-----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, NI9UMNDFwAeIsPO2jf2vzHRzmwGQQO97BC5aMPNa+9b2bF8EwFU9Uh8+ND8EM4d2 +IIRVRuQEIX/Qv/glMbnMQ== 0000950137-05-003102.txt : 20050316 0000950137-05-003102.hdr.sgml : 20050316 20050316153143 ACCESSION NUMBER: 0000950137-05-003102 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050316 DATE AS OF CHANGE: 20050316 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: 05685246 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 c92476e10vk.txt FORM 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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, 2004 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 35-2042093 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 707 RIDGE ROAD 46321 MUNSTER, INDIANA (Zip Code) (Address of Principal 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 month (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. [ ] 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, 2004, the aggregate value of the 12,290,934 shares of Common Stock of the Registrant outstanding on such date, which excludes 708,157 shares held by all directors and executive officers of the Registrant as a group, was approximately $153.5 million. This figure is based on the last known trade price of $13.25 per share of the Registrant's Common Stock on June 30, 2004. Number of shares of Common Stock outstanding as of March 11, 2005: 12,382,322 DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement for the Annual Meeting of Stockholders to be held on April 26, 2005 are incorporated by reference into Part III. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CFS BANCORP, INC. AND SUBSIDIARIES FORM 10-K INDEX
PAGE ---- PART I. Item 1. Business.................................................... 2 Item 2. Properties.................................................. 15 Item 3. Legal Proceedings........................................... 16 Item 4. Submission of Matters to a Vote of Security Holders......... 17 PART II. Item 5. Market for the Registrant's Common Stock, Related Stockholders Matters and Issuer Purchases of Equity Securities.................................................. 18 Item 6. Selected Financial Data..................................... 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 20 Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................................ 44 Item 8. Financial Statements and Supplementary Data................. 46 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures................................... 80 Item 9A. Controls and Procedures..................................... 80 Item 9B. Other Information........................................... 80 PART III. Item 10. Directors and Executive Officers of the Registrant.......... 81 Item 11. Executive Compensation...................................... 81 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.................. 81 Item 13. Certain Relationships and Related Transactions.............. 81 Item 14. Principal Accountant Fees and Services...................... 81 PART IV. Item 15. Exhibits and Financial Statement Schedules.................. 81 Signature Page............................................................... 83 Certifications for Principal Executive Officer and Principal Financial Officer.................................................................... 84
1 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, or the negative thereof, 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. (including its consolidated subsidiaries, the Company) is a registered unitary savings and loan holding company and was organized in March 1998 to facilitate the July 1998 conversion of its subsidiary, Citizens Financial Services, FSB (the Bank or Citizens Financial), from a federally-chartered mutual savings bank to a federally-chartered stock savings bank (Conversion). In conjunction with the Conversion, the Company completed an initial public offering. The Company and the Bank are subject to oversight and examination by the Office of Thrift Supervision (OTS). See "Regulation -- Regulation of Savings and Loan Holding Companies." The Company's primary assets consist of the outstanding shares of common stock of the Bank and the Company's loan to the Bank for the employee stock ownership plan (ESOP). The Company has no significant liabilities. The management of the Company and the Bank are substantially identical. 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. 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 (FDIC), administrator of the Savings Association Insurance Fund (SAIF). The Bank is also subject to certain reserve requirements established by the Board of Governors of the Federal Reserve System (FRB) and is a member of the Federal Home Loan Bank (FHLB) of Indianapolis, which is one of the 12 regional banks comprising the FHLB System. The Bank was originally organized in 1934 and conducts its business from its executive offices in Munster, Indiana, as well as 24 banking centers located in Lake and Porter Counties in northwest Indiana and Cook, DuPage and Will Counties in Illinois. The Bank also has an Operations Center located in Highland, Indiana which is dedicated to its Customer Call Center and other back office operations. The Bank's revenue is derived from interest on loans, mortgage-backed and related securities and investments, loan and deposit fees, and investment commissions. The Bank's operations are significantly impacted by general and economic conditions, the monetary policy of the federal government, including the FRB, legislative tax policies and governmental budgetary matters. The Bank's revenue has been largely dependent on net interest income, which is the difference between interest earned on interest-bearing assets 2 and the interest expense paid on interest-bearing liabilities. However, the Bank continues to focus on generating other sources of income through loan and deposit fees, investment commissions and other non-interest income to be a significant source of revenue. 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, DC 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 an internet website at www.cfsbancorp.com. The Company makes 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 on its website as soon as reasonably practicable after it files such material with or furnishes such documents to the SEC. CORPORATE GOVERNANCE The Company has established certain committees of its Board of Directors, specifically audit, compensation, and nominating committees. The charters of these committees as well as the Company's Code of Conduct and Ethics can be found on the above mentioned Company website. The information is also available in printed form to any shareholder who requests it by writing to the Company in care of the Vice President -- Corporate Secretary, 707 Ridge Road, Munster, Indiana 46321. MARKET AREA AND COMPETITION Citizens Financial maintains 24 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. The Bank has historically concentrated its efforts in the market surrounding its offices and has in recent years broadened that market into the Midwestern United States mainly through the development of commercial lending relationships. The Bank'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 is still 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 other non-depository financial institutions such as brokerage firms and insurance companies. LENDING ACTIVITIES General. Citizens Financial originates commercial and retail loans. Included in the Bank's commercial loan portfolio are commercial real estate, construction and land development, and commercial and industrial loans. The retail loan portfolio includes single-family residential mortgage loans, home equity loans and lines 3 of credit (together, HELOCs) and other consumer loans including auto loans. Since the Conversion, the Bank shifted its lending emphasis, increasing its involvement in commercial loans, while concurrently reducing its originations of single-family residential mortgage loans. The Bank's lending strategy is to diversify its portfolio in an effort to limit risks associated with any particular loan type or industry while building a quality loan portfolio. The Bank has established specific collateral concentration limits in a manner that will not hamper its lenders in the pursuit of new business in a variety of sectors. The Bank's commercial loan underwriting focuses on the financial strength of the borrower and guarantors, the cash flow of a business, and the underlying collateral. While the Bank offers both fixed- and adjustable-rate loan products, its emphasis remains on originating adjustable-rate loans, which management believes will better control its interest rate risk. The Bank utilizes secondary market standards for underwriting single-family residential mortgage loans which facilitates its ability to sell these loans into the secondary market. Secondary market requirements place limitations on debt to income ratios and loan size among other factors. As part of the underwriting process, the Bank evaluates, among other things, the customers' credit history, income, employment stability, repayment capacity and collateral. The Bank utilizes a Risk-Based Lending (RBL) approach for underwriting HELOCs and other consumer loans. The RBL approach employed by the Bank evaluates the borrower's credit score, debt-to-income ratio and the loan's collateral value. Borrowers with a higher credit score generally qualify for a lower interest rate. 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 FRB, legislative tax policies and governmental budgetary matters. Certain officers of the Bank have been authorized by the Board of Directors to approve loans up to certain designated amounts. The Loan Committee of Citizens Financial meets weekly and reviews all loans that exceed individual loan approval authorities. All new loans are reviewed by the full Board of Directors of Citizens Financial as part of its monthly review of the Loan Committee minutes. 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 $19.0 million in the case of the Bank at December 31, 2004), 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. Since January 2003, the Bank has had a general guideline of limiting any one loan or multiple loans to the same borrower to 75% of the regulatory limit. The Bank is also required to monitor its aggregate loans to corporate groups. These are loans that are given to individual entities that have a similar ownership group but are not considered to be a common enterprise. While the individual loans are secured by separate property and underwritten based on separate cash flows, the entities may all be owned or controlled by one individual or a group of individuals. The Bank is required by regulation to limit its aggregate loans to any corporate group to 50% of Tier 1 capital. At December 31, 2004, Tier 1 capital was $120.1 million. Citizens Financial's two largest corporate group relationships at December 31, 2004 equaled $40.9 million and $24.1 million, respectively. Both of these relationships are below the group limit of $60.1 million and are performing in accordance with their terms. COMMERCIAL AND CONSTRUCTION LENDING General. In recent years, the Company's strategy has changed with respect to its loan portfolio as the Company has significantly increased its emphasis on originating commercial loans. The Company increased the number of experienced commercial loan officers and employees to build a regionally structured Commercial Loan Department. The regional structure allows the loan officers to build relationships with the 4 businesses in their communities and to tailor business development plans based on the needs of that specific area. While the commercial lending group develops business relationships within its market area, they also pursue commercial lending opportunities outside the Bank's market area through participations with other financial institutions. Commercial Real Estate. The majority of the Bank's commercial loan portfolio is made up of loans secured by commercial real estate, including multi-family residential loans. These loans generally have 3 to 10 year terms with an amortization period of 25 years or less. The interest rates on these loans are generally fixed for the first five years followed by a one time adjustment which then becomes the fixed-rate of the loan for the remaining term. The Bank has also offered loans with a fixed interest rate for an initial three or five year period and which then adjusts annually to a designated index such as one-year U.S. Treasury obligations adjusted to a constant maturity (CMT) plus a stipulated margin for the remainder of the term. Commercial real estate loans generally have shorter terms to maturity and higher yields than the Bank's single-family residential mortgage loans. Upon closing, the Bank usually receives fees of between 0.5% and 1.0% of the principal loan balance. These loans are typically subject to prepayment penalties. The Bank generally obtains personal guarantees of the borrower's principals as additional security for any commercial real estate loans. Citizens Financial evaluates various aspects of commercial real estate loan transactions in an effort to mitigate credit risk. 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, market position, location and physical condition. In addition, the Bank also performs sensitivity analysis on cash flow, vacancy trends and interest rate projections when underwriting the loans to determine how different scenarios may impact the borrowers' ability to repay the loans. The Bank has generally imposed a debt coverage ratio (the ratio of net income before payment of debt service to debt service) of not less than 110% for commercial real estate 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 new commercial real estate loan transactions. All appraisal reports and any necessary environmental site assessments are reviewed by the Bank before the loan closes. Commercial real estate lending entails substantially different risks compared to single-family residential lending because such loans often involve large loan balances to single borrowers and because the payment experience on these 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 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. The Bank also invests, on a participating basis, in 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. The Bank's commercial real estate loans are secured by hotels, medical office facilities, multi-family residential buildings, churches, small office buildings, strip shopping centers and other commercial uses. These loans are usually originated in amounts of less than $15.0 million, and as of December 31, 2004, the average size of the Bank's commercial real estate loans was approximately $1.1 million. Construction and Land Development Loans. The Bank currently offers construction loans for commercial real estate and multi-family residential properties along with construction loans to local residential builders. The Bank's construction portfolio also includes construction/permanent, single-family residential loans which, by their terms, will convert to permanent mortgage loans upon the completion of their construction. At the time of conversion, these loans will become part of the Bank's single-family residential mortgage loan portfolio. The Bank also originates land loans to local developers for the purpose of developing the land (i.e., roads, sewer and water) for sale. These loans are secured by a mortgage on the property which is generally limited to 5 the lesser of 75% of its appraised value or 75% of its cost and are typically made for a period of up to three 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 borrower's principals for construction and land development loans. The Bank's loan underwriting and processing procedures require a property appraisal by an approved independent appraiser and that each construction and development loan is 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 primarily provides residential and commercial construction lending within the Midwestern United States. 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 cost (including interest) of construction. If the estimate of construction cost proves to be inaccurate, the Bank first requires the borrower to inject cash equity to cover any shortfall. The Bank may then need to advance funds beyond the amount originally committed to permit completion of the development. 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 inherent lending risk, the Bank may require performance bonds in the amount of the construction contract and often obtains personal guarantees from the principals of the borrower. At December 31, 2004, the average size of the Bank's construction and land development loans was approximately $810,000. Commercial and Industrial Loans. The Bank also originates commercial loans that are secured by business assets other than real estate and secured and unsecured operating lines of credit. These types of loans undergo an underwriting process similar to the other types of commercial lending the Bank offers; however, these loans tend to be riskier in nature since the repayment is based on the cash flows of the business operation. As of December 31, 2004, the average size of the Bank's commercial and industrial loans was approximately $250,000. RETAIL LENDING General. The Bank's retail lending program includes single-family residential loans, HELOCs, auto loans and other consumer loans. The Bank's primary focus continues to be on originating variable-rate retail products, primarily through its HELOC programs and by retaining any variable-rate single-family residential loans while selling most fixed-rate loans originated with servicing released. The Bank's retail lenders are responsible for originating its retail loans. The retail lenders are also assisted by the Bank's branch origination program and call center within its market area. Single-Family Residential Loans. Substantially all of the Bank's single-family residential mortgage loans consist of conventional loans. Conventional loans 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 Lake and Porter Counties in northwest Indiana and Cook, DuPage and Will Counties in Illinois. Citizens Financial's residential mortgage loans have either fixed interest rates or variable interest rates which adjust periodically during the term of the loan. Fixed-rate loans generally have maturities of 15 or 30 years and are fully amortizing with monthly loan payments sufficient to repay the total amount of the loan 6 and interest by the maturity date. 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 Bank's fixed-rate loans are generally originated under terms, conditions and documentation which permit them to be pre-sold in the secondary market for mortgages. By pre-selling these loans, the Bank limits the interest rate risk associated with fixed rate loans. At December 31, 2004, $60.1 million, or 21.6% of the Bank's single-family residential mortgage loans, were fixed-rate loans. During 2004, the Bank sold approximately $13.2 million of fixed-rate loans with servicing released. 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 then adjust annually to a CMT plus a stipulated margin. The Bank's ARMs 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. This cap is generally 6% above the initial rate. The Bank's ARMs 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, 2004, $218.1 million, or 78.4% of the Bank's single-family residential mortgage loans, were adjustable-rate loans. While the Bank has focused on providing ARMs to decrease the risk related to changes in the interest rate environment, these types of loans also involve other risks. As interest rates rise, the customers' payments on an ARM also increases to the extent permitted by the loan terms thereby increasing the potential for default. Also, when interest rates decline substantially, borrowers tend to refinance into fixed-rate loans. The Bank believes that these risks generally are less than the risks associated with holding long-term fixed-rate loans. 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 ARMs, the increased emphasis over the past few years on growing the Bank's commercial lending portfolio has reduced the proportion of single-family residential loans to total loans. The Bank's single-family residential loans generally do not exceed amounts limited to the maximum amounts contained in U.S. Government sponsored agency guidelines. In addition, the maximum loan-to-value (LTV) ratio for the Bank's single-family residential mortgage loans is generally 95% of the secured property's appraised value, provided that private mortgage insurance is generally obtained on the portion of the principal amount that exceeds 80% of the appraised value. HELOC. The majority of the Bank's home equity products are HELOCs which are structured as a variable-rate line of credit with terms up to 20 years including a 10 year repayment period. The Bank also offers home equity loans with a 10 year term which have a fixed-rate for the first five years and a one-time rate adjustment after the fifth year. Both types of home equity products are secured by the underlying equity in the borrower's residence. The Bank's HELOCs generally require LTV ratios of 90% or less after taking into consideration any first mortgage loan. However, the most creditworthy customers may qualify to receive up to 100% LTV. There is a higher risk associated with this type of lending since the HELOCs are typically secured by a second mortgage. The Bank looks to the borrower's credit history as an indication of risk and as a factor in establishing the interest rate on the loan or line of credit. Other Loans. Citizens Financial's other retail loans consist primarily of consumer loans, loans secured by deposit accounts and auto loans. The Bank is not actively marketing its consumer loans and offers them primarily as a service to its existing customers. 7 SECURITIES ACTIVITIES The Company's investment policy, which has been established by the Board of Directors, is designed to prescribe authorized investments and outline the Company's practices for managing risks involved with investment securities. The policy emphasizes: - principal preservation, - favorable returns on investment, - liquidity within designated guidelines, - minimal credit risk, and - flexibility. The Company's investment policy permits investments in various types of securities including obligations of the U.S. Treasury, federal agencies, government sponsored entities, 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. The Company evaluates securities for other-than-temporary (OTT) impairment on a quarterly basis, and more frequently when economic or market concerns warrant additional evaluations. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. The Company has the intent to recover the costs associated with these securities but can give no assurance that losses will not be realized if it is deemed that there will be a future economic benefit in realizing the loss. If management determines that an investment security has experienced an OTT decline in value, the loss is recognized in the income statement. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income in stockholders' equity) and not recognized in income until the security is ultimately sold. The Company currently utilizes an outside investment advisor for developing and monitoring an investment strategy designed to maximize the portfolio's total return while maintaining acceptable levels of risk. The Company currently employs a strategy that maximizes total returns by proactively managing where securities are purchased and held along the yield curve. An inherent byproduct of this strategy is the recognition of realized gains and losses. These gains and losses should be looked upon as part of the portfolio's overall total return. 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, prepayments, and borrowings. Loan repayments are historically a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. The Bank has used borrowings in the past, primarily FHLB advances, to supplement its deposits as a source of funds. Deposits. The Bank's deposit products include a broad selection of deposit instruments, including checking accounts, money market accounts, statement and passbook savings accounts, and term certificate accounts. The Bank considers its checking, money market and savings accounts to be its core deposits. Deposit account terms may vary with principal differences including: (i) the minimum balance required; (ii) the time periods the funds must remain on deposit; and (iii) the interest rate paid on the account. 8 The Bank utilizes traditional marketing methods to attract new customers and deposits, and it does not advertise for deposits outside of its market area. The Bank does not currently utilize the services of deposit brokers. The Bank traditionally has relied on customer service and convenience in marketing its deposit products. The Bank has implemented an initiative to attract core deposits in all markets by offering various limited-time promotions for new deposit accounts. As the need for funds warrant, the Bank may continue to use certificate of deposit promotions in new markets to build its customer base. Borrowings. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings, such as advances from the FHLB. The advances from the FHLB of Indianapolis are secured by capital stock of the FHLB of Indianapolis, a blanket pledge of certain of the Bank's mortgage loans, investment securities, and mortgage-backed securities and the FHLB of Indianapolis time deposits. These advances are made in accordance with several different credit programs, each of which has its own interest rate and range of maturities. TRUST ACTIVITIES The Company also provides limited fiduciary services through the Bank's Trust Department primarily for convenience to its existing customers. Services offered include fiduciary services for trusts and estates and land trusts. Prior to December 31, 2004, the Trust Department maintained 23 trust/fiduciary accounts with an aggregate principal balance of $1.0 million at such date. The Trust Department also administered 44 beneficiary-managed land trusts in Indiana during 2004. Gross revenue from the Trust Department for the year ended December 31, 2004 was $12,000. 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, estates and guardianships. Most of the significant operations of the Trust Department have been outsourced to a third-party trust company as of December 31, 2004. It is anticipated that all further trust prospects, with the exception of Indiana land trusts, will be referred to the third-party trust company for which the Bank will receive a referral fee. The Bank anticipates that it will continue to provide trust services for Indiana land trusts as needed in the future. Executive management of the Trust Department is provided by the Bank's Senior Vice President -- Corporate Counsel, subject to direction by the Trust Committee. SUBSIDIARIES During 2004, the Bank had one active, wholly-owned subsidiary, CFS Holdings, Ltd. (CFS Holdings). This subsidiary was approved by the OTS 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 investment securities and performs a significant amount of the Bank's 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 Holdings by the Bank. Revenues of CFS Holdings were $4.7 million for the year ended December 31, 2004 compared to $3.7 million and $5.2 million for the years ended December 31, 2003 and 2002, respectively. Operating expenses of this subsidiary were $68,000 for the year ended December 31, 2004 compared to $58,000 and $61,000 for the years ended December 31, 2003 and 2002, respectively. Prior to 2003, the Bank had two other subsidiaries which are no longer active. These subsidiaries were CFS Insurance Agency, Inc. (CFS Insurance) and CFS Investment Services, Inc. (CFS Investments). 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. In August 2002, the Bank entered into an agreement to outsource this activity and discontinued providing these services directly through CFS Investment Services. The outsourcing allowed the Bank to recognize commission income on the sale of these products while reducing the operating expenses associated with this subsidiary. 9 CFS Insurance was an independent insurance brokerage subsidiary which offered a full line of insurance products to the general public. 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. In 2004, the Bank sold the building to a third party for a profit of $220,000. EMPLOYEES Citizens Financial had 327 full-time equivalent employees at December 31, 2004. 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 (HOLA), as amended, 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 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 10 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 FRB 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. 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. The Sarbanes-Oxley Act of 2002 (Act) implemented legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which enforces auditing, quality control and independence standards and is 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 require pre-approval by the company's audit committee members. In addition, the audit partners must be rotated. The bill requires the principal chief executive officer and the principal chief financial officer 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 is 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. The Act extended the period during which certain types of suits can be brought against a company or its officers and provides for disgorgement of bonuses issued to top executives prior to restatement of a company's financial statements if such restatement was due to corporate misconduct and a range of enhanced penalties for corporate executives who are guilty of fraud or other violations. 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 accelerated 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 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 11 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) U.S. generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with U.S. generally accepted accounting principles and the rules and regulations of the SEC. Pursuant to the regulations of the SEC and its Exemptive Order dated November 30, 2004, the Company anticipates that management's annual report and the related attestation report of the Company's RPAF will be timely filed as an amendment to this Annual Report on Form 10-K. See Item 9A of this Form 10-K below. 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 single-family and multi-family 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 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: (i) 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, and similar risks of a high proportion of off-balance sheet risk; (ii) a savings association is growing, either internally or through acquisitions, at such a rate 12 that supervisory problems are presented and are not managed adequately under OTS regulations; and (iii) 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 9.24%, and its total risk-based capital ratio was 12.23% at December 31, 2004. At such date, the Bank met the capital requirements of a "well-capitalized" institution under applicable OTS regulations. Certain Consequences of Failure to Comply with Regulatory Capital Requirements. 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. Noncompliance with the standards established by the OTS or other regulators may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil monetary penalty assessments. 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 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, 2004, the Bank met the capital requirements of a "well-capitalized" institution under applicable OTS regulations. 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 13 qualified thrift investments but also, in the alternative, by qualifying under the Internal Revenue Code as a "domestic building 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 Bank Insurance Fund-insured institutions ranged from 0% of insured deposits for well-capitalized institutions with minor supervisory concerns to 0.27% of insured deposits for undercapitalized institutions with substantial supervisory concerns. The Bank's deposit insurance premiums totaled $139,000, or 0.015%, of its insured deposits for the year ended December 31, 2004. 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 Community Reinvestment Act (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, 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. The Bank received a satisfactory rating during its latest CRA examination in 2003. 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 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 14 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. ITEM 2. PROPERTIES OFFICES AND PROPERTIES The following table sets forth certain information relating to Citizens Financial's offices at December 31, 2004. In addition, the Bank maintains 31 automated teller machines (ATMs), with 26 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, 2004 DECEMBER 31, 2004 - -------- -------- ---------- ---------------------- -------------------- (DOLLARS IN THOUSANDS) EXECUTIVE OFFICE: 707 Ridge Road Owned -- $2,566 $126,911 Munster, IN 46321 BRANCH OFFICES: 5311 Hohman Avenue Owned -- 262 83,243 Hammond, IN 46320 155 N. Main Street Owned -- 285 85,325 Crown Point, IN 46307 1720 45(th) Street Owned -- 479 102,527 Munster, IN 46321 4740 Indianapolis Blvd. Owned -- 202 40,811 East Chicago, IN 46312 2121 E. Columbus Drive(1) Leased 2008 330 21,874 East Chicago, IN 46312 803 W. 57th Avenue Leased 2006 2 25,201 Merrillville, IN 46410 855 Thornapple Way Owned -- 263 35,617 Valparaiso, IN 46383 3853 45(th) Street Owned -- 824 21,990 Highland, IN 46322 10644 S. Cicero Avenue Leased 2006 7 7,655 Oak Lawn, IL 60453 9161 W. 151st Street Leased 2007 17 24,113 Orland Park, IL 60462 3301 W. Vollmer Road Leased 2007 43 48,062 Flossmoor, IL 60422 154th Street at Broadway Leased 2006 121 30,815 Harvey, IL 60426 13323 S. Baltimore Owned -- 196 28,241 Chicago, IL 60426
15
NET BOOK VALUE OF LEASE PROPERTY AND LEASEHOLD OWNED OR EXPIRATION IMPROVEMENTS AT DEPOSITS AT LOCATION LEASED DATE DECEMBER 31, 2004 DECEMBER 31, 2004 - -------- -------- ---------- ---------------------- -------------------- (DOLLARS IN THOUSANDS) 601 E. 162nd Street Owned -- 212 56,157 South Holland, IL 60473 7101 W. 127(th) Street Owned -- 196 43,236 Palos Heights, IL 60463 425 E. 170(th) Street(2) Owned -- 273 -- South Holland, IL 60473 1218 Sheffield Avenue(3) Leased 2005 -- 16,199 Dyer, IN 46311 7229 S. Kingery Highway Leased 2007 53 12,189 Willowbrook, IL 60527 7650 Harvest Drive(4) Owned -- 1,807 16,670 Schererville, IN 46375 2547 Plainfield/Naperville Road Leased 2006 84 1,777 Naperville, IL 60564 310 S. Weber Road Owned -- 1,150 5,056 Bolingbrook, IL 60490 1100 East Joliet Street Leased 2008 148 1,952 Dyer, IN 46311 8301 Cass Avenue Owned -- 3,312 2,337 Darien, IL 60561 OTHER PROPERTIES: 8149 Kennedy Avenue(5) Leased 2006 69 25,220 Highland, IN 46322
- --------------- (1) Full service branch facility located in grocery store chain. (2) Deposits included with office located at 162(nd) Street. (3) This full service branch facility located in a local grocery store chain closed on January 22, 2005. (4) Includes 3,570 square feet of space currently under lease to third party. (5) Operations Center. 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. 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 16 $26.0 million of remaining supervisory goodwill. Even excluding supervisory goodwill, however, the Bank exceeded the capital requirements of FIRREA at such date. As of January 1, 1994, the Bank adopted Financial Accounting Standards Board (FASB) Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions. Upon the adoption of this change in accounting principle, the Bank wrote down the remaining balance of the goodwill. 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 was filed 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 damages case went to trial in June 2004 and concluded in early July 2004. The Bank sought damages of more than $20.0 million based on the report and testimony of its expert witness. The Government's position was that the Bank suffered no compensable damage as a result of the breach. On March 7, 2005, the Court of Claims' judge entered judgment in favor of the Government holding that the Bank was not entitled to recover any damages. The Court of Claims also ruled that the Government is entitled to recover certain costs from the Bank with respect to one claim that the Bank had voluntarily dismissed during the proceeding. At this time, the Company has no information regarding the amount of cost that the Government may seek to recover from the Bank. Management of the Company is currently reviewing its options and has 60 days from the date of the trial court's decision in which to file an appeal. The Bank's cost, including attorneys' fees, experts' fees, and related expenses of the litigation was approximately $1.4 million, $183,000 and $258,000 in 2004, 2003 and 2002, respectively. The Bank is also in litigation to foreclose on its loans made to a golf course. The loans total $2.2 million. As a result of the Bank's foreclosure proceedings, the current owners of the property have attempted to avoid the foreclosure and collection on the debt and have further counterclaimed for damages, due to the Bank's alleged bad faith and breach of an alleged oral agreement with current ownership. While the Bank believes these claims to be without merit, the loss to the Bank could be substantial in the event the borrowers prevail on their counterclaim. At this stage, the opposing party has not made a formal demand for a specific amount of damages. Thus, the Bank cannot with any certainty determine the total amount at risk or what the amount of any potential loss might be. 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 17 PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES (a) The Company's common stock is traded on the NASDAQ National Market under the symbol "CITZ". As of December 31, 2004, there were 12,385,322 shares of common stock outstanding which was held by 2,285 stockholders of record. The following table sets forth the quarterly share price and dividends paid per share during each quarter of 2004 and 2003.
SHARE PRICE --------------- DIVIDEND HIGH LOW PAID ------ ------ -------- 2003 First Quarter............................................ $14.39 $13.51 $0.10 Second Quarter........................................... 15.00 13.69 0.11 Third Quarter............................................ 14.98 13.84 0.11 Fourth Quarter........................................... 15.00 13.90 0.11 2004 First Quarter............................................ $15.16 $14.57 $0.11 Second Quarter........................................... 14.84 12.99 0.11 Third Quarter............................................ 13.93 12.90 0.11 Fourth Quarter........................................... 14.85 13.54 0.11
The information for equity compensation plans is incorporated by reference from Item 12 of this Form 10-K. (b) Not applicable. (c) During the fourth quarter of 2004, the Company did not repurchase any shares of its common stock. ITEM 6. SELECTED FINANCIAL DATA
DECEMBER 31, -------------------------------------------------------------- 2004 2003 2002 2001 2000 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) SELECTED FINANCIAL CONDITION DATA: Total assets..................... $1,314,714 $1,569,270 $1,579,276 $1,604,134 $1,710,376 Loans receivable, net of deferred fees........................... 988,085 982,579 939,417 891,014 1,005,914 Allowance for losses on loans.... 13,353 10,453 8,721 7,662 7,187 Securities, available-for-sale... 202,219 326,304 335,363 323,383 313,383 Securities, held-to-maturity..... -- -- 21,402 37,034 249,641 Deposits......................... 863,178 978,440 953,042 945,948 934,012 Borrowed money................... 286,611 418,490 449,431 462,658 548,076 Stockholders' equity............. 147,911 155,953 160,662 171,284 199,368 Stockholders' equity per outstanding share.............. $ 11.94 $ 12.78 $ 12.68 $ 12.57 $ 11.88 Average stockholders' equity to average assets................. 10.58% 10.01% 10.55% 11.37% 11.87% Non-performing assets to total assets......................... 2.14 1.46 1.03 0.94 0.75 Allowance for losses on loans to non-performing loans........... 48.25 46.01 56.91 55.23 60.65 Allowance for losses on loans to total loans.................... 1.35 1.06 0.93 0.86 0.71
18
YEAR ENDED DECEMBER 31, -------------------------------------------------- 2004 2003 2002 2001 2000 -------- ------- ------- -------- -------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) SELECTED OPERATIONS DATA: Interest income........................... $ 68,986 $71,389 $86,664 $108,107 $118,876 Interest expense.......................... 38,900 43,678 53,068 70,288 73,033 -------- ------- ------- -------- -------- Net interest income....................... 30,086 27,711 33,596 37,819 45,843 Provision for losses on loans............. 8,885 2,326 1,956 1,150 3,375 -------- ------- ------- -------- -------- Net interest income after provision for losses on loans......................... 21,201 25,385 31,640 36,669 42,468 Non-interest income....................... 11,610 12,788 12,214 10,728 6,081 Non-interest expense...................... 46,592 34,034 33,678 31,433 31,035 -------- ------- ------- -------- -------- Income (loss) before income taxes......... (13,781) 4,139 10,176 15,964 17,514 Income tax expense (benefit).............. (7,204) 601 2,971 4,791 6,821 -------- ------- ------- -------- -------- Net income (loss)......................... $ (6,577) $ 3,538 $ 7,205 $ 11,173 $ 10,693 ======== ======= ======= ======== ======== Earnings (loss) per share (basic)......... $ (0.57) $ 0.31 $ 0.60 $ 0.80 $ 0.66 Earnings (loss) per share (diluted)....... (0.57) 0.30 0.58 0.77 0.66 Cash dividends declared per common share................................... 0.44 0.44 0.40 0.36 0.36 Dividend payout ratio..................... N/M 146.67% 68.96% 46.75% 54.55% SELECTED OPERATING RATIOS: Net interest margin....................... 2.13% 1.87% 2.22% 2.36% 2.83% Average interest-earning assets to average interest-bearing liabilities............ 111.59 110.45 109.54 112.09 113.59 Ratio of non-interest expense to average total assets............................ 3.14 2.19 2.12 1.86 1.84 Return (loss) on average assets........... (0.44) 0.23 0.45 0.66 0.63 Return (loss) on average equity........... (4.19) 2.28 4.30 5.82 5.34 Efficiency ratio(1)....................... 111.54 87.99 75.81 68.43 59.82
19
SELECTED QUARTERLY RESULTS OF OPERATIONS ------------------------------------------------------------- 2004 ------------------------------------------------------------- 4(TH) QUARTER 3(RD) QUARTER 2(ND) QUARTER 1(ST) QUARTER ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Interest income............. $17,101 $17,591 $16,832 $17,462 Interest expense............ 10,195 9,158 9,448 10,099 ------- ------- ------- ------- Net interest income......... 6,906 8,433 7,384 7,363 Provisions for losses on loans..................... 56 6,172 1,918 739 Non-interest income......... 2,868 3,060 2,550 3,132 Non-interest expense........ 18,097 10,683 9,279 8,533 ------- ------- ------- ------- Income (loss) before income taxes..................... (8,379) (5,362) (1,263) 1,223 Income tax expense (benefit)................. (3,696) (2,581) (906) (21) ------- ------- ------- ------- Net income (loss)........... $(4,683) $(2,781) $ (357) $ 1,244 ======= ======= ======= ======= Earnings (loss) per share (basic)................... $ (0.40) $ (0.24) $ (0.03) $ 0.11 Earnings (loss) per share (diluted)................. (0.40) (0.24) (0.03) 0.11 Dividends declared per share..................... 0.11 0.11 0.11 0.11 Net interest margin......... 2.06% 2.43% 2.06% 1.99% Average interest-earning assets to average interest-bearing liabilities............... 112.34 112.12 111.43 110.59 Ratio of non-interest expense to average total assets.................... 5.11 2.93 2.46 2.20 Return (loss) on average assets.................... (1.32) (0.76) (0.09) 0.32 Return (loss) on average equity.................... (11.95) (7.11) (0.90) 3.19 Efficiency ratio(1)......... 182.28 93.98 90.09 83.86 SELECTED QUARTERLY RESULTS OF OPERATIONS ------------------------------------------------------------- 2003 ------------------------------------------------------------- 4(TH) QUARTER 3(RD) QUARTER 2(ND) QUARTER 1(ST) QUARTER ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Interest income............. $18,044 $17,004 $17,711 $18,630 Interest expense............ 10,309 10,333 11,211 11,825 ------- ------- ------- ------- Net interest income......... 7,735 6,671 6,500 6,805 Provisions for losses on loans..................... 837 502 509 478 Non-interest income......... 4,167 3,204 2,920 2,497 Non-interest expense........ 10,131 8,091 7,955 7,857 ------- ------- ------- ------- Income (loss) before income taxes..................... 934 1,282 956 967 Income tax expense (benefit)................. (285) 315 258 313 ------- ------- ------- ------- Net income (loss)........... $ 1,219 $ 967 $ 698 $ 654 ======= ======= ======= ======= Earnings (loss) per share (basic)................... $ 0.11 $ 0.09 $ 0.06 $ 0.06 Earnings (loss) per share (diluted)................. 0.10 0.08 0.06 0.06 Dividends declared per share..................... 0.11 0.11 0.11 0.11 Net interest margin......... 2.10% 1.82% 1.69% 1.87% Average interest-earning assets to average interest-bearing liabilities............... 110.27 110.72 110.36 110.35 Ratio of non-interest expense to average total assets.................... 2.62 2.11 2.02 2.01 Return (loss) on average assets.................... 0.32 0.25 0.18 0.17 Return (loss) on average equity.................... 3.13 2.49 1.81 1.68 Efficiency ratio(1)......... 97.08 84.77 84.65 84.47
- --------------- (1) The Company's efficiency ratio is a percentage of non-interest expense to the sum of net interest income and non-interest income excluding gains or losses on the sale of securities and assets. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW During the fourth quarter of 2004, the Company restructured certain of its FHLB borrowings to reduce interest costs in future years, shorten the duration of its liabilities, reduce repricing risk, and eliminate the callable feature. In the debt restructuring, the Company prepaid $400.0 million of its callable fixed-rate borrowings and replaced that debt with $325.0 million of new non-callable FHLB borrowings. The Company structured the transaction in a manner it initially believed, based on its analysis and discussions with the Company's independent registered public accounting firm, would allow for extinguishment of debt accounting pursuant to Emerging Issues Task Force No. 96-19, Debtor's Accounting for a Modification or Exchange of Debt Instruments (EITF 96-19). Extinguishment of debt accounting would have resulted in the recognition of $42.0 million in prepayment penalties associated with the restructuring in the fourth quarter of 2004 as a charge to non-interest expense and significantly reduced the Company's interest expense in future periods. Subsequent to December 31, 2004, it was determined that the technical requirements for extinguishment of debt accounting of EITF 96-19 were not satisfied. As a result, the Company recognized $9.8 million on the early extinguishment of debt as a charge to non-interest expense during the fourth quarter of 2004 and deferred the remaining $32.2 million prepayment penalty in accordance with EITF 96-19. During the fourth quarter of 2004, the Company amortized as an adjustment to the cost of the new borrowings $2.1 million of interest expense. The remaining $30.1 million of prepayment penalties as of December 31, 2004 will be 20 recognized in interest expense as an adjustment to the cost of the Company's borrowings in future periods. The increase in interest expense related to the remaining prepayment penalties is expected to be $14.4 million, $9.6 million, $4.5 million, $1.5 million and $200,000 in the years ended December 31, 2005, 2006, 2007, 2008 and 2009, respectively. Although the accounting for this transaction under EITF 96-19 did not allow the Company to reduce its interest costs immediately, the Company anticipates the restructuring will have a positive overall effect in future periods by, among other things, improving the Company's interest rate risk profile. During the year ended December 31, 2004, the financial services industry continued to be impacted by the low interest rate environment. The Company was able to make strides in increasing its net interest margin by effectively managing its cost of deposits and redeploying certain lower yielding interest-earning assets into higher yielding loans. The Company's net interest income before the provision for losses on loans improved during 2004 to $30.1 million compared to $27.7 million for 2003, an increase of 8.6%. The Company's net interest margin increased 13.9% to 2.13% for the year ended December 31, 2004 from 1.87% for 2003. As discussed below, the composition of the Company's loan portfolio has changed significantly in recent years. The amounts of the Company's commercial real estate, construction and land development and commercial and industrial loans have become the predominant types of loans in the Company's loan portfolio. These types of loans amounted to 60.7%, in the aggregate, of the total loan portfolio at December 31, 2004 compared to 28.0% at December 31, 2000. See "Changes in Financial Position -- Loan Portfolio Composition" in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" below. Commercial loans are generally deemed to involve a greater degree of risk than single-family residential mortgage loans. During the year ended December 31, 2004, the Company's charge-offs of commercial real estate, construction and land development and commercial and industrial loans amounted to $5.7 million in the aggregate, or 92.2% of total charge-offs for the year. While the company believes the amount of its allowance for losses on loans at December 31, 2004 is appropriate, no assurance can be given that additional charge-offs and or provisions to the allowance for losses on loans may not be required in the future. The Company increased its provision for losses on loans by $6.6 million in 2004 compared to 2003, primarily as a result of increased impairment allocations related to eight loans. In addition, the Company's financial results for 2004 were also adversely impacted by the following: - legal expenses of $1.4 million related to the Company's goodwill litigation; - a $1.0 million impairment of a trust preferred security deemed to be other than temporarily impaired during the year; - the write-down of $421,000 in viatical receivables held by the Bank that were determined to be impaired; and - an increase in loan collection expenses of $300,000 compared to 2003. The Company also incurred an additional $1.0 million in compensation expense related to the resignation of a senior executive officer. This increase, however, was partially offset by an overall decrease of $1.1 million in pension related expenses during 2004 as compared to 2003. CRITICAL ACCOUNTING POLICIES The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, which require the Company to establish various accounting policies. Certain of these accounting policies require management to make estimates, judgments or assumptions that could have a material effect on the carrying value of certain assets and liabilities. The judgments and assumptions used by management are based on historical experience, projected results, internal cash flow modeling techniques and other factors which management believes are reasonable under the circumstances. The Company's significant accounting policies are presented in Note 1 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. These policies along with the disclosures 21 presented in the other financial statement notes and in this management's discussion and analysis, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the determination of the allowance for losses on loans to be a critical accounting policy. Allowance for Losses on Loans. The Company maintains an allowance for losses on loans at a level management believes is sufficient to absorb credit losses inherent in the loan portfolio. The allowance for losses on loans represents the Company's estimate of probable incurred losses in the loan portfolio at each balance sheet date and is based on the review of available and relevant information. One component of the allowance for losses on loans contains allocations for probable inherent but undetected losses within various pools of loans with similar characteristics pursuant to Statement of Financial Accounting Standards No. (SFAS) 5, Accounting for Contingencies. This component is based in part on certain loss factors applied to various loan pools as stratified by the Company. In determining the appropriate loss factors for these loan pools, management considers historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions. The second component of the allowance for losses on loans contains allocations for probable losses that have been identified relating to specific borrowing relationships pursuant to SFAS 114, Accounting by Creditors for Impairment of a Loan. This component of the allowance for losses on loans consists of expected losses resulting in specific credit allocations for individual loans not considered within the above mentioned loan pools. The analysis on each loan involves a high degree of judgment in estimating the amount of the loss associated with the loan, including the estimation of the amount and timing of future cash flows and collateral values. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. The Company assesses the adequacy of the allowance for losses on loans on a quarterly basis and adjusts the allowance for losses on loans by recording a provision for losses on loans in an amount sufficient to maintain the allowance at an appropriate level. The evaluation of the adequacy of the allowance for losses on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. To the extent that actual outcomes differ from management estimates, an additional provision for losses on loans could be required that could adversely affect earnings or the Company's financial position in future periods. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the provision for losses on loans for Citizens 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. AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID The table on the following page provides information regarding (i) the Company's interest income recognized from interest-earning assets and their related average yields; (ii) the amount of interest expense realized on interest-bearing liabilities and their related average rates; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin. Information is based on average daily balances during the indicated periods. 22
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------- 2004 2003 ---------------------------------- ---------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST ---------- -------- ---------- ---------- -------- ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable(1)... $ 998,706 $56,910 5.70% $ 965,373 $59,408 6.15% Securities(2)......... 311,605 10,029 3.22 311,652 8,637 2.77 FHLB stock............ 27,394 1,199 4.38 26,222 1,348 5.14 Other interest-earning assets(3)........... 71,873 848 1.18 179,468 1,996 1.11 ---------- ------- ---------- ------- Total interest- earning assets.......... 1,409,578 68,986 4.89 1,482,715 71,389 4.81 Non-interest earning assets................ 73,646 70,035 ---------- ---------- Total assets............ $1,483,224 $1,552,750 ========== ========== Interest-bearing liabilities: Deposits: Checking accounts... $ 94,857 241 0.25 $ 92,546 430 0.46 Money market accounts.......... 135,396 1,254 0.93 137,893 1,744 1.26 Savings accounts.... 205,682 730 0.35 212,765 1,347 0.63 Certificates of deposit........... 417,854 10,616 2.54 457,999 13,755 3.00 ---------- ------- ---------- ------- Total deposits...... 853,789 12,841 1.50 901,203 17,276 1.92 Borrowings............ 409,347 26,059 6.37 441,275 26,402 5.98 ---------- ------- ---------- ------- Total interest- bearing liabilities..... 1,263,136 38,900 3.08 1,342,478 43,678 3.25 ------- ------- Non-interest bearing deposits.............. 44,365 36,567 Non-interest bearing liabilities........... 18,776 18,308 ---------- ---------- Total liabilities....... 1,326,277 1,397,353 Stockholders' equity.... 156,947 155,397 ---------- ---------- Total liabilities and stockholders' equity................ $1,483,224 $1,552,750 ========== ========== Net interest-earning assets................ $ 146,442 $ 140,237 ========== ========== Net interest income/ interest rate spread................ $30,086 1.81% $27,711 1.56% ======= ====== ======= ====== Net interest margin..... 2.13% 1.87% ====== ====== Ratio of average interest-earning assets to average interest-bearing liabilities........... 111.59% 110.45% ====== ====== YEAR ENDED DECEMBER 31, ---------------------------------- 2002 ---------------------------------- AVERAGE AVERAGE BALANCE INTEREST YIELD/COST ---------- -------- ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable(1)... $ 914,688 $63,329 6.92% Securities(2)......... 383,699 18,559 4.84 FHLB stock............ 26,057 1,574 6.04 Other interest-earning assets(3)........... 189,911 3,202 1.69 ---------- ------- Total interest- earning assets.......... 1,514,355 86,664 5.72 Non-interest earning assets................ 75,397 ---------- Total assets............ $1,589,752 ========== Interest-bearing liabilities: Deposits: Checking accounts... $ 97,979 562 0.57 Money market accounts.......... 108,119 2,173 2.01 Savings accounts.... 207,552 2,668 1.29 Certificates of deposit........... 509,897 20,314 3.98 ---------- ------- Total deposits...... 923,547 25,717 2.78 Borrowings............ 458,864 27,351 5.96 ---------- ------- Total interest- bearing liabilities..... 1,382,411 53,068 3.84 ------- Non-interest bearing deposits.............. 22,853 Non-interest bearing liabilities........... 16,811 ---------- Total liabilities....... 1,422,075 Stockholders' equity.... 167,677 ---------- Total liabilities and stockholders' equity................ $1,589,752 ========== Net interest-earning assets................ $ 131,944 ========== Net interest income/ interest rate spread................ $33,596 1.88% ======= ====== Net interest margin..... 2.22% ====== Ratio of average interest-earning assets to average interest-bearing liabilities........... 109.54% ======
- --------------- (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 are based on historical costs. (3) Includes money market accounts, federal funds sold and interest-earning bank deposits. 23 RATE/VOLUME ANALYSIS The following table details the effects of changing rates and volumes on the Company's net interest income. 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).
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------------- 2004 COMPARED TO 2003 2003 COMPARED TO 2002 INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO --------------------------------------- ---------------------------------------- RATE/ TOTAL NET RATE/ TOTAL NET RATE VOLUME VOLUME INC./(DEC) RATE VOLUME VOLUME INC./(DEC) ------- ------- ------ ---------- -------- ------- ------ ---------- (DOLLARS IN THOUSANDS) Interest-earning assets: Loans receivable.......... $(4,397) $ 2,051 $(152) $(2,498) $ (7,040) $ 3,509 $ (390) $ (3,921) Securities................ 1,393 (1) 0 1,392 (7,925) (3,485) 1,488 (9,922) FHLB stock................ (200) 60 (9) (149) (235) 10 (1) (226) Other interest-earning assets.................. 121 (1,196) (73) (1,148) (1,090) (176) 60 (1,206) ------- ------- ----- ------- -------- ------- ------ -------- Total net change in income on interest-earning assets............... (3,083) 914 (234) (2,403) (16,290) (142) 1,157 (15,275) Interest-bearing liabilities: Deposits: Checking accounts....... (195) 11 (5) (189) (107) (31) 6 (132) Money market accounts... (466) (32) 8 (490) (805) 598 (222) (429) Savings accounts........ (592) (45) 20 (617) (1,354) 67 (34) (1,321) Certificates of deposit.............. (2,119) (1,206) 186 (3,139) (5,000) (2,068) 509 (6,559) ------- ------- ----- ------- -------- ------- ------ -------- Total deposits....... (3,372) (1,272) 209 (4,435) (7,266) (1,434) 259 (8,441) Borrowings................ 1,689 (1,910) (122) (343) 103 (1,048) (4) (949) ------- ------- ----- ------- -------- ------- ------ -------- Total net change in expense on interest-bearing liabilities............. (1,683) (3,182) 87 (4,778) (7,163) (2,482) 255 (9,390) ------- ------- ----- ------- -------- ------- ------ -------- Net change in net interest income.................... $(1,400) $ 4,096 $(321) $ 2,375 $ (9,127) $ 2,340 $ 902 $ (5,885) ======= ======= ===== ======= ======== ======= ====== ========
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003 Net Income. The Company recognized a net loss for the year ended December 31, 2004 of $6.6 million, or a $0.57 loss per share, compared to net income of $3.5 million, or $0.30 per diluted share ($0.31 per basic share), for the year ended December 31, 2003. The net loss was primarily a result of a $9.8 million charge to non-interest expense related to the Company's $400.0 million debt restructure which occurred during the fourth quarter of 2004 and an increase in the provision for losses on loans to $8.9 million from $2.3 million for the year ended December 31, 2003. Also adversely impacting the Company's results for the year ended December 31, 2004 were the following: - legal expenses of $1.4 million related to the Company's goodwill litigation; - a $1.0 million impairment of a trust preferred security deemed to be other than temporarily impaired during the year; 24 - the write-down of $421,000 in viatical receivables held by the Bank that were determined to be impaired; and - an increase in loan collection expenses of $300,000 compared to 2003. The Company also incurred an additional $1.0 million in compensation expense related to the resignation of a senior executive officer. However, this increase was partially offset by an overall decrease of $1.1 million in pension related expenses during 2004 as compared to 2003. Net Interest Income. Net interest income before the provision for losses on loans is the principal source of earnings for the Company and consists of interest income received on loans and investment securities less interest expense paid on deposits and borrowed funds. Net interest income is a function of the Company's interest rate spread, which is 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 net interest margin, which is net interest income as a percentage of average interest-earning assets, for the year ended 2004 improved 13.9% to 2.13% from 1.87% for 2003. The Company's net interest income before the provision for losses on loans for the year ended December 31, 2004 totaled $30.1 million and represented an 8.6% increase from $27.7 million for the year ended December 31, 2003. The increase in the net interest income and the net interest margin for the year was mainly the result of effective management of the cost of deposits combined with the redeployment of lower yielding other interest-earning assets into higher yielding loans. Although the Company refinanced its FHLB debt at lower fixed-rates, the amortization of a portion of the prepayment penalties negatively impacted the net interest margin for the year ended December 31, 2004. The Company expects the net interest margin to continue to be adversely impacted as a direct result of the amortization through interest expense of the remaining prepayment penalty during 2005 and in future years. Interest Income. The Company reported total interest income of $69.0 million for the year ended December 31, 2004 compared to $71.4 million for the year ended December 31, 2003. The decrease was primarily due to a 4.9% decrease in average interest-earning assets during 2004 from 2003 which was partially offset by a slight increase of 8 basis points in the yield of average interest-earning assets. The Company was able to redeploy certain lower yielding interest-earning assets into higher yielding loans throughout 2004 as well as use some of the repayments received on lower yielding assets to prepay a portion of its FHLB borrowings. During the year ended December 31, 2004 compared to the previous year, the Company's average loan balances increased $33.3 million or 3.5% while the average balance of the Company's other interest-earning assets (including the Company's money market accounts, federal funds sold and interest-bearing bank deposits) decreased $107.6 million or 60.0%. Interest Expense. During 2004, the Company proactively managed its cost of interest-bearing deposits and borrowings and reduced interest expense by $4.8 million or 10.9% as compared to 2003. Total interest expense amounted to $38.9 million for the year ended December 31, 2004 compared to $43.7 million for the year ended December 31, 2003. Interest expense on deposits decreased 25.7% to $12.8 million during 2004 from 2003 primarily as a result of a 42 basis point reduction in the average rate paid on total deposits coupled with a $47.4 million decrease in the average balance of total deposits. The Company continues to focus on increasing core deposits as a means of managing its total cost of deposits. Interest expense on borrowings during 2004 decreased by $343,000 from 2003 primarily as a result of the overall lower average level of debt during 2004. Included in interest expense in 2004 is the amortization of $2.1 million in prepayment penalties recognized as a result of the debt restructuring completed in the fourth quarter of 2004. The Company expects that the fourth quarter restructuring of the FHLB advances will continue to impact interest expense as the remaining prepayment penalties are amortized as an adjustment to the cost of the new borrowings. Additional interest expense related to the amortization of the remaining prepayment penalties is expected to be $14.4 million, $9.6 million, $4.5 million, $1.5 million and $200,000 in the years ended December 31, 2005, 2006, 2007, 2008 and 2009, respectively. 25 Provision for Losses on Loans. The Company's provision for losses on loans was $8.9 million for the year ended December 31, 2004 compared to $2.3 million in 2003. The $6.6 million increase in the provision was mainly the result of the Company's increased impairment allocation for impaired loans coupled with an increase in the amount of loan charge-offs during 2004. During 2004, the Company identified eight impaired loans with a total aggregate balance of $31.9 million. The aggregate required impairment allocation was $10.3 million, an increase from the previous allocation of $3.8 million for these loans. Each of these eight loans was reviewed for impairment based upon updated information received in conjunction with its overall evaluation of the adequacy of the allowance for losses on loans. This updated information identified either a change in the borrower's ability to perform their loan obligations or in the estimated value of the collateral. See additional information regarding the increases in the provision included in the "Allowance for Losses on Loans" section below in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section. Non-Interest Income. The Company's service charges and other fees increased by $615,000 or 8.9% for the full year of 2004 compared to 2003. The increases were primarily related to service charges generated by the Company's Overdraft Protection Privilege product provided to both retail and business customers. In 2004, the Company was able to realize a full year of income related to its Business Overdraft Privilege which was introduced in July 2003. The Company also increased the number of non-interest bearing checking accounts by approximately 15% since December 31, 2003 which added to the increase in service charges and other fees on deposit accounts. During the fourth quarter of 2004, the Company also realized a $220,000 gain on the sale of land and an office building. Prior to the sale, the building was leased to a company that acquired the assets of the CFS Insurance Agency, Inc. in November 2002. The improvements in service charges and other fees in the 2004 periods were more than offset by changes in the amount of net realized gains on sales of securities and losses realized in the cost basis of one impaired security in 2004 compared to 2003. Net realized gains on sales of securities were $719,000 for the year ended December 31, 2004 compared to $1.9 million for 2003. During 2004, the Company also recorded an impairment write-down of $1.0 million related to the other than temporary impairment of one trust preferred security that had an original cost basis of $1.1 million. Non-Interest Expense. The Company's non-interest expense for the year ended December 31, 2004 totaled $46.6 million compared to $34.0 million for the year ended December 31, 2003. The majority of this increase relates to the $9.8 million of prepayment penalties that were expensed during 2004 as part of the Company's restructuring of its FHLB borrowings. Exclusive of the prepayment penalties, the most significant changes in the Company's non-interest expense in 2004 compared to 2003 were in professional fees, which increased $991,000; data processing costs, which increased $477,000; and other general and administrative expenses, which increased $784,000. The increase in professional fees was due primarily to $1.4 million of legal expenses incurred during 2004 in connection with the Company's goodwill case that went to trial during the year. The increased data processing charges related to the conversion to a new processor. The increase in other general and administrative costs was primarily due to charges relating to the write-down of the carrying value of certain viatical receivables by $421,000 to $537,000. An increase in loan collection expense of $300,000 was also a factor in the increase in other general and administrative costs. The Company also incurred $1.0 million of compensation expense relating to the resignation of a senior executive officer during 2004. This increase in compensation expense was partially offset by a $1.1 million decrease in pension expense for 2004 as compared to 2003. Income Tax Expense. The Company's income tax benefit for the year ended December 31, 2004 totaled $7.2 million. The recognition during the year ended December 31, 2004 of income tax benefits was a significant change from the income tax expense incurred during 2003. The significant shift from income tax expense to income tax benefits during 2004 was the result of the pre-tax losses combined with the application of available tax credits, the effects of permanent tax differences on the Company's pre-tax earnings and the reversal of tax accruals no longer considered necessary. The available tax credits and permanent tax differences are expected to have a favorable impact on income tax expense throughout 2005. 26 YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 Net Income. Net income for the year ended December 31, 2003 was $3.5 million, or $0.30 per diluted share ($0.31 per basic share), compared to $7.2 million, or $0.58 per diluted share ($0.60 per basic share), for the year ended December 31, 2002. The historically low interest rate environment which prevailed throughout 2003 caused further deterioration in the Company's net interest margin. Net interest income for the year ended December 31, 2003 decreased by $5.9 million or 17.5% from the year ended December 31, 2002. The Company's results for the year ended December 31, 2003 were also adversely affected by a $1.3 million contribution to the Company's defined benefit pension plan to keep the plan appropriately funded and to avoid significantly higher estimated contributions in future years. As with many pension plans, the Company's plan had been adversely affected by three years of declining investment returns and record low interest rates which caused the level of funded benefits to drop significantly. Net Interest Income. The Company's average interest rate spread was 1.56% and 1.88% for the years ended December 31, 2003 and 2002, respectively. The Company's net interest margin was 1.87% and 2.22% during the years ended December 31, 2003 and 2002, respectively. The Company's net interest income for the year ended December 31, 2003 totaled $27.7 million and represented a $5.9 million decrease from $33.6 million for the year ended December 31, 2002. The decrease in net interest income in 2003 was due primarily to the combined effects of the low interest rate environment and lower average balances of interest-earning assets for the year ended December 31, 2003 compared to the year ended December 31, 2002. Interest Income. The Company reported total interest income of $71.4 million for the year ended December 31, 2003 compared to $86.7 million for the year ended December 31, 2002. The $15.3 million or 17.6% decrease was primarily due to a $31.6 million decrease in average interest-earning assets as well as a decrease in the average yield on interest-earning assets of 91 basis points for the year ended December 31, 2003 as compared to 2002. The average balances of the Company's interest-earning assets continued to decline during 2003 as a result of unprecedented refinancing activity which caused significant rate reductions within the loan portfolio and accelerated amortization of premiums on its mortgage-backed securities portfolio. Given the low interest rate environment during 2003, the Company reinvested these funds predominantly in relatively low yielding assets with estimated average durations of two years or less as well as overnight funds with the expectation that they will be readily available for investment in higher yielding assets when the interest rate cycle turns upward. During 2003, the Company made considerable progress in its strategy to transfer assets from lower yielding securities to higher yielding loans. During the year ended December 31, 2003 compared to the previous year, average loan balances increased $50.7 million or 5.5% while the average balance of the Company's securities portfolio decreased $72.0 million or 18.8%. Interest Expense. In contrast to the adverse impact on the asset side of the balance sheet, the low interest rate environment in 2003 provided some positive opportunities on the funding side. The Company proactively managed its funding costs throughout 2003 by aggressively lowering the interest rate paid on its core deposits which historically have not been rate sensitive. Total interest expense amounted to $43.7 million for the year ended December 31, 2003 compared to $53.1 million for the year ended December 31, 2002. The $9.4 million or 17.7% reduction in interest expense during 2003 was primarily the result of an 86 basis point reduction in the average rate paid on interest-bearing deposits coupled with a $22.3 million decrease in the average balance of interest-bearing deposits. Provision for Losses on Loans. The Company's provision for losses on loans was $2.3 million for the year ended December 31, 2003 compared to $2.0 million in 2002. The increase in provision was a result of the Company's increased emphasis on growing the commercial real estate and multi-family residential loan portfolios 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 on loans. 27 Non-Interest Income. The Company reported non-interest income of $12.8 million for the year ended December 31, 2003 compared to $12.2 million for the year ended December 31, 2002. The primary reasons for the increase in non-interest income in 2003 compared to 2002 were a: - $1.2 million increase in service charges and other fees, and - $1.6 million increase in net gains on the sale of securities, which were partially offset compared to the Company's results in 2002 by the absence of insurance commissions of $1.2 million and the $1.1 million net gain on the sale of the Company's insurance agency that were realized during 2002. The increase in service charges and other fees during 2003 was mainly realized from the Company's popular Overdraft Protection Privilege offered to both retail and business checking customers. The Company also realized $651,000 of commission income during 2003, which was the first full year of outsourcing its alternative investment program. Through this program, the Company's third party outsourcing partner sold nearly $36 million of tax deferred annuities and other investments as an alternative investment to our depositors. Non-Interest Expense. The Company reported non-interest expense of $34.0 million for the year ended December 31, 2003 compared to $33.7 million for the year ended December 31, 2002. While the Company's salary expense remained relatively stable during 2003 compared to 2002, compensation and employee benefits expense increased as a result of a $1.3 million payment to the Company's defined benefit pension plan during the fourth quarter of 2003. As with many pension plans, the Company's plan was adversely affected by three years of declining investment returns and record low interest rates which caused the level of funded benefits to drop significantly. The voluntary contribution was made to keep the plan funded at a level deemed appropriate. The Company froze the benefits associated with this plan in March 2003. Although no further benefits will accrue while the freeze remains in place, the freeze does not reduce the benefits accrued through March 2003. Professional fees were $1.8 million for the year ended December 31, 2003 compared to $1.3 million for 2002. The increase in professional fees was mainly the result of the Company hiring independent third parties to: - perform an information systems technology assessment which led to the decision to move forward to upgrade our core data processor and helped prioritize additional technology systems and upgrades, - improve the processing and underwriting for the Company's Home Equity Lines of Credit (HELOC) program and implementation of our HELOC equity access card, and - implement new software designed to streamline and enhance the processing and underwriting of retail loans. Income Tax Expense. The Company's income tax expense amounted to $601,000 and $3.0 million for the years ended December 31, 2003 and 2002, respectively. The Company's effective tax rates were 14.5% and 29.2% for the years ended December 31, 2003 and 2002, respectively. The significant decrease in income tax expense was a result of lower pre-tax income, the application of available tax credits and the effects of permanent tax differences on the lower pre-tax earnings. CHANGES IN FINANCIAL CONDITION General. During the year ended December 31, 2004, the Company's total assets decreased by $254.6 million to $1.31 billion from $1.57 billion at December 31, 2003. The significant changes in the composition of the Company's balance sheet during the year ended December 31, 2004 include a: - net decrease in cash and cash equivalents of $139.7 million, - net decrease in securities of $124.1 million, 28 - net decrease in total deposits of $115.3 million, and - net decrease in FHLB borrowings of $131.9 million. The decrease in total assets was a direct result of a decrease in certificates of deposit and FHLB borrowings. During 2004, certificates of deposit decreased $145.9 million due to managed runoff of above market rate certificates as they reached maturity. Partially offsetting the decrease in certificates was an increase in core deposits of $30.6 million. The Company has continued to focus on obtaining lower costing core deposits through its promotional efforts and retail incentive programs. During 2004, the Bank repaid $406.5 million of fixed-rate FHLB borrowings, of which $400.0 million was repaid and replaced with $325.0 million of new FHLB borrowings during the fourth quarter of 2004. Subsequent to the debt restructuring, an additional $20.0 million was repaid by the Company during the fourth quarter of 2004. The Company incurred $42.0 million of prepayment penalties related to the debt restructuring, of which, $32.2 million is being deferred as an adjustment to the carrying value of the total debt outstanding and will be recognized in interest expense as an adjustment to the cost of the borrowings over their remaining life. See further discussions related to these transactions in the "Borrowed Funds" section below in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." Loan Portfolio Composition. The following table sets forth the composition of the Bank's loans receivable, net of unearned fees, and the percentage of loans by category as of the dates indicated.
DECEMBER 31, ------------------------------------------------------------------------------------------------------------- 2004 2003 2002 2001 2000 ------------------- ------------------- ------------------- ------------------- --------------------- PERCENT PERCENT PERCENT PERCENT PERCENT AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL -------- -------- -------- -------- -------- -------- -------- -------- ---------- -------- (DOLLARS IN THOUSANDS) Commercial and construction loans: Commercial real estate........... $396,420 40.1% $429,883 43.7% $343,043 36.5% $193,373 21.7% $ 165,499 16.5% Construction and land development...... 145,162 14.7 125,636 12.8 122,833 13.1 95,017 10.7 98,522 9.8 Commercial and industrial....... 58,682 5.9 36,222 3.7 40,073 4.3 23,949 2.7 17,492 1.7 -------- -------- -------- -------- ---------- Total commercial and construction loans............ 600,264 60.7 591,741 60.2 505,949 53.9 312,339 35.1 281,513 28.0 Retail loans: Single-family residential...... 277,501 28.1 316,774 32.2 385,548 41.0 535,193 60.1 701,140 69.7 Home equity loans and lines of credit........... 102,981 10.5 71,360 7.3 45,106 4.8 41,416 4.6 20,534 2.0 Other.............. 7,339 0.7 2,704 0.3 2,814 0.3 2,066 0.2 2,727 0.3 -------- ----- -------- ----- -------- ----- -------- ----- ---------- ----- Total retail loans............ 387,821 39.3 390,838 39.8 433,468 46.1 578,675 64.9 724,401 72.0 -------- ----- -------- ----- -------- ----- -------- ----- ---------- ----- Total loans receivable....... $988,085 100.0% $982,579 100.0% $939,417 100.0% $891,014 100.0% $1,005,914 100.0% ======== ===== ======== ===== ======== ===== ======== ===== ========== =====
During the year ended December 31, 2004, the Company originated over $50.0 million of new loans within its commercial real estate portfolio which were more than offset by loan repayments, charge-offs and transfers to other real estate owned. The Company purchased total commercial real estate participations of $3.6 million which was more than offset by $9.1 million of commercial real estate participations sold. The Company's construction and land development loan portfolio increased as a result of over $129.0 million of originations and $47.0 million of participations purchased. The Company's construction and land development loans had $87.6 million of available credit under construction loans and land development lines of credit as of December 31, 2004. The Company's commercial and industrial loan portfolio also increased due to new fundings of over $21.0 million and participations purchased of $22.5 million. Both the construction and land development and the commercial and industrial loan portfolios were also impacted by principal repayments. 29 During 2004, the Company's single-family residential loan portfolio continued to decline as repayments more than offset new originations of over $29.0 million. The Bank also sold $13.2 million of fixed-rate single-family residential mortgage loans with servicing released during 2004. The continued decline in single-family residential loans since 2001 in each of the last three years is primarily due to the high levels of refinancing and prepayments experienced throughout the industry. Given the lower interest rate environment during the past three years, the Company focused on originating more variable-rate products, including HELOCs. Total HELOCs originated during 2004 were over $86.0 million and were partially offset by repayments. As of December 31, 2004, the Company had $70.3 million in unused HELOCs. The Company's other loans consist mainly of $6.7 million in participations purchased for indirect auto loans during 2004 which were offset by repayments on all consumer loans. As reflected in the preceding table, the Company's portfolio of commercial real estate loans has increased significantly in recent years. At December 31, 2004, these loans represented 40.1% of the company's total loan portfolio. In addition, the Company's construction and land development loans and commercial and industrial loans have increased and, at December 31, 2004, represented 14.7% and 5.9%, respectively, of the Company's total loan portfolio. These types of commercial loans are all generally deemed to have a higher degree of risk than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of the project or business or the successful completion of the construction project. Local and general economic conditions, supply and demand, the abilities of the borrower to manage the creditor's operations, and many other factors, affect the borrower's ability to repay. Included in the Company's commercial and construction loan portfolio is an aggregate of $122.9 million or 12.4% of the Company's total loan portfolio, of loans to the hotel and motel industry. The Company has no other concentrations of loans to any industry exceeding 10% of its total loan portfolio. The hotel and motel business is very competitive and the success of the hotel and motel operators and their ability to repay loans is dependent on local and general economic conditions among other factors. See further discussions related to the Company's commercial and construction portfolio charge-offs and non-performing assets in the "Allowance for Losses on Loans" and the "Non-Performing Assets" sections below in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." Contractual Principal Repayments and Interest Rates. The following table sets forth scheduled contractual amortization of the Bank's loans at December 31, 2004, 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 scheduled repayments and no stated maturity, and overdraft loans are reported as due in one year or less.
PRINCIPAL REPAYMENTS CONTRACTUALLY DUE TOTAL AT IN YEAR(S) ENDED DECEMBER 31, DECEMBER 31, --------------------------------------- 2004 2005 2006-2009 THEREAFTER --------------- ---------- ----------- ------------ (DOLLARS IN THOUSANDS) Commercial and construction loans: Commercial real estate................. $397,616 $ 21,600 $147,512 $228,504 Construction and land Development...... 145,736 53,528 86,367 5,841 Commercial and industrial.............. 58,706 34,590 20,029 4,087 -------- -------- -------- -------- Total commercial and construction loans............................... 602,058 109,718 253,908 238,432 Retail loans: Single-family residential.............. 278,234 1,627 15,532 261,075 Home equity loans and lines of credit.............................. 102,987 4,311 969 97,707 Other.................................. 7,339 1,301 4,689 1,349 -------- -------- -------- -------- Total retail loans..................... 388,560 7,239 21,190 360,131 -------- -------- -------- -------- Total loans receivable(1)(2)............. $990,618 $116,957 $275,098 $598,563 ======== ======== ======== ========
- --------------- (1) Gross loans receivable does not include deferred fees of $2.5 million as of December 31, 2004. (2) Of the $873.7 million of loan principal repayments contractually due after December 31, 2005, $222.0 million have fixed interest rates and $651.7 million have variable interest rates which reprice from one month up to five years. 30 Scheduled contractual loan amortization 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. ALLOWANCE FOR LOSSES ON LOANS The allowance for losses on loans is maintained at a level believed adequate by management to absorb estimated probable loan losses. Management's periodic evaluation of the adequacy of the allowance is based on the Company's past loan loss experience, known and inherent losses in the portfolio, evaluations of real estate collateral, composition of the loan portfolio, current economic conditions and levels of non-performing and other classified loans. Loans which are determined to be uncollectible are charged off against the allowance for losses on loans and recoveries of loans that were previously charged off are credited to the allowance. See further analysis in the "Critical Accounting Policies" previously discussed in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as Note 1 to the consolidated financial statements. The Company's charge-off policy varies with respect to the category of and specific circumstances surrounding each loan under consideration. The Company records charge-offs on the basis of management's ongoing evaluation of collectibility. As of December 31, 2004, the Bank's allowance for losses on loans amounted to $13.4 million or 48.25% and 1.35% of the Bank's non-performing loans and total loans receivable, respectively. The Bank's provision for losses on loans amounted to $8.9 million for the year ended December 31, 2004 and $2.3 million for 2003. Management of the Company believes that, as of December 31, 2004, the allowance for losses on loans was adequate. As of December 31, 2004, the Company had eight impaired loans with aggregate outstanding balances of $25.1 million with impairment allocation related to these loans of $6.4 million. Six of the impaired loans are commercial real estate loans, of which three are secured by hotels and total $20.5 million with aggregate impairment allocations of $4.1 million. The other three impaired commercial real estate loans are secured by a golf course and total $3.5 million with an impairment allocation of $1.5 million. The two remaining impaired loans are commercial loans, of which one is secured by business assets and the other by improved land. These two loans total $1.2 million with an aggregate impairment allocation of $751,000. 31 The following table sets forth the activity in the Bank's allowance for losses on loans during the periods indicated.
YEAR ENDED DECEMBER 31, ---------------------------------------------- 2004 2003 2002 2001 2000 ------- ------- ------- ------ ------- (DOLLARS IN THOUSANDS) Allowance at beginning of period.............. $10,453 $ 8,721 $ 7,662 $7,187 $ 5,973 Provision..................................... 8,885 2,326 1,956 1,150 3,375 Charge-offs: Commercial and construction loans: Commercial real estate................. (3,635) (178) (87) (279) (2,136) Construction and land development...... (1,206) (142) (31) (6) (10) Commercial and industrial.............. (903) (92) (877) (450) -- ------- ------- ------- ------ ------- Total commercial and construction loans............................... (5,744) (412) (995) (735) (2,146) Retail loans: Single-family residential.............. (217) (83) (82) (120) (115) Home equity loans...................... -- -- -- -- -- Other.................................. (268) (265) (106) -- (18) ------- ------- ------- ------ ------- Total retail loans..................... (485) (348) (188) (120) (133) ------- ------- ------- ------ ------- Total charge-offs........................ (6,229) (760) (1,183) (855) (2,279) Recoveries: Commercial and construction loans: Commercial real estate................. 7 4 -- 10 1 Construction and land development...... -- 90 24 42 50 Commercial and industrial.............. 105 14 38 -- -- ------- ------- ------- ------ ------- Total commercial and construction loans............................... 112 108 62 52 51 Retail loans: Single-family residential.............. 104 40 219 124 64 Home equity loans...................... 3 -- -- -- -- Other.................................. 25 18 5 4 3 ------- ------- ------- ------ ------- Total retail loans..................... 132 58 224 128 67 ------- ------- ------- ------ ------- Total recoveries......................... 244 166 286 180 118 ------- ------- ------- ------ ------- Net loans charged-off to allowance for losses on loans..................... (5,985) (594) (897) (675) (2,161) ------- ------- ------- ------ ------- Allowance at end of period.......... $13,353 $10,453 $ 8,721 $7,662 $ 7,187 ======= ======= ======= ====== ======= Allowance for losses on loans to total non-performing loans at end of period....... 48.25% 46.01% 56.91% 55.23% 60.65% Allowance for losses on loans to total loans at end of period............................ 1.35 1.06 0.93 0.86 0.71 Net charge-offs to average loans outstanding................................. 0.60 0.06 0.10 0.07 0.22
Net charge-offs for 2004 totaled $6.0 million, or 0.6% of average loans outstanding, as compared to $594,000 or 0.06% of average loans outstanding for 2003. Gross charge-offs in 2004 of $6.2 million relate primarily to commercial loans and include a: - $1.8 million charge-off during the second quarter of 2004 on a $4.5 million commercial real estate loan secured by a motel prior to this loan being transferred to other real estate owned and sold for $2.7 million during the same quarter; - $1.7 million partial charge-off during the fourth quarter of 2004 on a loan secured by a hotel in the Chicago metropolitan area; and 32 - $1.2 million partial charge-off during the fourth quarter of 2004 on a commercial construction loan secured by an apartment complex. Both of these loans with partial charge-offs are non-performing loans. See additional disclosure related to these loans within the "Non-Performing Assets" section of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section. Allocation of the Allowance for Losses on Loans. The Bank allocates its allowance for losses on loans by loan category. Various percentages are assigned to the loan categories based on their historical loss factors and management's analysis of their relative risks. The following table shows the allocation of the allowance for losses on loans by loan type for each of the last five years:
DECEMBER 31, ------------------------------------------------------------------------------------- 2004 2003 2002 2001 ---------------------- ---------------------- ---------------------- ---------- ALLOWANCE ALLOWANCE ALLOWANCE ALLOWANCE AS A % OF ALLOWANCE AS A % OF ALLOWANCE AS A % OF ALLOWANCE ALLOCATION CATEGORY ALLOCATION CATEGORY ALLOCATION CATEGORY ALLOCATION ---------- --------- ---------- --------- ---------- --------- ---------- (DOLLARS IN THOUSANDS) Residential real estate: Single-family owner occupied......... $ 730 0.20% $ 488 0.13% $ 481 0.11% $2,262 Single-family non- owner occupied... 56 0.20 134 0.24 233 0.47 276 Multi-family....... 1,005 1.20 2,352 2.31 2,282 2.29 716 Business/Commercial.. 9,368 2.34 5,155 1.48 4,159 1.47 3,067 Business/Commercial non-real estate.... 1,412 3.36 1,096 1.71 440 1.54 388 Developed Lots....... 125 0.36 102 1.04 55 0.75 95 Land................. 289 0.63 566 1.57 432 1.33 247 Consumer............. 368 3.55 447 12.70 277 0.71 48 Other assets......... -- -- 113 -- 189 -- -- Unallocated.......... -- -- -- -- 173 -- 563 ------- ------- ------ ------ $13,353 $10,453 $8,721 $7,662 ======= ======= ====== ====== DECEMBER 31, ---------------------------------- 2001 2000 --------- ---------------------- ALLOWANCE ALLOWANCE AS A % OF ALLOWANCE AS A % OF CATEGORY ALLOCATION CATEGORY --------- ---------- --------- (DOLLARS IN THOUSANDS) Residential real estate: Single-family owner occupied......... 0.40% $2,845 0.40% Single-family non- owner occupied... 0.80 298 0.80 Multi-family....... 1.00 773 1.00 Business/Commercial.. 1.75 2,393 1.75 Business/Commercial non-real estate.... 2.50 419 2.50 Developed Lots....... 1.25 57 1.25 Land................. 1.75 198 1.75 Consumer............. 2.00 73 2.00 Other assets......... -- -- -- Unallocated.......... -- 131 -- ------ $7,187 ======
ASSET QUALITY General. All of the Bank's assets are subject to review under its classification system. See discussion on "Classified and Criticized Assets." Loans are periodically reviewed by the Bank's Loan Committee. The Board of Directors also reviews the classified assets on 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 prior to 30 days after a payment is due. Late charges are generally assessed after 15 days with additional efforts being 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 may institute foreclosure or other proceedings, as deemed 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. The Bank does not accrue interest on loans past due 90 days or more. Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other 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). 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 the property's net realizable value. 33 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. For the periods presented, the Bank had no loans earning interest that are greater than 90 days delinquent.
DECEMBER 31, --------------------------------------------------------------- 2004 2003 2002 ------------------- ------------------- ------------------- 60-89 DAYS 60-89 DAYS 60-89 DAYS DELINQUENT DELINQUENT DELINQUENT ------------------- ------------------- ------------------- PERCENT OF PERCENT OF PERCENT OF LOAN LOAN LOAN AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY ------ ---------- ------ ---------- ------ ---------- (DOLLARS IN THOUSANDS) Commercial and construction loans: Commercial real estate............. $ 105 0.03% $ 943 0.22% $1,149 0.33% Construction and land development..................... 1,614 1.11 1,657 1.32 341 0.28 Commercial and industrial.......... 562 0.96 470 1.30 781 1.95 ------ ------ ------ Total commercial and construction loans........................... 2,281 0.38 3,070 0.52 2,271 0.45 Retail loans: Single-family residential.......... 2,358 0.85 2,704 0.85 4,482 1.16 Home equity loans.................. 73 0.07 49 0.07 161 0.36 Other.............................. 13 0.18 2 0.07 10 0.36 ------ ------ ------ Total retail loans................. 2,444 0.63 2,755 0.70 4,653 1.07 ------ ------ ------ Total................................ $4,725 0.48% $5,825 0.59% $6,924 0.74% ====== ====== ======
34 Non-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 at any of the below-referenced dates.
DECEMBER 31, ----------------------------------------------- 2004 2003 2002 2001 2000 ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Non-accrual loans: Commercial and construction loans: Commercial real estate.......... $19,197 $11,460 $ 5,657 $ 1,834 $ 1,330 Construction and land development................... 1,895 4,180 1,323 1,361 4,167 Commercial and industrial....... 236 1,205 692 1,117 559 ------- ------- ------- ------- ------- Total commercial and construction loans............ 21,328 16,845 7,672 4,312 6,056 Retail loans: Single-family residential....... 5,855 5,584 7,294 8,579 5,230 Home equity loans............... 460 272 324 692 405 Other........................... 32 19 35 291 158 ------- ------- ------- ------- ------- Total retail loans.............. 6,347 5,875 7,653 9,562 5,793 ------- ------- ------- ------- ------- Total non-accrual loans......... 27,675 22,720 15,325 13,874 11,849 Other real estate owned, net......... 525 206 893 1,128 1,058 ------- ------- ------- ------- ------- Total non-performing assets........ $28,200 $22,926 $16,218 $15,002 $12,907 ======= ======= ======= ======= ======= Performing troubled debt restructuring...................... $ 41 $ 296 $ 338 $ 417 $ 586 Non-performing assets to total assets............................. 2.14% 1.46% 1.03% 0.94% 0.75% Non-performing loans to total loans.............................. 2.80% 2.31% 1.63% 1.51% 1.13% Total non-performing assets and troubled debt restructurings to total assets....................... 2.15% 1.48% 1.05% 0.96% 0.79%
During 2004, the non-performing commercial real estate loans increased from December 31, 2003 primarily as a result of the following: - One loan totaling $8.8 million as of December 31, 2004 secured by a hotel in Michigan and was transferred to non-accrual status during the third quarter of 2004. As of December 31, 2004, this loan was considered an impaired loan with an estimated impairment allocation of $811,000. During December 2004, Bank management negotiated a forbearance agreement to obtain additional collateral of a total of 15 acres of land along with the borrower's hiring a hotel consultant to assist with the hotel's operation. - One loan totaling $8.7 million secured by a hotel in the Chicago metropolitan area was transferred to non-accrual during the second quarter of 2004 and was subsequently written-down through an impairment allocation to a balance of $7.0 million as of December 31, 2004. The loan was still considered impaired and has a remaining estimated impairment allocation of $1.8 million as of December 31, 2004. During December 2004, Bank management negotiated a forbearance agreement extending the maturity of the loan through May 2005 when the loan is required to be paid off. In conjunction with the forbearance agreement, the borrower placed the title of the property in escrow. The borrowers have the opportunity for a 120 day extension if they pay additional funds on the loan. Should the loan not be paid off at maturity under the terms of the forbearance agreement, the title to the property is to be transferred to the Bank. During the first quarter of 2005, the borrowers filed for reorganization under Chapter 11 of the Bankruptcy Code. 35 - Two loans totaling $2.2 million were transferred to non-accrual status during the second quarter of 2004. These loans are secured by a golf course in Indiana. The Bank has filed a foreclosure action; however, the current owners have filed a countersuit against the Bank. See "Legal Proceedings" for more details. Based on the collateral values, the Company believes there is little risk of loss related to the outstanding balance of these loans as of December 31, 2004. Partially offsetting the above increases in non-performing commercial real estate loans, the Bank foreclosed on and transferred a $2.7 million motel loan to other real estate owned prior to it being sold for $2.7 million during the second quarter of 2004. Also, the Bank received the full payoff during the second quarter of 2004 of a $3.8 million loan secured by a strip mall that was transferred to non-performing status during the fourth quarter of 2003. The decrease in non-performing loans related to construction and land development related to the full payoff of two loans totaling $3.5 million in the aggregate and the $1.2 million partial charge-off of a non-performing commercial construction loan secured by an apartment complex. The amount charged off on this loan was equal to the impairment allocation identified at the end of the third quarter of 2004. The interest income that would have been recorded during the year ended December 31, 2004, 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 $1.8 million. The actual amount of interest recorded as income (on a cash basis) on such loans during the period amounted to $357,000. 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 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. - Loss assets are considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Federal examiners have designated another category as "special mention" 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. As of December 31, 2004, the Bank had an aggregate of $41.9 million of classified assets, 81% of which were classified substandard and 19% of which were classified as doubtful, compared to $43.0 million of classified assets as of December 31, 2003. SECURITIES As of December 31, 2003, all of the Company's investment securities were classified as available-for-sale. 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. 36 The following table set forth information regarding the carrying and fair value of the Company's securities at the dates indicated.
DECEMBER 31, ------------------------------------------------------------------------ 2004 2003 2002 ---------------------- ---------------------- ---------------------- AMORTIZED AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE --------- ---------- --------- ---------- --------- ---------- (DOLLARS IN THOUSANDS) Available-for-sale: Government sponsored entity securities (GSE) and commercial paper(1)...... $ 96,663 $ 95,915 $132,127 $132,819 $ 30,767 $ 31,087 Mortgage-backed securities............... 55,602 55,983 108,468 109,101 64,084 64,768 Collateralized mortgage obligations.............. 48,815 48,738 75,245 75,798 231,752 231,870 Trust preferred securities............... 90 90 6,148 5,586 4,931 4,400 Equity securities........... 1,701 1,493 2,958 3,000 4,061 3,238 -------- -------- -------- -------- -------- -------- Total available-for-sale securities............. $202,871 $202,219 $324,946 $326,304 $335,595 $335,363 ======== ======== ======== ======== ======== ======== Held-to-maturity: Mortgage-backed securities............... $ -- $ -- $ -- $ -- $ 20,651 $ 21,161 Collateralized mortgage obligations.............. -- -- -- -- 751 816 -------- -------- -------- -------- -------- -------- Total held-to-maturity securities............. $ -- $ -- $ -- $ -- $ 21,402 $ 21,977 ======== ======== ======== ======== ======== ========
- --------------- (1) The majority of the GSE securities at December 31, 2002 were callable securities. The Company held no callable GSE securities at December 31, 2004 or December 31, 2003. The Company also held no commercial paper at December 31, 2004. The decrease in total securities from December 31, 2003 to December 31, 2004 was primarily a result of the Company selling approximately $60.0 million of securities available-for-sale during the fourth quarter of 2004 in conjunction with the restructuring of its FHLB debt in order to fund the prepayment penalties incurred in the restructuring. The remainder of the decline related to the sale of securities during the second quarter of 2004 as the Company took advantage of a steep yield curve to reposition its investment portfolio. During 2004, management identified one impaired trust preferred security. Write-downs to fair value of $1.0 million were made during 2004 when the issuer first deferred an interest payment during the second quarter of 2004 and again when the issuer announced the continuation of interest deferral on the trust preferred securities coupled with the sale of a significant portion of the issuer's assets, continuing restructuring objectives, and regulatory restrictions on the issuer. As of December 31, 2004, the new carrying value of this trust preferred security was $90,000, which was equal to its market value. Management does not believe any remaining individual unrealized loss as of December 31, 2004 represents an other-than-temporary (OTT) impairment. The unrealized losses reported for agency securities, mortgage-backed securities and collateralized mortgage obligations are, in their entirety, on securities issued by the federal government, its agencies or GSEs, including the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Government National Mortgage Association (GNMA), and in management's belief, are attributable to changes in interest rates and the resultant change in the shape of the yield curve. The unrealized losses associated with equity securities relate to one issuance. Management believes that the unrealized loss is specifically related to the changes in interest rates and the resultant change in the shape of the yield curve. 37 The following table sets forth certain information regarding the maturities and weighted average yield of the Company's securities as of December 31, 2004. The amounts listed in the table are based on carrying value and the yield is calculated based on amortized cost.
COLLATERALIZED MORTGAGE-BACKED MORTGAGE TRUST PREFERRED EQUITY GSE SECURITIES SECURITIES(1) OBLIGATIONS(1) SECURITIES SECURITIES TOTAL --------------- --------------- --------------- ---------------- -------------- ---------------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD ------- ----- ------- ----- ------- ----- ------- ------ ------ ----- -------- ----- (DOLLARS IN THOUSANDS) Maturities: Within 1 year...... $ -- --% $ 260 4.11% $24,367 3.66% $-- --% $ -- --% $ 24,627 3.67% 1 - 5 years........ 95,915 2.80 46,434 4.23 24,371 3.77 -- -- -- -- 166,720 3.34 5 - 10 years....... -- -- 9,289 5.39 -- -- -- -- -- -- 9,289 5.39 After 10 years(2).. -- -- -- -- -- -- 90 -- -- -- 90 -- Other(3)........... -- -- -- -- -- -- -- -- 1,493 -- 1,493 -- ------- ------- ------- --- ------ -------- $95,915 2.80% $55,983 4.40% $48,738 3.72% $90 --% $1,493 --% $202,219 3.45% ======= ======= ======= === ====== ======== Average months to Maturity........... 23 35 14 286 -- 24
- --------------- (1) The Company's mortgage-backed securities and collateralized mortgage obligations are amortizing in nature. As such, the maturities presented in the table for these securities are based on historical and estimated prepayment rates for the underlying mortgage collateral. The estimated average lives may differ from actual principal cash flows since cash flows include prepayments and scheduled principal amortization. (2) Security is impaired; therefore, the Company has not calculated a related yield. (3) Other securities include equity securities which have no stated maturity date and are not included in the average months to maturity. DEPOSITS The following table sets forth the dollar amount of deposits and the percentage of total deposits in each deposit category offered by the Bank at the dates indicated.
DECEMBER 31, --------------------------------------------------------------------- 2004 2003 2002 --------------------- --------------------- --------------------- AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE -------- ---------- -------- ---------- -------- ---------- (DOLLARS IN THOUSANDS) Checking accounts: Non-interest bearing........ $ 51,713 6.0% $ 40,017 4.1% $ 30,895 3.2% Interest-bearing............ 94,878 11.0 91,385 9.3 90,172 9.5 Money market accounts......... 147,211 17.1 123,799 12.7 121,982 12.8 Savings accounts.............. 196,358 22.7 204,312 20.9 212,323 22.3 -------- ----- -------- ----- -------- ----- Core deposits............ 490,160 56.8 459,513 47.0 455,372 47.8 Certificates of deposit: $100,000 or less............ 288,597 33.4 396,433 40.5 388,688 40.8 Over $100,000............... 84,421 9.8 122,494 12.5 108,982 11.4 -------- ----- -------- ----- -------- ----- Time deposits............ 373,018 43.2 518,927 53.0 497,670 52.2 -------- ----- -------- ----- -------- ----- Total deposits......... $863,178 100.0% $978,440 100.0% $953,042 100.0% ======== ===== ======== ===== ======== =====
Total deposits at December 31, 2004 decreased from total deposits at December 31, 2003 primarily due to a decrease of certificates of deposit of $145.9 million in the aggregate which was primarily a result of managed runoff of above-market-rate certificates as they reached maturity. The majority of these certificates 38 were originated during 2003 when the Company offered above-market-rate short-term certificates on new money deposits to attract new customers. While the Company did not offer similar promotions during 2004, it may continue to use these types of promotions from time to time to build its customer base. Partially offsetting the decrease in certificates of deposit during 2004 was an increase in core deposits of $30.6 million. The Company continues to manage its interest expense on deposits by effectively managing the cost of its deposits and by focusing on obtaining low cost core deposits through promotional efforts and retail incentive programs. The following table sets forth the amount and remaining maturities of the Bank's certificates of deposit at December 31, 2004.
OVER ONE OVER TWO YEAR YEARS THROUGH THROUGH THROUGH OVER INTEREST CATEGORY ONE YEAR TWO YEARS THREE YEARS THREE YEARS TOTALS -------- --------- ----------- ----------- ----------------- (DOLLARS IN THOUSANDS) 0.00% to 0.99%.................... $ 2,155 $ 186 $ -- $ -- $ 2,341 1.00% to 1.99%.................... 160,561 12,230 180 -- 172,971 2.00% to 2.99%.................... 68,588 35,049 4,609 1,318 109,564 3.00% to 3.99%.................... 6,375 7,481 2,670 14,305 30,831 4.00% to 4.99%.................... 870 1,918 7,850 3,143 13,781 5.00% to 5.99%.................... 3,411 1,417 2,190 581 7,599 6.00% to 6.99%.................... 13,939 9,043 988 963 24,933 7.00% to 8.99%.................... 8,402 844 1,274 478 10,998 -------- ------- ------- ------- -------- Total............................. $264,301 $68,168 $19,761 $20,788 $373,018 ======== ======= ======= ======= ========
As of December 31, 2004, the aggregate amount of outstanding time certificates of deposit in amounts greater than or equal to $100,000 was $90.6 million. The following table presents the maturity of these time certificates of deposit.
DECEMBER 31, 2004 ---------------------- (DOLLARS IN THOUSANDS) 3 months or less............................................ $27,275 Over 3 months through 6 months.............................. 15,134 Over 6 months through 12 months............................. 17,744 Over 12 months.............................................. 30,468 ------- $90,621 =======
39 BORROWED FUNDS A summary of the Company's borrowed funds at December 31, 2004 and 2003 is as follows:
DECEMBER 31, ----------------------------------------- 2004 2003 ------------------- ------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE RATE AMOUNT RATE AMOUNT -------- -------- -------- -------- (DOLLARS IN THOUSANDS) Secured advances from FHLB -- Indianapolis: Maturing in 2005 -- variable-rate.......... 1.95% $ 34,000 --% $ -- Maturing in 2005 -- fixed-rate............. 3.00 10,000 -- -- Maturing in 2006 -- fixed-rate............. 3.41 87,000 -- -- Maturing in 2007 -- fixed-rate............. 3.65 87,000 -- -- Maturing in 2008 -- fixed-rate............. 3.89 72,000 -- -- Maturing in 2009 -- fixed-rate............. 4.09 15,000 -- -- Maturing in 2010 -- fixed-rate............. -- -- 5.92 400,000 Maturing in 2014 -- fixed-rate(1).......... 6.71 1,227 6.71 1,244 Maturing in 2018 -- fixed-rate(1).......... 5.54 2,865 5.54 2,911 Maturing in 2019 -- fixed-rate(1).......... 6.31 7,691 6.32 7,835 Secured advances from FHLB -- Chicago: Maturing in 2008 -- fixed-rate............. -- -- 5.26 6,500 -------- -------- 316,783 418,490 Less: deferred premium on early extinguishment of debt..................... (30,172) -- -------- -------- $286,611 $418,490 ======== ======== Weighted-average interest rate............... 3.55% 5.92%
- --------------- (1) These advances are amortizing borrowings and are listed by their contractual maturity. During the third quarter of 2004, the Company repaid $6.5 million of advances maturing in 2008 which bore a 5.26% fixed interest rate and recognized a $485,000 charge to other non-interest expense. During the fourth quarter of 2004, the Company repaid $400.0 million of callable fixed-rate advances with an average cost of 5.92% and an average remaining term of 64.2 months. These prepaid advances were replaced with $325.0 million of new non-callable FHLB advances. These new advances included an aggregate $271.0 million of non-callable fixed-rate FHLB advances with an average cost of 3.64% and an average term of 34.3 months in a laddered portfolio with maturities ranging from 21 to 60 months. The new borrowings also included $54.0 million of short-term variable-rate borrowings, of which, $20.0 million was repaid on December 31, 2004. The Company paid $42.0 million of prepayment penalties related to the prepaid advances and recognized $9.8 million on the early extinguishment of debt as a charge to non-interest expense during the fourth quarter of 2004. The remaining $32.2 million of prepayment penalties is being deferred as an adjustment to the carrying value of the borrowings and will be recognized in interest expense as an adjustment to the cost of the new borrowings over their remaining life. The increase in interest expense related to the remaining prepayment penalties is expected to be $14.4 million, $9.6 million, $4.5 million, $1.5 million and $200,000 in the years ended December 31, 2005, 2006, 2007, 2008 and 2009, respectively. CAPITAL RESOURCES Stockholders' equity at December 31, 2004 was $147.9 million as compared to $156.0 million at December 31, 2003. The decrease was primarily due to a: 40 - $6.6 million net loss; - $1.3 million increase in unrealized losses on available-for-sale securities, net of tax; - $4.9 million declaration of cash dividends during 2004; and - $869,000 of repurchases of the Company's common stock during 2004. Partially offsetting the above decreases in stockholders' equity, the Company also realized during 2004: - $1.4 million of common stock that vested under the Company's Recognition and Retention Plan; - $1.7 million of shares earned under the Company's Employee Stock Ownership Plan; and - $2.3 million of stock option exercises. For the year ended December 31, 2004, the Company repurchased 61,713 shares of its common stock at an average price of $14.08 per share pursuant to the share repurchase program announced in March 2003. Since its initial public offering in 1998, the Company has repurchased an aggregate of 11,592,616 shares of its common stock at an average price of $11.75 per share. As of December 31, 2004, the Company has 1,180,156 of shares remaining to be repurchased under its current share repurchase program. At December 31, 2004, the Bank was deemed to be well capitalized based on its internal calculations with tangible and core regulatory capital ratios of 9.24% and a risk-based capital ratio of 12.23%. 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: - deposits, - scheduled payments of amortizing loans and mortgage-backed securities, - prepayments and maturities of outstanding loans and mortgage-backed securities, - maturities of investment securities and other short-term investments, - funds provided from operations, and - borrowings from the FHLB. Scheduled payments from the amortization of loans, mortgage-related 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 interest rates, 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 and other corporate funding requirements. At December 31, 2004, the Company had cash and cash equivalents of $38.1 million which was a decrease of $139.7 million from December 31, 2003. The decrease was mainly caused by decreases in total deposits and borrowed money of $115.3 million and $101.7 million, respectively. In addition, the Company utilized $42.0 million of cash to pay the prepayment penalties associated with its fourth quarter of 2004 debt restructuring and loan originations, net of principal payments received, utilized $16.3 million of liquidity. These decreases were partially offset by a net decrease in securities of $124.1 million. The Company uses its sources of funds primarily to meet its ongoing commitments, fund loan commitments, pay maturing certificates of deposit and savings withdrawals, and maintain a securities portfolio. The Company anticipates that it will continue to have sufficient funds to meet its current commitments. The liquidity needs of the parent company, CFS Bancorp, Inc., consist primarily of operating expenses, dividend payments to stockholders and stock repurchases. The primary sources of liquidity are cash and cash equivalents and dividends from the Bank. Under OTS regulations, without prior approval, the dividends from 41 the Bank are limited to the extent of the Bank's cumulative earnings for the year plus the net earnings (adjusted by prior distributions) of the prior two calendar years. On a parent company-only basis, for the year ended December 31, 2004, the Company received $2.9 million in dividends from the Bank. At December 31, 2004, the parent company had $11.9 million in cash on hand and $337,000 of securities available-for-sale. 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. At December 31, 2004, the Bank was deemed well- capitalized. See Note 12 in the consolidated financial statements for more information on the Bank's regulatory capital. Contractual Obligations. The following table presents significant fixed and determinable contractual obligations to third parties by payment date as of December 31, 2004.
PAYMENTS DUE BY PERIOD ----------------------------------------------------------- OVER ONE OVER THREE ONE YEAR THROUGH THROUGH OVER OR LESS THREE YEARS FIVE YEARS FIVE YEARS TOTAL -------- ----------- ---------- ---------- -------- (DOLLARS IN THOUSANDS) Federal Home Loan Bank advances(1).................... $44,221 $174,491 $87,561 $10,510 $316,783 Operating leases................. 589 742 127 -- 1,458 ------- -------- ------- ------- -------- $44,810 $175,233 $87,688 $10,510 $318,241 ======= ======== ======= ======= ========
- --------------- (1) Does not include interest expense at the weighted-average stated rate of 3.55% for the periods presented. See the "Borrowed Funds" section for further discussion surrounding the Company's FHLB advances. The Company's operating lease obligations reflected above include the future minimum rental payments, by year, required under the lease terms for premises and equipment. 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. See also Note 4 in the consolidated financial statements for further discussion related to the Company's operating leases. The Company also has commitments to fund certificates of deposit which are scheduled to mature within one year or less. These deposits total $264.3 million at December 31, 2004. Based on historical experience and the fact that these deposits are at current market rates, management believes that a significant portion of the maturing deposits will remain with the Bank. Off-Balance-Sheet Obligations. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by the third party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. 42 The following table details the amounts and expected maturities of significant commitments as of December 31, 2004.
OVER ONE OVER THREE ONE YEAR THROUGH THROUGH OVER OR LESS THREE YEARS FIVE YEARS FIVE YEARS TOTAL -------- ----------- ---------- ---------- -------- (DOLLARS IN THOUSANDS) Commitments to extend credit: Commercial............................. $11,478 $ -- $ -- $ -- $ 11,478 Retail................................. 9,011 -- -- -- 9,011 Commitments to purchase loans: Commercial............................. 5,000 -- -- -- 5,000 Commitments to fund unused construction loans.................................. 20,224 37,328 11,123 4,083 72,758 Commitments to fund unused lines of credit: Commercial............................. 14,978 14,822 740 352 30,892 Retail................................. 16,149 508 377 66,833 83,867 Letters of credit........................ 5,540 3,671 284 -- 9,495 Credit enhancements...................... -- 6,532 31,423 10,684 48,639 ------- ------- ------- ------- -------- $82,380 $62,861 $43,947 $81,952 $271,140 ======= ======= ======= ======= ========
The above listed commitments do not necessarily represent future cash requirements, in that certain of these commitments often expire without being drawn upon. Letters of credit include credit enhancements which are 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 which provides for a lower interest rate, the FHLB-IN issues, in favor of the bond trustee, an Irrevocable Direct Pay 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 had funded the project initially. The Company has not used, and has no intention of using, any significant off-balance sheet financing arrangements for liquidity purposes. 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 the Company's liquidity or capital resources. The Company has not utilized and has no intention of utilizing derivatives or commodity contracts. IMPACT OF INFLATION AND CHANGING PRICES The consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States, 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. Monetary items, such as cash, loans and deposits, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates generally have a more significant impact on a financial institution's performance than general inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as inflation. 43 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Bank, like other financial institutions, is subject to interest rate risk (IRR). This risk relates to changes in market interest rates which could adversely affect net interest income or the net portfolio value (NPV) of its assets, liabilities, and off-balance sheet contracts. IRR is primarily the result of an imbalance between the price sensitivity of the Bank's assets and its liabilities. These imbalances can be caused by differences in the maturity, repricing, and coupon characteristics of assets and liabilities as well as options (such as loan prepayment options). The Bank maintains a written Asset/Liability Management Policy that establishes written guidelines for the asset/liability management function, including the management of net interest margin, interest rate risk, and liquidity. The Asset/Liability Management Policy falls under the authority of the Board of Directors who in turn assigns its formulation, revision, and administration to the Asset/Liability Committee (ALCO). The ALCO meets monthly and consists of certain senior officers of the Bank and one outside director. The results of the monthly meetings are reported to the Board of Directors. The primary duties of the ALCO are to develop reports and establish procedures to measure and monitor IRR, verify compliance with Board approved IRR tolerance limits, take appropriate actions to mitigate those risks, monitor and discuss the status and results of implemented strategies and tactics, monitor the Bank's capital position, review the current and prospective liquidity positions, and monitor alternative funding sources. 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 adjustable interest rates or fixed rates of interest for an initial term of three or five years, that convert to an adjustable 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, 2004, the Bank had approximately $733.7 million of adjustable-rate loans in its portfolio. Second, the Bank's securities portfolio consists of securities that have expected average lives of five years or less at time of purchase. At December 31, 2004, the modified duration of the securities portfolio was less than two years. Third, the Bank has a substantial amount of 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, 2004, the Bank had $490.2 million of these types of accounts. The Bank utilizes the OTS NPV model as its primary method of monitoring its exposure to IRR. The NPV represents the excess of the present value of expected cash flows from assets over the present value of expected cash flows from liabilities. The NPV model estimates the sensitivity of the Bank's NPV over a series of instantaneous and sustained parallel shifts in interest rates. On a quarterly basis, the ALCO reviews the calculations of NPV as adjusted for expected cash flows from off-balance sheets contracts, if any, for compliance with Board approved tolerance limits. 44 The table below presents, as of December 31, 2004 and 2003, an analysis of the Bank's IRR as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve in 100 basis point (1%) increments, up to 300 basis points and down 100 basis points in 2004 and 2003 in accordance with OTS regulations. As illustrated in the table, the Bank's NPV in the base case (0 basis point change) increased $23.4 million from $138.2 million at December 31, 2003 to $161.6 million at December 31, 2004. The primary reason for the increase was a reduction in the effective duration of the Bank's liabilities resulting from the restructuring of the Company's FHLB advances completed in the fourth quarter of 2004. See further discussion regarding this restructure in the "Borrowed Money" section. At December 31, 2004, the Bank's overall sensitivity to interest rate risk has decreased in each of the assumed change in interest rate scenarios compared to December 31, 2003.
NET PORTFOLIO VALUE --------------------------------------------------------------- YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 2004 2003 ------------------------------ ------------------------------ $ AMOUNT $ CHANGE % CHANGE $ AMOUNT $ CHANGE % CHANGE -------- -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) Assumed Change in Interest Rates (Basis Points) +300.......................... $154,194 $(7,441) (4.8)% $118,872 $(19,316) (14.0)% +200.......................... 159,216 (2,419) (1.5) 130,804 (7,385) (5.3) +100.......................... 162,128 493 0.3 147,771 9,582 6.9 0........................ 161,635 -- -- 138,188 -- -- -100.......................... 157,103 (4,532) (2.9) 130,281 (7,908) (5.7)
As modeled above, the Bank's NPV increases nominally with an increase in interest rates of 100 basis points while the NPV decreases in each of the other rate scenarios. The relatively small percentage change in the Bank's NPV in each of the rate scenarios indicates the price sensitivity of the Bank's assets reasonably matches the price sensitivity of the Bank's liabilities. At December 31, 2004 and December 31, 2003, the Bank was within the Board-approved tolerance limits in each rate scenario. This NPV model is a static model and does not consider potential adjustments of strategies by management on a dynamic basis in a volatile rate environment in order to protect or conserve equity values. As such, actual results may vary from the modeled results. The above analysis includes the assets and liabilities of the Bank only. Inclusion of Company only assets and liabilities would increase NPV nominally at all levels. 45 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders CFS Bancorp, Inc., Munster, Indiana We have audited the accompanying consolidated statement of condition of CFS Bancorp, Inc. as of December 31, 2004, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CFS Bancorp, Inc. at December 31, 2004, and the results of its operations and its cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. /s/ Crowe Chizek and Company LLC Oak Brook, Illinois March 11, 2005 46 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTANT Board of Directors and Stockholders CFS Bancorp, Inc. We have audited the accompanying consolidated statement of condition of CFS Bancorp, Inc. (the Company) as of December 31, 2003, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2003. 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 standards of the Public Accounting Oversight Board (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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of CFS Bancorp, Inc. as of December 31, 2003, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Chicago, Illinois February 27, 2004 47 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF CONDITION
DECEMBER 31, ----------------------- 2004 2003 ---------- ---------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) ASSETS Cash and amounts due from depository institutions........... $ 16,878 $ 18,213 Interest-bearing deposits................................... 11,217 149,577 Federal funds sold.......................................... 9,999 9,961 ---------- ---------- Cash and cash equivalents............................... 38,094 177,751 Securities available-for-sale, at fair value................ 202,219 326,304 Investment in Federal Home Loan Bank stock, at cost......... 27,665 26,766 Loans receivable, net of unearned fees...................... 988,085 982,579 Allowance for losses on loans............................. (13,353) (10,453) ---------- ---------- Net loans............................................... 974,732 972,126 Accrued interest receivable................................. 5,456 6,624 Other real estate owned..................................... 525 206 Office properties and equipment............................. 15,511 13,738 Investment in bank-owned life insurance..................... 33,362 31,926 Prepaid expenses and other assets........................... 15,721 12,335 Intangible assets........................................... 1,429 1,494 ---------- ---------- Total assets......................................... $1,314,714 $1,569,270 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits.................................................... $ 863,178 $ 978,440 Borrowed money.............................................. 286,611 418,490 Advance payments by borrowers for taxes and insurance....... 8,177 5,595 Other liabilities........................................... 8,837 10,792 ---------- ---------- Total liabilities.................................... 1,166,803 1,413,317 Stockholders' equity: Preferred stock, $.01 par value; 15,000,000 shares authorized.............................................. -- -- Common stock, $.01 par value; 85,000,000 shares authorized; 23,423,306 shares issued as of December 31, 2004 and 2003; 12,385,322 and 12,200,015 shares outstanding as of December 31, 2004 and 2003, respectively............................................ 234 234 Additional paid-in capital................................ 189,991 189,879 Retained earnings, substantially restricted............... 94,904 106,354 Treasury stock, at cost: 11,037,984 and 11,223,291 shares at December 31, 2004 and 2003, respectively............. (130,689) (132,741) Unallocated common stock held by ESOP..................... (5,959) (7,158) Unearned common stock acquired by RRP..................... (148) (1,523) Accumulated other comprehensive income (loss), net of tax..................................................... (422) 908 ---------- ---------- Total stockholders' equity........................... 147,911 155,953 ---------- ---------- Total liabilities and stockholders' equity........... $1,314,714 $1,569,270 ========== ==========
See accompanying notes. 48 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, --------------------------------------------- 2004 2003 2002 ------------- ------------- ------------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Interest income: Loans............................................... $ 56,910 $ 59,408 $ 63,329 Securities.......................................... 10,029 8,637 18,559 Federal Home Loan Bank stock........................ 1,199 1,348 1,574 Other............................................... 848 1,996 3,202 ----------- ----------- ----------- Total interest income............................ 68,986 71,389 86,664 Interest expense: Deposits............................................ 12,841 17,276 25,717 Borrowed Money...................................... 26,059 26,402 27,351 ----------- ----------- ----------- Total interest expense........................... 38,900 43,678 53,068 ----------- ----------- ----------- Net interest income before provision for losses on loans............................................... 30,086 27,711 33,596 Provision for losses on loans......................... 8,885 2,326 1,956 ----------- ----------- ----------- Net interest income after provision for losses on loans............................................... 21,201 25,385 31,640 Non-interest income: Service charges and other fees...................... 7,523 6,908 5,679 Commission income................................... 666 651 1,980 Net realized gains on available-for-sale securities....................................... 719 1,900 299 Impairment on available-for-sale securities......... (1,018) (120) -- Net gain on sale of office properties and other assets........................................... 225 39 1,085 Income from bank-owned life insurance............... 1,439 1,437 1,524 Other income........................................ 2,056 1,973 1,647 ----------- ----------- ----------- Total non-interest income........................ 11,610 12,788 12,214 Non-interest expense: Compensation and employee benefits.................. 19,834 19,804 19,958 Net occupancy expense............................... 2,440 2,216 2,366 Professional fees................................... 2,797 1,806 1,347 Data processing..................................... 2,713 2,236 2,148 Furniture and equipment expense..................... 1,612 1,771 1,920 Marketing........................................... 1,060 1,196 974 Amortization of core deposit intangibles............ 65 16 -- Prepayment penalties on FHLB debt................... 10,298 -- -- Other general and administrative expenses........... 5,773 4,989 4,965 ----------- ----------- ----------- Total non-interest expense....................... 46,592 34,034 33,678 ----------- ----------- ----------- Income (loss) before income taxes..................... (13,781) 4,139 10,176 Income tax expense (benefit).......................... (7,204) 601 2,971 ----------- ----------- ----------- Net income (loss)..................................... $ (6,577) $ 3,538 $ 7,205 =========== =========== =========== Per share data: Basic earnings (loss) per share..................... $ (0.57) $ 0.31 $ 0.60 Diluted earnings (loss) per share................... (0.57) 0.30 0.58 Weighted-average shares outstanding................... 11,599,996 11,289,254 12,000,589 Weighted-average diluted shares outstanding........... 11,897,494 11,702,635 12,492,149
See accompanying notes. 49 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
UNEARNED UNEARNED COMMON COMMON ACCUM. OTHER ADDITIONAL STOCK STOCK COMPREHENSIVE COMMON PAID-IN RETAINED TREASURY ACQUIRED ACQUIRED INCOME STOCK CAPITAL EARNINGS STOCK BY ESOP BY RRP (LOSS) TOTAL ------ ---------- -------- --------- -------- -------- ------------- -------- (DOLLARS IN THOUSANDS) Balance at January 1, 2002.... $234 $189,547 $105,064 $(112,167) $(9,570) $(4,543) $ 2,719 $171,284 Net income for 2002........... -- -- 7,205 -- -- -- -- 7,205 Comprehensive income: Change in unrealized appreciation on available-for-sale securities, net of reclassification and tax....................... -- -- -- -- -- -- (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 exercised........... -- 92 -- -- -- -- -- 92 Dividends declared on common stock ($0.40 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 Net income for 2003........... -- -- 3,538 -- -- -- -- 3,538 Comprehensive income: Change in unrealized appreciation on available-for-sale securities, net of reclassification and tax....................... -- -- -- -- -- -- 1,031 1,031 -------- Total comprehensive income.... -- -- -- -- -- -- -- 4,569 Purchase of treasury stock.... -- -- -- (9,273) -- -- -- (9,273) Shares earned under ESOP...... -- 497 -- -- 1,198 -- -- 1,695 Amortization of award under RRP......................... -- (47) -- -- -- 1,304 -- 1,257 Exercise of stock options..... -- (450) -- 2,182 -- -- -- 1,732 Tax benefit related to stock options exercised........... -- 93 -- -- -- -- -- 93 Dividends declared on common stock ($0.44 per share)..... -- -- (4,782) -- -- -- -- (4,782) ---- -------- -------- --------- ------- ------- ------- -------- Balance at December 31, 2003........................ 234 189,879 106,354 (132,741) (7,158) (1,523) 908 155,953 Net loss for 2004............. -- -- (6,577) -- -- -- -- (6,577) Comprehensive income (loss): Change in unrealized appreciation on available-for-sale securities, net of reclassification and tax....................... -- -- -- -- -- -- (1,330) (1,330) -------- Total comprehensive income (loss)...................... -- -- -- -- -- -- -- (7,907) Purchase of treasury stock.... -- -- -- (869) -- -- -- (869) Shares earned under ESOP...... -- 475 -- -- 1,199 -- -- 1,674 Amortization of award under RRP......................... -- (20) -- -- -- 1,375 -- 1,355 Exercise of stock options..... -- (576) -- 2,921 -- -- -- 2,345 Tax benefit related to stock options exercised........... -- 233 -- -- -- -- -- 233 Dividends declared on common stock ($0.44 per share)..... -- -- (4,873) -- -- -- -- (4,873) ---- -------- -------- --------- ------- ------- ------- -------- Balance at December 31, 2004........................ $234 $189,991 $ 94,904 $(130,689) $(5,959) $ (148) $ (422) $147,911 ==== ======== ======== ========= ======= ======= ======= ========
See accompanying notes. 50 CFS BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------- 2004 2003 2002 --------- --------- --------- (DOLLARS IN THOUSANDS) OPERATING ACTIVITIES Net income (loss)........................................... $ (6,577) $ 3,538 $ 7,205 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on loans........................... 8,885 2,326 1,956 Depreciation and amortization........................... 1,543 1,548 1,787 Premium amortization on early extinguishment of debt.... 2,052 -- -- Net premium amortization on securities available-for-sale.................................... 2,539 6,209 3,931 Impairment of securities available-for-sale............. 1,018 120 -- Deferred income tax benefit............................. (1,137) (603) (1,582) Amortization of cost of stock benefit plans............. 3,029 2,952 3,362 Tax benefit from exercises of nonqualified stock options............................................... 233 93 92 Proceeds from sale of loans held for sale............... 13,180 12,697 12,128 Origination of loans held for sale...................... (12,818) (15,087) (11,484) Net gain realized on sale of securities................. (719) (1,900) (299) Dividends received on Federal Home Loan Bank stock...... (1,234) (1,003) (1,574) Net gain on sale of assets.............................. (225) -- (1,084) Increase in cash surrender value of bank-owned life insurance............................................. (1,439) (1,437) (1,524) Increase in goodwill from branch acquisition............ -- (1,510) -- Decrease (increase) in prepaid expenses and other assets................................................ 197 (2,187) 4,675 Decrease in other liabilities........................... (2,351) (1,263) (8,075) Other................................................... 90 166 239 --------- --------- --------- Net cash provided by operating activities............. 6,266 4,659 9,753 INVESTING ACTIVITIES Securities: Proceeds from sales....................................... 196,224 46,620 12,951 Proceeds from maturities and pay downs.................... 89,211 471,873 650,911 Purchases................................................. (166,193) (490,871) (668,267) Redemption of Federal Home Loan Bank stock.................. 335 17 1,959 Net loan fundings and principal payments received........... (16,269) (42,860) (53,877) Proceeds from sale of other real estate owned............... 3,782 1,857 2,687 Purchases of properties and equipment....................... (4,273) (1,179) (1,746) Purchase of property and equipment from branch acquisition............................................... -- (1,365) -- Disposal of properties and equipment........................ 1,242 1,109 2,191 --------- --------- --------- Net cash flows provided (used) by investing activities......................................... 104,059 (14,799) (53,191) FINANCING ACTIVITIES Proceeds from exercise of stock options..................... 2,345 1,732 858 Dividends paid on common stock.............................. (4,847) (4,713) (4,642) Purchase of treasury stock.................................. (869) (9,273) (14,626) Net increase (decrease) in deposit accounts................. (115,262) 22,216 7,599 Increase in deposit accounts from branch acquisitions....... -- 3,182 -- Net increase (decrease) in advance payments by borrowers for taxes and insurance....................................... 2,582 1,184 (87) Premium paid on the early extinguishment of debt............ (32,224) -- -- Increase in borrowed funds.................................. 325,000 -- -- Decrease in borrowed funds.................................. (426,707) (30,941) (13,227) --------- --------- --------- Net cash flows used in financing activities................. (249,982) (16,613) (24,125) --------- --------- --------- Decrease in cash and cash equivalents....................... (139,657) (26,753) (67,563) Cash and cash equivalents at beginning of year.............. 177,751 204,504 272,067 --------- --------- --------- Cash and cash equivalents at end of year.................... $ 38,094 $ 177,751 $ 204,504 ========= ========= ========= Supplemental disclosures: Loans transferred to other real estate owned.............. $ 4,043 $ 1,170 $ 2,368 Cash paid for interest on deposits........................ 13,088 17,251 25,860 Cash paid for interest on borrowings...................... 24,651 26,406 27,392 Cash paid for taxes....................................... -- 2,452 2,023
See accompanying notes. 51 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2004 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION CFS Bancorp, Inc. (including its consolidated subsidiaries, 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 or Citizens Financial). 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 as well as other types of consumer and commercial loans. The Company provides financial services through its offices in northwest Indiana and the suburban areas south of Chicago. Its primary deposit products are checking, savings and money market accounts as well as certificates of deposit. Its primary lending products are commercial and construction loans and retail loans. Substantially all loans are secured by specific items of collateral including commercial and residential real estate, business assets and consumer assets. Commercial loans are expected to be repaid from cash flow from business operations. The customers' ability to repay their loans is dependent on the general economic conditions in the area and the underlying collateral. 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 one active subsidiary, CFS Holdings, Ltd. The Bank also has the following inactive subsidiaries: CFS Insurance Agency, Inc., CFS Investment Services, Inc., and Suburban Mortgage Services, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided. The allowance for losses on loans and fair values of financial instruments are particularly subject to change. CASH FLOWS Cash and cash equivalents include cash, interest-bearing deposits in other financial institutions under 90 days, and federal funds sold. Generally, federal funds sold are purchased and sold for one-day periods. Net cash flows are reported for customer loan and deposit transactions, interest-bearing deposits in other financial institutions and federal funds sold. 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 when management has the positive 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 holding gains and losses, net of tax, reported in other comprehensive income. Other securities such as Federal Home Loan Bank stock are carried at cost. The Company has no trading account securities. 52 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Interest income includes amortization of purchase premiums or discounts. 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. Gains and losses on sales are recorded on the trade date and determined using the specific identification method. Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company's ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. LOANS Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and portions charged off. Interest income on loans is accrued on the active unpaid principal balance. Loans held-for-sale, if any, are carried at the lower of aggregate cost or market value. Interest income is not accrued on loans which are delinquent 90 days or more, or for loans which management believes, after giving consideration to economic and business conditions and collection efforts, collection of interest is doubtful. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis until qualifying for return to accrual. 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 Company is accreting these amounts over the contractual life of the related loans. Remaining deferred loan fees and costs are reflected in income upon sale or repayment of the loan. ALLOWANCE FOR LOSSES ON LOANS The Company maintains an allowance for losses on loans at a level management believes is sufficient to absorb credit losses inherent in the loan portfolio. The allowance for losses on loans represents the Company's estimate of probable incurred losses in the loan portfolio at each balance sheet date and is based on the review of available and relevant information. One component of the allowance for losses on loans contains allocations for probable inherent but undetected losses within various pools of loans with similar characteristics pursuant to Statement of Financial Accounting Standards No. (SFAS) 5, Accounting for Contingencies. This component is based in part on certain loss factors applied to various loan pools as stratified by the Company. In determining the appropriate loss factors for these loan pools, management considers historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions. The second component of the allowance for losses on loans contains allocations for probable losses that have been identified relating to specific borrowing relationships pursuant to SFAS 114, Accounting by Creditors for Impairment of a Loan. This component of the allowance for losses on loans consists of expected losses resulting in specific credit allocations for individual loans not considered within the above mentioned 53 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) loan pools. The analysis on each loan involves a high degree of judgment in estimating the amount of the loss associated with the loan, including the estimation of the amount and timing of future cash flows and collateral values. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. The Company assesses the adequacy of the allowance for losses on loans on a quarterly basis and adjusts the allowance for losses on loans by recording a provision for losses on loans in an amount sufficient to maintain the allowance at an appropriate level. The evaluation of the adequacy of the allowance for losses on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. To the extent that actual outcomes differ from management estimates, an additional provision for losses on loans could be required that could adversely affect earnings or the Company's financial position in future periods. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the provision for losses on loans for Citizens Financial 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. OTHER REAL ESTATE OWNED Other real estate owned is comprised of property acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. Other 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 Land is carried at cost. Office properties and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 30 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 15 years. Leasehold improvements are amortized over the life of the lease. BANK-OWNED LIFE INSURANCE The Bank has purchased life insurance policies on certain of its employees. The Bank-owned life insurance is recorded at its cash surrender value, or the amount that can be realized. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. Other intangible assets consist of core deposit intangible assets arising from branch acquisitions. They are initially measured at fair value and then are amortized on a straight-line basis over their estimated useful lives. LONG-TERM ASSETS Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. 54 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) LOAN COMMITMENTS AND RELATED FINANCIAL INSTRUMENTS Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. 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 which have been granted 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 Company's 1998 Recognition and Retention Plan (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, as amended (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. The effects of applying FAS No. 123 in this pro forma disclosure are not indicative of future amounts.
YEAR ENDED DECEMBER 31, ---------------------------------- 2004 2003 2002 ---------- --------- --------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Net income (loss) (as reported)........................... $(6,577) $3,538 $7,205 Stock-based compensation expense determined using fair value method, net of tax................................ 678 680 763 ------- ------ ------ Pro forma net income (loss)............................... $(7,255) $2,858 $6,442 ======= ====== ====== Basic earnings (loss) per share (as reported)............. $ (0.57) $ 0.31 $ 0.60 Pro forma basic earnings (loss) per share................. (0.63) 0.25 0.54 Diluted earnings (loss) per share (as reported)........... (0.57) 0.30 0.58 Pro forma diluted earnings (loss) per share............... (0.63) 0.24 0.52
The fair value of the option grants for the years ended December 31 was estimated using the Black-Scholes option value model with the following assumptions:
2004 2003 2002 ---------- ----------- ----------- Dividend yield.......................................... 3.3% 3.0% 2.8% Expected volatility..................................... 27.4 28.3 30.2 Risk-free interest...................................... 3.9 3.6 3.6 Original expected life.................................. 6 years 10 years 10 years
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models such as the Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility. For additional details on the Company's stock-based compensation plans, see Note 9 to the consolidated financial statements. 55 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) INCOME TAXES Income tax expense (benefit) is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Deferred tax assets are recognized for net operating losses that expire between 2016 and 2024 because the benefit is more likely than not to be realized. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders' equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on both allocated shares and unearned shares reduce debt and accrued interest. EARNINGS PER SHARE Basic earnings per common share (EPS) is net income divided by the weighted-average number of common shares outstanding during the period. ESOP shares not committed to be released and RRP shares which have not vested are not considered to be outstanding for purposes of calculating EPS. The basic EPS calculation excludes the dilutive effect of all common stock equivalents. Diluted EPS includes the dilutive effect of additional potential common shares issuable under stock options. The Company's potentially dilutive common shares represent shares issuable under its stock option and vested RRP plans. Such common stock equivalents are computed based on the treasury stock method using the average market price for the period. COMPREHENSIVE INCOME Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity. 56 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) PENDING ACCOUNTING PRONOUNCEMENTS SHARED-BASED PAYMENT In December 2004, the FASB issued SFAS 123, Revised, Share-Based Payment,which requires all public companies to record compensation cost for stock options and other awards provided to employees in return for employee service. The cost of the options is measured at the fair value of the options when granted, and this cost is to be expensed over the employee service period, which is normally the vesting period of the options granted. This statement will apply to awards granted or modified after the first quarter or year beginning after June 15, 2005. Compensation cost will also be recorded for prior options granted prior to this date that vest after the date of adoption. The Company plans to adopt this statement as of July 1, 2005. The effect on the Company's results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted for future awards. Existing options that will vest after the Company adopts SFAS 123, Revised, are expected to result in additional compensation expense as indicated in the table below.
ADDITIONAL COMPENSATION COST ---------------------- (DOLLARS IN THOUSANDS) Period ended July 1, 2005 thru December 31, 2005............ $ 261 Years ended December 31, 2006...................................................... 428 2007...................................................... 323 2008...................................................... 197 2009...................................................... 31 ------ $1,240 ======
ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3 (SOP 03-3), Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 requires that a valuation allowance for loans acquired in a transfer, including in a business combination, reflect only losses incurred after acquisition and should not be recorded at acquisition. It applies to any loan acquired in a transfer that showed evidence of credit quality deterioration since it was made. SOP 03-3 became effective for loans or debt securities acquired in fiscal years beginning after December 15, 2004. The effect of this new standard on the Company's financial position and results of operations is not expected to be material upon adoption. LOSS CONTINGENCIES Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements. RESTRICTIONS ON CASH Cash on hand or on deposit with the Federal Reserve Bank of $10.3 million and $9.4 million, respectively was required to be maintained in order to meet regulatory reserve and clearing requirements as of December 31, 2004 and 2003. 57 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) DIVIDEND RESTRICTION Banking regulations require maintaining certain regulatory capital levels at the Bank and also limit the amount of dividends payable by the Bank to the Company. These regulations may affect the amount of cash dividends which the Company may pay to stockholders in future periods. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 14 below. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. 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, and investment services through an outsource partner. Revenues for the significant products and services are disclosed separately in the consolidated statements of income. RECLASSIFICATIONS Some items in the prior year financial statements were reclassified to conform to the current presentation. 2. SECURITIES The amortized cost of securities available-for-sale and their fair values are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) At December 31, 2004: GSE securities........................... $ 96,663 $ 45 $ (793) $ 95,915 Mortgage-backed securities............... 55,602 522 (141) 55,983 Collateralized mortgage obligations...... 48,815 94 (171) 48,738 Trust preferred securities............... 90 -- -- 90 Equity securities........................ 1,701 2 (210) 1,493 -------- ------ ------- -------- $202,871 $ 663 $(1,315) $202,219 ======== ====== ======= ========
58 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) At December 31, 2003: GSE securities and commercial paper...... $132,127 $ 692 $ -- $132,819 Mortgage-backed securities............... 108,468 888 (255) 109,101 Collateralized mortgage obligations...... 75,245 626 (73) 75,798 Trust preferred securities............... 6,148 -- (562) 5,586 Equity securities........................ 2,958 178 (136) 3,000 -------- ------ ------- -------- $324,946 $2,384 $(1,026) $326,304 ======== ====== ======= ========
The following table provides information as to the amount of gross gains and losses realized through the sales of available-for-sale securities:
2004 2003 2002 ------- ----- ----- (DOLLARS IN THOUSANDS) Available-for-sale securities: Gross realized gains..................................... $ 1,544 $ 469 $ 740 Gross realized losses.................................... (825) (1) (441) Impairment losses........................................ (1,018) (120) -- ------- ----- ----- Net realized gains (losses)........................... $ (299) $ 348 $ 299 ======= ===== ===== Income tax expense (benefit) on realized gains (losses).............................................. $ (126) $ 123 $ 87
During 2003, the Company sold $15.3 million of held-to-maturity mortgage-backed securities. Market conditions were deemed optimal for selling these securities and allowed the Company to reinvest the proceeds into structures with anticipated higher total returns. The gross realized gains on the sales of these securities were $1.4 million (net of tax, $874,000). In conjunction with the 2003 sale of the above held-to-maturity securities, the Company reclassified the remaining held-to-maturity portfolio totaling $3.2 million to available-for-sale as a reflection of its intent to hold all investments as available-for-sale. The transfer of these securities to available-for-sale resulted in $61,000 of additional unrealized gains as of December 31, 2003. The amortized cost and fair value of securities at December 31, 2004, by contractual maturity, are shown in the table below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
AVAILABLE-FOR-SALE ---------------------- AMORTIZED FAIR COST VALUE ---------- --------- (DOLLARS IN THOUSANDS) Due in one year or less..................................... $ -- $ -- Due after one year through five years....................... 96,663 95,915 Due after more than ten years............................... 90 90 Mortgage-backed securities.................................. 55,602 55,983 Collateralized mortgage obligations......................... 48,815 48,738 Equity securities........................................... 1,701 1,493 -------- -------- $202,871 $202,219 ======== ========
59 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Securities pledged to secure public deposits as of December 31, 2004 and 2003 had carrying amounts of $1.6 million and $1.7 million, respectively. At year end 2004 and 2003, there were no holdings of securities of any one issuer, other than the U.S. Government, its agencies, and government sponsored entities, in an amount greater than 10% of stockholders' equity. Securities with unrealized losses as of December 31, 2004 and 2003, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are presented in the following tables.
DECEMBER 31, 2004 ------------------------------------------------------------------- LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL --------------------- ------------------- --------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES -------- ---------- ------ ---------- -------- ---------- (DOLLARS IN THOUSANDS) GSE securities.......... $ 81,837 $ (793) $ -- $ -- $ 81,837 $ (793) Mortgage-backed securities............ 21,096 (127) 1,623 (14) 22,719 (141) Collateralized mortgage obligations........... 17,726 (100) 5,005 (71) 22,731 (171) Trust preferred securities............ -- -- -- -- -- -- Equity securities....... -- -- 1,365 (210) 1,365 (210) -------- ------- ------ ----- -------- ------- $120,659 $(1,020) $7,993 $(295) $128,652 $(1,315) ======== ======= ====== ===== ======== =======
DECEMBER 31, 2003 ----------------------------------------------------------------- LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL -------------------- ------------------- -------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES ------- ---------- ------ ---------- ------- ---------- (DOLLARS IN THOUSANDS) Mortgage-backed securities.............. $34,371 $(255) $ -- $ -- $34,371 $ (255) Collateralized mortgage obligations............. 5,063 (73) -- -- 5,063 (73) Trust preferred securities.............. -- -- 5,884 (562) 5,884 (562) Equity securities......... 49 (1) 1,354 (135) 1,403 (136) ------- ----- ------ ----- ------- ------- $39,483 $(329) $7,238 $(697) $46,721 $(1,026) ======= ===== ====== ===== ======= =======
The Company evaluates securities for other-than-temporary (OTT) impairment on a quarterly basis, and more frequently when economic or market concerns warrant additional evaluations. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. If management determines that an investment experienced an OTT decline in value, the loss is recognized in the income statement. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income in stockholders' equity) and not recognized in income until the security is ultimately sold. During 2004, management identified one trust preferred security with an OTT impairment of $1.0 million. 60 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Management does not believe any remaining individual unrealized loss as of December 31, 2004 represents an OTT impairment. The unrealized losses reported for agency securities, mortgage-backed securities and collateralized mortgage obligations are, in their entirety, on securities issued by the federal government, its agencies or government sponsored entities (GSEs), including the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Government National Mortgage Association (GNMA), and in management's belief, are attributable to changes in interest rates and the resultant change in the shape of the yield curve. The unrealized losses associated with the equity relates to one issuance. Management believes that the unrealized loss is specifically related to the changes in the interest rates and resultant change in the shape of the yield curve. 3. LOANS RECEIVABLE Loans receivable, net of unearned fees, consist of the following:
DECEMBER 31, ----------------------- 2004 2003 ---------- ---------- (DOLLARS IN THOUSANDS) Commercial and construction loans: Commercial real estate.................................... $396,420 $429,883 Construction and land development......................... 145,162 125,636 Commercial and industrial................................. 58,682 36,222 -------- -------- Total commercial and construction loans................ 600,264 591,741 Retail loans: Single-family residential................................. 277,501 316,774 Home equity loans and lines of credit..................... 102,981 71,360 Other..................................................... 7,339 2,704 -------- -------- Total retail loans..................................... 387,821 390,838 -------- -------- Total loans receivable, net of unearned fees.............. $988,085 $982,579 ======== ========
The Bank's lending activities have been concentrated primarily within its market area as well as the Midwestern United States. At December 31, 2004 and 2003, the Company had $3.4 million and $3.4 million of loans held for sale. At December 31, 2004 and 2003, the Company serviced $14.3 million and $10.8 million, respectively, of loans for others. Activity in the allowance for losses on loans is summarized as follows:
YEAR ENDED DECEMBER 31, --------------------------- 2004 2003 2002 ------- ------- ------- (DOLLARS IN THOUSANDS) Balance at beginning of year............................ $10,453 $ 8,721 $ 7,662 Provision for losses on loans........................... 8,885 2,326 1,956 Charge-offs............................................. (6,229) (760) (1,183) Recoveries.............................................. 244 166 286 ------- ------- ------- Balance at end of year.................................. $13,353 $10,453 $ 8,721 ======= ======= =======
61 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Impaired loans were as follows:
DECEMBER 31, ---------------------- 2004 2003 ---------- --------- (DOLLARS IN THOUSANDS) Impaired loans: With a valuation reserve.................................. $25,120 $4,306 With no valuation reserve required........................ -- 387 ------- ------ Total impaired loans........................................ $25,120 $4,693 ======= ====== Valuation reserve relating to impaired loans................ $ 6,366 $ 798 Average impaired loans during year.......................... 37,669 4,745 Interest income recognized during impairment................ 226 -- Cash-basis interest income recognized....................... 79 3
Total nonperforming loans as of December 31, 2004 and 2003 were $27.7 million and $22.7 million, respectively. There were no loans past due greater than 90 days still on accrual as of December 31, 2004 and 2003. Of the total impaired loans as of December 31, 2004 and 2003, $16.1 million and $4.7 million, respectively, were on nonaccrual. 4. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment are summarized as follows:
DECEMBER 31, ESTIMATED ----------------------- USEFUL LIVES 2004 2003 ------------ ---------- ---------- (DOLLARS IN THOUSANDS) Land........................................... $ 3,288 $ 2,202 Buildings...................................... 30-40 years 16,232 15,315 Leasehold improvements......................... Over term of lease 1,472 1,511 Furniture and equipment........................ 3-15 years 12,038 12,421 Construction in progress....................... 98 196 ------- ------- 33,128 31,645 Less: accumulated depreciation and amortization................................. 17,617 17,907 ------- ------- $15,511 $13,738 ======= =======
Depreciation expense charged to operations in 2004, 2003 and 2002, approximated $1.5 million, $1.5 million and $1.8 million, respectively. 62 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) OPERATING LEASES At December 31, 2004, the Company and its subsidiaries were obligated under certain noncancelable operating leases for premises and equipment, which expire at various dates throughout the year 2008. 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, 2004, have initial or remaining noncancelable lease terms in excess of one year.
(DOLLARS IN THOUSANDS) Year Ended December 31: 2005...................................................... $ 589 2006...................................................... 509 2007...................................................... 233 2008...................................................... 127 ------ $1,458 ======
Rental expense charged to operations in 2004, 2003 and 2002, amounted to approximately $675,000, $405,000 and $605,000, respectively, including amounts paid under short-term cancelable leases. 5. GOODWILL AND INTANGIBLE ASSETS As of December 31, 2004 and 2003, the Company had $1.2 million of goodwill which was acquired through the Company's 2003 acquisition of a bank branch in Illinois. The goodwill was not impaired during either 2004 or 2003. The Company also acquired core deposit intangibles in conjunction with the same bank branch acquisition. The intangible assets acquired amounted to $325,000 in cost. For the years ended December 31, 2004 and 2003, the amortization expense related to these intangibles was $65,000 and $16,000, respectively. Estimated amortization expense for each of the next four years is as follows:
(DOLLARS IN THOUSANDS) Year Ended December 31: 2005...................................................... $ 65 2006...................................................... 65 2007...................................................... 65 2008...................................................... 49 ---- $244 ====
63 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. DEPOSITS Deposits and interest rate data are summarized as follows:
DECEMBER 31, ----------------------- 2004 2003 ---------- ---------- (DOLLARS IN THOUSANDS) Checking accounts: Non-interest bearing...................................... $ 51,713 $ 40,017 Interest-bearing.......................................... 94,878 91,385 Money market accounts....................................... 147,211 123,799 Savings accounts............................................ 196,358 204,312 -------- -------- Core deposits............................................. 490,160 459,513 Certificate of deposit accounts: One year or less.......................................... 264,301 414,341 Over one to two years..................................... 68,168 58,971 Over two to three years................................... 19,761 23,260 Over three to four years.................................. 12,501 15,422 Over four to five years................................... 6,648 5,348 More than five years...................................... 1,639 1,585 -------- -------- Total time deposits....................................... 373,018 518,927 -------- -------- Total deposits......................................... $863,178 $978,440 ======== ======== Weighted-average cost of deposits........................... 1.52% 1.69%
The aggregate amount of deposits in denominations of greater than $100,000 was $228.1 million and $232.6 million at December 31, 2004 and 2003, respectively. Deposits in excess of $100,000 generally are not federally insured. 64 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. BORROWED MONEY Borrowed money consists of the following:
DECEMBER 31, ----------------------------------------- 2004 2003 ------------------- ------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE RATE AMOUNT RATE AMOUNT -------- -------- -------- -------- (DOLLARS IN THOUSANDS) Secured advances from FHLB -- Indianapolis: Maturing in 2005 -- variable-rate.......... 1.95% $ 34,000 --% $ -- Maturing in 2005 -- fixed-rate............. 3.00 10,000 -- -- Maturing in 2006 -- fixed rate............. 3.41 87,000 -- -- Maturing in 2007 -- fixed rate............. 3.65 87,000 -- -- Maturing in 2008 -- fixed rate............. 3.89 72,000 -- -- Maturing in 2009 -- fixed rate............. 4.09 15,000 -- -- Maturing in 2010 -- fixed-rate............. -- -- 5.92 400,000 Maturing in 2014 -- fixed-rate(1).......... 6.71 1,227 6.71 1,244 Maturing in 2018 -- fixed-rate(1).......... 5.54 2,865 5.54 2,911 Maturing in 2019 -- fixed-rate(1).......... 6.31 7,691 6.32 7,835 Secured advances from FHLB -- Chicago: Maturing in 2008 -- fixed-rate............. -- -- 5.26 6,500 -------- -------- 316,783 418,490 Less: deferred premium on early extinguishment of debt..................... (30,172) -- -------- -------- $286,611 $418,490 ======== ======== Weighted-average interest rate............... 3.55% 5.92%
- --------------- (1) These advances are amortizing borrowings and are listed by their contractual maturity. During the third quarter of 2004, the Company repaid $6.5 million of advances maturing in 2008 which bore a 5.26% fixed interest rate and recognized a $485,000 charge to other non-interest expense. During the fourth quarter of 2004, the Company repaid $400.0 million of callable fixed-rate advances with an average cost of 5.92% and an average remaining term of 64.2 months. These prepaid advances were replaced with $325.0 million of new non-callable FHLB advances. These new advances included an aggregate $271.0 million of non-callable fixed-rate FHLB advances with an average cost of 3.64% and an average term of 34.3 months in a laddered portfolio with maturities ranging from 21 to 60 months. The new borrowings also included $54.0 million of short-term variable-rate borrowings, of which, $20.0 million was repaid on December 31, 2004. The Company paid $42.0 million of prepayment penalties related to the prepaid advances and recognized $9.8 million on the early extinguishment of debt as a charge to non-interest expense during the fourth quarter of 2004. The remaining $32.2 million of prepayment penalties are deferred as an adjustment to the carrying value of the borrowings and will be recognized in interest expense as an adjustment to the cost of the new borrowings over their remaining life. The increase in interest expense related to the remaining prepayment penalties is expected to be $14.4 million, $9.6 million, $4.5 million, $1.5 million and $200,000 in the years ended December 31, 2005, 2006, 2007, 2008 and 2009, respectively. 65 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Required principal payments are as follows:
(DOLLARS IN THOUSANDS) Year Ended December 31: 2005...................................................... $ 44,221 2006...................................................... 87,237 2007...................................................... 87,254 2008...................................................... 72,271 2009...................................................... 15,290 Thereafter................................................ 10,510 -------- $316,783 ========
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 - ------------------------- ---------------------- (DOLLARS IN THOUSANDS) FHLB-IN stock............................................... $ 27,665 Loans secured by residential first mortgage loans........... 255,006 Loans secured by commercial first mortgage loans............ 263,961 GSE securities.............................................. 15,426 Mortgage-backed securities and collateralized mortgage obligations............................................... 86,261 -------- $648,319 ========
As of December 31, 2004, the Company had two lines of credit with a maximum of $25.0 million and $15.0 million, respectively, in unsecured overnight federal funds. During 2004, these lines were used for liquidity purposes. As of December 31, 2004, these lines had a zero balance. The maximum amount borrowed during the year ended December 31, 2004 was $15.0 million and the weighted-average rate paid was 1.93%. Interest expense on borrowed money totaled $26.1 million, $26.4 million and $27.4 million for the years ended December 31, 2004, 2003 and 2002, respectively. 8. 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, 2004, 2003 and 2002 was $200,000, $1.6 million and $889,000, respectively. Asset and plan benefit information is not available for participating associations on an individual basis. Benefits were frozen under the defined benefit pension plan effective March 1, 2003. Although no further benefits will accrue while the freeze remains in place, the freeze does not reduce the benefits accrued to date. Even though the benefits are frozen, the Company will review the funding level and will continue to make necessary contributions to keep the plan adequately funded. 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 allows for employee contributions up to 12% of their compensation, which are matched equal to 50% of the first 6% of the compensation contributed. Plan 66 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) expense for the years ended December 31, 2004, 2003 and 2002 was $239,000, $230,000 and $252,000, respectively. Effective January 1, 2005, the Company's match under this plan will no longer be distributed as an addition to the employees' contributions. In accordance with the amended plan documents, the match will be paid out on an annual basis as shares distributed through the Company's Employee Stock Ownership Plan. Any distribution through the ESOP will be made under the original specified percentage of employee contributions and will constitute future expense under the ESOP plan. 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. This plan was frozen in 2003 along with the Company's pension plan. There was no expense related to this plan in 2004. Expenses related to this plan for the years ended December 31, 2003 and 2002, were $29,000 and $87,000, respectively. Effective January 1, 2005, the Company approved the Directors' Deferred Compensation Plan (DDCP) for compensation paid to non-executive directors of the Company and its affiliates. Under the plan, a director who elects to participate in the DDCP may elect to defer all or any part of the compensation earned by the director for services as a director until a designated time, the director's death or cessation of service as a director. The DDCP also allows the directors to receive common stock of the Company in lieu of the cash compensation that would otherwise be payable to them. The Company will accrue a liability for any obligation under these plans beginning in 2005. There has been no expense incurred for the deferred directors' fees prior to this plan taking effect. 9. STOCK-BASED BENEFIT PLANS In 1998, the Company established an Employee Stock Ownership Plan (ESOP) for the employees of the Company and the Bank. The ESOP is a qualified 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 $14.3 million 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 was $1.7 million for each of the three years ended December 31, 2004, 2003 and 2002. ESOP shares not committed to be released are not considered outstanding for purposes of computing EPS. The Bank made contributions to the ESOP plan in order to pay down the loan outstanding totaling $1.3 million for each of the three years ended December 31, 2004, 2003 and 2002. Effective January 1, 2005, the ESOP plan was amended to allow for the distribution of the Company's 401(k) match to be made by distributing shares from the ESOP to the employees. This distribution will be made on an annual basis in conjunction with the annual allocations of the ESOP. The following table summarizes shares of Company common stock held by the ESOP:
DECEMBER 31, ----------------------- 2004 2003 ---------- ---------- (DOLLARS IN THOUSANDS) Shares allocated to participants............................ 652,576 579,837 Unallocated and unearned shares............................. 595,947 715,680 ---------- ---------- 1,248,523 1,295,517 ========== ========== Fair value of unearned ESOP shares.......................... $ 8,504 $ 10,592
67 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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, 2004, 2003 and 2002, were $47,000, $72,000 and $86,000, 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 $7.5 million 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. On April 1, 2003, the Compensation Committee also granted 21,000 shares to five participants. On April 1, 2004, the remaining 1,050 shares were granted to two participants. The following table summarizes shares of Company's common stock within the RRP at December 31, 2004:
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 granted in 2003...................................... (21,000) Shares forfeited in 2003.................................... 800 Shares granted in 2004...................................... (1,050) -------- Shares available for grant December 31, 2004................ -- ========
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 from the date of grant 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. Compensation expense under this plan for the years ended December 31, 2004, 2003 and 2002 was $1.4 million, $1.3 million and $1.5 million, respectively. The Company has stock option plans under which shares of Company common stock are reserved for the grant of both incentive and non-qualified stock options to directors, officers, and employees. The dates the options are first exercisable and expire are determined by the Compensation Committee. The exercise price of the options is equal to the fair market value of the common stock on the grant date. 68 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following is a combined analysis of the stock option activity for each of the three years ended December 31, 2004, 2003 and 2002.
NUMBER OF EXERCISE PRICE SHARES PER SHARE -------------- -------------- (IN THOUSANDS) Outstanding at January 1, 2002......................... 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 Granted................................................ 280 13.99 - 14.76 Exercised.............................................. (185) 4.21 - 14.00 Forfeited.............................................. (79) 8.19 - 14.25 ----- -------------- Outstanding at December 31, 2003....................... 1,814 4.78 - 14.76 Granted................................................ 223 14.64 - 14.64 Exercised.............................................. (246) 4.78 - 13.09 Forfeited.............................................. (26) 8.44 - 14.64 ----- -------------- Outstanding at December 31, 2004....................... 1,765 $4.78 - $14.76 ===== ==============
At December 31, 2004, there were 230,845 shares available for future grants. The weighted average exercise price of stock options exercised during 2004 was $9.49. The weighted average exercise price of options forfeited during 2004 was $14.13. The fair value of stock options granted during 2004 was $3.27 per share. Assumptions for fair value of option grants are included in Note 1. Options outstanding at December 31, 2004 were as follows:
AS OF DECEMBER 31, 2004 -------------------------------------------------------------- OUTSTANDING EXERCISABLE --------------------------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE REMAINING EXERCISE EXERCISE RANGE OF EXERCISE PRICES: NUMBER CONTRACTUAL LIFE PRICE NUMBER PRICE ------------------------- --------- ---------------- -------- --------- -------- $ 4.78 - $ 7.00.............. 54,073 1.1 $ 5.54 54,073 $ 5.54 $ 7.01 - $10.00.............. 828,080 4.4 9.78 810,820 9.81 $10.01 - $13.00.............. 221,800 6.3 11.16 158,640 11.16 $13.01 - $14.76.............. 660,706 8.3 14.17 186,976 13.90 --------- --------- Outstanding.................. 1,764,659 1,210,509 ========= =========
69 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 10. INCOME TAXES The income tax provision consists of the following:
YEAR ENDED DECEMBER 31, -------------------------- 2004 2003 2002 ------- ------ ------- (DOLLARS IN THOUSANDS) Current tax expense (benefit): Federal................................................ $(6,066) $1,046 $ 4,236 State.................................................. -- 158 317 Deferred tax expense (benefit): Federal................................................ 114 (433) (1,423) State.................................................. (1,252) (170) (159) ------- ------ ------- $(7,204) $ 601 $ 2,971 ======= ====== =======
A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:
YEAR ENDED DECEMBER 31, ----------------------- 2004 2003 2002 ------ ------ ----- Statutory rate.............................................. (35.0)% 35.0% 35.0% State taxes................................................. (5.9) (0.3) 1.8 Bank-owned life insurance................................... (3.7) (12.2) (5.2) Other....................................................... (7.7) (8.0) (2.4) ----- ----- ---- Effective rate.............................................. (52.3)% 14.5% 29.2% ===== ===== ====
70 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Significant components of deferred tax assets and liabilities are as follows:
DECEMBER 31, ---------------- 2004 2003 ------- ------ (DOLLARS IN THOUSANDS) Deferred tax assets: Allowance for losses on loans............................. $ 5,204 $4,112 Deferred compensation..................................... 560 895 Deferred loan fees........................................ 1,291 1,238 Operating loss/tax credit carry forward................... 12,278 -- Other..................................................... 395 -- ------- ------ 19,728 6,245 Deferred tax liabilities: Depreciation.............................................. 144 98 Unamortized premium on early extinguishment of debt....... 11,715 -- FHLB stock dividends...................................... 1,146 689 Other..................................................... 601 474 ------- ------ 13,606 1,261 ------- ------ Net deferred tax asset...................................... 6,122 4,984 Tax effect of adjustment related to unrealized (appreciation) depreciation on available-for-sale securities................................................ 218 (450) ------- ------ Net deferred tax assets including adjustments............... $ 6,340 $4,534 ======= ======
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 earnings at December 31, 2004 include approximately $12.5 million, for which no provision for income taxes has been made. If in the future this portion of retained earnings 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 $4.9 million. At December 31, 2004, the Company had federal and state net operating losses of $28.5 million and $34.4 million, respectively, which are being carried forward to reduce future taxable income. The carryforwards expire between 2016 and 2024. 11. RELATED PARTY DISCLOSURES The Company has no material related party transactions which would require disclosure. In compliance with applicable banking regulations, the Company may extend credit to certain officers and directors of the Company and its subsidiaries in the ordinary course of business under substantially the same terms as comparable third-party lending arrangements. 12. 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 71 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Bank. Future payment of dividends by the Bank is dependent upon 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 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. As of December 31, 2004, the Bank met all capital adequacy requirements to which it is subject. As of December 31, 2004, the Bank is categorized 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 following table. There are no conditions or events since that notification that management believes have changed the institution's category. At December 31, 2004, the Bank's adjusted total assets were $1.3 billion and its risk-weighted assets were $1.1 billion.
TO BE WELL-CAPITALIZED FOR CAPITAL ADEQUACY UNDER PROMPT CORRECTIVE ACTUAL PURPOSES ACTION PROVISIONS ---------------- -------------------- ------------------------ AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO -------- ----- --------- -------- ----------- ---------- (DOLLARS IN THOUSANDS) As of December 31, 2004: Risk-based............... $131,660 12.23% $86,155 >8.00% $107,694 >10.00% Tangible................. 120,075 9.24 19,485 >1.50 25,980 >2.00 Core..................... 120,075 9.24 51,961 >4.00 64,951 >5.00 As of December 31, 2003: Risk-based............... $141,974 13.04% $87,083 >8.00% $108,854 >10.00% Tangible................. 131,521 8.46 23,307 >1.50 31,076 >2.00 Core..................... 131,521 8.46 62,152 >4.00 77,690 >5.00
72 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 13. COMMITMENTS
DECEMBER 31, ----------------------- 2004 2003 ---------- ---------- (DOLLARS IN THOUSANDS) TYPE OF COMMITMENT To originate retail loans: Fixed rates ( 3.90% - 10.25% in 2004 and 6.50% in 2003)... $ 5,761 $ 1,104 Variable rates............................................ 3,250 28,334 To originate commercial real estate loans: Fixed rates (6.00% in 2004 and 5.75% - 7.25% in 2003)..... 1,575 6,834 Variable rates............................................ 9,193 3,401 To originate commercial and industrial loans: Fixed rates (6.75% - 7.25%)............................... 255 -- Variable rates............................................ 455 1,139 To purchase loans on commercial real estate: Fixed rates (6.25% - 7.00%)............................... 3,500 -- Variable rates............................................ 1,500 -- Unused lines of credit and construction loans............... 187,517 139,913 Letters of credit: Secured by cash........................................... 270 965 Real estate............................................... 8,851 5,594 Business assets........................................... 365 -- Unsecured................................................. 9 -- Other -- Credit enhancements.............................. 48,639 44,149
The above listed commitments do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. All commitments to extend credit or to purchase loans expire within the following year. Letters of credit expire at various times through 2014. Letters of credit include credit enhancements which are 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 letters of credit and credit enhancements provided by the Company are considered financial guarantees under FASB Interpretation 45 Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others and are carried in the aggregate at a fair value of $564,000 as of December 31, 2004. 14. 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 73 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. No fair value disclosure is required with respect to certain financial instruments and all nonfinancial instruments. 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, ------------------------------------------------- 2004 2003 ----------------------- ----------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) FINANCIAL ASSETS Cash and cash equivalents............ $ 38,094 $ 38,094 $ 177,751 $ 177,751 Securities, available-for-sale....... 202,219 202,219 326,304 326,304 Federal Home Loan Bank stock......... 27,665 27,665 26,766 26,766 Loans receivable, net of allowance for losses on loans................ 974,732 984,445 972,126 1,004,592 Accrued interest receivable.......... 5,456 5,456 6,624 6,624 ---------- ---------- ---------- ---------- Total financial assets............... $1,248,166 $1,257,879 $1,509,571 $1,542,037 ========== ========== ========== ========== FINANCIAL LIABILITIES Deposits............................. $ 863,178 $ 863,562 $ 978,440 $ 986,052 Borrowed money....................... 286,611 317,391 418,490 474,930 Accrued interest payable............. 678 678 1,570 1,570 ---------- ---------- ---------- ---------- Total financial liabilities.......... $1,150,467 $1,181,631 $1,398,500 $1,462,552 ========== ========== ========== ==========
The carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, and accrued interest receivable and payable. Securities fair values are based on quotes received from a third-party pricing source. 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. The fair value of checking, savings, and money market accounts 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. The fair value of borrowed money is estimated based on rates currently available to the Company for debt with similar terms and remaining maturities. The fair value of the Company's off-balance sheet instruments is nominal. 74 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 15. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
YEAR ENDED DECEMBER 31, --------------------------------------------- 2004 2003 2002 ------------- ------------- ------------- (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) Net income (loss)............................. $ (6,577) $ 3,538 $ 7,205 =========== =========== =========== Weighted average common shares outstanding.... 11,599,996 11,289,254 12,000,589 Common share equivalents(1)................... 297,498 413,381 491,560 ----------- ----------- ----------- Weighted average common shares and common share equivalents outstanding............... 11,897,494 11,702,635 12,492,149 =========== =========== =========== Basic earnings (loss) per share............... $ (0.57) $ 0.31 $ 0.60 Diluted earnings (loss) per share............. (0.57) 0.30 0.58
- --------------- (1) Assumes exercise of dilutive stock options and also a portion of the unearned awards under the RRP. 16. OTHER COMPREHENSIVE INCOME The related income tax effect and reclassification adjustments to the components of other comprehensive income for the periods indicated are as follows:
YEAR ENDED DECEMBER 31, --------------------------- 2004 2003 2002 ------- ------- ------- (DOLLARS IN THOUSANDS) Unrealized holding gains (losses) arising during the period: Unrealized net gains (losses)......................... $(2,309) $ 3,371 $(3,838) Related tax (expense) benefit......................... 806 (1,241) 1,230 ------- ------- ------- Net................................................... (1,503) 2,130 (2,608) Less: reclassification adjustment for net gains realized during the period: Realized net gains (losses)........................... (299) 1,780 299 Related tax (expense) benefit......................... 126 (681) (65) ------- ------- ------- Net................................................... (173) 1,099 234 ------- ------- ------- Total other comprehensive income (loss)................. $(1,330) $ 1,031 $(2,842) ======= ======= =======
17. 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. 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 75 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. Even excluding supervisory goodwill, however, the Bank exceeded the capital requirements of FIRREA at such date. As of January 1, 1994, the Bank adopted FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions. Upon the adoption of this change in accounting principle, the Bank wrote down the remaining balance of the goodwill. 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 was filed 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 damages case went to trial in June 2004 and concluded in early July 2004. The Bank sought damages of more than $20.0 million based on the report and testimony of its expert witness. The Government's position was that the Bank suffered no compensable damage as a result of the breach. On March 7, 2005, the Court of Claims' judge entered judgment in favor of the Government holding that the Bank was not entitled to recover any damages. The Court of Claims also ruled that the Government is entitled to recover certain costs from the Bank with respect to one claim that the Bank had voluntarily dismissed during the proceeding. At this time, the Company has no information regarding the amount of costs that the Government may seek to recover from the Bank. Management of the Company is currently reviewing its options and has 60 days from the date of the trial court's decision in which to file an appeal. The Bank's cost, including attorneys' fees, experts' fees, and related expenses of the litigation was approximately $1.4 million, $183,000 and $258,000 in 2004, 2003 and 2002, respectively. 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. 76 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 18. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS The tables on the following pages represent the condensed statement of financial condition as of December 31, 2004 and 2003 and condensed statement of income and cash flows for the three years ended December 31, 2004 for CFS Bancorp, Inc., the parent company. CONDENSED STATEMENTS OF CONDITION (PARENT COMPANY ONLY)
DECEMBER 31, ----------------------- 2004 2003 ---------- ---------- (DOLLARS IN THOUSANDS) ASSETS Cash on hand and in banks................................... $ 11,926 $ 2,594 Securities available-for-sale............................... 337 7,374 Investment in subsidiary.................................... 126,943 134,269 Mortgage loans.............................................. -- 2,421 Loan receivable from ESOP................................... 7,429 8,580 Accrued interest receivable................................. -- 33 Prepaid expenses and other assets........................... 2,864 2,235 -------- -------- Total assets................................................ $149,499 $157,506 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accrued taxes and other liabilities....................... $ 1,588 $ 1,553 Total stockholders' equity.................................. 147,911 155,953 -------- -------- Total liabilities and stockholders' equity.................. $149,499 $157,506 ======== ========
CONDENSED STATEMENTS OF INCOME (PARENT COMPANY ONLY)
YEAR ENDED DECEMBER 31, --------------------------- 2004 2003 2002 ------- ------- ------- (DOLLARS IN THOUSANDS) Dividends from subsidiary................................... $ 2,941 $ 4,844 $12,500 Interest income............................................. 1,019 1,402 1,882 Net gain (loss) on sale of investments...................... (1,038) (11) 299 Non-interest expense........................................ (1,276) (1,202) (1,190) ------- ------- ------- Net income before income taxes and equity in earnings (loss) of subsidiary............................................. 1,646 5,033 13,491 Income tax benefit (expense)................................ 528 (15) (288) ------- ------- ------- Net income before equity in undistributed earnings (loss) of subsidiary................................................ 2,174 5,018 13,203 Equity in undistributed earnings (loss) of subsidiary....... (8,751) (1,480) (5,998) ------- ------- ------- Net income (loss)........................................... $(6,577) $ 3,538 $ 7,205 ======= ======= =======
77 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)
YEAR ENDED DECEMBER 31, ----------------------------- 2004 2003 2002 ------- -------- -------- (DOLLARS IN THOUSANDS) Operating activities: Net income (loss)......................................... $(6,577) $ 3,538 $ 7,205 Adjustments to reconcile net income (loss) to net cash used by operating activities: Net accretion of premiums/discounts.................. (3) (3) (710) Impairment of securities............................. 1,018 120 -- Equity in undistributed earnings (loss) of the Bank.............................................. 8,751 1,480 5,998 Net loss (gain) on sale of available-for-sale investment securities............................. 20 (109) (299) Decrease in interest receivable...................... 32 15 71 (Increase) decrease in prepaid expenses and other assets............................................ (631) (58) (1,196) Increase (decrease) in other liabilities............. 106 (1,832) 2,221 ------- -------- -------- Net cash provided by operating activities................... 2,716 3,151 13,290 Investing activities: Securities: Purchases.............................................. -- (500) (45) Proceeds from paydowns and sales....................... 6,415 416 13,202 Net loan originations and principal payment on loans...... 3,572 254 (624) ------- -------- -------- Net cash provided by investing activities................... 9,987 170 12,533 Financing activities: Purchase of treasury stock................................ (869) (9,273) (14,626) Proceeds from exercise of stock options................... 2,345 1,732 858 Dividends paid on common stock............................ (4,847) (4,713) (4,642) ------- -------- -------- Net cash used by financing activities....................... (3,371) (12,254) (18,410) ------- -------- -------- (Decrease) increase in cash and cash equivalents............ 9,332 (8,933) 7,413 Cash and cash equivalents at beginning of year.............. 2,594 11,527 4,114 ------- -------- -------- Cash and cash equivalents at end of year.................... $11,926 $ 2,594 $ 11,527 ======= ======== ========
78 CFS BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 19. QUARTERLY FINANCIAL DATA (UNAUDITED)
EARNINGS (LOSS) PER SHARE INTEREST NET INTEREST NET INCOME ---------------- INCOME INCOME (LOSS) BASIC DILUTED -------- ------------ ---------- ------ ------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 First quarter..................... $17,462 $7,363 $ 1,244 $ 0.11 $ 0.11 Second quarter.................... 16,832 7,384 (357) (0.03) (0.03) Third quarter..................... 17,591 8,433 (2,781) (0.24) (0.24) Fourth quarter.................... 17,101 6,906 (4,683) (0.40) (0.40) 2003 First quarter..................... $18,630 $6,805 $ 654 $ 0.06 $ 0.06 Second quarter.................... 17,711 6,500 698 0.06 0.06 Third quarter..................... 17,004 6,671 967 0.09 0.08 Fourth quarter.................... 18,044 7,735 1,219 0.11 0.10
During the third quarter of 2004, the Company's provision for losses on loans was $6.2 million as compared to $500,000 for the third quarter of 2003. This increase was a direct result of increased impairment allocations for eight impaired loans. In addition, the Company's financial results were adversely impacted by the following: - additional compensation expense of $1.0 million incurred as a result of a resignation of a senior executive officer; - an additional $585,000 OTT impairment in the cost basis of a trust preferred security; - the write-down of $421,000 in viatical receivables held by the Bank that were determined to be impaired; - additional legal expenses of $381,000 related to the Company's goodwill litigation; and - an increase in loan collection expenses of $231,000 compared to the third quarter of 2003. The Company's results during the fourth quarter of 2004 were negatively impacted by a $9.8 million charge to non-interest expense related to the early extinguishment of debt that was incurred in conjunction with the Bank's restructuring of its high fixed-rate FHLB debt. In addition, the Company also amortized through interest expense $2.1 million of the deferred premium on the early extinguishment of debts during the fourth quarter of 2004. 79 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Management evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the effectiveness of its disclosure controls and procedures (as defined in Rules 13a - 15(e) or 15(d) - 15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and regulations and are operating in an effective manner. Under the terms and provisions of the Securities Exchange Commission's Exemptive Order dated November 30, 2004, the Company will file its Management's Annual Report on Internal Control Over Financial Reporting as required by Item 308(a) of Regulation S-K and the related Attestation Report of the Registered Public Accounting Firm as required by Item 308(b) of Regulation S-K within the required 45 day period after March 16, 2005 as an amendment to this Form 10-K. ITEM 9B. OTHER INFORMATION Not applicable. 80 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required herein is incorporated by reference from the section of the Registrant's Proxy Statement which is expected to be filed on or about March 25, 2005 (Proxy Statement) titled Information With Respect to Nominees for Director, Continuing Directors and Executive Officers. Information related to the Company's Code of Conduct and Ethics is incorporated by reference from the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION. The information required herein is incorporated by reference from the section of the Registrant's Proxy Statement titled Executive Compensation. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information required herein by Item 403 of Regulation S-K is incorporated by reference from the section of the Registrant's Proxy Statement titled Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management. 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, 2004.
NUMBER OF SHARES NUMBER OF SHARES TO BE REMAINING AVAILABLE ISSUED UPON THE FOR FUTURE ISSUANCE EXERCISE OF OUTSTANDING WEIGHTED-AVERAGE (EXCLUDING SHARES OPTIONS, WARRANTS AND EXERCISE PRICE OF REFLECTED IN THE PLAN CATEGORY RIGHTS OUTSTANDING OPTIONS FIRST COLUMN) - ------------- ------------------------ ------------------- ------------------- Equity Compensation Plans Approved by Security Holders..................... 1,778,784 $11.26 230,845 Equity Compensation Plans Not Approved by Security Holders..................... -- -- -- Total....................... 1,778,784 $11.26 230,845
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required herein is incorporated by reference from the section of the Registrant's Proxy Statement titled Transactions with Certain Related Persons. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required herein is incorporated by reference from the section of the Registrant's Proxy Statement titled Auditor Fees and Expenses. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Document filed as part of this Report. (1) 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. 81 (2)(a) The following exhibits are filed with the SEC as part of this Form 10-K, and this list includes the Exhibit Index. 3.1 Certificate of Incorporation of CFS Bancorp, Inc.(1) 3.2 Bylaws of CFS Bancorp, Inc.(1) 4.0 Form of Stock Certificate of CFS Bancorp, Inc.(1) 10.1 Employment Agreement entered into between Citizens Financial Services, FSB and Thomas F. Prisby(2) 10.2 Employment Agreement entered into between Citizens Financial Services, FSB and James W. Prisby(2) 10.3 Employment Agreement entered into between CFS Bancorp, Inc. and Thomas F. Prisby(2) 10.4 Employment Agreement entered into between CFS Bancorp, Inc. and James W. Prisby(2) 10.5 CFS Bancorp, Inc. Amended and Restated 1998 Stock Option Plan(3) 10.6 CFS Bancorp, Inc. Amended and Restated 1998 Recognition and Retention Plan and Trust Agreement(3) 10.7 CFS Bancorp, Inc. 2003 Stock Option Plan(4) 10.8 Employment Agreement entered into between Citizens Financial Services, FSB and Charles V. Cole(5) 10.9 Employment Agreement entered into between Citizens Financial Services, FSB and Thomas L. Darovic(5) 10.10 Employment Agreement entered into between CFS Bancorp, Inc. and Charles V. Cole(5) 10.11 Employment Agreement entered into between CFS Bancorp, Inc. and Thomas L. Darovic(5) 10.12 Separation Agreement entered into between Citizens Financial Services, FSB, CFS Bancorp and James W. Prisby(6) 10.13 Employment Agreement entered into between Citizens Financial Services, FSB and Zoran Koricanac 10.14 Employment Agreement entered into between CFS Bancorp, Inc. and Zoran Koricanac 10.15 Amended and Restated Supplemental ESOP Benefit Plan of CFS Bancorp, Inc. and Citizens Financial Services, FSB 10.16 CFS Bancorp, Inc. Directors' Deferred Compensation Plan 23.0 Consent of Ernst & Young LLP 23.1 Consent of Crowe Chizek and Company LLC 31.1 Rule 13a-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a) Certification of Chief Financial Officer 32.0 Section 1350 Certifications
- --------------- (1) Incorporated by Reference from the Company's Registration Statement on Form S-1 filed on March 26, 1998, as amended and declared effective on May 14, 1998. (2) Incorporated by Reference from the Company's report on Form 10-Q for the quarterly period ended June 30, 2003. (3) Incorporated by Reference from the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders filed on March 23, 2001. (4) Incorporated by Reference from the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders filed on March 31, 2003. (5) Incorporated by Reference from the Company's annual report on Form 10-K for the year ended December 31, 2003. (6) Incorporated by Reference from the Company's report on Form 10-Q for the quarterly period ended September 30, 2004. 82 SIGNATURES In accordance with 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 March 16, 2005 - ------------------------------------------------ Chief Executive Officer Thomas F. Prisby (principal executive officer) /s/ Charles V. Cole Executive Vice President and Chief March 16, 2005 - ------------------------------------------------ Financial Officer (principal Charles V. Cole financial and accounting officer) /s/ Sally A. Abbott Director March 16, 2005 - ------------------------------------------------ Sally A. Abbott /s/ Gregory W. Blaine Director March 16, 2005 - ------------------------------------------------ Gregory W. Blaine /s/ Thomas J. Burns Director March 16, 2005 - ------------------------------------------------ Thomas J. Burns /s/ Gene Diamond Director March 16, 2005 - ------------------------------------------------ Gene Diamond /s/ Frank D. Lester Director March 16, 2005 - ------------------------------------------------ Frank D. Lester /s/ Joyce M. Simon Director March 16, 2005 - ------------------------------------------------ Joyce M. Simon /s/ Robert R. Ross Director March 16, 2005 - ------------------------------------------------ Robert R. Ross /s/ Charles R. Webb Director March 16, 2005 - ------------------------------------------------ Charles R. Webb
83 EX-10.13 2 c92476exv10w13.txt EMPLOYMENT AGREEMENT EXHIBIT 10.13 AGREEMENT AGREEMENT, dated this 3rd day of December 2004, between Citizens Financial Services, FSB (the "Bank"), a federally chartered savings bank, and Zoran Koricanac (the "Executive"). WITNESSETH WHEREAS, the Executive is presently an officer of the Bank; and WHEREAS, the Bank desires to be ensured of the Executive's continued active participation in the business of the Bank; and WHEREAS, the Bank desires to enter into an agreement with the Executive with respect to his employment therewith; and WHEREAS, in order to induce the Executive to remain in the employ of the Bank and in consideration of the Executive's agreeing to remain in the employ of the Bank, the parties desire to specify the severance benefits which shall be due the Executive by the Bank in the event that his employment with the Bank is terminated under specified circumstances; NOW THEREFORE, in consideration of the mutual agreements herein contained, and upon the other terms and conditions hereinafter provided, the parties hereby agree as follows: 1. DEFINITIONS. The following words and terms shall have the meanings set forth below for the purposes of this Agreement: a) Agreement Date. The "Agreement Date" shall be the date first set forth above. b) Base Salary. "Base Salary" shall have the meaning set forth in Section 4(a) hereof. c) Cause. Termination of the Executive's employment for "Cause" shall mean termination because of personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease-and-desist order or material breach of any provision of this Agreement. d)Change in Control. "Change in Control" means the occurrence of any of the following: (i) an event that would be required to be reported in response to Item 501 of Form 8-K or Item 6(e) of Schedule 14A of Regulation 14A pursuant to the 1934 Act, or any successor thereto, whether or not any class of securities of the Company (as defined below) is registered under the 1934 Act; (ii) any "person" is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the 1934 Act), directly or indirectly, of securities of the Company representing 20% or more of the combined voting power of the Company's then outstanding securities except for any securities purchased by the Company or the Bank; or (iii) during any period of thirty-six 2 consecutive months during the term of an Option, individuals who at the beginning of such period constitute the Board of Directors of the Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. i) For purposes of the definition of "Change in Control," a Person or group of Persons does not include the CFS Bancorp, Inc. Employee Stock Ownership Plan Trust which forms a part of the CFS Bancorp, Inc. Employee Stock Ownership Plan (the "ESOP"), or any other employee benefit plan, subsidiary or affiliate of the Company, and the outstanding shares of common stock of the Company, on a fully diluted basis, include all shares owned by the ESOP, whether allocated or unallocated to the accounts of participants, thereunder. ii) For purposes of the definition of "Change in Control," the term "Person" means any natural person, proprietorship, partnership, corporation, limited liability company, organization, firm, business, joint venture, association, trust or other entity and any government agency, body or authority. e) Code. "Code" shall mean the Internal Revenue Code of 1986, as amended. f) Company. "Company" means CFS Bancorp, Inc. a Delaware Corporation, its successors and assigns. g) Definitive Agreement. A "Definitive Agreement" is an agreement entered into by the Company which is intended to result in a Change of Control of the Company and which has been publicly announced on a Form 8-K filed by the Company. h) Date of Termination. "Date of Termination" shall mean (i) if the Executive's employment is terminated for Cause or for Disability, the date specified in the Notice of Termination, and (ii) if the Executive's employment is terminated for any other reason, the date on which a Notice of Termination is given or as specified in such Notice. i) Disability. Termination by the Bank of the Executive's employment based on "Disability" shall mean termination because of any physical or mental impairment which qualifies the Executive for disability benefits under the applicable long-term disability plan maintained by the Bank or the Company or, if no such plan applies, which would qualify the Executive for disability benefits under the Federal Social Security System. j) Good Reason. Termination by the Executive of the Executive's employment for "Good Reason" shall mean termination by the Executive within twenty-four (24) months following a Change in Control of the Company based on: i) Without the Executive's express written consent, the failure to elect or to re-elect or to 3 appoint or to re-appoint the Executive to the office of Senior Vice President of the Bank or a material adverse change made by the Bank in the Executive's functions, duties or responsibilities as Senior Vice President of the Bank; ii) Without the Executive's express written consent, a reduction by either of the Employers in the Executive's Base Salary as the same may be increased from time to time or, except to the extent permitted by Section 4(b) hereof, a reduction in the package of fringe benefits provided to the Executive, taken as a whole; iii) The Executive's office is relocated more than twenty miles from Dyer, Indiana, unless said relocation is approved in advance by the Executive. iv) Any purported termination of the Executive's employment for Disability or Retirement which is not effected pursuant to a Notice of Termination satisfying the requirements of paragraph (l) below; or v) The failure by the Bank to obtain the assumption of and agreement to perform this Agreement by any successor. vi) The notification to the Executive pursuant to Section 2(b) that his term of Employment will not be renewed following a Trigger Event. k) IRS. "IRS" shall mean the Internal Revenue Service. l) Notice of Termination. Any purported termination of the Executive's employment by the Bank for any reason, including without limitation for Cause, Disability or Retirement, or by the Executive for any reason, including without limitation for Good Reason, shall be communicated by written "Notice of Termination" to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a dated notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated, (iii) specifies a Date of Termination, which shall be not less than thirty (30) nor more than ninety (90) days after such Notice of Termination is given, except in the case of the Bank's termination of Executive's employment for Cause, which shall be effective immediately; and (iv) is given in the manner specified in Section 9 hereof. m) Retirement. "Retirement" shall mean voluntary termination by the Executive after the Executive attains the age sixty-five (65). n) Trigger Event. A "Trigger Event" shall be the execution of a Definitive Agreement. 4 2. TERM OF EMPLOYMENT. a) As of the Agreement Date, the Bank will employ the Executive to perform such executive and managerial duties at such times and in such manner as the company may from time to time direct. Unless otherwise provided herein, the Executive acknowledges and agrees that the Executive serves at the will of the Bank, and that this Agreement shall not be construed as a contract for employment for a specific term . b) Following a Trigger Event, the employment term of the Executive shall be a term of one year subject to annual review and extension by the Bank, provided any notice not to renew or extend the term of his employment following a Trigger Event must be provided no less than sixty (60) days prior to the end of the existing term. c) During his employment with the Bank, the Executive shall perform such executive services for the Bank as may be consistent with his titles and from time to time assigned to him by the Bank's Board of Directors. The Executive further agrees to serve without additional compensation as an officer and director of any of the Bank's subsidiaries and agrees that any amounts received from such corporation may be offset against the amounts due hereunder. In addition, it is agreed that the Bank may assign the Executive to one of its subsidiaries for payroll purposes. 3. LOYALTY, CONFIDENTIALITY AND NON-COMPETITION a) The Executive shall devote his full time and best efforts to the performance of his duties while employed with the Bank. During such time, the Executive shall not, at any time or place, either directly or indirectly engage in any business or activity in competition with the business affairs or interests of the Company or be a director, officer or consultant to any bank, savings and loan association, credit union, thrift, savings bank, or similar institution in the Chicago CMSA. b) For purposes of this Agreement, directly or indirectly engaging in any business activity in competition with the business or affairs of the Bank includes, but is not limited to, serving or acting as an owner, partner, agent, beneficiary, or employee of any person, firm or corporate entity so engaged; except that nothing herein contained shall be deemed to prevent or limit the right of employee to invest any of his surplus funds in the capital stock or other securities of any corporation whose stock or securities are publicly owned or are regularly traded on any public exchange, nor shall anything herein contained be deemed to prevent employee from investing or limit employee's right to invest his surplus funds in real estate. c) All information relating to business of the Bank including, but not limited to, that business obtained or serviced by the Bank and all customer listings, contact lists, expiration cards, asset reports, instruments, documents, papers and other material used in connection with such business, shall be the exclusive property of the Bank. The Executive shall keep all such information and material confidential; none of it will be copied, reproduced or duplicated without the express written permission of the Bank, and Executive shall return all material containing 5 such information to the Bank upon its request or upon termination of employment. Executive also agrees that he will not utilize the confidential information or trade secrets of the Bank, either directly or indirectly, for any purposes except performance of his responsibilities and in furtherance of the Bank's business, unless otherwise expressly authorized by the Bank in writing in advance. d) Executive agrees that, during his employment, and for a period of one (1) year following the date of his involuntary termination of employment for Cause, or his voluntary termination without Good Reason, the Executive: i) will not solicit any of the Bank's past or current customers or clients for the benefit of anyone other than Bank or its affiliates; ii) will not divulge the names of any of the Bank's past or then current customers to any other person, corporation or entity; and iii) will not, either directly or indirectly, induce or solicit any person to leave the employ of the Bank. 4. COMPENSATION AND BENEFITS. a) The Bank shall compensate and pay the Executive for his services during the term of this Agreement at a minimum base salary of $139,000 per year ("Base Salary"), which may be increased from time to time in such amounts as may be determined by the Board of Directors of the Bank and may not be decreased without the Executive's express written consent. In addition to his Base Salary, the Executive shall be entitled to receive during the term of this Agreement such bonus payments as may be determined by the Board of Directors of the Employers. b) During his employment with the Bank, the Executive shall be entitled to participate in and receive the benefits of any pension or other retirement benefit plan, profit sharing, stock option, employee stock ownership, or other plans, benefits and privileges given to employees and executives of the Bank, to the extent commensurate with his then duties and responsibilities, as fixed by the Board of Directors. The Bank shall not make any changes in such plans, benefits or privileges which would adversely affect the Executive's rights or benefits thereunder, unless such change occurs pursuant to a program applicable to all executive officers of the Bank and does not result in a proportionately greater adverse change in the rights of or benefits to the Executive as compared with any other executive officer of the Bank. Nothing paid to the Executive under any plan or arrangement presently in effect or made available in the future shall be deemed to be in lieu of the salary payable to the Executive pursuant to Section 4(a) hereof. c) During his employment with the Bank, the Executive shall be entitled to paid annual vacation in accordance with the policies as established from time to time by the Board of Directors. The Executive shall not be entitled to receive any additional compensation from the Employers for failure to take a vacation, nor shall the Executive be able to accumulate unused vacation time from one year to the next, except to the extent authorized by the Board of Directors. 6 d) During the Executive's employment with the Bank, the Bank will provide suitable office space, desk, chairs, filing cabinets, telephones and other usual and customary office furniture, fixtures and equipment adequate for the efficient performance of the duties assigned to the Executive. e) During the Executive's employment with the Bank, the Bank will provide to the Executive, at the Employer's cost, all perquisites which other Senior Vice Presidents of the Company are generally entitled to receive, including the payment of his annual dues at a health club. f) During the term of this Agreement, the Bank will provide to Executive the use of an automobile of the Bank's choice and will replace the automobile with a new one at no less often than once every four years. The Bank will pay all automobile operating expenses incurred by Executive in the performance of an Executive's company duties. The Bank will procure and maintain in force an automobile liability policy for the automobile with coverage, including Executive, in the minimum amount of $1,000,000 combined single limit on bodily injury and property damage. 5. EXPENSES. The Bank shall reimburse the Executive or otherwise provide for or pay for all reasonable expenses incurred by the Executive in furtherance of or in connection with the business of the Bank, including, but not by way of limitation, automobile expenses and other traveling expenses, and all reasonable entertainment expenses (whether incurred at the Executive's residence, while traveling or otherwise), subject to such reasonable documentation and other limitations as may be established by the Board of Directors of the Bank. If such expenses are paid in the first instance by the Executive, the Bank shall reimburse the Executive therefor. 6. TERMINATION. a) The Bank shall have the right, at any time upon prior Notice of Termination, to terminate the Executive's employment hereunder for any reason, including without limitation termination for Cause, Disability or Retirement, and the Executive shall have the right, upon prior Notice of Termination, to terminate his employment hereunder for any reason. b) In the event that (i) the Executive's employment is terminated following the occurrence of a Trigger Event for other than Cause, Disability, Retirement or the Executive's death or (ii) such employment is terminated by the Executive (a) due to a material breach of this Agreement by the Bank, which breach has not been cured within fifteen (15) days after a written notice of non-compliance has been given by the Executive to the Employers, or (b) for Good Reason, then the Bank shall, subject to the provisions of Section 7 hereof, if applicable: 7 A) pay to the Executive, in either twelve (12) equal monthly installments beginning with the first business day of the month following the Date of Termination or in a lump sum within five business days of the Date of Termination (at the Executive's election), a cash severance amount equal to the 100% of the Executive's Base Salary plus cash incentive bonuses earned during the previous year, regardless of when paid, and B) maintain and provide for a period ending at the earlier of (i) the expiration of the remaining term of employment pursuant hereto prior to the Notice of Termination or (ii) the date of the Executive's full-time employment by another employer (provided that the Executive is entitled under the terms of such employment to benefits substantially similar to those described in this subparagraph (B)), at no cost to the Executive, the Executive's continued participation in all group insurance, life insurance, health and accident insurance, disability insurance and other employee benefit plans, programs and arrangements offered by the Bank in which the Executive was entitled to participate immediately prior to the Date of Termination excluding stock plans and bonuses, provided, however, that in the event that the Executive's participation in any plan, program or arrangement as provided in this subparagraph is barred, or during such period any such plan, program or arrangement is discontinued or the benefits thereunder are materially reduced, the Bank shall arrange to provide the Executive with benefits substantially similar to those which the Executive was entitled to receive under such plans, programs and arrangements immediately prior to the Date of Termination. 7. WITHHOLDING. All payments required to be made by the Bank hereunder to the Executive shall be subject to the withholding of such amounts, if any, relating to tax and other payroll deductions as the Bank may reasonably determine should be withheld pursuant to any applicable law or regulation. 8. ASSIGNABILITY. The Bank may assign this Agreement and its rights and obligations hereunder in whole, but not in part, to any corporation, bank or other entity with or into which the Bank may hereafter merge or consolidate or to which the Bank may transfer all or substantially all of its assets, if in any such case said corporation, bank or other entity shall by operation of law or expressly in writing assume all obligations of the Bank hereunder as fully as if it had been originally made a party hereto, but may not otherwise assign this Agreement or its rights and obligations hereunder. The Executive may not assign or transfer this Agreement or any rights or obligations hereunder. 9. NOTICE. For the purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by certified or registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below: a) To the Bank: Corporate Secretary 8 Citizens Financial Services, FSB 707 Ridge Road Munster, Indiana 46321 b) To the Executive: Zoran Koricanac 2741 Wood Drive Dyer, IN 46311 10. AMENDMENT; WAIVER. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer or officers as may be specifically designated by the Board of Directors of the Bank to sign on its behalf. No waiver by any party hereto at any time of any breach by any other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 11. GOVERNING LAW. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the United States where applicable and otherwise by the substantive laws of the State of Indiana. 12. NATURE OF OBLIGATIONS. Nothing contained herein shall create or require the Bank to create a trust of any kind to fund any benefits which may be payable hereunder, and to the extent that the Executive acquires a right to receive benefits from the Bank hereunder, such right shall be no greater than the right of any unsecured general creditor of the Bank. 13. HEADINGS. The section headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 14. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 15. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 16. REGULATORY ACTIONS. The following provisions shall be applicable to the parties to the extent that they are required to be included in employment agreements between a savings association and its employees pursuant to Section 563.39(b) of the Regulations Applicable to All Savings Associations, 12 C.F.R. 563.39(b), or any successor thereto, and shall be controlling in the event of a conflict with any other provision of this Agreement, including without limitation Section 5 hereof. 9 a)If the Executive is suspended from office and/or temporarily prohibited from participating in the conduct of the Bank's affairs pursuant to notice served under Section 8(e)(3) or Section 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. 1818(e)(3) and 1818(g)(1)), the Bank's obligations under this Agreement shall be suspended as of the date of service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank may, in its discretion: (i) pay the Executive all or part of the compensation withheld while its obligations under this Agreement were suspended, and (ii) reinstate (in whole or in part) any of its obligations which were suspended. b)If the Executive is removed from office and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Section 8(e)(4) or Section 8(g)(1) of the FDIA (12 U.S.C. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order, but vested rights of the Executive and the Bank as of the date of termination shall not be affected. c)If the Bank is in default, as defined in Section 3(x)(1) of the FDIA (12 U.S.C. 1813(x)(1)), all obligations under this Agreement shall terminate as of the date of default, but vested rights of the Executive and the Bank as of the date of termination shall not be affected. d)All obligations under this Agreement shall be terminated pursuant to 12 C.F.R. 563.39(b)(5) (except to the extent that it is determined that continuation of the Agreement for the continued operation of the Bank is necessary): (i) by the Director of the Office of Thrift Supervision ("OTS"), or his/her designee, at the time the Federal Deposit Insurance Corporation ("FDIC") enters into an agreement to provide assistance to or on behalf of the Bank under the authority contained in Section 13(c) of the FDIA (12 U.S.C. 1823(c)); or (ii) by the Director of the OTS, or his/her designee, at the time the Director or his/her designee approves a supervisory merger to resolve problems related to operation of the Bank or when the Bank is determined by the Director of the OTS to be in an unsafe or unsound condition, but vested rights of the Executive and the Bank as of the date of termination shall not be affected. 17. REGULATORY PROHIBITION. The terms and conditions of this Agreement are subject to OTS approval. Notwithstanding any other provision of this Agreement to the contrary, any payments made to the Executive pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with Section 18(k) of the Federal Deposit Insurance Act (12 U.S.C. 1828(k)) and the regulations promulgated thereunder, including 12 C.F.R. Part 359. In the event of the Executive's termination of employment with the Bank for Cause, all employment relationships and managerial duties with the Bank shall immediately cease. Furthermore, following such termination for Cause, the Executive will not, directly or indirectly, influence or participate in the affairs or the operations of the Bank. 18. PAYMENT OF COSTS AND LEGAL FEES. In the event any dispute or controversy arising under or in connection with this Agreement is resolved in favor of any party, whether by judgment, arbitration or settlement, the party shall be entitled to the payment of all legal fees incurred by the prevailing party in resolving such dispute or controversy. 10 19. ENTIRE AGREEMENT. This Agreement embodies the entire agreement between the Bank and the Executive with respect to the matters agreed to herein. All prior agreements between the Bank and the Executive with respect to the matters agreed to herein are hereby superseded and shall have no force or effect. IN WITNESS WHEREOF, this Agreement has been executed as of the date first above written. Attest: CITIZENS FINANCIAL SERVICES, FSB /s/ Monica F. Sullivan By: - ---------------------- /s/ Thomas F. Prisby -------------------- EXECUTIVE /s/ Zoran Koricanac ------------------- EX-10.14 3 c92476exv10w14.txt EMPLOYMENT AGREEMENT EXHIBIT 10.14 EMPLOYMENT AGREEMENT AGREEMENT, dated this 3rd day of December 2004, between CFS Bancorp, Inc., a Delaware Corporation (the "Company"), a federally chartered savings bank, and Zoran Koricanac (the "Executive"). WITNESSETH WHEREAS, the Executive is presently an officer of Citizens Financial Services, FSB ("Bank") a wholly owned subsidiary of the Company; and WHEREAS, the Company and the desires to be ensured of the Executive's continued active participation in the business of the Bank and the Company; and WHEREAS, the Company desires to enter into an agreement with the Executive with respect to his employment therewith; and WHEREAS, in order to induce the Executive to remain in the employ of the Company and in consideration of the Executive's agreeing to remain in the employ of the Company, the parties desire to specify the severance benefits which shall be due the Executive by the Company in the event that his employment with the Company is terminated under specified circumstances; NOW THEREFORE, in consideration of the mutual agreements herein contained, and upon the other terms and conditions hereinafter provided, the parties hereby agree as follows: 1. DEFINITIONS. The following words and terms shall have the meanings set forth below for the purposes of this Agreement: a) Agreement Date. The "Agreement Date" shall be the date first set forth above. b) Base Salary. "Base Salary" shall have the meaning set forth in Section 4(a) hereof. c) Cause. Termination of the Executive's employment for "Cause" shall mean termination because of personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease-and-desist order or material breach of any provision of this Agreement. d) Change in Control. "Change in Control" means the occurrence of any of the following: (i) an event that would be required to be reported in response to Item 501 of Form 8-K or Item 6(e) of Schedule 14A of Regulation 14A pursuant to the 1934 Act, or any successor thereto, whether or not any class of securities of the Company (as defined below) is registered under the 1934 Act; (ii) any "person" is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the 1934 Act), directly or indirectly, of securities of the Company representing 20% 2 or more of the combined voting power of the Company's then outstanding securities except for any securities purchased by the Company; or (iii) during any period of thirty-six consecutive months during the term of an Option, individuals who at the beginning of such period constitute the Board of Directors of the Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. i) For purposes of the definition of "Change in Control," a Person or group of Persons does not include the CFS Bancorp, Inc. Employee Stock Ownership Plan Trust which forms a part of the CFS Bancorp, Inc. Employee Stock Ownership Plan (the "ESOP"), or any other employee benefit plan, subsidiary or affiliate of the Company, and the outstanding shares of common stock of the Company, on a fully diluted basis, include all shares owned by the ESOP, whether allocated or unallocated to the accounts of participants, thereunder. ii) For purposes of the definition of "Change in Control," the term "Person" means any natural person, proprietorship, partnership, corporation, limited liability company, organization, firm, business, joint venture, association, trust or other entity and any government agency, body or authority. e) Code. "Code" shall mean the Internal Revenue Code of 1986, as amended. f) Company. "Company" means CFS Bancorp, Inc. a Delaware Corporation, its subsidiaries, successors and assigns for purposes of this Agreement. g) Definitive Agreement. A "Definitive Agreement" is an agreement entered into by the Company which is intended to result in a Change of Control of the Company and which has been publicly announced on a Form 8-K filed by the Company. h) Date of Termination. "Date of Termination" shall mean (i) if the Executive's employment is terminated for Cause or for Disability, the date specified in the Notice of Termination, and (ii) if the Executive's employment is terminated for any other reason, the date on which a Notice of Termination is given or as specified in such Notice. i) Disability. Termination by the Company of the Executive's employment based on "Disability" shall mean termination because of any physical or mental impairment which qualifies the Executive for disability benefits under the applicable long-term disability plan maintained by the Company or the Company or, if no such plan applies, which would qualify the Executive for disability benefits under the Federal Social Security System. j) Good Reason. Termination by the Executive of the Executive's employment for "Good Reason" shall mean termination by the Executive within twenty-four (24) months following a Change in Control of the Company based on: 3 i) Without the Executive's express written consent, the failure to elect or to re-elect or to appoint or to re-appoint the Executive to the office of Senior Vice President of the Bank or a material adverse change made by the Company in the Executive's functions, duties or responsibilities as Senior Vice President of the Company; ii) Without the Executive's express written consent, a reduction by either of the Employers in the Executive's Base Salary as the same may be increased from time to time or, except to the extent permitted by Section 3(b) hereof, a reduction in the package of fringe benefits provided to the Executive, taken as a whole; iii) The principal executive office of either of the Employers is relocated more than twenty miles from Dyer, Indiana; iv) Any purported termination of the Executive's employment for Disability or Retirement which is not effected pursuant to a Notice of Termination satisfying the requirements of paragraph (l) below; v) The failure by the Company to obtain the assumption of and agreement to perform this Agreement by any successor; or vi) Notification to the Executive pursuant to Section 2(b) hereof that his term of employment will not be extended. k) IRS. "IRS" shall mean the Internal Revenue Service. l) Notice of Termination. Any purported termination of the Executive's employment by the Company for any reason, including without limitation for Cause, Disability or Retirement, or by the Executive for any reason, including without limitation for Good Reason, shall be communicated by written "Notice of Termination" to the other party hereto. For purposes of this Agreement, a "Notice of Termination" shall mean a dated notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated, (iii) specifies a Date of Termination, which shall be not less than thirty (30) nor more than ninety (90) days after such Notice of Termination is given, except in the case of the Company's termination of Executive's employment for Cause, which shall be effective immediately; and (iv) is given in the manner specified in Section 9 hereof. m) Retirement. "Retirement" shall mean voluntary termination by the Executive after the Executive attains the age sixty-five (65). n) Trigger Event. A "Trigger Event" shall be the execution of a Definitive Agreement. 4 2. TERM OF EMPLOYMENT. a) As of the Agreement Date, the Company will employ the Executive to perform such executive and managerial duties at such times and in such manner as the company may from time to time direct. Unless otherwise provided herein, the Executive acknowledges and agrees that the Executive serves at the will of the Company, and that this Agreement shall not be construed as a contract for employment for a specific term. b) Following a Trigger Event, as defined in Section (n), the employment term of the Executive shall be a period of one year commencing as of the date thereof (the "Trigger Date"), subject to earlier termination as provided herein. Beginning on a Trigger Date, and on each day thereafter, the term of this Agreement shall be extended for a period of one day in addition to the then-remaining term, provided that the Company has not given notice to the Executive in writing at least 60 days prior to such day that the term of the Agreement shall not be extended further. Reference herein to the term of this Agreement shall refer to both such initial term and such extended terms. c) During his employment with the Company, the Executive shall perform such executive services for the Company as may be consistent with his titles and from time to time assigned to him by the Company's Board of Directors. The Executive further agrees to serve without additional compensation as an officer and director of any of the Company's subsidiaries and agrees that any amounts received from such corporation may be offset against the amounts due hereunder. In addition, it is agreed that the Company may assign the Executive to one of its subsidiaries for payroll purposes. 3. LOYALTY, CONFIDENTIALITY AND NON-COMPETITION a) The Executive shall devote his full time and best efforts to the performance of his duties while employed with the Company. During such time, the Executive shall not, at any time or place, either directly or indirectly engage in any business or activity in competition with the business affairs or interests of the Company or be a director, officer or consultant to any bank, savings and loan association, credit union, thrift, savings bank, or similar institution in the Chicago CMSA. b) For purposes of this Agreement, directly or indirectly engaging in any business activity in competition with the business or affairs of the Company includes, but is not limited to, serving or acting as an owner, partner, agent, beneficiary, or employee of any person, firm or corporate entity so engaged; except that nothing herein contained shall be deemed to prevent or limit the right of employee to invest any of his surplus funds in the capital stock or other securities of any corporation whose stock or securities are publicly owned or are regularly traded on any public exchange, nor shall anything herein contained be deemed to prevent employee from investing or limit employee's right to invest his surplus funds in real estate. c) All information relating to business of the Company including, but not limited to, that business obtained or serviced by the Company and all customer listings, contact lists, expiration 5 cards, asset reports, instruments, documents, papers and other material used in connection with such business, shall be the exclusive property of the Company. The Executive shall keep all such information and material confidential; none of it will be copied, reproduced or duplicated without the express written permission of the Company, and Executive shall return all material containing such information to the Company upon its request or upon termination of employment. Executive also agrees that he will not utilize the confidential information or trade secrets of the Company, either directly or indirectly, for any purposes except performance of his responsibilities and in furtherance of the Company's business, unless otherwise expressly authorized by the Company in writing in advance. d) Executive agrees that, during his employment, and for a period of one (1) year following the date of his involuntary termination of employment for Cause, or his voluntary termination without Good Reason, the Executive: i) will not solicit any of the Company's past or current customers or clients for the benefit of anyone other than Company or its affiliates; ii) will not divulge the names of any of the Company's past or then current customers to any other person, corporation or entity; and iii) will not, either directly or indirectly, induce or solicit any person to leave the employ of the Company. 4. COMPENSATION AND BENEFITS. a) The Company shall compensate and pay the Executive for his services during the term of this Agreement at a minimum base salary of $139,000 per year ("Base Salary"), which may be increased from time to time in such amounts as may be determined by the Board of Directors of the Company and may not be decreased without the Executive's express written consent. In addition to his Base Salary, the Executive shall be entitled to receive during the term of this Agreement such bonus payments as may be determined by the Board of Directors of the Employers. b) During his employment with the Company, the Executive shall be entitled to participate in and receive the benefits of any pension or other retirement benefit plan, profit sharing, stock option, employee stock ownership, or other plans, benefits and privileges given to employees and executives of the Company, to the extent commensurate with his then duties and responsibilities, as fixed by the Board of Directors. The Company shall not make any changes in such plans, benefits or privileges which would adversely affect the Executive's rights or benefits thereunder, unless such change occurs pursuant to a program applicable to all executive officers of the Company and does not result in a proportionately greater adverse change in the rights of or benefits to the Executive as compared with any other executive officer of the Company. Nothing paid to the Executive under any plan or arrangement presently in effect or made available in the future shall be deemed to be in lieu of the salary payable to the Executive pursuant to Section 4(a) hereof. 6 c) During his employment with the Company, the Executive shall be entitled to paid annual vacation in accordance with the policies as established from time to time by the Board of Directors. The Executive shall not be entitled to receive any additional compensation from the Employers for failure to take a vacation, nor shall the Executive be able to accumulate unused vacation time from one year to the next, except to the extent authorized by the Board of Directors. d) During the Executive's employment with the Company, the Company will provide suitable office space, desk, chairs, filing cabinets, telephones and other usual and customary office furniture, fixtures and equipment adequate for the efficient performance of the duties assigned to the Executive. e) During the Executive's employment with the Company, the Company will provide to the Executive, at the Employer's cost, all perquisites which other Senior Vice Presidents of the Company are generally entitled to receive, including the payment of his annual dues at a health club. f) During the term of this Agreement, the Company will provide to Executive the use of an automobile of the Company's choice and will replace the automobile with a new one at no less often than once every four years. The Company will pay all automobile operating expenses incurred by Executive in the performance of an Executive's company duties. The Company will procure and maintain in force an automobile liability policy for the automobile with coverage, including Executive, in the minimum amount of $1,000,000 combined single limit on bodily injury and property damage. 5. EXPENSES. The Company shall reimburse the Executive or otherwise provide for or pay for all reasonable expenses incurred by the Executive in furtherance of or in connection with the business of the Company, including, but not by way of limitation, automobile expenses and other traveling expenses, and all reasonable entertainment expenses (whether incurred at the Executive's residence, while traveling or otherwise), subject to such reasonable documentation and other limitations as may be established by the Board of Directors of the Company. If such expenses are paid in the first instance by the Executive, the Company shall reimburse the Executive therefor. 6. TERMINATION. a) The Company shall have the right, at any time upon prior Notice of Termination, to terminate the Executive's employment hereunder for any reason, including without limitation termination for Cause, Disability or Retirement, and the Executive shall have the right, upon prior Notice of Termination, to terminate his employment hereunder for any reason. b) In the event that (i) the Executive's employment is terminated by the Company following the occurrence of a Trigger Event for other than Cause, Disability, Retirement or the Executive's death or (ii) such employment is terminated by the Executive (a) due to a material breach of this Agreement by the Company, which breach has not been cured within fifteen (15) days after a written notice of non-compliance has been given by the Executive to the Employers, or 7 (b) for Good Reason, then the Company shall, subject to the provisions of Section 7 hereof, if applicable: A) pay to the Executive, in either twelve (12) equal monthly installments beginning with the first business day of the month following the Date of Termination or in a lump sum within five business days of the Date of Termination (at the Executive's election), a cash severance amount equal to the Executive's Base Salary plus cash incentive bonuses earned during the previous year, regardless of when paid, and B) maintain and provide for a period ending at the earlier of (i) the expiration of the remaining term of employment pursuant hereto prior to the Notice of Termination or (ii) the date of the Executive's full-time employment by another employer (provided that the Executive is entitled under the terms of such employment to benefits substantially similar to those described in this subparagraph (B)), at no cost to the Executive, the Executive's continued participation in all group insurance, life insurance, health and accident insurance, disability insurance and other employee benefit plans, programs and arrangements offered by the Company in which the Executive was entitled to participate immediately prior to the Date of Termination excluding stock plans and bonuses, provided, however, that in the event that the Executive's participation in any plan, program or arrangement as provided in this subparagraph is barred, or during such period any such plan, program or arrangement is discontinued or the benefits thereunder are materially reduced, the Company shall arrange to provide the Executive with benefits substantially similar to those which the Executive was entitled to receive under such plans, programs and arrangements immediately prior to the Date of Termination. 7. WITHHOLDING. All payments required to be made by the Company hereunder to the Executive shall be subject to the withholding of such amounts, if any, relating to tax and other payroll deductions as the Company may reasonably determine should be withheld pursuant to any applicable law or regulation. 8. ASSIGNABILITY. The Company may assign this Agreement and its rights and obligations hereunder in whole, but not in part, to any corporation, bank or other entity with or into which the Company may hereafter merge or consolidate or to which the Company may transfer all or substantially all of its assets, if in any such case said corporation, bank or other entity shall by operation of law or expressly in writing assume all obligations of the Company hereunder as fully as if it had been originally made a party hereto, but may not otherwise assign this Agreement or its rights and obligations hereunder. The Executive may not assign or transfer this Agreement or any rights or obligations hereunder. 9. NOTICE. For the purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by certified or registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below: 8 a)To the Company: Corporate Secretary Citizens Financial Services, FSB 707 Ridge Road Munster, Indiana 46321 b)To the Executive: Zoran Koricanac 2741 Wood Drive Dyer, IN 46311 10. AMENDMENT; WAIVER. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer or officers as may be specifically designated by the Board of Directors of the Company to sign on its behalf. No waiver by any party hereto at any time of any breach by any other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 11. GOVERNING LAW. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the United States where applicable and otherwise by the substantive laws of the State of Indiana. 12. NATURE OF OBLIGATIONS. Nothing contained herein shall create or require the Company to create a trust of any kind to fund any benefits which may be payable hereunder, and to the extent that the Executive acquires a right to receive benefits from the Company hereunder, such right shall be no greater than the right of any unsecured general creditor of the Company. 13. HEADINGS. The section headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 14. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 15. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 16. REGULATORY PROHIBITION. Notwithstanding any other provision of this Agreement to the contrary, the Executive's employment and the terms of this Agreement is subject to continued approval by the Company's regulators. In the event of the Executive's termination of employment with the Company for Cause or by virtue of order by a count or regulatory body, all employment relationships and managerial duties with the Bank or the Company shall immediately cease. 9 Furthermore, following such termination, the Executive will not, directly or indirectly, influence or participate in the affairs or the operations of the Company. 17. PAYMENT OF COSTS AND LEGAL FEES. In the event any dispute or controversy arising under or in connection with this Agreement is resolved in favor of any party, whether by judgment, arbitration or settlement, the party shall be entitled to the payment of all legal fees incurred by the prevailing party in resolving such dispute or controversy. 18. ENTIRE AGREEMENT. This Agreement embodies the entire agreement between the Company and the Executive with respect to the matters agreed to herein. All prior agreements between the Company and the Executive with respect to the matters agreed to herein are hereby superseded and shall have no force or effect. IN WITNESS WHEREOF, this Agreement has been executed as of the date first above written. Attest: CFS BANCORP, INC. /s/ Monica F. Sullivan By: - ---------------------- /s/ Thomas F. Prisby -------------------- EXECUTIVE /s/ Zoran Koricanac ------------------- EX-10.15 4 c92476exv10w15.txt AMENDED/RESTATED SUPPLEMENTAL ESOP BENEFIT PLAN EXHIBIT 10.15 AMENDED AND RESTATED SUPPLEMENTAL ESOP BENEFIT PLAN OF CFS BANCORP, INC. AND CITIZENS FINANCIAL SERVICES, FSB This Amended and Restated Supplemental ESOP Excess Benefit Plan ("Plan") of CFS Bancorp, Inc. ("Company") and Citizens Financial Services, FSB ("Bank") was first adopted effective as of May 17, 1999, and amended and restated effective as of November 19, 2001. The Plan is established and maintained by the Company and the Bank for the purpose of permitting the officers listed in Appendix A attached hereto, (which may be amended by the Company and/or the Bank from time to time hereafter) who will be participating in the CFS Bancorp, Inc. Employee Stock Ownership Plan ("ESOP") to receive allocations representing shares of common stock of the Company pursuant to this Plan in excess of the number of shares of common stock of the Company which are allocable to their accounts within the ESOP ("ESOP Allocation") under the limitation imposed by Sections 401(a)(17), 414 and 415 of the Internal Revenue Code of 1986, as amended, or as a result of the maximum amount of compensation which may be taken into consideration for the purposes of the ESOP. The Plan is an unfunded plan maintained for the purpose of providing deferred compensation for selected officers of the Company and the Bank, each of whom is a member of a select group of management or highly compensated employees for purposes of Title I of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Accordingly, the Company and the Bank hereby adopt the Plan pursuant to the terms and provisions set forth below: ARTICLE ONE DEFINITIONS In addition to those terms defined above, the following terms shall have the meanings hereinafter set forth whenever used herein: 1.1. "Board" means the Boards of Directors of the Company and the Bank. 1.2. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any regulations relating thereto. 1.3 Change in Control" means the occurrence of any of the following: (i) the acquisition of control of the Company as defined in 12 C.F.R. Section 574.4, unless a presumption of control is successfully rebutted or unless the transaction is exempted by 12 C.F.R. Section 574.3(c)(vii), or any successor to such sections; (ii) an event that would be required to be reported in response to Item 1(a) of Form 8-K or Item 6(e) of Schedule 14A of Regulation 14A pursuant to the Securities Exchange Act of 1934, as amended ("Exchange Act"), or any successor thereto, whether or not any class of securities of the Company is registered under the Exchange Act; (iii) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act, but excluding CFS Bancorp, Inc. and any stock benefit plan, including this Plan, of CFS Bancorp, Inc. or any subsidiary thereof) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Employer representing 20% or more of the combined voting power of the Employer's then outstanding securities; (iv) the stockholders of the Company approve (or, in the event no approval of the Company's stockholders is required, the Company consummates) a merger, consolidation, share exchange, division or other reorganization or transaction involving the Employer ("Fundamental Transaction") with any other corporation or entity, other than a Fundamental Transaction which results in both (a) the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 60% of the combined voting power of the surviving entity immediately after such Fundamental Transaction, and (b) the members of the Board of Directors of the Employer immediately prior thereto continuing to represent at least 60% of the members of the Board of Directors of the surviving entity; or (v) during any period of three consecutive years, individuals who at the beginning of such period constitute the Board of Directors of the Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by stockholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. 1.4 "Company Common Stock" means shares of common stock of the Company. 1.5 "ESOP Allocation" means the number of shares allocable to the individual account of a participant in the ESOP pursuant to Article 5 of the ESOP. 1.6 "Participant" means a salaried employee of the Company and/or the Bank who is a participant in the ESOP, who is a member of a select group of management or highly compensated employees within the meaning of Section 201 (2) of the ERISA and who is selected by the Board to participate in the Plan. 1.7 "Plan Year" means the 12-consecutive-month period ending December 31 of each year. 1.8 "Stock Unit" means a bookkeeping unit used for the purpose of crediting amounts to the account of a Participant, each such Stock Unit being equivalent to one share of Company Common Stock. 1.9 "Supplemental ESOP Allocation" shall mean the number of Stock Units allocated to a Participant's account pursuant to Article Three of the Plan. 1.10 Words in the masculine gender shall include the feminine and the singular shall include the plural, and vice versa, unless qualified by the context. Any headings used herein are included for ease of reference only, and are not to be construed so as to alter the terms hereof. ARTICLE TWO ELIGIBILITY A salaried employee of the Company and/or the Bank who is eligible to receive the benefit of an ESOP Allocation, the total amount of which is reduced by reason of the limitation on the amount of compensation which may be taken into account for the purpose of calculating allocations pursuant to Sections 401(a)(17), 414 and 415 of the Code shall be eligible to be selected by the Boards of Directors of the Company and the Bank to participate in the Plan. ARTICLE THREE SUPPLEMENTAL ESOP ALLOCATIONS A Participant in the Plan shall receive a Supplemental ESOP Allocation of Stock Units each year at the same time that allocations of Company Common Stock related to Company Contributions (as such term is defined in Section 4.01 of the ESOP) are made pursuant to Section 5.04 of the ESOP. The number of Stock Units allocable to a Participant for any Plan Year shall be an amount equal to the difference between (a) and (b) below: (a) The ESOP Allocation which would have been allocated to the Participant for the Plan Year, as determined by Article IV of the ESOP and the definition of "Compensation" in Section 2.13 of the ESOP without giving effect to the limitation imposed by Sections 401(a)(17), 414 and 415 of the Code on the maximum amount of compensation which may be taken into consideration for the purposes of the ESOP; LESS (b) The ESOP Allocation actually allocated to the account of the Participant in the ESOP for the Plan Year. Supplemental ESOP Allocations made for the benefit of a Participant for any Plan Year shall be credited to a bookkeeping account maintained under the Plan in the name of each Participant. ARTICLE FOUR INVESTMENT OF SUPPLEMENTAL ESOP ALLOCATIONS 4.1 INVESTMENT OF FUNDS. Investment of amounts credited hereunder to the account of a Participant shall be treated as if they were actually invested in the ESOP account of the Participant and shall be credited with gains and losses at the same time and in the same manner as is applicable to amounts invested in the ESOP account of such Participant. 4.2 FORMATION OF TRUST. In connection with the adoption of the Plan, the Company and the Bank have elected to form a trust ("Trust") in order to permit contributions from the Company or the Bank to purchase and hold shares of Company Common Stock and other assets, subject to compliance with all applicable securities laws. If the Company and the Bank elect to contribute to the Trust to fund their obligations under the Plan, a Participant shall have no right to demand the transfer to him of stock or other assets from the Company and the Bank or from such Trust. Any assets held in the Trust, including shares of Company Common Stock, may be distributed to a Participant in payment of part or all of the Company's and the Bank's obligations under the Plan. ARTICLE FIVE VESTING; DISTRIBUTIONS 5.1. VESTING. The vested portion of a Participant's account shall be a percentage of the total amount credited to the account determined on the basis of the Participant's number of Years of Service" (as defined in Section 2.45 (or any successor thereto) of the ESOP) according to the following schedule: Years of Service Percentage Less than 5 years 0% 5 100%
In determining Years of Service for purposes of vesting under the Plan, Years of Service with the Company or the Bank prior to adoption of this Plan shall be included. Notwithstanding the above vesting schedule, a Participant shall be 100% vested in his account upon attainment of "Normal Retirement Date" (as defined in Section 2.32 (or any successor thereto) of the ESOP). In addition, notwithstanding the above vesting schedule, a Participant will be 100% vested in his account upon (i) the effective date of a Change of Control of the Company or (ii) the termination of the Plan. 5.2 Distribution. The vested portion of the amounts credited to a Participant's account shall be distributed in such number of installments as may be directed by the Participant in his or her election relating to such account (provided that the period for payment of such installments shall not exceed ten years and be more frequent than quarterly) and shall be in the same form and commence at the same time as benefits shall be distributed to a Participant's pursuant to Article Seven of the ESOP; provided, however, in the event of a Change in Control of the Company payments in settlement of a Participant's account (including an account with respect to which one or more installment payments have previously been made) shall be made no later than fifteen business days following the effective date of such Change in Control. If a Participant should die before distribution of the vested portion of his account pursuant to the Plan has been made to him, any remaining vested amounts shall be distributed to his beneficiary in the method designated by the Participant in a writing delivered to the Company and the Bank prior to his death. If a Participant has not designated a beneficiary, or method of distribution, or if no designated beneficiary is living on the date of distribution, such vested amounts shall be distributed to those persons entitled to receive distributions of the Participant's account under the ESOP and in the same method as distribution is made under the ESOP. ARTICLE SIX ADMINISTRATION OF THE PLAN 6.1. ADMINISTRATION BY THE COMPANY AND THE BANK. The Company and the Bank shall be responsible for the general operation and administration of the Plan and for carrying out the provisions thereof. 6.2. GENERAL POWERS OF ADMINISTRATION. All provisions set forth in the ESOP with respect to the administrative powers and duties of the Company and the Bank, expenses of administration, and procedures for filing claims shall also be applicable with respect to the Plan, The Company and the Bank shall be entitled to rely conclusively upon all tables, valuations, certificates, opinions and reports furnished by any actuary, accountant, controller, counsel or other person employed or engaged by the Company and the Bank with respect to the Plan. ARTICLE SEVEN AMENDMENT OR TERMINATION 7.1. AMENDMENT OR TERMINATION. The Company and the Bank reserve the right to amend or terminate the Plan when, in the sole opinion of the Company and the Bank such amendment or termination is advisable. Any such amendment or termination shall be made pursuant to a resolution of the Board and shall be effective as of the date of such resolution. Notwithstanding the foregoing, this Plan shall not be amended, modified or terminated in any respect in contemplation of a Change in Control of the Company. For purposes of this Section 7.1, an amendment, modification or termination in contemplation of a Change in Control of the Company shall be deemed to have occurred if a Change in Control of the Company occurs within twelve months of any amendment, modification or termination of this Plan. In such event, any such amendment, modification or termination shall be null and void unless such amendment or modification has been consented to in writing by the Participants at the time of such amendment or modification. 7.2. EFFECT OF AMENDMENT OR TERMINATION. No amendment or termination of the Plan shall directly or indirectly reduce the vested portion of any account held hereunder as of the effective date of such amendment or termination. Upon termination of the Plan, distribution of vested amounts credited to the account of a Participant shall be made to the Participant or his beneficiary in the manner and at the time described in Section 5.2 of the Plan. No additional credits of ESOP Allocations shall be made to the account of a Participant and no additional Years of Service (within the meaning of Section 5. 1) shall be credited after termination of the Plan, but the Company and the Bank shall continue to credit gains and losses pursuant to Article Four until the vested balance of his account has been fully distributed to the Participant or his beneficiary. ARTICLE EIGHT GENERAL PROVISIONS 8.1. PARTICIPANT'S RIGHTS UNSECURED. The right of a Participant or his designated beneficiary to receive a distribution hereunder shall be an unsecured claim against the general assets of the Company and the Bank, and neither the Participant nor a designated beneficiary shall have any rights in or against any specific assets of the Company and the Bank. 8.2. GENERAL CONDITIONS. Except as otherwise expressly provided herein, all terms and conditions of the ESOP applicable to an ESOP Allocation will also be applicable to an allocation of Stock Units pursuant to this Plan. Nothing in this Plan shall operate or be construed in any way to modify, amend or affect the terms and provisions of the ESOP. 8.3. NO GUARANTEE OF BENEFITS. Nothing contained in the Plan shall constitute a guaranty by the Company and the Bank or any other person or entity that the assets of the Company and the Bank will be sufficient to pay any benefit hereunder. 8.4. NO ENLARGEMENT OF EMPLOYEE RIGHTS. No Participant shall have any right to receive a distribution of contributions made under the Plan except in accordance with the terms of the Plan. Establishment of the Plan shall not be construed to give any Participant the right to be retained in the service of the Company and the Bank. 8.5. SPENDTHRIFT PROVISION. No interest of any person or entity in, or right to receive a distribution under, the Plan shall be subject in any manner to sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind; nor may such interest or tight to receive a distribution be taken, either voluntarily or involuntarily for the satisfaction of the debts of, or other obligations or claims against, such person or entity, including claims for alimony, support, separate maintenance and claims in bankruptcy proceedings. 8.6. APPLICABLE LAW. Federal law shall construed and administered under the laws of the State of Indiana to the extent such laws are not superseded by federal law. 8.7. INCAPACITY OF RECIPIENT. If any person entitled to a distribution under the Plan is deemed by the Company and the Bank to be incapable of personally receiving and giving g a valid receipt for such payment, then, unless and until claim therefor shall have been made by a duly appointed guardian or other legal representative of such person, the Company and the Bank may provide for such payment or any part thereof to be made to any other person or institution then contributing toward or providing for the care and maintenance of such person. Any such payment shall be a payment for the account of such person and a complete discharge of any liability of the Company, the Bank and the Plan therefor. 8.8. CORPORATE SUCCESSORS. The Plan shall not be automatically terminated by the transfer or sale of assets of the Company and the Bank. However, notwithstanding anything contained herein to the contrary, this Plan shall automatically terminate as of the effective date of a Change in Control of the Company, as defined in Article 1.3 hereof. 8.9. UNCLAIMED BENEFIT. Each Participant shall keep the Company and the Bank informed of his current address and the current address of his designated beneficiary. The Company and the Bank shall not be obligated to search for the whereabouts of any person. If the location of a Participant is not made known to the Company and the Bank within three years after the date on which payment of the Participant's account may first be made, payment may be made as though the Participant had died at the end of the three-year period. If, within one additional year after such three-year period has elapsed, or, within three years after the actual death of a Participant, the Company or the Bank is unable to locate any designated beneficiary of the Participant, then the Company and the Bank shall have no further obligation to pay any benefit hereunder to such Participant or designated beneficiary and such benefit shall be irrevocably forfeited. 8.10. LIMITATIONS ON LIABILITY. Notwithstanding any of the preceding provisions of the Plan, neither the Company and the Bank nor any individual acting as employee or agent of the Company and the Bank shall be liable to any Participant, former Participant or other person for any claim, loss, liability or expense incurred in connection with the Plan. IN WITNESS WHEREOF, CFS Bancorp, Inc. and Citizens Financial Services, FSB have caused this Plan to be duly amended and restated on this 19th day of November, 2001. CFS BANCORP, INC. Attest: /s/ Monica F. Sullivan By /s/ Thomas F. Prisby - ---------------------- --------------------- Secretary CEO and Chairman CITIZENS FINANCIAL SERVICES, FSB Attest: /s/ Monica F. Sullivan By /s/ James W. Prisby - ---------------------- --------------------- Secretary President APPENDIX A The Company and the Bank have designated the following persons as Participants in its Amended and Restated Supplemental ESOP Benefit Plan: Thomas F. Prisby James W. Prisby John T. Stephens EX-10.16 5 c92476exv10w16.txt DIRECTORS' DEFERRED COMPENSATION PLAN EXHIBIT 10.16 DIRECTORS' DEFERRED COMPENSATION PLAN OF CFS BANCORP, INC. EFFECTIVE JANUARY 1, 2005 KRIEG DEVAULT LLP ONE INDIANA SQUARE SUITE 2800 INDIANAPOLIS, IN 46204 INTRODUCTION The purpose of this Plan and its related Trust is to permit Directors to defer the receipt and resulting taxation of the Fees to be received for services as a Director. All benefits payable under this Plan shall be paid solely out of the Trust assets or from the general assets of the Company. ARTICLE I DEFINITIONS Whenever the initial letter of the following words or phrases is capitalized herein, those words and phrases shall have the meanings stated below unless a different meaning is plainly required by the context: 1.1. "Accounting Date" means the last day of each calendar three-month period (and any other date selected by the Committee). 1.2. "Affiliate" means the Company and any other corporation or trade or business whose employees are treated as being employed by the Company under Code Sections 414(b), 414(c), 414(m) or 414(o). 1.3. "Bank" means Citizens Financial Services, FSB. 1.4. "Board" means the Board of Directors of CFS Bancorp, Inc. 1.5. "Code" means the Internal Revenue Code of 1986, as amended. 1.6. "Committee" means the committee appointed by the Board to administer the Plan. 1.7. "Company" means CFS Bancorp, Inc. 1.8. "Company Stock" means CFS Bancorp, Inc. common voting stock. 1.9. "Company Stock Account" means the sub-account under each Participant's Individual Account to which shares of Company Stock will be credited as of each Accounting Date. 1.10. "Company Stock Dividend" means the cash dividend payable with respect to one (1) share of Company Stock which shall be equal to and payable under the Plan at the same time as a cash dividend is paid with respect to one (1) share of Company Stock. Section 3.4 provides for the method by which Company Stock Dividends will be allocated to a Participant's Company Stock Account. 1.11. "Director" means any duly elected and serving member of the board of directors or advisory board of directors of the Company, the Bank or an Affiliate. 2 1.12. "Effective Date" means the effective date of this Plan, which is January 1, 2005. 1.13. "Fair Market Value" means the per share value of a share of Company Stock, as determined by the Committee in its sole discretion. 1.14. "Fees" means all fees payable to a Participant for a Plan Year, for services rendered to the Company, the Bank or an Affiliate as a Director, with respect to such Plan Year, including cash retainers, fees for attendance at regularly scheduled board meetings, special meetings called from time to time and any and all meetings of committees of the board of directors. 1.15. "Individual Account" means the individual bookkeeping account maintained for each Participant in accordance with Section 3.1. Such Individual Account is comprised of whichever of the following sub-accounts are applicable to a particular Participant: Company Stock Account and Interest Bearing Account. 1.16. "Interest Bearing Account" means the sub-account under a Participant's Individual Account to which interest will be credited as of each Accounting Date. 1.17. "Participant" means a Director who becomes a Participant pursuant to Article II of the Plan. 1.18. "Participation Agreement" means the written agreement between the Participant and the Company, pursuant to which the Participant elects to defer receipt of Fees, elects an investment alternative, designates a beneficiary, and elects the time of distribution of benefits under the Plan. 1.19. "Plan" means this Directors' Deferred Compensation Plan of CFS Bancorp, Inc. 1.20. "Plan Year" means the 12-month period beginning each January 1 and ending each December 31. 1.21. "Trust" means the agreement entered into between the Company and the Trustee pursuant to Article IV. 1.22. "Trustee" means such independent financial institution as shall be designated in the Trust to hold in trust any assets of the Plan for the purpose of providing benefits under the Plan, and shall include any successor to the Trustee initially designated thereunder. ARTICLE II PARTICIPATION 2.1. Eligibility. Each Director shall be eligible to participate in the Plan on its Effective Date, or if later, on or after the date he becomes a Director. 3 2.2. Participation and Deferrals. A Director shall become a Participant by electing, on a Participation Agreement, to defer the receipt of all or any portion of the Fees he would otherwise receive with respect to a Plan Year, consistent with Section 2.3. 2.3. Participation Agreement. As a condition to the Company's and the Committee's obligation to withhold and credit deferred Fees for a Participant under the Plan, the Participant must execute a Participation Agreement on such forms as shall be prescribed by the Committee. (a) Timing of Execution and Delivery of Participation Agreement. Except as provided below, a Participation Agreement must be executed by the Participant and the Committee prior to the first day of the Plan Year in which the Fees specified in the Participation Agreement will be paid. For example, to defer Fees payable in the 2006 Plan Year, a Participation Agreement must be executed on or prior to December 31, 2005. The Participation Agreement may not be amended or revoked during the Plan Year. (b) Directors Elected Mid-Year. Notwithstanding subsection (a), a non-employee who is elected or appointed to fill a vacancy on the Board and who was not a Director on the preceding December 31st may, by completing a Participation Agreement, elect to defer Fees for the balance of the Plan Year and succeeding Plan Years. In order to defer Fees under this subsection (b), the newly elected or appointed Director must, within thirty (30) days after such election or appointment, execute and deliver a Participation Agreement to the Committee, which will be effective for Fees payable on or after the date the executed Participation Agreement is delivered to the Committee. (c) Modification of Participant Deferral Election. During each December, a Participant and the Committee may execute and deliver an amended Participation Agreement which increases, decreases, commences or terminates the deferral of the Participant's Fees payable after the 31st day of that December. ARTICLE III DEFERRALS AND ALLOCATIONS 3.1. Establishment of Individual Accounts. The Committee shall establish and maintain an Individual Account for each Participant, to which the Committee shall credit the Fees deferred by the Participant pursuant to Article II and from which the Committee shall debit all amounts paid to the Participant or his or her designated beneficiary pursuant to Article V. 3.2. Accounting. As of each Accounting Date, each Participant's Individual Account will be adjusted as follows: (a) First, by charging the Individual Account with any distributions pursuant to Article V made to or on behalf of the Participant or his or her designated beneficiary since the last Accounting Date. 4 (b) Second, by allocating any Company Stock Dividends which are allocable to the Participant's Company Stock Account in accordance with Section 3.4. (c) Third, by allocating any interest which is allocable to the Participant's Interest Bearing Account in accordance with Section 3.6. (d) Finally, by crediting the Individual Account with any deferred Fees that are to be allocated in accordance with Section 3.7. 3.3. Conversion of Deferrals. For deferred Fees that are to be invested in Company Stock and allocated to the Participant's Company Stock Account on any Allocation Date, such Account shall be credited with a number of shares of Company Stock, including fractions thereof, determined by dividing the Fair Market Value of the Company's common stock on that Accounting Date into the applicable amount of such deferred Fees to be invested in shares of Company Stock since the last Accounting Date. 3.4. Allocation of Company Stock Dividends to Company Stock Accounts. As of each Accounting Date, the number of shares of Company Stock, including fractions thereof, allocated to a Participant's Company Stock Account shall be credited with any Company Stock Dividends which were paid with respect to such shares of Company Stock since the preceding Accounting Date. The aggregate amount of such Company Stock Dividends shall be divided by the Fair Market Value of the Company Stock as of the Accounting Date specified in the first sentence of this Section to determine the number of shares of Company Stock, including fractions thereof, to be credited to the Participant's Company Stock Account. 3.5. Changes in Stock. In the event of any change in Company Stock through stock dividends, split-ups, recapitalizations, reclassifications, conversions or otherwise, or in the event that other stock shall be converted into or substituted for the present Company Stock as the result of any merger, consolidation, reorganization or similar transaction, then the Committee shall make appropriate adjustment in the aggregate number, price and kind of shares of Company Stock held in each Individual Account. 3.6. Allocation of Interest to Interest Bearing Accounts. The interest rate to be credited to a Participant's Interest Bearing Account as of each Accounting Date shall be equal to Forty-Five Percent (45%) of the prime rate as reported in the Wall Street Journal on the applicable Accounting Date. Interest shall be compounded on each Accounting Date, based on the amount of the Participant's Individual Account allocated to the Interest Bearing Account as of the prior Accounting Date. 3.7. Crediting of Deferrals. All amounts deferred by a Participant pursuant to Article II shall be credited to the Participant's Individual Account effective as of the Accounting Date immediately following the period in which the Fees would otherwise have been paid to the Participant had they not been deferred. 5 ARTICLE IV INVESTMENT OF DEFERRALS 4.1. Trust and Investments. Each Participant's deferrals under the Plan shall be credited to the Participant's Individual Account as provided in Section 3.2 and may be invested by the Trustee in accordance with the terms and conditions of the Trust. The Participant may, upon (i) initial enrollment in the Plan, and (ii) making any subsequent deferral election, direct that his or her Individual Account be invested in shares of Company Stock in the Trust, credited to the Interest Bearing Account, or in a combination of these investments. The Participant may change his or her investment direction at any time after the initial election; provided, however, any such change shall relate only to Fees being deferred in the the Plan Year to which the deferral election which includes the investment direction relates. Thus, once given, an investment direction applicable to Fees deferred in a particular Plan Year cannot later be changed insofar as it relates to such Fees. 4.2. Unsecured Contractual Rights. The Plan at all times shall be unfunded and shall constitute a mere promise by the Company to make benefit payments in the future. No provision of the Plan shall impose or be deemed to impose any obligation upon the Company, other than an unsecured contractual obligation to make a cash payment to Participants and their beneficiaries in accordance with the terms of the Plan. Benefits payable under the Plan shall be paid directly by the Trustee from the Trust or by the Company from its general assets. Notwithstanding any other provision of this Plan, neither a Participant nor his designated beneficiary shall have any preferred claim on, or any beneficial ownership interest in, any assets of the Company or any Affiliate prior to the time benefits are distributed as provided in Article V. ARTICLE V DISTRIBUTIONS 5.1. Time of Payment of Benefits. All amounts credited to a Participant's Individual Account shall be distributed for the benefit of a Participant (or his designated beneficiary) as soon as administratively practicable following the earlier of (i) the Participant's death, (ii) the date the Participant ceases to be a Director or (iii) the date elected by the Director. 5.2. Method of Payment of Benefits. The balance of a Participant's Individual Account shall be distributed in a single sum payment unless the Participant has made an election, at the time of his or her initial deferral election, to receive the distribution in annual installments over a period of five (5) years. All shares of Company Stock held in the Company Stock Account at the time of distribution will be distributed in kind, and all amounts invested in the Interest Bearing Account at the time of distribution will be distributed in cash. 5.3. Benefit Payment Elections. In order to be effective, a Participant's election to receive installment payments or to select an earlier distribution date must be made by delivering a Participation Agreement to the Committee that includes such elections at the same time as the 6 Participant's initial deferral election. If the Participant does not elect to receive installment payments or if such election is not timely or properly made under this Section 5.3, the Company shall pay the entire benefit in the form of a single sum within nine (9) months after the date the Participant first becomes eligible for the distribution under Section 5.1. If the Participant does not elect an additional distribution date, or if such election is not timely or properly made under this Section 5.3, the Company shall pay the benefit at the time provided in Section 5.1. 5.4. Death of a Participant and Beneficiary Designation. (a) Time of Payment. In the event of a Participant's death prior to the time his benefits under the Plan are distributed, the balance in his Individual Account shall be paid, or begin to be paid, to his designated beneficiary within nine (9) months of the date of the Participant's death. (b) Designation of Beneficiaries. The Participant may designate a primary and contingent beneficiary or beneficiaries on forms provided by the Committee, which for this purpose may include the Participation Agreement. Such designation may be changed at any time for any reason by the Participant. If the Participant fails to designate a beneficiary, or if such designation shall for any reason be illegal or ineffective, or if the designated beneficiary(ies) shall not survive the Participant, his benefits under the Plan shall be paid to his estate. 5.5. Participant Ceases to be a Director. In the event a Participant ceases to be a Director prior to the time his benefits under the Plan are distributed, the balance in his Individual Account shall be paid, or begin to be paid, within nine (9) months of the Participant's cessation as a Director. ARTICLE VI PLAN ADMINISTRATION 6.1. Administration by the Committee. The Committee shall be responsible for administering the Plan. Except as the Company shall otherwise expressly determine, the Committee shall be charged with the full power and the responsibility for administering the Plan in all its details. No Participant who is also a member of the Committee shall vote on any matter concerning that Participant's individual benefit hereunder. 6.2. Powers and Responsibilities of the Committee. (a) The Committee shall have all powers necessary to administer the Plan, including the power to construe and interpret the Plan documents; to decide all questions relating to an individual's eligibility to participate in the Plan; to determine the amount, manner and timing of any distribution of benefits under the Plan; to resolve any claim for benefits in accordance with Section 6.4, and to appoint or employ advisors, including legal counsel, to render advice with respect to any of the Committee's responsibilities under the Plan. Any construction, interpretation, 7 or application of the Plan by the Committee shall be final, conclusive and binding on all persons. All actions by the Committee shall be taken pursuant to uniform standards applied to all similarly situated persons. (b) Records and Reports. The Committee shall be responsible for maintaining sufficient records to determine each Participant's eligibility to participate in the Plan, and the Fees of each Participant for purposes of determining the amount of contributions that may be made by or on behalf of the Participant under the Plan. (c) Rules and Decisions. The Committee may adopt such rules as it deems necessary, desirable or appropriate in the administration of the Plan. All rules and decisions of the Committee shall be applied uniformly and consistently to all Participants in similar circumstances. When making a determination or calculation, the Committee shall be entitled to rely upon information furnished by a Participant or beneficiary, the Company or the Company's legal counsel. (d) Application and Forms for Benefits. The Committee may require a Participant or beneficiary to complete and file with it an application for a benefit, and to furnish all pertinent information requested by it. The Committee may rely upon all such information so furnished to it, including the Participant's or beneficiary's current mailing address. 6.3. Liabilities. The Committee members shall be indemnified and held harmless by the Company with respect to any actual or alleged breach of responsibilities performed or to be performed hereunder in their official capacities in the administration of the Plan. 6.4. Claims Procedure. (a) Filing a Claim. Any Participant or beneficiary under the Plan may file a written claim for a Plan benefit with the Committee or with a person named by the Committee to receive claims under the Plan. (b) Notice of Denial of Claim. In the event of a denial or limitation of any benefit or payment due to or requested by any Participant or beneficiary under the Plan ("Claimant"), the Claimant shall be given a written notification containing specific reasons for the denial or limitation of his benefit. The written notification shall contain specific reference to the pertinent Plan provisions on which the denial or limitation of his benefit is based. (c) Court Action. No Participant or beneficiary shall have the right to seek judicial review of a denial of benefits, or to bring any action in any court to enforce a claim for benefits prior to filing a claim for benefits or exhausting his rights to review under this Section 6.4. 6.5. Trustee. The Company shall appoint an independent financial institution to act as Trustee under the Trust Agreement. The Trustee shall serve at the pleasure of the Company and 8 its powers and responsibilities shall be set forth in a written Trust Agreement between the Company and the Trustee. An amount equal to the amount of contributions made pursuant to the Plan may be contributed to the Trust and held by the Trustee in accordance with the terms of the Trust Agreement. ARTICLE VII AMENDMENT AND TERMINATION The Company may amend, suspend or terminate the Plan, in whole or in part, without the consent of the Committee, Participants, beneficiaries or any other person, except that no amendment, suspension or termination shall retroactively impair or otherwise adversely affect (without written consent) the rights of a Participant or beneficiary which have accrued prior to the date of such action, as determined by the Committee in its sole discretion. It is noted, however, that the Participant's benefits under the Plan constitute mere unsecured claims on the general assets of the Company. ARTICLE VIII GENERAL PROVISIONS 8.1. Governing Law. The Plan shall be construed, regulated and administered according to the laws of the State of Indiana, without regard to the choice of law principles thereof, except in those areas preempted by the laws of the United States of America in which case such laws will control. 8.2. Headings and Gender. The headings and subheadings in the Plan have been inserted for convenience of reference only and shall not affect the construction of the provisions hereof. In any necessary construction the masculine shall include the feminine and the singular the plural, and vice versa. 8.3. Participant's Rights; Acquittance. No Participant shall acquire any right to be retained as a Director by virtue of the Plan, nor, upon his dismissal, or upon his voluntary termination as a Director shall he have any right or interest in or to any Plan assets other than as specifically provided herein. 8.4. Spendthrift Clause. No benefit or interest available hereunder will be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment or garnishment by creditors of the Participant or the Participant's designated beneficiary, either voluntarily or involuntarily. 8.5. Counterparts. This Plan may be executed in any number of counterparts, each of which shall constitute but one and the same instrument and may be sufficiently evidenced by any one counterpart. 9 8.6. No Enlargement of Rights. Nothing contained in the Plan shall be construed as a contract of employment between the Company or any Affiliate and any person, nor shall the Plan be deemed to give any person the right to be retained in the employ or as a Director or limit the right of the Company to employ or discharge any person with or without cause. 8.7. Limitations on Liability. Notwithstanding any of the preceding provisions of the Plan, neither the Company, the Committee nor any individual acting as an employee or agent of the Company shall be liable to any Participant, Director or beneficiary for any claim, loss, liability or expense incurred in connection with the Plan, except when the same shall have been judicially determined to be due to the gross negligence or willful misconduct of such person. 8.8. Incapacity of Participant or Beneficiary. If any person entitled to receive a distribution under the Plan is physically or mentally incapable of personally receiving and giving a valid receipt for any payment due (unless prior claim therefor shall have been made by a duly qualified guardian or other legal representative), then, unless and until claim therefor shall have been made by a duly appointed guardian or other legal representative of such person, the Committee may provide for such payment or any part thereof to be made to any other person or institution then contributing toward or providing for the care and maintenance of such person. Any such payment shall be a payment for the account of such person and a complete discharge of any liability of the Company and the Plan. 8.9. Corporate Successors. The Plan shall not be automatically terminated by a transfer or sale of assets of the Company or by the merger or consolidation of the Company into or with any other corporation or other entity ("Transaction"), but the Plan shall be continued after the Transaction only if and to the extent that the transferee, purchaser or successor entity agrees to continue the Plan. 8.10. Evidence. Evidence required of anyone under the Plan may be by certificate, affidavit, document or other information which the person relying thereon considers pertinent and reliable, and signed, made or presented by the proper party or parties. 8.11. Action by the Company. Any action required of or permitted by the Company under the Plan shall be by resolution of its Board, or by resolution of a committee of the Board or by a person or persons authorized by resolution of the Board or a committee. 8.12. Severability. In the event any provisions of the Plan shall be held to be illegal or invalid for any reason, such illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and endorsed as if such illegal or invalid provisions had never been contained in the Plan. 10 SIGNATURES IN WITNESS WHEREOF, the Company has caused this Directors' Deferred Compensation Plan of CFS Bancorp, Inc. to be established by its officers hereunder duly authorized, this 20th day of December 2004, but effective as of January 1, 2005. CFS BANCORP, INC. By: /s/ Thomas F. Prisby ---------------------------------------------------- Thomas F. Prisby, President, Chief Executive Officer 11 EX-23.0 6 c92476exv23w0.txt CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.0 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTANT We consent to the incorporation by reference in following documents of our report dated February 27, 2004, with respect to the 2003 consolidated financial statements of CFS Bancorp, Inc. incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 2004: o Registration Statement (Form S-8 No. 333-62053) pertaining to the Citizens Financial Services, FSB Employees' Savings and Profit Sharing Plan and Trust. o Registration Statement (Form S-8 No. 333-62049) pertaining to the Stock Options Assumed in the Acquisition of SuburbFed Financial Corp. o Registration Statement (Form S-8 No. 333-84207) pertaining to the 1998 Stock Option Plan of CFS Bancorp, Inc. o Registration Statement (Form S-8 No. 333-105687) pertaining to the 2003 Stock Option Plan of CFS Bancorp, Inc. /s/ Ernst & Young LLP Chicago, Illinois March 14, 2005 EX-23.1 7 c92476exv23w1.txt CONSENT OF CROWE CHIZEK AND COMPANY LLC EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Form S-8 Registration Statements Number 333-62053, 333-62049, 333-84207, and 333-105687 of CFS Bancorp, Inc. of our report dated March 11, 2005 on the consolidated financial statements of CFS Bancorp, Inc. as of December 31, 2004 and the year then ended as included in the registrant's annual report on Form 10-K. /s/ Crowe Chizek and Company LLC Oak Brook, Illinois March 14, 2005 EX-31.1 8 c92476exv31w1.txt RULE 13A-14(A) CERTIFICATION OF CEO EXHIBIT 31.1 CERTIFICATION I, Thomas F. Prisby, Chairman of the Board and Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of CFS Bancorp, Inc. (the "Registrant"); 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The Registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. /s/ Thomas F. Prisby -------------------------------------- Thomas F. Prisby Chairman of the Board and Chief Executive Officer Date: March 16, 2005 84 EX-31.2 9 c92476exv31w2.txt RULE 13A-14(A) CERTIFICATION OF CFO EXHIBIT 31.2 CERTIFICATION I, Charles V. Cole, Executive Vice President and Chief Financial Officer certify that: 1. I have reviewed this annual report on Form 10-K of CFS Bancorp, Inc. (the "Registrant"); 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The Registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. /s/ Charles V. Cole -------------------------------------- Charles V. Cole Executive Vice President and Chief Financial Officer Date: March 16, 2005 85 EX-32.0 10 c92476exv32w0.txt SECTION 1350 CERTIFICATIONS EXHIBIT 32.0 SECTION 1350 CERTIFICATIONS I, Thomas F. Prisby, Chairman of the Board and Chief Executive Officer, and Charles V. Cole, 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 year ended December 31, 2004 (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. By: /s/ Thomas F. Prisby ------------------------------------ Thomas F. Prisby Chairman of the Board and Chief Executive Officer Date: March 16, 2005 By: /s/ Charles V. Cole ------------------------------------ Charles V. Cole Executive Vice President and Chief Financial Officer Date: March 16, 2005 A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act has been provided to CFS Bancorp, Inc. and will be retained by CFS Bancorp, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 86 -----END PRIVACY-ENHANCED MESSAGE-----