestern, the Bank acquired NW Financial, which is active in the development of unimproved land for development into residential subdivisions, as well as the construction of single-family homesites on the improved lots. NW Financial currently has two projects whereby it and a developer share in the profits of the projects on a 50/50 basis. NW Financial also provides the funds, via loans, to the projects. The projects are located in the north and northwest suburbs of Chicago.
OTS regulations imposed restrictions on the Bank's participation in real estate development activities. See "Regulation and Supervision - Federal Savings Institution Regulation - Capital Requirements." In response to the restrictions imposed by the OTS, Mid America Developments did not initiate any new projects. In 1993, the Company formed a wholly-owned subsidiary, MAF Developments, to continue its land development activities. As a subsidiary of the Company, the activities of MAF Developments are not restricted by OTS regulations as they are for the Bank. The Bank also plans to limit the activity of NW Financial to the completion of its existing projects. As of December 31, 1998, Mid America Developments completed its remaining land development projects.
The following is a summary as of December 31, 1998, of the residential real estate projects NW Financial and MAF Developments currently has an interest in:
The following table is a summary of the Bank's investment in and advances to Mid America Developments and NW Financial at the dates indicated:
During the years ended December 31, 1998, 1997, and six months ended December 31, 1996, Mid America Developments and NW Financial paid aggregate dividends of $5.5 million, $1.2 million, and $3.0 million, respectively, to the Bank. The remaining investment at December 31, 1998 is a deduction for the Bank in computing its regulatory capital requirements.
The following is a description of the projects currently under development:
Tallgrass of Naperville
MAF Developments, Inc., with a venture partner who shares in 40% of the profits, has invested in 473 acres in three separate parcels from 1996 to 1998 for the development of 926 residential lots in Naperville, Illinois. As of December 31, 1998, the Company's investment was $17.8 million.
Creekside of Remington
MAF Developments, Inc. entered into a joint venture agreement to develop 170 lots in Bolingbrook, Illinois. The joint venture partner contributed the land while MAF Developments contributes development costs. Each joint venture partner receives 50% of the profit of the project. Development commenced in late fiscal 1994 in the first unit that consists of 91 lots. Due to the slow absorption in this development, the Company has not begun development of the next phase of the project. At December 31, 1998, the Company's investment in Creekside of Remington was $1.5 million. The Company is currently in negotiations to attempt to sell the remaining lots in bulk.
Harmony Grove
MAF Developments, Inc. entered into a joint venture to develop 386 lots in Naperville, Illinois by purchasing, from its venture partner, 160 acres of land, which included a 5-acre commercial parcel. The joint venture partner shares in 50% of the profits. The Company's investment at December 31, 1998 was reduced to $6,000, as the project is nearly complete. Final sales are expected to close in 1999.
Reigate Woods
Reigate Woods consists of approximately 106 acres of land in Green Oaks, Illinois. The subdivision was developed into 85 lots for single-family home construction in conjunction with a developer, who shares in 50% of the profits of the project. The project is funded solely by funds from NW Financial. The Company's investment at December 31, 1998 was $3.4 million.
Woodbridge
Woodbridge consists of 341 acres of land in Elgin, Illinois. The project is being developed with a developer who shares in 50% of the project's profits. The project includes 232 acres for the construction of 531 single-family homes, which is complete, and 48 acres of commercially-zoned property. At December 31, 1998, the Company has an investment of $2.4 million, all related to the commercial property.
The following projects were completed during the year ended December 31, 1998:
Ashbury
The Ashbury subdivision is located in Naperville, Illinois, and consisted of 1,115 lots. A venture partner participates in 50% of the profits on 482 of the total lots under a joint venture agreement. As of December 31, 1998, all residential lots are sold. A remaining 2.3-acre commercial parcel was sold in 1998.
Woods of Rivermist
Mid America Developments was a participant in a joint venture for this 31-lot development in Naperville, Illinois. Mid America Developments received 50% of the profits from the development. The remaining two lots were sold during 1998.
Clow Creek Farm
MAF Developments, Inc. purchased a 103-acre parcel of land in 1993 for the development of 260 lots in Naperville, Illinois, adjacent to the Ashbury subdivision. The last six lots in this subdivision were sold in 1998.
Fields of Ambria
Fields of Ambria consists of approximately 80 acres of land in Mundelein, Illinois. The subdivision was developed into 240 lots for single-family home construction in conjunction with a developer, who shares in the profits of the project. The last six homesites were sold in 1998.
Mid America Finance Corporation. In 1988, the Bank issued CMOs through MAFC, a wholly-owned special purpose finance subsidiary. The Bank contributed $149.8 million of mortgage-backed securities to MAFC which, in turn, pledged the securities to an independent trustee as collateral for the CMOs. The issuance of the CMOs resulted in net proceeds to the Bank of $130.9 million which were ultimately used to fund loan originations. Substantially all of the payments of principal and interest on the underlying collateral are paid through to the holders of the CMOs.
The CMOs were issued in four maturity classes. The actual maturity of each class of CMO varies according to the timing of the cash receipts from the underlying collateral. The CMOs are accounted for as a financing transaction and are reflected as borrowed funds in the consolidated financial statements of the Company. At December 31, 1997, the CMOs had an outstanding balance of $10.6 million. The mortgage-backed securities securing the CMOs had a carrying value and market value of $11.1 million and $11.7 million, respectively, at December 31, 1997. The CMO bonds and the mortgage-backed securities that collateralize them both carry fixed interest rates, adjusted for amortization of discounts based upon prepayment assumptions. The mortgage-backed securities yield averaged 8.25% for the year ended December 31, 1997, while the cost of the CMO bonds averaged 11.72%. This negative spread led to a $337,000 reduction to net interest income for the year ended December 31, 1997.
In the first quarter of 1998, the Bank entered into a transaction to sell its 100% beneficial interest in the trust that owned the mortgage-backed securities and issued the CMOs. Because the mortgage-backed securities collateralizing the CMO bonds had high coupons relative to the current market, the Bank felt it could mitigate the potential negative impact of higher prepayments by selling its residual interest. Because of the sale of 100% of the residual interest in the trust, the Bank has no more ownership in the trust, and no longer consolidates the assets and liabilities of MAFC. The loss on the sale totaled $739,000.
Northwestern Acceptance Corporation. In 1986, Northwestern issued $300 million of CMOs through NWAC, a special purpose finance subsidiary. The CMOs were issued in two classes. Class A-1 CMOs, with an original face of $200 million, have an interest rate that is indexed to LIBOR for three-month eurodollar deposits, with a maximum rate of 13.5% per year. The Class A-2 CMOs, originally issued for $100 million, have an interest rate that adjusts in inverse proportion to the LIBOR rate, but in no event may be less than 0% per year or greater than 23.89% per year. The CMOs have a stated maturity of February 20, 2018, although actual maturity of each class of CMO will vary due to prepayments in the underlying mortgage collateral. The CMOs are also subject to mandatory and optional redemption provisions, depending on the repayment of the underlying collateral and the amount of CMOs outstanding.
At December 31, 1997, the CMOs had an outstanding balance of $19.7 million. The CMOs are collateralized by 9.0% fixed-rate FHLMC mortgage-backed securities that had a carrying value and market value of $19.4 million and $20.5 million, respectively at December 31, 1997. In addition to the mortgage-backed securities, cash and investment securities totaling $425,000 were held by the trustee to pay principal and interest on the CMOs. The mortgage-backed securities pledged, as well as the cash and investment securities held by the trustee are solely for the repayment of the CMOs.
During 1998, the Bank sold its 100% residual interest in NWAC via the sale of the optional redemption rights on the CMO bonds issued by NWAC, which gave the buyer the right to call the bonds prior to maturity, along with ownership of the mortgage-backed securities collateralizing the CMO bonds. The Bank recognized a profit on the sale of the optional redemption rights of $815,000. Upon the calling of the bonds and the release of the mortgage-backed securities, NWAC was dissolved.
Mid America Insurance Agency. Mid America Insurance Agency, Inc. ("Mid America Insurance") is a wholly-owned subsidiary of the Bank which provides insurance brokerage services, including personal and commercial insurance products, to the Bank's customers. For the years ended December 31, 1998 and 1997, the six months ended December 31, 1996 and the year ended June 30, 1996, Mid America Insurance generated pre-tax income of $60,000, $77,000, $50,000 and $97,000, respectively.
INVEST. The Bank, through Mid America Developments, is a subscriber to INVEST, a registered broker-dealer that provides certain securities brokerage and investment advisory services under its INVEST service mark to the general public. Through this program and licensed dual employees, these services are offered to customers of the Bank. Presently 12 brokers are employed and operate from 14 Bank locations. Revenues are generated from the sales of securities products in the form of commissions which are apportioned between INVEST and the Bank. For the years ended December 31, 1998 and 1997, six months ended December 31, 1996 and the year ended June 30, 1996, pre-tax income from INVEST operations was $1.0 million, $852,000, $349,000, and $711,000, respectively.
Year 2000 Compliance
The Year 2000 Issue is the result of computer programs being written using two digits rather than four digits to define an applicable year in a record of data. Computer programs or hardware that have date-sensitive software or embedded microprocessor chips may recognize a date using "00" as 1900 rather than 2000. The result of such problem could result in system failure, miscalculations, and disruption of the Company's operations as is pertains to transacting customer business.
The Company has assessed the scope of its Year 2000 Issue as it relates to its mainframe, its companywide PC based network, as well as any other operational issues that may be hindered by system failures due to the Year 2000 bug. The Company presently believes that with modifications and/or replacements of existing software and certain hardware, its Year 2000 Issue can be mitigated. However, if such modifications and replacements are not made, or are not completed on a timely basis, the Year 2000 Issue could have a material negative impact on the operations of the Company.
The Company has designed a plan to resolve its Year 2000 Issue that includes phases for assessment, testing and implementation. The plan's implementation status is reviewed quarterly with senior management and the Board of Directors. To date, the Company has fully completed its assessment of systems that could be significantly affected by the Year 2000. This assessment indicated that many of the software applications could have been affected by the Year 2000. Additionally, the assessment phase identified the potential for embedded chips in certain systems (such as vault security, elevators, etc.) that may also be at risk. The assessment plan also identified the potential impact of Year 2000 compliance as it relates to its significant suppliers and vendors, and as part of the implementation phase, the Company is obtaining information regarding their status of Year 2000 compliance.
The Company has completed its testing and implementation of software that upgrades its mainframe computer to achieve Year 2000 readiness. Software was provided to the Company by its third party vendor under a maintenance contract that the Company maintains in the normal course of business. In October 1998, the Company received and tested this vendor's major software upgrade for the Year 2000 Issue. The Company believes that this upgrade has fully addressed potential Year 2000 problems. In addition, the Company has written proprietary programs for internal management reporting or for the support of other operations of the Bank. Many of these programs contain code that is date dependent, and are being reviewed and tested as part of the Year 2000 plan. The Company believes that the testing and reprogramming of critical proprietary programs has been successfully completed.
In addition to software and mainframe computer hardware Year 2000 issues, there are other important mechanical devices that the Company relies upon in the normal course of business, including alarm systems, vault security systems, and other functioning equipment which protect the assets of the Company. The Company has assessed all of these items, and is 90% complete with the testing of these functions. Testing and upgrades to these systems is expected to be complete by April 1999.
The Company relies on computer links with third party vendors in its normal course of business, including obtaining credit reports, title policies, and preparing closing statements with title companies. The Company is currently in the process of working with these "EDI" links to ensure that the Company's systems that interface with these third parties are Year 2000 compliant by December 31, 1999. Testing of these such links is expected to be complete by April 1999. The Company has queried and received indications from its major vendors in this area that they will be Year 2000 compliant.
The Company has also evaluated the potential Year 2000 impact of significant suppliers that do not share information systems with the Company (external agents). For the Company, these would include certain government agencies and utility providers. The Company has identified and contacted certain vendors that would create the most material impact on the Company's operations, and has been advised that they will be Year 2000 ready. However, the Company has no means of ensuring that these external agents will be Year 2000 compliant by the end of 1999. The effect of non-compliance by critical external agents has been addressed in the Company's contingency plan.
The Company has relied primarily on its own Information Technology ("IT") department to reprogram, replace, test and implement the software and operating equipment for Year 2000 modifications. Although this has diverted a material amount of the Company's IT resources during this process, the Company does not believe this diversion has had or will have a material impact on the results of operations. The Year 2000 plan has included the upgrading of mainframe software, which was accomplished pursuant to existing software maintenance agreements at no incremental cost to the Company. With respect to various PC software applications, necessary upgrades in some cases required a total replacement. At December 31, 1998, the Company estimates the incremental cost expended for Year 2000 compliance has amounted to approximately $250,000, not including the salaries and benefit costs of internal personnel. In total, the Company believes its total cost of achieving Year 2000 compliance will not exceed $500,000.
Management of the Company believes it has an effective program in place to resolve the Year 2000 Issue in a timely manner. Management also believes that its testing and implementation to date, as well as the continued implementation of its Year 2000 plan will ready the Company for Year 2000. However, to the extent that the Company's preparation and testing does not prove to be adequate, leading to the unforeseen failure of its mainframe computer, or if significant external agents prove to fail in their Year 2000 compliance efforts, the Company's ability to conduct its business may be materially adversely affected as it relates to processing customer transactions related to its core banking operation. Management is in the process of developing contingency plans to address potential risks in the event of Year 2000 failure, including non- compliance by third parties. The contingency plan will attempt to address failure of mission critical systems, including the telecommunications network, to allow the Company to continue operating on a reduced, semi-manual basis for a limited period of time. Non-compliance caused by third parties (including utilities) and Year 2000 disruptions to the national or local economy in general could also have a material adverse impact on the Company.
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file certain reports with, and otherwise comply with the rules and regulations of the OTS under the Home Owners' Loan Act (the "HOLA"). In addition, the activities of savings institutions, such as the Bank, are governed by the HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and supervision by the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its deposit accounts are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF") managed by the FDIC. The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The OTS and/or the FDIC conduct periodic examinations to test the Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the OTS, the FDIC or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company within the meaning of the HOLA. As a unitary savings and loan holding company, the Company generally will not be restricted under existing laws as to the types of business activities in which it may engage, provided that the Bank continues to be a qualified thrift lender ("QTL"). See "Federal Savings Institution Regulation - QTL Test." Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the QTL test and is deemed to be a savings institution by the OTS, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would be subject to extensive limitations on the types of business activities in which it could engage. The HOLA limits the activities of a multiple savings and loan holding company and its non-insured institution subsidiaries primarily to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act of 1956, as amended ("BHC Act"), subject to the prior approval of the OTS, and activities authorized by OTS regulation and no multiple savings and loan holding company may acquire more than 5% of the voting stock of a company engaged in impermissible activities.
The HOLA prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of the voting stock of another savings institution or holding company thereof, without prior written approval of the OTS; or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition of the institution on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
Although savings and loan holding companies are not subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, HOLA does prescribe such restrictions on subsidiary savings institutions, as described below. The Bank must notify the OTS 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the OTS and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3% leverage (core capital) ratio and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital ratio (3% for institutions receiving the highest rating on the CAMEL financial institution rating system), and, together with the risk-based capital standard itself, a 4% Tier I risk-based capital standard. The OTS regulations also require that, in meeting the leverage ratio, tangible and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank. For the Bank, this includes its $12.5 million investment in Mid America Developments and NW Financial at December 31, 1998, which the Bank must deduct from regulatory capital for purposes of calculating its capital requirements. The risk-based capital standard for savings institutions requires the maintenance of Tier I (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively.
The OTS regulatory capital requirements also incorporate an interest rate risk component. Savings institutions with "above normal" interest rate risk exposure are subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. For the present time, the OTS has deferred implementation of the interest rate risk component. If the Bank had been subject to an interest
rate risk capital component as of December 31, 1998 and 1997, the Bank's total risk-weighted capital would not have been subject to a deduction based on interest rate risk. At December 31, 1998 and 1997, the Bank met each of its capital requirements on a fully phased-in basis.
At December 31, 1998 and 1997, the Bank was in compliance with the current capital requirements as follows:
The following table reflects the Bank's regulatory capital as of December 31, 1998 as it relates to these three capital requirements:
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution is considered "well capitalized" if its ratio of total capital to risk-weighted assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted assets is at least 6%, its ratio of core capital to total assets is at least 5%, and it is not subject to any order or directive by the OTS to meet a specific capital level. A savings institution generally is considered "adequately capitalized" if its ratio of total capital to risk-weighted assets is at least 8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%, and its ratio of core capital to total assets is at least 4% (3% if the institution receives the highest CAMEL rating). A
savings institution that has a ratio of total capital to weighted assets of less of than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized," and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The FDIC has adopted a risk-based deposit insurance system that assesses deposit insurance premiums according to the level of risk involved in an institution's activities. An institution's risk category is based upon whether the institution is classified as "well capitalized," "adequately capitalized" or "undercapitalized" and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation and information which the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. Based on its capital and supervisory subgroups, each Bank Insurance Fund ("BIF") and SAIF member institution is assigned an annual FDIC assessment rate, with an institution in the highest category (i.e., well-capitalized and healthy) receiving the lowest rates and an institution in the lowest category (i.e., undercapitalized and posing substantial supervisory concern) receiving the highest rates. The FDIC has authority to further raise premiums if deemed necessary. If such action is taken, it could have an adverse effect on the earnings of the Bank.
The Deposit Insurance Funds Act of 1996 (the "Funds Act") imposed a special one-time assessment on SAIF members, including the Bank, to recapitalize the SAIF. The SAIF was undercapitalized due primarily to a statutory requirement that SAIF members make payments on bonds issued in the late 1980's by the Financing Corporation ("FICO") to recapitalize the predecessor to SAIF. The Funds Act spreads the obligations for payment of the FICO bonds across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits were assessed for a FICO payment of 1.3 basis points, while SAIF deposits paid 6.48 basis points. Full pro rata sharing of the FICO payments between BIF and SAIF members will occur on the earlier of January 1, 2000 or the date the BIF and SAIF are merged.
As a result of the Funds Act, the FDIC Act, the FDIC voted to effectively lower SAIF assessments to 0 to 27 basis points as of January 1, 1997. The Bank's assessment rate for the year ended December 31, 1998 was the lowest available to well-capitalized financial institutions. A significant increase in SAIF insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Recent Federal Legislative Initiatives. Various proposals to eliminate or grandfather unitary savings and loan holding companies, create a uniform financial institutions charter and allow the affiliation between financial institutions, insurance companies and securities firms have been introduced in Congress as part of an effort to modernize the financial services industry. Some of these bills provide that savings and loan holding companies would become subject to the same regulation as holding companies that control commercial banks, with some limited grandfathering and that the grandfathering would be lost under certain circumstances such as a change in control of the Company. Unless grandfathered, these restrictions would prevent unitary savings and loan holding companies from engaging in such non-commercial activities as real estate development. A bill has also been introduced in the Senate to provide the thrift and banking industries with regulatory relief including, but not limited to, the following initiatives: allowing banks and savings institutions to pay interest on business NOW accounts, repealing the HOLA's statutory liquidity requirement, the 30-day notice for dividends declared by thrifts in a holding company structure, the 5% ownership threshold of voting shares of a non-subsidiary thrift, and eliminating the SAIF special reserve. The Company is unable to predict whether any of these legislative initiatives would be enacted or the extent to which such legislation would restrict or disrupt its operations.
Loans to One Borrower. Under the HOLA, savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Generally, savings institutions may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily-marketable collateral, which is defined to include certain financial instruments and bullion. At December 31, 1998, the Bank's limit on loans to one borrower was $44.4 million. At December 31, 1998, the Bank's largest aggregate outstanding balance of loans to any one borrower was $8.2 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under the QTL test, a savings and loan association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total assets less (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. A savings institution that fails the QTL test is subject to certain operating restrictions and may be required to convert to a bank charter. As of December 31, 1998, the Bank maintained 95.5% of its portfolio assets in qualified thrift investments and, therefore, met the QTL test.
Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without obtaining approval of the OTS, make capital distributions during a calendar year equal to the greater of (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year or (ii) 75% of its net income for the previous four quarters. Any additional capital distributions would require prior regulatory approval. In the event the Bank's capital fell below its regulatory requirements or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. At December 31, 1998, the Bank is considered a Tier 1 Bank.
Liquidity. The Bank is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage of its net withdrawable deposit accounts plus short-term borrowings. This liquidity requirement was 4% for 1998 and may be changed from time to time by the OTS to any amount within the range of 4% to 10% depending upon economic conditions and the savings flows of member institutions. The Bank's liquidity ratio at December 31, 1998 was 11.3% which exceeded the then applicable requirements. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessment, paid on a semi-annual basis, is computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the twelve months ended December 31, 1998 totaled $512,000.
Branching. OTS regulations permit nationwide branching by federally chartered savings institutions to the extent allowed by federal statute. This permits federal savings institutions to establish interstate networks and to geographically diversify their loan portfolios and lines of business. The OTS authority preempts any state law purporting to regulate branching by federal savings institutions.
Transactions with Related Parties. The Bank's authority to engage in transactions with related parties or "affiliates" (e.g., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of covered transactions with any individual affiliate to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with 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 generally 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 institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and 10% shareholders, as well as entities such persons control, is governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder. Among other things, such loans are generally required to be made on terms substantially the same as those offered to unaffiliated individuals and to not involve more than the normal risk of repayment. Regulation O also places individual and aggregate limits on the amount of loans the Bank may make to such persons based, in part, on the Bank's capital position and requires certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all "institution-affiliated parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of proceedings for receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and may amount to as much as $1 million per day in certain circumstances. Under the FDI Act, the FDIC has the authority to recommend to the Director of the OTS enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") and a final rule to implement safety and soundness standards required under the FDI Act. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The standards set forth in the Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; asset quality; earnings and compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final rule establishes deadlines for the submission and review of such safety and soundness compliance plans when such plans are required.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of Chicago, is required to acquire and hold shares of capital stock in that FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB-Chicago, whichever is greater. At December 31, 1998, the Bank was in compliance with this requirement, with an investment in FHLB of Chicago stock of $50.9 million. FHLB of Chicago advances must be secured by specified types of collateral and may be obtained primarily for the purpose of providing funds for residential housing finance.
The FHLBs are required to provide funds to cover certain obligations on bonds issued to fund the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. For the years ended December 31, 1998, 1997, six months ended December 31, 1996, and the year ended June 30, 1996, dividends from the FHLB of Chicago to the Bank amounted to $2.6 million, $2.0 million, $1.1 million, and $1.3 million, respectively. If FHLB dividends were reduced, or interest on future FHLB advances increased, the Bank's net interest income might also be reduced.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $46.5 million or less (subject to adjustment by the Federal Reserve Board) the reserve requirement is 3%; and for accounts greater than $46.5 million, the reserve requirement is $1,395,000 plus 10% (subject to adjustment by the Federal Reserve Board between 8% and 14%) against that portion of total transaction accounts in excess of $46.5 million. The first $4.9 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The Bank is in compliance with the foregoing requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
Impact of New Accounting Standards
In February 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement revises financial statement disclosure requirements for pensions and other postretirement benefit plans. It standardizes the disclosure requirements for pension and other postretirement plans, requires additional disclosure information regarding changes in benefit obligations
and fair value of plan assets and eliminates certain disclosures that are no longer considered useful. The Statement is effective for fiscal years beginning after December 15, 1997. The Company adopted this Statement in 1998 and it did not have a material effect on the Company's financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires all derivatives to be recognized as either assets or liabilities in the statement of financial condition and to be measured at fair value. The Statement is effective for all fiscal quarters beginning after June 15, 1999. The Company intends to adopt this statement in the third quarter of 1999. The Company does not believe this statement will have a material impact on its financial position or results of operations.
In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This Statement requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities and other retained interests based on its ability and intent to sell or hold those investments. The Statement is effective for all fiscal years beginning after December 15, 1998. The Company intends to adopt this statement in 1999, and does not expect it to have a material impact on its financial position or results of operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As part of its normal operations, the Bank is subject to interest-rate risk on the interest-sensitive assets it invests in and the interest-sensitive liabilities it borrows. The Bank's asset/liability management committee ("ALCO"), which includes members of senior management, monitors and determines the strategy of managing the rate and sensitivity repricing characteristics of the individual asset and liability portfolios the Bank maintains. The overall goal is to manage this interest rate risk to most efficiently utilize the Bank's capital, as well as to maintain an acceptable level of change to its net portfolio value ("NPV"), and net interest income. The Bank's strategy is to minimize the impact of sudden and sustained changes in interest rates on NPV and its net interest margin.
The Bank's exposure to interest rate risk is reviewed at least quarterly by the ALCO and the Board of Directors of the Company. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Bank's change in NPV in the event of hypothetical changes in interest rates, as well as interest rate sensitivity gap analysis, which monitors the repricing characteristics of the Bank's interest-earning assets and interest-bearing liabilities. The Board of Directors has established limits to changes in NPV and net interest income across a range of hypothetical interest rate changes. If estimated changes to NPV and net interest income are not within these limits, the Board may direct management to adjust its asset/liability mix to bring its interest rate risk within Board limits.
In an effort to reduce its interest rate risk, the Bank has focused on strategies limiting the average maturity of its assets by emphasizing the origination of adjustable-rate mortgage loans, consumer loans and to a lesser extent, variable-rate mortgage and asset-backed securities. The Bank, from time to time, also invests in long-term fixed-rate mortgages to the extent it can adequately match such investments against liabilities, provided it is compensated with an acceptable spread. Because the Bank's loans are generally underwritten within the guidelines of FNMA, the Bank can quickly change its investment strategy with longer-term fixed rate mortgage loans by selling them into the secondary market without disrupting its origination operations.
Interest rate sensitivity analysis is used to measure the Bank's interest rate risk by calculating the estimated change in the NPV of its cash flows from interest sensitive assets and liabilities, as well as certain off-balance sheet items, in the event of a series of sudden and sustained changes in interest rates ranging from 100 to 400 basis points. Management assumes that a 200 basis point movement up or down is considered reasonable and plausible for purposes of managing its interest-rate risk on a day-to-day basis. NPV is the market value of portfolio equity and is computed as the difference between the market value of assets and the market value of liabilities, adjusted for the value of off- balance sheet items. The following table presents the Bank's projected change in NPV for the various rate shocks as of December 31, 1998. The Bank does not maintain any securities for trading purposes.
The NPV is calculated by the Bank using guidelines established by the OTS related to interest rates, loan prepayment rates, deposit decay rates and market values of certain assets under the various interest rate scenarios. These assumptions should not be relied upon as indicative of actual results due to the inherent shortcomings of the NPV analysis. These shortcomings include (i) the possibility that actual market conditions could vary from the assumptions used in the computation of NPV, (ii) certain assets, including adjustable-rate loans, have features which affect the potential repricing of such instruments, which may vary from the assumptions used, and (iii) the likelihood that as interest rates are changing, the ALCO would likely be changing strategies to limit the indicated changes in NPV as part of its management process.
In addition to the NPV analysis above, the Bank utilizes an interest rate sensitivity gap analysis to monitor the relationship of maturing or repricing interest-earning assets and interest-bearing liabilities, while maintaining an acceptable interest rate spread. Interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific period of time and the amount of interest-bearing liabilities maturing or repricing within that same period of time, and is usually analyzed at a period of one year. Generally, a negative gap, where more interest-bearing liabilities are repricing or maturing than interest-earning assets, would tend to result in a reduction in net interest income in a period of rising interest rates. Conversely, during a period of falling interest rates, a negative gap would likely result in an improvement in net interest income. Management's goal is to maintain its cumulative one-year gap within the range of (15)% to 15%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" for further analysis.
The Bank does not currently engage in trading activities or use derivative instruments in a material amount to control interest rate risk. In addition, interest rate risk is the most significant market risk affecting the Bank. Other types of market risk, such as foreign currency exchange risk and commodity price risk, do not arise in the normal course of the Company's business activities and operations.
Item 8.
Item 8. Financial Statements and Supplementary Data
MAF Bancorp, Inc. and Subsidiaries Consolidated Statements of Financial Condition
MAF Bancorp, Inc. and Subsidiaries Consolidated Statements of Operations
See accompanying Notes to Consolidated Financial Statements.
MAF Bancorp, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity
(Continued)
MAF Bancorp, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity (Continued)
See accompanying Notes to Consolidated Financial Statements.
MAF Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows
MAF Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Continued)
See accompanying Notes to Consolidated Financial Statements
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include the accounts of MAF Bancorp, Inc. ("Company") and its two wholly-owned subsidiaries, Mid America Bank, fsb ("Bank") and MAF Developments, Inc., as well as the Bank's wholly-owned subsidiaries, Mid America Development Services, Inc. ("Mid America Developments"), Mid America Finance Corporation ("MAFC"), Mid America Insurance Agency, Inc., Mid America Mortgage Securities, Inc., NW Financial, Inc. ("NW Financial"), Northwestern Acceptance Corporation ("NWAC"), and Centre Point Title Services, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior year amounts have been made to conform with the current year presentation.
As of December 31, 1996, the Company changed its year-end to coincide with a calendar year, as opposed to the June 30 year-end it followed in the past.
Use of Estimates. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Statement of Cash Flows. For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits and federal funds sold. Generally, federal funds are sold for one-day periods and interest-bearing deposits mature within one day to three months.
Restrictions on Cash. Based on the types and amounts of deposits received, the Bank maintains vault cash and non-interest bearing cash balances in accordance with Federal Reserve Bank reserve requirements. At December 31, 1998 and 1997, the Bank's reserve requirements were met with vault cash.
Investment and Mortgage-Backed Securities. All investment securities and mortgage-backed securities are classified in one of three categories: trading, held to maturity, or available for sale. Trading securities include investment and mortgage-backed securities that the Company has purchased and holds for the purpose of selling in the future. These investments are carried at fair value, with unrealized gains and losses reflected in income in the current period. Held to maturity securities include investment and mortgage-backed securities which the Company has the positive intent and ability to hold to maturity. These investments are carried at amortized cost, with no recognition of unrealized gains or losses in the financial statements. All other investment and mortgage- backed securities are classified as available for sale. These investments are carried at fair value, with unrealized gains and losses reflected in stockholders' equity, net of tax. Securities that have losses deemed other than temporary are recognized as losses in the statement of operations and a new cost basis is determined.
Amortization of premiums, accretion of discounts, and the amortization of purchase accounting adjustments for investment and mortgage-backed securities acquired are recognized in interest income over the period to maturity for investment securities, or the estimated life of mortgage-backed securities using the level-yield method. Gains and losses on sales of investment securities, mortgage-backed securities, and equity securities are determined using the specific identification method.
The Bank arranges for "swap" transactions with the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC") which involve the exchange of whole mortgage loans originated by the Bank for mortgage-backed securities.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Loans receivable held for sale. The Bank sells, generally without recourse, whole loans and participation interests in mortgage loans that it originates. Loans originated are identified as either held for investment or sale upon origination. Loans which the Bank intends to sell before maturity are classified as held for sale, and are carried at the lower of cost, adjusted for applicable deferred loan fees or expenses, or estimated market value in the aggregate.
The Bank enters into forward commitments to sell mortgage loans primarily with FNMA to deliver mortgage loans originated by the Bank at a specific time and specific price in the future. Loans subject to forward sales are classified as held for sale. Unrealized losses, if any, on forward commitments are included in gain (loss) on sale of mortgage loans in the period the loans are committed.
Loans Receivable. Loans receivable are stated at unpaid principal balances less unearned discounts, deferred loan origination fees, loans in process and allowance for loan losses.
Discounts on loans receivable are amortized to interest income using the level-yield method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Amortization of purchase accounting discounts are being amortized over the contractual term of loans receivable acquired, adjusted for anticipated prepayments, using the level-yield method.
Loan fees and certain direct loan origination costs are deferred, and the net deferred fee or cost is recognized as an adjustment to yield using the level- yield method over the contractual life of the loans.
The Bank considers a loan impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan. For loans which are not individually significant (i.e. loans under $750,000), and represent a homogeneous population, the Bank evaluates impairment collectively based on management reports on the level and extent of delinquencies, as well as historical loss experience for these types of loans. The Bank uses this criteria on one-to four-family residential loans, consumer loans, multi-family residential loans, and land loans. Impairment for loans considered individually significant and commercial real estate loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. There were no impaired loans as of December 31, 1998. One commercial real estate loan was classified as impaired under the Company's impairment criteria as of December 31, 1997. Charge-offs of principal occur when a loss has deemed to have occurred as a result of the book value exceeding the fair value or net realizable value.
A loan (whether considered impaired or not) is classified as non-accrual when collectibility is in doubt, and is normally analyzed upon the borrower becoming 90 days past due on contractual principal or interest payments. When a loan is placed on non-accrual status, or in the process of foreclosure, previously accrued but unpaid interest is reversed against interest income. Income is subsequently recorded to the extent cash payments are received, if the entire principal balance is considered collectible, or at a time when the loan is brought current in accordance with its original terms.
Allowance for Loan Losses. The allowance for loan losses is increased by charges to operations and decreased by charge-offs, net of recoveries. The allowance for loan losses reflects management's estimate of the reserves needed to cover the risks inherent in the Bank's loan portfolio. In determining a proper level of loss reserves, management periodically evaluates the adequacy of the allowance based on the Bank's past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and current economic conditions.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Foreclosed Real Estate. Real estate properties acquired through, or in lieu of, foreclosure are initially recorded at the lower of carrying value or fair value less the cost to sell at the date of foreclosure, establishing a new cost basis. Valuations are periodically performed by management and an allowance for loss is established by a charge to operations if the carrying value of a property exceeds its estimated fair value less cost to dispose.
Real Estate Held for Development or Sale. Real estate properties held for development or sale, are carried at the lower of cost, including capitalized holding costs or net realizable value. Gains and losses on individual lot sales in a particular development are based on cash received less the estimated cost of sales per lot. Cost of sales is calculated as the current investment in the particular development plus anticipated costs to complete the development, which includes interest capitalized, divided by the remaining number of lots to be sold. Periodic estimates are made as to a development's cost to complete. Per unit cost of sales estimates are adjusted on a prospective basis when, and if, estimated costs to complete change.
Premises and Equipment. Land is carried at cost. Buildings, leasehold improvements, furniture, fixtures, and equipment are carried at cost, less accumulated depreciation and amortization. Buildings, furniture, fixtures, and equipment are depreciated using the straight-line method over the estimated useful lives of the assets. Useful lives are 20 to 50 years for office buildings, 10 to 15 years for parking lot improvements, and 2 to 10 years for furniture, fixtures, and equipment. The cost of leasehold improvements is being amortized using the straight-line method over the lesser of the life of the leasehold improvement or the term of the related lease.
Intangibles. Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in business combinations. Core deposit intangibles represent the value assigned to the core deposit base acquired. Each is recognized as a result of the purchase method of accounting for business combinations, which the Company used in its acquisition of N.S. Bancorp in 1996 and Westco Bancorp in 1998. Goodwill is generally amortized over a period not to exceed 25 years, while core deposit intangibles are amortized on an accelerated method over a period not to exceed 10 years.
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment is measured based on the present value of expected future cash flows from the use of the asset and its eventual disposition. If expected future cash flows are less than the carrying amount of the asset, an impairment loss is recognized based on current fair values.
Mortgage Servicing Rights. SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." provides guidance for the recognition of mortgage servicing rights as a separate asset, regardless of how these rights are acquired. SFAS No. 125 also requires the measurement of impairment of servicing rights based on the difference between carrying value and fair value. Previous to July 1, 1996, the Company recognized mortgage servicing rights for only those rights which it purchased.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Mortgage servicing rights are initially capitalized upon acquisition, and are subsequently amortized over the estimated life of the loan servicing income stream, using the level-yield method. The Bank conducts periodic impairment analysis by evaluating the present value of the future economic benefit to be derived from the servicing rights using current information regarding interest rates, prepayment assumptions, and the cost to service such loans. For purposes of measuring impairment, the mortgage servicing rights are stratified based on the predominant risk characteristics of the underlying loans. The Bank stratifies loans by interest rate, maturity, and whether the loans are fixed or adjustable rate. An impairment is recognized in the amount by which the capitalized servicing rights for a specific stratum exceeds its fair value.
Borrowed Funds. Discounts and premiums on collateralized mortgage obligations are amortized using the level-yield method over the remaining contractual maturities of the underlying mortgage-backed security collateral, adjusted for estimated prepayments. The discount on subordinated capital notes is amortized using the level-yield method over the life of the notes.
Income Taxes. The Company and its subsidiaries file a consolidated federal income tax return. Deferred income taxes are provided for all significant items of income and expense that are recognized in different periods for financial reporting purposes and income tax reporting purposes. The asset and liability approach is used for the financial accounting and reporting of income taxes. This approach requires companies to take into account changes in the tax rates when valuing the deferred income tax accounts recorded on the balance sheet. In addition, it provides that a deferred tax liability or asset shall be recognized for the estimated future tax effects attributable to "temporary differences" and loss and tax credit carryforwards. Temporary differences include differences between financial statement income and tax return income which are expected to reverse in future periods as well as differences between tax bases of assets and liabilities and their amounts for financial reporting purposes which are also expected to be settled in future periods. To the extent a deferred tax asset is established which is not likely to be realized, a valuation allowance shall be established against such asset.
Derivative Financial Instruments. The Company utilizes forward commitments to sell mortgage loans and interest rate futures contracts, primarily U.S. Treasury bond futures, as part of its mortgage loan origination hedging strategy. Gains and losses on open and closed futures positions are deferred and recognized as an adjustment to gain (loss) on the sale of loans receivable when the underlying loan being hedged is sold into the secondary market.
Stock Splits. On April 29, 1998, the Board of Directors of the Company declared a 3-for-2 stock split in the form of a 50% stock dividend to be distributed on July 10, 1998 to shareholders of record on June 18, 1998. Shares distributed totaled 7,525,121 shares. Additionally, on April 30, 1997, the Board of Directors declared a 3-for-2 stock split in the form a 50% stock dividend to be distributed on July 9, 1997 to shareholders of record on June 17, 1997. Shares distributed totaled 7,695,605. All per share information has been adjusted on a retroactive basis to reflect the impact of these stock splits.
Comprehensive Income. The Company adopted SFAS No. 130, "Reporting Comprehensive Income" on January 1, 1998. Comprehensive income includes net income plus other comprehensive income. Other comprehensive income includes revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. The Company reports comprehensive income in its statement of changes in stockholders' equity.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Segments. The Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" on January 1, 1998. The Company uses the management approach for determining segment reporting. Based on the management approach, the Company operates two separate lines of business, retail banking and land development operations.
Earnings Per Share. SFAS No. 128, "Earnings per Share," was issued in February 1997. This statement was effective in the fourth quarter of 1997. All periods presented have been adjusted to conform to SFAS No. 128. In accordance with SFAS No. 128, earnings per share is determined by dividing net income for the period by the weighted average number of shares outstanding. Stock options are regarded as future common stock and are considered in the earnings per share calculations, and are the only adjustment made to average shares outstanding in computing diluted earnings per share. Future common stock is computed using the treasury stock method. Weighted average shares used in calculating earnings per share are summarized below for the periods indicated:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
2. Acquisitions
On December 31, 1998, the Company acquired Westco Bancorp, Inc. ("Westco"), and its wholly owned subsidiary First Federal Savings and Loan of Westchester ("Westchester"). Under the terms of the merger agreement, all of the outstanding shares of Westco were exchanged for 1.395 shares of MAF Bancorp common stock, or a total of 3,305,129 shares. As of December 31, 1998, Westco and Westchester were merged into the Company and Bank, respectively.
As of the date of acquisition, Westco had total assets of $312.3 million, loans receivable of $245.2 million, deposits of $259.5 million, and stockholders' equity of $46.7 million. The transaction was accounted for as a purchase, and created goodwill of $31.6 million, and a core deposit intangible of $1.7 million. Premiums and discounts on the fair value adjustments amounted to $3.7 million and $2.6 million, respectively. Acquisition expenses incurred in the transaction include professional fees as well as $4.2 million of severance costs, net of applicable tax benefits. The effect of the Westco acquisition on the Company's consolidated financial statements as if this acquisition occurred on January 1, 1997 is not material, and accordingly pro forma data is not being provided. Westco operated one branch in Westchester, Illinois, along with a drive-up facility.
On May 30, 1996, the Company acquired N.S. Bancorp, Inc. ("Northwestern"), and its wholly-owned subsidiary Northwestern Savings Bank, through the issuance of .8529 shares of MAF Bancorp common stock plus $20.1799 of cash for each share of Northwestern common stock. The Company issued 11,687,474 shares of its common stock in the acquisition. The funds used for the purchase were obtained primarily from cash acquired, and an unsecured long-term bank borrowing for $35.0 million (See note 13). At May 31, 1996, Northwestern had total assets of $1.2 billion, loans receivable of $749.7 million, deposits of $872.0 million, and stockholders' equity of $231.6 million. The transaction was accounted for as a purchase. The transaction created goodwill of $26.7 million and a core deposit intangible of $8.8 million. Northwestern operated six branches, primarily in Chicago, Illinois.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
3. Investment Securities
Investment securities available for sale and held to maturity are summarized below:
The table above classifies investment securities by contractual maturities. Expected maturities may differ from contractual maturities because certain borrowers have the right to call obligations without penalty.
In accordance with an implementation guide to SFAS No. 115 issued in November 1995, the Bank reclassified $18.0 million of investment securities from held to maturity to available for sale on December 31, 1995. The unrealized loss at the date of transfer was $75,000. As of December 31, 1998 and 1997, the Company recorded unrealized gains (losses) on investment securities available for sale as increases to stockholders' equity of $548,000, and $1.5 million, respectively, net of deferred income taxes of $364,000, and $1.0 million, respectively. Additionally, during the year ended December 31, 1998, the Company recognized losses deemed other than temporary in marketable equity securities available for sale totaling $375,000.
Activity in the sales of investment securities available for sale is as follows:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)
4. Mortgage-Backed Securities
Mortgage-backed securities available for sale and held to maturity are summarized below:
In accordance with an implementation guide to SFAS No. 115 issued in November 1995, the Bank reclassified $108.7 million of mortgage-backed securities from held to maturity to available for sale on December 31, 1995. The unrealized loss on the date of transfer was $192,000. As of December 31, 1998 and 1997, the Company recorded unrealized gains (losses) on mortgage-backed securities available for sale as increases (decreases) to stockholders' equity of $(124,000), and $12,000, respectively, net of deferred income tax expense (benefit) of $(81,000), and $7,000, respectively.
During the years ended December 31, 1998 and 1997, six months ended December 31, 1996, and the year ended June 30, 1996, the Bank swapped $26.6 million, $3.4 million, $8.2 million and $41.2 million, respectively, all of which were sold in the same period swapped. Included in mortgage-backed securities at December 31, 1998 and December 31, 1997, are $2.9 million, and $16.0 million, respectively, of loans originated by the Bank which were swapped into mortgage-backed securities. In addition to the above swaps, proceeds from the sale of mortgage- backed securities available for sale were $16.6 million during the six months ended December 31, 1996, at a gross loss of $301,000.
The book value and fair value of mortgage-backed securities held to maturity by contractual maturity term is shown in the table below. Expected maturities may differ from contractual maturities because of prepayments on underlying mortgage loans:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
In March, 1998, the Bank sold its 100% beneficial interest in its two special- purpose finance subsidiaries, MAFC and NWAC for net proceeds of $912,000, and recorded a gain on sale of investment securities of $76,000. MAFC and NWAC had issued CMO bonds collateralized by FHLMC mortgage-backed securities on a duration-matched basis, which were classified as held to maturity. By selling more than 50% of its beneficial interest, the Company no longer consolidates MAFC and NWAC in its consolidated financial statements. As such, mortgage- backed securities held to maturity were reduced by $30.9 million. The Company considers this transaction a permissible sale of held to maturity securities.
5. Loans Receivable Held For Sale
The Bank classifies loan originations that it has the intention of selling into the secondary market as held for sale at the time of origination. At December 31, 1998 and 1997, the Bank had $89.4 million and $6.5 million of fixed-rate loans classified as held for sale with weighted average rates of 6.79% and 7.27%, respectively.
6. Loans Receivable
Loans receivable are summarized as follows:
Adjustable-rate loans included in loans receivable totaled $1.5 billion, and $1.7 billion at December 31, 1998 and 1997, respectively.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Allowance for loan losses. Activity in the allowance for loan losses is summarized as follows for the periods indicated:
At December 31, 1998, 1997 and 1996, and at June 30, 1996, the Bank had $12.6 million, $8.5 million, $11.8 million and $6.1 million, respectively, of loans which were on non-accrual status. Interest income that would have been recorded on non-accrual loans amounted to $421,000, $663,000, $573,000 and $631,000 for the years ended December 31, 1998 and 1997, six months ended December 31, 1996 and the year ended June 30, 1996, respectively, had these loans been accruing under their contractual terms. Interest income that was included in net income was $229,000, $120,000, $150,000 and $313,000, for the years ended December 31, 1998 and 1997, six months ended December 31, 1996 and the year ended June 30, 1996, respectively.
At December 31, 1997, the Bank had one impaired loan totaling $500,000, net of a $2.9 million charge-off taken in 1997. The loan was a second mortgage on a commercial office park. In addition to the second mortgage, the Bank had issued a standby letter of credit that collateralizes the first mortgage on this property, which is a long-term industrial revenue bond for $6.0 million. In January 1998, the Bank received title to the property, and assumed the obligation of the industrial revenue bond, and recorded foreclosed real estate of $6.5 million. The Bank continues to maintain its standby letter of credit against the industrial revenue bond obligation. There were no loans outstanding as of December 31, 1998 that the Bank considers impaired.
Loan servicing and mortgage servicing rights. The Bank services loans for the benefit of others pursuant to loan servicing agreements. Pursuant to these agreements, the Bank typically collects from the borrower monthly payments of principal and interest, as well as funds for the payment of real estate taxes and insurance. The Bank retains its loan servicing fee from these payments and remits the balance of the principal and interest payments to the various investors. Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of these loans were $1.07 billion, $997.2 million, $1.05 billion and $1.04 billion at December 31, 1998, December 31, 1997, December 31, 1996, and June 30, 1996, respectively. Non-interest bearing custodial balances maintained in connection with mortgage loans serviced for others (included in deposits) were $22.8 million and $21.6 million at December 31, 1998 and 1997, respectively.
Mortgage servicing rights are included in the statements of financial condition in other assets. The company capitalizes servicing rights on loan originations it identifies for sale at the time of origination. During 1998, steadily declining long-term interest rates had a negative effect on the value of the Bank's mortgage servicing rights. Actual prepayments in the Bank's loans serviced for others portfolio were greater than management's initial estimate at the time of capitalization, requiring the writedown in value of $1.3 million. No such writedown was necessary during the year ended December 31, 1997, the six months ended December 31, 1996 or the year ended June 30, 1996.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Activity in mortgage servicing rights is as follows for the periods indicated:
7. Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
8. Foreclosed Real Estate
Foreclosed real estate is summarized as follows:
At December 31, 1998, foreclosed commercial real estate primarily consists of a commercial office park, which had previously been considered as an impaired loan prior to foreclosure on January 29, 1998. Upon foreclosure, the Bank also assumed an industrial revenue bond obligation in the amount of $6.0 million that is collateralized by the property. In addition, the Bank maintains a standby letter of credit against the industrial revenue bond obligation in the amount of $6.5 million.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
9. Real Estate Held for Development or Sale
Real estate held for development or sale is summarized by project as follows:
Income (loss) from real estate operations is summarized by project for the periods indicated:
The loss of $424,000 in the year ended June 30, 1996 represents the write-off of capitalized costs on a parcel of land that the Company decided not to exercise its option to purchase. Interest capitalized to real estate held for development or sale amounted to $267,000, $308,000, $271,000, and $579,000 for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and year ended June 30, 1996, respectively.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
10. Premises and Equipment
Premises and equipment are summarized as follows:
Depreciation and amortization of premises and equipment, included in data processing expense and office occupancy and equipment expense was $3.7 million, $3.1 million, $1.4 million, and $2.0 million, for the years ended December 31, 1998 and 1997, six months ended December 31, 1996 and year ended June 30, 1996, respectively.
The Bank is obligated under non-cancelable leases primarily for office space. Rent expense under these leases for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, was $1.2 million, $1.1 million, $265,000, and $260,000, respectively. The projected minimum rentals under existing leases (excluding lease escalations) as of December 31, 1998, are as follows: 1999 $1.2 million; 2000 $1.0 million; 2001 $940,000; 2002 $909,000; 2003 $884,000; 2004 and thereafter $2.0 million.
11. Intangible Assets
Intangible assets are summarized as follows:
Adjustments to goodwill after acquisition are generally made within one year of acquisition date and are primarily related to tax adjustments on assets and liabilities assumed in the acquisition.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
12. Deposits Deposit account balances by interest rate are summarized as follows:
Scheduled maturities of certificate accounts at December 31, 1998 are as follows (in thousands):
Interest expense on deposit accounts is summarized as follows for the periods indicated:
The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $195.6 million, $159.8 million, $142.5 million, and $136.2 million at December 31, 1998, 1997 and 1996, and at June 30, 1996, respectively.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
At December 31, 1998, U.S. Treasury Notes, FHLMC and FNMA mortgage-backed securities, as well as mortgage loans with an aggregate carrying value and market value of $11.6 million, were pledged as collateral for certain jumbo certificates.
Federal Deposit Insurance Special Assessment. The Deposit Insurance Funds Act of 1996 imposed a special one-time assessment on Savings Associations Insurance Fund ("SAIF") members to increase the reserve levels of the SAIF to 1.25% of insured deposits. The rate charged members, including the Bank, was 65.7 basis points. On September 30, 1996, the Bank recorded a pre-tax charge of $14.2 million ($8.7 million on an after-tax basis) as a result of the special assessment.
13. Borrowed Funds
Borrowed funds are summarized as follows:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Federal Home Loan Bank of Chicago Advances. The Bank has adopted a collateral pledge agreement whereby the Bank has agreed to at all times keep on hand, free of all other pledges, liens, and encumbrances, first mortgages with unpaid principal balances aggregating no less than 167% of the outstanding secured advances from the Federal Home Loan Bank ("FHLB") of Chicago. All stock in the FHLB of Chicago is pledged as additional collateral for these advances. At December 31, 1998, adjustable-rate advances adjust as follows: $50.0 million at the three month London interbank offering rate ("LIBOR") less .12%; $25.0 million at 1 month LIBOR less .29%; and $25.0 million at the FHLB of Chicago Daily Investment Deposit rate plus .45%.
Included in FHLB of Chicago advances at December 31, 1998 are $360.0 million of fixed-rate advances and $25.0 million of adjustable-rate advances with original scheduled maturities of 7 to 10 years, which are callable at the discretion of the FHLB of Chicago at periods from 3 to 7 years from the origination date. The Bank receives a lower cost of borrowing on such advances than on similar non-callable long-term advances in return for granting the FHLB of Chicago the right to call the advances prior to their final maturity.
Collateralized Mortgage Obligations. The Bank issued collateralized mortgage obligations ("CMOs") in 1988 through MAFC. The CMOs are collateralized by mortgage-backed securities of the Bank. Substantially all of the collections of principal and interest from the underlying collateral are paid through to the holders of the CMOs. At December 31, 1997, the CMOs were secured by mortgage- backed securities of the Bank with a carrying value of $11.1 million and a fair value of $11.7 million, respectively. In 1998, the Bank sold its 100% beneficial interest in MAFC, at a net loss of $(739,000). Due to the sale, the Bank no longer consolidates MAFC. For the year ended December 31, 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, the effective annual cost of the CMOs was approximately 11.72%, 11.07%, and 11.24%, respectively.
Through acquisition, the Bank has CMOs that were issued by NWAC in 1988. The CMOs were issued in two classes, which have floating interest rates tied to LIBOR. The CMOs are collateralized by mortgage-backed securities of the Bank. Substantially all of the collections of principal and interest from the underlying collateral are paid through to the holders of the CMOs. At December 31, 1997, the CMOs were secured by mortgage-backed securities of the Bank with a carrying value of $19.4 million and fair value of $20.5 million. In 1998, the NWAC sold its 100% beneficial interest in NWAC at a net gain of $815,000. Due to the sale, the Bank no longer consolidates NWAC. For the year ended December 31, 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, the effective annual cost of the CMOs was approximately 8.24%, 8.30% and 8.05%, respectively.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Reverse Repurchase Agreements. The Bank enters into sales of securities under agreements to repurchase the identical securities ("reverse repurchase agreements") with nationally recognized primary securities dealers and are treated as financings. The securities underlying the agreements are delivered to the dealers who arrange the transaction and are reflected as assets. The following table presents certain information regarding reverse repurchase agreements as of and for the periods indicated:
At December 31, 1998 and 1997, reverse repurchase agreements were collateralized by investment and mortgage-backed securities with a carrying value of $20.7 million and $48.2 million and a market value of $20.7 million and $48.7 million, respectively. At December 31, 1998, the bank has one reverse repurchase agreement with a remaining term to maturity of 8 months.
Unsecured Term Bank Loan. The Company obtained a $35.0 million unsecured term bank loan in conjunction with its acquisition of Northwestern. The loan provides for an interest rate of the prime rate or 1% over one, two or three-month LIBOR at management's discretion adjustable and payable at the end of the repricing period. The loan currently carries an interest rate of 1% over three-month LIBOR. The loan is convertible all or in part, with certain limitations at the end of any repricing period, at management's election to a fixed rate at 1.25% over the U.S. Treasury rate with a maturity corresponding to the remaining term of the loan. At December 31, 1998, the balance of the unsecured term loan is $33.0 million. Prepayments of principal are allowed, but fixed-rate portions are subject to penalty. In conjunction with the term bank loan, the Company also maintains a $15.0 million one year unsecured revolving line of credit which is renewable annually on April 30. The interest rate on the line of credit is the prime rate or 1% over one, two, or three-month LIBOR, at management's discretion with interest payable at the end of the repricing period. The financing agreements contain covenants that, among other things, require the Company to maintain a minimum stockholders' equity balance and to obtain certain minimum operating results, as well as requiring the Bank to maintain "well capitalized" regulatory capital levels and certain non-performing asset ratios. In addition, the Company has agreed not to pledge any stock of the Bank or MAF Developments for any purpose. At December 31, 1998, the Company was in compliance with these covenants.
Scheduled principal repayments of the unsecured term bank loan are as follows as of December 31, 1998 (in thousands):
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Other Borrowing. The other borrowing of $6.0 million is an industrial revenue bond obligation collateralizing a commercial office building that the Bank foreclosed on in 1998. The borrowing is remarketed periodically by an independent broker for a term determined by the owner of the property. In 1998, the borrowing was remarketed on a quarterly basis. The borrowing is assumable by any purchaser of the commercial office building.
Interest expense on borrowed funds and subordinated capital notes is summarized as follows for the periods indicated:
14. Subordinated Capital Notes
During the year ended December 31, 1998, the Company called its $27.6 million of 8.32% Subordinated Capital Notes due September 30, 2005. Under the terms of the bond indenture, the call was made at par plus accrued interest, and resulted in an extraordinary charge to income of $456,000, or $.02 per diluted share, representing the after-tax impact of the remaining $750,000 of unamortized transaction costs, net of income tax benefits of $294,000.
During the year ended June 30, 1996, the Company refinanced its $20.9 million of 10% Subordinated Capital Notes due June 30, 2002 with $27.6 million of 8.32% Subordinated Notes due September 30, 2005. The refinance transaction resulted in a $474,000, or $0.03 per share extraordinary charge to earnings due to the early extinguishment of debt as a result of writing-off the remaining unamortized transaction costs of $774,000, net of income tax benefits of $300,000.
15. Derivative Financial Instruments
The Bank enters into forward commitments to sell mortgage loans for future delivery as a means of limiting exposure to changing interest rates between the date a loan customer commits to a given rate, or closes the loan, whichever is sooner, and the sale date, which is generally 10 to 60 days after the closing date. These commitments to sell require the Bank to deliver mortgage loans at stated coupon rates within the specified forward sale period, and subject the Bank to risk to the extent the loans do not close. The Bank attempts to mitigate this risk by collecting a non-refundable commitment fee, where possible, and by estimating a percentage of fallout when determining the amount of forward commitments to sell.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
The following is a summary of the Bank's forward sales commitment activity for the periods indicated:
The Bank also enters into interest rate futures contracts to hedge its exposure to price fluctuations on firm commitments to originate loans intended for sale, that have not been covered by forward commitments to sell loans for future delivery. Included in gain (loss) on sale of mortgage loans for the year ended December 31, 1998 and 1997, the six months ended December 31, 1996 and the year ended June 30, 1996 are $110,000, $-0-, $22,000 of net futures losses, and $75,000 of net futures gains, respectively, from hedging activities. At December 31, 1998 the Bank had $17,000 of net deferred gains. At December 31, 1997, the Bank had $2,000 of net deferred gains on futures contracts.
The following is a summary of the notional amount of interest rate futures contract activity for the periods indicated:
16. Income Taxes
Total income tax expense was allocated as follows for the periods indicated:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Retained earnings at December 31, 1998 include $59.4 million of tax bad debt reserves for which no provision for income taxes has been made. If in the future this amount or a portion thereof, is used for certain purposes other than to absorb losses on bad debts, an income tax liability will be imposed on the amount so used at the then current corporate income tax rate. If deferred taxes were required to be provided on this item, the amount of this deferred tax liability would be approximately $23.5 million.
Income tax expense (benefit) attributable to income from continuing operations for the periods indicated is summarized as follows:
The reasons for the differences between the effective income tax rate attributable to income from continuing operations and the corporate federal income tax rate are summarized in the following table:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below:
The Company believes that it is more likely than not that the net deferred tax asset will be realized, based on historical taxable income levels and anticipated future earnings and taxable income levels. The Company has reported federal taxable income and pre-tax book income amounts totaling approximately $113 million and $122 million over the past two years, respectively.
17. Regulatory Capital
The Bank is subject to regulatory capital requirements under the OTS. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators which could have a material impact 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.
Quantitative measures established by the OTS to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (as set forth in the table on the following page) of three capital requirements: a tangible capital (as defined in the regulations) to adjusted total assets ratio, a core capital (as defined) to adjusted total assets ratio, and a risk-based capital (as defined) to total risk-weighted assets ratio. Management believes, as of December 31, 1998, that the Bank meets all capital adequacy requirements to which it is subject.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
The Bank's actual capital amounts and ratios, as well as minimum amounts and ratios required for capital adequacy and prompt corrective action provisions are presented below:
OTS regulations require that in meeting the tangible, core and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities not permissible for a national bank. For the Bank, this includes its $12.5 million investment in Mid America Developments and NW Financial at December 31, 1998, all of which the Bank must deduct from regulatory capital for purposes of calculating its capital requirements.
The Bank is subject to certain annual restrictions on the amount of dividends it may declare to the Company without prior regulatory approval, based on its earnings and its excess capital over the minimum required for capital adequacy purposes. At December 31, 1998, $43.8 million of the Bank's retained earnings were available for dividend declaration without prior regulatory approval.
As of December 31, 1998 and 1997, the most recent notification from the 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 a minimum core capital to adjusted total assets, risk-based capital to adjusted risk-weighted assets, and core capital to adjusted risk-weighted assets ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank's category.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
18. Officer, Director and Employee Benefit Plans
Employee Stock Ownership Plan (ESOP). The Mid America Bank, fsb ESOP covers substantially all employees with more than one year of employment who have attained the age of 21. Contributions to the ESOP by the Bank are currently made to purchase additional common shares of the Company's stock. For the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, total contributions to the ESOP were $800,000, $750,000, $598,000, and $360,000, respectively. The Company purchased 34,314, 35,250, 51,750, and 32,079 of its own shares on behalf of the ESOP for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and year June 30, 1996, respectively.
Profit Sharing Plan/401(k) Plan. The Mid America Bank, fsb Profit Sharing/401(k) Plan allows employees to make pre-tax contributions of up to 15% of their compensation and after-tax contributions of up to 10% of compensation, subject to certain limitations. The Bank matches the pre-tax contributions of employees at a rate equal to 35% of the first 4% of salary deferral up to $30,000 of annual compensation, and 25% of the first 2% of salary deferral for annual compensation over $30,000. The Bank, at its discretion, may make additional contributions. Employees' contributions vest immediately while the Bank's contributions vest gradually based on an employee's years of service. The Bank made discretionary and matching contributions of $800,000, $700,000, $62,000, and $360,000 for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, respectively.
Westco Benefit Plans. The Westco ESOP and Westco Profit Sharing Plan will be merged with the Mid America Bank, fsb ESOP and Mid America Bank, fsb Profit Sharing/401(k) Plan, respectively, during 1999. The Westco Retirement Plan will be terminated during 1999. There is no financial statement impact for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and the year ended June 30, 1996 for any of these plans.
Stock Option Plans. The Company and its shareholders have adopted an incentive stock option plan ("Incentive Plan") and a premium price stock option plan ("Premium Plan") for the benefit of employees and directors of the Bank.
The number of shares of common stock authorized under the Incentive Plan is 2,227,791. The option exercise price must be at least 100% of the fair market value of the common stock on the date of grant, and the option term cannot exceed 10 years. A summary of the stock option activity and related information in the Incentive Plan follows:
At December 31, 1998, options for 639,603 shares were available for grant under the Incentive Plan.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
The number of shares of common stock authorized under the Premium Plan is 556,875. The option exercise price equals 133% of the fair market value of the common stock on the date of grant with respect to executive officers, 110% with respect to directors and 100% with respect to non-executive employees. The option term cannot exceed 10 years. A summary of the stock option activity and related information in the Premium Plan follows:
At December 31, 1998, options for 102,747 shares were available for grant under the Premium Plan.
In conjunction with the Company's acquisitions, certain stock options owned by individuals of the acquired institutions were carried over into stock options of the Company based on the transactions' exchange ratios. The values of these stock options were included in the purchase price of the transactions as well as in additional paid-in capital in the consolidated statements of financial condition. A summary of the activity in these carryover stock options is as follows:
The following table summarizes information about stock options outstanding at December 31, 1998:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for its Incentive and Premium stock option plans. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated in the table below:
The fair value of each option grant is estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants during the year ended December 31, 1998, December 31, 1997 and the six months ended December 31, 1996, respectively: dividend yield of .84%, 1.05% and 1.33%; expected volatility of 21.1%, 17.9% and 18.6%; risk-free interest rates of 5.80%, 6.72% and 6.34%; expected life of 10 years for each period.
Supplemental Executive Retirement Plan. The Bank sponsors a supplemental executive retirement plan ("SERP") for the purpose of providing certain retirement benefits to executive officers and other corporate officers approved by the Board of Directors. The annual retirement plan benefit under the SERP is calculated equal to 2% of final average salary times the years of service after 1994. Ten additional years of service are credited to participants in the event of a change in control transaction although in no event may total years of service exceed 20 years. The maximum annual retirement is equal to 40% of final average salary. Benefits are payable in various forms in the event of retirement, death, disability and separation from service, subject to certain conditions defined in the plan. The SERP also provides for certain death benefits to the extent such amounts exceed a participant's accrued benefit at the time of death. The plan is unfunded, however, the Company funds life insurance policies that may be used to satisfy obligations of the SERP.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
The following table sets forth the change in benefit obligations and the related assumptions for the SERP for the periods indicated:
The following sets forth the components of the net periodic benefit cost related to the SERP for the period indicated:
19. Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk
The Bank is a party to various financial instruments with off-balance sheet risk in the normal course of its business. These instruments include commitments to extend credit, standby letters of credit, and forward commitments to sell loans. These financial instruments carry varying degrees of credit and interest- rate risk in excess of amounts recorded in the financial statements.
Commitments to originate and purchase loans of $332.0 million at December 31, 1998, represent amounts which the Bank plans to fund within the normal commitment period of 30 to 90 days of which $248.8 million were fixed-rate, with rates ranging from 5.50% to 8.25%, and $83.2 million were adjustable-rate loans. Because the credit worthiness of each customer is reviewed prior to extension of the commitment, the Bank adequately controls their credit risk on these commitments, as it does for loans recorded on the balance sheet. As part of its effort to control interest-rate risk on these commitments, the Bank generally sells fixed-rate mortgage loan commitments, for future delivery, at a specified price and at a specified future date. Such commitments for future delivery present a risk to the Bank, in the event it cannot deliver the loans during the delivery period. This could lead to the Bank being charged a fee for non- performance, or being forced to reprice the mortgage loans at a lower rate,
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
causing a loss to the Bank. The Bank seeks to mitigate this potential loss by charging potential borrowers, at the time of application, a fee to fix the interest rate, or by requiring the interest rate to float at market rates until shortly before closing. At December 31, 1998, forward commitments to sell mortgage loans for future delivery were $112.3 million, of which $89.4 million are related to loans held for sale, and $22.9 million are unfunded as of December 31, 1998.
Additionally, the Bank has approved, but unused, home equity lines of credit of $90.1 million at December 31, 1998. Approval of equity lines is based on underwriting standards that generally do not allow total borrowings, including the equity line of credit to exceed 80% of the current appraised value of the customer's home, which is similar to guidelines used when the Bank originates first mortgage loans, and are a means of controlling its credit risk on the loan. However, the Bank offers home equity lines of credit up to 100% of the homes current appraised value, less existing liens, at a commensurate higher interest rate.
At December 31, 1998, the Bank had standby letters of credit totaling $15.7 million. Two of these standby letters of credit total $13.3 million, and enhance a developer's industrial revenue bond financings of commercial real estate in the Bank's market. One of these, in the amount of $6.5 million, is related to a foreclosed real estate parcel. At December 31, 1998, the Bank had pledged mortgage-backed securities and investment securities with an aggregate carrying value and market value of $22.3 million and $25.4 million respectively, as collateral for these two standby letters of credit. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in these transactions is essentially the same as that involved in extending a loan to a customer, as performance under the letters of credits creates a first position lien in favor of the Bank. Additionally, at December 31, 1998, the Company had 15 standby letters of credit totaling $7.9 million, which insure the completion of land development improvements on behalf of MAF Developments, Inc.
The contractual amounts of credit-related financial instruments such as commitments to extend credit, and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.
In addition to financial instruments with off-balance sheet risk, the Bank is exposed to varying risks with concentrations of credit. Concentrations of credit include significant lending activities in specific geographical areas and large extensions of credit to individual borrowers. The Bank's loan portfolio primarily consists of loans within its market area. At December 31, 1998 and 1997, loans representing 92.6% and 84.9%, respectively, of the Bank's total loans receivable were located in the State of Illinois.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
20. Parent Company Only Financial Information
The information as of December 31, 1998, and 1997, and for the years ended December 31, 1998, December 31, 1997, the six months ended December 31, 1996 and 1995, and the year ended June 30, 1996 presented below should be read in conjunction with the other Notes to Consolidated Financial Statements.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
21. Segment Information
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" (SFAS No. 131) was issued in June 1997, and utilizes the "management approach" for segment reporting. This approach is based on the way that a chief decision maker for the Company organizes segments for making operating decisions and assessing performance.
The Company operates two separate lines of business. The Bank operates primarily as a retail consumer bank, participating in mortgage loan portfolio lending, deposit gathering and offering other financial services mainly to individuals. Land development consists primarily of developing raw land for residential use and sale to builders. Selected segment information is included in the table below:
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
22. Fair Values of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" requires the disclosure of estimated fair values of all asset, liability and off-balance sheet financial instruments. The estimated fair value amounts under SFAS No.107 have been determined as of a specific point in time utilizing various available market information, assumptions and appropriate valuation methodologies. Accordingly, the estimated fair values presented herein are not necessarily representative of the underlying value of the Company. Rather the disclosures are limited to reasonable estimates of the fair value of only the Company's financial instruments. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. The Company does not plan to sell most of its assets or settle most of its liabilities at these fair values.
The estimated fair values of the Company's financial instruments as of December 31, 1998 and 1997 are set forth in the following table below.
The following methods and assumptions are used by the Company in estimating the fair value amounts for its financial instruments.
Cash and cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to the relatively short period of time between the origination of the instruments and their expected realization.
Investment securities and mortgage-backed securities. The fair value of these financial instruments were estimated using quoted market prices, when available. If quoted market prices were not available, fair value was estimated using quoted market prices for similar assets. The fair value of FHLB of Chicago stock is based on its redemption value.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (Continued)
Loans receivable. The fair value of loans receivable held for investment is estimated based on contractual cash flows adjusted for prepayment assumptions, discounted using the current rate at which similar loans would be made to borrowers with similar credit ratings and remaining terms to maturity. The fair value of mortgage loans held for sale are based on estimated values that could be obtained in the secondary market.
Interest receivable and payable. The carrying value of interest receivable, net of the reserve for uncollected interest, and interest payable approximates fair value due to the relatively short period of time between accrual and expected realization.
Deposits. The fair value of deposits with no stated maturity, such as demand deposit, passbook savings, NOW and money market accounts, are disclosed as the amount payable on demand. The fair value of fixed-maturity deposits is the present value of the contractual cash flows discounted using interest rates currently being offered for deposits with similar remaining terms to maturity.
Borrowed funds. The fair value of FHLB of Chicago advances and reverse repurchase agreements is the present value of the contractual cash flows, discounted by the current rate offered for similar remaining maturities. The carrying value of the unsecured term bank loan approximates fair value due to the short term to repricing and adjustable rate nature of the loan.
The fair values of the subordinated capital notes and CMO bonds payable were estimated using quoted market prices.
Commitments to extend credit and standby letters of credit. The fair value of commitments to extend credit is estimated based on current levels of interest rates versus the committed rates. As of December 31, 1998 and 1997, the fair value of the Bank's mortgage loan commitments of $332.0 million and $173.9 million, respectively, was $471,000 and $512,000, respectively, which represents the differential between the committed value and value at current rates. The fair value of the standby letters of credit approximate the recorded amounts of related fees and are not material at December 31, 1998 and 1997.
Mortgage servicing rights. The fair value of mortgage servicing rights is estimated based on the contractual terms of the servicing agreements and the underlying mortgage loans, the current levels of interest rates, and assumed prepayment rates on the underlying mortgage loans. As of December 31, 1998 and 1997, the estimated fair value of the Bank's purchased mortgage servicing rights of $4.2 million and $2.5 million, was $4.2 million, and $2.8 million, respectively. In addition, the estimated value of the mortgage servicing rights related to the remaining loans serviced for others totaling $546.0 million and $741.5 million as of December 31, 1998 and 1997, respectively, for which there is no recorded balance, was $6.2 million and $8.2 million, respectively.
MAF Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements - (End)
23. Selected Quarterly Financial Data (Unaudited)
The following are the consolidated results of operations on a quarterly basis:
Independent Auditors' Report
The Board of Directors MAF Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition of MAF Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 1998, the six months ended December 31, 1996 and the year ended June 30, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MAF Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 1998, the six months ended December 31, 1996, and the year ended June 30, 1996, in conformity with generally accepted accounting principles.
KPMG LLP
Chicago, Illinois January 29, 1999
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information regarding directors of the registrant is included in the Registrant's proxy statement under the heading "Election of Directors" and the information included therein is incorporated herein by reference. Information regarding the executive officers of the registrant and the Bank is included in "Part I. Business."
Item 11.
Item 11. Executive Compensation
Information regarding compensation of executive officers and directors is included in the registrant's proxy statement under the headings "Directors Compensation," "Executive Compensation - Summary Compensation Table," "Employment and Special Termination Agreements," "Supplemental Executive Retirement Plan," "Option Plans," and "Long Term Incentive Plan," and the information included therein is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners and management is included in the registrant's proxy statement under the headings "Voting Securities," and "Security Ownership of Certain Beneficial Owners," and "Information With Respect to Nominees, Continuing Directors and Others," and the information included therein is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions is included in the registrant's proxy statement under the heading "Transactions with Certain Related Persons," and the information included therein is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K
(a)(1) Financial Statements
The following consolidated financial statements of the registrant and its subsidiaries are filed as a part of this document under "Item 8. Financial Statements and Supplementary Data."
Consolidated Statements of Financial Condition at December 31, 1998 and 1997.
Consolidated Statements of Operations for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996 and 1995 (unaudited) and the year ended June 30, 1996.
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996 and the year ended June 30, 1996.
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1997, the six months ended December 31, 1996 and the year ended June 30, 1996.
Notes to Consolidated Financial Statements.
Independent Auditors' Report.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
(a)(3) Exhibits
The following exhibits are either filed as part of this report or are incorporated herein by reference:
Exhibit No. 3. Certificate of Incorporation and By-laws.
(i) Certificate of Incorporation, as amended. (Incorporated herein by reference to exhibit No. 3 to Registrant's June 30, 1996 Form 10-K).
(ii) Bylaws of Registrant, as amended. (Incorporated herein by reference to exhibit No. 3 to Registrant's June 30, 1990 Form 10-K).
Exhibit No. 10. Material Contracts
(i) Mid America Bank, fsb Employee Stock Ownership Plan; as amended.*
(ii) Trust Agreement between Mid America Bank, fsb and LaSalle National Bank, Trustee (as successor to NBD Bank, N.A., INB National Bank and Chesterton State Bank) for the Mid America Bank, fsb Employee Stock Ownership Trust. (Incorporated herein by reference to Exhibit No. 10 to Registrant's June 30, 1990 Form 10-K).*
(iii) Mid America Bank, fsb Management Recognition and Retention Plan and Trust Agreement. (Incorporated herein by reference to Exhibit No. 10 to Registrant's June 30, 1992 Form 10-K).*
(iv) MAF Bancorp, Inc. 1990 Incentive Stock Option Plan, as amended. (Incorporated herein by reference to Exhibit A to Registrant's Proxy Statement, dated March 23, 1998, relating to the 1998 Annual Meeting of Shareholders, File No. 0-18121).*
(v) MAF Bancorp, Inc. 1993 Amended and Restated Premium Price Stock Option Plan.*
(vi) Credit Agreement dated as of May 22, 1996, as amended, between MAF Bancorp, Inc. and Harris Trust and Savings Bank.
(vii) Mid America Bank, fsb Employees' Profit Sharing Plan, as amended.*
(viii) Mid America Federal Savings and Loan Association Deferred Compensation Trust Agreement. (Incorporated herein by reference to Exhibit No. 10 to Registrant's June 30, 1990 Form 10-K).*
(ix) Mid America Bank, fsb Directors' Deferred Compensation Plan. (Incorporated herein by reference to Exhibit No. 10 to Registrant's December 31, 1997 Form 10-K).*
(x) Mid America Bank, fsb Executive Deferred Compensation Plan. (Incorporated herein by reference to Exhibit No. 10 to Registrant's December 31, 1997 Form 10-K).*
(xi) MAF Bancorp, Inc. Executive Annual Incentive Plan. (Incorporated herein by reference to Exhibit No. 10 to Registrant's June 30, 1994 Form 10-K).*
(xii) MAF Bancorp, Inc. Shareholder Value Long-Term Incentive Plan, as amended.*
(xiii) Mid America Bank, fsb Supplemental Executive Retirement Plan, as amended.*
(xiv) Form of Employment Agreement, as amended, between MAF Bancorp, Inc. and various officers.*
(xv) Form of Employment Agreement, as amended, between Mid America Bank, fsb and various officers.*
(xvi) Employment Agreement between David C. Burba and MAF Bancorp, Inc.*
(xvii) Form of Special Termination Agreement, as amended, between MAF Bancorp, Inc. and various officers. (Incorporated herein by reference to exhibit No. 10 to Registrant's June 30, 1996 Form 10-K).*
(xviii) Form of Special Termination Agreement, as amended, between Mid America Bank, fsb and various officers. (Incorporated herein by reference to Exhibit No. 10 to Registrant's December 31, 1997 Form 10-K).*
(xix) Agreement Regarding Post-Employment Restrictive Covenants between MAF Bancorp, Inc., Mid America Bank, fsb and David C. Burba.*
(xx) Form of Agreement Regarding Post-Employment Restrictive Covenants between MAF Bancorp, Inc., Mid America Bank, fsb and Richard A. Brechlin and Gregg P. Goossens.*
(xxi) N.S. Bancorp, Inc. 1990 Incentive Stock Option Plan, as amended (Incorporated by reference to Registrant's Form S-8 Registration Statement No. 333-06593).*
(xxii) Westco Bancorp, Inc. 1992 Incentive Stock Option Plan, as amended (Incorporated by reference to the Post-Effective Amendment No. 1 to Form S-8 Registration Statement filed by Westco Bancorp, Inc. with the Commission on March 17, 1995, Registration Statement No. 33-54764 and to Exhibit 99.2 to the Registrant's Post-Effective Amendment No. 1 on Form S-8 to Form S-4, Registration Statement No. 33-66693).*
(xxiii) Westco Bancorp, Inc. 1992 Stock Option Plan for Outside Directors (Incorporated by reference to the Post-Effective Amendment No. 1 to Form S-8 Registration Statement filed by Westco Bancorp, Inc. with the Commission on March 17, 1995, Registration No. 33-54766 and to Exhibit 99.4 to the Registrant's Post-Effective Amendment No. 1 on Form S-8 to Form S-4, Registration Statement No. 33-66693).*
___________________ * Indicates management contracts or compensatory plans or arrangements required to be filed as an exhibit
Exhibit No. 11. Statement re: Computation of Per Share Earnings for the periods indicated:
Exhibit No. 12. Statements re: computation of ratio of earnings to fixed charges.
Exhibit No. 21. Subsidiaries of the Registrant
A list of the Company's and Mid America Bank's subsidiaries is included as an exhibit to this report.
Exhibit No. 23. Consent of KPMG LLP
Exhibit No. 24. Power of Attorney (Included on Signature Page)
Exhibit No. 27. Financial Data Schedule
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MAF Bancorp, Inc. ----------------------------- (Registrant)
By: /s/ Allen H. Koranda ----------------------------- Allen H. Koranda Chairman of the Board and Chief Executive Officer
March 5, 1999 ----------------------------- (Date)
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Allen H. Koranda or Kenneth Koranda or either of them, his true and lawful attorney-in-fact and agents, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming said attorneys-in-fact and agents or their substitutes or substitute may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: /s/ Allen H. Koranda March 5, 1999 ------------------------------------ -------------- Allen H. Koranda (Date) Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
By: /s/ Jerry A. Weberling March 5, 1999 ------------------------------------ -------------- Jerry A. Weberling (Date) Executive Vice President and Chief Financial Officer and Director (Principal Financial Officer)
By: /s/ Gerard J. Buccino March 5, 1999 ------------------------------------ -------------- Gerard J. Buccino (Date) Senior Vice President and Controller (Principal Accounting Officer)
By: /s/ Robert Bowles, M.D. March 5, 1999 ----------------------------- ----------------- Robert Bowles, M.D. (Date) Director
By: /s/ David C. Burba March 5, 1999 ----------------------------- ----------------- David C. Burba (Date) Director
By: /s/ Terry Ekl March 5, 1999 ----------------------------- ----------------- Terry Ekl (Date) Director
By: /s/ Joe F. Hanauer March 5, 1999 ----------------------------- ----------------- Joe F. Hanauer (Date) Director
By: /s/ Kenneth Koranda March 5, 1999 ----------------------------- ----------------- Kenneth Koranda (Date) Director
By: /s/ Henry Smogolski March 5, 1999 ----------------------------- ----------------- Henry Smogolski (Date) Director
By: /s/ F. William Trescott March 5, 1999 ----------------------------- ----------------- F. William Trescott (Date) Director
By: /s/ Lois B. Vasto March 5, 1999 ----------------------------- ----------------- Lois B. Vasto (Date) Director
By: /s/ Andrew J. Zych March 5, 1999 ----------------------------- ----------------- Andrew J. Zych (Date) Director