-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AdV+c2vqBzX6AfusB9K08WT6UKdHhxcGvlHiW6NVgHGBOXf6Pdg+YmYo4pIWw9w7 L6lJw5FnqOvXZES65M5d6w== 0000950137-03-001892.txt : 20030331 0000950137-03-001892.hdr.sgml : 20030331 20030331160520 ACCESSION NUMBER: 0000950137-03-001892 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20030331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CFS BANCORP INC CENTRAL INDEX KEY: 0001058438 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 332042093 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-24611 FILM NUMBER: 03630787 BUSINESS ADDRESS: STREET 1: 707 RIDGE ROAD CITY: MUNSTER STATE: IN ZIP: 46321 BUSINESS PHONE: 2198365500 MAIL ADDRESS: STREET 1: 707 RIDGE ROAD CITY: MUNSTER STATE: IN ZIP: 46321 10-K 1 c75186e10vk.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No.: 0-24611 CFS BANCORP, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 33-2042093 - ------------------------------------- ---------------------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 707 Ridge Road Munster, Indiana 46321 - ------------------------------------- ---------------------------------- (Address of Principal (Zip Code) Executive Offices) Registrant's telephone number, including area code: (219) 836-9990 Securities registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to Section 12(g) of the Act: Common Stock (par value $0.01 per share) - -------------------------------------------------------------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES [X] NO [ ] As of June 30, 2002, the aggregate value of the 12,472,591 shares of Common Stock of the Registrant outstanding on such date, which excludes 784,757 shares held by all directors and executive officers of the Registrant as a group, was approximately $192.8 million. This figure is based on the last known trade price of $15.46 per share of the Registrant's Common Stock on June 30, 2002. Number of shares of Common Stock outstanding as of March 7, 2003: 12,289,297 DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated: (1) Portions of the Company's Annual Report to Stockholders for the year ended December 31, 2002 (the "2002 Annual Report") are incorporated into Parts II and IV. (2) Portions of the definitive proxy statement for the Annual Meeting of Stockholders to be held on April 29, 2003 are incorporated into Part III. 2 When used in this Annual Report on Form 10-K or future filings by the Company with the Securities and Exchange Commission ("SEC"), in the Company's press releases or other public or stockholder communications, the words or phrases "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, changes in levels of market interest rates, credit and other risks which are inherent in the Company's lending and investment activities, legislative changes, changes in the cost of funds, demand for loan products and financial services, changes in accounting principles and competitive and regulatory factors, could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected. Such forward-looking statements are not guarantees of future performance. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. PART I. ITEM 1. BUSINESS GENERAL CFS Bancorp, Inc. (the "Company") was organized in March 1998 at the direction of the Board of Directors of Citizens Financial Services, FSB (the "Bank" or "Citizens Financial") for the purpose of holding all of the capital stock of the Bank and in order to facilitate the conversion of the Bank from a federally-chartered mutual savings bank to a federally-chartered stock savings bank (the "Conversion"). (Unless the context otherwise requires, reference to the Company includes the Bank and the Bank's subsidiaries). In connection with the Conversion, the Office of Thrift Supervision (the "OTS") approved the Company's application to become a savings and loan holding company. The Company now conducts business as a registered unitary savings and loan holding company and is subject to oversight and examination by the OTS. See "Regulation - Regulation of Savings and Loan Holding Companies." Immediately after the Conversion, on July 24, 1998, SuburbFed Financial Corp., a Delaware corporation with its principal place of business in Illinois ("SFC"), merged with and into the Company (the "Merger"). In connection with the Merger, each outstanding share of SFC common stock, par value $0.01 per share, was converted into the right to receive 3.6 shares of the Company's Common Stock. The Conversion and the Merger were interdependent transactions. The Merger was accounted for on a pooling-of-interests basis and, as such, all financial data in this report includes the assets and the liabilities of the Company and SFC and their subsidiaries on a combined basis. The Company's assets consist of the outstanding shares of common stock of the Bank, investments made with the portion of the net proceeds from the sale of Company shares in the 3 Company's July 1998 initial public offering (which was undertaken in conjunction with the Conversion) (the "Offering") retained by the Company, and the Company's loan to the Bank for the employee stock ownership plan (the "ESOP"). The Company has no significant liabilities. The management of the Company and the Bank are substantially identical, and the Company neither owns nor leases any property but instead uses the premises, equipment and furniture of the Bank. The Company does not employ any persons other than officers who are also officers of the Bank. In addition the Company utilizes the support staff of the Bank from time to time. Additional employees may be hired as appropriate to the extent the Company expands or changes its business in the future. Management believes that the holding company structure provides the Company and the Bank with additional flexibility to diversify its business activities through existing or newly-formed subsidiaries, or through acquisitions of other entities, including potentially other financial institutions and financial services-related companies. Such expansion is subject to regulatory limitations and the Company's financial position. The activities of the Company have been funded by the portion of the net proceeds of the Offering which was retained by the Company and earnings thereon, as well as dividends from the Bank. The Bank is subject to examination and comprehensive regulation by the OTS, which is the Bank's chartering authority and primary federal regulator. The Bank is also regulated by the Federal Deposit Insurance Corporation (the "FDIC"), administrator of the Savings Association Insurance Fund (the "SAIF"). The Bank is also subject to certain reserve requirements established by the Board of Governors of the Federal Reserve System (the "FRB") and is a member of the Federal Home Loan Bank (the "FHLB") of Indianapolis, which is one of the 12 regional banks comprising the FHLB System. Citizens Financial is a federally-chartered stock savings bank that was originally organized in 1934. The Bank conducts its business from its executive offices in Munster, Indiana, as well as 23 banking centers located in Lake and Porter Counties in northwest Indiana and Cook, DuPage and Will Counties in Illinois. At December 31, 2002, the Company had $1.6 billion in total assets, $954.2 million in deposits, $449.4 million in borrowed funds and $160.7 million of stockholders' equity. The Bank is primarily engaged in attracting deposits from the general public and using those funds to originate loans and invest in securities. During 1998 the Bank began leveraging its capital base, using borrowings to provide additional funds to support its lending and investing activities. Historically, the Bank's primary lending emphasis was on loans secured by the first liens on single-family (one-to four-units) residential properties located in northwest Indiana and southeastern Cook County, Illinois. However, the Bank decided not to participate aggressively in the substantial refinancing of home loans that occurred nationally in 2001 and 2002 due to record low interest rates. Instead the Banks' strategy was to accumulate liquidity in order to take advantage of loans and other investments that would become available as the economy improved and interest rates rose to expected higher levels. The Bank also originated construction and land development loans, multi-family residential real estate loans, commercial real estate and other commercial loans, home equity loans and other loans. Since 1998, the Bank has shifted its lending emphasis, increasing its involvement in construction and land development loans, commercial loans and commercial and multi-family real estate loans while concurrently reducing its originations of single-family residential loans. 4 AVAILABLE INFORMATION CFS Bancorp, Inc. is a public company and files annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. The Company's filings are available to the public at the SEC's web site at http://www.sec.gov. Members of the public may also read and copy any document the Company files at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these documents by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for more information about the operation of the public reference room. In addition, the Company's stock is listed for trading on the Nasdaq National Market and trades under the symbol "CITZ." You may find additional information regarding the Company at www.nasdaq.com. In addition to the foregoing, the Company maintains a web site at www.bankcfs.com. The Company makes available on its Internet web site copies of its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such documents as soon as reasonably practicable after we file such material with or furnish such documents to the SEC. MARKET AREA AND COMPETITION Citizens Financial operates out of its headquarters in Munster, Indiana, which is located in Lake County in northwest Indiana. Citizens Financial also maintains 23 banking centers in Lake and Porter Counties in northwest Indiana and in Cook, DuPage and Will Counties in Illinois. The areas served by Citizens Financial are part of the Chicago Metropolitan Statistical Area. Citizens Financial has historically concentrated its efforts in the market surrounding its offices. Citizens Financial's market area reflects diverse socioeconomic factors. Traditionally, the market area in northwest Indiana and the suburban areas south of Chicago were dependent on heavy manufacturing. While manufacturing still is an important component of the local economies, service-related industries have become increasingly significant to the region in the last decade. Growth in the local economies can be expected to occur largely as a result of the continued interrelation with Chicago as well as suburban business centers in the area. The Bank faces significant competition both in making loans and in attracting deposits. The Chicago metropolitan area is one of the largest money centers in the United States, and the market for deposit funds is highly competitive. The Bank's competition for loans comes principally from commercial banks, other savings banks, savings associations and mortgage-banking companies. The Bank's most direct competition for deposits has historically come from savings banks, commercial banks and credit unions. The Bank faces additional competition for deposits from short-term money market funds, other corporate and government securities funds and from other non-depository financial institutions such as brokerage firms and insurance companies. LENDING ACTIVITIES GENERAL. At December 31, 2002, the Company's net loans amounted to $930.3 million, or 58.7% of the Company's total assets, at such date. In addition to loans secured by single-family residential real estate, the Bank's mortgage loan portfolio at December 31, 2002 includes loans secured by multi-family (over four units) residential properties, which amounted to an aggregate of 5 $71.2 million, or 7.3% of the total loan portfolio, construction and land development loans, which totaled $165.0 million, or 16.8% of the total loan portfolio, loans secured by commercial real estate, which amounted to $271.4 million, or 27.7% of the loan portfolio, and home equity loans, which totaled $45.1 million, or 4.6% of the total loan portfolio. In addition to mortgage loans, the Bank originates various other loans which, at December 31, 2002, amounted to an aggregate of $42.6 million, or 4.4% of the total loan portfolio. Included in this total were $40.0 million of commercial loans and $2.6 million of consumer loans at December 31, 2002. The types of loans that the Bank may originate are subject to federal and state laws and regulations. Interest rates charged by the Bank on loans are affected principally by the demand for such loans, the supply of money available for lending purposes, the rates offered by its competitors and the risks involved on such loans. These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters. 6 LOAN PORTFOLIO COMPOSITION. The following table sets forth the composition of the Bank's loans at the dates indicated.
December 31, ------------------------------------------------------------------------------ 2002 2001 2000 ------------------------------------------------------------------------------ Percent of Percent of Percent of Amount Total Amount Total Amount Total ------------------------------------------------------------------------------ (Dollars in Thousands) Mortgage loans: Single-family residential $ 386,050 39.34% $ 535,197 58.38% $ 700,790 66.62% Multi-family residential 71,170 7.25 51,635 5.63 41,903 3.98 Commercial real estate 271,426 27.66 142,663 15.56 124,477 11.83 Construction and land development: Single-family residential 12,118 1.23 17,208 1.88 29,889 2.84 Multi-family residential 63,893 6.51 26,443 2.88 43,689 4.16 Commercial and land development 88,951 9.06 76,168 8.31 70,486 6.70 Home equity 45,106 4.60 41,416 4.52 20,534 1.95 --------------------------------------------------------------------------- Total mortgage loans 938,714 95.65 890,730 97.16 1,031,768 98.08 Other loans: Commercial, non-real estate 40,034 4.08 23,996 2.62 17,503 1.66 Consumer 2,610 .27 2,066 .22 2,727 .26 --------------------------------------------------------------------------- Total loans receivable 981,358 100.00% 916,792 100.00% 1,051,998 100.00% ====== ====== ====== Less: Undisbursed portion of loan proceeds 39,704 24,454 45,022 Allowance for losses on loans 8,674 7,662 7,187 Net deferred yield adjustments 2,632 1,324 1,062 ---------- ---------- ---------- Loans receivable, net $ 930,348 $ 883,352 $ 998,727 ========== ========== ========== December 31, ---------------------------------------------------- 1999 1998 ---------------------------------------------------- Percent of Percent of Amount Total Amount Total ---------------------------------------------------- (Dollars in Thousands) Mortgage loans: Single-family residential $ 669,280 69.46% $ 596,199 80.08% Multi-family residential 33,840 3.51 21,050 2.83 Commercial real estate 93,320 9.68 38,999 5.24 Construction and land development: Single-family residential 39,045 4.05 31,516 4.23 Multi-family residential 36,843 3.82 - - Commercial and land development 57,417 5.96 19,645 2.64 Home equity 16,001 1.66 19,589 2.63 ------------------------------------------------- Total mortgage loans 945,746 98.14 726,998 97.65 Other loans: Commercial, non-real estate 13,646 1.42 11,072 1.49 Consumer 4,215 .44 6,431 .86 ------------------------------------------------- Total loans receivable 963,607 100.00% 744,501 100.00% ====== ====== Less: Undisbursed portion of loan proceeds 73,086 13,068 Allowance for losses on loans 5,973 5,357 Net deferred yield adjustments 1,872 (5) ---------- ---------- Loans receivable, net $ 882,676 $ 726,081 ========== ==========
7 CONTRACTUAL PRINCIPAL REPAYMENTS AND INTEREST RATES. The following table sets forth scheduled contractual amortization of the Bank's loans at December 31, 2002, as well as the dollar amount of such loans which are scheduled to mature after one year which have fixed or adjustable interest rates. Demand loans, loans having no schedule of repayments and no stated maturity, and overdraft loans are reported as due in one year or less.
Principal Repayments Contractually Due In Year(s) Ended December 31, ----------------------------------------- Total at December 31, 2002 2003 2004-2007 Thereafter ----------------------------------------------------------- (In Thousands) Mortgage loans: Single-family residential $386,050 $ 2,315 $ 14,939 $368,796 Multi-family residential 71,170 1,420 30,393 39,357 Commercial real estate 271,426 6,826 64,835 199,765 Construction and land development 164,962 61,541 72,198 31,223 Home equity 45,106 3,111 7,287 34,708 Other loans: Commercial 40,034 26,396 6,926 6,712 Consumer 2,610 843 1,608 159 ----------------------------------------------------------- Total (1) $981,358 $102,452 $198,186 $680,720 ==========================================================
- ---------- (1) Of the $878.9 million of loan principal repayments contractually due after December 31, 2003, $281.8 million have fixed rates of interest, and $597.1 million have adjustable rates of interest. Scheduled contractual amortization of loans does not reflect the expected term of the Bank's loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current market rates of interest for mortgage loans are higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are higher than current market rates as borrowers refinance adjustable-rate and fixed-rate loans at lower rates. Under the latter circumstance, the weighted average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates. 8 ACTIVITY IN LOANS. The following table shows the activity in the Bank's loans during the years indicated.
Year Ended December 31, -------------------------------------------------------------- 2002 2001 2001 1999 -------------------------------------------------------------- (In Thousands) Gross loans held at beginning of year $ 916,792 $ 1,051,998 $ 963,607 $ 744,501 Originations of loans: Mortgage loans: Single-family residential 41,007 23,541 85,871 164,302 Multi-family residential 22,588 2,477 6,165 13,910 Commercial real estate 136,994 23,191 31,035 52,596 Construction and land development: Single-family residential 10,337 12,893 37,832 47,197 Multi-family residential 41,339 6,629 15,166 37,874 Commercial and land development 46,450 43,482 38,465 57,788 Home equity 42,331 30,689 19,078 13,163 Other loans: Commercial 76,137 14,831 17,883 21,009 Consumer 2,947 1,328 825 3,715 -------------------------------------------------------------- Total originations 420,130 159,061 252,320 411,554 -------------------------------------------------------------- Purchases of participating interests in loans: Single-family residential 2,515 12,920 13 24 Multi-family residential 7,840 -- -- -- Commercial real estate 46,861 1,108 -- -- Commercial 8,709 15,000 -- -- -------------------------------------------------------------- Total purchases 65,925 29,028 13 24 -------------------------------------------------------------- Total originations and purchases 486,055 188,089 252,333 411,578 -------------------------------------------------------------- Single-family residential loans sold (22,014) (5,873) (1,335) (8,628) Multi-family residential loans sold (900) -- -- -- Transfers to real estate owned (2,382) (1,875) (1,721) (1,112) Charge-offs (1,183) (855) (2,279) (171) Repayments (395,010) (314,692) (158,607) (182,561) -------------------------------------------------------------- Net activity in loans 64,567 (135,206) 88,391 219,106 -------------------------------------------------------------- Gross loans held at end of year $ 981,358 $ 916,792 $ 1,051,998 $ 963,607 ==============================================================
The lending activities of Citizens Financial are subject to the credit policy approved by the Bank's Board of Directors. Applications for mortgage and consumer loans are taken at all of the Bank's branch offices, while commercial loan officers take loan applications at both the Bank's offices and the customers' offices. In addition, the Bank's business development officers call on individuals and businesses in the Bank's market area in their efforts to solicit new loan 9 originations as well as other banking relationships. All loan applications are forwarded to the Bank's credit administration offices for underwriting and analysis. The Bank requires that a property appraisal or evaluation be obtained in connection with all new real estate mortgage loans. Citizens Financial requires that title insurance and hazard insurance be maintained on all security properties (except for home equity loans) and that adequate flood insurance be maintained if the property is within a designated flood plain. Certain officers of the Bank have been authorized by the Board of Directors to approve loans up to certain designated amounts. The Asset/Liability Management Committee of Citizens Financial meets weekly and reviews all loans that exceed individual loan authority. The full Board of Directors of Citizens Financial is provided with a monthly report of all loans made in the period. A federal savings bank generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus (or approximately $19.8 million in the case of the Bank at December 31, 2002), although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities. Generally, Citizens Financial's aggregate loans to one borrower and related entities have been well below the regulatory limits. As of December 31, 2002, Citizens Financial's two largest relationships with one borrower and related entities amounted to $24.2 million and $19.9 million, and all of the Bank's loans included in such relationships were performing in accordance with their terms. Both relationships were originated when the Bank's loans to one borrower limitation was greater than the current level of $19.8 million. The Bank currently has a general policy of limiting any one loan or multiple loans to the same borrower to 75% of the legal limit. SINGLE-FAMILY RESIDENTIAL AND HOME EQUITY LOANS. Substantially all of the Bank's single-family residential mortgage loans consist of conventional loans. Conventional loans are loans that are neither insured by the Federal Housing Administration ("FHA") nor partially guaranteed by the Department of Veterans Affairs ("VA"). The vast majority of the Bank's single-family residential mortgage loans are secured by properties located in northwest Indiana and DuPage, Will and Cook Counties, Illinois. Historically, the Bank retained virtually all mortgage loans which it originated and did not engage in sales of residential mortgage loans. Beginning July 1, 1999, the Bank instituted a new policy and began selling its newly originated fixed-rate loans; such sales amounted to $22.0 million in 2002 and included the release of servicing. As of December 31, 2002, $386.1 million, or 39.3%, of the Bank's total loans consisted of single-family residential mortgage loans. Citizens Financial originated $41.0 million, $23.5 million and $85.9 million of single-family residential mortgage loans in 2002, 2001 and 2000, respectively. Although the Bank will continue to originate single-family residential mortgage loans, it anticipates construction and land development, commercial and commercial real estate and multi-family real estate loans will continue to increase as a percentage of total new loan originations as the Bank continues to implement its strategic plan. Citizens Financial's residential mortgage loans have either fixed rates of interest or interest rates which adjust periodically during the term of the loan. Fixed-rate loans generally have maturities of 10, 15 or 30 years and are fully amortizing with monthly loan payments 10 sufficient to repay the total amount of the loan with interest by the end of the loan term. The Bank's fixed-rate loans are generally originated under terms, conditions and documentation which permit them to be sold to U.S. Government-sponsored agencies ("GSE's"), such as the Federal National Mortgage Association ("Fannie Mae"), and other investors in the secondary market for mortgages. At December 31, 2002, $97.4 million, or 25.3% of the Bank's single-family residential mortgage loans, were fixed-rate loans. Substantially all of the Bank's single-family residential mortgage loans contain due-on-sale clauses, which permit the Bank to declare the unpaid balance to be due and payable upon the sale or transfer of any interest in the property securing the loan. The Bank enforces such due-on-sale clauses. The adjustable-rate single-family residential mortgage ("ARM") loans currently offered by the Bank have interest rates which are fixed for the initial three or five years and are thereafter adjusted on an annual basis in accordance with a designated index such as one-year U.S. Treasury obligations adjusted to a constant maturity ("CMT"), plus a stipulated margin. The Bank's adjustable-rate single-family residential real estate loans generally have a cap of 2% on any increase or decrease in the interest rate at any adjustment date and include a specified cap on the maximum interest rate over the life of the loan, which cap generally is 6% above the initial rate. From time to time, based on prevailing market conditions, the Bank may offer ARM loans with initial rates which are below the fully indexed rate. Such loans generally are underwritten based on the fully indexed rate. The Bank's adjustable-rate loans require that any payment adjustment resulting from a change in the interest rate of an adjustable-rate loan be sufficient to result in full amortization of the loan by the end of the loan term and, thus, do not permit any of the increased payment to be added to the principal amount of the loan, or so-called negative amortization. At December 31, 2002, $288.7 million, or 74.7% of the Bank's single-family residential mortgage loans, were adjustable-rate loans. Adjustable-rate loans decrease the Bank's risks associated with changes in interest rates but involve other risks, primarily because as interest rates increase, the loan payment by the borrower increases to the extent permitted by the terms of the loan, thereby increasing the potential for default. Moreover, as with fixed-rate loans, as interest rates increase, the marketability of the underlying collateral property may be adversely affected by higher interest rates. Also, when interest rates decline substantially, borrowers tend to refinance into fixed rate loans. The Bank believes that these risks, which have not had a material adverse effect on the Bank to date, generally are less than the risks associated with holding fixed-rate loans in an increasing interest rate environment. The volume and types of ARMs originated by Citizens Financial are affected by such market factors as the level of interest rates, competition, consumer preferences and availability of funds. Accordingly, although the Bank anticipates that it will continue to offer single-family ARMs, the increased emphasis over the past few years on originating more construction and land development and commercial and multi-family real estate loans has reduced the proportion that single-family residential loans bear to total loans. The Bank's single-family residential mortgage loans generally do not exceed amounts limited to the maximum amounts contained in GSE guidelines. In addition, the maximum loan-to-value ("LTV") ratio for the Bank's single-family residential mortgage loans generally is 95% 11 of the appraised value of the security property, provided, however, that private mortgage insurance generally is obtained on the portion of the principal amount that exceeds 80% of the appraised value. At December 31, 2002, Citizens Financial's home equity loans amounted to $45.1 million, or 4.6% of the Bank's total loans. The preponderance of the Bank's home equity loans are structured as fixed-rate, fixed-term loans, although the Bank also offers floating rate home equity lines of credit. Home equity loans, like single-family residential mortgage loans, are secured by the underlying equity in the borrower's residence. However, the Bank generally obtains a second mortgage position to secure its home equity loans. The Bank's home equity loans require LTV ratios of 90% or less after taking into consideration any first mortgage loan. The Bank originated $42.3 million, $30.7 million and $19.1 million of home equity loans in 2002, 2001 and 2000, respectively. MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LOANS. After the completion of the Conversion in July 1998, the Company increased its emphasis on the origination of commercial real estate loans, multi-family residential loans and construction and land development loans. In order to implement the Bank's strategy, the Bank has significantly increased the number of employees dedicated to multi-family residential and commercial real estate lending. Such loans often have interest rates that are adjustable or float based on the prime rate and generally have shorter terms to maturity and higher yields than the Bank's single-family residential mortgage loans. At December 31, 2002, Citizens Financial's multi-family residential mortgage loans and commercial real estate loans amounted to $71.2 million and $271.4 million, or 7.3% and 27.7%, respectively, of the Bank's total loan portfolio, as compared to $21.1 million and $39.0 million, or 2.8% and 5.2%, respectively, of the Bank's total loan portfolio at December 31, 1998 (the first fiscal year end after Conversion). The Bank's multi-family residential real estate loans are concentrated in northwest Indiana and DuPage, Will and Cook Counties, Illinois. The Bank originated $22.6 million of multi-family residential real estate loans in 2002 compared to $2.5 million and $6.2 million in 2001 and 2000, respectively. The Bank's commercial real estate loans generally are secured by hotels, medical office facilities, churches, small office buildings, strip shopping centers and other commercial uses primarily located in the Bank's market area. The Bank's commercial real estate loans usually are less than $5.0 million, and as of December 31, 2002, the average size of the Bank's commercial real estate loans was approximately $1.3 million. The Bank originated $137.0 million of commercial real estate loans during the year ended December 31, 2002 compared to $23.2 million and $31.0 million, respectively, in 2001 and 2000. As of December 31, 2002, the Bank's five largest commercial real estate and multi-family residential loan relationships were $24.2 million, $19.9 million, $17.5 million, $14.8 million and $13.8 million, all of which were performing in accordance with their terms. The Bank's multi-family residential and commercial real estate loans generally are five-year, fixed-rate loans with an amortization period of up to 25 years and loan to value ratios of not more than 80%. Citizens Financial also originates floating-rate and adjustable-rate multi-family 12 residential and commercial real estate loans. Generally, fees of between 0.5% and 1.0% of the principal loan balance are charged to the borrower upon closing. The Bank generally charges prepayment penalties on commercial real estate and multi-family residential mortgage loans. The Bank generally obtains personal guarantees of the borrower's principals as additional security for any commercial real estate and multi-family residential loans. Citizens Financial evaluates various aspects of commercial and multi-family residential real estate loan transactions in an effort to mitigate credit risk to the greatest extent possible. In underwriting these loans, consideration is given to the stability of the property's cash flow history, future operating projections, management experience, current and projected occupancy, position in the market, location and physical condition. The Bank has also generally imposed a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of not less than 120% for commercial real estate loans and for multi-family residential loans. The underwriting analysis also includes credit checks and a review of the financial condition of the borrower and guarantor. An appraisal report is prepared by an independent appraiser commissioned by the Bank to substantiate property values for every commercial real estate and multi-family loan transaction. All appraisal reports are reviewed by the Bank prior to the closing of the loan, as are environmental site assessments that are deemed necessary. Commercial real estate and multi-family residential lending entails substantially different risks when compared to single-family residential lending because such loans often involve large loan balances to single borrowers and because the payment experience on such loans is typically dependent on the successful operation of the project or the borrower's business. These risks can also be significantly affected by supply and demand conditions in the local market for apartments, offices, warehouses, or other commercial space. The Bank attempts to minimize its risk exposure by limiting such lending to proven businesses, only considering properties with existing operating performance which can be analyzed, requiring conservative debt coverage ratios, and periodically monitoring the operation and physical condition of the collateral as well as the business occupying the property. As of December 31, 2002, multi-family residential real estate loans totaling $36,000 were considered non-performing loans while $5.6 million, or 2.1%, of its commercial real estate loans were considered non-performing. The Bank also invests, on a participating basis, in multi-family and commercial real estate loans originated by other lenders. In these transactions, the Bank reviews such loans utilizing the same credit policies applicable to loans it originates. At December 31, 2002 participation loans purchased totaled approximately $60.0 million. CONSTRUCTION AND LAND DEVELOPMENT LOANS. As previously indicated, the Bank increased its emphasis on construction and land development loans beginning in the second half of 1998. Historically, in the several years prior to the Bank's Conversion, the Bank had concentrated its construction lending efforts primarily on residential construction loans to local real estate builders, generally with whom it had an established relationship. The Bank also originated such loans to individuals for the construction of their residences. Commencing in the second half of 1998, the Bank expanded its efforts to originate construction loans for commercial 13 real estate and multi-family residential properties. At December 31, 2002 the average size of construction loans for commercial real estate and multi-family residential properties was approximately $1.5 million. At December 31, 2002, construction and land development loans amounted to $165.0 million, or 16.8% of the Bank's loan portfolio (including $39.7 million of loans in process). Of the Bank's construction and land development loans at December 31, 2002, $1.7 million were construction/permanent, single-family residential loans which loans, by their terms, convert to permanent mortgage loans upon the completion of construction. The Bank originated $98.1 million of construction and land development loans during 2002, compared to $63.0 million and $91.5 million of construction and land development loans in 2001 and 2000, respectively. Of the $98.1 million of construction and land development loans originated in 2002, an aggregate of $87.8 million was for commercial real estate and multi-family residential construction loans. Of the Bank's commercial real estate and multi-family residential mortgage loans at December 31, 2002, $73.0 million were construction/permanent loans. Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property by an approved independent appraiser. The Bank's staff, or a third-party contractor retained by Citizens Financial, also reviews and inspects each project at the commencement of construction and prior to every disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspections of the project based on a percentage of completion and acknowledgement of title company lien endorsements. The Bank originates land loans to local developers for the purpose of developing the land (i.e., roads, sewer and water) for sale. Such loans are secured by a mortgage on the property, are generally limited to 75% of the appraised value of the secured property and are typically made for a period of up to two years. The Bank requires monthly interest payments during the term of the loan. The principal of the loan is reduced as lots are sold and released. All of the Bank's land loans are secured by property located in its primary market area. In addition, the Bank generally obtains personal guarantees from the borrowers' principals. The Bank's loan underwriting and processing procedures require that construction and development loans be reviewed by independent architects, engineers or other qualified third parties for verification of costs. Disbursements during the construction phase are based on regular on-site inspections and approved certifications. In the case of construction loans on commercial projects where the Bank provides the permanent financing, the Bank usually requires firm lease commitments on some portion of the property under construction from qualified tenants. In addition, the Bank limits both its residential and commercial construction lending to northwest Indiana and the Chicago-land area. At December 31, 2002 the Bank's five largest construction and land development relationships were $13.0 million, $10.4 million, $7.5 million, $6.7 million and $6.7 million, all of which were performing in accordance with their terms. Construction and development financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate. The Bank's risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated 14 cost (including interest) of construction. If the estimate of construction cost proves to be inaccurate, the Bank may need to advance funds beyond the amount originally committed to permit completion of the development. Construction and development loans generally are considered to be more difficult to evaluate and monitor than single-family residential mortgage loans. In addition, the Bank's commercial real estate and construction and development loans generally have larger principal balances than its single-family residential mortgage loans. In evaluating any new originations of construction and development loans, the Bank generally considers evidence of the availability of permanent financing or a takeout commitment to the borrower, the reputation of the borrower and the contractor, the amount of the borrower's equity in the project, independent valuations and reviews of cost estimates, pre-construction sale and leasing information, and cash flow projections of the borrower. To reduce the risk inherent in such lending, on certain occasions the Bank may require performance bonds in the amount of the construction contract and often obtains personal guarantees from the principals of the borrower. As of December 31, 2002, $1.3 million, or 0.8%, of Citizens Financial's construction and land development loans were considered non-performing. OTHER LOANS. Citizens Financial's other loans consist primarily of commercial loans, consumer loans and loans secured by deposit accounts. Included in the category of commercial loans are loans secured by business assets other than real estate, unsecured loans, and secured and unsecured operating lines of credit. As of December 31, 2002, Citizens Financial's other loans amounted to $42.6 million compared to $26.1 million and $20.2 million at December 31, 2001 and 2000, respectively. The Bank is not actively marketing its consumer loans and offers them primarily as a service to its existing customers. ASSET QUALITY GENERAL. All of the Bank's assets are subject to review under its classification system. Loans are periodically reviewed, and the classifications are reviewed by the Asset/Liability Management Committee of the Board of Directors on at least a quarterly basis. When a borrower fails to make a required payment on a loan, the Bank attempts to cure the deficiency by contacting the borrower and seeking payment. Contacts are generally made 30 days after a payment is due. In most cases, deficiencies are cured promptly. If a delinquency continues, late charges are assessed and additional efforts are made to collect the past due payments. While the Bank generally prefers to work with borrowers to resolve such problems, when the account becomes 90 days delinquent, the Bank institutes foreclosure or other proceedings, as necessary, to minimize any potential loss. Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. As a matter of policy, the Bank does not accrue interest on loans past due 90 days or more. 15 Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until sold. Foreclosed assets are held for sale and such assets are carried at the lower of fair value minus estimated costs to sell the property, or cost (generally the balance of the loan on the property at the date of acquisition with any resulting losses being charged to the allowance for losses on loans). After the date of acquisition, all costs incurred in maintaining the property are expensed, and costs incurred for the improvement or development of such property are capitalized up to the extent of their net realizable value. DELINQUENT LOANS. The following table sets forth information concerning certain delinquent loans, at the dates indicated, in dollar amounts and as a percentage of each category of the Bank's loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans. The following table contains information on loans that are 60 to 89 days delinquent. Loans that are delinquent 90 days or more are included in the table on page 17 in the non accrual loans category.
At December 31, ------------------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------------------- 60-89 Days Delinquent 60-89 Days Delinquent 60-89 Days Delinquent ------------------------------------------------------------------- Percent of Percent of Percent of Loan Loan Loan Amount Category Amount Category Amount Category ------------------------------------------------------------------- (Dollars in Thousands) Residential: Single-family $ 4,537 1.18% $ 3,593 0.68% $ 4,905 0.70% Multi-family 360 0.51 1,945 3.77 30 0.07 Commercial real estate 79 0.03 4,842 3.40 163 0.13 Construction and land development 1,035 0.63 846 0.71 275 0.19 Home equity 522 1.16 257 0.62 288 1.40 Other: Commercial 1,536 3.84 396 1.65 892 5.10 Consumer 292 11.2 29 1.41 65 2.39 ------------------------------------------------------------------- Total $ 8,361 0.85% $11,908 1.30% $ 6,618 0.63% ===================================================================
16 NON-PERFORMING AND UNDER-PERFORMING ASSETS. The following table sets forth information with respect to non-performing and certain under-performing assets identified by Citizens Financial, including non-accrual loans and other real estate owned. Citizens Financial had no accruing loans 90 days or more past due as to principal or interest at any of the below-referenced dates.
At December 31, ----------------------------------------------------------- 2002 2001 2000 1999 1998 ----------------------------------------------------------- (Dollars in Thousands) Non-accrual loans: Mortgage loans: Single-family residential $ 7,294 $ 8,579 $ 5,230 $ 7,303 $ 5,137 Multi-family residential 36 36 -- 460 516 Commercial real estate 5,621 1,798 1,330 2,498 2,754 Construction and land development 1,323 1,361 4,167 1,313 469 Home equity 324 692 405 206 1 Other loans: Commercial 692 1,117 559 -- -- Consumer 35 291 158 52 76 ----------------------------------------------------------- Total non-accruing loans 15,325 13,874 11,849 11,832 8,953 Other real estate owned, net 893 1,128 1,058 609 435 ----------------------------------------------------------- Total non-performing assets $16,218 $15,002 $12,907 $12,441 $ 9,388 =========================================================== Performing troubled debt restructurings $ 338 $ 417 $ 586 $ 668 $ 916 Non-performing assets to total assets 1.02% 0.94% 0.75% 0.75% 0.64% Non-performing loans to total loans 1.56 1.51 1.13 1.23 1.20 Total non-performing assets and troubled debt restructurings to total assets 1.05 0.96 0.75 0.75 0.64
Included in non-accrual commercial real estate loans at December 31, 2002 is a loan secured by a motel with a carrying value of approximately $3.9 million. A receiver has been appointed. Citizens ordered and received an appraisal for this property indicating an amount in excess of the carrying value. This property is expected to become real estate owned sometime during 2003. 17 The interest income that would have been recorded during the year ended December 31, 2002, if all of the Bank's non-performing loans at the end of such period had been current in accordance with their terms during such periods, was $1.9 million. The actual amount of interest recorded as income (on a cash basis) on such loans during the period amounted to $1.0 million. CLASSIFIED AND CRITICIZED ASSETS. Federal regulations require that each insured institution classify its assets on a regular basis. Furthermore, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: "substandard," "doubtful" and "loss." Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high probability of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Another category designated "special mention" is also established and maintained for assets which have some identified weaknesses but do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. At December 31, 2002, Citizens Financial had an aggregate of $48.3 million of classified assets, 98.3% of which were classified substandard and 1.7% of which were classified as doubtful, compared to $39.3 million of classified assets as of December 31, 2001. The Bank utilizes a third party to review the Bank's commercial loans and commercial real estate loans. As a result of the third party consultant's review the Company hired and/or reassigned personnel to perform monitoring functions. ALLOWANCE FOR LOSSES ON LOANS. The Bank's policy is to establish allowances for estimated losses on loans when it determines that losses are expected to be incurred on such loans. The allowance for losses on loans is maintained at a level believed adequate by management to absorb losses inherent in the portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loss experience, current economic conditions, volume, growth and composition of the portfolio, and other relevant factors. The allowance is increased by provisions for loan losses which are charged against income. As shown in the table below, at December 31, 2002, the Bank's allowance for losses on loans amounted to $8.7 million or 56.6% and 0.92% of the Bank's non-performing loans and total loans receivable, respectively. The Bank's provision for losses on loans amounted to $2.0 million for the year ended December 31, 2002 and $1.2 million for 2001. While no assurance can be given that future charge-offs and/or additional provisions will not be necessary, management of the Company believes that, as of December 31, 2002, the allowance for losses on loans was adequate. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Office of Thrift Supervision which can order the establishment of additional general or specific loss allowances. The Office of Thrift Supervision, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment 18 and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems; that management has analyzed all significant factors that affect the collectibility of the portfolio in a reasonable manner; and that management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Our policy for establishing loan losses is consistent with the Office of Thrift Supervision's policy statement. In July 2001, the SEC issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues." The guidance contained in the SAB was effective immediately and focuses on the documentation the SEC staff normally expects registrants to prepare and maintain in support of the allowance for loan and lease losses. Concurrent with the SEC's issuance of SAB No. 102, the federal banking agencies, represented by the Federal Financial Institutions Examination Council ("FFIEC"), issued an interagency policy statement entitled "Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions" (Policy Statement). The SAB and Policy Statement were the result of an agreement between the SEC and the federal banking agencies in March 1999 to provide guidance on allowance for loan and lease losses methodologies and supporting documentation. There was no impact on earnings, financial condition, or stockholder's equity upon implementation of the SAB or FFIEC pronouncement. 19 The following table sets forth the activity in the Bank's allowance for losses on loans during the periods indicated.
Year Ended December 31, --------------------------------------------------------------- 2002 2001 2000 1999 1998 --------------------------------------------------------------- (In Thousands) --------------------------------------------------------------- Allowance at beginning of period $ 7,662 $ 7,187 $ 5,973 $ 5,357 $ 3,825 --------------------------------------------------------------- Provisions 1,956 1,150 3,375 675 1,630 Charge-offs: Mortgage loans: Single-family residential (82) (120) (203) (138) (49) Multi-family residential (3) -- -- -- -- Commercial real estate (974) (429) (2,048) -- -- Construction and land development (31) (6) (10) -- (13) Other loans (93) (300) (18) (33) (63) --------------------------------------------------------------- Total charge-offs (1,183) (855) (2,279) (171) (125) --------------------------------------------------------------- Recoveries: Mortgage loans: Single-family residential 210 124 64 70 25 Multi-family residential -- -- 1 -- -- Commercial real estate development 24 56 -- -- -- Construction and land development -- -- 50 -- -- Other loans 5 -- 3 42 2 --------------------------------------------------------------- Total recoveries 239 180 118 112 27 --------------------------------------------------------------- Net loans charged-off to allowance for losses on loans (944) (675) (2,161) (59) (98) --------------------------------------------------------------- Allowance at end of period $ 8,674 $ 7,662 $ 7,187 $ 5,973 $ 5,357 =============================================================== Allowance for losses on loans to total non-performing loans at end of period 56.60% 55.23% 60.65% 50.48% 59.84% =============================================================== Allowance for losses on loans to total loans at end of period .92% 0.86% 0.71% 0.67% 0.74% =============================================================== Net charge-offs to average loans outstanding 0.10% 0.07% 0.22% 0.01% 0.02% ===============================================================
ALLOCATION OF THE ALLOWANCE FOR LOSSES ON LOANS. Management of the Bank determines the sufficiency of the allowance for losses on loans based upon its periodic assessment of the risk elements in its loan portfolio. Management of Citizens Financial utilizes analytical data as well as anticipated borrower performance in light of general economic conditions existing in the Bank's market area. 20 The determination of the adequacy of the allowance at December 31, 2002 specifically considered various factors, including the balance of outstanding loans and the increases in the ratio of commercial, commercial land multi-family real estate and construction and land development loans to total loans. These loans are in excess of 50% of total loans receivable at December 31, 2002. Because of the increase in balances of these types of loans and the fact that such loans have historically resulted in more losses than single-family residential mortgage loans, management adjusted the manner by which the allowance for losses on loans is allocated during 2002. Previously, various percentages were assigned to loan categories based on management's analysis of their relative risks. Beginning in 2002, classified commercial type loans were evaluated and allocated separately from the general allocation of the entire portfolio. Citizens Financial will continue to monitor and modify its approach to estimate the allowances for losses on loans as conditions dictate. While management believes that, based on information currently available, the Bank's allowance for losses on loans is sufficient to cover losses inherent in its loan portfolio at this time, no assurance will be given that the Bank's level of allowance for losses on loans will be sufficient to absorb loan losses inherent in the portfolio or that future adjustments to the allowance for losses on loans will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for losses on loans. In addition, the OTS, as an integral part of its examination process, periodically reviews the Bank's allowance for loan losses. Such agency may require the Bank to make additional provisions for estimated loan losses based upon judgments different from those of management. The resulting allocation as of December 31, 2002 was as follows:
Allowance Allocation For Allowance as a Allowance Allowance as a Specifically For Percentage of Allocation Percentage of Identified Classified Classified for Remainder Remainder of Total Category Losses Loans Loans of Category Category Allocated ------------------------------------------------------------------------------------------- (Dollars in Thousands) Residential real estate: Single-family owner occupied $ -- $ 55 50.00% $ 417 .10% $ 472 Single-family non-owner occupied -- 162 8.41 71 .15 233 Multi-family -- 1,966 5.39 316 .50 2,282 Business/Commercial 150 2,110 7.62 1,899 .75 4,159 Business/Commercial non-real estate 55 82 6.36 265 1.00 402 Developed lots -- -- -- 55 .75 55 Land -- 127 6.39 305 1.00 432 Consumer -- 245 50.00 32 1.50 277 Other Assets -- 180 10.00 9 1.00 189 ------------------------------------------------------------------------------------------- $ 205 $4,927 $3,369 $8,501 ====== ====== ====== Unallocated 173 ------ Total $8,674 ======
21 The Bank allocates its allowance for losses on loans by loan category. Various percentages are assigned to the loan categories based on management's analysis of their relative risks. At December 31, 2001, 2000, 1999 and 1998, the allowance for losses on loans was allocated as follows:
December 31, --------------------------------------------------------------------------------------- 2002 2001 2000 --------------------------------------------------------------------------------------- Allowance as a Allowance as a Allowance as a Allowance Percentage of Allowance Percentage of Allowance Percentage of CATEGORY Allocation Category Allocation Category Allocation Category --------------------------------------------------------------------------------------- (Dollars in Thousands) Residential real estate: Single-family owner occupied $ 472 .11% $2,262 .40% $2,845 .40% Single-family non- owner occupied 233 .47 276 .80 298 .80 Multi-family 2,282 2.29 716 1.00 773 1.00 Business/Commercial 4,159 1.47 3,067 1.75 2,393 1.75 Business/Commercial non-real estate 402 1.41 388 2.50 419 2.50 Developed Lots 55 .75 95 1.25 57 1.25 Land 432 1.33 247 1.75 198 1.75 Consumer 277 .71 48 2.00 73 2.00 Other assets 189 N/A -- -- -- -- --------------------------------------------------------------------------------------- 8,501 7,099 7,056 Unallocated 173 563 131 -------- ------ ------ Total $8,674 $7,662 $7,187 ======== ====== ====== December 31, ------------------------------------------------------ 1999 1998 ------------------------------------------------------ Allowance as a Allowance as Allowance Percentage of Allowance a Percentage CATEGORY Allocation Category Allocation of Category ------------------------------------------------------ (Dollars in Thousands) Residential real estate: Single-family owner occupied $2,663 .40% $3,052 .50% Single-family non- owner occupied 280 .80 229 .75 Multi-family 409 1.00 203 1.00 Business/Commercial 1,003 1.75 884 1.75 Business/Commercial non-real estate 280 2.50 296 2.50 Developed Lots 62 1.25 121 1.25 Land 221 1.75 82 1.75 Consumer 73 2.00 110 2.00 Other assets -- -- -- -- ------------------------------------------------------ 4,991 4,977 Unallocated 982 380 ------ ------ Total $5,973 $5,357 ====== ======
22 INVESTMENT SECURITIES ACTIVITIES GENERAL. As of December 31, 2002, the Company had an aggregate of $39.1 million of investment securities, or 2.5%, of its total assets at such date. At such date, the unrealized loss on the Company's available-for-sale investment securities amounted to $630,000, net of deferred income taxes. The Company's investment securities consist primarily of callable agency securities, which amounted to $15.3 million, and commercial paper, which amounted to $15.7 million, at December 31, 2002. The Company attempts to maintain a high degree of liquidity in its other securities and generally does not invest in debt securities with estimated average lives in excess of 10 years. In recent years, the Company has purchased substantial amounts of callable agency securities, which are U.S. Government agency debt obligations, generally having a contractual term to maturity of 10 years. These securities may be called for redemption at predetermined dates (generally every three months) throughout their terms. During 1998 and the first half of 1999 virtually all of the Company's callable agency securities were called within one year of purchase. As interest rates rose during the second half of 1999, these agency securities were not called. This trend continued into 2000, with no securities being called until late in the year, when rates again began to decline. The trend to lower interest rates continued throughout 2001 and 2002 with the Federal Reserve Board reducing rates eleven times in 2001. As of December 31, 2002, the contractual weighted average lives of the Company's investment securities was 3.0 years. At December 31, 2002, all of the Company's investment securities were classified as available-for-sale, and none were classified as held to maturity. Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses on available-for-sale securities are recognized as direct increases or decreases in equity, net of applicable deferred income taxes. Securities which are classified as held-to-maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts using a method which approximates a level yield. The investment policy of the Company, which has been established by the Board of Directors, is designed, among other things, to assist the Company in its asset/liability management policies. The Company's investment policy emphasizes principal preservation, favorable returns on investment, liquidity within designated guidelines, minimal credit risk, and flexibility. The Company's current investment policy permits investments in various types of securities including obligations of the U.S. Treasury and federal agencies, investment grade corporate obligations ("A" rated or better), trust preferred stocks, other equity securities, commercial paper, certificates of deposit, and federal funds sold to financial institutions approved by the Board of Directors. The Company currently does not participate in hedging programs, interest rate swaps, or other activities involving the use of off-balance sheet derivative instruments. 23 The following table set forth information regarding the carrying and fair value of the Company's investment securities at the dates indicated.
December 31, ----------------------------------------------------------------------- 2002 2001 2000 ----------------------------------------------------------------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value ----------------------------------------------------------------------- (Dollars in Thousands) Available-for-sale: Callable agency securities, corporate notes and commercial paper $30,767 $31,087 $33,169 $33,148 $20,017 $20,056 Trust preferred securities 4,931 4,400 4,929 4,395 4,926 4,566 Equity securities 4,400 3,577 7,489 7,646 9,763 9,164 Asset-backed note -- -- 2,026 2,036 -- -- ----------------------------------------------------------------------- $40,098 $39,064 $47,613 $47,225 $34,706 $33,786 =======================================================================
The following table sets forth certain information regarding the maturities of the Company's callable agency securities, corporate bonds, commercial paper and trust preferred securities at December 31, 2002.
Contractually Maturing ----------------------------------------------------------------------------------------- Weighted Weighted Weighted Weighted Under 1 Average 1-5 Average 6-10 Average Over 10 Average Year Yield Years Yield Years Yield Years Yield ----------------------------------------------------------------------------------------- (Dollars in Thousands) ----------------------------------------------------------------------------------------- Callable agency securities $ -- --% $10,277 4.00% $5,041 5.21% $ -- --% Corporate notes -- -- 50 10.00 -- -- -- -- Commercial paper 15,719 1.68 -- -- -- -- -- -- Trust preferred -- -- -- -- -- -- 4,400 2.33
MORTGAGE-BACKED SECURITIES GENERAL. At December 31, 2002, the Company's mortgage-backed securities included $318.0 million of mortgage participation certificates, collateralized mortgage obligations ("CMOs") and securities which qualified as real estate mortgage investment conduits ("REMICs"). At December 31, 2002 the unrealized gain on the Company's mortgage-backed securities available-for-sale amounted to $507,000, net of deferred income taxes. At December 31, 2002, $296.6 million of the Company's mortgage-backed securities were classified as available-for-sale, and $21.4 million were classified as held to maturity. Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses on available-for-sale securities are recognized as direct increases or decreases in equity, net of applicable deferred income taxes. Securities which are held to maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts using a method which approximates a level yield. 24 The following table sets forth information regarding the carrying and fair value of the Company's mortgage-backed securities at the dates indicated.
December 31, ----------------------------------------------------------------------- 2002 2001 2000 ----------------------------------------------------------------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value ----------------------------------------------------------------------- (Dollars in Thousands) Available-for-sale (at fair value): Participation certificates and collateralized mortgage obligations $ 64,084 $ 64,768 $ 32,089 $ 33,225 $ 54,227 $ 54,460 REMICs 231,752 231,870 239,776 242,933 229,535 225,137 ----------------------------------------------------------------------- $295,836 $296,638 $271,865 $276,158 $283,762 $279,597 ======================================================================= Held to maturity: Participation certificates and collateralized mortgage obligations $ 20,651 $ 21,161 $ 28,644 $ 29,234 $ 34,349 $ 34,074 REMICs 751 816 8,390 8,510 44,508 44,442 ----------------------------------------------------------------------- $ 21,402 $ 21,977 $ 37,034 $ 37,744 $ 78,857 $ 78,516 =======================================================================
At December 31, 2002, $39.9 million, or 12.6%, of the Company's mortgage-backed securities portfolio consisted of adjustable-rate securities, as compared to $28.7 million, or 9.2%, and $26.6 million, or 7.4%, at December 31, 2001 and 2000, respectively. Participation certificates represent a participation interest in a pool of single-family or multi-family mortgages. The principal and interest payments on mortgage-backed securities are passed from the mortgage originators, as servicers, through intermediaries (generally U.S. Government agencies and government-sponsored enterprises) that pool and repackage the participation interests in the form of securities, to investors such as the Company. Such U.S. Government agencies and government sponsored enterprises, which guarantee the payment of principal and, in some cases, interest to investors, primarily include the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Government National Mortgage Association. In contrast to pass-through mortgage-backed securities, in which cash flow is received pro rata by all security holders, the cash flow from the mortgages underlying a CMO is segmented and paid in accordance with a predetermined priority to investors holding various CMO classes. By allocating the principal and interest cash flows from the underlying collateral among the separate CMO classes, different classes of bonds are created, each with its own stated maturity. CMOs are typically issued by governmental agencies, government sponsored enterprises and special purpose entities, such as trusts, corporations or partnerships, established by financial institutions or other similar institutions. REMICS are a form of CMOs with particular attributes under the Internal Revenue Code. At December 31, 2002 $173.0 million of the Company's REMICs were issued by government-related entities while $59.6 million were issued by other issuers. 25 SOURCE OF FUNDS GENERAL. Deposits are the primary source of the Bank's funds for lending and other investment purposes. In addition to deposits, the Bank derives funds from loan principal repayments and prepayments and borrowings. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. The Bank also uses borrowings, primarily Federal Home Loan Bank advances, to supplement its deposits as a source of funds. DEPOSITS. Citizens Financial's deposit products include a broad selection of deposit instruments, including checking accounts, money market accounts, passbook and statement savings accounts, and term certificate accounts. Deposit account terms may vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate. Citizens Financial utilizes traditional marketing methods to attract new customers and deposits. The Bank does not advertise for deposits outside of its market area. The Bank does not utilize the services of deposit brokers. The Bank traditionally has relied on customer service and convenience in marketing its deposit products. In addition, Citizens Financial generally has been competitive in the types of accounts and interest rates offered, and often it has been among the leaders in its market area on the rates paid on its deposits. Citizens Financial experienced a net decrease in deposits before interest credited of $14.5 million in 2002 and $24.6 million in 2001. The following table sets forth the activity in the Bank's deposits during the periods indicated.
Year Ended December 31, -------------------------------------------- 2002 2001 2000 -------------------------------------------- (In Thousands) Beginning balance $945,444 $933,073 $924,193 Net before interest credited (14,469) (24,574) (29,651) Interest credited 22,886 36,945 38,531 -------------------------------------------- Net increase in deposits 8,417 12,371 8,880 -------------------------------------------- Ending balance $953,861 $945,444 $933,073 ============================================
26 The following table sets forth the amount and remaining maturities of the Bank's certificates of deposit at December 31, 2002.
Over One Year Over Two Years Interest Through One Through Two Through Three Over Three Category Year Years Years Years Totals -------------------------------------------------------------------------------- (Dollars in Thousands) 2.00% to 2.99% $282,483 $18,262 $ 3,326 $ 37 $304,108 3.00% to 3.99% 28,823 13,611 5,746 3,150 51,330 4.00% to 4.99% 7,759 3,976 867 10,584 23,186 5.00% to 5.99% 17,185 5,475 3,192 4,065 29,917 6.00% to 6.99% 36,078 13,036 13,336 8,508 70,958 7.00% to 8.99% 4,884 2,759 7,900 2,533 18,076 -------------------------------------------------------------------------------- Total $377,212 $57,119 $34,367 $28,877 $497,575 ================================================================================
As of December 31, 2002, the aggregate amount of outstanding time certificates of deposit in amounts greater than or equal to $100,000 was $117.1 million. The following table presents the maturity of these time certificates of deposit at such dates. December 31, 2002 ----------------- (In Thousands) 3 months or less $ 29,838 Over 3 months through 6 months 30,524 Over 6 months through 12 months 25,190 Over 12 months 31,530 ----------------- $117,082 ================= The following table sets forth the dollar amount of deposits and the percentage of total deposits in various types of deposits offered by the Bank at the dates indicated.
December 31, ---------------------------------------------------------------------------------- 2002 2001 2000 ---------------------------------------------------------------------------------- Amount Percentage Amount Percentage Amount Percentage ---------------------------------------------------------------------------------- (Dollars in Thousands) Passbook accounts $212,370 22.27% $203,165 21.49% $207,422 22.23% Certificates of deposit 497,575 52.16 544,887 57.63 568,399 60.90 Money market accounts 121,693 12.76 89,205 9.44 47,226 5.07 Checking accounts: Noninterest-bearing 31,318 3.28 26,970 2.85 26,468 2.84 Interest-bearing 90,905 9.53 81,217 8.59 83,558 8.96 ---------------------------------------------------------------------------------- Total $953,861 100.00% $945,444 100.00% $933,073 100.00% ==================================================================================
27 BORROWINGS The following table sets forth certain information as to the Bank's FHLB advances and other borrowings at the dates indicated and the weighted-average interest rates paid on borrowings for the years ended December 31, 2002, 2001 and 2000.
At December 31, ------------------------------------------------------- 2002 2001 2000 ------------------------------------------------------- (Dollars in Thousands) FHLB advances $449,431 $462,658 $483,151 Securities sold under agreements to repurchase -- -- 64,925 ------------------------------------------------------- Total borrowings $449,431 $462,658 $548,076 ======================================================= Weighted average interest rate of borrowings 5.87% 5.88% 5.92%
Refer to Note 8, "Borrowed Money", in the Consolidated Financial Statements for additional information related to Borrowings. TRUST ACTIVITIES The Company also provides fiduciary services through the Bank's Trust Department. Services offered include fiduciary services for trusts and estates and land trusts. As of December 31, 2002, the Trust Department maintained 69 trust/fiduciary accounts, of which 49 were land trusts with an aggregate principal balance of $3.0 million at such date. Revenue from the Trust Department for the year ended December 31, 2002 was $27,000. The accounts maintained by the Trust Department consist of "managed" and "non-managed" accounts. "Managed accounts" are those accounts under custody for which the Bank has responsibility for administration and investment management and/or investment advice. "Non-managed" accounts are those accounts for which the Bank merely acts as a custodian. The Company receives fees dependent upon the level and type of service provided. The Trust Department administers various trust accounts (revocable and irrevocable trusts, and trusts under wills), estates and guardianships. Executive management of the department is provided by the Bank's Vice President and Corporate Counsel, subject to direction by the Trust Committee. SUBSIDIARIES During 2002 the Bank had three active, wholly-owned subsidiaries, CFS Holdings, Ltd., CFS Insurance Agency, Inc. and CFS Investment Services, Inc. CFS Holdings, Ltd. ("CFS Holdings") was approved by the Office of Thrift Supervision in January 2001 and was funded and began operations in June 2001. CFS Holdings is located in Hamilton, Bermuda. It was funded with approximately $140.0 million of the Bank's investments and performs a significant amount of the Bank's investment securities and mortgage-backed securities investing activities. Certain of these activities are performed by a resident agent in Hamilton in accordance with the operating procedures and investment policy established for CFS 28 Holdings by the Bank. Revenues of CFS Holdings were $5.6 million for the year ended December 31, 2002 compared to $4.2 million for the period from inception through December 31, 2001. Operating expenses of this operation were $61,000 for the year ended December 31, 2002 compared to $35,000 for the seven months of 2001. CFS Insurance Agency, Inc. ("CFS Insurance") was an independent insurance brokerage subsidiary which offered a full line of insurance products to the general public. CFS Insurance operated out of the Bank's Insurance/Investment Center in Munster, Indiana. The Bank has owned CFS Insurance since 1972. Effective November 30, 2002 the Bank sold the assets of this agency and entered into a five year lease, with the purchaser, for the building from which the agency conducted its operations. Pre-tax profit on the sale of these assets was approximately $1.1 million. Revenues of CFS Insurance were $1.3 million, $1.1 million, and $902,000 in 2002, 2001 and 2000, respectively. CFS Investments Services, Inc. ("CFS Investments") was primarily involved in the sale of mutual funds and other securities to members of the general public in the Bank's primary market area. CFS Investments commenced full service securities brokerage activities in 1994. During August 2002 the Bank entered into an agreement to outsource this activity and discontinue providing these services directly through CFS Investment Services, Inc. In addition to its presence in the CFS Insurance/Investments Center, CFS Investments maintained offices in eight of the Bank's branches. CFS Investments had total commission revenue of $770,000, $873,000 and $1.4 million in each of the years ended 2002, 2001 and 2000, respectively. EMPLOYEES Citizens Financial had 328 full-time equivalent employees at December 31, 2002. None of these employees is represented by a collective bargaining agent, and the Bank believes that it enjoys good relations with its personnel. REGULATION REGULATION OF SAVINGS AND LOAN HOLDING COMPANIES The Company is a registered savings and loan holding company. The Home Owners' Loan Act, as amended ("HOLA"), and OTS regulations generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring, directly or indirectly, the ownership or control of any other savings association or savings and loan holding company, or all, or substantially all, of the assets or more than 5% of the voting shares thereof. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings association not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS. Holding Company Activities. The Company currently operates as a unitary savings and loan holding company. Generally, there are limited restrictions on the activities of a unitary savings and loan holding company and its non-savings association subsidiaries. If the Company 29 ceases to be a unitary savings and loan holding company, the activities of the Company and its non-savings association subsidiaries would thereafter be subject to substantial restrictions. The HOLA requires every savings association subsidiary of a savings and loan holding company to give the OTS at least 30 days' advance notice of any proposed dividends to be made on its guarantee, permanent or other non-withdrawable stock, or else such dividend will be invalid. Affiliate Restrictions. Transactions between a savings association and its "affiliates" are subject to quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings association include, among other entities, the savings association's holding company and companies that are under common control with the savings association. In general, Sections 23A and 23B and OTS regulations issued in connection therewith limit the extent to which a savings association or its subsidiaries may engage in certain "covered transactions" with affiliates to an amount equal to 10% of the association's capital and surplus, in the case of covered transactions with any one affiliate, and to an amount equal to 20% of such capital and surplus, in the case of covered transactions with all affiliates. In addition, a savings association and its subsidiaries may engage in covered transactions and certain other transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the savings association or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" is defined to include a loan: or extension of credit to an affiliate; a purchase of investment securities issued by an affiliate; a purchase of assets from an affiliate, with certain exceptions; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; or the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, under OTS regulations, a savings association may not make a loan or extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies; a savings association may not purchase or invest in securities of an affiliate other than shares of a subsidiary; a savings association and its subsidiaries may not purchase a low-quality asset from an affiliate; and covered transactions and certain other transactions between a savings association or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. With certain exceptions, each loan or extension of credit by a savings association to an affiliate must be secured by collateral with a market value ranging from 100% to 130% (depending on the type of collateral) of the amount of the loan or extension of credit. The OTS regulation generally excludes all non-bank and non-savings association subsidiaries of savings associations from treatment as affiliates, except to the extent that the OTS or the Federal Reserve Board decides to treat such subsidiaries as affiliates. The regulation also requires savings associations to make and retain records that reflect affiliate transactions in reasonable detail and provides that certain classes of savings associations may be required to give the OTS prior notice of transactions with affiliates. 30 Financial Modernization. Under the Gramm-Leach-Bliley Act enacted into law on November 12, 1999, no company may acquire control of a savings and loan holding company after May 4, 1999, unless the company is engaged only in activities traditionally permitted for a multiple savings and loan holding company or newly permitted for a financial holding company under Section 4(k) of the Bank Holding Company Act. Existing savings and loan holding companies, such as the Company, and those formed pursuant to an application filed with the OTS before May 4, 1999 may engage in any activity including non-financial or commercial activities provided such companies control only one savings and loan association that meets the Qualified Thrift Lender test. Corporate reorganizations are permitted, but the transfer of grandfathered unitary holding company status through acquisition is not permitted. Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client will require preapproval by the company's audit committee members. In addition, the audit partners must be rotated. The bill requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Act, counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the Board of Directors or the Board itself. Longer prison terms will also be applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution ("FAIR") provision also requires the SEC to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company's securities within two business days of the change. The Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company's "registered public accounting firm" ("RPAF"). Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a "financial expert" as 31 such term is defined by the SEC and if not, why not. Under the Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding the audit initiation date. The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statement's materially misleading. The Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. The Act requires the RPAF that issues the audit report to attest to and report on management's assessment of the company's internal controls. In addition, the Act requires that each financial report required to be prepared in accordance with (or reconciled to) generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC. REGULATION OF FEDERAL SAVINGS BANKS As a federally insured savings bank, lending activities and other investments of the Bank must comply with various statutory and regulatory requirements. The Bank is regularly examined by the OTS and must file periodic reports concerning its activities and financial condition. Although the OTS is the Bank's primary regulator, the FDIC has "backup enforcement authority" over the Bank. The Bank's eligible deposit accounts are insured by the FDIC under the SAIF, up to applicable limits. Federal Home Loan Banks. The Bank is a member of the FHLB System. Among other benefits, FHLB membership provides the Bank with a central credit facility. The Bank is required to own capital stock in a FHLB in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year or 5% of its advances from the FHLB, whichever is greater. Regulatory Capital Requirements. OTS capital regulations require savings banks to satisfy minimum capital standards: risk-based capital requirements, a leverage requirement, and a tangible capital requirement. Savings banks must meet each of these standards in order to be deemed in compliance with OTS capital requirements. In addition, the OTS may require a savings association to maintain capital above the minimum capital levels. All savings banks are required to meet a minimum risk-based capital requirement of total capital (core capital plus supplementary capital) equal to 8% of risk-weighted assets (which includes the credit risk equivalents of certain off-balance sheet items). In calculating total capital for purposes of the risk-based requirement, supplementary capital may not exceed 100% of core capital. Under the leverage requirement, a savings bank is required to maintain core capital equal to a minimum of 3% of adjusted total assets. (In addition, under the prompt corrective action 32 provisions of the OTS regulations, all but the most highly-rated institutions must maintain a minimum leverage ratio of 4% in order to be adequately capitalized.) A savings bank is also required to maintain tangible capital in an amount at least equal to 1.5% of its adjusted total assets. These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above the minimum. In addition, the OTS regulations provide that minimum capital levels higher than those provided in the regulations may be established by the OTS for individual savings associations, upon a determination that the savings association's capital is or may become inadequate in view of its circumstances. The OTS regulations provide that higher individual minimum regulatory capital requirements may be appropriate in circumstances where, among others: (1) a savings association has a high degree of exposure to interest rate risk, prepayment risk, credit risk, concentration of credit risk, certain risks arising from nontraditional activities, or similar risks of a high proportion of off-balance sheet risk; (2) a savings association is growing, either internally or through acquisitions, at such a rate that supervisory problems are presented that are not dealt with adequately by OTS regulations; and (3) a savings association may be adversely affected by activities or condition of its holding company, affiliates, subsidiaries or other persons or savings associations with which it has significant business relationships. The Bank is not subject to any such individual minimum regulatory capital requirement. The Bank's tangible and core capital ratios were 8.42%, and its total risk-based capital ratio was 14.0% at December 31, 2002. At such date, the Bank was classified as a "well-capitalized" institution. Certain Consequences of Failure to Comply with Regulatory Capital Requirements. A savings bank's failure to maintain capital at or above the minimum capital requirements may be deemed an unsafe and unsound practice and may subject the savings bank to enforcement actions and other proceedings. Any savings bank not in compliance with all of its capital requirements is required to submit a capital plan that addresses the bank's need for additional capital and meets certain additional requirements. While the capital plan is being reviewed by the OTS, the savings bank must certify, among other things, that it will not, without the approval of its appropriate OTS Regional Director, grow beyond net interest credited or make capital distributions. If a savings bank's capital plan is not approved, the bank will become subject to additional growth and other restrictions. In addition, the OTS, through a capital directive or otherwise, may restrict the ability of a savings bank not in compliance with the capital requirements to pay dividends and compensation, and may require such a bank to take one or more of certain corrective actions, including, without limitation: (i) increasing its capital to specified levels, (ii) reducing the rate of interest that may be paid on savings accounts, (iii) limiting receipt of deposits to those made to existing accounts, (iv) ceasing issuance of new accounts of any or all classes or categories except in exchange for existing accounts, (v) ceasing or limiting the purchase of loans or the making of other specified investments, and (vi) limiting operational expenditures to specified levels. The HOLA permits savings banks not in compliance with the OTS capital standards to seek an exemption from certain penalties or sanctions for noncompliance. Such an exemption will be granted only if certain strict requirements are met and must be denied under certain 33 circumstances. If an exemption is granted by the OTS, the savings bank still may be subject to enforcement actions for other violations of law or unsafe or unsound practices or conditions. Prompt Corrective Action. The prompt corrective action regulation of the OTS, promulgated under the Federal Deposit Insurance Corporation Improvement Act of 1991, requires certain mandatory actions and authorizes certain other discretionary actions to be taken by the OTS against a savings bank that falls within certain undercapitalized capital categories specified in the regulation. The regulation establishes five categories of capital classification: "well-capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." Under the regulation, the ratio of total capital to risk-weighted assets, core capital to risk-weighted assets and the leverage ratio are used to determine an institution's capital classification. At December 31, 2002, the Bank met the capital requirements of a "well-capitalized" institution under applicable OTS regulations. Enforcement Powers. The OTS and, under certain circumstances, the FDIC have substantial enforcement authority with respect to savings associations, including authority to bring various enforcement actions against a savings association and any of its "institution-affiliated parties" (a term defined to include, among other persons, directors, officers, employees, controlling stockholders, agents and stockholders who participate in the conduct of the affairs of the institution). This enforcement authority includes, without limitation, the ability to: (i) terminate a savings association's deposit insurance, (ii) institute cease-and-desist proceedings, (iii) bring suspension, removal, prohibition and criminal proceedings against institution-affiliated parties, and (iv) assess substantial civil money penalties. As part of a cease-and-desist order, the agencies may require a savings association or an institution-affiliated party to take affirmative action to correct conditions resulting from that party's actions, including making restitution or providing reimbursement, indemnification or guarantee against loss, restricting the growth of the institution, and rescinding agreements and contracts. Capital Distribution Regulation. In January 1999, the OTS amended its capital distribution regulation to bring such regulations into greater conformity with the other bank regulatory agencies. Specifically, savings associations that would be well-capitalized following a capital distribution are not subject to any requirement for notice or application unless the total amount of all capital distributions, including any proposed capital distribution, for the applicable calendar year would exceed an amount equal to the savings bank's net income for that year to date plus the savings bank's retained net income for the preceding two years. However, because the Bank is a subsidiary of a savings and loan holding company, the Bank is required to give the OTS at least 30 days notice prior to any capital distribution to the Company. Qualified Thrift Lender Test. In general, savings associations are required to maintain at least 65% of their portfolio assets in certain qualified thrift investments (which consist primarily of loans and other investments related to residential real estate and certain other assets). A savings association that fails the qualified thrift lender test is subject to substantial restrictions on activities and to other significant penalties. A savings association may qualify as a qualified thrift lender not only by maintaining 65% of portfolio assets in qualified thrift investments but also, in the alternative, by qualifying under the Internal Revenue Code as a "domestic building 34 and loan association." The Bank is a domestic building and loan association as defined in the Code. FDIC Assessments. The deposits of the Bank are insured to the maximum extent permitted by the SAIF, which is administered by the FDIC, and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action. Under FDIC regulations, institutions are assigned to one of three capital groups for insurance premium purposes -- "well-capitalized," "adequately capitalized" and "undercapitalized" -- which are defined in the same manner as the regulations establishing the prompt corrective action system, as discussed above. These three groups are then divided into subgroups which are based on supervisory evaluations by the institution's primary federal regulator, resulting in nine assessment classifications. Effective January 1, 1997, assessment rates for both SAIF-insured institutions and BIF-insured institutions ranged from 0% of insured deposits for well-capitalized institutions with minor supervisory concerns to .27% of insured deposits for undercapitalized institutions with substantial supervisory concerns. The Bank's deposit insurance premiums totaled $164,000, or .017%, of its insured deposits for the year ended December 31, 2002. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. There are no pending proceedings to terminate the deposit insurance of the Bank. Community Reinvestment Act and the Fair Lending Laws. Savings institutions have a responsibility under the CRA and related regulations of the OTS to help meet the credit needs of their communities, including low and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act (together, the "Fair Lending Laws") prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution's failure to comply with the provisions of CRA could, at a minimum, result in regulatory restrictions on its activities, and failure to comply with the Fair Lending Laws could result in enforcement actions by the OTS, as well as other federal regulatory agencies and the Department of Justice. Safety and Soundness Guidelines. The OTS and the other federal banking agencies have established guidelines for safety and soundness, addressing operational and managerial, as well as compensation matters for insured financial institutions. Institutions failing to meet these 35 standards are required to submit compliance plans to their appropriate federal regulators. The OTS and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. Change of Control. Subject to certain limited exceptions, no company can acquire control of a savings association without the prior approval of the OTS, and no individual may acquire control of a savings association if the OTS objects. Any company that acquires control of a savings association becomes a savings and loan holding company subject to extensive registration, examination and regulation by the OTS. Conclusive control exists, among other ways, when an acquiring party acquires more than 25% of any class of voting stock of a savings association or savings and loan holding company, or controls in any manner the election of a majority of the directors of the company. In addition, a rebuttable presumption of control exists if, among other things, a person acquires more than 10% of any class of a savings association or savings and loan holding company's voting stock (or 25% of any class of stock) and, in either case, any of certain additional control factors exist. Companies subject to the Bank Holding Company Act of 1956, as amended, that acquire or own savings associations are no longer defined as savings and loan holding companies under the HOLA and, therefore, are not generally subject to supervision and regulation by the OTS. OTS approval is no longer required for a bank holding company to acquire control of a savings association, although the OTS has a consultative role with the FRB in examination, enforcement and acquisition matters. TAXATION FEDERAL TAXATION GENERAL. The Company and Citizens Financial are subject to federal income taxation in the same general manner as other corporations with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to the Bank. The Bank's federal income tax returns have been closed without audit by the IRS through 1996. The Company will file consolidated tax returns with Citizens Financial. Accordingly, it is anticipated that any cash distributions made by the Company to its stockholders will be treated as cash dividends and not as a non-taxable return of capital to stockholders for federal and state tax purposes. METHOD OF ACCOUNTING. For federal income tax purposes, Citizens Financial reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its consolidated federal income tax returns. The Small Business Protection Act of 1996 (the "1996 Act") eliminated the use of the reserve method of accounting for bad debts by large savings institutions, effective for taxable years beginning after 1995. BAD DEBT RESERVES. Prior to the 1996 Act, the Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within 36 specified formula limits, be deducted in arriving at taxable income. As a result of the 1996 Act, large savings associations must use the specific charge-off method in computing their bad debt deduction beginning with their 1996 Federal tax return. In addition, the federal legislation requires the recapture (over a six year period with a deferral of one or two years if certain requirements were met) of the excess of tax bad debt reserves at December 31, 1995 over those established as of December 31, 1987. The amount of such reserve subject to recapture as of December 31, 2002 is approximately $1.0 million for Citizens Financial. TAXABLE DISTRIBUTIONS AND RECAPTURE. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if the Bank failed to meet certain thrift asset and definitional tests, made certain excess distributions to, or redemption of, shareholders, or changed to a bank charter. Under current law, pre-1988 reserves are subject to recapture only if the Bank makes certain non-dividend distributions or redemptions or ceases to maintain a bank charter. At December 31, 2002 the total federal pre-1988 reserve was approximately $12.5 million for Citizens Financial. This reserve reflects the cumulative effects of federal tax deductions by the Bank for which no Federal income tax provision has been made. MINIMUM TAX. The Code imposes a minimum tax at a rate of 20% on a base of regular taxable income plus certain tax adjustments and preferences ("alternative minimum taxable income" or "AMTI"). The minimum tax is payable to the extent such tax is in excess of the regular tax. This excess is the alternative minimum tax ("AMT"). Net operating losses can offset no more than 90% of AMTI. Payments of AMT may be used as credits against regular tax liabilities in future years subject to certain limitations. Citizens Financial has not been subject to the AMT, nor does it have any such amounts available as credits for carryover. NET OPERATING LOSS CARRYOVERS. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. Losses incurred in tax years beginning before August 6, 1997 and after December 31, 1986 can be carried back three years and forward 15 years. Prior to 1987, various carryback and carryforward provisions apply. At December 31, 2002, Citizens Financial had no net operating loss carryforwards for federal income tax purposes. CORPORATE DIVIDENDS-RECEIVED DEDUCTION. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is 80% in the case of dividends received from corporations, the stock of which the corporate recipient owns 20% or more but generally less than 80%, and corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct only 70% of dividends received or accrued on their behalf. STATE AND LOCAL TAXATION INDIANA STATE TAXATION. The Company and the Bank are subject to an 8.5% franchise tax, imposed by the State of Indiana, on the net income of financial (including thrift) institutions, exempting them from the current gross income, supplemental net income and intangible taxes. 37 Net income for franchise tax purposes is federal taxable income before net operating loss deductions and special deductions, adjusted for certain items, including Indiana income taxes, property taxes, charitable contributions, tax-exempt interest and bad debts. Other applicable Indiana taxes include sales, use and property taxes. Beginning in 1999, the Company and the Bank can apportion income outside of Indiana. ILLINOIS STATE TAXATION. For Illinois income tax purposes, the Company and the Bank are taxed at a rate of 7.18% of Illinois taxable income. For these purposes, "Illinois Taxable Income" generally means federal taxable income, subject to certain adjustments (including the addition of interest income on state and municipal obligations and the exclusion of interest income on United States Treasury obligations) and apportionment. The exclusion of income on United States Treasury obligations has the effect of reducing the Illinois taxable income of the Bank. DELAWARE STATE TAXATION. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. The tax is imposed as a percentage of the capital base of the Company with an annual maximum of $150,000. 38 ITEM 2. PROPERTIES OFFICES AND PROPERTIES The following table sets forth certain information relating to Citizens Financial's offices at December 31, 2002. In addition, the Bank maintains 33 automated teller machines ("ATMs"), with 28 of such ATMs at the Bank's branch offices.
Net Book Value of Lease Property and Leasehold Owned or Expiration Improvements at Deposits at Location Leased Date December 31, 2002 December 31, 2002 - ---------------------------------------------------------------------------------------------------------------------- (In Thousands) EXECUTIVE OFFICE: 707 Ridge Road Owned -- $2,815 $147,066 Munster, IN 46321 BRANCH OFFICES: 5311 Hohman Avenue Owned -- 373 97,627 Hammond, IN 46320 155 N. Main Street Owned -- 320 89,481 Crown Point, IN 46307 1720 45th Street Owned -- 590 109,577 Munster, IN 46321 4740 Indianapolis Blvd. Owned -- 244 48,365 East Chicago, IN 46312 2121 E. Columbus Drive(1) Leased 2003 360 26,926 East Chicago, IN 46312 803 W. 57th Avenue Leased 2003 1 29,126 Merrillville, IN 46410 855 Thornapple Way Owned -- 294 38,198 Valparaiso, IN 46383 3853 45th Street Owned -- 870 23,976 Highland, IN 46322 10644 S. Cicero Avenue Leased 2005 13 18,978 Oak Lawn, Illinois 60453 9161 W. 151st Street Leased 2005 60 28,118 Orland Park, Illinois 60462 3301 W. Vollmer Road Leased 2007 75 38,595 Flossmoor, IL 60422 154th Street at Broadway(2) Leased 2006 182 35,262 Harvey, IL 60426 (Table continued on next page) (Footnotes on following page)
39
Net Book Value of Lease Property and Leasehold Owned or Expiration Improvements at Deposits at Location Leased Date December 31, 2002 December 31, 2002 - ---------------------------------------------------------------------------------------------------------------------- (In Thousands) 13323 S. Baltimore Owned -- $211 $30,815 Chicago, IL 60426 601 E. 162nd Street Owned -- 249 51,243 South Holland, IL 60473 7101 W. 127th Street Owned -- 207 50,464 Palos Heights, IL 60463 425. E. 170th Street(6) Owned -- 300 -- South Holland, IL 60473 16145 S. State Street(1) Leased 2003 -- 10,824 South Holland, IL 60473 16039 S. Harlem Avenue(1) Leased 2003 -- 18,670 Tinley Park, IL 60477 2345 W. 183rd Street(1) Leased 2003 -- 17,362 Homewood, IL 60430 1100 E. Exchange Road(1) Leased 2003 -- 14,525 Crete, IL 60417 1218 Sheffield Avenue(1) Leased 2003 22 9,802 Dyer, IN 46311 7229 S. Kingery Highway Leased 2007 170 7,889 Willowbrook, IL 60527 7650 Harvest Drive (3) Owned -- 1,874 10,820 Schererville, IN 46375 OTHER PROPERTIES: 1730 45th Street(4) Owned -- 1,014 -- Munster, IN 46321 8149 Kennedy Avenue(5) Leased 2003 104 513 Highland, IN 46322 10S660 State Route 83 (7) Owned -- 644 -- Willowbrook, IL 60527 - ----------------------------------------------------------------------------------------------------------------------
(1) Full service branch facilities located in a local grocery store chain. (2) Building donated to the United Way, June 30, 1999, Citizens Financial Services now leases approximately ten percent of building for branch operations. (3) Includes 3,570 square feet of space currently under lease to third party. (4) Former site of Insurance and Investment Center currently under a five year lease (expiring in 2008) with purchaser of insurance agency assets as lessor. (5) Operations Center. (6) Deposits included with office located at 162nd Street. (7) Former branch location, currently used as telecommunications and ATM site. 40 ITEM 3 LEGAL PROCEEDINGS LEGAL PROCEEDINGS In 1983, with the assistance of the Federal Savings and Loan Insurance Corporation ("FSLIC") as set forth in an assistance agreement ("Assistance Agreement"), the Bank acquired First Federal Savings and Loan Association of East Chicago, East Chicago, Indiana ("East Chicago Savings"), and Gary Federal Savings and Loan Association, Gary, Indiana ("Gary Federal"). The FSLIC-assisted supervisory acquisitions of East Chicago Savings and Gary Federal were accounted for using the purchase method of accounting which resulted in supervisory goodwill (the excess of cost over the fair value of net assets acquired), an intangible asset, of $52.9 million, compared to $40.2 million of goodwill as reported on a generally accepted accounting principles basis. Such goodwill was included in the Bank's regulatory capital as required by the Assistance Agreement. The Assistance Agreement relating to the Bank's acquisitions of East Chicago Savings and Gary Federal provided for the inclusion of supervisory goodwill as an asset on the Bank's balance sheet, to be amortized over 35 years for regulatory purposes and includable in regulatory capital. Pursuant to the regulations adopted by the OTS to implement the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), the regulatory capital requirement for federal savings banks was increased and the amount of supervisory goodwill that could be included in regulatory capital decreased significantly. At September 30, 1989, the Bank had approximately $26.0 million of remaining supervisory goodwill. However, excluding supervisory goodwill, the Bank continued to exceed its capital requirements of FIRREA at such date. On May 13, 1993, the Bank filed suit against the U.S. government seeking damages and/or other appropriate relief on the grounds, among others, that the government had breached the terms of the Assistance Agreement. The suit is pending in the United States Court of Federal and is titled Citizens Financial Services, FSB, et al. v. United States (Case No. 93-306-C). The Bank was granted summary judgment on its breach of contract claim, leaving for trial the issue of damages. The Government has filed a motion for summary judgment on the Bank's damages claims. Their motion is still pending. All pre-trial discovery has been substantially completed. No trial date has been set. In its complaint, the Bank did not specify the amount of damages it is seeking from the United States. The Bank has retained experts in order to attempt to quantify the amount of damages. The Bank's primary expert has filed his report detailing the Bank's claim under three alternative methods: lost profits, restitution, and capital replacement. The government's experts have sought to rebut the Bank's claims that it has been damaged. This is consistent with the government's current litigation strategy of denying that there have been any damages suffered and refusing to settle any pending goodwill cases. The Bank is unable to predict the outcome of its claim against the United States and the amount of damages that may actually be awarded to the Bank, if any, in the event that a judgment is rendered in the Bank's favor. Consequently, no assurance can be given as to the result of this claim or the timing of any proceedings in relation thereto. The cost, including 41 attorneys' fees, experts' fees, and related expenses of the litigation was approximately $258,000, $436,000, and $550,000 in 2002, 2001 and 2000, respectively. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required herein is incorporated by reference from page 52 of the Registrant's 2002 Annual Report. ITEM 6. SELECTED FINANCIAL DATA The information required herein is incorporated by reference from pages 13 and 14 of the Registrant's 2002 Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required herein is incorporated by reference from pages 15 to 25 of the Registrant's 2002 Annual Report. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required herein is incorporated by reference from pages 22 and 23 of the Registrant's 2002 Annual Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required herein is incorporated by reference from pages 26 to 51 of the Registrant's 2002 Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required herein is incorporated by reference from pages 3 and 4 of the Registrant's Proxy Statement dated March 28, 2003 ("Proxy Statement"). 42 ITEM 11. EXECUTIVE COMPENSATION. The information required herein is incorporated by reference from pages 6 to 13 of the Registrant's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required herein by Item 403 of Regulation S-K is incorporated by reference from page 15 and 16 of the Registrant's Proxy Statement. EQUITY COMPENSATION PLAN INFORMATION. The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of December 31, 2002.
Number of Share Remaining Number of Shares to be issued Weighted-Average Available for Future Issuance upon the Exercise of Outstanding Exercise Price of (Excluding Shares Reflected Plan Category Options, Warrants and Rights Outstanding Options in the First Column) ------------- ---------------------------- ------------------- -------------------- Equity Compensation Plans Approved by Security Holders 1,797,968 $10.21 229,065 Equity Compensation Plans Not Approved by Security Holders -- -- -- Total 1,797,968 $10.21 299,065
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required herein is incorporated by reference from page 13 of the Registrant's Proxy Statement. ITEM 14. CONTROLS AND PROCEDURES Under the supervision and with the participation of the Company's management, including its chief executive officer and chief financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures within 90 days of the filing date of this annual report, and based on their evaluation, the Company's chief executive officer and chief financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to the Company's management, 43 including its chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Document filed as part of this Report. (1) The following documents are filed as part of this report and are incorporated herein by reference from the Registrant's 2002 Annual Report to Shareholders. Independent Auditors' Report. Consolidated Statements of Financial Condition as of December 31, 2002 and 2001. Consolidated Statements of Income for the Years Ended December 31, 2002, 2001 and 2000. Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2002, 2001 and 2000. Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000. Notes to Consolidated Financial Statements. (2) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or notes thereto. (3)(a) The following exhibits are filed as part of this Form 10-K, and this list includes the Exhibit Index. 3.1 Certificate of Incorporation of CFS Bancorp, Inc.* 3.2 Bylaws of CFS Bancorp, Inc.* 4.0 Form of Stock Certificate of CFS Bancorp, Inc.* 10.1 Form of Employment Agreement entered into between Citizens Financial Services, FSB and each of Thomas F. Prisby, James W. Prisby and John T. Stephens* 10.2 Form of Employment Agreement entered into between CFS Bancorp, Inc. and each of Thomas F. Prisby, James W. Prisby and John T. Stephens* 10.3 CFS Bancorp, Inc. 1998 Stock Option Plan as amended** 10.4 CFS Bancorp, Inc. 1998 Recognition and Retention Plan and Trust Agreement as amended** 10.5 Supplemental ESOP Benefit Plan*** 44 13.0 2002 Annual Report to Stockholders of the Registrant's Annual Report to Stockholders for the year ended December 31, 2002. 21.0 Subsidiaries of the Registrant - Reference is made to Item 1. "Business" for the required information. 23.0 Consent of Independent Auditors - Ernst & Young LLP 99.1 Certifications Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002. - ------------- * Incorporated by Reference from the Company's Registration Statement on Form S-1 filed on March 31, 1998, as amended and declared effective on May 14, 1998. ** Incorporated by Reference from the Company's Definitive Proxy Statement for the Meeting of Stockholders filed on March 23, 2001. ***Incorporated by Reference from the Company's December 31, 1999 Annual Report on Form 10-K filed on March 30, 2000. (3)(b) Reports filed on Form 8-K. On November 12, 2002, the Company filed a Current Report on Form 8-K in connection with the announcement that the Bank's subsidiary, CFS Insurance Agency, Inc. had entered into a definitive agreement to sell all of its assets. On December 2, 2002, the Company filed a Current Report on Form 8-K in connection with the announcement that the Bank intended to close four of its branch offices in the first quarter of 2003. On December 19, 2002, the Company filed a Current Report on Form 8-K in connection with the announcement of its quarterly dividend. 45 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. CFS BANCORP, INC. By: /s/ Thomas F. Prisby -------------------- Thomas F. Prisby Chairman of the Board and Chief Executive Officer 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.
Name Title Date /s/ Thomas F. Prisby Chairman of the Board and Chief March 31, 2003 - ------------------------------ Executive Officer Thomas F. Prisby (principal executive officer) /s/ James W. Prisby Vice Chairman, President and Chief March 31, 2003 - ------------------------------ Operating Officer James W. Prisby /s/ John T. Stephens Executive Vice President and March 31, 2003 - ------------------------------ Chief Financial Officer John T. Stephens (principal financial and accounting officer) /s/ Sally A. Abbott Director March 31, 2003 - ------------------------------ Sally A. Abbott
46 /s/ Gregory W. Blaine Director March 31, 2003 - ------------------------------ Gregory W. Blaine /s/ Thomas J. Burns Director March 31, 2003 - ------------------------------ Thomas J. Burns /s/ Gene Diamond Director March 31, 2003 - ------------------------------ Gene Diamond /s/ Frank D. Lester Director March 31, 2003 - ------------------------------ Frank D. Lester /s/ Charles R. Webb Director March 31, 2003 - ------------------------------ Charles R. Webb
47 CERTIFICATION PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Thomas F. Prisby, the Chairman of the Board and Chief Executive Officer of CFS Bancorp, Inc, certify that: 1. I have reviewed this annual report on Form 10-K of CFS Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 By: /s/ Thomas F. Prisby ------------------ ------------------------------ Thomas F. Prisby Chairman of the Board and Chief Executive Officer 48 CERTIFICATION PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John T. Stephens, the Executive Vice President and Chief Financial Officer of CFS Bancorp, Inc., certify that: 1. I have reviewed this annual report on Form 10-K of CFS Bancorp, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 By: /s/ John T. Stephens ------------------ ------------------------------------- John T. Stephens Executive Vice President and Chief Financial Officer 49 EX-13 3 c75186exv13.txt 2002 ANNUAL REPORT TO STOCKHOLDERS . . . EXHIBIT 13 SELECTED CONSOLIDATED FINANCIAL DATA CFS BANCORP, INC.
AT DECEMBER 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ SELECTED FINANCIAL CONDITION DATA Total assets $1,584,762 $1,604,134 $1,710,376 $1,649,535 $1,470,617 Loans receivable, net 930,348 883,352 998,727 882,676 726,081 Mortgage-backed securities, 296,638 276,158 279,597 299,056 277,888 available-for-sale Mortgage-backed securities, held-to-maturity 21,402 37,034 78,857 101,066 176,956 Investment securities, available-for-sale 39,064 47,225 33,786 32,693 34,720 Investment securities, held-to-maturity -- -- 170,784 176,737 166,500 Deposits 954,222 945,948 934,012 925,047 969,802 Borrowed money 449,431 462,658 548,076 494,699 215,271 Stockholders' equity 160,662 171,284 199,368 205,433 260,088 Non-performing assets to total assets 1.02% 0.94% 0.75% 0.75% 0.64% Stockholders' equity to total assets 10.14 10.68 11.66 12.45 17.69 Stockholders' equity per outstanding share $ 12.68 $ 12.57 $ 11.88 $ 10.97 $ 11.13 Allowance for losses on loans to non-performing loans 56.60% 55.23% 60.65% 50.48% 59.82% Allowance for losses on loans to total loans 0.92 0.86 0.71 0.67 0.74 YEAR ENDED DECEMBER 31, 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ SELECTED OPERATIONS DATA Interest income $ 86,561 $ 108,107 $ 118,876 $104,609 $ 97,353 Interest expense 53,068 70,288 73,033 57,543 56,910 Net interest income 33,493 37,819 45,843 47,066 40,443 Provision for losses on loans(1) 1,956 1,150 3,375 675 1,630 Net interest income after provision for losses on 31,537 36,669 42,468 46,391 38,813 loans Noninterest income 11,313 10,728 6,081 5,191 5,900 Noninterest expense(2) 32,674 31,433 31,035 30,210 39,004 Income before income taxes 10,176 15,964 17,514 21,372 5,709 Income tax expense 2,971 4,791 6,821 8,282 2,587 Net income 7,205 11,173 10,693 13,090 3,122 Earnings per share (basic) 0.60 0.80 0.66 0.69 0.15 Earnings per share (diluted) 0.58 0.77 0.66 0.68 0.14 Cash dividends declared per common share 0.40 0.36 0.36 0.34 0.16 SELECTED OPERATING RATIOS Net interest margin 2.20% 2.36% 2.83% 3.18% 3.08% Average interest-earning assets to average interest-bearing liabilities 110.96 112.09 113.59 118.70 114.57 Ratio of general and administrative expenses to average total assets (adjusted for one-time charges)(3) 2.04 1.86 1.84 1.88 2.16 Return on average assets 0.45 0.66 0.63 0.85 0.23 Return on average equity 4.30 5.82 5.34 5.70 1.85 Efficiency ratio (adjusted for one-time charges)(3) 75.25 68.43 59.82 57.95 64.35
(1) The provision for losses on loans in 1998 reflects a $1,200 adjustment in order to conform the credit policies of Suburban Financial Corp. to those of the CFS Bancorp, Inc. (2) Noninterest expense in 1998 includes one-time charges of $9,519 related to the Merger and Conversion (as described in the General Section of Management's Discussion and Analysis of Financial Condition and Results of Operations). (3) Calculated on a pro forma basis which excludes the effects of the special charges referred to in (2) above. 13 SELECTED QUARTERLY RESULTS OF OPERATIONS CFS BANCORP, INC.
2002 1ST 2ND 3RD 4TH (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER - ------------------------------------------------------------------------------------------------------------------------------- Interest income $21,978 $22,128 $22,047 $20,408 Interest expense 14,013 12,978 13,291 12,786 Net interest income 7,965 9,150 8,756 7,622 Provisions for losses on loans 200 350 500 906 Noninterest income 2,246 2,494 2,639 3,934 Noninterest expense 7,786 8,452 8,324 8,112 Income before income taxes 2,225 2,842 2,571 2,538 Income taxes 661 859 755 696 Net income 1,564 1,983 1,816 1,842 Earnings per share - basic 0.13 0.16 0.15 0.16 Earnings per share - diluted 0.12 0.16 0.15 0.15 Dividends declared per share 0.10 0.10 0.10 0.10 2001 1ST 2ND 3RD 4TH (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER - ------------------------------------------------------------------------------------------------------------------------------- Interest income $29,746 $28,293 $26,791 $23,277 Interest expense 18,563 18,393 17,693 15,639 Net interest income 11,183 9,900 9,098 7,638 Provisions for losses on loans 450 450 250 -- Noninterest income 2,011 2,351 3,968 2,398 Noninterest expense 7,765 8,044 7,540 8,084 Income before income taxes 4,979 3,757 5,276 1,952 Income taxes 1,656 1,094 1,628 413 Net income 3,323 2,663 3,648 1,539 Earnings per share - basic 0.22 0.18 0.26 0.14 Earnings per share - diluted 0.22 0.18 0.25 0.12 Dividends declared per share 0.09 0.09 0.09 0.09
14 CFS BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL CFS Bancorp, Inc. ("Company") was formed as the holding company for Citizens Financial Services, FSB ("Bank") in connection with the Bank's conversion from a federally-chartered mutual savings bank to a federally-chartered stock savings bank ("Conversion"). The Conversion and the Company's initial public offering of its common stock were completed on July 24, 1998. Concurrent with the Conversion, the Company completed its merger with SuburbFed Financial Corp. ("SFC") ("Merger"), and SFC's subsidiary, Suburban Federal Savings, a Federal Savings Bank, was merged into the Bank. CHANGES IN FINANCIAL CONDITION GENERAL Total assets of the Company were $1.6 billion at both December 31, 2002 and December 31, 2001. Assets decreased $19.4 million primarily as a result of the decrease in cash and cash equivalents of $61.9 million offset partially by the increase in loans receivable of $47.0 million. During the year ended December 31, 2002, the Company's total liabilities decreased by $8.8 million as a result of a decrease in borrowed money of $13.2 million and a decrease in other liabilities of $3.7 million, which were partially offset by an increase in deposits of $8.3 million. During the year ended December 31, 2002, stockholders' equity decreased by $10.6 million with the most significant portion of the decrease being the utilization of $14.6 million in cash to repurchase 1,050,854 shares for treasury through the Company's share repurchase program. The Company continues to maintain a strong capital structure. At December 31, 2002, the Bank had tangible and core regulatory capital ratios of 8.42% and a risk-based capital ratio of 13.97%. Liquidity, which was at historically high levels for the Company at December 31, 2001 as a result of the continuing trend of historically low market rates of interest and the resulting accelerated level of repayments of mortgage loans, was reduced by about 23% during 2002 even though interest rates were reduced further during the year and accelerated loan repayments continued. The Company continued to implement its strategy during 2002 of restructuring its balance sheet to emphasize more commercial and commercial real estate loans that have relatively higher rates of interest and shorter durations than single-family mortgage loans. CASH AND CASH EQUIVALENTS Cash and cash equivalents, which consist of cash, interest-bearing deposits at other financial institutions and federal funds sold, amounted to $210.1 at December 31, 2002 compared to $272.1 million at December 31, 2001. This $62.0 million decrease primarily was a result of the Company redeploying these funds to fund new loan originations in line with the Company's business strategy of having the Company's balance sheet contain more bank-like assets. This redeployment of cash and cash equivalents was utilized to assist in increasing loans receivable by $47.0 million, repaying $13.3 million in borrowed money and repurchasing $14.6 million of shares of the Company's common stock on the open market at an average price per share of $13.92. INVESTMENT SECURITIES At December 31, 2002 the Company had $39.1 million of investment securities available-for-sale compared to $47.2 million of investment securities available-for-sale at December 31, 2001. MORTGAGE-BACKED SECURITIES At December 31, 2002 the Company had $296.6 million in mortgage-backed securities available-for-sale and $21.4 million in mortgage-backed securities held-to-maturity, or an aggregate of $318.0 million, compared to $276.2 million in mortgage-backed securities available-for-sale and $37.0 million in mortgage-backed securities held-to-maturity, or an aggregate of $313.2 million in mortgage-backed securities, at December 31, 2001. This net increase of $4.8 million in the aggregate from December 31, 2001 to December 31, 2002 was the result of purchases of $225.6 in mortgage-backed securities, reduced by normal 15 CFS BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED repayments and increased prepayments as mortgage interest rates continued to drop during 2002. At December 31, 2002 the Company had an unrealized loss, net of taxes, on available-for-sale investment securities and mortgage-backed securities of $.1 million. LOANS RECEIVABLE The net loan portfolio of the Company increased to $930.3 million at December 31, 2002 from $883.4 million at December 31, 2001. The 5.3% increase was the result of the Company continuing its strategy of restructuring its loan portfolio by redeploying assets into commercial and commercial real estate loans even as accelerated loan repayments on single-family residential mortgage loans continued in 2002. INVESTMENT IN BANK-OWNED LIFE INSURANCE The Company's investment in Bank-owned life insurance ("BOLI") was $31.0 million at December 31, 2002 compared to $30.1 million at December 31, 2001. The Company's original investment in BOLI was made in September 2000 and increased by $6.2 million in September 2001. At this time the Company does not intend any further purchase of BOLI. This investment provides tax-exempt earnings to help defray the cost of employee benefits. The investment is represented by life insurance contracts on approximately 300 Company employees issued by the Hartford Life Insurance Company. All employees covered under these contracts have agreed to be included in the program. DEPOSITS Deposits were $954.2 million at December 31, 2002 compared to $945.9 million at December 31, 2001. This net increase of $8.3 million resulted primarily from the Company's opening of two new branch offices in July 2002. When the two new branch offices opened, a special promotion that paid higher interest rates during the three months after the opening resulted in additional deposits of approximately $80 million. At December 31, 2002 $47.1 million of these new deposits have been retained. These deposit increases were partially offset by reductions of deposits throughout other offices as the Company generally set its interest rates offered on deposits at moderate levels compared to competitors during 2002. BORROWED MONEY Borrowed money amounted to $449.4 million at December 31, 2002 compared to $462.7 million at December 31, 2001. The decrease of $13.3 million reflects principal repayments by the Company as certain borrowings matured. STOCKHOLDERS' EQUITY Total stockholders' equity of the Company amounted to $160.7 million, or 10.14% of total assets, at December 31, 2002 compared to $171.3 million, or 10.68% of total assets, at December 31, 2001. Total stockholders' equity included unrealized losses on investment securities and mortgage-backed securities available-for-sale, net of taxes of $123,000 at December 31, 2002 compared to unrealized gains of $2.7 million at December 31, 2001. The decrease in stockholders' equity for the year was primarily the result of the utilization of cash to fund the Company's ongoing stock repurchase programs. Since its initial public offering in July 1998, the Company has repurchased an aggregate of 10,871,062 shares of its common stock at an average price of $11.60 per share. 16 CFS BANCORP, INC. AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest income of the Company from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rate; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin. Information is based on average daily balances during the indicated periods. YEARS ENDED DECEMBER 31,
2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE (DOLLARS IN THOUSANDS) BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST - ------------------------------------------------------------------------------------------------------------------------------------ Interest - earning assets: Loans receivable(1) Real estate loans $ 883,265 $ 60,750 6.88% $ 920,461 $ 69,398 7.54% $ 948,159 $ 72,129 7.61% Other loans 33,288 1,969 5.92 22,115 1,665 7.53 21,177 1,980 9.35 - ------------------------------------------------------------------------------------------------------------------------------------ Total loans 916,553 62,719 6.84 942,576 71,063 7.54 969,336 74,109 7.65 Securities(2) 388,382 19,211 4.95 457,796 29,439 6.43 589,816 40,926 6.94 Other interest- earning assets(3) 215,549 4,631 2.15 204,563 7,605 3.72 57,893 3,841 6.63 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest- earning assets 1,520,484 86,561 5.69 1,604,935 108,107 6.74 1,617,045 118,876 7.35 Noninterest-earning assets 80,628 82,640 70,690 - ------------------------------------------------------------------------------------------------------------------------------------ Total assets $1,601,112 $1,687,575 $1,687,735 ==================================================================================================================================== Interest-bearing liabilities: Deposits: Checking and money market accounts $ 193,812 2,735 1.41 $ 146,565 3,298 2.25 $ 127,502 $ 3,219 2.52 Passbook accounts 214,609 2,768 1.29 203,951 4,591 2.25 214,421 6,456 3.01 Certificates of deposit 502,970 20,214 4.02 586,677 32,958 5.62 572,144 33,420 5.84 - ------------------------------------------------------------------------------------------------------------------------------------ Total deposits 911,391 25,717 2.82 937,193 40,847 4.36 914,067 43,095 4.71 Borrowings 458,864 27,351 5.96 494,637 29,441 5.95 509,503 29,938 5.88 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest- bearing liabilities 1,370,255 53,068 3.87 1,431,830 70,288 4.91 1,423,570 73,033 5.13 Noninterest-bearing liabilities(4) 63,200 63,869 63,830 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 1,433,455 1,495,699 1,487,400 Stockholders' equity 167,657 191,876 200,335 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $1,601,112 $1,687,575 $1,687,735 ==================================================================================================================================== Net interest-earning assets $ 150,229 $ 173,105 $ 193,475 ==================================================================================================================================== Net interest income/interest rate spread $ 33,493 1.82% $ 37,819 1.83% $ 45,843 2.22% ==================================================================================================================================== Net interest margin 2.20% 2.36% 2.83% ==================================================================================================================================== Ratio of average interest- earning assets to average interest-bearing liabilities 110.96% 112.09% 113.59% ====================================================================================================================================
(1) The average balance of loans receivable includes non-performing loans, interest on which is recognized on a cash basis. (2) Average balances of securities available-for-sale are based on historical costs. (3) Includes money market accounts, Federal Funds sold and interest-earning bank deposits. (4) Consists primarily of demand deposit accounts. 17 CFS BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED RATE/VOLUME ANALYSIS The following table sets forth the effects of changing rates and volumes on net interest income of the Company. Information is provided with respect to (i) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume); (ii) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (iii) changes in rate/volume (changes in rate multiplied by changes in volume).
YEARS ENDED DECEMBER 31, 2002 COMPARED TO 2001 2001 COMPARED TO 2000 - ------------------------------------------------------------------------------------------------------------------------------------ INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO - ------------------------------------------------------------------------------------------------------------------------------------ RATE/ TOTAL NET RATE/ TOTAL NET (DOLLARS IN THOUSANDS) RATE VOLUME VOLUME INC./(DEC) RATE VOLUME VOLUME INC./(DEC) - ------------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets: Loans receivable: Real estate loans $ (6,090) $ (2,804) $ 246 $ (8,648) $ (643) $ (2,107) $ 19 $ (2,731) Other loans (357) 841 (180) 304 (386) 88 (17) (315) - ------------------------------------------------------------------------------------------------------------------------------------ Total loans receivable (6,447) (1,963) 66 (8,344) (1,029) (2,019) 2 (3,046) Securities (6,794) (4,464) 1,030 (10,228) (2,997) (9,161) 671 (11,487) Other interest-earning assets (3,210) ,408 (172) (2,974) (1,689) 9,731 (4,278) 3,764 - ------------------------------------------------------------------------------------------------------------------------------------ Total net change in income on interest-earning assets (16,451) (6,019) 924 (21,546) (5,715) (1,449) (3,605) (10,769) - ------------------------------------------------------------------------------------------------------------------------------------ Interest-bearing liabilities: Deposits: Checking and money markets (1,230) 1,063 (396) (563) (350) 481 (52) 79 Passbook accounts (1,960) 240 (103) (1,823) 181 (449) (12) (280) Certificates of deposit (9,380) (4,702) 1,338 (12,744) 2,496 617 51 3,164 - ------------------------------------------------------------------------------------------------------------------------------------ Total deposits (12,570) (3,399) 839 (15,130) 2,981 298 53 3,332 Borrowings 42 (2,129) (3) (2,090) 1,775 9,440 943 12,158 - ------------------------------------------------------------------------------------------------------------------------------------ Total net change in expense on interest-bearing liabilities (12,528) (5,528) 836 (17,220) 4,756 9,738 996 15,490 - ------------------------------------------------------------------------------------------------------------------------------------ Net change in net interest income $ (3,923) $ (491) $ 88 $ (4,326) $ (1,408) $ 608 $ (423) $ (1,223) ====================================================================================================================================
18 CFS BANCORP, INC. RESULTS OF OPERATIONS GENERAL The Company reported net income of $7.2 million for the year ended December 31, 2002 compared to net income of $11.2 million and $10.7 million for the years ended December 31, 2001 and 2000, respectively. The Company's net interest income for the year ended December 31, 2002 decreased $4.3 million from the year ended December 31, 2001. Net interest income for the year ended December 31, 2001 decreased $8.0 million when compared to the year ended December 31, 2000. During the year ended December 31, 2002, the Company's average balances of interest-earning assets, which is comprised primarily of loans and securities, decreased as the result of continued accelerated repayments on mortgage loans and mortgage-backed securities in the low interest rate environment. The Company's reinvestment of cash into interest-earning assets increased in 2002 compared to 2001 as the Company emphasized the origination of commercial and multi-family real estate, construction and commercial loans. The Company's results of operations during the year ended December 31, 2002 were positively affected by a $1.1 million gain on the sale of the insurance agency operations. The Company's results of operations were affected during the year ended December 31, 2001 by a $2.0 million gain on the sale of two La Porte County branches while, during the year ended December 31, 2000, the Company recorded a loan loss provision of $2.0 million related to the writedown of a non-performing loan on an office building obtained in the July 1998 Merger with SFC. NET INTEREST INCOME Net interest income is determined by the Company's interest rate spread (i.e., the difference between the average yield earned on the Company's interest-earning assets and the average rate paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. The Company's average interest rate spreads were 1.82%, 1.83% and 2.22% for the years ended December 31, 2002, 2001 and 2000, respectively. The Company's net interest margin (i.e., net interest income as a percentage of average interest-earning assets) was 2.20%, 2.36% and 2.83% during the years ended December 31, 2002, 2001 and 2000, respectively. The Company's net interest income amounted to $33.5 million for the year ended December 31, 2002 compared to $37.8 million and $45.8 million for the years ended December 31, 2001 and 2000, respectively. The 11.4% decrease from 2001 to 2002 was a result of the compression of interest rate spreads as well as a reduction in the ratio of average interest-earning assets to average interest-bearing liabilities to 110.96% in 2002 from 112.1% in 2001. The 17.5% decrease in net interest income from 2000 to 2001 was similarly a result of the compression of interest rate spreads, as well as a reduction in the ratio of average interest-earning assets to average interest-bearing liabilities to 112.1% in 2001 from 113.6% in 2000. The Company also utilized $14.6 million of cash in 2002 and $43.6 million of cash in 2001 for the Company's stock repurchase program, which affected net interest income, as the cash used for such repurchases was not invested in interest-earning assets. INTEREST INCOME The Company reported total interest income of $86.6 million for the year ended December 31, 2002 compared to $108.1 million and $118.9 million for the years ended December 31, 2001 and 2000, respectively. The $21.5 million or 19.9% decrease in interest income in 2002 compared to 2001 was primarily due to a $69.4 million decrease in the average balances of securities from $457.8 million in 2001 to $388.4 million in 2002 coupled with a reduction of 148 basis points in the average yield earned on these securities. In addition, the average balances of real estate loans decreased by $37.2 million to $883.3 million in 2002 from $920.5 million in 2001 in conjunction with a reduction of 66 basis points in the yield earned on these loans. The $10.8 million or 9.1% decrease in interest income in 2001 compared to 2000 was primarily due to a $132.0 million decrease in the average balances of securities from $589.8 million in 2000 to $457.8 million in 2001 coupled with a reduction of 51 basis points in the yield earned on these securities. 19 CFS BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED INTEREST EXPENSE Total interest expenses amounted to $53.1 million for the year ended December 31, 2002 compared to $70.3 million and $73.0 million in 2001 and 2000, respectively. The $17.2 million or 24.5% reduction in interest expense during 2002 was primarily the result of a 154 basis point reduction in the rate paid on total deposits coupled with a $25.8 million decrease in average balances of total deposits. Total interest expense amounted to $70.3 million for the year ended December 31, 2001 compared to $73.0 million in 2000. The $2.7 million or 3.8% reduction in interest expense during 2001, was primarily the result of a $2.2 million decrease in interest on deposits. This was the result of a 35 basis point decrease in the average rate paid on deposits, which was partially offset by a $23.1 million increase in the average balance of deposits. PROVISION FOR LOSSES ON LOANS The Company establishes provisions for losses on loans, which are charged to operations, in order to maintain the allowance for losses on loans at a level which is deemed appropriate to absorb losses inherent in the portfolio. In determining the appropriate level of the allowance for losses on loans, management considers past and anticipated loss experience, evaluations of real estate collateral, current and anticipated economic conditions, volume and type of lending, and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates, and ultimate losses may vary from such estimates. Management assesses the allowance for losses on loans on a quarterly basis and makes appropriate provisions to maintain the adequacy of the allowance. The actual determination of the total provision is the combination of specific reserves, which may be established from time to time on individual classified assets, and a general reserve that is based in part on certain ratios applied to various loan pools as stratified by the Company, considering historical charge-offs and delinquency levels. Additionally, the Company engages an independent firm to perform a loan review every four to six months. The results of this review are compared to the Company's classification of assets, and adjustments are made as deemed appropriate by management. The Company's provision for losses on loans was $2.0 million for the year ended December 31, 2002 compared to $1.2 million in 2001 and $3.4 million in 2000. The Company has increased its emphasis in recent years on construction and land development loans, multi-family residential real estate loans, commercial loans, and commercial real estate loans, all of which are generally deemed to involve more risk of loss than single-family residential real estate loans. This change in emphasis has resulted in an increase in the allowance for losses. The Company's allowance for losses on loans to total loans was 0.92% at December 31, 2002 compared to 0.86% and 0.71% at December 31, 2001 and 2000, respectively. The Company's non-performing loans were $15.3 million at December 31, 2002 compared to $13.8 and $11.8 million at December 31, 2001 and 2000, respectively. The primary changes in non-performing loans when comparing 2002 to 2001 were an overall decrease in non-performing single-family-residential loans of approximately $1.3 million and an increase in non-performing commercial real estate loans. The increase in non-performing commercial real estate loans is primarily due to one loan of approximately $3.9 million on a motel, which became non-performing in the third quarter of 2002. The Company anticipates foreclosing on this property in 2003. A motel management company has been appointed to run the daily operations of the motel until occupancy levels can be improved and the property offered for sale. The ratio of the Company's allowance for losses on loans to non-performing loans was 56.6% at December 31, 2002 compared to 55.2% and 60.7% at December 31, 2001 and 2000, respectively. Although management believes that the Company's allowance for losses on loans was adequate at December 31, 2002 based on available facts and circumstances, there can be no assurances that additions will not be necessary in the future. Such allowances would adversely affect the Company's results of operations. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the Bank's 20 CFS BANCORP, INC. provision for losses on loans and the carrying value of its other non-performing assets, based on information available to them at the time of their examinations. Any of these agencies could require the Bank to make additional provisions for losses on loans in the future. NONINTEREST INCOME The Company reported noninterest income of $11.3 million for the year ended December 31, 2002 compared to $10.7 million and $6.1 million for the years ended December 31, 2001 and 2000, respectively. The primary reasons for the increase in noninterest income in 2002 compared to 2001 was the $1.1 million gain recognized on the sale of the Company's insurance agency in December 2002 coupled with the $1.5 million increase in deposit fees in 2002 compared to 2001, while 2001 noninterest income included a $2.0 million gain on the sale of two branch offices. The increase in deposit fees in 2002 compared to 2001 was a result of a re-evaluation of operations completed in 2001. One of the results of this process improvement program was reflected in deposit fees earned of $4.1 million in 2002 compared to $2.6 million in 2001 and $1.4 million in 2000. In addition to the sale of the insurance agency in December 2002, the Company changed its method of delivery of investments in the third quarter of 2002 by discontinuing delivering non-deposit products through its subsidiary and having its subsidiary outsource this activity. Both the investment and insurance subsidiaries have provided marginally incremental profit and loss results to the Company over the years. Therefore, the outsourcing of investment services and the sale of the insurance agency operations are expected to improve the Company's operating results beginning in 2003. The primary reasons for the increase in noninterest income in 2001 compared to 2000 was the $2.0 million gain recognized on the sale of two branch offices, a $1.2 million increase in deposit fees and a $1.1 million increase in BOLI income. Income from BOLI was $1.5 million in 2002 and in 2001, and $406,000 in 2000. The Company initially invested $22.7 million in BOLI in September 2000 and made an additional investment of $6.2 million in September 2001. Prior to this investment being made, the cash invested in BOLI had been invested primarily in interest-earning assets. Noninterest income also included $299,000 from net gains on the sale of investment securities in 2002, compared to $599,000 and $42,000 for the years ending December 31, 2001 and 2000, respectively. NONINTEREST EXPENSE The Company reported noninterest expense of $32.7 million, $31.4 million and $31.0 million for the years ended December 31, 2002, 2001 and 2000, respectively. Compensation and employee benefits, the largest single component of noninterest expense, was $20.0 million for the year ended December 31, 2002 compared to $19.0 million and $19.3 million for the years ended December 31, 2001 and 2000, respectively. Aggregate salary and wage expenses were unchanged when comparing 2002 to 2001 while this expense was approximately 8.0% less in 2001 than it was in 2000, due primarily to the Company's process improvements program undertaken in 2001 which resulted in reductions of the average number of full-time equivalent employees to 343 for 2002 compared to 363 for 2001 and 416 for 2000. While the Company's salary expense was held flat in 2002 compared to 2001 and was reduced in 2001 compared to 2000, salary expense levels were offset by increases in employee benefits expenses related to the Company's pension plan and ESOP plan. After being fully funded for several years, funding was resumed for the pension plan year beginning July 1, 2001 and ending June 30, 2002. Pension expense was $889,000 for the calendar year ending December 31, 2002 compared to $134,000 for 2001 and $-0- for 2000, respectively. Due to the cost of the numerous benefit plans offered by the Company, the Board of Directors in December 2002 elected to freeze benefits under the pension plan as of March 1, 2003. ESOP expense is recorded based on the shares to be allocated for the year to participants in the plan multiplied by the average share price for the year. The average share price for 2002 increased to $14.07. As a result, $177,000 of additional ESOP expense was recorded in 2002 compared to 2001. ESOP expense increased by $412,000 in 2001 compared to 2000 due to the increase in the Company's average 21 CFS BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED share price. Also included in compensation and employee benefits expense was $1.5 million in 2002 compared to $1.4 million in both 2001 and 2000 from the Company's Recognition and Retention Plan approved by the shareholders in February 1999. Aggregate net occupancy expense was $4.3 million for the year ended December 31, 2002 compared to $4.5 million and $4.8 million for the years ended December 31, 2001 and 2000, respectively. Data processing expense amounted to $1.7 million for the year ended December 31, 2002 compared to $1.4 million and $1.0 million for the years ended December 31, 2001 and 2000, respectively. Data processing expense for 2002 and 2001 included additional costs of outsourcing some of the processing associated with a new proof of deposit system implemented in 2001. Federal Deposit Insurance Corporation ("FDIC") insurance premiums amounted to $164,000 for the year ended December 31, 2002 compared to $183,000 and $197,000 for the years ended December 31, 2001 and 2000, respectively. Marketing expenses were $904,000 for 2002 compared to $853,000 and $715,000 for 2001 and 2000, respectively. Other general and administrative expenses amounted to $5.5 million for the year ended December 31, 2002 compared to $5.4 million and $5.0 million for the years ended December 31, 2001 and 2000, respectively. Other general and administrative expenses for 2002 included $258,000 compared to $436,000 and $550,000 in 2001 and 2000, respectively, for fees and expenses paid to law firms representing the Company in the "Goodwill" suit against the U.S. Government. See note 16 in the Consolidated Financial Statements for additional information relating to this suit. INCOME TAX EXPENSE The Company's income tax expense amounted to $3.0 million, $4.8 million and $6.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. The Company's effective rates were 29.2%, 30.0%, and 38.9% for the years ended December 31, 2002, 2001, and 2000, respectively. The Company has implemented several tax strategies in the past few years that have resulted in the significant reductions in its effective tax rates. ASSET/LIABILITY MANAGEMENT The Bank, like other financial institutions, is subject to interest rate risk to the extent that its interest-bearing liabilities with short- and intermediate-term maturities reprice more rapidly, or on a different basis, than its interest-earning assets. Management attempts to moderate the effect of changes in interest rates on the Bank's net portfolio value ("NPV"). The NPV represents the excess of the present value of expected cash flows from assets over the present value of expected cash flows for liabilities. On a quarterly basis, management reviews the calculations of NPV as adjusted for expected cash flows from off-balance sheets contracts, if any. Management of the Bank's assets and liabilities is dependent, in part, on the market-place and customer preferences. However, management attempts to maintain the mix on the Bank's interest rate-sensitive assets and liabilities within limits established by the Board of Directors on the amount of change in NPV which is acceptable assuming certain interest rate changes. In an attempt to manage its exposure to changes in interest rates, management closely monitors the Bank's interest rate risk. The Bank has an asset/liability management committee consisting of senior officers and an advisory director which meets weekly to review the Bank's interest rate risk position and to make recommendations for adjustments to the Bank's Board of Directors. In addition, the Board reviews simulations of how the Company's earnings could be affected under various interest rate scenarios. In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, places greater emphasis on maximizing its net interest margin than on strictly matching the interest rate sensitivity of its assets and liabilities. The Board believes that the increased net income resulting from a difference in the maturity of its asset and liability portfolios can, during periods of stable interest rates, provide high enough returns to justify the increased exposure which can result from such a difference in maturities. 22 CFS BANCORP, INC. While maintaining its interest rate spread objectives, the Bank attempts to reduce interest rate risk with a variety of strategies designed to maintain what the Bank believes to be an appropriate relationship between its assets and liabilities. First, the Bank emphasizes real estate mortgage loans and commercial loans with fixed rates of interest for an initial term of three or five years, that convert to a rate based on the one, three and five-year constant maturity of United States Treasury obligations as the index after the initial terms and for subsequent adjustment periods. At December 31, 2002, the Bank had approximately $613.6 million of adjustable-rate mortgage loans in its portfolio. Second, the Bank's mortgage-backed securities portfolio is made up primarily of securities that have expected average lives of five years or less at time of purchase. Third, the Bank has a substantial amount of passbook savings, demand deposit and money market accounts which the Bank believes may be less sensitive to changes in interest rates than certificate accounts. At December 31, 2002 the Bank had $456.3 million of these types of accounts. Fourth, the Bank's liability management program seeks to lengthen the maturities of customer deposits by aggressively pricing longer-term certificates of deposit. The following table presents, as of December 31, 2002 and 2001, an analysis of the Bank's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve in 100 basis point (1%) increments, up 300 basis points and down 100 basis points in 2002 and 2001 in accordance with Office of Thrift Supervision ("OTS") regulations. As illustrated in the table, the Bank's NPV is more sensitive to, and may be more negatively impacted by, declining rates than rising rates. This occurs principally because, as rates rise, the market value of fixed-rate loans declines due to both the rate increase and slowing prepayments. When rates decline, the Bank does not experience a significant rise in market value for these loans because borrowers prepay at relatively high rates. The value of the Bank's borrowings in a rising rate environment decline by a greater percentage than loans resulting in a greater NPV in a rising rate environment.
NET PORTFOLIO VALUE (DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2001 - -------------------------------------------------------------------------------------------------------------------- ASSUMED CHANGE IN INTEREST RATES (BASIS POINTS) $ AMOUNT $ CHANGE % CHANGE $ AMOUNT $ CHANGE % CHANGE - -------------------------------------------------------------------------------------------------------------------- +300 $ 127,883 $ 8,001 7% $ 103,298 $ (45,544) (31)% +200 134,727 14,845 12 122,708 (26,134) (18) +100 133,656 13,775 11 139,189 (9,654) (6) 0 119,882 - - 148,842 - - - -100 104,896 (14,986) (13) 140,725 (8,118) (5)
As noted above, decreases in interest rates would have more of an effect on the percentage change in the Bank's NPV than increases. For instance, at December 31, 2002 for a 200 basis point increase in interest rates, net portfolio value is anticipated to rise by 12% with the remaining NPV at 8.37% of the Bank's total assets. However, a 100 basis point decrease in rates will change the NPV by (13)% with the remaining NPV still at 6.36% of the Bank's total assets. The above analysis includes the assets and liabilities of the Bank only. Inclusion of Holding Company assets and liabilities would increase NPV nominally at all levels. 23 CFS BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTINUED LIQUIDITY AND COMMITMENTS The Company's liquidity, represented by cash and cash equivalents, is a product of operating, investing and financing activities. The Company's primary historical sources of funds are 1) deposits, 2) scheduled payments of amortizing loans and mortgage-backed securities, 3) prepayments and maturities of outstanding loans and mortgage-backed securities, 4) maturities of investment securities and other short-term investments, 5) funds provided from operations, and 6) borrowings from the Federal Home Loan Bank ("FHLB"). Scheduled payments from the amortization of loans, mortgage-backed securities, maturing investment securities, and short-term investments are relatively predictable sources of funds, while deposit flows and loan prepayments are greatly influenced by market rates of interest, economic conditions and competitive rate offerings. In addition, the Company invests excess funds in federal funds sold and other short-term interest-earning assets which provide liquidity to meet lending requirements. At December 31, 2002 the Company had cash and cash equivalents of $210.1 million. Liquidity management is both a daily and long-term function. Excess liquidity is generally invested in short-term investments such as federal funds sold. On a longer-term basis, the Company invests funds not used for maintaining and expanding the loan portfolio in mortgage-backed securities. The Company uses its sources of funds primarily to meet its ongoing commitments, pay maturing certificates of deposit and savings withdrawals, fund loan commitments, and maintain a portfolio of mortgage-backed and investment securities. At December 31, 2002 total commitments to purchase or originate loans outstanding were $57.7 million. Certificates of deposit scheduled to mature in one year or less at December 31, 2002 totaled $377.2 million. Investment securities scheduled to mature or permitted to be called for redemption in one year or less at December 31, 2002 totaled $20.7 million. Based on historical experience, management believes that a significant portion of maturing deposits will remain with the Bank. The Company anticipates that it will continue to have sufficient funds to meet its current commitments. The liquidity needs of CFS Bancorp (the "parent company") consist primarily of operating expenses, dividend payments to stockholders and stock repurchases. The primary sources of liquidity for the parent company are securities available-for-sale and dividends from the Bank. On a parent company only basis, at December 31, 2002, the Company had $6.4 million in securities available-for-sale and, for the year ended December 31, 2001 received $12.5 million in dividends from the Bank. However, these sources can also be supplemented by fees assessed by the Company to the Bank. Under certain banking regulations, the Bank is required to file a notice or, under certain circumstances, an application with the OTS prior to paying any dividends to the Company. In addition, the Bank is required to maintain certain regulatory capital requirements. See note 10 to the Consolidated Financial Statements. The Company has not used, and has no intention of using, any significant off-balance sheet financing arrangements for liquidity purposes. The Company's financial instruments with off-balance sheet risk are limited to obligations to fund loans to customers and participation loans with other financial institutions pursuant to existing commitments. In addition, the Company has not had, and has no intention to have, any significant transactions, arrangements or other relationships with any unconsolidated, limited purpose entities that could materially affect our liquidity or capital resources. The Company has not traded in and has no intention of trading in commodity contracts. IMPACT OF INFLATION AND CHANGING PRICES The consolidated financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results generally in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation. Unlike most industrial companies, virtually all of the Company's assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation. 24 CFS BANCORP, INC. APPLICATION OF CRITICAL ACCOUNTING POLICIES The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. Future changes in information may affect these estimates, assumptions, and judgments, which, in turn, may affect amounts reported in the financial statements. Most accounting policies are not considered by management to be critical accounting policies. All significant accounting policies are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management has determined that its accounting policies with respect to the allowance for loan losses is the accounting area requiring subjective or complex judgments that is most important to the Company's financial position and results of operations, and therefore, is its only critical accounting policy. The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated statement of condition. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses. In addition, a discussion of the factors driving changes in the amount of the allowance for loan losses is included in the Provision for Losses for Loans section on page 20. FORWARD-LOOKING STATEMENTS This Annual Report contains certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by and information currently available to management. These forward-looking statements include, but are not limited to, statements regarding the anticipated net earnings effect of the reconfiguration of the balance sheet and the loan portfolio, tax strategies, general economic conditions, changes in interest rate levels and maturities, marketing initiatives, the adequacy of loan loss provisions, changes in liquidity levels, deposit retention rates, bank-owned life insurance, asset liability management strategies, the outsourcing of investment services, the sale of the insurance agency, and the process improvement program. In addition, the words "anticipate," "believe," "estimate," "expect," "intend," "should" and similar expressions, or the negative thereof, as they relate to the Company or the Company's management, are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company does not intend to update these forward-looking statements. 25 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders CFS Bancorp, Inc. We have audited the accompanying consolidated statements of condition of CFS Bancorp, Inc. (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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, based on our audits, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CFS Bancorp, Inc. as of December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Chicago, Illinois February 19, 2003 26 CONSOLIDATED STATEMENTS OF CONDITION CFS BANCORP, INC.
DECEMBER 31 (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) 2002 2001 - --------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and amounts due from depository institutions $ 30,312 $ 28,250 Interest-bearing deposits 105,479 137,978 Federal funds sold 74,350 105,839 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 210,141 272,067 Investment securities available-for-sale 39,064 47,225 Mortgage-backed securities available-for-sale 296,638 276,158 Mortgage-backed securities held-to-maturity (fair value: 2002 - $21,977; 2001 - $37,744) 21,402 37,034 Loans receivable, net 930,348 883,352 Investment in FHLB stock, at cost 25,780 26,165 Office properties and equipment 13,835 14,983 Accrued interest receivable 6,597 6,887 Real estate owned 893 1,128 Investment in Bank-owned life insurance 31,009 30,052 Prepaid expenses and other assets 9,055 9,083 - --------------------------------------------------------------------------------------------------------------------------- Total assets $ 1,584,762 $ 1,604,134 =========================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 954,222 $ 945,948 Borrowed money 449,431 462,658 Advance payments by borrowers for taxes and insurance 4,410 4,497 Other liabilities 16,037 19,747 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,424,100 1,432,850 Stockholders' equity: Preferred stock, $.01 par value: Authorized shares - 15,000,000 Issued and outstanding shares - none at December 31, 2002 and 2001 - - Common stock, $.01 par value: Authorized shares - 85,000,000 Issued shares -23,423,306 at December 31, 2002 and 2001 Outstanding shares - 12,674,597 and 13,626,146 at December 31, 2002 and 2001, respectively 234 234 Additional paid-in capital 189,786 189,547 Retained earnings, substantially restricted 107,598 105,064 Treasury stock, at cost: 10,748,709 and 9,797,160 shares at December 31, 2002 and 2001, respectively (125,650) (112,167) Unearned common stock acquired by ESOP (8,356) (9,570) Unearned common stock acquired by RRP (2,827) (4,543) Accumulated other comprehensive income (loss), net of tax (123) 2,719 - --------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 160,662 171,284 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 1,584,762 $ 1,604,134 ===========================================================================================================================
See accompanying notes. 27 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31 (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) 2002 2001 2000 - -------------------------------------------------------------------------------------------------------------------- Interest income: Loans $ 62,719 $ 71,063 $ 74,109 Mortgage-backed securities 17,491 21,270 26,403 Investment securities 1,720 8,169 14,523 Other 4,631 7,605 3,841 - -------------------------------------------------------------------------------------------------------------------- Total interest income 86,561 108,107 118,876 Interest expense: Deposits 25,717 40,847 43,095 Borrowed money 27,351 29,441 29,938 - -------------------------------------------------------------------------------------------------------------------- Total interest expense 53,068 70,288 73,033 - -------------------------------------------------------------------------------------------------------------------- Net interest income before provision for losses on loans 33,493 37,819 45,843 Provision for losses on loans 1,956 1,150 3,375 - -------------------------------------------------------------------------------------------------------------------- Net interest income after provision for losses on loans 31,537 36,669 42,468 Noninterest income: Loan fees 1,393 1,319 1,426 Deposit fees 4,112 2,563 1,391 Insurance commissions 1,210 1,067 902 Investment commissions 770 873 1,442 Bank-owned life insurance income 1,524 1,500 406 Net gain on sale of investment securities 299 599 42 Net gain on sale of branches -- 2,014 -- Gain on sale of insurance agency 1,084 -- -- Other income 921 793 472 - -------------------------------------------------------------------------------------------------------------------- Total noninterest income 11,313 10,728 6,081 Noninterest expense: Compensation and employee benefits 20,070 19,028 19,303 Net occupancy expense 2,362 2,471 2,430 Furniture and equipment expense 1,925 2,037 2,331 Data processing 1,743 1,448 1,013 Federal insurance premiums 164 183 197 Marketing 904 853 715 Other general and administrative expenses 5,506 5,413 5,046 - -------------------------------------------------------------------------------------------------------------------- Total noninterest expense 32,674 31,433 31,035 - -------------------------------------------------------------------------------------------------------------------- Income before income taxes 10,176 15,964 17,514 Income tax expense 2,971 4,791 6,821 - -------------------------------------------------------------------------------------------------------------------- Net income $ 7,205 $ 11,173 $ 10,693 ==================================================================================================================== Per share data: Basic earnings per share $ .60 $ .80 $ .66 Diluted earnings per share .58 .77 .66 Weighted-average shares outstanding 12,000,589 14,038,096 16,125,560 Weighted-average diluted shares outstanding 12,492,149 14,453,344 16,322,212
See accompanying notes. 28 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
UNEARNED UNEARNED COMMON COMMON ACCUMULATED ADDITIONAL STOCK STOCK OTHER COMMON PAID-IN RETAINED TREASURY ACQUIRED ACQUIRED COMPREHENSIVE (DOLLARS IN THOUSANDS) STOCK CAPITAL EARNINGS STOCK BY ESOP BY RRP INCOME (LOSS) TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 2000 $ 232 $ 187,138 $ 93,927 $ (48,079) $ (11,962) $ (6,389) $(9,434) $205,433 Net income for 2000 -- -- 10,693 -- -- -- -- 10,693 Other comprehensive income, net of tax: Change in unrealized appreciation on available-for-sale securities, net of reclassification adjustment -- -- -- -- -- -- 6,410 6,410 Total comprehensive income -- -- -- -- -- -- -- 17,103 Purchase of treasury stock -- -- -- (20,750) -- -- -- (20,750) Shares earned under ESOP -- (72) -- -- 1,196 -- -- 1,124 Amortization of award under RRP -- (12) -- -- -- 370 -- 358 Exercise of stock options 2 812 -- -- -- -- -- 814 Tax benefit related to stock options -- 110 -- -- -- -- -- 110 exercised Liability for common stock in Rabbi Trust -- 1,014 -- -- -- -- -- 1,014 Dividends declared on common stock ($.34 per share) -- -- (5,838) -- -- -- -- (5,838) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2000 234 188,990 98,782 (68,829) (10,766) (6,019) (3,024) 199,368 Net income for 2001 -- -- 11,173 -- -- -- -- 11,173 Other comprehensive income, net of tax: Change in unrealized appreciation on available-for-sale securities, net of reclassification adjustment -- -- -- -- -- -- 5,743 5,743 Total comprehensive income -- -- -- -- -- -- -- 16,916 Purchase of treasury stock -- -- -- (43,634) -- -- -- (43,634) Shares earned under ESOP -- 340 -- -- 1,196 -- -- 1,536 Amortization of award under RRP -- (52) -- -- -- 1,476 -- 1,424 Exercise of stock options -- 136 -- 296 -- -- -- 432 Tax benefit related to stock options -- 133 -- -- -- -- -- 133 exercised Dividends declared on common stock ($.36 per share) -- -- (4,891) -- -- -- -- (4,891) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2001 234 189,547 105,064 (112,167) (9,570) (4,543) 2,719 171,284 Net income for 2002 -- -- 7,205 -- -- -- -- 7,205 Other comprehensive income, net of tax: Change in unrealized appreciation on available-for-sale securities, net of reclassification adjustment -- -- -- -- -- -- (2,842) (2,842) Total comprehensive income -- -- -- -- -- -- -- 4,363 Purchase of treasury stock -- -- -- (14,626) -- -- (14,626) Shares earned under ESOP -- 494 -- -- 1,214 -- -- 1,708 Amortization of award under RRP -- (62) -- -- -- 1,716 -- 1,654 Exercise of stock options -- (285) -- 1,143 -- -- -- 858 Tax benefit related to stock options -- 92 -- -- -- -- -- 92 exercised Dividends declared on common stock ($.36 per share) -- -- (4,671) -- -- -- -- (4,671) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2002 $ 234 $ 189,786 $ 107,598 $(125,650) $ (8,356) $ (2,827) $ (123) $ 160,662 ====================================================================================================================================
See accompanying notes. 29 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------ Operating activities Net income $ 7,205 $ 11,173 $ 10,693 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for losses on loans 1,956 1,150 3,375 Depreciation expense 1,787 1,944 2,135 Deferred income taxes (1,582) (254) (825) Amortization of cost of stock benefit plans 3,362 2,960 2,538 Tax benefit from exercises of nonqualified stock options 92 133 110 Change in deferred income 1,327 263 (47) Decrease (increase) in interest receivable 290 3,728 (937) (Decrease) increase in accrued interest payable (184) (958) 204 Proceeds from sale of loans held-for-sale 12,128 5,873 1,327 Origination of loans held-for-sale (11,484) (6,229) (2,674) Gain on sale of branches -- (2,014) -- Net gain on sale of securities available-for-sale (299) (599) (42) Purchase of Bank-owned life insurance -- (6,192) (22,689) Decrease (increase) in prepaid expenses and other assets 6,060 (1,345) (5,146) (Decrease) increase in other liabilities (3,879) (2,545) 3,652 - ------------------------------------------------------------------------------------------------------------------------ Net cash provided (used) by operating activities 16,779 7,088 (8,326) Investing activities Available-for-sale investment securities: Purchases $(443,023) $(453,709) $ (45,339) Repayments 448,026 422,436 45,060 Sales 2,757 19,499 587 Held-to-maturity investment securities: Repayments and maturities -- 171,130 6,000 Available-for-sale mortgage-backed securities: Purchases (225,603) (83,058) -- Repayments 187,905 80,411 30,256 Sales 10,194 15,046 -- Held-to-maturity mortgage-backed securities: Repayments 15,288 40,263 22,209 Purchase of Federal Home Loan Bank stock (27) (96) (5,357) Redemption of Federal Home Loan Bank stock 412 856 880 Loan originations and principal payments on loans, net (53,291) 112,443 (118,989) Additions to real estate owned (84) (264) (96) Proceeds from sale of real estate owned 2,687 2,069 1,368 Purchases of properties and equipment (1,746) (1,262) (2,160) Disposal of properties and equipment 1,107 693 890 - ------------------------------------------------------------------------------------------------------------------------ Net cash flows (used in) provided by investing activities (55,398) 326,457 (64,691)
30 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31 2002 2001 2000 - ---------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Proceeds from exercise of stock options 858 432 814 Dividends paid on common stock (4,642) (5,143) (5,966) Purchase of treasury stock (14,626) (43,634) (20,750) Net increase (decrease) in checking, passbook, and money market accounts 55,729 46,766 (1,053) Net (decrease) increase in certificates of deposit (47,312) 4,680 9,933 Net (decrease) increase in advance payments by borrowers for taxes and insurance (87) (1,356) 115 Decrease in checking, passbook and money market accounts in connection with sale of branches -- (10,823) -- Decrease in certificates of deposit in connection with sale of -- (28,252) -- branches Premium on deposits received in connection with sale of branches -- 2,014 -- Net (decrease) increase of borrowed money (13,227) (85,418) 53,377 - ---------------------------------------------------------------------------------------------------------------------- Net cash flows (used in) provided by financing activities (23,307) (120,734) 36,470 - ---------------------------------------------------------------------------------------------------------------------- (Decrease) increase in cash and cash equivalents (61,926) 212,811 (36,547) Cash and cash equivalents at beginning of year 272,067 59,256 95,803 - ---------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 210,141 $ 272,067 $ 59,256 ====================================================================================================================== Supplemental disclosure of noncash activities: Loans transferred to real estate owned $ 2,368 $ 1,875 $ 1,721
See accompanying notes. 31 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 ------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION CFS Bancorp, Inc. (the Company) is a Delaware corporation, incorporated in March 1998 for the purpose of becoming the holding company for Citizens Financial Services, FSB (the Bank). The Company is headquartered in Munster, Indiana. The Bank is a federal savings bank offering a full range of financial services to customers who are primarily located in Northwest Indiana and the south and southwest Chicagoland area. The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits to originate residential and commercial mortgage loans. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts and transactions of the Company and its wholly-owned subsidiary, the Bank. The Bank has the following subsidiaries: CFS Insurance Agency, Inc., CFS Investment Services, Inc., CFS Holdings, Ltd., and Suburban Mortgage Services, Inc. Significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 2001 and 2000 consolidated financial statements to conform to the 2002 presentation. 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. CASH AND CASH EQUIVALENTS Cash and cash equivalents include amounts due from depository banks and federal funds sold. Generally, federal funds sold are purchased and sold for one-day periods. INVESTMENT AND MORTGAGE-BACKED SECURITIES Management determines the classification of securities at the time of purchase. Debt securities are classified as held-to-maturity and carried at amortized cost if management has the intent and ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized gains and losses, net of tax, included in Accumulated Other Comprehensive Income. The Company has no trading account securities. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-related securities, over the estimated life of the security using the level-yield method. Such amortization is included in interest income from securities. A decline in the market value of any available-for-sale or held-to-maturity security below amortized cost that is deemed to be other than temporary results in a charge to earnings thereby establishing a new cost basis for such security. Gains and losses on sales of securities are determined by specifically identifying the carrying amount of the security sold. LOANS Loans are carried at the principal amount outstanding, net of unearned income, including net deferred loan origination and commitment fees, and portions charged off. Interest on loans is recorded as income as borrowers' monthly payments become due. Interest on loans is not accrued on loans which are 90 days or more past due, or for loans which management believes, after giving consideration to economic and business conditions and collection efforts, collection of interest is doubtful. Loans held-for-sale, if any, are carried at the lower of aggregate cost or market value. LOAN FEES AND COSTS Loan origination and commitment fees and direct loan origination costs are deferred and amortized as an adjustment of the related loan's yield. The Bank is accreting these amounts over the contractual life of the related loans. Remaining deferred loan fees are reflected in income upon sale or repayment of the loan. 32 CFS BANCORP, INC. ALLOWANCE FOR LOSSES ON LOANS The allowance for losses on loans is maintained at a level believed adequate by management to absorb losses inherent in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio and, among other things, the borrowers' ability to repay, estimated collateral values, prior loss experience, growth and composition of the portfolio, assessment of individual problem loans, and current economic events in specific industries and regions including unemployment levels, regulatory guidance and general economic conditions. Determination of the allowance for losses on loans is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for losses on loans is expensed based on management's periodic evaluation of the factors previously mentioned. Future changes to the allowance may be necessary based on changes in economic conditions, financial condition of borrowers, and loan loss experience. Management considers a loan to be impaired when it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the note agreement, including principal and interest. Loans subject to impairment valuation are defined as nonaccrual and restructured loans exclusive of homogeneous loans such as single-family residential and consumer loans. Specific allowances are established for impaired loans for which the recorded investment in the loan exceeds the value of the loan. The value of the loan is determined based on the fair value of the collateral, if the loan is collateral-dependent, at the present value of expected future cash flows discounted at the loan's effective interest rate or at the observable market price of the impaired loan. Interest income on impaired loans is recorded when cash is received and only if principal is considered to be fully collectible. Commercial loans and loans secured by real estate are generally charged off to the extent principal and interest due exceed the net realizable value of the collateral with the charge off occurring when the loss is reasonably quantifiable. Consumer loans are subject to mandatory charge off at a specific date, typically at the end of the month in which the loan becomes 120 days past due. REAL ESTATE OWNED Real estate owned is comprised of property acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. Real estate owned is recorded at fair value at the date of foreclosure. After foreclosure, valuations are periodically performed by management, and the real estate is carried at the lower of cost or fair value minus estimated costs to sell. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are stated at cost less accumulated depreciation. Provisions for depreciation of office properties and equipment are computed using the straight-line method over the estimated useful lives of the related assets. Long-lived assets are periodically evaluated for impairment. ADVERTISING COSTS All advertising costs incurred by the Company are expensed in the period in which they are incurred. EARNINGS PER SHARE Basic earnings per common share (EPS) is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Employee Stock Ownership Plan (ESOP) shares not committed to be released and Recognition and Retention Plan (RRP) shares which have not vested are not considered to be outstanding. The basic EPS calculation excludes the dilutive effect of all common stock equivalents. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company's potentially dilutive common shares represent shares issuable under its 33 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 stock option and RRP plans. Such common stock equivalents are computed based on the treasury stock method using the average market price for the period. STOCK BASED COMPENSATION The Company accounts for its stock options in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25). Under APB No. 25, as the exercise price of the Company's employees' stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Compensation expense for shares granted under the RRP is ratably recognized over the period of service, usually the vesting period, based on the fair value of the stock on the date of grant. Pursuant to Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based Compensation (FAS No. 123), pro forma net income and pro forma earnings per share are presented in the following table as if the fair value method of accounting for stock-based compensation plans had been utilized.
YEAR ENDED DECEMBER 31 2002 2001 2000 - --------------------------------------------------------------- Net income (as reported) $ 7,205 $11,173 $10,693 Pro forma net income 6,442 10,494 10,089 Diluted earnings per share (as reported) .58 .77 .66 Pro forma diluted earnings per share .52 .73 .62
The pro forma results above may not be representative of the effect reported in net income for future years. The fair value of the option grants for the years ended December 31, 2002, 2001, and 2000 was estimated using the Black Scholes option value model, with the following assumptions: dividend yield of approximately 2.8% in 2002, 3.6% in 2001, and 3.6% for 2000, expected volatility of 30.2% in 2002, 30.2% in 2001, and 26.0% for 2000, risk-free interest of 3.6%, 5.03%, and 5.87% for 2002, 2001, and 2000, respectively; and an original expected life of ten years for all options granted. For additional details on the Company's stock-based compensation plans, see Note 12 to the consolidated financial statements. INCOME TAXES The Company provides for deferred tax assets and liabilities, which represent the difference between the financial statement and tax basis of assets and liabilities and are measured using the enacted tax rates and laws applicable to periods when the differences are expected to reverse. Deferred taxes arise because certain transactions affect the determination of taxable income for tax return purposes differently than for book purposes. Current tax expense is provided based upon the actual tax liability incurred for tax return purposes. COMPREHENSIVE INCOME Comprehensive income is the total of reported net income and all other revenues, expenses, gains, and losses that under generally accepted accounting principles are not included in net income. The Company includes unrealized gains or losses, net of tax, on securities available-for-sale in other comprehensive income. SEGMENT REPORTING Operating segments are components of a business about which separate financial information is available and that are evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and assessing performance. Public companies are required to report certain financial information about operating segments in interim and annual financial statements. Senior management evaluates the operations of the Company as one operating segment, community banking, due to the materiality of the banking operation to the Company's financial condition and results of operations, taken as a whole. As a result, separate segment disclosures are not required. The Company offers the following products and services to external customers: deposits, loans, mortgage-related services, investment and insurance services, and trust services. Revenues for the significant products and services are disclosed separately in the consolidated statements of income. 34 CFS BANCORP, INC. DERIVATIVE FINANCIAL INSTRUMENTS On January 1, 2002, the Company adopted FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (FAS No. 133). The adoption of FAS No. 133 did not have a material impact on the financial position or results of operations of the Company, as the Company does not utilize derivatives. NEW ACCOUNTING PRONOUNCEMENTS GOODWILL AND OTHER INTANGIBLE ASSETS - Effective January 1, 2002, the Company adopted FASB Statement No. 142, Goodwill and Other Intangible Assets (FAS No. 142), which addresses the accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion 17. Under FAS No. 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but reviewed for impairment annually, or more frequently if certain indicators arise. In addition, the Statement requires intangible assets with identifiable lives to be evaluated periodically and to continue to be amortized over their useful lives. The Company had no goodwill and other intangible assets as of December 31, 2002. LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF - Effective January 1, 2002, the Company adopted FASB Statement No. 144, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of (FAS No. 144), which addresses how and when to measure impairment on long-lived assets and how to account for long-lived assets that an entity plans to dispose of either through sale, abandonment, exchange, or distribution to owners. The new provisions supersede FAS No. 121, which addressed asset impairment, and certain provisions of APB Opinion 30 related to reporting the effects of the disposal of a business segment and requires expected future operating losses from discontinued operations to be recorded in the period in which the losses are incurred rather than the measurement date. Under FAS No. 144, more dispositions may qualify for discontinued operations treatment in the income statement. The adoption of FAS No. 144 had no material impact on the Company's financial position or results of operations. ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS - In October 2002, the FASB issued FASB Statement No. 147, Acquisitions of Certain Financial Institutions (FAS No. 147), which provides guidance on the accounting for the acquisition of a financial institution and supersedes the specialized accounting guidance provided in FAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions. FAS No. 147 became effective upon issuance and requires companies to cease amortization of unidentified intangible assets associated with certain branch acquisitions and reclassify these assets to goodwill. FAS No. 147 also modifies FAS No. 144 to include in its scope long-term customer-relationship intangible assets and thus subject those intangible assets to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions required for other long-lived assets. While FAS No. 147 may affect how future business combinations, if undertaken, are accounted for and disclosed in the financial statements, the issuance of the new guidance had no effect on the Company's results of operations, financial position, or liquidity as the Company does not have any assets subject to the specialized accounting guidance provided in FAS No. 72 or FAS No. 147. ACCOUNTING FOR STOCK-BASED COMPENSATION - In December 2002, the FASB issued FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (FAS No. 148), which provides guidance on how to transition from the intrinsic value method of accounting for stock-based employee compensation under APB No. 25 to FAS No. 123's fair value method of accounting, if a company so elects. The Statement also amends the disclosure provisions of FAS No. 123 and APB No. 25 to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While FAS No. 148 does not amend FAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of FAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of 35 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 whether they account for that compensation using the fair value method of FAS No. 123 or the intrinsic value method of APB No. 25. Although the recognition provisions of FAS No. 148 are not applicable to the Company at this time as it continues to account for stock-based compensation using the intrinsic value method, the Company has provided the required disclosures in Note 1 to the consolidated financial statements. GUARANTEES - In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation expands the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees and requires the guarantor to recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are effective for the Company as of December 31, 2002 and require disclosure of the nature of the guarantee, the maximum potential amount of future payments that the guarantor could be required to make under the guarantee, and the current amount of the liability, if any, for the guarantor's obligations under the guarantee. The recognition requirements of FIN 45 are to be applied prospectively to guarantees issued or modified after December 31, 2002. Significant guarantees that have been entered into by the Company are disclosed in Note 15 to the consolidated financial statements. The Company does not expect the requirements of FIN 45 to have a material impact on its results of operations, financial position, or liquidity. CONSOLIDATION OF VARIABLE INTEREST ENTITIES - In January 2003 the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. The objective of this interpretation is to provide guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, noncontrolling interest, and results of operations of a VIE need to be included in a company's consolidated financial statements. Because the Company does not have interest in any VIE's, the Company does not expect the adoption of FIN 46 to have a material impact on its results of operations, financial position, or liquidity. 36 CFS BANCORP, INC. 2. INVESTMENT SECURITIES The amortized cost of investment securities and their fair values are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE - ----------------------------------------------------------------------------------------------------------------------------- Available-for-sale at December 31, 2002: Callable agency securities, corporate bonds, and commercial paper $ 30,767 $ 320 $ - $ 31,087 Trust preferred securities 4,931 - 531 4,400 Equity securities 4,400 83 906 3,577 - ----------------------------------------------------------------------------------------------------------------------------- $ 40,098 $ 403 $ 1,437 $ 39,064 =============================================== Available-for-sale at December 31, 2001: Callable agency securities, corporate bonds, notes and commercial paper $ 33,169 $ 12 $ 33 $ 33,148 Trust preferred securities 4,929 - 534 4,395 Equity securities 7,489 611 454 7,646 Asset-backed notes 2,026 10 - 2,036 - ----------------------------------------------------------------------------------------------------------------------------- $ 47,613 $ 633 $ 1,021 $ 47,225 ===============================================
The callable agency securities at December 31, 2002 and 2001 have call features at amounts not less than par and were not purchased with significant premiums or discounts. The amortized cost and fair value of investment securities at December 31, 2002, by contractual maturity, are shown below:
AVAILABLE-FOR-SALE --------------------- AMORTIZED FAIR COST VALUE - ----------------------------------------------------------- Due in one year or less $ 15,719 $ 15,719 Due after one year through five years 10,050 10,327 Due after five years through ten years 4,998 5,041 Due more than ten years 4,931 4,400 Equity securities with no stated maturity 4,400 3,577 - ----------------------------------------------------------- $ 40,098 $ 39,064 =====================
For the year ended December 31, 2002, gross gains and gross losses of $506 ($358 net of taxes) and $441 ($312 net of taxes), respectively, were recorded from sales of available-for-sale investment securities. For the year ended December 31, 2001, gross gains and gross losses of $739 ($517 net of taxes) and $84 ($59 net of taxes), respectively, were recorded from sales of available-for-sale investment securities. For the year ended December 31, 2000, gross gains and gross losses of $74 ($46 net of taxes) and $32 ($20 net of taxes), respectively, were recorded from sales of available-for-sale investment securities. 37 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 3. MORTGAGE-BACKED SECURITIES The amortized cost of mortgage-backed securities and their fair values are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAIN LOSSES VALUE - ---------------------------------------------------------------------------------------------------------------------------------- Available-for-sale at December 31, 2002: Participation certificates and collateralized mortgage obligations $ 64,084 $ 820 $ 136 $ 64,768 Real estate mortgage investment conduits 231,752 862 744 231,870 - ---------------------------------------------------------------------------------------------------------------------------------- $295,836 $ 1,682 $ 880 $296,638 ======================================================== Available-for-sale at December 31, 2001: Participation certificates and collateralized mortgage obligations $ 32,089 $ 1,215 $ 79 $ 33,225 Real estate mortgage investment conduits 239,776 3,438 282 242,933 - ---------------------------------------------------------------------------------------------------------------------------------- $271,865 $ 4,653 $ 361 $276,158 ======================================================== Held-to-maturity at December 31, 2002: Participation certificates and collateralized mortgage obligations $ 20,651 $ 520 $ 10 $ 21,161 Real estate mortgage investment conduits 751 65 -- 816 - ---------------------------------------------------------------------------------------------------------------------------------- $ 21,402 $ 585 $ 10 $ 21,977 ======================================================== Held-to-maturity at December 31, 2001: Participation certificates and collateralized mortgage obligations $ 28,644 $ 659 $ 69 $ 29,234 Real estate mortgage investment conduits 8,390 125 5 8,510 - ---------------------------------------------------------------------------------------------------------------------------------- $ 37,034 $ 784 $ 74 $ 37,744 ========================================================
The mortgage-backed securities have contractual maturities that range from 2003 to 2032. Expected maturities may differ from contractual maturities because the underlying mortgages collateralizing the securities are subject to prepayment without penalty. For the year ended December 31, 2002, gross gains of $234 ($166 net of tax) were recorded from sales of available-for-sale mortgage-backed securities. There were no losses on sales of available-for-sale mortgage-backed securities. For the year ended December 31, 2001 there were no gains on the sale of available-for-sale mortgage-backed securities. There were gross losses of $56 ($39 net of tax). For the year ended December 31, 2000 there were no sales of available-for-sale mortgage-backed securities. 38 CFS BANCORP, INC. 4. LOANS RECEIVABLE Loans receivable consist of the following:
DECEMBER 31 2002 2001 - --------------------------------------------------------------------------------------------------- First mortgage loans: Single-family residential $ 386,050 $ 535,197 Multi-family residential 71,170 51,635 Commercial real estate 271,426 142,663 Construction and land development: Single-family residential 12,118 17,208 Multi-family residential 63,893 26,443 Commercial real estate 88,951 76,168 Home equity loans 45,106 41,416 Other loans: Commercial 40,034 23,996 Consumer 2,610 2,066 Undisbursed portion of loan proceeds (39,704) (24,454) Net deferred yield adjustments (2,632) (1,324) - --------------------------------------------------------------------------------------------------- 939,022 891,014 Allowance for losses on loans 8,674 7,662 - --------------------------------------------------------------------------------------------------- Loans receivable, net $ 930,348 $ 883,352 ===================================================================================================
The Bank's lending activities have been concentrated primarily within its immediate geographic area. The Bank generally requires collateral on loans and loan-to-value ratios of no greater than 80%. At December 31, 2002, 2001, and 2000, the Company serviced $16,816, $21,125, and $27,665, respectively, of loans for others. Activity in the allowance for losses on loans is summarized as follows:
2002 2001 2000 - -------------------------------------------------------------- Balance at beginning of year $ 7,662 $ 7,187 $ 5,973 Provision for losses on loans 1,956 1,150 3,375 Charge-offs (1,183) (855) (2,279) Recoveries 239 180 118 - -------------------------------------------------------------- Balance at end of year $ 8,674 $ 7,662 $ 7,187 ==============================================================
DECEMBER 31 2002 2001 - ---------------------------------------------------------------- Impaired loans: With a valuation reserve $ 3,853 $ - No valuation reserve required $ 2,460 $ - - ---------------------------------------------------------------- Total impaired loans $ 6,313 $ 2,915 - ---------------------------------------------------------------- Valuation reserve relating to impaired loans $ 150 $ - Average impaired loans during year $ 3,949 $ 2,760 ================================================================
39 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 5. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are summarized as follows:
DECEMBER 31 ESTIMATED USEFUL LIVES 2002 2001 - ---------------------------------------------------------------------- Cost: Land $ 1,921 $ 1,934 Buildings 30-40 years 15,341 14,890 Leasehold improvements Over term of lease 2,310 2,402 Furniture and equipment 3-15 years 12,844 13,582 Construction in progress 257 550 - ---------------------------------------------------------------------- 32,673 33,358 Less: Accumulated depreciation and amortization 18,838 18,375 - ---------------------------------------------------------------------- $ 13,835 $ 14,983
OPERATING LEASES At December 31, 2002, the Company and its subsidiaries were obligated under certain noncancelable operating leases for premises and equipment, which expire at various dates through the year 2007. Many of these leases contain renewal options, and certain leases provide options to purchase the leased property during or at the expiration of the lease period at specific prices. Some leases contain escalation clauses calling for rentals to be adjusted for increased real estate taxes and other operating expenses, or proportionately adjusted for increases in the consumer or other price indices. The following summary reflects the future minimum rental payments, by year, required under operating leases that, as of December 31, 2002, have initial or remaining noncancelable lease terms in excess of one year.
YEAR ENDED DECEMBER 31 - ---------------------------- 2003 $349 2004 262 2005 151 2006 125 2007 75 2008 3 - ---------------------------- $965 ============================
Rental expense charged to operations in 2002, 2001, and 2000, amounted to approximately $605, $640, and $607, respectively, including amounts paid under short-term cancelable leases. 6. ACCRUED INTEREST RECEIVABLE Accrued interest receivable consists of the following:
DECEMBER 31 2002 2001 - ---------------------------------------------------------------------------------------------------------- Callable agency securities and other investments $ 349 $ 318 Participation certificates and collateralized mortgage obligations 525 793 Real estate mortgage investment conduits 1,187 775 Loans receivable 4,536 5,001 - ---------------------------------------------------------------------------------------------------------- $ 6,597 $ 6,887 =========================
40 CFS BANCORP, INC. 7. DEPOSITS Deposits and interest rate data are summarized as follows:
DECEMBER 31 2002 2001 ================================================================================ Checking accounts: Noninterest-bearing $ 31,318 $ 26,970 Interest-bearing 90,905 81,217 - -------------------------------------------------------------------------------- Total checking accounts 122,223 108,187 Passbook accounts: Savings accounts 197,530 187,997 Individual retirement accounts 14,840 15,168 - -------------------------------------------------------------------------------- Total passbook accounts 212,370 203,165 Money market accounts 121,693 89,205 Certificates of deposit accounts: Less than one year 377,212 405,576 One to two years 57,119 68,027 Two to three years 34,367 29,746 Three to four years 12,248 24,846 Four to five years 13,980 11,913 Greater than five years 2,649 4,779 - -------------------------------------------------------------------------------- Total certificates of deposit accounts 497,575 544,887 Accrued interest payable 361 504 - -------------------------------------------------------------------------------- $ 954,222 $ 945,948 ============================ Weighted-average cost of deposits 2.32% 3.43% ================================================================================
Interest expense on deposits consists of the following:
YEAR ENDED DECEMBER 31 2002 2001 2000 - -------------------------------------------------------------------------------- Checking accounts $ 562 $ 1,111 $ 1,290 Passbook accounts 2,768 4,591 6,456 Money market accounts 2,173 2,187 1,929 Certificates of deposit 20,214 32,958 33,420 - -------------------------------------------------------------------------------- $25,717 $40,847 $43,095 =============================================
The aggregate amount of deposits in denominations of greater than one hundred thousand dollars was $214,978 and $198,602 at December 31, 2002 and 2001, respectively. Deposits in excess of one hundred thousand dollars generally are not federally insured. Interest paid on deposits during 2002, 2001, and 2000 totaled $25,860, $41,282, and $43,010, respectively. 41 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 8. BORROWED MONEY Borrowed money consists of the following:
DECEMBER 31 2002 2001 -------------------------------------------------------------- WEIGHTED- WEIGHTED- AVERAGE AVERAGE RATE AMOUNT RATE AMOUNT - -------------------------------------------------------------------------------------------------------------------------- Secured advances from FHLB - Indianapolis: Maturing in 2003 - fixed rate 5.22% $ 30,748 5.31% $ 36,095 Maturing in 2010 - fixed rate 5.92 400,000 5.92 400,000 Maturing in 2014 - fixed rate 6.71 1,259 6.71 1,274 Maturing in 2018 - fixed rate 5.54 2,954 5.54 2,994 Maturing in 2019 - fixed rate 6.32 7,970 6.32 8,095 Secured advances from FHLB - Chicago: Maturing in 2002 - fixed rate - - 6.20 7,700 Maturing in 2008 - fixed rate 5.26 6,500 5.26 6,500 ---------------------------------------- $ 449,431 $462,658 =========== ======== Weighted-average interest rate 5.87% 5.88% ==========================================================================================================================
Advances with unpaid balances totaling $400,000 and final maturities in 2010 contain call dates in 2003. Advances with unpaid balances totaling $6,500 and final maturities in 2008 contain call dates in 2003. Pursuant to collateral agreements with the Federal Home Loan Bank of Indianapolis (FHLB-IN), advances are secured by the following assets:
DESCRIPTION OF COLLATERAL AMOUNT PLEDGED - ----------------------------------------------------- FHLB-IN stock $ 25,455 First mortgage loans 378,261 Mortgage-backed securities 134,584 FHLB-IN time deposits 67,000 - ----------------------------------------------------- $ 605,300 ==============
Pursuant to collateral agreements with the Federal Home Loan Bank of Chicago (FHLB-C), advances are secured by stock in the FHLB-C and certain mortgage-backed securities having a carrying value of $14,619. The Company has a borrowing agreement with Bank One for a maximum of $5,000 federal funds borrowing line of credit at a rate quoted as the market rate by ANB for the purchase of federal funds at the time the purchase is requested. The advance is secured by certain mortgage-backed securities having a carrying value of $4,854. The line was not used in 2002 or 2001. The Bank enters into sales of securities under agreements to repurchase (repurchase agreements). These repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as borrowed funds in the consolidated statements of condition. The securities underlying these repurchase agreements continue to be reflected as assets of the Company. There were no securities sold under agreements to repurchase at December 31, 2002 or December 31, 2001. Interest expense on borrowed money is summarized as follows:
YEAR ENDED DECEMBER 31 2002 2001 2000 - ------------------------------------------------------------ Advances from FHLBs $27,351 $28,366 $26,705 Securities sold under agreements to repurchase - 1,075 3,233 - ------------------------------------------------------------ $27,351 $29,441 $29,938 ===============================
Interest paid on borrowings during 2002, 2001, and 2000 was $27,392, $29,964, and $29,818, respectively. 42 CFS BANCORP, INC. 9. INCOME TAXES The income tax provision consists of the following:
YEAR ENDED DECEMBER 31 2002 2001 2000 - ----------------------------------------------------------------- Current tax expense: Federal $ 4,236 $ 4,454 $ 6,782 State 317 591 864 Deferred tax expense (benefit): Federal (1,423) (262) (813) State (159) 8 (12) - ----------------------------------------------------------------- $ 2,971 $ 4,791 $ 6,821 =================================================================
A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:
YEAR ENDED DECEMBER 31 2002 2001 2000 - --------------------------------------------------------------- Statutory rate 35.0% 35.0% 35.0% State taxes 1.8 3.8 4.9 Bank-owned life insurance (5.2) (3.3) - Other (2.4) (5.5) (1.0) - --------------------------------------------------------------- Effective rate 29.2% 30.0% 38.9% ===============================================================
Significant components of deferred tax assets and liabilities are as follows:
DECEMBER 31 2002 2001 - -------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses $ 3,558 $ 3,105 Deferred compensation 681 692 Loan fees deferred 1,129 397 Other 18 85 - -------------------------------------------------------------------- 5,386 4,279 Deferred tax liabilities: Excess tax accumulated provision for losses over base year 300 651 Depreciation 210 250 Stock dividends on FHLB stock 182 182 Other 313 397 - -------------------------------------------------------------------- 1,005 1,480 ===================== Net deferred tax asset 4,381 2,799 Tax effect of adjustment related to unrealized depreciation (appreciation) on available-for-sale securities 132 (1,185) - -------------------------------------------------------------------- Net deferred tax assets including adjustments $ 4,513 $ 1,614 ====================================================================
The Bank has qualified under provisions of the Internal Revenue Code, which permitted it to deduct from taxable income an allowance for bad debts, which differs from the provision for such losses charged to income. Accordingly, retained income at December 31, 2002 includes approximately $12,497, for which no provision for income taxes has been made. If in the future this portion of retained income is distributed, or the Bank no longer qualifies as a bank for tax purposes, income taxes may be imposed at the then applicable rates. If income taxes had been provided, the deferred tax liability would have been approximately $4,499. The Company made net federal and state income tax payments of $2,023, $5,679, and $6,180 during 2002, 2001, and 2000, respectively. 43 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 10. REGULATORY CAPITAL The principal source of cash flow for the Company is dividends from the Bank. Various federal banking regulations and capital guidelines limit the amount of dividends that may be paid to the Company by the Bank. Future payment of dividends by the Bank is dependent on individual regulatory capital requirements and levels of profitability. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum total requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to quantitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, set forth in the table below of the total risk-based, tangible, and core capital, as defined in the regulations. Management believes, as of December 31, 2002, that the Bank met all capital adequacy requirements to which it is subject. As of December 31, 2002, the most recent notification from the Office of Thrift Supervision categorized the Bank as "well-capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well-capitalized," the Bank must maintain minimum total risk-based, tangible, and core ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category.
TO BE WELL-CAPITALIZED FOR CAPITAL UNDER PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS ------------------------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - ------------------------------------------------------------------------------------------------------------------------------------ As of December 31, 2002 Risk-based $140,233 13.97% $80,310 >8.00% $100,388 >10.00% Tangible 131,559 8.42 23,435 >1.50 31,246 >2.00 Core 131,559 8.42 62,492 >4.00 78,116 >5.00 As of December 31, 2001 Risk-based $141,612 15.40% $73,606 >8.00% $ 92,008 >10.00% Tangible 133,950 8.48 23,694 >1.50 31,599 >2.00 Core 133,950 8.48 63,184 >4.00 78,997 >5.00
At December 31, 2002, adjusted total assets were $1,562,312 and risk-weighted assets were $1,003,878. A reconciliation of the Bank's equity capital in accordance with generally accepted accounting principles to regulatory capital is as follows:
DECEMBER 31 2002 2001 Total equity $ 132,289 $136,932 Intangibles - (283) Unrealized gain on securities available-for-sale, net of equity securities losses (730) (2,699) - ----------------------------------------------------------- Tangible and core capital 131,559 133,950 Allowance for loan losses 8,674 7,662 - ----------------------------------------------------------- Risk-based capital $140,233 $141,612 ===========================================================
44 CFS BANCORP, INC. 11. EMPLOYEE BENEFIT PLANS The Company participates in an industry-wide, multi-employer, defined-benefit pension plan, which covers all full-time employees who have attained at least 21 years of age and completed one year of service. Calculations to determine full-funding status are made annually as of June 30. Pension expense for the years ended December 31, 2002, 2001 and 2000 was $889, $134, and $0, respectively. Asset and plan benefit information is not available for participating associations on an individual basis. The Company also participates in a single-employer defined-contribution plan, which qualifies under section 401(k) of the Internal Revenue Code. Participation eligibility in this plan is substantially the same as in the aforementioned defined-benefit pension plan. This plan called for a discretionary contribution within specified limits and a matching Company contribution equal to a specified percentage of employee contributions. Plan expense for the years ended December 31, 2002, 2001 and 2000 was approximately $252, $251, and $265, respectively. The Company provides supplemental retirement benefits for certain senior officers in the form of payments upon retirement, death, or disability. The annual benefit is based on actuarial computations of existing plans without imposing Internal Revenue Service limits. Expenses related to this plan for the years ended December 31, 2002, 2001, and 2000, were $87, $97, and $84, respectively. 12. STOCK-BASED BENEFIT PLANS In 1998, the Company established an Employee Stock Ownership Plan (the ESOP) for the employees of the Company and the Bank. The ESOP is a qualifying pension plan under Internal Revenue Service guidelines. It covers all full-time employees who have attained at least 21 years of age and completed one year of service. Upon formation, the ESOP borrowed $14,283 from the Company and purchased 1,428,300 shares of common stock. Expense is recognized based on the fair value (average stock price) of shares scheduled to be released from the ESOP trust. One-twelfth of the shares are scheduled to be released each year as one-twelfth of the loan (principal and interest) is scheduled to be repaid each year. Dividends on both allocated and unallocated shares are used to pay down the loan. Expense related to this ESOP for the years ended December 31, 2002, 2001, and 2000 was $1,713, $1,536, and $1,124, respectively. ESOP shares not committed to be released are not considered outstanding for purposes of computing EPS. The following table summarizes shares of Company common stock held by the ESOP at December 31, 2002 and 2001:
2002 2001 - ------------------------------------------------------------ Shares allocated to participants 533,565 433,095 Unallocated and unearned shares 835,645 956,992 - ------------------------------------------------------------ 1,369,210 1,390,087 ======================= Fair value of unearned ESOP shares $ 11,950 $ 13,733 ============================================================
The Company also provides supplemental retirement benefits for certain senior officers under the ESOP. This benefit is also based on computations for the existing plan exclusive of Internal Revenue Service limits. Expenses related to this plan for the years ended December 31, 2002, 2001, and 2000, were $86, $59, and $45, respectively. In February 1999, the Company, with shareholder approval, established the RRP, which is a stock-based incentive plan, and a stock option plan. The Bank contributed $7,500 to the RRP to purchase a total of 714,150 shares of Company common stock. On April 1, 1999, the Compensation Committee of the Board of Directors granted 707,000 shares under this plan to 92 participants. The following table summarizes shares of Company's common stock held by the RRP at December 31, 2002: Shares purchased by the plan 714,150 Shares granted in 1999 (707,000) Shares forfeited in 1999 2,000 Shares forfeited in 2000 6,800 Shares forfeited in 2001 2,700 Shares forfeited in 2002 2,600 - --------------------------------------------------------- Shares available for grant December 31, 2002 21,250 =========================================================
45 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 The shares granted in the RRP vest to the participants at the rate of 20% per year. As a result, expense for this plan is being recorded over a 60-month period and is based on the market value of the Company's stock as of the date of grant. The remaining unamortized cost of the RRP is reflected as a reduction in stockholders' equity. Expenses under this plan for the years ended December 31, 2002, 2001, and 2000 were $1,542, $1,413, and $1,414, respectively. The Company has stock option plans under which shares of Company common stock are reserved for the grant of both incentive and nonincentive stock options to directors, officers, and employees. The dates the options are first exercisable and expire is determined by the Compensation Committee of the Board of Directors. The exercise price of the options is equal to the fair market value of the common stock on the grant date. The following is a combined analysis of the stock option activity for each of the three years ended December 31, 2002.
NUMBER EXERCISE PRICE OF SHARES PER SHARE - --------------------------------------------------------------- (IN THOUSANDS) Outstanding at January 1, 2000 1,661 $1.85 - $13.83 Granted 245 8.19 - 10.44 Exercised (178) 3.65 - 10.00 Forfeited (154) 8.44 - 13.09 - ---------------------------------------------------------------- Outstanding at December 31, 2000 1,574 1.85 - 13.83 Granted 308 11.00 - 14.46 Exercised (70) 1.85 - 13.09 Forfeited (40) 8.44 - 13.83 - ---------------------------------------------------------------- Outstanding at December 31, 2001 1,772 1.85 - 14.46 Granted 159 13.43 - 14.24 Exercised (99) 1.85 - 11.25 Forfeited (34) 8.44 - 14.24 - ---------------------------------------------------------------- Outstanding at December 31, 2002 1,798 $4.21 - $14.46 ================================================================
At December 31, 2002, 948 options were exercisable with a range in exercise price from $4.21 to $14.46. The weighted-average remaining contractual life of outstanding options was 7.9 years at December 31, 2002. At December 31, 2002, there were 29,815 shares available for future grants. At December 31, 2002, the average exercise price on outstanding options was $10.21. 13. OTHER COMPREHENSIVE INCOME The related income tax effect and reclassification adjustments to the components of other comprehensive income for the years ended December 31, 2002, 2001, and 2000 is as follows:
2002 2001 2000 - -------------------------------------------------------------------------------------------------------------------------- Unrealized holding gains (losses) arising during the period: Unrealized net gains (losses) $ (3,838) $ 9,588 $ 10,820 Related tax (expense) benefit 1,230 (3,426) (4,384) - -------------------------------------------------------------------------------------------------------------------------- Net (2,608) 6,162 6,436 Less: Reclassification adjustment for net gains realized during the period: Realized net gains 299 599 42 Related tax expense (65) (180) (16) - -------------------------------------------------------------------------------------------------------------------------- Net 234 419 26 - -------------------------------------------------------------------------------------------------------------------------- Total other comprehensive income (loss) $ (2,842) $ 5,743 $ 6,410 ==========================================================================================================================
46 CFS BANCORP, INC. 14. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
YEAR ENDED DECEMBER 31 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------- Net income $ 7,205 $ 11,173 $ 10,693 ========================================================================================================================== Average common shares outstanding 12,000,589 14,038,096 16,125,560 Common share equivalents - assuming exercise of dilutive stock options 491,560 415,248 196,652 - -------------------------------------------------------------------------------------------------------------------------- Average common shares and common share equivalents outstanding 12,492,149 14,453,344 16,322,212 ========================================================================================================================== Basic earnings per share $ .60 $ .80 $ .66 Diluted earnings per share .58 .77 .66
15. COMMITMENTS The Company had outstanding commitments as follows:
DECEMBER 31 TYPE OF COMMITMENT 2002 2001 - -------------------------------------------------------------------------------------------------- To originate loans on residential property: Fixed rates (6.25% - 6.75% in 2002, 6.00% - 8.25% in 2001) $ 5,380 $10,616 Variable rates 5,762 5,656 To originate loans on nonresidential property: Fixed rates (6.75% - 7.50% in 2002, 7.25% - 8.25% in 2001) 7,093 6,233 Variable rates 23,608 42,132 To purchase loans on nonresidential property: Variable rates 2,500 25,500 To originate commercial loans: Fixed rates (5.90-9.00% in 2002) 1,507 1,250 Variable rates 1,825 5,455 To purchase commercial loans: Variable rates 10,000 3,000 Unused lines of credit 44,329 41,537 Letters of credit: Secured by cash 1,406 ,750 Real estate 5,285 7,756 Other - Credit enhancements 49,486 50,692
47 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 Credit enhancements are letter of credit facilities related to the issuance by municipalities of taxable and nontaxable revenue bonds. The proceeds from the sale of such bonds are loaned to for-profit and not-for-profit companies for economic development projects. In order for the bonds to receive a triple-A rating, and thus a lower interest rate, the FHLB-IN issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (Letter of Credit) for the account of the Bank. Since the Bank, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB-IN and the Bank, would be required to reimburse the FHLB-IN for draws against the Letter of Credit, these facilities are analyzed, appraised, secured by real estate mortgages, and monitored as if the Bank funded the project initially. The Bank estimates that substantially all commitments will be funded or will expire within one year. Letters of credit expire at various times through 2005. 16. LEGAL PROCEEDINGS In 1983, with the assistance of the Federal Savings and Loan Insurance Corporation (FSLIC) as set forth in an assistance agreement (Assistance Agreement), the Bank acquired First Federal Savings and Loan Association of East Chicago, Indiana (East Chicago Savings), and Gary Federal Savings and Loan Association, Gary, Indiana (Gary Federal) through mergers. The FSLIC-assisted supervisory acquisitions of East Chicago Savings and Gary Federal were accounted for using the purchase method of accounting which resulted in supervisory goodwill (the excess of cost over fair value of net assets acquired), an intangible asset, of $52.9 million, compared to $40.2 million of goodwill as reported on a generally accepted accounting principles basis. Such goodwill was included in the Bank's regulatory capital. The Assistance Agreement relating to the Bank's acquisitions of East Chicago Savings and Gary Federal provided for the inclusion of goodwill as an asset on the Bank's balance sheet, to be amortized over 35 years for regulatory purposes and includable in capital. Pursuant to the regulations adopted by the Office of Thrift Supervision to implement the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), the regulatory capital requirement for federal savings banks was increased and the amount of supervisory goodwill that could be included in regulatory capital decreased significantly. At September 30, 1989, the Bank had approximately $26.0 million of remaining supervisory goodwill but, even excluding supervisory goodwill, the Bank exceeded the capital requirements of FIRREA at such date. On May 13, 1993, the Bank filed suit against the U.S. government seeking damages and/or other appropriate relief on the grounds, among others, that the government had breached the terms of the Assistance Agreement. The suit is pending in the United States Court of Federal Claims and is titled Citizens Financial Services, FSB v. United States (Case No. 93-306-C). The Bank was granted summary judgment on its breach of contract claim, leaving for trial the issue of damages. The Government has filed a motion for summary judgment on the Bank's damages claims. Their motion is still pending. All pre-trial discovery has been substantially completed. No trial date has been set. In its complaint, the Bank did not specify the amount of damages it is seeking from the United States. The Bank has retained an expert in order to attempt to quantify the amount of damages. The Bank is unable to predict the outcome of its claim against the United States and the amount of damages that may be awarded to the Bank, if any, in the event that a judgment is rendered in the Bank's favor. Consequently, no assurances can be given as to the results of this claim or the timing of any proceedings in relation thereto. The cost, including attorney's fees and expenses, of the litigation were approximately $258, $436, and $550, in 2002, 2001, and 2000, respectively, which is included in other general and administrative expenses in the Consolidated Statement of Income. Other than the above-referenced litigation, the Company is involved in routine legal proceedings occurring in the ordinary course of business, which, in the aggregate, are believed to be immaterial to the financial condition of the Company. 48 CFS BANCORP, INC. 17. FAIR VALUE OF FINANCIAL INSTRUMENTS Disclosure of fair value information about financial instruments, whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate their value, is summarized below. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The fair value disclosure of certain financial instruments and all nonfinancial instruments is not required. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The carrying amounts and fair values of financial instruments consist of the following:
DECEMBER 31 2002 2001 CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE - ----------------------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 210,141 $ 210,141 $ 272,067 $ 272,067 Investment securities available-for-sale 39,064 39,064 47,225 47,225 Mortgage-backed securities available-for-sale 296,638 296,638 276,158 276,158 Mortgage-backed securities held-to-maturity 21,402 21,977 37,034 37,744 Loans receivable 930,348 970,158 883,352 901,116 Investment in Bank-owned life insurance 31,009 31,009 30,052 30,052 - ----------------------------------------------------------------------------------------------------------------- Total assets financial instruments $1,528,602 $1,568,987 $1,545,888 $1,564,362 ================================================================================================================= Liabilities Deposits $ 954,222 $ 966,542 $ 945,948 $ 956,672 Borrowed money 449,431 520,821 462,658 502,726 - ----------------------------------------------------------------------------------------------------------------- Total liabilities financial instruments $1,403,653 $1,487,363 $1,408,606 $1,459,398 =================================================================================================================
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: CASH AND CASH EQUIVALENTS For cash and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value. INVESTMENT SECURITIES Fair values for securities held-for-investment, sale, or trading account purposes are based on quoted market prices as published in financial publications or dealer quotes. MORTGAGE-BACKED SECURITIES Fair values for mortgage-backed securities are based on the lower of quotes received from third-party brokers. LOANS RECEIVABLE The Company determined that for both variable-rate and fixed-rate loans, fair values are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and collateral to borrowers of similar credit quality. INVESTMENT IN BANK-OWNED LIFE INSURANCE The fair value of Bank-owned life insurance is equal to its cash surrender value. 49 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) DECEMBER 31, 2002 DEPOSIT LIABILITIES The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. BORROWED MONEY Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. The fair value of the Company's off-balance sheet instruments is nominal. 18. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS The following represents the condensed statement of financial condition as of December 31, 2002 and 2001 and condensed statement of income and cash flows for the three years ended December 31, 2002 for CFS Bancorp, Inc., the parent company. CONDENSED STATEMENTS OF CONDITION (Parent Company Only)
DECEMBER 31 2002 2001 - -------------------------------------------------------------------------------------------- Assets Cash on hand and in banks $ 11,527 $ 4,114 Securities available-for-sale 6,415 19,913 Investment in subsidiary 132,289 136,932 Mortgage loans 1,617 Loan receivable from ESOP 9,638 10,631 Accrued interest receivable 47 118 Prepaid expenses and other assets 2,178 ,982 - -------------------------------------------------------------------------------------------- Total assets $ 163,711 $ 172,690 ============================================================================================ Liabilities and stockholders' equity Liabilities: Accrued taxes and other liabilities $ 3,049 $ 1,406 Stockholders' equity: Common stock 234 234 Additional paid-in capital 189,786 189,547 Retained earnings, substantially restricted 97,108 93,649 Treasury stock, at cost (125,650) (112,167) Accumulated other comprehensive income (loss), net of tax (816) 21 - -------------------------------------------------------------------------------------------- Total stockholders' equity 160,662 171,284 - -------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 163,711 $ 172,690 ============================================================================================
50 CONDENSED STATEMENTS OF INCOME (Parent Company Only)
YEAR ENDED DECEMBER 31 2002 2001 2000 - -------------------------------------------------------------------------------------------------------------------- Dividends from subsidiary $ 12,500 $ 10,000 $ 22,774 Interest income 1,682 3,283 4,585 Dividend income 200 391 400 Net gain on sale of investments 299 599 40 Other income -- 61 -- Noninterest expense (1,190) (1,259) (1,214) - -------------------------------------------------------------------------------------------------------------------- Net income before income taxes and equity in earnings of subsidiary 13,491 13,075 26,585 Income tax expense (288) (924) (1,544) - -------------------------------------------------------------------------------------------------------------------- Net income before equity in undistributed earnings of subsidiary 13,203 12,151 25,041 Equity in undistributed dividends in excess of earnings of subsidiary (5,998) (978) (14,348) - -------------------------------------------------------------------------------------------------------------------- Net income $ 7,205 $ 11,173 $ 10,693 ==================================================================================================================== CONDENSED STATEMENTS OF CASH FLOWS (Parent Company Only) YEAR ENDED DECEMBER 31 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------- Operating activities: Net income $ 7,205 $ 11,173 $ 10,693 Adjustments to reconcile net income to net cash used by operating activities: Amortization/accretion of premiums/discounts (710) (646) (708) Equity in undistributed earnings of the Bank 5,998 978 14,348 Net gain on sale of available-for-sale investment securities (299) (599) (40) Decrease in interest receivable 71 214 110 Decrease (increase) in prepaid expenses and other assets (1,196) 1,609 954 Increase (decrease) in other liabilities 2,221 (611) (1,278) - ------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 13,290 12,118 24,079 Investing activities: Available-for-sale investment securities: Purchases (45) (24,173) (749) Repayments 200 -- 60 Sales 2,808 26,224 602 Available-for-sale mortgage-backed securities: Purchases -- -- -- Repayments -- 919 793 Sales 10,194 36,122 -- Net loan originations and principal payment on loans (624) 891 819 - ------------------------------------------------------------------------------------------------------------------- Net cash provided by investing activities 12,533 39,983 1,525 Financing activities: Purchase of treasury stock (14,626) (43,634) (20,750) Proceeds from exercise of stock options 858 432 814 Dividends paid on common stock (4,642) (5,143) (5,966) - ------------------------------------------------------------------------------------------------------------------- Net cash used by financing activities (18,410) (48,345) (25,902) - ------------------------------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 7,413 3,756 (298) Cash and cash equivalents at beginning of year 4,114 358 656 - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 11,527 $ 4,114 $ 358 ===================================================================================================================
51 CFS BANCORP, INC. CFS BANCORP, INC. CORPORATE INFORMATION BOARD OF DIRECTORS CHAIRMAN OF THE BOARD Thomas F. Prisby Chairman and CEO VICE CHAIRMAN James W. Prisby President and Chief Operating Officer Sally A. Abbott Retired Vice President Citizens Financial Services, FSB Gregory W. Blaine Retired Chairman TN Technologies Thomas J. Burns President Burns-Kish Funeral Homes Gene Diamond Regional Chief Operating Officer St. Margaret Mercy Healthcare Centers Frank D. Lester President Union Tank Car Company Charles R. Webb Retired Executive Vice President Keefe, Bruyette and Woods, Inc. SHAREHOLDER INFORMATION CORPORATE HEADQUARTERS CFS Bancorp, Inc. 707 Ridge Road Munster, Indiana 46321 219-836-5500 INVESTOR INFORMATION Investors and analysts interested in additional information may contact: Michael P. Prisby Assistant Treasurer CFS Bancorp, Inc. 707 Ridge Road Munster, Indiana 46321 219-836-9990 STOCK INFORMATION CFS Bancorp, Inc. trades on the NASDAQ under the ticker symbol CITZ. DIVIDEND REINVESTMENT Dividend reinvestment is available to registered shareholders with 100 or more shares. For additional information, contact our transfer agent. TRANSFER AGENT AND REGISTRAR LaSalle National Bank 135 South LaSalle Street Chicago, Illinois 60603 800-246-5761 INDEPENDENT AUDITORS Ernst & Young LLP Sears Tower 233 South Wacker Drive Chicago, Illinois 60606 312-879-2000 SPECIAL COUNSEL Elias, Matz, Tiernan and Herrick LLP 734 Fifteenth Street, N.W. Washington, D.C. 20005 SHAREHOLDER MEETING The Annual Meeting of Shareholders will be held at 10:00 a.m. on April 29, 2003 CDT at The Center for Visual and Performing Arts, 1040 Ridge Road, Munster, Indiana 46321. FORM 10-K A copy of the CFS Bancorp, Inc. Annual Report on Form 10-K filed with the Securities and Exchange Commission is available without charge upon written request to: Monica F. Sullivan Corporate Secretary CFS Bancorp, Inc. 707 Ridge Road Munster, Indiana 46321 As of December 31, 2002, there were 12,674,597 shares of common stock outstanding, held by 2,445 stockholders of record. RESEARCH The following companies indicated that they provide a market in CFS Bancorp, Inc. common stock: RBL Dain Rauscher Inc. Friedman Billings Ramsey & Co. Howe Barnes Investments, Inc. McDonald Investments/Trident Securities Sandler O'Neill & Partners LP Stifel, Nicolaus & Co. Inc. QUARTERLY SHARE PRICE AND DIVIDEND INFORMATION
STOCK PRICE DIVIDEND HIGH LOW PAID - -------------------------------------------------------------- 2001 First Quarter $ 11.44 $ 10.44 $ .09 Second Quarter 13.83 10.75 .09 Third Quarter 14.87 13.27 .09 Fourth Quarter 14.52 13.41 .09 2002 First Quarter $ 14.35 $ 13.34 $ .09 Second Quarter 15.46 13.43 .10 Third Quarter 14.70 13.42 .10 Fourth Quarter 14.95 13.05 .10
52 EX-23 4 c75186exv23.txt CONSENT OF INDEPENDENT AUDITORS Exhibit 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-62053) pertaining to the Citizens Financial Services, FSB Employees' Savings & Profit Sharing Plan and Trust of our report dated February 19, 2003, with respect to the consolidated financial statements of CFS Bancorp, Inc. incorporated by reference in the Annual Report (Form 10-K) for the year ended December 31, 2002. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-62049) pertaining to the Stock Options Assumed In The Acquisition Of SuburbFed Financial Corp. of our report dated February 19, 2003, with respect to the consolidated financial statements of CFS Bancorp, Inc. incorporated by reference in the Annual Report (Form 10-K) for the year ended December 31, 2002. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-84207) pertaining to the 1998 Stock Option Plan of CFS Bancorp, Inc. of our report dated February 19, 2003, with respect to the consolidated financial statements of CFS Bancorp, Inc. incorporated by reference in the Annual Report (Form 10-K) for the year ended December 31, 2002. /s/ ERNST & YOUNG LLP Chicago, Illinois March 31, 2003 EX-99.1 5 c75186exv99w1.txt CERTIFICATIONS EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Thomas F. Prisby, Chairman and Chief Executive Officer of CFS Bancorp, Inc. (the "Company"), hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) The Annual Report on Form 10-K of the Company for the quarterly period ended December 31, 2002(the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m (a) or 78o(d)) and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 31, 2003 By: /s/ Thomas F. Prisby ------------------------------------- Thomas F. Prisby, Chairman and Chief Executive Officer CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, John T. Stephens, Executive Vice President and Chief Financial Officer of CFS Bancorp, Inc. (the "Company"), hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) The Annual Report on Form 10-K of the Company for the quarterly period ended December 31, 2002(the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m (a) or 78o(d)) and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 31, 2003 By: /s/ John T. Stephens ------------------------------------------ John T. Stephens, Executive Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----