-----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, LuSfp21KY+I0PfXHRW8v4SPohzEVrpWp1VtHjWf5PAMFreLL4sf44uHqOLlo03CY Prq/66b57fivCOISrZO9NQ== 0000897069-97-000486.txt : 19971208 0000897069-97-000486.hdr.sgml : 19971208 ACCESSION NUMBER: 0000897069-97-000486 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971205 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANTAGE BANCORP INC CENTRAL INDEX KEY: 0000881892 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 391714425 STATE OF INCORPORATION: WI FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-19794 FILM NUMBER: 97733078 BUSINESS ADDRESS: STREET 1: 5935 SEVENTH AVE CITY: KENOSHA STATE: WI ZIP: 53141 BUSINESS PHONE: 4146584861 MAIL ADDRESS: STREET 1: P.O. BOX 728 CITY: KENOSHA STATE: WI ZIP: 53141 10-K405 1 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 September 30, 1997 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________ to ________ Commission file number: 0-19794 ADVANTAGE BANCORP, INC. (Exact name of registrant as specified in its charter) Wisconsin 39-1714425 (State or other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 5935 Seventh Avenue 53140 Kenosha, Wisconsin (ZIP Code) (Address of principal executive offices) Registrant's telephone number, including area code: (414) 658-4861 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K X . Based upon the closing price of the registrant's common stock as of November 21, 1997, the aggregate market value of the voting stock held by non-affiliates of the registrant was $187,445,000.* The number of shares of Common Stock outstanding as of November 21, 1997 was 3,235,830 shares. Documents Incorporated by Reference: None * For purposes of this calculation, all executive officers and directors of the registrant and its bank subsidiary are considered to be affiliates. PART 1 Item 1. Business General Advantage Bancorp, Inc. (the "Company") is a registered savings and loan holding company incorporated under the laws of the State of Wisconsin and is engaged in the savings and loan business through its wholly-owned subsidiary, Advantage Bank, FSB (the "Bank"). The Bank was organized in 1902 as a Wisconsin-chartered savings institution. Effective December 31, 1993, the Bank changed to a federal savings bank charter. The Bank's deposits are insured up to the maximum allowable amount by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is a member of the Federal Home Loan Bank of Chicago ("FHLB"), and is regulated by the Office of Thrift Supervision ("OTS") and the FDIC. The Bank is also regulated by the Board of Governors of the Federal Reserve System relating to reserves required to be maintained against deposits and certain other matters. See "REGULATION." As a consumer-oriented financial institution, the Bank offers a range of retail banking services to residents of its market area. The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits to originate residential loans in its primary market area. The Bank also originates commercial real estate, multi-family, construction, consumer and commercial business loans. In addition, the Bank also invests in mortgage-related securities, investment securities, certificates of deposit and short-term liquid assets. Finally, the Bank offers, through a subsidiary, certain securities brokerage services and insurance products to its customers. The Company's executive office is located at 5935 Seventh Avenue, Kenosha, WI 53140. The telephone number is (414) 658-4861. Proposed Merger On November 3, 1997, the Company entered into an Agreement and Plan of Merger with Marshall & Ilsley Corporation, a Wisconsin corporation, providing for the merger of the Company with and into Marshall & Ilsley Corporation. The merger and related transactions are discussed in more detail in "Management's Discussion and Analysis". Copies of the Agreement and Plan of Merger and the related Stock Option Agreement have been filed as exhibits to this Annual Report on Form 10-K. Special Note Regarding Forward-Looking Statements Certain matters discussed in this Annual Report on Form 10-K are "forward-looking statements" intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as the Company "believes," "anticipates," "expects," or other words of similar import. Similarly, statements that describe the Company's future plans, objectives or goals are also forward-looking statements. Such forward- looking statements are subject to certain risks and uncertainties which are described in close proximity to such statements and which could cause actual results to differ materially from those currently anticipated. Additional factors that may cause actual results to differ materially from those contemplated in the forward-looking statements include: interest rate trends, the general economic climate in the Company's market area, loan delinquency rates and legislative enactments or regulatory changes which adversely affect the business of the Company and/or the Bank. Shareholders, potential investors and other readers are urged to consider these factors in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included herein are only made as of the date of this Annual Report on Form 10-K and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Market Area At September 30, 1997, the Bank conducted business from 15 branch offices located in Kenosha County and Walworth County, Wisconsin and Lake County and Cook County, Illinois. The Bank also has mortgage loan origination offices located in Kenosha, Racine and Wauwatosa, Wisconsin and Grayslake, Naperville and Tinley Park, Illinois. Kenosha has a population of approximately 85,000 and is located in southeastern Wisconsin approximately 40 miles south of Milwaukee, Wisconsin and 55 miles north of Chicago, Illinois. The Bank has historically focused its operations in Kenosha County, Wisconsin. The Bank expanded its operations to Walworth County, Wisconsin in 1973, to Lake County, Illinois in 1988 and to Cook County, Illinois in 1994. In recent years, the Kenosha area economy has expanded due to the aggressive marketing of local industrial parks and the solicitation of businesses from northern Illinois. In addition, Lake County, Illinois has grown rapidly as a result of the northward expansion of the Chicago metropolitan area. Walworth County, and particularly Lake Geneva, is well-established as a leading vacation area in the Midwest. Cook County includes the City of Chicago which is the third largest city in the United States. Competition The Bank faces extensive competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other savings institutions, commercial banks and mortgage bankers who also make loans in the Bank's primary market area. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers. The Bank faces substantial competition in attracting deposits from other savings institutions, commercial banks, securities firms, money market mutual funds, other mutual funds, credit unions and other investment vehicles. The ability of the Bank to attract and retain deposits depends on its ability to provide investment opportunities that satisfy the requirements of investors as to rate of return, liquidity, risk and other factors. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and a customer-oriented staff. The Bank estimates its market share of insured savings deposits to be as follows as of June 30, 1996 based on its own calculation using publicly available data: Kenosha County, Wisconsin - 28%; Walworth County, Wisconsin - 5%; Racine County, Wisconsin - less than 1%, Lake County, Illinois - 1%, and Cook County, Illinois - less than 1%. Lending Activities General. The principal lending activity of the Bank is originating first mortgage loans secured by owner-occupied one- to four-family residential properties located in its primary market area. In addition, in order to increase the yield and interest rate sensitivity of its portfolio, the Bank also originates commercial real estate, multi-family, construction, consumer and commercial business loans in its primary market area. Loan Portfolio Composition. The following table presents information concerning the composition of the Bank's loan portfolios in dollar amounts and in percentages as of the dates indicated. The table includes loans held for sale but does not include advances to unconsolidated partnerships.
Loan Portfolio Composition: September 30 1993 1994 1995 1996 1997 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent (dollars in thousands) Real Estate Loans: One- to four- family (1) . . . . $292,093 69.97% $307,169 68.17% $399,467 72.90% $418,647 70.01% $378,701 64.42% Multi-family . . . . 31,254 7.49 30,667 6.81 27,810 5.08 24,993 4.18 26,923 4.58 Commercial . . . . . 46,570 11.15 51,962 11.53 49,393 9.01 54,671 9.14 63,755 10.85 One- to four-family construction (2) 8,532 2.04 12,185 2.70 11,057 2.02 7,598 1.27 5,148 0.88 Other construction and land . . . . . . . 13,238 3.17 16,474 3.66 20,629 3.77 30,161 5.04 24,448 4.16 -------- ------ -------- ------- -------- ------ -------- ------ -------- ------ Total real estate loans 391,687 93.82 418,457 92.88 508,356 92.78 536,070 89.64 498,975 84.89 -------- ------ -------- ------- -------- ------ -------- ------ -------- ------ Other Loans: Consumer loans: Home equity . . . . 9,570 2.29 12,051 2.67 22,741 4.15 43,893 7.34 67,997 11.57 Student . . . . . . 2,341 0.56 3,010 0.67 3,613 0.66 4,040 0.68 4,307 0.73 Automobile . . . . . 906 0.22 565 0.13 1,020 0.19 1,553 0.26 1,662 0.28 Other consumer loans 3,857 0.92 4,030 0.89 1,323 0.24 1,732 0.29 2,503 0.43 Commercial business loans . . . . . . . 9,142 2.19 12,436 2.76 10,853 1.98 10,691 1.79 12,429 2.10 -------- ------ -------- ------- -------- ------ -------- ------ -------- ------ Total other loans . . . 25,816 6.18 32,092 7.12 39,550 7.22 61,909 10.36 88,898 15.11 -------- ------ -------- ------- -------- ------ -------- ------ -------- ------ Gross loans receivable 417,503 100.00% 450,549 100.00% 547,906 100.00% 597,979 100.00% 587,873 100.00% ====== ======= ====== ====== ====== Add: Accrued interest 2,414 2,723 3,390 3,718 3,755 Less: Undisbursed portion of loan proceeds . . . (26,844) (19,119) (31,531) (30,100) (19,150) Unamortized loan fees (2,482) (2,220) (2,017) (2,104) (859) Allowance for losses on loans . . . . . . . (4,937) (5,327) (5,271) (5,773) (5,797) Allowance for uncollected interest (859) (1,037) (195) (938) (563) -------- ------- ------- ------- ------- Net deduction . . . (32,708) (24,980) (35,624) (35,197) (22,614) -------- ------- ------- ------- ------- Total loans receivable, net . . . . . . . . . $384,795 $425,569 $512,282 $562,782 $565,259 ======== ======== ======== ======== ======== (1) Includes construction/permanent loans to persons intending to occupy their homes upon the completion of construction totalling $37.3 million, $22.5 million, $46.7 million, $50.7 million and $31.8 million as of September 30, 1993, 1994, 1995, 1996 and 1997, respectively. (2) Consists of short-term balloon construction loans to builders and developers who intend to sell the homes upon completion of construction.
The following schedule illustrates the maturity of the Bank's loan portfolio at September 30, 1997. The schedule does not reflect scheduled principal amortizations, projected repayments, or the period to repricing for adjustable rate loans. This schedule is based on contractual maturity dates since, under the Bank's "rollover" policy, the Bank does not automatically rollover balloon notes at maturity but reserves the right to demand payment in full based on its evaluation of the borrower, collateral and other material factors.
Real Estate Loans Other Loans One- to Total Four- Multi- Commercial Construction Commercial Loans Maturing Family Family Real Estate and Land Business Consumer Receivable (In thousands) Within one year $7,658 $1,300 $22,217 $15,993 $5,667 $3,164 $55,999 After one year: 1 to 3 years 8,018 1,529 21,508 10,223 3,668 7,603 52,549 3 to 5 years 8,502 1,404 6,753 634 1,478 15,281 34,052 5 to 10 years 29,492 4,890 7,958 2,337 648 35,821 81,146 10 to 20 years 82,970 9,112 4,960 409 968 14,070 112,489 Over 20 years 242,061 8,688 359 - 530 251,638 -------- --------- --------- -------- -------- --------- --------- Total due after one year . . 371,043 25,623 41,538 13,603 6,762 73,305 531,874 -------- --------- --------- -------- -------- --------- --------- Gross loan receivable . $378,701 $26,923 $63,755 $29,596 $12,429 $76,469 $587,873 ======== ========= ========= ========= ======== ========= ========== Add: Accrued interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,755 Less: Undisbursed portion of loan proceeds . . . . . . . . . . . . . . . . . . . . . . . . (19,150) Less: Unamortized loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (859) Less: Allowance for losses on loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,797) Less: Allowance for uncollected interest . . . . . . . . . . . . . . . . . . . . . . . . . (563) -------- Loans receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $565,259 ========
The following table sets forth, at September 30, 1997, the dollar amount of all loans due after September 30, 1998 and whether such loans have fixed interest rates or adjustable interest rates. Due after September 30, 1998 Fixed Adjustable Total Real estate loans: (In thousands) One- to four-family . . . $108,853 $262,190 $371,043 Multi-family . . . . . . . 9,928 15,695 25,623 Commercial real estate . . 26,877 14,661 41,538 Construction and land . . 10,192 3,411 13,603 --------- --------- --------- Total real estate loans . 155,850 295,957 451,807 --------- --------- --------- Other loans . . . . . . . . . 42,032 38,035 80,067 --------- --------- --------- Total loans receivable . . $197,882 $333,992 $531,874 ========= ========= ========= Lending - General Under federal law and regulations, the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% (25% if the security for such a loan has a "readily ascertainable" value or 30% for certain residential development loans) of unimpaired capital and surplus. At September 30, 1997, based on the above, the Bank's regulatory loan-to-one-borrower limit was $10.7 million. On the same date, the Bank had no loans to one borrower which had aggregate balances in excess of this limit. Loan applications are initially considered and approved at various levels of authority, depending on the type, amount and loan-to-value ratio of the loan. Mortgage loans up to $400,000 are approved by designated employees and officers. Mortgage loans in excess of $400,000 and up to $1 million are approved by a Loan Committee consisting of the President, the Senior Vice President-Mortgage Lending, the Senior Vice President- Finance and the Vice President-Commercial Lending. Mortgage loans in excess of $1 million must be approved by the Board of Directors of the Bank. Commercial business loans in excess of $250,000 must be approved by the President. Commercial business loans in excess of $350,000 and up to $1 million must be approved by the Loan Committee. Commercial business loans in excess of $1 million must be approved by the Board of Directors of the Bank. Certain higher risk commercial loans, such as loans to restaurants and motels, must be approved by the Board of Directors of the Bank if the balance exceeds $100,000. All of the Bank's lending is subject to its written, nondiscriminatory underwriting standards and to loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and property valuations (consistent with the Bank's written appraisal policy) by independent appraisers. The loan applications are designed primarily to determine the borrower's ability to repay and the more significant items on the application are verified through use of credit reports, financial statements, tax returns, and/or confirmations from third parties. The Bank requires evidence of marketable title and lien position on all loans secured by real property and requires fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan. The Bank may also require flood insurance to protect the property securing its interest. The Bank requires title insurance on all first mortgage loans secured by real estate and on second mortgage loans with balances over $75,000. The Bank encounters certain environmental risks in its lending activities. Under federal and state environmental laws, lenders may become liable for the costs of cleaning up hazardous material found on security properties. Although environmental risks are more usually associated with industrial and commercial loans, environmental risks may be substantial for residential loans since environmental contamination may render the residential properties unsuitable for residential use. In addition, the value of residential properties may become substantially diminished by contamination of nearby properties. In accordance with secondary mortgage market guidelines, appraisals for single-family loans include comments on environmental influences and conditions. The Bank attempts to control its exposure to environmental risks with respect to loans secured by larger properties by monitoring available information on hazardous waste disposal sites and requiring environmental inspections on such properties prior to disbursing the loan. No assurance can be given, however, that the value of properties securing loans in the Bank's portfolio will not be adversely affected by the presence of hazardous materials or that future changes in federal or state laws will not increase the Bank's exposure to liability for environmental cleanup. One- to Four-Family Residential Real Estate Lending The cornerstone of the Bank's lending program has long been the origination of permanent loans secured by mortgages on owner-occupied one- to four-family residences. At September 30, 1997, $378.7 million, or 64.4%, of the Bank's loan portfolio consisted of permanent loans on one- to four-family residences. Substantially all of the residential loans originated by the Bank are secured by properties located in the Bank's primary market area. The Bank originates a variety of different types of residential loans including various types of one- to four-family residential adjustable rate mortgage loans ("ARMs") and fixed rate loans with 30 year and shorter contractual maturities. The Bank's ARMs are fully amortizing loans with contractual maturities of up to 30 years. The interest rates on the ARMs are subject to adjustment at stated intervals. A substantial portion of the Bank's ARMs have interest rates which adjust annually. Some of the Bank's ARMs have been originated with fixed rates for the first three or five years with adjustable rates thereafter. At September 30, 1997, the Bank had $68.0 million of ARMs which will adjust annually after a specified period after origination and which had more than 12 months remaining until the next repricing date. Prior to 1988, substantially all of the Bank's ARMs carried interest rates which were subject to annual adjustment by the Bank on a discretionary basis ("Non-index ARMs"). Since 1988, the Bank has originated ARMs with interest rates which are reset to a stated margin over an index based on yields for one year U.S. Treasury Securities ("Treasury ARMs"). At September 30, 1997, the Bank had approximately $23.0 million of Non-index ARMs and $231.3 million of Treasury ARMs in its mortgage loan portfolio. The Bank's ARMs generally establish limits on the amount of the periodic interest rate changes. Decreases or increases in the interest rate of the Bank's Treasury ARMs are generally limited to between 1% and 2% at any adjustment date with a lifetime cap that applies over the entire term of the loan. Annual interest rate increases on Non-index ARMs are limited to 1% per year, calculated on a cumulative basis from the loan origination date. The Bank's delinquency experience on its ARMs has generally been similar to its experience on fixed rate residential loans. Most of the Bank's ARMs originated after 1987 are convertible into fixed-rate loans at the market rate at the time of conversion. The Bank evaluates both the borrower's ability to make principal, interest and escrow payments and the value of the property that will secure the loan. The Bank originates residential mortgage loans with loan-to-value ratios of up to 97%. On any mortgage loan exceeding an 80% loan-to-value ratio at the time of origination, the Bank generally requires private mortgage insurance in an amount intended to reduce the Bank's exposure to 75% or less of the appraised value of the underlying property. The Bank's residential mortgage loans usually include "due-on-sale" clauses, which are provisions giving the Bank the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property subject to the mortgage. The Bank enforces due-on-sale clauses to the extent permitted under applicable law. As of September 30, 1997, one- to four-family residential loans included $31.8 million of permanent loans to individuals for the construction of their primary residences. These loans require only the payment of interest during the construction phase and thereafter have rates and terms which are similar to those of any one- to four-family residential loans offered by the Bank. The interest rate and loan term is established at the time the construction loan commitment is made. These loans are underwritten pursuant to the same guidelines used for originating other one- to four-family residential loans. Multi-Family and Commercial Real Estate Lending In order to enhance the yield on, and decrease the average term to maturity of, its assets, the Bank originates permanent multi-family and commercial real estate loans on a wide variety of different types of properties. The Bank has originated both adjustable and fixed rate multi-family and commercial real estate loans. Rates on the Bank's adjustable rate multi-family and commercial real estate loans generally adjust in a manner consistent with the Bank's residential ARMs. Multi-family and commercial real estate loans are generally written in amounts of up to 80% of the appraised value of the underlying property. Appraisals on properties securing multi-family and commercial real estate loans originated by the Bank are performed by an independent appraiser selected by the Bank. All appraisals on multi-family and commercial real estate loans are reviewed by the Bank's management. In addition, the Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships, references and income projections for the property. Borrowers are generally personally liable for all or a portion of their multi-family and commercial real estate loans. At September 30, 1997, the Bank had (in addition to loans to unconsolidated partnerships) 11 borrowers on multi-family and commercial real estate loans that were indebted to the Bank in excess of $3.0 million and 28 other borrowers with total loan balances in excess of $1.0 million. On the same date, the Bank's largest group of multi-family and commercial real estate loans to one borrower had an aggregate balance of $8.9 million consisting of loans secured by land and condominiums. Substantially all of the Bank's multi-family residential and commercial real estate loans are secured by properties located within 150 miles of the Bank's headquarters. Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties, and the difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. Nevertheless, the Bank's delinquency experience on its multi-family and commercial real estate loans has been generally satisfactory to date. The Bank generally obtains annual cashflow statements from borrowers for multi-family and commercial real estate loans in excess of $1 million. These statements are analyzed to determine the quality of the loan. Construction and Land Lending The Bank makes construction loans to builders and developers for the construction of one- to four-family residences and other types of properties. The Bank also makes loans for the acquisition of land. Substantially all of these loans are secured by properties located within 150 miles of the Bank's headquarters. The Bank offers short-term construction balloon loans to builders for the construction of one- to four-family residences. These loans generally have terms from 12 to 24 months and carry fixed rates of interest. At September 30, 1997, the Bank had $5.1 million of loans to builders for the construction of one- to four-family residences. Most of the Bank's construction and land loans to developers and builders (for properties other than one- to four-family residences) have been originated with terms of three years or less. Construction and land loans are generally made in amounts up to a maximum loan-to-value ratio of 80% based upon an independent appraisal. Some of the Bank's construction and land loans provide an interest reserve for the payment of interest and fees from the loan proceeds. The Bank also obtains personal guarantees for substantially all of its construction and land loans. The Bank reviews the personal financial statements of its borrowers and guarantors on construction and land loans. At September 30, 1997, the Bank had five construction and land loans with balances in excess of $1 million. The Bank's construction and land loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. The amount of each disbursement is based on the construction cost estimate of an independent architect, engineer or qualified inspector who inspects the project in connection with each disbursement request. The Bank periodically reviews the progress of the underlying construction project. Construction and land loans are obtained principally through continued business from developers and builders who have previously borrowed from the Bank as well as walk-in customers, broker referrals and direct solicitations of builders. The application process includes a submission to the Bank of plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the current appraised value of the property to be constructed and/or the costs of construction (including the value of the land). Construction and land lending generally affords the Bank an opportunity to receive interest at rates higher than those obtainable from residential lending and to receive higher origination and other loan fees. In addition, construction and land loans are generally made with adjustable rates of interest and/or for relatively short terms. Nevertheless, construction and land lending to persons other than owner-occupants is generally considered to involve a higher level of credit risk than one- to four-family residential lending because loan amounts are larger, and the effects of general economic conditions on construction projects, real estate developers and managers can be substantial. The nature of these loans is such that they are more difficult to evaluate and monitor. The Bank's risk of loss on a construction or land loan is dependent largely upon the accuracy of the initial estimate of the property's value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the project may have a value which is insufficient to assure full repayment of the loan. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. When loan payments become due, the cash flow from the property may not be adequate to service the debt. In such cases, the Bank may be required to modify the terms of the loan. At September 30, 1997, the Bank was not aware of any material cash flow or other problems on any of its construction and land loans. Commercial Business Lending The Bank's commercial business loans include secured and unsecured loans. These loans are for a broad variety of purposes including working capital, accounts receivable, inventory, equipment and acquisitions. The Bank has no agricultural, energy or foreign loans. Most of the Bank's commercial business loans have terms to maturity of five years or less or they have adjustable interest rates. At September 30, 1997, the Bank had two commercial business loans with balances in excess of $500,000. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income and which are secured by real property with a value that tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which is likely to be dependent upon the general economic environment.) The Bank's commercial business loans are sometimes, but not always, secured by business assets, such as accounts receivable, equipment and inventory as well as real estate. However, the collateral securing the loans may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. The Bank recognizes the generally increased risks associated with commercial business lending. The Bank's commercial business lending policy emphasizes (1) credit file documentation, (2) analysis of the borrower's character, (3) analysis of the borrower's capacity to repay the loan, (4) adequacy of the borrower's capital and collateral, and (5) evaluation of the industry conditions affecting the borrower. Analysis of the borrower's past, present and future cash flows is also an important aspect of the Bank's credit analysis. The Bank plans to continue to expand its commercial business lending, subject to market conditions. The Bank generally obtains annual financial statements from borrowers for commercial business loans. These statements are analyzed to monitor the quality of the loan. Consumer Lending Management believes that offering consumer loan products helps to expand the Bank's customer base and create stronger ties to its existing customer base. In addition, consumer loans generally have shorter terms to maturity (or have adjustable interest rates) and carry higher interest rates than residential mortgage loans. For these reasons, the Bank has increased its consumer lending in recent years. The Bank offers a variety of secured consumer loans, including home equity loans, automobile loans, education loans and loans secured by savings deposits. In addition, the Bank also offers home improvement loans and unsecured consumer loans. Consumer loan terms vary according to the type of collateral, term of the loan and creditworthiness of the borrower. The Bank offers both open-end and closed-end credit. Open-end credit is extended through home equity lines of credit. This credit line product generally bears interest at a variable rate tied to the prime rate of interest. The underwriting standards employed by the Bank for consumer loans include (1) obtaining the borrower's credit score from an independent, nationally-recognized credit-scoring firm, (2) a determination of the applicant's payment history on previous debts, and (3) an assessment of the borrower's ability to meet payments on the proposed loan along with the applicant's existing obligations. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount. Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for defaulted consumer loans may not provide adequate sources of repayment for the outstanding loan balances as a result of the greater likelihood of damage to or depreciation of the collateral. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Although the level of delinquencies in the Bank's consumer loan portfolio has generally been low, there can be no assurance that delinquencies will remain low in the future. Originations, Purchases and Sales of Loans The Bank originates real estate and other loans through internal loan production personnel located in the Bank's offices and through independent companies known as third-party originators. Walk-in customers and referrals from real estate brokers and builders are also important sources of loan originations. Consistent with the Bank's asset/liability management strategy, the Bank sells all of its 30 year fixed-rate loan originations and varying portions of its 15 year fixed-rate loan originations in the secondary market. The Bank's sales are usually made through forward sales commitments. The Bank attempts to limit any interest rate risk related to its origination of fixed rate loans by limiting the number of days between the loan commitment and the forward sales commitment, charging fees for loan commitments longer than 60 days, and attempting to match its fixed rate loan commitments to customers with forward sales commitments. When loans are sold, the Bank generally retains the responsibility for servicing the loan. At September 30, 1997, the Bank serviced $218.6 million of loans for others, principally the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The following table shows the loan origination, business acquisition, purchase, sale and repayment activities of the Bank for the periods indicated. Year Ended September 30 1995 1996 1997 (in thousands) Mortgage Loans (gross): At beginning of period . . . . . . . $418,457 $508,356 $536,070 Business acquisitions . . . . . . . . 33,448 - - Mortgage loan originations: 114,214 One- to four-family . . . . . . . . 170,377 190,749 Multi-family . . . . . . . . . . . . 4,807 525 7,888 Commercial real estate, other construction and land . . . . . . . 62,499 78,224 39,833 -------- -------- -------- Total mortgage loans originations and acquisitions . . . . . . . 214,968 249,126 238,470 -------- -------- -------- Mortgage loans purchased: One- to four-family . . . . . . . . 9,929 - - -------- -------- -------- Total mortgage loans purchased . 9,929 0 0 -------- -------- -------- Total mortgage loans originated and purchased . . . . . . . . . 224,897 249,126 238,470 Principal repayments . . . . . . . . (116,918) (165,561) (154,146) Transfers (to) from foreclosed properties . . . . . . . . . . . . . (2,152) (748) 1,665 Sales of fixed rate loans . . . . . . (15,928) (55,103) (123,084) -------- -------- -------- At end of period . . . . . . . . . . $508,356 $536,070 $498,975 ======== ======== ======== Commercial Business Loans (gross): At beginning of period . . . . . . . $12,436 $10,853 $10,691 Business acquisitions . . . . . . . . 95 - - Commercial loans originated . . . . . 15,650 15,772 23,116 Principal repayments . . . . . . . . (17,328) (15,934) (21,378) -------- -------- -------- At end of period . . . . . . . . . . $10,853 $10,691 $12,429 ======== ======== ======== Consumer Loans (gross): At beginning of period . . . . . . . . $19,656 $28,697 $51,218 Business acquisitions . . . . . . . . 3,638 - - Consumer loans originated . . . . . . 22,091 44,622 58,489 Principal repayments . . . . . . . . (16,688) (22,101) (33,239) -------- -------- -------- At end of period . . . . . . . . . . $28,697 $51,218 $76,468 ======== ======== ======== Delinquencies and Non-Performing Assets Delinquency Procedures. When a borrower fails to make a required payment on a loan, the Bank attempts to cause the delinquency to be cured by contacting the borrower. In the case of residential loans, a late notice is sent 15 days after the due date. If the delinquency is not cured by the 30th day, contact with the borrower is made by phone. Additional written and oral contacts are made with the borrower between 30 and 60 days after the due date. In the event a loan payment is past due for more than 30 days, it is classified as a delinquent loan. In such cases, the Bank regularly reviews the loan status, the condition of the property, and circumstances of the borrower. Based upon the results of its review, the Bank may negotiate and accept a repayment program with the borrower, accept a voluntary deed in lieu of foreclosure, or initiate foreclosure proceedings. If foreclosed on, real property is sold at a public sale and the Bank may bid on the property to protect its interest. A decision as to whether and when to initiate foreclosure proceedings is based on such factors as the amount of the outstanding loan in relation to the original indebtedness, the extent of delinquency, and the borrower's ability and willingness to cooperate in curing the delinquency. Delinquent consumer loans are handled in a generally similar manner, except that initial contacts are made when the payment is 15 days past due and personal contacts are made when the loan becomes more than 20 days past due. Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed property until it is sold. When property is acquired, it is recorded at the lower of cost or estimated fair value at the date of acquisition, and any writedown resulting therefrom is charged to expense. Upon acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of net realizable value. Loan Delinquencies. The following tables set forth the Bank's loan delinquencies by type, by amount and by percentage of loan category at September 30, 1996 and 1997.
60-89 Days Delinquent Delinquent 90 days and over Total Delinquent Loans Percent Percent Percent of Loan of Loan of Loan Number Amount Category Number Amount Category Number Amount Category (dollars in thousands) Delinquent loans at September 30, 1996 Real estate: One- to four- family . . . 10 $935 0.22% 17 $574 0.14% 27 $1,509 0.36% Multi-family and commercial . 4 352 0.44 4 708 0.89 8 1,060 1.33 Construction and land . . . . - - - 7 1,774 4.70 7 1,774 4.70 Commercial business . . . - - - 5 274 2.56 5 274 2.56 Consumer . . . . 8 14 0.03 8 84 0.16 16 98 0.19 ---- ----- ---- ------ ---- ----- Total . . . . . . 22 $1,301 0.22% 41 $3,414 0.57% 63 $4,715 0.79% ==== ===== ===== ==== ====== ===== ===== ===== ===== Delinquent loans at September 30, 1997 Real estate: One- to four- family . . . 14 $813 0.21% 12 $1,796 0.47% 26 $2,609 0.68% Multi-family and commercial . 2 233 0.26 6 645 0.71 8 878 0.97 Construction and land . . . . 2 78 0.32 1 283 1.16 3 361 1.48 Commercial business . . . - - - 4 51 0.41 4 51 0.41 Consumer . . . . 6 63 0.08 20 385 0.50 26 448 0.58 ----- ------ ----- ----- ----- ----- Total . . . . . . 24 $1,187 0.20% 43 $3,160 0.54% 67 $4,347 0.74% ===== ====== ===== ===== ===== ===== ===== ===== =====
As of September 30, 1997, loans delinquent 60 days or more totalled $4.3 million compared to $4.7 million as of September 30, 1996. As a percent of total loans receivable, delinquencies decreased from 0.79% as of September 30, 1996 to 0.74% as of September 30, 1997. Foreclosed Properties. Foreclosed properties increased from $1.4 million as of September 30, 1996 to $1.8 million as of September 30, 1997. As of September 30, 1997, there was one foreclosed property with a balance over $400,000. Classification of Assets. Federal regulations require that each savings institution classify its own assets on a regular basis. In addition, in connection with examinations of savings institutions, OTS and FDIC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: Substandard, Doubtful and Loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of Substandard assets, with the additional characteristics 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 possibility of loss. An asset classified Loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations have also created a Special Mention category, consisting of assets which do not currently expose a savings institution to a sufficient degree of risk to warrant classification, but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets classified as Substandard or Doubtful require the institution to establish prudent general allowances for losses on loans. If an asset, or portion thereof, is classified as Loss, the institution must either establish specific allowances for losses on loans in the amount of 100% of the portion of the asset classified Loss, or charge off such amount. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the District Director of the OTS. Classified assets include non-performing assets plus other loans and assets which meet the criteria for classification. Non-performing assets include loans which are not performing under all material contractual terms of the original notes and foreclosed properties. The Bank does not accrue interest on non-performing assets. Loans are placed into non-accrual (non-performing) status when they are contractually delinquent more than 90 days, or earlier if warranted based on management's assessment of the loan. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. Classified assets, including non-performing assets, are set forth in the following table. September 30 1996 1997 (in thousands) Non-performing loans: One- to four-family . . . . . . . . . $574 $1,796 Commercial real estate . . . . . . . 708 646 Construction and land . . . . . . . . 1,774 283 Commercial business . . . . . . . . . 274 51 Consumer and other . . . . . . . . . 84 385 ------- ------- Total non-performing loans . . . . . 3,414 3,161 ------- ------- Foreclosed properties: One- to four-family . . . . . . . . . 869 954 Commercial real estate . . . . . . . 534 839 Land . . . . . . . . . . . . . . . . - - ------- ------- Total foreclosed properties . . . . . 1,403 1,793 ------- ------- Total non-performing assets . . . . . . 4,817 4,954 Non-performing assets not included in classified assets due to adequate collateral value: One- to four-family loans . . . . . . (38) (18) Commercial real estate loans . . . . - - Consumer loans . . . . . . . . . . . (15) (30) Foreclosed properties . . . . . . . . (631) (768) Additional classified assets (not considered non-performing): One- to four-family loans . . . . . . 1,216 856 Multi-family loans . . . . . . . . . - 233 Consumer loans . . . . . . . . . . . 44 62 Commercial real estate loans . . . . 1,311 - Construction and land . . . . . . . - 78 Commercial business . . . . . . . . . - - ------- ------- Total classified assets . . . . . . . . $6,704 $5,367 ======= ======= Total classified assets decreased to $5.4 million as of September 30, 1997 from $6.7 million as of September 30, 1996. Any loans classified for regulatory purposes as Loss, Doubtful, Substandard or Special Mention that have not been included in non- performing loans do not (1) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources, or (2) represent material credits about which management is aware of any information which causes management to have serious doubt as to the ability of such borrower to comply with the loan repayment terms. As of September 30, 1997, management is not aware of any significant potential problem loans which are not included in non-performing loans. For the years ended September 30, 1997 and 1996, additional interest income which would have been recorded had the non-performing loans been current in accordance with their original terms amounted to $213,000 and $265,000, respectively. These amounts were not included in the Bank's income for these periods. The amounts that were included in interest income on such loans for these periods was $73,000 and $103,000, respectively. Allowance for losses on loans: Management has considered the Bank's delinquent loans, non-performing loans, and classified assets in establishing its allowance for losses on loans as of September 30, 1997. The allowance reflects management's evaluation of the risks inherent in the Bank's loan portfolio and the collectibility of the delinquent loans and non-performing loans. Although the Bank maintains its allowance at a level which it considers adequate to provide for potential losses, there can be no assurances that such losses will not exceed the estimated amounts or that higher provisions will not be necessary in the future. The distribution of the allowance for losses on loans by type of loan is as follows (dollars in thousands):
September 30, 1993 September 30, 1994 Percent of Percent of Loans in Allowance Loans in Allowance Total Each for Total Each for Losses Loan Category to Losses Loan Category to on Loans Balances Total Loans on Loans Balances Total Loans Real estate loans: One- to four-family . . . . . . . . . . $ 708 $300,625 72.01% $ 789 $319,355 70.88% Multi-family and commercial . . . . . 3,377 91,062 21.81 3,556 99,103 22.00 Consumer loans . . . . . . . . . . . . . 320 16,674 3.99 330 19,656 4.36 Commercial business . . . . . . . . . . . 532 9,142 2.19 652 12,436 2.76 ----- ------- ------- ------ ------- ------ Total . . . . . . . . . . . . . . . . . $4,937 $417,503 100.00% $5,327 $450,550 100.00% ====== ======= ======= ====== ======= ====== September 30, 1995 September 30, 1996 September 30, 1997 Percent of Percent of Percent Loans in Loans in of Loans Allowance Each Allowance Each Allowance in Each for Total Category for Category for Total Category Losses Loan to Total Losses Total Loan to Total Losses Loan to Total on Loans Balances Loans on Loans Balances Loans on Loans Balances Loans Real estate loans: One- to four- family . . . . $1,262 $410,524 72.90% $1,782 $426,245 71.28% $1,361 $383,849 65.29% Multi-family and commercial 2,824 97,832 19.88 2,824 109,824 18.37 2,824 115,126 19.58 Consumer loans . 360 28,697 5.24 351 51,219 8.57 241 76,469 13.01 Commercial business . . . . 825 10,853 1.98 816 10,691 1.78 1,371 12,429 2.12 ------ ------- ------ ------ ------- ------ ------ ------- ------ Total . . . . . $5,271 $547,906 100.00% $5,773 $597,979 100.00% $5,797 $587,873 100.00% ====== ======= ====== ====== ======= ====== ====== ======= ======
Investment Activities - General The Company's investment policy provides for a held-to-maturity portfolio, an available-for-sale portfolio, and a trading portfolio. Securities purchased for the held-to-maturity portfolio are made with the intent to hold until maturity. This portfolio is accounted for on an amortized cost basis. Securities in the available-for-sale portfolio are accounted for at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. All U.S. government and agency securities are currently held in the available-for-sale portfolio. The Company does not presently hold any securities in its trading portfolio. Investment Activities - Mortgage Securities The Bank purchases mortgage securities to supplement loan production and to provide collateral for borrowings. The following table shows purchases and repayments of mortgage securities: Year Ended September 30 1995 1996 1997 (in thousands) At beginning of period . . . $240,676 $351,599 $337,794 Business acquisitions . . . . 34,168 - - Purchases . . . . . . . . . . 118,139 46,924 73,149 Principal repayments and (37,782) (59,016) (55,684) amortization . . . . . . . . Sales . . . . . . . . . . . . (9,459) - - Market value adjustment . . . 5,857 (1,713) 2,953 -------- -------- -------- At end of period . . . . . . $351,599 $337,794 $358,212 ======== ======== ======== The following table shows the carrying value of the Company's mortgage-related securities by type:
September 30 Type 1993 1994 1995 1996 1997 (in thousands) Mortgage-backed securities held to maturity: One- to four-family . . . . . $164,921 $ 29,201 $ 44,767 $ 11,011 $ 8,322 Multi-family . . . . . . . . 4,843 - - - - Commercial real estate . . . 80 - - - - ------- ------- -------- -------- -------- 169,844 29,201 44,767 11,011 8,322 Mortgage-related securities held to maturity: Fixed-rate CMOs (1-4 family) 35,610 69,633 107,700 132,246 166,880 Floating-rate CMOs (1-4 family) . . . . . . . . . . - - 43,606 39,224 51,571 Interest-only strips . . . . 91 - - - - Principal-only strips . . . . 10,071 - - - - CMO residual . . . . . . . . 23 - - - - ------- ------- -------- -------- -------- 45,795 69,633 151,306 171,470 218,451 Mortgage-backed securities One-to four-family . . . . . - 129,000 143,971 139,766 117,033 Multi-family . . . . . . . . - 2,213 1,060 321 300 ------- ------- -------- -------- -------- - 131,213 145,031 140,087 117,333 Mortgage-related securities available for sale: CMOs (1-4 family) . . . . . . - - - 5,684 5,357 Interest-only strips . . . . - 3,948 2,738 2,815 2,194 Principal-only strips . . . . - 6,681 7,757 6,727 6,555 ------- ------- -------- -------- -------- - 10,629 10,495 15,226 14,106 ------- ------- -------- -------- -------- Total mortgage securities . . . $215,639 $240,676 $351,599 $337,794 $358,212 ======= ======= ======== ======== ========
Mortgage-backed securities: Almost all of the Company's mortgage-backed securities are either (1) one- to four-family mortgage securities issued by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA"), or the Federal Home Loan Mortgage Corporation ("FHLMC"); or (2) one- to four- family mortgage securities with at least an AA rating from a national rating agency. Accordingly, management believes that most of the Company's mortgage-backed securities are generally resistant to credit problems. Mortgage-related securities: All except one of the Company's mortgage- related securities are either (1) derived from (and therefore backed by) mortgage-backed securities issued by GNMA, FNMA or FHLMC; or (2) have at least a AA rating from a national rating agency and are backed by one- to four-family residential mortgage loans. The only exception is a floating-rate CMO with a net book value of $4.7 million at September 30, 1997 which has an A rating. The CMO mortgage securities consist of (1) short-term, primarily sequential pay class, fixed-rate securities with projected average lives as of the date of purchase of between two and four years, and (2) floating rate securities for which the rate is based on a predetermined margin over the London Interbank Borrowing Rate (LIBOR) with a lifetime cap. The risks involved in holding these securities are similar to the risks involved in holding mortgage-backed securities. The risks relating to the fixed-rate securities are that (1) prepayment rates on the underlying mortgage-backed securities will be less than projected, resulting in a longer than expected life probably during a period in which market interest rates have increased (extension risk), and (2) prepayment rates on the underlying mortgage-backed securities will exceed projections resulting in a shorter than expected life possibly during a period in which the funds will have to be reinvested at lower market interest rates (prepayment risk and reinvestment risk). The risks relating to the floating-rate securities include (1) that market rates will exceed the lifetime cap, and (2) that the index used to determine the rate on the security will change in a manner different than the Company's short-term cost of funds. Interest-only strip mortgage securities receive only the interest portion of the payments received by the underlying mortgage-backed securities. The risk involved in holding interest-only strips is that the underlying mortgage-backed securities will prepay at a faster rate than originally projected. Faster prepayments reduce the yield and the market value of the strip since less interest is received over the life of the security. The Company has purchased interest-only strips to protect against increases in interest rates, since interest-only strip securities increase in value if prepayments decrease, which generally occurs if interest rates increase. Principal-only strip mortgage securities receive only the principal portion of the payments received by the underlying mortgage-backed securities. The risk involved in holding a principal-only strip is that the underlying mortgage-backed securities will prepay at a slower rate than originally projected. This reduces the yield rate on the strip since the principal payments are received over a longer time period. The Company has purchased principal-only strips to protect against prepayment risk and reinvestment risk since these securities increase in value if prepayments increase, which generally occurs if interest rates decrease. Investment Activities - Other In addition to lending activities and investments in mortgage securities, the Company and the Bank conduct other investment activities on an ongoing basis in order to diversify assets, limit interest rate risk and credit risk, and to meet regulatory liquidity requirements. Investment decisions are made by authorized officers in accordance with policies established by the respective Boards of Directors. The Company and the Bank normally invest in high quality short- and medium-term investments, primarily interest-bearing deposits of insured banks and U.S. government and agency securities. Under their investment policies, the Company and the Bank may also invest in high-grade corporate bonds, mutual funds, repurchase agreements, federal funds, high-grade commercial paper, banker's acceptances, municipal and state government obligations, financial futures contracts, foreign bank CDs, and asset- backed securities. No such investments were made during 1997 but they may be made in the future, depending on market conditions. The Bank is required by federal regulations to maintain a minimum amount of liquid assets that must be invested in specified securities. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is provided. As of September 30, 1997, the Bank's liquidity ratio (liquid assets as a percentage of net withdrawable savings and current borrowings) was 8.5% compared to the OTS requirement of 5.0%. The following table sets forth the composition of the Company's other investments at the dates indicated.
September 30 1995 1996 1997 Carrying % of Carrying % of Carrying % of Value Total Value Total Value Total (dollars in thousands) Securities available for sale: U.S. government and agency securities . . . . . . . . $25,016 100.0% $29,385 100.0% $19,956 100.0% ------- ----- ------- ------ ------ ----- Total . . . . . . . . . . . $25,016 100.0% $29,385 100.0% $19,956 100.0% ======= ===== ======= ====== ====== ===== Other investments: Demand deposits in other financial institutions . . . $9,603 48.6% $17,715 65.3% $30,519 76.4% Time deposits in other financial institutions . . . 308 1.6 611 2.3 509 1.3 ------- ------- ------- ------ -------- ------ Subtotal . . . . . . . . . . 9,911 50.2 18,326 67.6 31,028 77.7 FHLB stock . . . . . . . . . 9,848 49.8 8,796 32.4 8,918 22.3 ------- ------- ------- ------ ------- ------ Total . . . . . . . . . . . . $19,759 100.0% $27,122 100.0% $39,946 100.0% ======= ======= ======= ====== ======= ======
The composition and contractual maturities (except for securities available for sale, which are classified as maturing in one year) of the available for sale portfolio and the investment portfolio, excluding FHLB stock, is indicated in the following table.
At September 30, 1997 Total Less Than 1 to 10 Over 10 Carrying Market 1 Year Years Years Value Value (dollars in thousands) Securities available for sale: U.S. government securities and federal agency obligations(1) $19,956 $ - $ - $19,956 $19,956 ======= ====== ======= ======= ======= Other investments: Demand deposits in other financial institutions . . . $ 30,519 $ - $ - $ 30,519 $30,519 Time deposits in other financial institutions . . . 509 - - 509 509 -------- ------ -------- ------- ------- Total . . . . . . . . . . . $31,028 $ - $ - $31,028 $31,028 ======= ====== ======= ======= ======= Total securities available for sale and other investments . $50,984 $ - $ - $50,984 $50,984 ======= ====== ======= ======= ======= Weighted average yield . . . . 6.34% 6.34% ===== ===== _________________________ (1) These securities contractually mature between one and five years from September 30, 1997 but are classified as maturing in one year as they are classified as available for sale.
Subsidiaries As of September 30, 1997, the Bank had three active wholly-owned subsidiaries, Advantage Real Estate Services, Inc. ("ARES"), Advantage Investments, Inc. ("AII") and Advantage Financial Services and Insurance, Inc.("AFS&I"). As of September 30, 1997, ARES had investments in three partnerships, Cranberry III Partnership, Geneva Professional Building Associates, and Pleasantview Limited Partnership with book values of $786,000, $217,000 and $481,000, respectively. These partnerships have investments in real estate. In addition to ARES' investment, the Company has a total of $5.7 million in adjustable-rate mortgage loans to the Cranberry III Partnership as of September 30, 1997. These loans are guaranteed by the individual partners in a percentage equal to their percentage interest in the partnership. ARES owns a 50% interest in the Cranberry III Partnership, which owns a 264 unit apartment complex located in Kenosha. The other partners in this project are two real estate professionals. A corporation owned by these individuals is acting as operating manager on the project. Occupancy is in excess of 90%. ARES owns a 77% interest in Geneva Professional Building Associates, which owns a medical office building in Lake Geneva, Wisconsin. AII is a Nevada corporation formed in December, 1992 to hold and manage certain investments in mortgage-related securities. At September 30, 1997, AII's total investment in mortgage-related securities was $181.0 million and its investment in U.S. government agency securities was $5.0 million. These investments are not subject to state income tax because Nevada has no state income tax. AFS&I is a Wisconsin corporation which is engaged in the business of selling non-insured investments and insurance and providing financial planning. Total commissions generated by the AFS&I for the 1997 fiscal year were $610,000. Sources of Funds General. The Bank's primary sources of funds are deposits, principal and interest payments on loans receivable and mortgage-related securities, reverse repurchase agreements and FHLB borrowings. Deposits. The Bank attracts both short-term and long-term deposits from the Bank's primary market area by offering a wide assortment of accounts and rates. The Bank offers regular passbook accounts, NOW accounts, money market accounts, fixed-rate certificates of deposits with varying maturities and individual retirement accounts. Deposit account terms vary based on the type of account. In setting rates for deposits, the Bank regularly evaluates (1) the cost of borrowing funds, (2) rates offered by competing institutions, (3) its investment and lending opportunities, and (4) its liquidity position. In order to decrease the volatility of its deposits, the Bank imposes early withdrawal penalties on its certificates of deposit. The Bank had $89.3 million and $74.6 million in brokered certificates of deposits as of September 30, 1996 and September 30, 1997, respectively. The following table presents, by various interest-rate intervals, the Bank's long-term (one year and over) time deposits as of the dates indicated. September 30 Interest rate 1995 1996 1997 (In thousands) below 4.00% . . . $2,141 $114 $815 4.00 - 5.99% . . 176,292 183,666 155,146 6.00 - 7.99% . . 122,341 115,153 139,818 8.00% and above . 1,668 552 414 ------- ------- ------- $302,442 $299,485 $296,193 ======= ======= ======= The following table presents, by various interest-rate intervals, the amounts of long-term (one year and over) time deposits at September 30, 1997 maturing during the periods indicated.
3.99% 4.00% 6.00% 8.00% or to to and Percent Less 5.99% 7.99% above Total of Total (dollars in thousands) Accounts maturing in year ending: September 30, 1998 . . $609 $89,997 $61,517 $293 $152,416 51.5% September 30, 1999 . . 206 42,488 23,028 121 65,843 22.2 September 30, 2000 . . 0 17,670 48,061 0 65,731 22.2 After September 30, 2000 0 4,991 7,212 - 12,203 4.1 ---- ------- ------- ---- ------- ----- Total . . . . . . . . . . $815 $155,146 $139,818 $414 $296,193 100.0% Percent of total . . . . 0.3% 52.4% 47.2% 0.1% 100.0% ==== ===== ===== ===== ======
The following table presents the maturities of the Bank's time deposits in amounts of $100,000 or more at September 30, 1997 by time remaining to maturity. September 30, 1997 Maturities (In thousands) October 1, 1997 through December 31, 1997 . . . $12,578 January 1, 1998 through March 31, 1998 . . . . 7,859 April 1, 1998 through June 30, 1998 . . . . . . 4,827 July 1, 1998 through September 30, 1998 . . . . 6,356 October 1, 1998 and after . . . . . . . . . . . 8,199 --------- $39,819 ========= The Bank's deposit base at September 30, 1997 included $391.9 million of certificates of deposits with a weighted average interest rate of 5.79%. Of these certificates of deposit, $248.1 million will mature during the 12 months ending September 30, 1998. The Company will seek to retain these deposits consistent with its long-term objective of maintaining acceptable interest rate spreads. Depending upon interest rates existing at the time such certificates mature, the Bank's cost of funds may be significantly affected by the maturity of these certificates. Sources of Funds - Borrowings The Bank's other available sources of funds include borrowings from the FHLB and reverse repurchase agreements. As a member of the FHLB, the Bank is required to own capital stock in the FHLB and is authorized to apply for borrowings from the FHLB. FHLB credit programs have a wide range of terms and maturities, and rates may be fixed or variable. The FHLB may prescribe the acceptable uses for these borrowings, as well as limitations on the size of the advances and repayment provisions. The Bank has also entered into sales of securities under agreements to repurchase ("reverse repurchase agreements") with securities dealers and other institutions. Reverse repurchase agreements are accounted for as borrowings by the Bank and are generally secured by mortgage-backed securities. The proceeds of these transactions are used to meet cash flow needs of the Bank. Certain risks are associated with the use of reverse repurchase agreements, including the possibility that additional collateral will be required in the event the value of the collateral falls and the possibility that these short-term agreements may not be renewed upon their expiration. The following table sets forth the maximum month-end balance and the average daily balance of FHLB borrowings and securities sold under agreements to repurchase. Year Ended September 30 1995 1996 1997 (in thousands) Maximum month-end balance: FHLB borrowings . . . . . . . . . . $163,010 $175,910 $176,360 Securities sold under agreements to repurchase . . . . . . . . . . . . 12,110 48,355 83,262 Average daily balance: FHLB borrowings . . . . . . . . . . 150,484 165,131 164,710 Securities sold under agreements to repurchase . . . . . . . . . . . . 4,289 19,779 72,105 The following table sets forth certain information as to the Bank's FHLB borrowings and securities sold under agreements to repurchase as of the dates indicated. September 30 1995 1996 1997 (in thousands) FHLB borrowings . . . . . . . . . . . $163,010 $175,910 $176,360 Securities sold under agreements to repurchase . . . . . . . . . . . . . 12,110 48,355 72,115 ------- ------- ------- Total borrowings . . . . . . . . . . . $175,120 $224,265 $248,475 ======= ======= ======= Weighted average interest rate of FHLB borrowings . . . . . . . . . . . . . 6.20% 6.16% 6.44% Weighted average interest rate of securities sold under agreements to repurchase . . . . . . . . . . . . . 5.77% 5.66% 5.77% Employees At September 30, 1997, the Company and its subsidiaries had a total of 271 full-time employees and 58 part-time employees. None of the these employees are represented by any collective bargaining group. Management considers its employee relations to be excellent. REGULATION General The Bank is a federally-chartered savings institution, the deposits of which are federally insured (up to applicable regulatory limits) by the FDIC. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all aspects of its operations. The Bank's primary federal regulator is the OTS. The Bank is a member of the Federal Home Loan Bank of Chicago ("FHLB Chicago") and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). As the savings and loan holding company of the Bank, the Company also is subject to regulation by the OTS. Legislative Proposals Several broad financial reform proposals were introduced in Congress in 1997 which, by their terms, could significantly affect federally chartered savings institutions, including proposals which would eliminate the federal thrift charter and require federal thrifts, such as the Bank, to convert to national banks. Management of the Company is unable to predict whether any such legislative proposal will be enacted into law in its current form or with substantial modifications and, accordingly, management cannot predict what impact, if any, such legislation may have on the Company or the Bank. Federal Regulation of Savings Banks The OTS has extensive regulatory and supervisory authority over the operations of all insured savings institutions, including the Bank. This regulation and supervision establishes a comprehensive framework of activities in which the Bank can engage and is intended primarily for the protection of the deposit insurance fund and depositors. It also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in the laws and regulations governing the operations of the Bank could have an adverse impact on the Bank and its operations. The OTS also has enforcement authority over all savings institutions and their holding companies, including the Bank and the Company, and their affiliated parties. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and- desist or removal orders and initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws or regulations or for unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required. The Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. When these examinations are conducted, the examiners may, among other things, require the Bank to provide for higher general or specific loan loss allowances or write down the value of certain assets. The last regular examination of the Bank by the OTS was as of June 30, 1996 and the last examination by the FDIC was as of January 31, 1990. The OTS assesses all savings institutions to fund the operations of the OTS. The general assessment, to be paid on a semi-annual basis, is computed upon a savings institution's total assets, including consolidated subsidiaries, as reported in the institution's latest Quarterly Thrift Financial Report. The Bank's OTS assessment for the six-month period ended December 31, 1997 was $103,000 (based upon the Bank's assets as of March 31, 1997 of $1.01 billion and the current OTS assessment rate). Business Activities The activities of savings associations are governed by the Home Owner's Loan Act of 1933, as amended (the "HOLA") and, in certain respects, the Federal Deposit Insurance Act ("FDI Act"). The HOLA and the FDI Act were amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). FIRREA and FDICIA contain provisions affecting numerous aspects of the operations and regulation of federally- insured savings institutions and empower the OTS and the FDIC, among other agencies, to promulgate regulations implementing the provisions thereof. The federal banking statutes as amended by FIRREA and FDICIA (1) restrict the solicitation of brokered deposits by troubled savings associations that are not well-capitalized, (2) prohibit the acquisition of any corporate debt security that is not rated in one of the four highest rating categories, (3) restrict the aggregate amount of loans secured by non-residential real property to 400% of capital, (4) permit savings and loan holding companies to acquire up to 5% of the voting shares of non-subsidiary savings associations or savings and loan holding companies without prior approval, (5) permit bank holding companies to acquire healthy savings associations, and (6) require the federal banking agencies to establish, by regulation, standards for extension of credit secured by real estate lending. Under HOLA, the Bank does have the authority to make (i) non-conforming loans (loans in excess of the specific limitations of HOLA) not exceeding 5.0% of its total assets, and (ii) construction loans without security for the purpose of financing what is expected to be residential property not to exceed, in the aggregate, the greater of total capital or 5.0% of its total assets. To assure repayment of such loans, the Bank relies substantially on the borrower's general credit standing, personal guarantees and projected future income on the properties. Brokered Deposits; Interest Rate Limitations FDIC regulations promulgated under FDICIA govern the acceptance of brokered deposits by insured depository institutions. The capital position of an institution determines whether and with what limitations an institution may accept brokered deposits. A "well capitalized" institution (one that significantly exceeds specified capital ratios) may accept brokered deposits without restriction. "Undercapitalized" institutions (those that fail to meet minimum regulatory capital requirements) may not accept brokered deposits and "adequately capitalized" institutions (those that are not "well capitalized" or "undercapitalized") may only accept such deposits with the consent of the FDIC. "Adequately capitalized" institutions may apply for a waiver by letter to the FDIC. An institution that is not "well capitalized," even if meeting minimum capital requirements, may not solicit brokered or other deposits by offering interest rates that are significantly higher than the relevant local or national rate as determined under the regulations. The Bank meets the definition of a "well capitalized" institution and, therefore, may accept brokered deposits without restriction. At September 30, 1997, the Bank had $74.6 million of brokered deposits. Uniform Lending Standards Under FDICIA, federal bank regulators are required to adopt uniform regulations prescribing standards for extensions of credit that are secured by liens on interests in real estate or made for the purpose of financing the construction of a building or other improvements to real estate. Under current regulations, savings institutions must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens on or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value limits) that are clear and measurable, loan administration procedures and documentation, approval and reporting requirements. The real estate lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies that have been adopted by federal bank regulators. Standards for Safety and Soundness As required by FDICIA and subsequently amended by the Riegle Community Development and Regulatory Improvement Act of 1994, the OTS and other federal banking regulators have adopted interagency guidelines establishing standards for safety and soundness for depository institutions on matters such as internal controls and audit systems, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, asset quality, earnings and compensation and other benefits. The agencies may request a compliance plan from any institution which fails to meet one or more of the standards. Branching by Federally Chartered Banks OTS rules permit nationwide branching by federally chartered savings institutions to the extent permitted by federal statute, subject to OTS supervisory clearance. This permits institutions with interstate networks to diversify their loan portfolios and lines of business. OTS authority preempts any state law purporting to regulate branching by federal savings institutions. However, subject to certain exceptions, federal law continues to prohibit branching which would result in formation of a multiple savings and loan holding company controlling savings institutions in more than one state, unless the statutory law of the additional state specifically authorizes acquisition of its state-chartered institutions by state-chartered institutions or their holding companies in the state where the acquiring institution or holding company is located. Insurance of Accounts and Regulation by the FDIC The Bank is a member of FDIC. Savings deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States government. In its capacity as an insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious risk to the FDIC. Under the FDI Act and FIDICIA, the FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action, and may terminate an institution's deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition. Management does not know of any practice, condition or violation of the Bank that could lead to termination of deposit insurance for the accounts of the Bank. Deposits of the Bank are currently insured by the FDIC under the Savings Association Insurance Fund ("SAIF"). The FDIC also maintains the Bank Insurance Fund ("BIF"), which primarily insures the deposits of commercial banks (and some state savings banks). Applicable law requires that the SAIF and BIF each achieve and maintain a ratio of insurance reserves to total insured deposits equal to 1.25%. The BIF reached this 1.25% reserve level in 1995, and the FDIC thereafter reduced BIF premiums for most banks. As a result of such reduction, the highest-rated BIF- insured institutions pay the statutory annual minimum of $2,000 for FDIC insurance. Prior to January 1, 1997, SAIF-member institutions paid deposit insurance premiums based on a schedule of $0.23 to $0.31 per $100 of deposits, creating a substantial disparity between SAIF and BIF deposit insurance premiums. On September 30, 1996 President Clinton signed into law the Deposit Insurance Funds Act of 1996 (the "1996 Deposit Insurance Act") which, among other things, provided for the recapitalization of the SAIF through a one-time special assessment of approximately 65.7 basis points on the amount of deposits held by each SAIF-insured institution as of March 31, 1995. The one-time special assessment payable by the Bank as of September 30, 1996 was $4.4 million. As a result of the recapitalization of the SAIF by the special assessment, SAIF insurance premiums were substantially reduced, effective as of January 1, 1997, with the highest rated SAIF-insured institutions, such as the Bank, paying the statutory minimum of $2,000 plus 6.4 basis points for payment of the FICO obligations referenced below, thereby eliminating the disparity between the premiums paid by SAIF and BIF members of equivalent rating (except for the differential in the FICO portion of the premiums as described below). The 1996 Deposit Insurance Act also provided for full pro rata sharing by SAIF and BIF institutions, beginning no later than January 1, 2000, of the debt service obligation on bonds issued by the federally chartered Financing Corporation ("FICO") to fund the thrift rescue plan of the late 1980's, and until such time the premiums for BIF and SAIF will include a portion for FICO bond debt service of 1.3 and 6.4 basis points, for BIF and SAIF respectively, effective as of January 1, 1997. The 1996 Deposit Insurance Act further provides that the BIF and SAIF will be merged on January 1, 1999 if bank and savings association charters are merged into a single federal charter by that date, in which case full pro-rata sharing of the FICO obligation will commence on that date. FDICIA required the FDIC to implement a risk-based deposit insurance assessment system. Pursuant to this requirement, the FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine assessment risk classifications and assessed insurance premiums based upon their level of capital and supervisory evaluation. The FDIC assigns an institution to one of three capital categories consisting of (i) well capitalized, (ii) adequately capitalized or (iii) undercapitalized, and one of three supervisory subcategories. The supervisory subgroup to which an association is assigned is based on a supervisory evaluation provided to the FDIC by the association's primary federal regulator and information which the FDIC determines to be relevant to the association's financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the association's state supervisor). An association's assessment rate depends on the capital category and supervisory category to which it is assigned. The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, under FDICIA, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. As of September 30, 1997, the Bank had approximately $620 million of deposit accounts covered by deposit insurance and was classified as well capitalized and healthy. Regulatory Capital Requirements Federally-insured savings institutions, such as the Bank, are required to maintain certain minimum levels of regulatory capital. The OTS has established three different capital standards: (i) a 1.5% "tangible capital" standard; (ii) a 3% "leverage ratio" (or core capital ratio); and (iii) an 8% "risk-based capital" standard. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. Savings institutions must meet all of the standards in order to comply with the capital requirements. The following table summarizes the Bank's capital ratios and the ratios required by OTS federal regulations at September 30, 1997: Risk- Tangible Core based Capital Capital Capital (Dollars in thousands) Bank's regulatory percentage 6.43% 6.43% 14.81% Required regulatory percentage 1.50% 3.00% 8.00% ----- ------ ------ Excess regulatory percentage 4.93% 3.43% 6.81% ===== ====== ====== Bank's regulatory capital $65,339 $65,339 $71,121 Required regulatory capital 15,235 30,470 38,420 ------ ------ ------ Excess regulatory capital $50,104 $34,869 $32,701 ====== ====== ====== The capital standards established by the OTS require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity (including retained earnings) and certain noncumulative perpetual preferred stock and related surplus, less equity and debt investments in subsidiaries which are not "includable" subsidiaries. For this purpose all subsidiaries engaged solely in activities permissible for national banks or engaged solely in mortgage banking or in certain other activities solely as agent for its customers are "includable" subsidiaries. The Bank's wholly-owned subsidiary, Advantage Real Estate Services, Inc., is not an includable subsidiary and, accordingly, its assets are not included in the Bank's assets and capital for purposes of determining the Bank's regulatory capital. In addition, all intangible assets, other than a limited amount of mortgage servicing rights, must be deducted from tangible capital. At September 30, 1997, the Bank had $3.9 million in intangible assets (net of applicable income tax effect) relating to the acquisition of branch deposits which is a deduction from capital for regulatory purposes. The OTS capital standards also require core capital equal to at least 3% of adjusted total assets. Core capital generally consists of tangible capital plus certain intangible assets, including mortgage servicing rights and purchased credit card relationships (subject to certain valuation and other percentage limitations). As a result of the prompt corrective action provisions of FDICIA and OTS regulations thereunder discussed below, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless it is rated a composite 1 (the highest rating) under the "CAMEL" rating system for savings institutions, in which case it is allowed to maintain a 3% core capital ratio. The OTS risk-based capital standard requires savings institutions to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital (subject to certain exclusions described below) and supplementary capital, minus the amount of its interest rate risk ("IRR") component discussed below. Supplementary capital consists of certain types of subordinated debt, certain nonwithdrawable accounts and certain other capital instruments that do not qualify as core capital and a portion of an institution's general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only up to the amount of core capital. At September 30, 1997, the Bank had not issued any capital instruments that qualified as supplementary capital and had $5.8 million of general valuation loan and lease loss allowances included in supplementary capital. Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. At September 30, 1997, the Bank excluded all of its $2.1 million investments in its unconsolidated partnerships for this purpose. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, are multiplied by a risk weight ranging from 0% to 100%, as assigned by the OTS capital regulation, based on the risks OTS believes are inherent in the type of asset. A savings association whose measured interest rate risk (IRR) exposure exceeds 2% must deduct an IRR component in calculating its total capital for purposes of determining whether it meets its risk-based capital requirement. The IRR component is an amount equal to the product of (i) 50% of the difference between its measured interest-rate risk exposure and 2%, multiplied by (ii) the estimated economic value of its total assets. This exposure is a measure of the potential decline in the Net Portfolio Value ("NPV") of a savings institution, that would result from a hypothetical 200 basis point increase or decrease (except when the 3-month Treasury bond equivalent yield is less than 4%, in which case the decrease will be one-half such Treasury rate) in market interest rates (whichever results in a lower NPV) divided by the estimated economic value of assets (calculated in accordance with certain OTS guidelines). The OTS will calculate changes in an institution's NPV from data submitted by the institution in a schedule to its Quarterly Thrift Financial Report. NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. Management does not expect this rule to have a material impact of the Bank. Pursuant to FDICIA, in December 1994, the federal banking agencies, including the OTS, also adopted final regulations authorizing the agencies to require a depository institution to maintain additional total capital to account for concentration of credit risk and the risk of non- traditional activities, as well as an institution's ability to monitor and control such risks. While no quantitative measure will be generally applicable, the OTS is given authority to require individual institutions to maintain higher capital levels than those required under the quantitative tests described above, based upon such institution's particular concentration of credit risk and risks arising from nontraditional activities, as identified by OTS from time to time. Management does not believe that the Bank has any concentrations of credit or is a engaged in any non-traditional activities which in either case are likely to cause the OTS to require the Bank to maintain additional capital under this regulation. Prompt Corrective Action Requirements FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, federal bank regulators are required to take certain supervisory actions with respect to undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. FDICIA establishes the following 5 capital categories: "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized", and "critically undercapitalized." Generally, subject to narrow exceptions, FDICIA requires federal bank regulators to appoint a receiver or conservator for an institution that is critically undercapitalized and prohibits such institution from making any payment of principal or interest on its subordinated debt. FDICIA authorizes federal bank regulators to specify the ratio of tangible capital to assets at which an institution becomes critically undercapitalized and requires that ratio to be no less than 2% of total assets. Under OTS regulations, an institution is deemed to be "undercapitalized" if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4% or (generally) a leverage ratio of less than 4%. An institution which has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage ratio of less than 3% is deemed to be "significantly undercapitalized", and an institution which has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2% is deemed to be "critically undercapitalized". In addition, the OTS is effectively authorized to downgrade an institution to a lower capital category than the institution's capital ratios would otherwise indicate, based upon safety and soundness considerations, such as when the institution has received a less-than-satisfactory examination rating for asset quality, management, earnings or liquidity under the OTS's "CAMEL" rating system for savings institutions. Subject to limited exceptions, savings institutions are prohibited from declaring dividends, making any other capital distribution or paying management fees to controlling persons if, after giving effect thereto, the institution would be undercapitalized. Undercapitalized institutions are also subject to certain mandatory supervisory actions, including increased monitoring, required capital restoration planning and restricted growth, and acquisition and branching restrictions. Significantly and critically undercapitalized institutions face even more severe restrictions. At September 30, 1997, the Bank was "well capitalized" as defined under the OTS regulations and, accordingly, was not subject to the foregoing limitations and restrictions placed upon undercapitalized institutions. Limitations on Dividends and Other Capital Distributions OTS regulations impose various restrictions and requirements on savings institutions with respect to their ability to pay dividends or make other capital distributions (such as stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account). The OTS utilizes a three-tiered approach to permit savings institutions, based on their capital level and supervisory condition, to make capital distributions. Generally, an institution that before and after the proposed distribution meets or exceeds its "fully phased in capital requirements" (a "Tier 1 institution") and has not been informed by OTS that it is in need of more than normal supervision, may, after 30 days prior notice to but without the approval of the OTS, make capital distributions during any calendar year equal to the higher of (a) 100% of its net income for the year-to-date plus the amount that would reduce by 50% its "surplus capital ratio" (the percentage by which the institution's ratio of total capital to assets exceeds the ratio of its fully phased-in capital requirement to assets) at the beginning of the calendar year or (b) 75% of its net income over the most recent four-quarter period. Any additional capital distributions would require prior regulatory approval. The Bank currently meets the requirements for a Tier 1 institution and has not been notified of a need for more than normal supervision. In the event the Bank were to fail to satisfy such standards, its ability to make capital distributions would be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Tier 2 institutions, which are institutions that before and after the proposed distribution meet or exceed their current minimum capital requirements but do not meet their fully phased-in capital requirements, may make capital distributions up to 75% of their net income for the most recent four-quarter period after notice is given to the OTS and no objection is made by the OTS within a 30-day period. Tier 3 institutions, which are institutions that do not meet current minimum capital requirements, that propose to make a capital distribution, and Tier 1 and Tier 2 institutions which propose to make a capital distribution in excess of the noted safe harbor levels described above, must obtain OTS approval prior to making such a distribution. Liquidity Each savings institution, including the Bank, is required to maintain an average daily balance of liquid assets for each calendar month equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and short-term borrowings for the immediately preceding calendar month. This average liquidity requirement may be changed from time to time by the OTS (between 4% and 10%), depending upon economic conditions and deposit flows of all savings institutions. At the present time, the minimum average liquidity requirement is 5%. In addition, the average daily balance of short term liquid assets (e.g., cash, certain time deposits, certain bankers acceptances and short-term United States Treasury obligations) must currently constitute at least 1% of an institution's average daily balance of net withdrawable deposit accounts and current borrowings for the preceding calendar month. Monetary penalties may be imposed for a violation of either liquidity ratio requirement. In May 1997, the OTS proposed revisions to its liquidity regulations which are intended to simplify and reduce the requirements thereunder. Among other changes, the proposed amendments would (i) reduce the minimum average liquidity requirement from 5% to 4% and (ii) eliminate the 1% short-term liquid asset requirement. At September 30, 1997, the Bank was in compliance with both liquidity requirements, with an average liquidity ratio of 8.5% and a short-term liquidity ratio of 5.5%. Qualified Thrift Lender Test All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to maintain at least 65% of its portfolio assets (which consist of total assets less (i) intangibles, (ii) properties used to conduct the savings institution's business and (iii) liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average for nine out of every twelve months on a rolling basis. As of September 30, 1997, the Bank was in compliance with the QTL requirements. Generally, qualified thrift investments consist of loans to purchase, construct or improve residential housing, home equity loans and mortgage- related securities secured by residential housing, small business loans, credit card loans and student loans, as well as certain obligations of the FDIC and stock in any Federal Home Loan Bank. Certain other loans and investments may be included up to a maximum aggregate limit of 20% of portfolio assets. Any savings institution that fails to meet the QTL test must either convert to a national bank charter (and pay the applicable exit and entrance fees involved in converting from one insurance fund to another) or become subject to numerous operating restrictions. Loans-to-One-Borrower Limit Under the HOLA, savings associations are subject to maximum loans-to- one-borrower limits applicable to national banks. In general, a savings institution may make loans-to-one-borrower in an amount up to the greater of $500,000 or 15% of the institution's unimpaired capital and unimpaired surplus (plus an additional 10% of its unimpaired capital and unimpaired surplus for loans fully secured by certain readily marketable collateral). At September 30, 1997, the Bank's lending limit for loans-to-one-borrower not fully secured by marketable collateral was $10.7 million. Under the HOLA, a broader limitation (the lesser of $30 million or 30% of unimpaired capital and unimpaired surplus) is provided under certain circumstances and subject to OTS approval, for loans to develop domestic residential housing units. In addition, under HOLA as limited by OTS regulation, a savings institution may provide purchase money mortgage financing in connection with the sale by it of real property acquired in satisfaction of debts previously contracted in good faith without regard to the loans- to-one-borrower limitation provided that no new funds are advanced and the institution is not placed in a more detrimental position than if it had held the property. As of September 30, 1997, the Bank is in compliance with these loans-to-one-borrower limitations. Transactions with Affiliates; Loans to Insiders Transactions between savings institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. With certain limited exceptions, an affiliate of a savings institution is any company or entity which controls, is controlled by or is under common control with the savings institution. In a holding company context, the parent holding company of a savings institution (such as the Company) and any companies which are controlled by such parent holding company are affiliates of the savings institution. Generally, Sections 23A and 23B (i) limit the extent to which the savings institution or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates of 20% of capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions. In addition to the restrictions imposed by Sections 23A and 23B, no savings institution may (a) loan or otherwise extend credit to an affiliate, except for an affiliate which engages only in activities which are permissible for bank holding companies, or (b) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings institution. In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans by savings institutions to executive officers, directors and principal stockholders of the institution and their related interests ("insiders"). Under Section 22(h), loans to an insider of a savings institution (other than a stockholder of which the savings institution is a subsidiary) or to a director, executive officer or greater than 10% stockholder of the company that controls the savings institution, and certain affiliated interests of any such person, may not exceed, together with all other outstanding loans to such person and affiliated interests of such person, the institution's loans-to-one- borrower limit. Section 22(h) also requires that loans to insiders be made on substantially the same terms offered in, and applying underwriting policies and procedures no less stringent than those applied to, comparable transactions with persons who are not insiders or employees and requires prior approval of a majority of the institution's board (with the interested party abstaining) for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders, and directors, executive officers and greater than 10% shareholders of a company that controls the savings institution and their related interests, cannot exceed the institution's unimpaired capital and surplus. Federal Reserve System Regulation D of the Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, (primarily checking, NOW and certain other accounts that permit payments or transfers to third parties) and non-personal time deposits (including certain money market deposit accounts). These reserve levels are subject to adjustment from time to time by the Federal Reserve Board. At September 30, 1997, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "Liquidity." Federal Home Loan Bank System members such as the Bank are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require institutions to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank. Federal Home Loan Bank System The Bank is a member of the FHLB Chicago, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions throughout the United States. Each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLB makes loans to members (i.e. advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All loans from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term loans may be made only for the purpose of providing funds for residential home financing. At September 30, 1997, the Bank had $176.4 million in advances from the FHLB Chicago. As a member of the FHLB Chicago, the Bank is required to purchase and maintain stock in the FHLB Chicago. At September 30, 1997, the Bank had $8.9 million in FHLB stock, which satisfied this requirement. In past years, the Bank has received dividends on its FHLB stock. The dividend rate on such FHLB stock in fiscal 1997 was 6.75%. Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and affordable housing projects. These contributions may adversely affect the level of dividends paid by FHLBs to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. Any such reduction in dividends paid or increase in the rate charged on advances could have an adverse affect on the Bank's net interest income and the value of FHLB Chicago stock held by the Bank. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's stockholders' equity. Holding Company Regulation The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries, which authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings bank. The regulations of the OTS are primarily concerned with the safety and soundness of the institutions under its jurisdiction rather than the protection of such institutions' stockholders. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. However, if the Company were to acquire control of another savings institution and hold it as a separate subsidiary, the Company would become a multiple savings and loan holding company, and the activities of the Company and any of its subsidiaries (other than the Bank or any other SAIF-insured savings institution) would become subject to such activity restrictions unless such other institutions each qualified as a QTL and were acquired in a supervisory acquisition. Among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings institution may commence or continue for more than a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof, any business activity, except upon prior notice to, and no objection by, the OTS, other than: (i) furnishing or performing management services for a subsidiary savings institution; (ii) conducting an insurance agency or escrow business; (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings institution; (iv) holding or managing properties used or occupied by a subsidiary savings institution; (v) acting as trustee under deeds of trust; (vi) those activities authorized by regulation as of March 5, 1987 to be engaged in by multiple savings and loan holding companies; or (vii) unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies, those activities authorized by the FRB as permissible for bank holding companies. Those activities described in (vii) above must also be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company. If the Bank were to fail the QTL test, the Company would have to obtain the approval of the OTS prior to continuing, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within one year of such failure, the Company would have to register as, and would become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. The Company must obtain approval from the OTS before acquiring control of more than 5% of the voting shares of any other SAIF-insured institution or savings and loan holding company. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings institutions in more than one state. However, such interstate acquisitions are permitted based on specific state statutory authorization in the state of the target institution or in a supervisory acquisition of a failing savings institution. Community Reinvestment Act Under the Community Reinvestment Act ("CRA"), as implemented by OTS regulations, a savings institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. An institution is assigned one of four overall ratings: "outstanding", "satisfactory", "needs improvement" or "substantial noncompliance". The CRA also requires all institutions to make their CRA ratings available to the public. The Bank's latest CRA rating, received in November, 1996, was "satisfactory". In 1995, the OTS and other federal financial supervisory agencies issued a final revised regulation to implement the CRA. The revised regulation, which became fully effective on July 1, 1997, eliminates the twelve assessment factors under the prior regulation and substitutes a performance based evaluation system. The Bank has not yet been evaluated under the new system. Pursuant to the revised regulation, an institution's performance in meeting the credit needs of its entire community, as required by the CRA, will generally be evaluated under three tests: the "lending test"; the "investment test"; and the "service test". The lending test analyzes lending performance using five criteria: (i) the number and amount of loans in the institution's assessment area, (ii) the geographic distribution of lending, including the proportion of lending in the assessment area, the dispersion of lending in the assessment area, and the number and amount of loans in low-, moderate-, middle- and upper-income areas in the assessment area, (iii) borrower characteristics, such as the income level of individual borrowers and the size of businesses or farms, (iv) the number and amount, as well as the complexity and innovativeness, of an institution's community development lending and (v) the use of innovative or flexible lending practices in a safe and sound manner to address the credit needs of low- or moderate- income individuals or areas. The investment test analyzes investment performance using four criteria: (i) the dollar amount of qualified investments, (ii) the innovativeness or complexity of qualified investments, (iii) the responsiveness of qualified investments to credit and community development needs, and (iv) the degree to which the qualified investments made by the institution are not routinely provided by private investors. The service test analyzes service performance using six criteria: (i) the institution's branch distribution among low-, moderate-, middle-, and upper-income areas, (ii) its record of opening and closing branches, particularly in low- and moderate- income areas, (iii) the availability and effectiveness of alternative systems for delivering retail banking services, (iv) the range of services provided in low-, moderate-, middle- and upper-income areas and extent to which those services are tailored to meet the needs of those areas, (v) the extent to which the institution provides community development services, and (vi) the innovativeness and responsiveness of community development services provided. As an alternative to the lending, service and investment tests, an institution may submit to the OTS for approval its own "strategic plan", developed with community input, describing in detail the manner in which it proposes to meet its CRA obligations. If the plan is approved by OTS and the institution has operated under the plan for at least one year, the institution will be evaluated based upon its achieving the goals and benchmarks outlined in the plan. Institutions are required to collect and report data on a variety of matters, including originations and purchases of home mortgage, small business and small farm loans, and certain information on community development loans. Collection of information on consumer loans is optional. The OTS is required to prepare annually and make available to the public individual CRA Disclosure Statements for each reporting thrift institution. Each institution must place its CRA Disclosure Statement in its public file within three days of receipt of the Statement from the OTS. Each institution is required to maintain one copy of its public file in each state in which it has its main office or a branch. Federal Securities Law The common stock of the Company is registered with the Securities Exchange Commission under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is, therefore, subject to the periodic reporting, proxy solicitation and tender offer rules, insider trading restrictions and other requirements under the Exchange Act. Shares of Company common stock held by persons who are affiliates (generally officers, directors and principal shareholders) of the Company may not be sold without registration under the Securities Act of 1933, as amended, unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is, subject to certain limitations, able to sell in the public market, without registration, a limited number of shares in any three-month period. Federal and State Taxation For fiscal 1996 and prior years, Savings associations such as the Bank that met certain definitional tests relating to the composition of assets and other conditions prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), were permitted to establish reserves for bad debts and to make annual additions thereto which could, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes. The amount of the bad debt reserve deduction for "non-qualifying loans" was computed under the experience method. The amount of the bad debt reserve deduction for "qualifying real property loans" (generally loans secured by improved real estate) was computed under either the experience method or the percentage of taxable income method (based on an annual election). The percentage of specially computed taxable income that was used to compute a savings association's bad debt reserve deduction under the percentage of taxable income method (the "percentage bad debt deduction") was 8.0%. The percentage bad debt deduction thus computed was reduced by the amount permitted as a deduction for non-qualifying loans under the experience method. For fiscal 1996 and prior years, if an association's specified assets (generally, loans secured by residential real estate or deposits, educational loans, cash and certain government obligations) constituted less than 60% of its total assets, the association could not deduct any addition to a bad debt reserve and generally was required to include existing reserves in income over a four year period. The Bank has historically met this 60% test. Under the percentage of taxable income method, the percentage bad debt deduction could not exceed the amount necessary to increase the balance in the reserve for "qualifying real property loans" to an amount equal to 6% of such loans outstanding at the end of the taxable year or the greater of (i) the amount deductible under the experience method or (ii) the amount which when added to the bad debt deduction for "non-qualifying loans" equals the amount by which 12% of the amount comprising savings accounts at year-end exceeds the sum of surplus, undivided profits and reserves at the beginning of the year. Effective for fiscal 1997 and future years, the Small Business Job Protection Act of 1996 (the "Job Protection Act") was enacted on August 10, 1996 and eliminates the percent-of-taxable-income method for computing additions to a savings association's tax bad debt reserves. The Job Protection Act requires all savings associations to recapture, over a six year period, all or a portion of their tax bad debt reserves added since the last taxable year beginning before January 1, 1988. Taxes have been provided in the financial statements for this recapture. The Job Protection Act allows a savings association to postpone the recapture of bad debt reserves for up to two years if the institution meets a minimum level of mortgage lending activity during those years. The Bank engaged in sufficient mortgage lending activity during fiscal year 1997 to be able to postpone any recapture of its bad debt reserves until at least fiscal 1998. The Bank believes that it will engage in sufficient mortgage lending activity during fiscal 1998 to be able to postpone any recapture of its bad debt reserves until fiscal 1999. Effective for fiscal 1997 and future years, under the Job Protection Act, the Bank determines additions to its tax bad debt reserves using the same method as a commercial bank of comparable size, and, if the Bank were to decide to convert to a commercial bank charter, such conversion would not cause any additional tax liability. As of September 30, 1997, retained earnings included approximately $22.4 million for which no provision for income tax has been made. This essentially represents pre-1988 accumulated bad debt deductions. Income taxes would be imposed at the then-applicable rates if the Bank were to use these reserves for any other purpose or were to no longer qualify as a bank. The income tax liability on this $22.4 million would approximate $8.5 million. In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. For taxable years beginning after 1986 and before 1996, corporations, including savings associations such as the Bank, were also subject to an environmental tax equal to 0.12% of the excess of alternative minimum taxable income for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2 million. This tax does not apply to the Bank beginning for fiscal 1997. The Company and its subsidiaries file a consolidated federal income tax return on a fiscal year basis using the accrual method of accounting. Savings associations, such as the Bank, that file federal income tax returns as part of a consolidated group are required by applicable Treasury regulations to reduce their taxable income for purposes of computing the percentage bad debt deduction for losses attributable to activities of the non-savings association members of the consolidated group that are functionally related to the activities of the savings association member. The Company and its subsidiaries were last audited by the IRS with respect to its consolidated federal income tax return for the year ended September 30, 1994. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, the Bank) would not result in a deficiency which could have a material adverse effect on the consolidated financial condition of the Company. Wisconsin Taxation. Wisconsin imposes a corporate franchise tax on the Wisconsin taxable income of the Company and its subsidiaries. The current corporate franchise tax rate imposed by Wisconsin is 7.9%. Wisconsin taxable income is substantially similar to federal taxable income except that no deduction is allowed for state income taxes paid. The current bad-debt deduction for Wisconsin income tax purposes is the same as the deduction permitted for federal income tax purposes. Wisconsin does not allow the carryback of a net operating loss to prior taxable years. Thus, any net operating loss for state income tax purposes must be carried forward to offset income in future years. The Wisconsin corporate franchise tax is deductible for purposes of computing federal taxable income. Illinois Taxation. Illinois imposes a corporate income tax on the Illinois taxable income of the Company and its subsidiaries. For Illinois income tax purposes, the Bank is taxed at a rate equal to 7.3% of Illinois taxable income. For these purposes, Illinois taxable income generally means federal taxable income, subject to certain adjustments (including the addition of interest income on state and municipal obligations and the exclusion of interest income on United States Treasury obligations). The exclusion of income on United States Treasury obligations has the effect of substantially reducing Illinois taxable income. Executive Officers of the Registrant The following table sets forth certain information with respect to the executive officers of the Company and the Bank as of September 30, 1997. Name Position With Company Paul P. Gergen Chairman, President and Chief Executive Officer of the Company and the Bank John Stampfl Treasurer, Secretary and Chief Financial Officer of the Company and Treasurer, Secretary and Senior Vice President- Finance of the Bank William K. Koeper Senior Vice President-Retail Banking and Development of the Bank Robert J. Muth Senior Vice President of the Company and Senior Vice President-Mortgage Lending of the Bank David W. Adam Senior Vice President-Information Systems of the Bank The following information as to the business experience during the past five years is supplied with respect to the above executive officers. Paul P. Gergen, age 64, joined the Bank in 1984 as President and Chief Executive Officer. Mr. Gergen is a licensed attorney and CPA and has been involved in banking in various capacities for 37 years. He has been Chairman, President and Chief Executive Officer of the Company since its inception in 1992. John Stampfl, age 42, joined the Bank in 1984 as Vice President- Finance. He is a licensed CPA. He has been Treasurer, Secretary and Chief Financial Officer of the Company since its inception in 1992. William K. Koeper, age 49, joined the Bank in 1991 as Vice President- Marketing and Development. From 1988 to 1991, he was Dean of Business at Gateway Technical College, Kenosha, Wisconsin. Robert J. Muth, age 63, joined the Bank in 1985 as Vice President- Mortgage Lending. Mr. Muth has been involved in banking in various capacities for 44 years. He has been Vice President of the Company since its inception in 1992. David W. Adam, age 32, joined the Bank in 1988 as Financial Analyst, became Vice President-Information Systems in 1994 and became Senior Vice President-Information Systems in 1996. He is a licensed CPA. Item 2. Properties At September 30, 1997, the Bank operated through fifteen full-service savings institution offices and three mortgage loan origination limited offices located in Wisconsin and Illinois. The aggregate book value at September 30, 1997 of the properties owned was $12.8 million. The following table sets forth the location of the Bank's offices. Owned or Date Location Leased Acquired/Leased Executive Offices and Home Office: 5935 Seventh Avenue Owned 1960 Kenosha, Wisconsin 5125 6th Avenue Leased 1996 Kenosha, Wisconsin Branch Offices: 7535 Pershing Boulevard Owned 1968 Kenosha, Wisconsin 410 Broad Street Owned 1973 Lake Geneva, Wisconsin 4235 52nd Street Owned 1975 Kenosha, Wisconsin 25100 75th Street Owned 1989 Paddock Lake, Wisconsin 8035 22nd Avenue Owned 1980 Kenosha, Wisconsin 927 North Green Bay Road Owned 1996 Waukegan, Illinois 1011 14th Street Owned 1989 North Chicago, Illinois 3401 80th Street Leased 1993 Kenosha, Wisconsin 2811 18th Street Leased 1991 Kenosha, Wisconsin 2580 Sheridan Road Owned 1991 Zion, Illinois 5914-75th Street Leased 1994 Kenosha, Wisconsin 2406 South Green Bay Road Leased 1994 Racine, Wisconsin 7151 West 159th Street Owned 1995 Tinley Park, Illinois 4900 West 87th Street Owned 1995 Burbank, Illinois Loan Origination Offices: 4015-80th Street Leased 1993 Kenosha, Wisconsin 53142 100 N. Atkinson Road Leased 1993 Grayslake, Illinois 4900 Spring Street Leased 1994 Racine, Wisconsin 933 N. Mayfair Road Leased 1995 Wauwatosa, Wisconsin 1230 East Diehl Road, Suite 302 Leased 1995 Naperville, Illinois Possible future branch site 12300 75th Street Owned 1989 Bristol, Wisconsin Advantage Service Center 5942 6th Ave. Owned 1993 Kenosha, Wisconsin Item 3. Legal Proceedings As of September 30, 1997, there were no pending legal proceedings which in the aggregate involve amounts which are believed by management to be material to the Company on a consolidated basis. Item 4. Submission of Matters to a Vote of Security Holders During the fourth quarter of the fiscal year ended September 30, 1997, no matters were submitted to a vote of security holders through a solicitation of proxies or otherwise. PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters The Company's common stock is traded on The Nasdaq Stock Market under the symbol AADV. The table below shows the reported high and low sales prices of the common stock and dividends declared per share during the periods indicated: Cash High Low Dividend Fiscal year 1996: First quarter . . . . $31.40 $26.00 $.064 Second quarter . . . $35.00 $28.50 $.080 Third quarter . . . . $35.50 $30.75 $.080 Fourth quarter . . . $34.25 $32.35 $.080 Fiscal year 1997 . . First quarter . . . . $33.00 $31.25 $.080 Second quarter . . . $41.50 $31.75 $.100 Third quarter . . . . $40.75 $36.50 $.100 Fourth quarter . . . $58.50 $38.00 $.100 See Note 11 of the Notes to Consolidated Financial Statements which describes restrictions on dividend payments by the Bank. As of September 30, 1997, the Company had approximately 2,700 shareholders of record. Item 6. Selected Financial Data
of September 30 1993 1994 1995 1996 1997 (In thousands) Selected Financial Condition Data: Total assets . . . . . . . . . . . . $653,286 $741,307 $973,234 $1,016,386 $1,037,462 Loans receivable - net . . . . . . . 384,795 425,569 512,282 562,782 565,259 Mortgage-related securities . . . . . 215,639 240,676 351,599 337,794 358,211 Investment securities, certificates of deposits and marketable equity securities . . . . . . . . . . . . 10,805 12,213 29,969 35,040 29,746 Deposits . . . . . . . . . . . . . . 412,500 507,338 681,925 680,851 670,775 Borrowings . . . . . . . . . . . . . 145,160 135,810 175,120 224,265 248,475 Stockholders' equity . . . . . . . . 80,816 82,935 93,078 88,866 99,004 Year Ended September 30 1993 1994 1995 1996 1997 (In thousands) Selected Operations Data: Total interest income . . . . . . . . $45,918 $47,862 $67,516 $73,590 $76,667 Total interest expense . . . . . . . 24,249 24,954 39,376 43,765 45,714 ------- ------- ------- ------- ------- Net interest income . . . . . . . 21,669 22,908 28,140 29,825 30,953 Provision for losses on loans . . . . 720 720 460 480 360 ------- ------- ------- ------- ------- Net interest income after provision for losses on loans . 20,949 22,188 27,680 29,345 30,593 ------- ------- ------- ------- ------- Fees and service charges . . . . . . 1,483 1,807 2,668 5,135 5,275 Net gain on loans, securities and other . . . . . . . . . . . . . . . 1,262 584 253 1,742 1,665 Other non-interest income . . . . . . 903 884 1,201 1,138 1,380 ------- ------- ------- ------- ------- Total non-interest income . . . . 3,648 3,275 4,122 8,015 8,320 ------- ------- ------- ------- ------- 23,708 22,272 Non-interest expenses . . . . . . . . 13,078 13,834 19,133 Assessment to recapitalize Savings Association Insurance Fund . . . . - - - 4,435 - Writedown of intangible assets . . . - - - 4,720 - ------- ------- ------- ------- ------- Income before taxes . . . . . . . . . 11,519 11,629 12,669 4,497 16,641 Income taxes . . . . . . . . . . . . 4,354 4,289 4,518 1,464 5,953 ------- ------- ------- ------- ------- Net income . . . . . . . . . . . . . $7,165 $7,340 $8,151 $3,033 $10,688 ======= ======== ======== ======= ======= Earnings per share . . . . . . . . . $1.82 $1.96 $2.20 $0.83 $3.09 ======= ======== ======== ======= ======= Earnings per share excluding non- recurring items (1) . . . . . . . . $1.82 $1.96 $2.20 $2.39 $3.09 ======= ======== ======== ======= ======= Year Ended September 30 1993 1994 1995 1996 1997 Other Data: Interest rate spread information: Average during year . . . . . . 3.19% 3.07% 2.92% 2.88% 2.85% End of year . . . . . . . . . . 2.93% 2.87% 2.67% 2.78% 2.83% Net interest margin (net interest income divided by average interest-earning assets) . . . 3.66% 3.46% 3.26% 3.19% 3.17% Allowance for losses on loans to non-performing loans . . . . . 79.71% 106.78% 219.00% 169.10% 183.4% Non-performing assets to total assets at end of year . . . . . 1.20% 0.79% 0.46% 0.48% 0.49% Stockholders' equity to total assets at end of year . . . . . 12.37% 11.19% 9.56% 8.74% 9.54% Dividends declared per share . . - - $0.192 $0.304 $0.38 Dividend payout ratio (dividends per share to earnings per share) - - 8.73% 36.63% 12.30% Return on assets (ratio of net income to average total assets) 1.16% 1.07% 0.91% 0.31% 1.05% Return on stockholders' equity . 8.99% 8.88% 9.42% 3.20% 11.67% Facilities at end of year: Number of full-service offices 11 11 15 15 15 Number of loan production offices 3 4 5 5 5 (1) Excludes the following nonrecurring items--assessment to recapitalize Savings Association Insurance Fund and writedown of intangible assets
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Advantage Bancorp, Inc. (the "Company") is the holding company and owner of 100% of the common stock of Advantage Bank, FSB (the "Bank"), a federally-chartered stock savings institution. In this discussion and analysis, reference to the operations and financial condition of the Company includes the operations and financial condition of the Bank and its subsidiaries. Proposed Merger On November 3, 1997, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Marshall & Ilsley Corporation, a Wisconsin corporation ("M&I"), providing for the merger of the Company with and into M&I (the "Merger"). The Merger Agreement provides that each outstanding share of common stock, $.01 par value, of the Company ("Company Common Stock"), will be converted (other than certain shares that will be cancelled as specified in the Merger Agreement) into the right to receive 1.2 shares of common stock, $1.00 par value, of M&I ("M&I Common Stock"), subject to adjustment in the event that the average closing price of M&I Common Stock for the ten consecutive trading days preceding the fifth business day prior to the effective time of the Merger is above $61.67 per share or below $46.67 per share. The Merger is structured as a pooling-of-interests for financial accounting purposes and as a tax-free reorganization for shareholders of the Company. Completion of the Merger is subject to certain conditions, including approval by the shareholders of the Company, approval by the Federal Reserve Board, and other conditions to closing customary in transactions of this type. Management currently anticipates that the Merger will be completed in early 1998. Overview The Company's business currently consists of the business of the Bank. As a consumer-oriented financial institution, the Company offers a range of retail banking services to residents in its market area. The Company is principally engaged in the business of attracting deposits from the general public and investing those deposits, along with funds generated from operations and borrowings, by originating residential loans in its primary market area and investing in those loans. The Company also originates commercial real estate, multi-family, construction, consumer and commercial business loans. The Company also invests in mortgage- related securities and other investments. Finally, the Company offers, on an agency basis, certain securities brokerage services and insurance products to its customers. At September 30, 1997, the Company operated 15 full-service offices located in Kenosha County, Lake Geneva and Racine, Wisconsin and Lake County and Cook County, Illinois. The Company also operates mortgage loan origination offices in Kenosha, Racine and Wauwatosa, Wisconsin and Grayslake and Naperville, Illinois. Deposits with the Bank are insured up to the maximum allowable amount by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is subject to regulation by the Office of Thrift Supervision (the "OTS") and the FDIC. The Bank has three active subsidiaries: (1) Advantage Real Estate Services, Inc., which invests in real estate through three partnerships, (2) Advantage Investments, Inc., a Nevada corporation, which manages certain investments in mortgage-related securities, and (3) Advantage Financial Services and Insurance, Inc., which is engaged in the business of selling non-insured investments and insurance and providing financial planning. The Company's results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on its loans, mortgage-related securities and other investment portfolios, and its cost of funds, consisting of interest paid on its deposits and borrowings. The Company's operating results are also affected to a lesser extent by gains or losses on the sale of investment securities, loans and real estate. The Company's operating expenses principally consist of employee compensation, occupancy expenses, federal insurance premiums and other general and administrative expenses. The Company's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities. The Company's basic mission is to serve its local communities while earning a profit for its shareholders. In seeking to accomplish this mission, management has adopted a business strategy designed to (1) maintain the Bank's capital well in excess of regulatory requirements, (2) manage the Company's vulnerability to changes in interest rates, (3) maintain the Company's high asset quality, (4) control operating expenses, and (5) take advantage of loan and deposit growth opportunities in the Company's primary market area as well as contiguous areas. Management has attempted to achieve these goals by focusing on (1) origination of adjustable rate one- to four-family mortgage loans ("ARM loans"), (2) origination of commercial real estate, multi-family, consumer, construction and commercial business loans, (3) increasing the Company's core deposit base, and (4) acquisition of deposits and loans from other financial institutions. Results of Operations -- Comparison of Years Ended September 30, 1997 and 1996 General Net income for the year ended September 30,1997 was $10.7 million, an increase of $7.7 million over 1996 net income of $3.0 million. Net income was lower in fiscal 1996 primarily due to a $4.7 million write-down of intangible assets and a $4.4 million one-time assessment to recapitalize the Savings Association Insurance Fund ("SAIF") of the FDIC. Without the two one-time charges in 1996 mentioned above, net income for 1996 would have been $8.8 million. Net Interest Income Total interest income was $76.7 million for the year ended September 30, 1997, an increase of $3.1 million, or 4.2%, compared to the year ended September 30, 1996. This increase was primarily due to a $43.9 million increase in average interest-earning assets in 1997 compared to 1996. Average interest-earning assets increased to $977.5 million in 1997 from $933.6 million in 1996. The Company's average interest rate margin decreased slightly from 3.19% in 1996 to 3.17% in 1997. This decrease in interest rate spread was due primarily to competitive market pressures. Management believes that the interest rate margin could continue to decline modestly during the 1998 fiscal year. The components of net interest income fluctuated significantly during 1997 due to various rate and volume changes (see "Rate Volume Analysis" table). The average yield on interest-earning assets decreased from 7.88% in 1996 to 7.84% in 1997. Total interest expense increased by $1.9 million in 1997 compared to 1996. The average cost of interest-bearing liabilities decreased slightly from 5.01% in 1996 to 4.99% in 1997. Provision for Losses on Loans The Company established provisions for losses on loans of $360,000 in 1997, compared to $480,000 in 1996. Nonperforming loans decreased from $3.4 million as of September 30, 1996 to $3.2 million as of September 30, 1997. This resulted in an increase in the ratio of the allowance for loan losses to nonperforming loans from 169% as of September 30, 1996 to 183% as of September 30, 1997. Non-interest Income Non-interest income for 1997 totalled $8.3 million compared to $8.0 million in 1996. The largest increase in non-interest income was in service charges on deposit accounts, which increased from $2.5 million in 1996 to $2.8 million in 1997 due primarily to an increase in checking account activity. This increase was offset by a decrease in mortgage brokerage commissions from $2.0 million in 1996 to $1.7 million in 1997. Gains on sales of loans decreased from $876,000 in 1996 to $627,000 in 1997. Gains on securities available for sale increased from $866,000 in 1996 to $1.0 million in 1997. These gains relate to marketable securities held by the Company which have increased in value during the last few years. Non-interest Expense Non-interest expense decreased 32.2% from $32.9 million in 1996 to $22.3 million in 1997. Non-interest expense was higher in 1996 primarily due to (1) the $4.4 million one-time special assessment to recapitalize the SAIF, and (2) the $4.7 million writedown of intangible assets. Non-interest expense before these one-time charges decreased 6.1% from$23.7 million in 1996 to $22.3 million in 1997. This decrease relates primarily to (1) a $1.6 million decrease in amortization of intangible assets and (2) a $1.0 million decrease in FDIC premiums relating to a decrease in the FDIC premium rate from 0.23% to 0.065% effective January 1, 1997. These decreases were partially offset by a $891,000 increase in salaries and employee benefits relating primarily to growth in the Company's business. Occupancy expenses increased from $3.0 million in 1996 to $3.2 million in 1997. This increase was due primarily to the lease of new corporate office space for a number of administrative departments beginning in March 1996. Income Taxes Federal and state income taxes increased from $1.5 million in 1996 to $6.0 million in 1997 due primarily to an increase in income before income taxes from $4.5 million in 1996 to $16.6 million in 1997. The Company's effective tax rate increased from 32.6% in 1996 to 35.8% in 1997 primarily due to a change in state income taxes. Results of Operations -- Comparison of Years Ended September 30, 1996 and 1995 General Net income for the year ended September 30,1996 was $3.0 million, a decrease of $5.2 million over 1995 net income of $8.2 million. This decrease in net income resulted primarily from a $4.7 million write-down of intangible assets and a $4.4 million one-time assessment to recapitalize the SAIF. For a further discussion of these one-time charges, see "Non-interest Expense" below. Without the two one-time charges mentioned above, net income for 1996 would have been $8.8 million, a 7.4% increase over 1995 net income of $8.2 million. Net Interest Income Total interest income was $73.6 million for the year ended September 30, 1996, an increase of $6.1 million, or 9.0%, compared to the year ended September 30, 1995. This increase was primarily due to a $69.7 million increase in average interest-earning assets in 1996. Average interest- earning assets increased to $933.6 million in 1996 from $863.9 million in 1995. The Company's average interest rate margin decreased from 3.26% in 1995 to 3.19% in 1996. The decrease in interest rate spread was due primarily to competitive market pressures. The components of net interest income fluctuated significantly during 1996 due to various rate and volume changes (see "Rate Volume Analysis" table). The average yield on interest-earning assets increased from 7.82% in 1995 to 7.88% in 1996. Total interest expense increased by $4.4 million in 1996 compared to 1995. The average cost of interest-bearing liabilities increased from 4.89% in 1995 to 5.01% in 1996. Provision for Losses on Loans The Company established provisions for losses on loans of $480,000 in 1996, generally comparable to the 1995 provision of $460,000. Nonperforming loans increased from $2.4 million as of September 30, 1995 to $3.4 million as of September 30, 1996. This resulted in a decrease in the ratio of the allowance for loan losses to nonperforming loans from 219% as of September 30, 1995 to 169% as of September 30, 1996. Non-interest Income Non-interest income for 1996 totalled $8.0 million compared to $4.1 million in 1995. Mortgage brokerage commissions increased $1.8 million from $235,000 in 1995 to $2.0 million in 1996. This increase was due to the acquisition by the Bank of substantially all of the assets of Financial Center of Illinois, Inc.(a mortgage brokerage company with offices in Wauwatosa, Wisconsin and Naperville, Illinois) on August 21, 1995. Service charges on deposit accounts increased from $1.9 million in 1995 to $2.5 million in 1996 due primarily to an increase in checking accounts. Gains on sales of loans increased from $108,000 in 1995 to $876,000 in 1996. This increase resulted primarily from an increase in the volume of fixed-rate loan sales from $15.9 million in 1995 to $55.1 million in 1996 relating to an increase in fixed-rate loan originations due to lower market interest rates during 1996. Gains on securities available for sale increased from $145,000 in 1995 to $866,000 during 1996. These gains relate to marketable equity securities held by the Company which had increased in value from the time of purchase to the time of sale. Non-interest Expense Non-interest expense increased 72.3% from $19.1 million in 1995 to $32.9 million in 1996. This increase was primarily due to (1) the $4.4 million one-time special assessment to recapitalize the SAIF, (2) the $4.7 million writedown of intangible assets, and (3) a $1.8 million increase in salaries and employee benefits relating primarily to the addition of the employees of the Financial Center of Illinois, Inc. The legislation affecting the SAIF recapitalization was enacted on September 30, 1996 and decreased the Bank's FDIC insurance premium from 0.230% to 0.064% of deposits effective January 1, 1997. The $4.7 million write-down of intangible assets related primarily to the core deposit intangible asset arising from the acquisition of Amity Bancshares, Inc. on December 16, 1994. The writedown reduced the book value of the intangible asset to fair value based on a calculation of the present value of estimated future cashflows associated with the deposits. This writedown was necessitated by a faster-than-projected rolloff of acquired deposits and lower-than-projected market interest rates which lowered the cost of alternative sources of funds used to value the intangible asset. Occupancy expenses increased from $2.4 million in 1995 to $3.0 million in 1996 relating to occupancy expenses of the Financial Center of Illinois, Inc. and the lease of new corporate office space for administrative departments beginning in March 1996. Other non-interest expenses increased from $3.6 million in 1995 to $4.8 million in 1996 primarily due to operating expenses of the Financial Center of Illinois, Inc. and other growth in the Bank's business. Income Taxes Federal and state income taxes decreased from $4.5 million in 1995 to $1.5 million in 1996 due primarily to the decrease in net income associated with the one-time charges described above. The Company's effective tax rate decreased from 35.7% in 1995 to 32.6% in 1996 primarily relating to a decrease in state income taxes. CONSOLIDATED AVERAGE BALANCE SHEETS The following table sets forth certain information relating to the consolidated statements of financial condition and reflects the average yield on assets and average costs of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets and liabilities, respectively, for the periods shown. Non-accruing loans are included in average outstanding balance at a 0% rate. Interest earned includes fees which are considered adjustments to yields. Average balances are derived from average daily balances.
September 30 1995 1996 1997 Average Interest Average Interest Average Interest Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate Balance Paid Rate Balance Paid Rate (dollars in thousands) Interest-Earning Assets: Loans receivable (1) $489,201 $40,649 8.31% $533,037 $45,038 8.46% $573,430 $48,275 8.42% Mortgage-backed securities . . . . . 189,239 13,430 7.10 170,838 12,092 7.08 139,207 9,853 7.08 Mortgage-related securities . . . . . 137,206 9,978 7.27 172,487 12,566 7.29 200,159 14,666 7.33 ------- ------ ----- ------- ------- ------ ------- ------ ----- Total mortgage securities . . . . 326,445 23,408 7.17 343,325 24,658 7.18 339,366 24,519 7.22 U.S government and agency securities . 19,317 1,466 7.59 26,958 2,070 7.68 23,411 1,523 6.51 Investment and other securities . . . . . 19,339 1,368 7.07 21,103 1,206 5.71 32,559 1,758 5.40 FHLB stock . . . . . 9,602 625 6.51 9,183 618 6.73 8,700 592 6.80 ------- ------ ----- ------- ------- ------ ------- ------ ----- 863,904 67,516 7.82 933,606 73,590 7.88 977,466 76,667 7.84 ------- ------ ----- ------- ------- ------ ------- ------ ----- Interest-Bearing Liabilities: Time deposits . . . . 402,735 22,379 5.56 418,496 24,065 5.75 399,128 22,833 5.72 Savings deposits and NOW accounts (2) . . 238,871 7,220 3.02 263,072 7,757 2.95 272,826 7,640 2.80 ------- ------ ----- ------- ------- ------ ------- ------ ----- Total deposits . . . 641,606 29,599 4.61 681,568 31,822 4.67 671,954 30,473 4.54 Advance payments by borrowers for taxes and insurance . . . 7,873 183 2.32 7,191 155 2.16 6,522 133 2.04 Borrowings . . . . . 155,216 9,486 6.11 185,503 11,408 6.15 236,815 14,869 6.28 Interest rate swaps and caps . . . . . . N/A 108 N/A N/A 380 N/A N/A 239 N/A ------- ------ ----- ------- ------- ------ ------- ------ ----- 804,695 39,376 4.89 874,262 43,765 5.01 915,291 45,714 4.99 ------- ------ ----- ------- ------- ------ ------- ------ ----- Net interest income $28,140 $29,825 $30,953 ====== ====== ====== Net interest rate spread 2.92% 2.88% 2.85% ===== ===== ===== Net earning assets . . $59,209 $59,344 $62,175 ====== ======= ======= Net yield on average interest-earning assets . . . . . . . 3.26% 3.19% 3.17% ===== ====== ===== Average interest-earning assets to average interest-bearing liabilities . . . . . 1.07 1.07 1.07 ==== ==== ==== ________________ (1) Calculated net of deferred loan fees, loan discounts, loans in process and allowance for losses on loans. (2) Includes NOW and checking accounts with a zero interest rate.
RATE VOLUME ANALYSIS The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to changes in outstanding balances and those due to changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume (i.e., changes in volume multiplied by the prior year's rate) and (2) changes in rate (i.e., changes in rate multiplied by the prior year's balance). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Year Ended September 30 1995 vs. 1996 1996 vs. 1997 Increase Increase (Decrease) Total (Decrease) Total Due to Increase Due to Increase Volume Rate (Decrease) Volume Rate (Decrease) (In thousands) Interest-Earning Assets: Loans receivable . . . . . . $3,694 $695 $4,389 $3,400 ($163) $3,237 Mortgage-backed securities . (1,302) (36) (1,338) (2,239) - (2,239) Mortgage-related securities 2,570 18 2,588 2,028 72 2,100 ------ ------ ------- ------- ------ ------- Total mortgage securities 1,268 (18) 1,250 (211) 72 (139) U.S. government and agency securities . . . . . . 586 30 616 (253) (294) (547) Investments and other securities . . . . . . 147 (309) (162) 615 (63) 552 FHLB stock . . . . . . . . . (32) 26 (6) (33) 7 (26) ------ ------ ------- ------- ------ ------- $5,663 $424 $6,087 $3,518 ($441) $3,077 ====== ===== ====== ====== ===== ====== Interest-Bearing Liabilities: Time deposits . . . . . . . $892 $801 $1,693 ($1,109) ($123) ($1,232) Savings deposits and NOW accounts . . . . . . . . . 709 (166) 543 330 (447) (117) ------ ------ ------- ------- ------ ------- Total deposits . . . . . . 1,601 635 2,236 (779) (570) (1,349) Advance payments by borrowers for taxes and insurance . (15) (13) (28) (14) (8) (22) Borrowings . . . . . . . . . 1,863 59 1,922 3,217 244 3,461 Interest rate swaps . . . . 272 - 272 (141) - (141) ------ ------ ------- ------- ------ ------- $3,721 $681 $4,402 $2,283 ($334) $1,949 ====== ====== ======= ======= ====== ======= Change in net interest income . $1,685 $1,128 ====== ======
NET INTEREST SPREAD AT END OF PERIOD The following table sets forth the weighted average yields on the Company's interest-earning assets, the weighted average interest rates on interest-bearing liabilities and the interest rate spread between the weighted average yields and rates at the dates indicated.Non-accruing loans have been included in the table as loans carrying a zero yield. The yield rates do not reflect fees which are considered adjustments to yield on loans receivable. At September 30 1995 1996 1997 Weighted average yield on: Loans receivable . . . 8.13% 8.22% 8.41% Mortgage-backed securities . . . . . . 7.06 7.12 7.08 Mortgage-related securities . . . . . . 7.48 7.41 7.37 ----- ------ ------ Total mortgage securities . . . . . 7.26 7.28 7.27 U.S. government and agency securities . . 6.70 6.20 6.48 Investments and other securities . . . . . . 5.62 5.29 5.10 FHLB stock . . . . . . 6.25 6.75 6.75 ----- ------ ------ Combined weighted average yield on interest-earning assets . . . . . . . 7.70 7.75 7.82 Weighted average rate on: Time deposits . . . . . 5.72 5.67 5.79 Savings deposits and NOW accounts . . . . . 2.95 2.89 2.74 ----- ------ ------ Total deposits . . . . 4.67 4.56 4.52 Advance payments by borrowers for taxes and insurance . . . . . . 2.32 2.16 2.04 Borrowings . . . . . 6.30 6.39 6.36 ----- ------ ------ Combined weighted average rate on interest-bearing liabilities 4.98 4.97 4.99 Net interest rate spread 2.72% 2.78% 2.83% ===== ===== ===== Financial Condition General Total consolidated assets of the Company increased 2.0% to $1.04 billion as of September 30, 1997 from $1.02 billion as of September 30, 1996. Liquidity and Capital Resources The Company's primary sources of funds are deposits, principal and interest payments on loans receivable and mortgage-related securities, securities sold under agreement to repurchase (reverse repurchase agreements) and Federal Home Loan Bank ("FHLB") borrowings. While maturities and scheduled amortization of loans and mortgage-related securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company utilizes particular sources of funds based upon comparative costs and availability. The Company's largest source of funds from financing activities during the year ended September 30, 1997 consisted of net proceeds of $23.8 million from securities sold under agreements to repurchase. For the year ended September 30, 1996, the largest source of funds from financing activities was $36.2 million from securities sold under agreements to repurchase and a $12.9 million net increase in notes payable to the FHLB. The primary investing activities of the Company are the origination and purchase of loans and the purchase of mortgage securities. During the years ended September 30, 1996 and 1997, the Company originated and purchased loans in the amounts of $309.5 million and $351.6 million, respectively. These amounts include loans originated for sale. Purchases of mortgage securities totalled $46.9 million and $73.1 million in fiscal years 1996 and 1997, respectively. During fiscal years 1996 and 1997, the Company's investing activities were funded by (1) principal repayments on loans and mortgage securities totalling $264.2 million and $282.4 million, respectively, (2) proceeds from the sale of loans totalling $55.1 million and $123.1 million, respectively, (3) proceeds from sales and maturities of U.S. government and agency securities available for sale of $4.5 million and $12.5 million, respectively, (4) proceeds from sales of marketable equity securities of $2.1 million and $1.9 million, respectively, and (5) proceeds from the financing activities discussed above. The Bank is required to maintain minimum levels of liquid assets as defined by regulations of the OTS. This requirement, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The required percentage is currently 5.0%. The Bank's regulatory liquidity ratios were 9.5% and 8.5% at September 30, 1996 and 1997, respectively. The Company's most liquid assets are cash and cash equivalents, which include investments in highly liquid, short-term investments. The levels of these assets are dependent on the Company's operating, financing and investing activities during any given period. At September 30, 1996 and 1997, cash and cash equivalents totalled $35.4 million and $42.9 million, respectively. Excess funds are generally invested in short-term investments such as interest-earning deposits or in mortgage securities. In the event that the Company should require funds beyond its ability to generate them internally, additional sources of funds are available through the use of FHLB borrowings and reverse repurchase agreements. At September 30, 1997, the Company had outstanding loan origination commitments of $20.3 million and no commitments to purchase loans. The Company also had extended to customers unused lines of credit under home equity line of credit loans and commercial line of credit loans totalling $39.0 million and $29.4 million, respectively. The Company anticipates that it will have sufficient funds available to meet its current loan commitments. Certificates of deposit held by depository customers of the Company which are scheduled to mature in one year or less at September 30, 1997 totalled $248.1 million. Based on the Company's deposit withdrawal experience, management believes that a significant portion of such deposits will remain with the Company. During fiscal years 1996 and 1997, the Company repurchased under its stock repurchase programs a total of 173,255 shares and 125,894 shares, respectively. The aggregate purchase price was $5.7 million and $4.2 million, respectively. During fiscal years 1996 and 1997, the Bank made dividend payments to the Company of $8.3 million and $8.8 million, respectively. During fiscal years 1996 and 1997, the Company paid dividends to its shareholders of $1.0 million and $1.2 million, respectively. At September 30, 1997, the Bank's capital exceeded all of the capital requirements of the OTS as mandated by federal law and regulations. Mortgage Securities Mortgage securities, which consist of mortgage-backed and mortgage-related securities, increased to $358.2 million as of September 30, 1997 from $337.8 million as of September 30, 1996. Purchases of mortgage securities totalled $46.9 million and $73.1 million in fiscal years 1996 and 1997, respectively. All purchases of mortgage securities were either (1) one- to four-family residential mortgage securities issued by the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC), or (2) one- to four-family residential mortgage securities with at least an AA rating from a national rating agency. All purchases of mortgage-related securities were securities backed by mortgage-backed securities of the type described in the previous sentence. Loans Receivable Loans receivable increased to $565.3 million as of September 30, 1997 from $562.8 million as of September 30, 1996 as loan originations exceeded loan repayments. One- to four-family residential first mortgage loans represented 70.0% and 64.4% of total gross loans receivable as of September 30, 1996 and 1997, respectively. Consumer loans (primarily second mortgage loans) increased from 8.6% to 13.0% of total gross loans receivable as of September 30, 1996 and 1997, respectively. Additional information regarding loans receivable, non-performing loans and non- performing assets is provided below. Deposits Deposit accounts decreased to $670.8 million as of September 30, 1997 from $680.9 million as of September 30, 1996. This decrease was primarily the result of a $14.7 million decrease in brokered deposits from $89.3 million as of September 30, 1996 to $74.6 million as of September 30, 1997, offset in part by internal growth in deposits, including interest credited, of 4.6 million. Borrowings Notes payable to FHLB increased slightly to $176.4 million as of September 30, 1997 from $175.9 million as of September 30, 1996. Borrowings under securities sold under agreements to repurchase increased to $72.1 million as of September 30, 1997 from $48.4 million as of September 30, 1996. This increase was due to an increase in repurchase agreements with local governmental units that are customers of the Bank. LOAN PORTFOLIO COMPOSITION Total loans, including loans held for sale, increased to $565.3 million as of September 30, 1997 from $562.8 million as of September 30, 1996. The components of this increase are summarized, by type of collateral, as follows: September 30 Increase 1996 1997 (Decrease) (In thousands) Real estate loans: One- to four-family . . . . . . $418,647 $378,701 ($39,946) One- to four-family construction 7,598 5,148 (2,450) Multi-family . . . . . . . . . . 24,993 26,923 1,930 Commercial . . . . . . . . . . . 54,671 63,755 9,084 Other construction and land . . 30,161 24,448 (5,713) -------- -------- --------- Total real estate loans . . . 536,070 498,975 (37,095) Other loans: Home equity and second mortgage 43,893 67,997 24,104 Other consumer . . . . . . . . 7,325 8,472 1,147 Commercial business . . . . . 10,691 12,429 1,738 -------- -------- --------- Total other loans . . . . . . 61,909 88,898 26,989 -------- -------- --------- Gross loans receivable . . . . . . 597,979 587,873 (10,106) Add: Accrued interest . . . . . . . 3,718 3,755 37 Less: Net items to loans receivable . . . . . . . (38,915) (26,369) 12,546 -------- -------- --------- Total loans receivable . . . . . $562,782 $565,259 $2,477 ======== ======== ========= Total loans receivable increased by $2.5 million during fiscal 1997. One- to four-family residential mortgage loans decreased by $39.9 million, or 9.5%, during fiscal 1997 due primarily to customers with adjustable-rate mortgage loans exercising their option to convert to fixed rate loans which were then sold by the Bank into the secondary market. One- to four- family residential mortgage loans include permanent loans to individuals for construction of single-family residences (which they will occupy upon completion of construction) totalling $50.7 million and $31.8 million as of September 30, 1996 and 1997, respectively. One- to four-family construction loans decreased by $2.5 million. These loans are made to builders and developers for construction of single family detached residences and condominiums in the Company's market area. Commercial real estate loans increased by $9.1 million during fiscal 1997 as the Company continued to increase its lending to small businesses and professionals in the Company's market area. Other construction and land loans decreased by $5.7 million during fiscal 1997. These loans are primarily secured by commercial construction projects (usually multi-family and condominium projects) in the Company's market area. Home equity and fixed-rate second mortgage loans increased by $24.1 million in 1997 as the Company continued its emphasis on growth in consumer lending. This growth in consumer loans is expected to continue in the future. Commercial business loans increased by $1.7 million during fiscal 1997. These loans are loans to businesses which are secured by property other than real estate or are unsecured. NON-PERFORMING ASSETS Non-performing assets (consisting of non-performing loans and foreclosed properties) increased slightly to $5.0 million as of September 30, 1997 from $4.8 million as of September 30, 1996. The Company places loans into non-performing and non-accrual status when loans are contractually delinquent more than 90 days, or earlier if warranted based on management's assessment of the loan. Non-performing assets are summarized as follows for the dates indicated: September 30 1993 1994 1995 1996 1997 (In thousands) Non-performing loans: One- to four-family $191 $867 $604 $666 $1,796 Commercial real estate . . . . . . 5,565 3,666 1,685 616 646 Construction and land 40 280 - 1,774 283 Commercial business 316 70 105 274 51 Consumer and other . 81 106 13 84 385 ------ ------ ------ ------ ------ Total non- performing loans . . . . 6,193 4,989 2,407 3,414 3,161 ------ ------ ------ ------ ------ Foreclosed properties and properties subject to foreclosure: One- to four-family 1,203 224 1,547 869 954 Commercial real estate . . . . . . 429 662 533 534 839 Land . . . . . . . . - - - - - ------ ------ ------ ------ ------ Total foreclosed assets . . . 1,632 886 2,080 1,403 1,793 ------ ------ ------ ------ ------ Total non-performing assets . . . . . . . $7,825 $5,875 $4,487 $4,817 $4,954 ====== ====== ====== ====== ====== Total as a percentage of total assets . . . . 1.20% 0.79% 0.46% 0.47% 0.48% ==== ==== ==== ==== ==== ALLOWANCE FOR LOSSES ON LOANS The Company establishes specific allowances for losses on loans when any significant and permanent decline in value occurs. In addition, general loss allowances are provided based on past experience and on prevailing market conditions. Management's evaluation of loss considers various factors including, but not limited to, fair value of the property, general economic conditions, loan portfolio composition, prior loss experience, estimated sales price, refurbishing costs, and holding and selling costs. The evaluation of the allowance for losses on loans includes a review of both known loan problems as well as a review of potential problems based upon historical trends and ratios. Management believes that the allowance for losses on loans is adequate as of September 30, 1997 based upon its current evaluation of the factors discussed above. Net charge-offs increased from net recoveries of $22,000 in 1996 to net charge-offs of $336,000 in 1997. A summary of activity in the allowance for losses on loans is as follows: Year Ended September 30 1993 1994 1995 1996 1997 (Dollars In thousands) Balance at beginning of year . . . . . . . . . $4,204 $4,937 $5,327 $5,271 $5,773 Additions charged to operations: One- to four-family . 50 50 30 - - Multi-family and commercial real estate . . . . . . . 526 526 60 - - Consumer . . . . . . . 24 24 50 - 150 Commercial business . 120 120 320 480 210 ------ ------ ------ ------ ------ 720 720 460 480 360 Additions from loan purchases and mergers: One- to four-family . - - 469 - - Multi-family and commercial real estate . . . . . . . - - 49 - - ------ ------ ------ ------ ------ - - 518 - - Recoveries: One- to four-family . 25 31 14 40 26 Multi-family and commercial real estate - 61 - - - Consumer . . . . . . . 6 6 12 22 1 Commercial business . 13 - 12 1 444 ------ ------ ------ ------ ------ 44 98 38 63 471 Charge-offs: One- to four-family . (6) - (40) (29) (447) Multi-family and commercial real estate . . . . . . . - (408) (841) - - Consumer . . . . . . . (25) (20) (32) (8) (261) Commercial business . - - (159) (4) (99) ------ ------ ------ ------ ------ (31) (428) (1,072) (41) (807) ------ ------ ------ ------ ------ Net recoveries (charge- offs) . . . . . . . . 13 (330) (1,034) 22 (336) ------ ------ ------ ------ ------ Balance at end of year . $4,937 $5,327 $5,271 $5,773 $5,797 ====== ====== ====== ====== ====== Ratio of net charge-offs to average loans outstanding during the year . . . . . . . . . 0.00% 0.08% 0.20% 0.00% 0.06% ====== ====== ====== ====== ====== Allowance for losses on loans to non-performing loans . . . . . . . . 79.7% 106.8% 219.0% 169.1% 183.4% ====== ====== ====== ====== ====== Allowance for losses on loans to total loans at end of year . . . . . 1.28% 1.25% 1.03% 1.03% 1.03% ====== ====== ====== ====== ====== ASSET / LIABILITY MANAGEMENT The Company's asset/liability management program seeks to maximize net income while managing the sensitivity of earnings to interest rate fluctuations. By using a computer simulation model, the Company assesses the effect of changing interest rates on the Company's projected future profitability. The Company uses a variety of tools to adjust its asset/liability position. First, the Company has focused its residential lending on ARMs, which generally reprice within one to three years. Second, the Company has focused its non-residential lending on adjustable or floating rate and/or short-term loans. Third, the Company has focused its investment activities on short- and medium-term securities. Fourth, the Company has attempted to maintain and increase its passbook and transaction deposit accounts, which are considered to be relatively resistant to changes in interest rates. Fifth, the Company has utilized long-term borrowings and deposit marketing programs to adjust the term to repricing of its liabilities. Sixth, the Company has used interest rate swaps to reduce its exposure to changes in interest rates. The Company's asset/liability position may be analyzed by examining the extent to which its assets and liabilities are "interest rate sensitive" and by monitoring the interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the estimated amount of interest-earning assets maturing or repricing within a specific time period and the estimated amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap tends to adversely affect net interest income while a positive gap tends to result in an increase in net interest income. During a period of falling interest rates, a negative gap tends to result in an increase in net interest income while a positive gap tends to adversely affect net interest income. Management seeks to maintain a relatively balanced gap position in order to limit the Company's exposure to interest-rate risk. At September 30, 1997, total interest-bearing assets maturing or repricing within one year exceeded total interest-bearing liabilities maturing or repricing in the same period by $6.1 million, representing a positive one-year gap of 0.6% of total assets. This gap compares to a negative one-year gap of $46.7 million, or 4.6% of total assets, as of September 30, 1996. This change relates primarily to the fact that the Company has sold almost of all its fixed-rate residential loans for the last several years and has purchased no fixed-rate mortgage securities for several years. Management considers its gap position as of September 30, 1997 to be acceptable. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at September 30, 1997 which the Company estimates will reprice or mature in the future time periods shown, based upon certain assumptions. Except as stated below, the amount of assets and liabilities shown as repricing or maturing during a particular period was determined based on the remaining term to repricing or maturity of the asset or liability. Fixed rate loans and mortgage-related securities are shown on the basis of management's estimate of annual payments and prepayments based on contractual amortization and forecasted prepayment rates. Loans and securities with adjustable rates are shown as repricing in the period during which the interest rates are next subject to change. The Company has assumed that its passbook savings, money market and NOW accounts are withdrawn at the following rates: Within Over Over One 1-3 3-5 Year Years Years Passbook accounts . . . . . 17% 26% 17% Money market accounts . . . 79% 11% 5% NOW accounts: Interest bearing . . . . 37% 34% 9% Non-interest bearing . . 41% 27% 14% For purposes of the gap analysis, loans receivable is reflected after deducting the undisbursed portion of loan proceeds and non-performing loans. However, no deductions are made for the allowance for losses on loans or unamortized loan origination fees. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The Company's estimates for prepayments and withdrawals are subject to changing economic circumstances (especially changes in interest rates) and consumer behavior, both of which are beyond the Company's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may, in fact, mature or reprice at different times or at different volumes. In addition, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the changes in interest rates on certain types of assets and liabilities may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features which limit changes in interest rates on a short-term basis and over the life of the asset. CONSOLIDATED GAP ANALYSIS AS OF SEPTEMBER 30, 1997
Amount Maturing or Repricing Within Over 1-3 Over 3-5 Over 5 Total One Year Years Years Years Amount (Dollars in Thousands) Interest-earning assets: Fixed-rate loans receivable and mortgage securities: Loans receivable . . . . . . $44,222 $67,048 $43,249 $62,211 $216,730 Mortgage securities . . . . 74,708 121,731 57,896 32,660 286,995 ------- ------- ------- ------- ------- 118,930 188,779 101,145 94,871 503,725 Adjustable-rate loans receivables and mortgage securities: Loans receivable . . . . . . 276,462 68,029 7,073 430 351,994 Advances to unconsolidated partnerships . . . . . . . 3,649 2,071 - - 5,720 Mortgage securities . . . . 70,547 669 - - 71,216 ------- ------- ------- ------- ------- 350,658 70,769 7,073 430 428,930 Investment securities and other 41,445 16,980 1,477 - 59,902 ------- ------- ------- ------- ------- Total interest-earning assets . . . . . . . $511,033 $276,528 $109,695 $95,301 $992,557 ======= ======== ======= ======= ======= Interest-bearing liabilities: Deposits . . . . . . . . . . . $356,619 $221,934 $38,974 $53,248 $670,775 Borrowings . . . . . . . . . . 141,082 98,793 2,240 6,360 248,475 Advance payments by borrowers for taxes and insurance 7,187 - - - 7,187 ------- ------- ------- ------- ------- Total interest-bearing liabilities . . . . . $504,888 $320,727 $41,214 $59,608 $926,437 ======= ======== ======= ======= ======= Interest-earning assets less interest-bearing liabilities $6,145 ($44,199) $68,481 $35,693 $66,120 ====== ======== ======= ======= ======= Cumulative interest rate sensitivity gap . . . . . . $6,145 ($38,054) $30,427 $66,120 $66,120 ====== ======== ======= ======= ======= Cumulative interest rate sensitivity gap as a percentage of total assets . 0.6% (3.7%) 2.9% 6.4% ===== ===== ===== =====
Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company's financial performance is impacted by, among other factors, interest rate risk and credit risk. The Company utilizes no derivatives to mitigate its credit risk, relying instead on loan review and an adequate loan loss reserve (see Management's Discussion and Analysis of Financial Condition and Results of Operation). Interest rate risk is the risk of loss in value due to changes in interest rates. This risk is addressed by the Company's Asset Liability Management Committee ("ALCO"), which includes senior management representatives. The ALCO monitors and considers methods of managing interest rate risk by monitoring changes in net portfolio value ("NPV") and net interest income under various interest rate scenarios. The ALCO attempts to manage the various components of the Company's balance sheet to minimize the impact of sudden and sustained changes in interest rates on NPV and net interest income. The Company's exposure to interest rate risk is reviewed on at least a quarterly basis by the Board of Directors and the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Company's change in NPV in the event of hypothetical changes in interest rates and interest liabilities. If potential changes to NPV and net interest income resulting from hypothetical interest rate swings are not within the limits established by the Board, the Board may direct management to adjust its asset and liability mix to bring interest rate risk within Board-approved limits. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, shorten the effective maturities of certain interest-earning assets, and increase the effective maturities of certain interest-bearing liabilities. First, the Company has focused its residential lending on ARMs, which generally reprice within one to three years. Second, the Company has focused its non-residential lending on adjustable or floating rate and/or short-term loans. Third, the Company has focused its investment activities on short- and medium-term securities. Fourth, the Company has attempted to maintain and increase its passbook and transaction deposit accounts, which are considered to be relatively resistant to changes in interest rates. Fifth, the Company has utilized long-term borrowings and deposit marketing programs to adjust the term to repricing of its liabilities. Sixth, the Company has used interest rate swaps to reduce its exposure to changes in interest rates. Interest rate sensitivity analysis is used to measure the Company's interest rate risk by computing estimated changes in NPV of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market rate sensitive instruments in the event of sudden and sustained increases and decreases in market interest rates ranging from one hundred to four hundred basis points. The Company's Board of Directors has adopted an interest rate risk policy which establishes maximum decreases in the NPV ranging from 15% to 60% in the event of sudden and sustained increases and decreases in market interest rates. The following table presents the Company's projected change in NPV for the various rate shock levels as of September 30, 1997 and the Board's established limitations relating thereto. All market rate sensitive instruments presented in this table are classified as either held to maturity or available for sale. The Company has no trading securities.
Percent Change Change in Market Value of Actual Board Interest Rates Portfolio Equity Change Actual Limit 400 basis point rise $81,266,000 $(25,363,000) 24% 60% 300 basis point rise 89,568,000 (17,061,000) 16% 45% 200 basis point rise 97,100,000 (9,529,000) 9% 30% 100 basis point rise 103,121,000 (3,508,000) 3% 15% Base Scenario 106,629,000 0 0% 0% 100 basis point decline 106,998,000 369,000 1% 15% 200 basis point decline 102,955,000 (3,674,000) 3% 20% 300 basis point decline 95,143,000 (11,486,000) 11% 25% 400 basis point decline 85,820,000 (20,809,000) 20% 30%
The preceding table indicates that at September 30, 1997, in the event of a sudden and sustained increase or decrease in prevailing market interest rates, the Company's NPV would be expected to decrease. At September 30, 1997, the Company's estimated changes in NPV were within the targets established by the Board of Directors. NPV is calculated based on the net present value of estimated cash flows utilizing market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources. Computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposits decay, and should not be relied upon as indicative of actual future results. Further, the computations do not contemplate any actions the ALCO could undertake in response to changes in interest rates. Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. Actual values may differ from those projections presented, should market conditions vary from assumptions used in the calculation of the NPV. Certain assets, such as adjustable-rate loans, which represent one of the Company's primary loan products, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. In addition, the proportion of adjustable-rate loans in the Company's portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinance activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the NPV. Finally, the ability of many borrowers to repay their adjustable-rate mortgage loans may decrease in the event of interest rate increases. Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors . . . Page 53 Consolidated Statements of Financial Condition as of September 30, 1996 and 1997 . . . . . . . . . . . . . Page 54 Consolidated Statements of Income for each year in the three-year period ended September 30, 1997 . . . . . Page 55 Consolidated Statements of Stockholders' Equity for each year in the three-year period ended September 30, 1997 . . . . . . . . . . . . . . . . . Page 56 Consolidated Statements of Cash Flows for each year in the three-year period ended September 30, 1997 . . . Page 57 Notes to Consolidated Financial Statements . . . . . . Page 60 Report of Ernst & Young LLP, INDEPENDENT AUDITORS The Board of Directors Advantage Bancorp, Inc. We have audited the accompanying consolidated statements of financial condition of Advantage Bancorp, Inc. and subsidiaries ("the Company") as of September 30, 1996 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at September 30, 1996 and 1997, and the consolidated results of its operations and cash flows for each of the three years in the period ended September 30, 1997 in conformity with generally accepted accounting principles. October 31, 1997 Milwaukee, Wisconsin ADVANTAGE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30 ASSETS 1996 1997 Cash and cash equivalents (includes interest earning deposits of $17,714,761 - 1996; $30,518,837- 1997) . . . . . . . . . . . . . . . . $35,445,646 $42,908,363 Certificates of deposit (approximates market value) . . . . . . . . . . . 611,067 508,664 U.S. government and agency securities available for sale (at market value) 29,385,356 19,956,301 Mortgage-backed securities available for sale (at market value) . . . . . 140,086,665 117,332,556 Mortgage-backed securities held to maturity (market value $11,159,367 - 1996; $8,421,309-1997) . . . . . . . . 11,011,238 8,321,934 Mortgage-related securities available for sale (at market value) . . . . . . 15,226,120 14,105,718 Mortgage-related securities held to maturity (market value of $172,913,430 - 1996; $222,150,681 - 1997) . . . . . . . . . . . . . . 171,470,022 218,450,643 Marketable equity securities available for sale (at market value) . . . . . . 5,043,091 9,281,261 Loans held for sale . . . . . . . . . 3,056,000 4,907,212 Loans receivable - net . . . . . . . . 559,725,640 560,352,039 Foreclosed properties and properties subject to foreclosure - net . . . . 1,403,440 1,792,677 Investments in and advances to unconsolidated partnerships . . . . 7,397,416 7,204,387 Office properties and equipment . . . 12,531,601 12,756,398 Federal Home Loan Bank stock - at cost 8,795,600 8,918,000 Accrued interest on investments and mortgage-related securities . . . . . 2,640,672 2,515,698 Deferred income taxes . . . . . . . . . 2,641,659 - Intangible assets . . . . . . . . . . . 6,902,259 5,860,052 Prepaid expenses and other assets . . . 3,012,020 2,290,536 ------------- ------------- $1,016,385,512 $1,037,462,439 ============= ============= LIABILITIES Deposits . . . . . . . . . . . . . . . $680,850,865 $670,775,364 Notes payable to Federal Home Loan Bank 175,910,000 176,360,000 Securities sold under agreements to repurchase . . . . . . . . . . . . . 48,355,457 72,115,303 Advance payments by borrowers for taxes and insurance . . . . . . . . . . . . 8,496,925 7,187,361 Accrued interest on deposit accounts . 3,711,995 2,825,851 Accrued interest on notes payable and other borrowings . . . . . . . . . . 1,377,204 2,607,869 Deferred income tax . . . . . . . . . . - 2,226,660 Other liabilities . . . . . . . . . . . 8,419,561 2,898,434 Accrued income taxes . . . . . . . . . 397,102 1,461,468 ------------ ------------ Total liabilities . . . . . . . . 927,519,109 938,458,310 STOCKHOLDERS' EQUITY Serial preferred stock, $.01 par value; authorized 5,000,000 shares; none outstanding . . . . . . . . . . . . . - - Common stock, $.01 par value; authorized 10,000,000 shares; issued 4,124,780 shares; outstanding: 3,326,768 - 1996; 3,235,830 - 1997 . 33,000 33,000 Additional paid-in capital . . . . . . 37,751,499 38,536,160 Loan to Employee Stock Ownership Plan . (1,704,941) (1,405,470) Unearned restricted stock awarded . . . (894,777) (839,055) Treasury stock, at cost: 798,102 shares - 1996; 888,950 - 1997 . . . . . . . . (17,627,105) (21,319,434) Unrealized gain (loss) on securities available for sale . . . . . . . . . (699,857) 2,667,084 Retained earnings . . . . . . . . . . 72,008,584 81,331,844 ------------- ------------- Total stockholders' equity . . . . 88,866,403 99,004,129 Commitments and contingent liabilities (see note 14) . . . . . . . . . . . . ------------- ------------- $1,016,385,512 $1,037,462,439 ============= ============= See accompanying notes to consolidated financial statements. ADVANTAGE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Year Ended September 30 1995 1996 1997 Interest income: Interest on loans . . . . $40,649,023 $45,037,786 $48,275,124 Interest on mortgage-related securities . . . . . . . 23,407,834 24,658,171 24,518,920 Interest and dividends on investment securities . 2,305,959 2,897,154 2,405,839 Other interest income . . 1,152,621 996,962 1,466,945 ----------- ----------- ----------- Total interest income . . . 67,515,437 73,590,073 76,666,828 Interest expense: Interest on deposits . . 29,598,632 31,821,842 30,473,315 Interest on notes payable and other borrowings . . 9,777,075 11,943,590 15,240,188 ----------- ----------- ----------- Total interest expense . 39,375,707 43,765,432 45,713,503 ----------- ----------- ----------- Net interest income . . . 28,139,730 29,824,641 30,953,325 Provision for losses on loans . . . . . . . . . . 460,000 480,000 360,000 ----------- ----------- ----------- Net interest income after provision for losses on loans . . . . . . . . . . 27,679,730 29,344,641 30,593,325 Non-interest income: Loan fees and service charges . . . . . . . . 508,614 659,828 783,525 Mortgage brokerage commissions . . . . . . . 234,803 2,009,193 1,700,755 Service charges on deposit accounts . . . . . . . . 1,924,993 2,466,310 2,790,423 Gain on sales of loans - net . . . . . . . . . . 107,513 875,830 627,446 Net realized gain on securities available for sale . . . . . . . . . . 145,000 866,070 1,037,848 Equity in net income of unconsolidated partnerships . . . . . . 116,335 113,685 178,610 Other . . . . . . . . . . 1,084,969 1,024,137 1,201,819 ------------ ------------ ----------- Total non-interest income 4,122,227 8,015,053 8,320,426 Non-interest expenses: Salaries and employee benefits . . . . . . . . 8,200,652 10,014,275 10,905,060 Occupancy . . . . . . . . 2,397,697 2,985,996 3,239,517 Data processing . . . . . 590,938 655,837 728,589 Advertising . . . . . . . 530,953 533,066 698,127 Federal deposit insurance premiums . . . . . . . . 1,323,680 1,595,462 647,775 Assessment to recapitalize Savings Association Insurance Fund of FDIC - 4,434,589 - Writedown of intangible assets . . . . . . . . . - 4,719,529 - Amortization of intangible assets . . . . . . . . . 2,062,530 2,611,780 1,042,207 Professional services . . 380,987 540,674 469,104 Other . . . . . . . . . . 3,645,987 4,772,125 4,542,044 ------------- ------------- ------------- Total non-interest expenses . . . . . . . . 19,133,424 32,863,333 22,272,423 ------------- ------------- ------------- Income before income taxes 12,668,533 4,496,361 16,641,328 Income taxes . . . . . . . 4,517,548 1,463,824 5,953,449 ------------- ------------- ------------- Net income . . . . . . . . $8,150,985 $3,032,537 $10,687,879 ============= ============= ============= Earnings per share (Note 1) $2.20 $0.83 $3.09 ===== ===== ===== See accompanying notes to consolidated financial statements. ADVANTAGE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Unrealized Unearned Gain (Loss) Additional Restricted on Securities Common Paid-in Retained Treasury Loan Stock Available Stock Capital Earnings Stock to ESOP Awarded for Sale Total Balance at September 30, 1994 . . . . $33,000 $37,004,174 $63,221,297 $(10,027,931) $(2,497,791) $(1,075,464) $(3,722,622) $82,934,663 Net income . . --- --- 8,150,985 --- --- --- --- 8,150,985 Awards of restricted stock . . . . --- 105,511 --- --- --- (105,511) --- --- Purchase of treasury stock (162,591 shares) . . . --- --- --- (3,781,661) --- --- --- (3,781,661) Exercise of stock options (115,315 shares) . . . --- 139,441 (463,940) 1,458,135 --- --- --- 1,133,636 Dividends paid --- --- (665,120) --- --- --- --- (665,120) Repayment of ESOP loan . . --- --- --- --- 511,988 --- --- 511,988 Amortization of unearned restricted stock awarded --- --- --- --- --- 294,369 --- 294,369 Unrealized gain on securities available for sale . . . . . --- --- --- --- --- --- 4,497,466 4,497,466 Other . . . . . --- 512 1,598 57 --- --- --- 2,167 --------- ---------- ---------- ----------- --------- -------- ------- ---------- Balance at September 30, 1995 . . . . 33,000 37,249,638 70,244,820 (12,351,400) (1,985,803) (886,606) 774,844 93,078,493 Net income . . - - 3,032,537 - - - - 3,032,537 Awards of restricted stock . . . . - 342,098 - - - (140,557) - 201,541 Purchase of treasury stock (173,255 shares) . . . - - - (5,729,530) - - - (5,729,530) Exercise of stock options (35,891 shares) . . . - 159,763 (223,543) 453,825 - - - 390,045 Dividends paid - - (1,045,230) - - - - (1,045,230) Repayment of ESOP loan . . - - - - 280,862 - - 280,862 Amortization of unearned restricted stock . . . . - - - - - 132,386 - 132,386 Unrealized loss on securities available for - sale . . . . . - - - - - (1,474,701) (1,474,701) --------- ---------- ---------- ----------- --------- -------- ------- ---------- Balance at September 30, 1996 . . . . 33,000 37,751,499 72,008,584 (17,627,105) (1,704,941) (894,777) (699,857) 88,866,403 Net income . . - - 10,687,879 - - - - 10,687,879 Awards of restricted stock . . . . - 466,819 - - - (155,472) - 311,347 Purchase of treasury stock (125,894 shares) . . . - - - (4,185,066) - - - (4,185,066) Exercise of stock options (34,956 shares) . . . - 317,842 (128,149) 492,737 - - - 682,430 Dividends paid - - (1,236,470) - - - - (1,236,470) Repayment of ESOP loan . . - - - - 299,471 - - 299,471 Amortization of unearned restricted stock . . . . - - - - - 211,194 - 211,194 Unrealized gain on securities available for - sale . . . . . - - - - - 3,366,941 3,366,941 --------- ---------- ---------- ----------- ---------- -------- ------- ---------- Balance at September 30, 1997 . . . . $33,000 $38,536,160 $81,331,844 ($21,319,434) ($1,405,470) ($839,055) $2,667,084 $99,004,129 ========= ========== ========== =========== ========== ======== ========= ==========
See accompanying notes to consolidated financial statements. ADVANTAGE BANCORP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended September 30 1995 1996 1997 Operating activities: Net income . . . . . . . . $8,150,985 $3,032,537 $10,687,879 Adjustments to reconcile net income to net cash provided by operating activities Provision for losses on loans . . . . . . . . . 460,000 480,000 360,000 Provision for depreciation . . . . . . 912,397 1,085,360 1,369,030 Writedown of intangible assets . . . . . . . . . - 4,719,529 - Amortization of intangible assets . . . 2,062,530 2,611,780 1,042,207 Equity in net income of unconsolidated partnerships . . . . . . (116,335) (113,685) (178,610) Net loss (gain) on sale of foreclosed properties (140,721) (10,794) 90,747 Net amortization of discount and premiums on mortgage securities . . (785,634) (816,812) (708,347) Increase (decrease) in deferred income taxes . 1,620,723 (4,157,935) 2,732,466 Increase (decrease) in accrued income taxes . . 243,187 (668,768) 1,064,366 Decrease (increase) in interest receivable . . (408,757) (266,448) 109,093 Increase (decrease) in interest payable . . . . 1,574,886 (408,534) 344,521 Loans originated for sale (17,349,224) (55,754,049) (95,740,854) Proceeds from sale of loans . . . . . . . . . 15,928,424 55,103,049 93,889,642 Receipt of FHLB stock dividend . . . . . . . . (149,400) - - Amortization of cost of restricted stock benefit plan . . . . . . . . . . 294,369 132,386 211,194 Increase (decrease) in accrued FDIC SAIF special assessment . . . - 4,434,589 (4,434,589) Other . . . . . . . . . . (3,599,256) (1,091,778) (1,693,475) ---------- ---------- ---------- Net cash provided by operating activities . . 8,698,174 8,310,427 9,145,270 Investing activities: Proceeds from maturities of certificates of deposit . . . . . . . . 914,598 198,000 102,706 Proceeds from sale and maturity of U.S. government and agency securities available for sale . . . . . . . . . . 36,326,805 4,500,000 12,500,000 Proceeds from sale of marketable equity securities . . . . . . . 435,750 2,088,713 1,934,877 Proceeds from sale of mortgage-backed securities available for sale . . . . . . . . . . 9,459,280 - - Proceeds from sale of FHLB stock . . . . . . . - 1,477,600 677,600 Purchases of certificates of deposit . . . . . . . (202,474) (500,820) - Purchase of U.S. government and agency securities available for sale . . . . . . . . . . (6,008,203) (9,000,000) (3,000,000) Purchase of FHLB stock . - (425,600) (800,000) Purchases of mortgage loans . . . . . . . . . (9,929,250) - - Loans transferred to held for sale and sold . . . - - 29,194,553 Purchases of mortgage- related securities held to maturity . . . . . . (88,527,687) (44,888,700) (73,148,108) Purchases of mortgage- backed securities held to maturity . . . . . . (4,874,040) - - Principal repayments on mortgage-related securities held to maturity . . . . . . . . 12,322,954 18,930,463 26,695,410 Principal repayments on mortgage-backed securities held to maturity . . . . . . . . 4,080,032 3,151,987 2,948,927 Loan principal repayments 163,171,984 204,629,823 226,027,966 Loans originated . . . . (201,912,372) (253,766,609) (255,900,375) Principal repayments on loan to ESOP . . . . . . 511,988 280,863 299,471 Purchases of marketable equity securities . . . (1,553,187) (2,785,453) (3,631,618) Purchases of mortgage- backed securities available for sale . . . (24,737,402) (2,035,207) - Principal repayments on mortgage-backed securities available for sale . . . . . . . . . 21,257,261 35,708,578 25,319,336 Principal repayments on mortgage-related securities available for sale . . . . . . . . . . 707,853 1,742,150 1,366,393 Proceeds from sale of foreclosed properties . 1,098,902 1,435,313 1,184,664 Investments in and advances to unconsolidated partnerships . . . . . . - (2,690,555) - Principal repayments on loans to unconsolidated partnerships . . . . . . 166,907 178,500 247,635 Cash distribution from unconsolidated partner- ship . . . . . . . . . . 50,000 100,000 124,004 Additions to office properties and equipment (740,142) (3,070,369) (1,593,827) Business acquisition, net of cash and cash equivalents acquired of $5,727,802: Loans receivable . . . . (37,181,491) - - Mortgage-backed securities . . . . . . (34,168,133) - - U.S. government and agency securities . . (45,543,011) - - Intangible assets . . . (14,722,843) - - Deposit accounts . . . . 106,934,528 - - FHLB advances . . . . . 3,000,000 - - Other - net . . . . . . 2,402,297 - - ------------ ------------ ------------ Net cash used in investing activities . . . . . . . (107,259,096) (44,741,323) (9,450,386) Financing activities: Net increase (decrease) in deposit accounts . . 67,652,253 (1,074,018) (10,075,501) Proceeds from notes payable to the Federal Home Loan Bank . . . . . 41,000,000 64,500,000 51,000,000 Repayment of notes payable to the Federal Home Loan Bank . . . . . (14,400,000) (51,600,000) (50,550,000) Net increase in securities sold under agreements to repurchase 9,709,637 36,245,820 23,759,846 Net increase (decrease) in advance payments by borrowers for taxes and insurance . . . . . . . 546,332 (2,161,009) (1,309,564) Proceeds from exercise of stock options . . . . . 994,252 230,304 364,588 Dividends paid . . . . . (665,120) (1,045,230) (1,236,470) Purchase of treasury stock . . . . . . . . . . (3,781,661) (5,729,530) (4,185,066) ------------ ------------ ----------- Net cash provided by financing activities . . 101,055,693 39,366,337 7,767,833 ------------ ------------ ----------- Increase in cash and cash equivalents . . . . . . . 2,494,771 2,935,441 7,462,717 Cash and cash equivalents: At beginning of year . . . 30,015,434 32,510,205 35,445,646 ----------- ------------ ----------- At end of year . . . . . . $32,510,205 $35,445,646 $42,908,363 =========== ============ =========== Supplemental disclosures of cash flow information: Interest paid (including amounts credited to deposit accounts) . . . $37,787,908 $44,173,966 $45,368,982 Income taxes paid . . . . 2,195,556 4,889,068 2,156,615 Supplemental schedule of noncash investing activities: Loans receivable transferred to (from) foreclosed properties . 2,152,524 (747,536) (1,664,648) Securities transferred from held-to-maturity to available for sale . . . - 37,300,000 - See accompanying notes to consolidated financial statements. ADVANTAGE BANCORP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1997 1. Summary of significant accounting policies Advantage Bancorp, Inc. (the "Company") is a Wisconsin corporation incorporated in December 1991 for the purpose of becoming a savings and loan holding company for Advantage Bank FSB (the "Bank"). On March 20, 1992, the Bank converted from a mutual to a stock form of ownership and the Company completed its initial public offering selling 4,124,780 shares at $9.20 per share. The Company acquired all of the issued and outstanding capital stock of the Bank using a portion of the net proceeds from the conversion. Business - The Company provides a full range of financial services to individual customers and small businesses through the Bank in Wisconsin and Illinois. The Company is subject to competition from other financial institutions. The Company and its subsidiaries are also subject to the regulations of certain governmental agencies and undergoes periodic examinations by those regulatory authorities. Basis of financial statement presentation - The accounting and reporting policies of the Company and its subsidiaries conform to generally accepted accounting principles ("GAAP") and to general practices within the financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed properties, management obtains independent appraisals for significant properties. Principles of consolidation - The consolidated financial statements include the accounts and operations of the Company, the Bank and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The Bank's investments in unconsolidated partnerships are accounted for using the equity method. Interest on loans - Interest on loans is recorded as income in the period earned. Allowances are established for accrued interest on loans on which any payments are considered uncollectible. Allowance for losses on loans - Specific allowances for losses on loans are established when any significant and permanent decline in value occurs. In addition, general loss allowances are provided based on past experience and on prevailing market conditions. Management's evaluation of loss considers various factors, including, but not limited to, fair value of the property, general economic conditions, loan portfolio composition, prior loss experience, estimated sales price, refurbishing costs, holding costs and selling costs. Where loss is indicated, a specific allowance for the estimated loss is provided or the uncollectible portion of the asset is written off. As of October 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114 entitled "Accounting by Creditors for Impairment of a Loan" (SFAS No. 114). SFAS No. 114 requires that impaired loans be measured at the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The Company's financial statement were not significantly impacted by the adoption of SFAS No. 114. Loan fees - Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amounts are amortized as an adjustment of the related loan's yield. The Bank is amortizing these amounts using the level-yield method over the contractual life of the related loans. Sales of loans - As of October 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 122 entitled "Accounting for Mortgage Servicing Rights," (SFAS No. 122) which requires that an allocation of costs be made between loans and their related servicing rights for loans originated with a definitive plan to sell or securitize these loans and retain the servicing rights. SFAS No. 122 requires entities to recognize a separate asset for servicing rights which increases the gain on sale of loans when the servicing rights are retained. Prior to October 1, 1995, costs were fully allocated to the loan and servicing income was recognized as it was received over the life of the loan. Adoption of SFAS No. 122 had the effect of increasing net income for fiscal years 1996 and 1997 by approximately $400,000 and $450,000, respectively. Loans held for sale - Loans held for sale are carried at the lower of aggregate cost or market. Mortgage servicing rights - The cost of mortgage servicing rights is amortized over the estimated life of the estimated net servicing revenue using the level yield method. Impairment of mortgage servicing rights is determined periodically based on the fair value of those rights. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights exceed their fair value. The fair value of mortgage servicing rights is based on the present value of estimated future cashflows using current estimates of required market rates of return, loan prepaymenr rates, servicing costs, fee income, investment interest rates and other relevant factors. Investments in debt and equity securities - Investments in equity securities that have readily determinable fair values and investments in debt securities are classified in one of three categories and accounted for as follows: (1) Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as "held-to-maturity securities" and reported at amortized cost. (2) Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as "trading securities" and reported at fair value, with unrealized gains and losses included in earnings. The Company had no trading securities during fiscal year 1996 or 1997. (3) Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as "available-for-sale securities" and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Management determines the appropriate classification for its securities at the time of purchase. As of December 31, 1995, the Company reclassified approximately $37.3 million in securities from held-to-maturity to available-for-sale under the one-time opportunity allowed under the Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities, which was issued by the Financial Accounting Standards Board ("FASB") in November 1995. Under this Guide, a one-time reclassification could be made without calling into question the propriety of the Company's stated intent relating to these securities in prior or subsequent periods. Foreclosed properties and properties subject to foreclosure - Real estate owned (which was acquired by foreclosure or by deed in lieu of foreclosure) and real estate in judgment are written down to their fair value upon acquisition and are subsequently carried at the lower of cost or net realizable value. Costs relating to the development and improvement of property are capitalized; holding costs are charged to expense. Office properties and equipment - Land is carried at cost. Buildings, furniture and equipment are carried at cost, less accumulated depreciation. The costs of buildings, furniture and equipment are depreciated principally using the straight-line method over the estimated useful lives of the assets. Income taxes - Deferred income tax assets and liabilities are adjusted regularly to amounts estimated to be receivable or payable based on current tax law and the Company's tax status. Consequently, tax expense in future years may be impacted by changes in tax rates and tax return limitations. Intangible assets - The cost in excess of net assets of acquired businesses is being amortized on an accelerated basis over the lives of the long-term assets acquired in the business combination. The cost in excess of net assets of acquired businesses, net of accumulated amortization, was $1,826,000 and $1,440,000 as of September 30, 1996 and 1997, respectively. Premiums resulting from the valuation of core deposits acquired in business combinations and the purchase of branch offices are being amortized on an accelerated basis over the estimated lives of the deposits using the level yield method. Core deposit intangibles, net of accumulated amortization, were $5,076,000 and $4,420,000 as of September 30, 1996 and 1997, respectively. As of September 30, 1996, a $4,720,000 writedown of core deposit intangibles was recorded. This writedown related primarily to the core deposit intangible asset arising from the acquisition of Amity Bancshares, Inc. ("Amity") on December 16, 1994. The writedown brings the book value of the intangible asset to fair value based on a calculation of the present value of estimated future cashflows associated with the deposits. This writedown was necessitated by a faster-than-projected net withdrawals of acquired deposits and lower-than-projected market interest rates which has lowered the cost of alternative sources of funds used to value the intangible. Cash equivalents - The Company considers its demand deposits at other financial institutions to be cash equivalents. Interest rate swap agreements - The Company enters into interest rate swap agreements as a means of managing its exposure to rising market interest rates. The agreements involve the receipt of floating rate amounts in exchange for the payment of fixed rate interest payments over the life of the agreement without an exchange of the underlying principal amount (the "notional amount"). The differential to be paid or received on interest rate swaps entered into to reduce the impact of changes in market interest rates is accrued as interest rates change and is recognized over the life of the agreements as interest income or expense. The fair value of the swap agreements are not recognized in the financial statements. Stock based compensation - The Company adopted the provisions of Statement of Financial Accounting Standards No. 123 entitled "Accounting for Stock- Based Compensation" (SFAS No. 123) as of October 1, 1996. SFAS No. 123 establishes accounting and disclosure requirements using a fair value based method of accounting for stock-based compensation plans. As permitted under the provisions of SFAS No. 123, the Company elected to continue to recognize compensation expense using the intrinsic value-based method of valuing stock options as contained in Accounting Principles Board Opinion No. 25. For fiscal 1997, the Company determined that the effect on net income and earnings per share of using the fair value based method of accounting defined in SFAS No. 123 applied on a pro forma basis for awards granted since July 1, 1995 under employee stock-based compensation plans was not material. Earnings per share - Earnings per share of common stock is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the year. The resulting number of shares used in computing earnings per share for fiscal 1995, 1996 and 1997 was 3,706,235, 3,661,833 and 3,463,502, respectively. Stock options are regarded as common stock equivalents and are therefore considered in the earnings per share calculations. Common stock equivalents are computed using the treasury stock method. Stock dividend - All per share amounts have been adjusted to reflect a 25% stock dividend paid as of February 23, 1996 in the form of a five-for- four stock split. Accounting for transfers and servicing of financial assets and extinguishments of liabilities - In June 1996, Statement of Financial Accounting Standards No. 125 entitled "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 125) was issued. This statement, among other provisions, applies a "financial-components approach" that focuses on control, whereby an entity recognizes the sale of financial and servicing assets when control has been surrendered, and de-recognizes liabilities when extinguished. SFAS No. 125 provides consistent standards of distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This statement, effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after December 31, 1996, was applied prospectively. In December 1996, the FASB reconsidered certain provisions of SFAS No. 125 and issued Statement of Financial Accounting Standards No. 127, entitled "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125, an amendment of FASB Statement No. 125" (SFAS No. 127), which defers until December 31, 1997, the effective date of implementation for transactions related to repurchase agreements, dollar roll repurchase agreements, securities lending and similar transactions. All provisions of SFAS No. 125 continue to be applied prospectively, with earlier or retroactive application not permitted. Management of the Company does not believe that the adoption of SFAS No. 127 will have a material effect on the Company's financial position, liquidity or results of operations. Reclassifications - Certain amounts in the 1995 and 1996 financial statements have been reclassified to conform to the 1997 presentations. Pending accounting changes - (1) Earnings per share: In February 1997, the FASB issued Statement of Financial Accounting Standards No. 128, entitled "Earnings Per Share" (SFAS No. 128). This statement establishes standards for computing and presenting earnings per share (EPS) and simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion No. 15, "Earnings Per Share." SFAS No. 128 supersedes Accounting Principles Board Opinion No. 15 and its interpretations and supersedes or amends other accounting pronouncements related to present computations of EPS. The statement replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation with equal prominence of basic and diluted EPS for income from continuing operations and for net income on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The provisions of SFAS No. 128 are effective for financial statements for both interim and annual periods ending after December 15, 1997, with all prior periods EPS data restated to conform with SFAS No. 128. Basic earnings per share for the fiscal years 1995, 1996 and 1997 would have been $2.36, $0.88 and $3.29, respectively. Diluted earnings per share for the fiscal years 1995, 1996 and 1997 would have been $2.20, $0.83 and $3.05, respectively. (2) Disclosure of information about capital structure: In February 1997, the FASB issued Statement of Financial Accounting Standards No. 129 entitled "Disclosure of Information About Capital Structure" (SFAS No. 129). This statement basically consolidates disclosure requirements found in other previously existing accounting literature regarding capital structure. SFAS No. 129 is effective for financial statements for periods ending after December 15, 1997, and since it contains no changes in the disclosure requirements, such adoption will not have a material effect on the Company's current capital structure disclosures. (3) Reporting comprehensive income: In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130 entitled "Reporting Comprehensive Income" (SFAS No. 130). This statement establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements. Comprehensive income is the total of reported net income and all other revenues, expenses, gains and losses that under generally accepted accounting principles bypass reported net income. SFAS No. 130 requires that comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements with the aggregate amount of comprehensive income reported in that same financial statement. SFAS No. 130 permits the statement of changes in stockholders' equity to be used to meet this requirement. Companies are encouraged, but not required, to display the components of other comprehensive income below the total for net income in the statement of operations or in a separate statement of comprehensive income. Companies are also required to display the cumulative total of other comprehensive income for the period as a separate component of equity in the statement of financial position. This statement is effective for fiscal years beginning after December 15, 1997, with earlier application permitted. Companies are also required to report comparative totals for comprehensive income in interim reports. Management of the Company has not determined the period in which to adopt the provisions of this statement. (4) Disclosures about segments of an enterprise and related information: In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 entitled "Disclosures About Segments of an Enterprise and Related Information" (SFAS No. 131). This statement supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," and utilizes the "management approach" for segment reporting. The management approach is based on the way that the chief operating decision maker organizes segments within a company for making operating decisions and assessing performance. Reportable segments are based on any manner in which management disaggregates its company such as by products and services, geography, legal structure and management structure. SFAS No. 131 requires disclosures for each segment that are similar to those required under current standards with the addition of quarterly disclosure requirements and more specific and detailed geographic disclosures especially by countries as opposed to broad geographic regions. This statement also requires descriptive information about the way the operating segments were determined, the products/services provided by the operating segments, the differences between the measurements used in reporting segment information and those used in the general purpose financial statements, and the changes in the measurement of segment amounts from period to period. The provisions of SFAS No. 131 are effective for fiscal years beginning December 15, 1997, with earlier application permitted. SFAS No. 131 does not need to be applied to interim statements in the initial year of application but such comparative information will be required in interim statements for the second year. Comparative information for earlier years must be restated in the initial year of application. Management of the Company has not determined the period in which to adopt the provisions of this statement. 2. Business combinations On December 16, 1994, the Company completed the acquisition of Amity Bancshares, Inc. ("Amity") in a cash transaction for $25.0 million. The transaction was accounted for as a purchase. Amity, based in Tinley Park, Illinois, was the parent company of Amity Federal Bank for Savings. Amity had total assets of $141.2 million as of December 16, 1994. This acquisition resulted in the recording of a core deposit intangible of $11.8 million and goodwill (unidentifiable intangible asset) of $2.6 million. The core deposit intangible is being amortized to expense on an accelerated basis over the estimated life of the deposits. Goodwill is being amortized to expense at a constant rate applied to the carrying amount of the long-term interest-earning assets. On August 21, 1995, the Company completed the cash purchase of substantially all of the assets of The Financial Center of Illinois, Inc., a mortgage broker operating in the Chicago and Milwaukee metropolitan areas. The purchase price was not material to the Company's consolidated financial statements. 3. Investments in securities The amortized cost and estimated market values of investment securities at September 30, 1996 and 1997 are as follows:
Estimated Amortized Market Cost at Gross Gross Value at September 30 Unrealized Unrealized September 30 1996 Gains Losses 1996 U.S government and agency securities available for sale: U.S. Treasury notes . . . . $2,997,903 $ - $38,528 $2,959,375 Federal Home Loan Bank notes 12,388,116 98,621 24,425 12,462,312 Federal National Mortgage Association notes . . . . 7,510,349 23,972 10,685 7,523,636 Federal Farm Credit notes . 1,997,671 36,704 - 2,034,375 Federal Home Loan Mortgage Corp. notes . . . . . . . 1,989,803 - 9,933 1,979,870 Sallie Mae notes . . . . . . 2,393,577 32,992 781 2,425,788 ----------- ------- --------- ----------- $29,277,419 $192,289 $84,352 $29,385,356 =========== ======= ========= =========== Mortgage-backed securities available for sale . . . . . $142,359,026 $564,865 $2,837,226 $140,086,665 =========== ======= ========= =========== Mortgage-backed securities held to maturity . . . . . . . . $11,011,238 $151,302 $3,173 $11,159,367 =========== ======= ========= =========== Mortgage-related securities available for sale: Interest only strips backed by FNMA MBS . . . . . . . $1,733,846 $1,081,127 $ - $2,814,973 Principal only strips backed by FNMA MBS . . . . . . . 7,873,451 109,782 1,255,757 6,727,476 A-rated whole loan CMO . . . 4,746,922 97,233 - 4,844,155 AAA-rated FHLMC CMO . . . . 869,831 - 30,315 839,516 ----------- --------- --------- ---------- $15,224,050 $1,288,142 $1,286,072 $15,226,120 =========== ========= ========= ========== Mortgage-related securities held to maturity: CMOs backed by FNMA/FHLMC MBS . . . . . . . . . . . $52,773,160 $1,242,603 $302,219 $53,713,544 AAA- and AA-rated whole loan CMOs . . . . . . . . . . 118,696,862 1,158,180 655,156 119,199,886 ----------- --------- ---------- ----------- $171,470,022 $2,400,783 $957,375 $172,913,430 =========== ========= ========== =========== Marketable equity securities available for sale . . . . . $4,431,768 $675,767 $64,464 $5,043,091 =========== ========= ========== =========== U.S government and agency securities available for sale: U.S. Treasury notes . . . . . $2,998,607 $1,664 $8,083 $2,992,188 Federal Home Loan Bank notes 7,935,356 62,859 2,389 7,995,826 Federal National Mortgage Association notes . . . . . 3,493,830 11,482 - 3,505,312 Federal Farm Credit notes . . 1,998,536 39,589 - 2,038,125 Federal Home Loan Mortgage Corp. notes . . . . . . . . 1,993,963 4,318 - 1,998,281 Sallie Mae notes . . . . . . 1,419,079 7,490 - 1,426,569 ----------- --------- ------- ----------- $19,839,371 $127,402 $10,472 $19,956,301 =========== ========= ======= =========== Mortgage-backed securities available for sale . . . . . $116,349,132 $1,590,742 $607,318 $117,332,556 =========== ========= ======= =========== Mortgage-backed securities held to maturity. . . . . . . . . . $8,321,934 $112,896 $13,521 $8,421,309 =========== ========= ======= =========== Mortgage-related securities available for sale: Interest only strips backed by FNMA MBS . . . . . . . . . . $1,576,636 $617,790 $ - $2,194,426 Principal only strips backed by FNMA MBS . . . . . . . . 7,153,619 102,277 682,871 6,573,025 A-rated whole loan CMO . . . 4,692,896 96,126 - 4,789,022 AAA-rated FHLMC CMO . . . . . 562,417 - 13,172 549,245 ----------- --------- -------- ----------- $13,985,568 $816,193 $696,043 $14,105,718 =========== ========= ======== =========== Mortgage-related securities held to maturity: CMOs backed by FNMA/FHLMC MBS $97,750,808 $1,822,023 $217,710 $99,355,121 AAA- and AA-rated whole loan CMOs . . . . . . . . . . . 120,699,579 2,344,783 248,802 122,795,560 ----------- --------- ------- ----------- $218,450,387 $4,166,806 $466,512 $222,150,681 =========== ========= ======== =========== Marketable equity securities available for sale . . . . . $6,128,529 $3,173,131 $20,399 $9,281,261 =========== ========= ======= ========== The amortized cost and estimated market values of U.S. government and agency securities available for sale at September 30, 1997 by contractual maturity, are shown below. Estimated Amortized Market Cost Value Due in one year or less . . . . . . . . . $1,991,190 $2,003,438 Due after one year through five years . . 17,848,181 17,952,863 ---------- ---------- $19,839,371 $19,956,301 ========== ========== Mortgage securities generally have long-term (15 to 30 year) contractual maturities. However, actual maturities are usually less than contractual maturities because borrowers have the right to call or prepay obligations without call or prepayment penalties. Proceeds from sales of securities available for sale were $2,088,713 and $1,934,877 for fiscal 1996 and 1997, respectively . Gross gains of $866,070 and $1,037,848 were realized on those sales for fiscal 1996 and 1997, respectively. Accrued interest on investments and mortgage securities consists of: September 30 1996 1997 Certificates of deposit . . . . . . . . . . . $ 1,027 $ 1,071 U.S. Government and agency securities . . . . 387,168 229,247 Mortgage securities . . . . . . . . . . . . . 2,252,477 2,285,380 ---------- ---------- $2,640,672 $2,515,698 ========== ========== 4. Loans receivable Loans receivable, including loans held for sale, consist of: September 30 1996 1997 First mortgage loans: One- to four-family residential . . . $418,646,211 $378,701,477 Multi-family . . . . . . . . . . . . 24,993,017 26,923,038 Commercial real estate . . . . . . . 54,671,293 63,755,361 One- to four-family residential spec construction . . . . . . . . . . . . 7,598,430 5,148,277 Other construction and land . . . . . 30,160,649 24,447,585 ----------- ----------- 536,069,600 498,975,738 Other loans: Home equity and second mortgage . . . 43,893,371 67,996,673 Education . . . . . . . . . . . . . . 4,039,550 4,307,204 Automobile . . . . . . . . . . . . . 1,553,137 1,662,553 Other consumer . . . . . . . . . . . 1,732,221 2,501,883 Commercial business loans . . . . . . 10,691,062 12,429,365 ----------- ----------- 61,909,341 88,897,678 ----------- ----------- Total gross loans receivable . . . . . 597,978,941 587,873,416 Add: Accrued interest on all loans . . 3,718,382 3,754,653 Less: Undisbursed portion of loan proceeds (30,099,538) (19,149,988) Unamortized loan fees . . . . . . . . (2,104,405) (858,614) Allowance for loan losses . . . . . . (5,773,354) (5,796,842) Allowance for uncollected interest . (938,386) (563,374) ----------- ----------- (35,197,301) (22,614,165) ----------- ----------- $562,781,640 $565,259,251 =========== =========== As of September 30, 1997, there were no loans that had been the subject of a troubled debt restructuring. 5. Foreclosed properties and properties subject to foreclosure Foreclosed properties and properties subject to foreclosure are summarized as follows: September 30 1996 1997 Real estate owned . . . . . . . . . . . $1,034,703 $1,568,918 Real estate judgments subject to redemption . . . . . . . . . . . . . 368,737 223,759 ---------- ---------- $1,403,440 $1,792,677 ========== ========== 6. Allowance for losses on loans A summary of the activity in the allowance for losses on loans follows: September 30 1995 1996 1997 Balance at beginning of year . . . . . . . . . . $5,327,515 $5,271,182 $5,773,354 Additions from loan purchases . . . . . . . 517,798 - - Provisions . . . . . . . . 460,000 480,000 360,000 Charge-offs . . . . . . . . (1,072,115) (39,975) (807,973) Recoveries . . . . . . . . 37,984 62,147 471,461 --------- --------- --------- Balance at end of year . . $5,271,182 $5,773,354 $5,796,842 ========= ========= ========= A substantial portion of the Company's loans are collaterized by real estate in southern Wisconsin and northern Illinois. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio is susceptible to changes in market conditions in these geographic areas. Management believes that the allowance for losses on loans is adequate. While management uses available information to recognize losses, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination. 7. Office properties and equipment Office properties and equipment are summarized as follows: September 30 1996 1997 Cost: Land and improvements . . . . . . . $2,349,393 $2,361,411 Office buildings . . . . . . . . . . 9,399,227 9,868,976 Furniture and equipment . . . . . . 9,116,848 8,830,159 ---------- ---------- 20,865,468 21,060,546 Less allowances for depreciation . . . (8,333,867) (8,304,148) ---------- ---------- $12,531,601 $12,756,398 ========== ========== 8. Deposit accounts Deposit accounts are summarized as follows: September 30 1996 1997 Amount Rate Amount Rate Checking accounts: Noninterest bearing $31,345,513 0.00% $34,967,734 0.00% Interest-bearing . 50,322,957 1.81 48,506,401 1.55 Variable rate money market accounts 147,038,443 3.92 155,016,308 3.92 Regular savings accounts . . . . 43,010,687 2.50 40,378,028 1.98 Certificate accounts (by original maturity): One year or less . 140,487,605 5.28 134,693,723 5.41 One to two years . 95,289,041 5.80 93,122,979 5.76 Two to three years 94,304,153 5.81 86,551,604 6.09 Three to four years 49,092,040 6.07 47,965,892 6.19 Four to five years 27,644,036 6.00 26,861,399 5.99 Five or more years 2,316,390 6.54 2,711,296 6.33 ----------- ----- ----------- ----- Total certificates . 409,133,265 5.67 391,906,893 5.79 ----------- ----- ----------- ----- $680,850,865 4.55% $670,775,364 4.52% =========== ===== =========== ===== Deposit accounts with individual balances greater than $100,000 totaled $87,676,000 and $93,266,486 at September 30, 1996 and 1997, respectively. Aggregate annual maturities of certificate accounts at September 30, 1997 were as follows: Matures during year ending September 30: 1998 . . . . . . . . . . . . . . . . . $248,128,557 1999 . . . . . . . . . . . . . . . . . . 65,843,581 2000 . . . . . . . . . . . . . . . . . . 65,731,484 2001 . . . . . . . . . . . . . . . . . . 8,264,815 2002 . . . . . . . . . . . . . . . . . . 3,009,981 Thereafter . . . . . . . . . . . . . . . 928,475 ----------- $391,906,893 =========== 9. Notes payable to the Federal Home Loan Bank Notes payable to the Federal Home Loan Bank consist of the following: September 30 Matures During 1996 1997 Year Ending Weighted Weighted September 30 Rate Amount Rate Amount 1997 . . . . . . . . 5.37% $50,550,000 - % $ - 1998 . . . . . . . . 6.45 59,000,000 6.42 69,000,000 1999 . . . . . . . . 6.42 56,925,000 6.41 61,925,000 2000 . . . . . . . . 6.44 6,835,000 6.31 36,835,000 2001 . . . . . . . . 6.64 1,000,000 6.64 1,000,000 2002 . . . . . . . . 7.76 1,240,000 7.76 1,240,000 2005 . . . . . . . . 8.45 360,000 8.45 360,000 2007 . . . . . . . . - - 6.91 6,000,000 ----------- ----------- 6.15% $175,910,000 6.43% $176,360,000 =========== =========== At September 30, 1997, $28,500,000 of the above notes payable may be repaid without a prepayment penalty at six- month intervals. All other notes are subject to a prepayment penalty if they are repaid prior to maturity. The Bank is required to maintain as collateral unencumbered mortgage loans and mortgage-related securities such that the outstanding notes payable balance does not exceed 60% of the book value of this collateral. In addition, these notes are collaterized by all Federal Home Loan Bank stock. 10. Securities sold under agreements to repurchase The Company enters into sales of securities under fixed coupon agreements to repurchase the identical securities (reverse repurchase agreements). Fixed-coupon reverse repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability in the statement of financial condition. The dollar amount of securities underlying the agreements remains in the asset accounts. The outstanding agreements had a weighted average interest rate of 5.87% and 5.67% at September 30, 1996 and 1997, respectively, and generally mature within twelve months after the fiscal year-end. The securities underlying the agreements, as summarized below, are held in safekeeping. September 30 1996 1997 FHLMC mortgage-backed securities . . . . . $42,485,232 $50,827,442 FNMA mortgage-backed securities . . . . . . 8,738,500 4,800,918 Collaterized mortgage obligations . . . . . 22,133,917 32,302,752 Accrued interest . . . . . . . . . . . . . 444,748 516,403 ----------- ----------- Total book value (approximates market value) . . . . . . . . . . . . . . . . . . $73,802,397 $88,447,515 =========== =========== 11. Stockholders' equity The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to adjusted total assets (as defined). Management believes, as of September 30, 1997, that the Bank meets all capital adequacy requirements to which it is subject. As of September 30, 1997, the most recent notification from the Office of Thrift Supervision ("OTS") categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the institution's category. The Bank's actual capital amounts and ratios are presented in the table below (dollars in thousands):
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of September 30, 1997: Total Capital to Risk-Weighted Assets . . . . . . . . . . . . $71,121 14.81% $38,420 8.00% $48,026 10.00% Tier 1 Capital to Risk-Weighted Assets . . . . . . . . . . . . 65,339 13.61% 19,210 4.00% 28,815 6.00% Tier 1 Capital to Adjusted Total Assets . . . . . . . . . . . . 65,339 6.43% 30,470 3.00% 50,874 5.00% As of September 30, 1996: Total Capital to Risk-Weighted Assets . . . . . . . . . . . . $63,199 13.48% $37,495 8.00% $46,868 10.00% Tier 1 Capital to Risk-Weighted Assets . . . . . . . . . . . . 57,440 12.26% 18,747 4.00% 28,121 6.00% Tier 1 Capital to Adjusted Total Assets . . . . . . . . . . . . 57,440 5.72% 30,129 3.00% 50,215 5.00%
Applicable rules and regulations of the OTS impose limitations on dividends by the Bank. Within those limitations, certain "safe harbor" dividends are permitted, subject to providing the OTS at least 30 days advance notice. The safe harbor amounts are based upon an institution's regulatory capital level. Thrift institutions which have capital in excess of all capital requirements before and after the proposed dividend are permitted to make capital distributions during any calendar year up to the greater of (1) 100% of net income to date during the calendar year, plus one-half of the surplus over such institution's capital requirements at the beginning of the calendar year, or (2) 75% of net income over the most recent four-quarter period. Additional restrictions would apply to an institution which does not meet its capital requirement before or after a proposed dividend. Unlike the Bank, the Company is not subject to regulatory restrictions on the payment of dividends to its shareholders. However, the source of its future dividends may depend upon dividends from the Bank. 12. Income taxes The Company and its subsidiaries file a consolidated federal income tax return and separate state income tax returns. Provisions are made in the income tax expense accounts for deferred taxes applicable to income and expense items reported in different periods for financial statement purposes than for income tax return purposes. Prior to October 1, 1996, the Bank qualified under provisions of the Internal Revenue Code which permitted as a deduction from taxable income allowable bad debt deductions based on a percentage of taxable income which significantly exceeded actual loss experience and the financial statement loan loss provisions. At September 30, 1997, retained earnings includes approximately $22,400,000 for which no provision for income tax has been made. Income taxes would be imposed at the then-applicable rates if the Bank were to use these reserves for any other purpose. The income tax liability on this $22,400,000 would approximate $8,500,000. The provision for income taxes consists of the following: Year Ended September 30 1995 1996 1997 Current: Federal . . . . . . $3,000,755 $5,377,588 $2,845,124 State . . . . . . . 78,952 129,357 266,707 --------- --------- --------- 3,079,707 5,506,945 3,111,831 Deferred: Federal . . . . . . 1,381,170 (3,578,723) 2,656,897 State . . . . . . . 56,671 (464,398) 184,721 ---------- ---------- ---------- 1,437,841 (4,043,121) 2,841,618 ---------- ---------- ---------- $4,517,548 $1,463,824 $5,953,449 ========== ========== ========== The provision for income taxes differs from that computed at the federal statutory corporate tax rate as follows: Year Ended September 30 1995 1996 1997 Income before income taxes . . . $12,668,533 $4,496,361 $16,641,328 ========== ========== ========== Tax at federal statutory rate of 34% . . . . . . . . . $4,307,301 $1,528,763 $5,658,052 Add (deduct) effect of: State income taxes (net of federal income tax benefit) 89,511 (221,127) 297,942 Amortization of goodwill . . . 113,973 137,265 131,253 Tax exempt interest-net . . . (6,436) (7,287) (6,021) Low income housing tax credit - - (81,400) Other . . . . . . . . . . . . 13,199 26,210 (46,377) ---------- ---------- ---------- Provision for income taxes . . . $4,517,548 $1,463,824 $5,953,449 ========== ========== ========== Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of the Company's deferred tax assets (liabilities) are as follows: September 30 1996 1997 Deferred tax assets: Allowance for losses on loans . . . . . . $1,115,048 $1,241,783 Accrued expenses deducted on a cash basis for tax purposes . . . . . . . . . . . . 2,142,966 739,855 Deferred loan fees . . . . . . . . . . . . 372,571 38,041 Reserve for uncollected interest . . . . . 328,553 197,435 State income taxes . . . . . . . . . . . . 386,999 227,048 Unrealized losses on securities available for sale . . . . . . . . . . . . . . . . 425,085 - Other . . . . . . . . . . . . . . . . . . 175,836 5,438 ---------- ---------- Total deferred tax assets . . . . . . . 4,947,058 2,449,600 Valuation allowance . . . . . . . . . . . (254,354) (254,354) ---------- ---------- Adjusted deferred tax assets . . . . . . 4,692,704 2,195,246 Deferred tax liabilities: Differences between book and tax depreciation . . . . . . . . . . . . . . (585,423) (657,662) Income of partnerships . . . . . . . . . . (243,090) (304,332) Recognition of discounts/premiums (related to acquisitions) . . . . . . . . . . . . (997,773) (997,956) FHLB dividends . . . . . . . . . . . . . . (224,759) (277,445) Originated mortgage servicing rights . . . - (473,745) Unrealized gains on securities available for sale . . . . . . . . . . . . . . . . - (1,710,766) ---------- ---------- Total deferred tax liabilities . . . . . (2,051,045) (4,421,906) ---------- ---------- Total net deferred tax asset (liability) . . $2,641,659 ($2,226,660) ========= ========== 13. Officer, director and employee plans Employees' Profit-Sharing and Savings Retirement Plan ("401k plan"): The Company has a trusteed profit-sharing plan for all employees meeting minimum eligibility requirements. Under this plan, participants may elect to defer a portion of their compensation (between 1% and 10%) and contribute this amount to the plan. Employee contributions of up to 5% of compensation are matched 25% by the Company through employer contributions to the Employee Stock Ownership Plan discussed below. No employer contributions have been made to the 401(k) plan since 1991. Stock Option Plans: Under the Company's 1991 stock option plan, 1995 equity incentive plan and 1996 non-employee director stock option plan, shares of common stock are reserved for the grant of both incentive and non-incentive stock options to officers, key employees and directors. The 1991 and 1995 plans also provide for the issuance of restricted stock and stock appreciation rights. All of the plans provide that option prices will not be less than the fair market value of the stock at the grant date. The date on which the options are first exercisable is determined by the Personnel Committee of the Board of Directors. Options granted under the 1991 and 1996 plans expire no later than ten years from the grant date. Options granted under the 1995 plan have such terms as are determined by the Personnel Committee, except that the term of an incentive stock option may not exceed 10 years. A summary of stock option transactions follows: Number of Average Option Shares Price Per Share Balance September 30, 1994 . . . 356,686 $10.07 Granted . . . . . . . . . . . 31,938 $25.14 Conversion of acquired company options to Advantage options . . . . . . . . . . 97,936 $6.26 Exercised . . . . . . . . . . (115,315) $8.62 --------- ------ Balance September 30, 1995 . . . 371,245 $10.82 Granted . . . . . . . . . . . 26,476 $32.42 Forfeited . . . . . . . . . . (16,250) $24.51 Exercised . . . . . . . . . . (35,887) $6.42 --------- ------ Balance September 30, 1996 . . . 345,584 $20.38 Granted . . . . . . . . . . . 16,726 $31.58 Forfeited . . . . . . . . . . (2,000) $34.00 Exercised . . . . . . . . . . (34,956) $10.43 --------- ------ Balance September 30, 1997 . . . 325,354 $13.34 ========= ====== Options to purchase 299,999 shares were exercisable as of September 30, 1997. Employee Stock Ownership Plan("ESOP"): The Company sponsors an ESOP which covers substantially all employees with more than one year of employment and who have attained the age of 21. In 1992, the ESOP borrowed $3,036,000 from the Company to purchase 330,000 common shares of the Company in the initial public offering. The Bank makes scheduled discretionary cash contributions to the ESOP sufficient to service the amount borrowed. The unpaid balance of the ESOP loan is reflected as a reduction from stockholders' equity in the Company's consolidated statements of financial condition. ESOP expense was $366,589, $ 347,594 and $312,280 in fiscal years 1995, 1996 and 1997, respectively. These amounts include the amounts allocated to employer matching contributions under the 401(k) plan. Bank Incentive Plans: The Company has four Bank Incentive Plans ("BIPs") which acquired a total of 4% of the shares of common stock in the initial public offering. The Bank contributed $1,518,000 to the BIPs to enable the BIP trustee to acquire a total of 165,000 shares of the common stock in the initial public offering. Shares were awarded to employees in management positions in order to provide them with a proprietary interest in the Company in a manner designed to encourage such employees to remain with the Company. A summary of shares granted under the BIPs follows: Market Value of Number of Stock at Shares Date of Grant Balance September 30, 1994 . . . . . . . . . 129,371 $11.25 Granted . . . . . . . 8,116 $22.20 Forfeited . . . . . . (8,700) $10.34 -------- ------ Balance September 30, 1995 . . . . . . . . . 128,787 $12.00 Granted . . . . . . . 7,747 $27.35 Forfeited . . . . . . (13,579) $22.25 -------- ------ Balance September 30, 1996 . . . . . . . . . 122,955 $11.83 Granted . . . . . . . 6,501 $33.12 -------- ------ Balance September 30, 1997 129,456 $12.90 ======== ====== The contribution to the BIPs is being amortized to compensation expense as the Bank's employees become vested in those shares. Amortization expense was $294,369, $132,386 and $211,194 for fiscal years 1995, 1996, and 1997, respectively. The unamortized cost, which is comparable to deferred compensation, is reflected as a reduction of stockholders' equity. 14. Financial instruments with off-balance sheet risk The Company is a party to various financial instruments with off-balance sheet risk in the normal course of business. These instruments include commitments to extend credit and interest rate swaps used to manage its interest rate risk. These instruments involve, in varying degrees, elements of credit risk and interest rate risk in excess of the amounts recorded in the consolidated financial statements. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and minimize interest rate risk is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on balance-sheet instruments. Financial instruments whose contract amounts represent credit risk are as follows at September 30: 1996 1997 Commitments to originate mortgage loans: Fixed-rate (average rate of 7.62%- 1997) . . . . . . . . . . . . . . $1,119,500 $3,720,200 Adjustable-rate . . . . . . . . . . . $7,401,310 $4,498,321 Unused lines of credit: Home equity (adjustable-rate) . . . . $27,592,918 $39,008,824 Commercial loans (fixed-rate) . . . . $28,080,000 $29,356,595 Interest rate swaps--notional amount (pay fixed rate, receive floating rate): Maturing 1997 . . . . . . . . . . . . $30,000,000 $ -- Maturing 1998 . . . . . . . . . . . . 10,000,000 10,000,000 Maturing 1999 . . . . . . . . . . . . --- 30,000,000 ---------- ---------- Total interest rate swaps . . . . . . $40,000,000 $40,000,000 ========== ========== Commitments to originate mortgage loans are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. Collateral varies but consists primarily of one- to four-family residences and income-producing commmercial properties. Commitments to extend credit on a fixed-rate basis expose the Company to a certain amount of interest-rate risk if market rates of interest substantially increase during the commitment period. This exposure, however, is mitigated by contracting for firm commitments to sell the majority of these loans. Commitments outstanding to sell loans at September 30, 1997 amounted to $7,720,000. The Company enters into interest rate swaps to help manage its interest rate risk. In these swaps, the Company agrees to exchange, at specified intervals, the difference between fixed- and floating-interest amounts calculated on an agreed-upon notional principal amount. Because the Company tends to have have interest-earning assets with a longer duration than its interest-bearing liabilities, interest-rate swaps are used in which the Company pays a fixed rate and receives a floating rate to reduce the impact of changes in interest rates on the Company's net interest income. The net amount payable or receivable from interest-rate swap agreements is accrued as an adjustment to interest income. The Company's current credit exposure on swaps is limited to the value of interest rate swaps that have become favorable to the Company. At September 30, 1997, the market value of interest-rate swaps was a negative $170,109. 15. Fair value of financial instruments The Company discloses fair value information about financial instruments, whether or not recognized in the statements of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent market data and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all non- financial instruments are excluded from this disclosure. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. It is not the Company's intent to liquidate and realize the difference between market value and carrying value of its financial instruments. Even if the Company's financial instruments were liquidated, there can be no assurance that the estimated market values could be realized. The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial instruments: Cash and cash equivalents, certificates of deposit, and accrued interest: The carrying amounts reported in the statements of financial condition approximate the fair values of those assets and liabilities. Investment and mortgage securities: Fair values for investment, mortgage- backed and mortgage-related securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans receivable: The fair value of loans held for sale is based on quoted market prices. The fair value of residential mortgage loans held for investment, commercial real estate loans, commercial business loans, consumer loans and other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Mortgage servicing rights: Mortgage loan servicing rights, which represent the Company's contractual right to service loans for others, represent a distinct income producing intangible asset that could be realized by selling those rights to another party. The Company's consolidated balance sheet reflects only originated mortgage servicing rights acquired after September 30, 1995. The Company has no purchased servicing rights. Federal Home Loan Bank stock: The fair value of Federal Home Loan Bank stock is based on cost, which is also equal to its redeemable value. Deposits: The fair value disclosed for NOW accounts, passbook accounts and money market accounts is equal to the amount payable on demand (i.e., their carrying value). The fair value of fixed-rate certificates of deposit is estimated using discounted cash flow calculations with the discount rates equal to interest rates currently being offered by the Company for certificates with similar terms and maturities. Notes payable to Federal Home Loan Bank and Securities sold under agreements to repurchase: The fair value of these borrowings is estimated using discounted cash flow calculations with the discount rates equal to interest rates currently being offered for borrowings with similar terms and maturities. The carrying amounts and fair values of the Company's financial instruments consist of the following:
September 30, 1996 September 30, 1997 Carrying Carrying Amount Fair Value Amount Fair Value FINANCIAL ASSETS Cash and cash equivalents . . . . . . $35,445,646 $35,445,646 $42,908,363 $42,908,363 Certificates of deposit . . . . . . . 611,067 611,067 508,664 508,664 U.S. government and agency securities available for sale . . . . . . . 29,385,356 29,385,356 19,956,301 19,956,301 Mortgage-backed securities available for sale . . . . . . . . . . . . . 140,086,665 140,086,665 117,332,556 117,332,556 Mortgage-backed securities held to maturity . . . . . . . . . . . . . 11,011,238 11,159,367 8,321,934 8,421,309 Mortgage-related securities available for sale . . . . . . . . . . . . . 15,226,120 15,226,120 14,105,718 14,105,718 Mortgage-related securities held to maturity . . . . . . . . . . . . . 171,470,022 172,913,430 218,450,643 222,150,681 Marketable equity securities . . . . 5,043,091 5,043,091 9,281,261 9,281,261 Loans held for sale . . . . . . . . . 3,056,000 3,056,000 4,907,212 4,907,212 Loans receivable: First mortgage loans . . . . . . . 494,452,348 502,024,395 467,930,645 472,849,646 Consumer loans . . . . . . . . . . 50,863,848 51,574,813 76,237,377 76,768,349 Commercial business loans . . . . 10,691,062 10,731,328 12,429,365 12,588,234 Accrued interest receivable . . . 3,718,382 3,718,382 3,754,653 3,754,653 ----------- ----------- ----------- ----------- 559,725,640 568,048,918 560,352,040 565,960,882 Mortgage servicing rights . . . . . . 630,512 724,268 1,353,558 1,353,558 Federal Home Loan Bank stock . . . . 8,795,600 8,795,600 8,918,000 8,918,000 Accrued interest on investments and mortgage securities . . . . . . . 2,640,672 2,640,672 2,515,698 2,515,698 ----------- ----------- ------------- ------------- $983,127,629 $993,136,200 $1,008,911,948 $1,018,320,203 =========== =========== ============= ============= FINANCIAL LIABILITIES Deposits: NOW accounts . . . . . . . . . . . $81,668,470 $81,668,470 $83,474,135 $83,474,135 Variable rate money market deposits . . . . . . . . . . . 147,038,443 147,038,443 155,016,308 155,016,308 Regular savings accounts . . . . . 43,010,687 43,010,687 40,378,028 40,378,028 Certificates of deposit . . . . . 409,133,265 410,443,753 391,906,893 392,663,715 ----------- ----------- ----------- ----------- 680,850,865 682,161,353 670,775,364 671,532,186 Notes payable to Federal Home Loan 175,910,000 175,848,137 176,360,000 177,122,765 Bank . . . . . . . . . . . . . . . Securities sold under agreement to repurchase . . . . . . . . . . . . 48,355,457 48,419,656 72,115,303 72,048,397 Accrued interest on deposit accounts 3,711,995 3,711,995 2,825,851 2,825,851 Accrued interest on borrowings . . . 1,377,204 1,377,204 2,607,869 2,607,869 Interest rate swaps . . . . . . . . . - 183,641 - 170,109 ----------- ----------- ----------- ----------- $910,205,521 $911,701,986 $924,684,387 $926,307,177 =========== =========== =========== ===========
The above table does not include any amount for the value of core deposit intangibles. The above table also does not include off-balance sheet items except interest rate swaps (see Note 14) since the fair value of these items is not significant. 16. Condensed parent company only financial statements The following condensed statements of financial condition as of September 30, 1996 and 1997 and the condensed statements of income and cash flows for the years ended September 30, 1996 and 1997 for the Company only should be read in conjunction with the consolidated financial statements and the notes thereto. Statements of Financial Condition Advantage Bancorp, Inc. September 30 Assets 1996 1997 Cash and cash equivalents deposited in Bank $11,971,650 $10,362,754 Certificates of deposit . . . . . . . . . . 11,067 8,664 Marketable equity securities available for sale . . . . . . . . . . . . . . . . . . 5,043,091 9,281,261 U.S. agency securities available for sale . 500,514 501,719 Loans to Cranberry III Partnership . . . . - 5,719,736 Mortgage-backed securities available for sale . . . . . . . . . . . . . . . . . . 306,110 222,263 Mortgage-related securities available for sale . . . . . . . . . . . . . . . . . . 3,216,380 3,210,143 Equity in net assets of subsidiaries . . . 69,348,903 71,937,377 Accrued interest on investments and mortgage securities . . . . . . . . . . 17,465 16,720 Other assets . . . . . . . . . . . . . . . - 66,856 ----------- ------------ $90,415,180 $101,327,493 =========== ============ Liabilities Other liabilities . . . . . . . . . . . . . $307,015 $193,439 Deferred income taxes . . . . . . . . . . . 106,676 1,253,164 Accrued income taxes . . . . . . . . . . . 240,309 37,706 Payable to Bank - unearned restricted stock 894,777 839,055 ---------- ---------- Total liabilities . . . . . . . . . 1,548,777 2,323,364 Stockholders' Equity Common stock . . . . . . . . . . . . . . . 33,000 33,000 Additional paid-in capital . . . . . . . . 37,751,499 38,536,160 Loan to Employee Stock Ownership Plan . . (1,704,941) (1,405,470) Unearned restricted stock awarded . . . . . (894,777) (839,055) Unrealized gain (loss) on securities available for sale . . . . . . . . . . . (699,857) 2,667,084 Treasury stock . . . . . . . . . . . . . . (17,627,105) (21,319,434) Retained earnings . . . . . . . . . . . . . 72,008,584 81,331,844 ----------- ----------- Total stockholders' equity . . . . . 88,866,403 99,004,129 ----------- ----------- $90,415,180 $101,327,493 =========== =========== Statements of Income Advantage Bancorp, Inc. Year Ended September 30 1995 1996 1997 Interest and dividend income: Interest income from deposits in Bank . . . . . $467,569 $583,889 $440,639 Interest on mortgage securities . . . . . . . . 249,254 155,054 178,708 Interest on loans to Cranberry III Partnership - - 356,602 Interest on loan to Employee Stock Ownership Plan . . . 206,962 167,052 138,209 Other interest and dividends 87,562 197,952 207,256 --------- --------- --------- Total interest and dividend income . . . . . . . . . . 1,011,347 1,103,947 1,321,414 Non-interest income: Equity in net income of Bank and its subsidiaries . . . 7,602,935 2,247,751 9,654,843 Gain on sale of securities 145,000 973,848 604,393 --------- --------- ---------- Total non-interest income . 7,747,935 3,221,599 10,259,236 --------- --------- ---------- 8,759,282 4,325,546 11,580,650 Non-interest expense . . . . 291,138 576,867 210,477 --------- --------- ---------- Income before income taxes . 8,468,144 3,748,679 11,370,173 Income taxes . . . . . . . . 317,159 716,142 682,294 --------- --------- ---------- Net income . . . . . . . . . $8,150,985 $3,032,537 $10,687,879 ========= ========= ==========
Statements of Cash Flows Advantage Bancorp, Inc. Year Ended September 30 1995 1996 1997 Operating activities: Net income . . . . . . . . . . . $8,150,985 $3,032,537 $10,687,879 Less equity in earnings of the Bank and its subsidiaries (7,602,935) (2,247,751) (9,654,843) Decrease in interest receivable 164,816 2,972 743 Increase in deferred income taxes . . . . . . . . . . . - - 24,940 Increase (decrease) in accrued income taxes . . . . . . . . (114,813) 471,342 (202,603) Net amortization of discount on securities . . . . . . . . . (248,382) (117,738) (165,493) Other . . . . . . . . . . . . . 297,950 254,703 (233,795) -------- --------- -------- Net cash provided by operating activities . . . . . . . . . . . 647,621 1,396,065 456,828 Investing activities: Dividends from Bank . . . . . . 21,250,000 8,250,000 8,750,000 Proceeds from sale of marketable equity securities . . . . . 435,750 2,088,713 1,934,877 Principal repayments on loans to Cranberry III Partnership . . - - 188,607 Principal repayments on mortgage-related securities 366,046 514,598 428,094 Principal repayments on mortgage-backed securities . - 156,669 89,751 Proceeds from maturities of U.S. Government securities . . . - 500,000 - Purchase of loans to Cranberry III Partnership from Bank . - - (5,908,343) Purchase of marketable securities available for sale (1,553,188) (2,785,453) (3,631,618) Principal repayments on loan to Employee Stock Ownership Plan 511,988 280,862 299,471 Business acquisition, net of cash and cash equivalents acquired of $1,243,515: Investment in bank . . . . . . . (22,371,397) - - Mortgage-backed securities available for sale . . . . . (453,733) - - U.S agency securities available for sale . . . . . . . . . . (970,937) - - Other-net . . . . . . . . . . . (49,838) - - ----------- ---------- --------- Net cash provided by (used in) investing activities . . . . . . (2,835,309) 9,005,389 2,150,839 Financing activities: Proceeds from exercise of stock options . . . . . . . . . . 994,252 230,303 492,737 Dividends paid . . . . . . . . . (665,120) (1,045,230) (1,236,470) Purchase of treasury stock . . . (3,781,661) (5,729,530) (4,185,066) Other . . . . . . . . . . . . . - 223,529 712,236 ----------- ----------- ----------- Net cash used in financing activities . . . . . . . . . . . (3,452,529) (6,320,928) (4,216,563) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents . . . . . . . . (5,640,217) 4,080,526 (1,608,896) Cash and cash equivalents at beginning of period . . . . . . 13,531,341 7,891,124 11,971,650 ---------- ----------- ----------- Cash and cash equivalents at end of period . . . . . . . . . . . . . $7,891,124 $11,971,650 $10,362,754 ========== =========== ===========
17. Investments in and advances to unconsolidated partnerships The Company held the following investments in and advances to unconsolidated partnerships: September 30 1996 1997 Cranberry III Partnership (50% ownership interest) . . . . . . . . . . . . . . . $6,710,667 $6,506,033 Geneva Professional Building Associates (75% ownership interest) . . . . . . . 182,378 217,088 Pleasantview Limited Partnership (55% ownership interest) . . . . . . . . . . 504,371 481,266 --------- --------- $7,397,416 $7,204,387 ========= ========= Cranberry III Partnership owns a 264-unit apartment complex. Condensed financial statements of this partnership are as follows: CRANBERRY III PARTNERSHIP BALANCE SHEETS (Unaudited) September 30 1996 1997 ASSETS Land, buildings and furniture-net . . . $7,190,381 $6,971,270 Other assets . . . . . . . . . . . . . 790,447 879,194 --------- --------- $7,980,828 $7,850,464 ========= ========= LIABILITIES AND PARTNERS' CAPITAL Mortgage payable to the Bank or Company . . . . . . . . . . . . . . . 5,967,370 5,719,736 Other liabilities . . . . . . . . . . . 456,422 446,458 Partners' capital: Advantage Bank . . . . . . . . . . . 778,518 842,135 Other partners . . . . . . . . . . . 778,518 842,135 --------- --------- $7,980,828 $7,850,464 ========= ========= STATEMENTS OF INCOME (Unaudited) Year Ended September 30 1995 1996 1997 Rental and other income . . . . . $1,699,053 $1,748,315 $1,747,536 Rental expense . . . . . . . . . 725,631 810,585 716,272 --------- --------- --------- 973,422 937,730 1,031,264 Depreciation . . . . . . . . . . 230,978 221,449 219,111 Interest expense . . . . . . . . 555,376 551,640 484,919 --------- --------- --------- Net income . . . . . . . . . . . $187,068 $164,641 $327,234 ========= ========= ========= The Geneva Professional Building Associates owns a medical office building which is funded by a mortgage loan from an unrelated financial institution with an outstanding balance at September 30, 1997 of $257,566. Operating results in 1995, 1996 and 1997 yielded cash flows of $50,373, $51,518 and $62,418 after payment of financing costs, respectively. Pleasantview Limited Partnership owns a 30-unit apartment complex which is funded by a mortgage loan from an unrelated financial institution with an outstanding balance at September 30, 1997 of $912,000. Pleasantview began operations in June 1996 and had net income before depreciation of $69,983 for the period ended September 30, 1997. The property qualifies for the low income housing tax credit under the Internal Revenue Code. 18. Mortgage banking activities Mortgage banking activities are summarized as follows: At, or For the Year Ended, September 30 1995 1996 1997 Statement of financial condition information: Mortgage loans held for sale $2,405,000 $3,056,000 $4,907,212 ========= ========= ========= Mortgage servicing rights . $ - $630,512 $1,353,558 ========= ========= ========= Statement of income information: Loan servicing fees . . . . $376,475 $387,715 $404,205 ========= ========= ========= Gain on sales of mortgage loans held for sale . . . $107,513 $875,830 $627,446 ========= ========= ========= Amortization of mortgage servicing rights . . . . $ - $42,567 $80,778 ========= ========= ========= Statement of cash flow information: Mortgage loans originated for sale . . . . . . . . . $17,349,224 $55,754,049 $95,740,854 Sales of mortgage loans originated for sale . . . . $15,928,424 $55,103,049 $93,889,642 Loans serviced for investors (primarily FNMA and FHLMC) were $147,313,000, $179,183,000 and $218,564,785 at September 30, 1995, 1996 and 1997, respectively. These loans are not reflected in the consolidated financial statements. The Company originates mortgage loans which may be sold in the secondary market or to other private investors if the loans do not meet the Company's investment objectives. All loans are sold on a nonrecourse basis and the servicing of these loans may or may not be retained by the Company. Direct origination and servicing costs for mortgage banking activities cannot be presented as these operations are integrated with and not separable from the origination and servicing of portfolio loans, and, as a result, cannot be accurately estimated. 19. Federal Legislation On September 30, 1996, legislation was enacted to recapitalize the Savings Association Insurance Fund (the SAIF) of the Federal Deposit Insurance Corporation (FDIC), which insures deposits of thrifts such as the Bank. Effective January 1, 1997, the new law reduced FDIC insurance premiums for SAIF members from a rate of 23 cents to a rate of 6.4 cents for every $100 of deposts . The new law imposed on SAIF members a one-time assessment payable in November 1996 equal to 65.7 basis points (0.657%) based on insured deposits as of March 31, 1995. The Bank's one-time assessment of $4,435,000 was expensed during the year ended September 30, 1996. 20. Merger Agreement with Marshall & Ilsley Corporation On November 3, 1997, the Company signed a definitive merger agreement with Marshall & Ilsley Corporation providing for the merger of the Company with and into Marshall & Ilsley Corporation. Subject to the satisfaction of certain conditions and the approval of shareholders and regulatory agencies, the Company anticipates the merger will be completed during March or April 1998. QUARTERLY DATA The following table sets forth the Company's unaudited quarterly income and expense data for fiscal years 1996 and 1997 (dollars in thousands):
Dec. 31 March 31 June 30 Sept. 30 Dec. 31 March 31 June 30 Sept. 30 1995 1996 1996 1996 1996 1997 1997 1997 Interest income . . $18,398 $18,150 $18,380 $18,704 $19,151 $18,790 $19,184 $19,542 Interest expense . 10,997 10,789 10,797 11,224 11,453 11,287 11,386 11,588 ------- ------- ------- ------- ------- ------- ------- ------- Net interest income 7,401 7,361 7,583 7,480 7,698 7,503 7,798 7,954 Provision for losses on loans . . . . 120 120 100 140 80 100 90 90 ------- ------- ------- ------- ------- ------- ------- ------- Net interest income after provision for losses on loans . 7,281 7,241 7,483 7,340 7,618 7,403 7,708 7,864 Gain on sale of assets . . . . . 744 359 224 415 422 280 457 506 Other non-interest income . . . . . 1,390 1,647 1,658 1,578 1,651 1,551 1,649 1,804 ------- ------- ------- ------- ------- ------- ------- ------- Total non-interest income . . . . . 2,134 2,006 1,882 1,993 2,073 1,831 2,106 2,310 Assessment to recapitalize SAIF - - - 4,435 - - - - Writedown of intangible assets - - - 4,720 - - - - Other non-interest expense . . . . . 5,830 5,716 5,910 6,253 5,794 5,315 5,543 5,620 ------- ------- ------- ------- ------- ------- ------- ------- Total non-interest expenses . . . 5,830 5,716 5,910 15,408 5,794 5,315 5,543 5,620 -------- -------- ------- -------- -------- ------- -------- -------- Income before income taxes . . . . . . 3,585 3,531 3,455 (6,075) 3,897 3,919 4,271 4,554 Income taxes . . . 1,305 1,292 1,266 (2,400) 1,444 1,382 1,490 1,637 ------- ------- ------- ------- ------- ------- ------- ------- Net income . . . . $2,280 $2,239 $2,189 ($3,675) $2,453 $2,537 $2,781 $2,917 ======== ======== ======= ======== ======== ======= ======== ======== Earnings per share $0.62 $0.60 $0.60 ($1.02) $0.70 $0.73 $0.81 $0.85 ===== ===== ===== ===== ===== ===== ===== ===== Earnings per share excluding nonrecurring items (1) . . . . . . . $0.62 $0.60 $0.60 $0.56 $0.70 $0.73 $0.81 $0.85 ==== ==== ==== ==== ==== ==== ==== ==== (1) The information for quarter ended September 30, 1996, excludes the one-time assessment to recapitalize the SAIF and the writedown of intangible assets.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant The following sets forth certain information, as of September 30, 1997, about each member of the Board of Directors. Unless otherwise indicated, each person has served in the principal occupation noted below for at least the past five years. Ben-Ami Chemerow, 71, retired in 1996 as Chairman of the Board of the Leader Store, a retail clothing store which formerly operated in Kenosha, Wisconsin. Mr. Chemerow has been a director of the Bank since 1975 and a director of the Company since its inception in 1991. His term as director of the Company expires at the 1998 annual meeting of shareholders.. Paul P. Gergen, 64, has served as President, Chief Executive Officer and Chairman of the Board of the Company since its inception in 1991, as President and Chief Executive Officer of the Bank since 1984 and as Chairman of the Board of Directors of the Bank since 1987. Mr. Gergen is a licensed attorney and a Certified Public Accountant. His term as director of the Company expires at the year 2000 annual meeting of shareholders. Rita Petretti, 55, is Vice President of Petretti Builders and Developers located in Kenosha, Wisconsin and is a licensed real estate broker. She has been a director of the Bank and the Company since April 1996. Her term as director of the Company expires at the 1999 annual meeting of shareholders. Eugene Snarski, 70, is a licensed attorney practicing in Waukegan, Illinois. Mr. Snarski served as a director of North Chicago Federal Savings and Loan Association prior to its merger with the Bank in 1989. Mr. Snarski has been a director of the Company since its inception in 1991. His term as director of the Company expires at the year 2000 annual meeting of shareholders. Dennis Troha, 51, has been President of ATC Leasing, Inc., a fixed asset leasing company, located in Kenosha, Wisconsin since 1994. He previously was President of Jupiter Corp. Transportation Systems, Inc., a trucking company, located in Kenosha, Wisconsin. He has been a director of the Bank and the Company since November 1996. His term as director of the Company expires at the 1998 annual meeting of shareholders. Michael Wells, 55, is Chairman of the Board and President of Frank L. Wells Co., a manufacturer of wire machinery located in Kenosha, Wisconsin. Mr. Wells has been a director of the Bank since 1979 and a director of the Company since its inception in 1991. His term as a director of the Company expires at the 1999 annual meeting of shareholders. Information regarding the executive officers of the Company and the Bank is included under the heading "Business" in Part I of this Annual Report on Form 10-K. Item 11. Executive Compensation The following table sets forth certain information concerning compensation paid for the last three fiscal years to the Company's Chief Executive Officer and the only other executive officer whose total salary and bonus exceeded $100,000 in fiscal 1997. The amounts reflected in the table were paid by the Bank for services rendered to the Bank. Officers of the Company do not receive any additional compensation for serving in such capacities. The persons named in the table are sometimes referred to herein as the "named executive officers." Summary Compensation Table
Annual Long-Term Compensation (1) Compensation Awards Restricted All Name and Stock Other Principal Position Year Salary Bonus Awards(2) Compensation(3) Paul P. Gergen 1997 $336,090 $113,000 $113,000 $18,646 Chairman, President and Chief 1996 312,146 139,000 140,000 32,685 Executive Officer of the Company 1995 312,146 120,000 109,000 1,875 and the Bank John W. Stampfl 1997 141,703 17,500 17,500 18,276 Secretary, Treasurer and Chief 1996 130,521 30,000 30,000 32,685 Financial Officer of the Company and 1995 129,691 25,000 25,000 1,875 Senior Vice President-Finance, Treasurer and Secretary of the Bank (1) Certain personal benefits provided by the Bank to the named executive officers are not included in the table. The aggregate amount of such benefits for either officer did not exceed 10% of the sum of such officer's salary and bonus in each respective year. (2) The amounts in the table reflect the market value on the date of grant of restricted shares of Common Stock awarded under the BIPs. The number of shares of restricted Common Stock held by the named executive officers and the market value of such shares as of September 30, 1997 were as follows: Mr. Gergen, 17,635 shares ($1,005,195), and Mr. Stampfl, 3,518 shares ($200,526). Holders of shares of restricted Common Stock under the Advantage Bancorp, Inc. Bank Incentive Plans ("BIPs") are entitled to receive dividends on such shares if any dividends are paid. (3) Consists of Bank contributions to the Advantage Bancorp, Inc. Employee Stock Ownership Plan ("ESOP").
Directors' Compensation Directors' Fees. Directors of the Company who are not officers receive a retainer of $750 per month. Directors of the Bank, who are not officers, likewise receive a monthly retainer of $750. Non-officer directors of the Company and/or the Bank also receive a fee of $250 per committee meeting attended. Directors of the Company and the Bank who are officers of either the Company or the Bank receive no additional compensation for serving as directors. Stock Options. Under the 1996 Director Stock Option Plan, each newly- elected director who is not a full-time employee of the Company or the Bank and who has not previously served on the Board of either the Company or the Bank, receives (assuming such individual is elected to the Board of the Directors of both the Company and the Bank) an automatic grant of options to purchase 14,726 shares of the Company's Common Stock as of the date of his or her election. Each such option has a per share price equal to the market value of a share of Common Stock on the date of the grant and has a ten-year term. On election to the Board, Mr. Troha received options to purchase 14,726 shares of Common Stock at a per share exercise prices of $31.25. Deferred Compensation. Under the Company's director deferred compensation program, each director has the option of deferring all or a specified portion of certain fees payable to the director for services rendered to the Company and/or the Bank (hereinafter referred to as "Director's Fees"). At the time such Director's Fees would otherwise be payable in cash, each participating director's deferred account is credited in book entry form with the number of shares of Common Stock the amount of deferred Director's Fees would have purchased based upon the average of the high and low sales price of the Common Stock on that day. Distribution of a participating director's account balance in cash commences within 60 days after the end of the calendar year in which the director's death occurs, or in which the director resigns, retires or is removed from office. Directors have the option of electing a single lump sum payment or payments in a specified number of annual installments. The amount of a participating director's deferred account balance is determined by multiplying the number of shares credited to the deferred account by the average of the high and low sales price of the Common Stock on the business day immediately preceding distribution of such director's account balance. Employment Agreements The Bank has entered into three-year employment agreements with Messrs. Gergen and Stampfl. The employment agreements provide for an annual salary in an amount not less than the officer's current salary. The employment agreements provide for an initial term of three years and are automatically extended for one year at each anniversary date, provided there is a satisfactory performance review of the employee, or until either the Bank or the employee gives written notice to the contrary. The agreements provide for termination upon the employee's death, for cause or in certain events specified by the regulations of the Office of Thrift Supervision. The employment agreements are terminable by the employee upon 90 days notice to the Bank. The agreements provide for the payment of an amount equal to the employee's salary for the remainder of the agreement term plus health benefits in the event employment is terminated without cause and a change in control payment, as described below, is not applicable. The agreements provide for payment to the employee of 299% of annual salary in the event there is a change in control of the Company, and where employment terminates involuntarily in connection with such a change in control or within 12 months thereafter; provided that the total amount payable to the employee in the event of a change in control shall not exceed three times the employee's annual salary. Such termination payment is provided on a similar basis to the employee in connection with the voluntary termination of employment, where the change in control was at any time opposed by the Board. The agreements provide, among other things, for participation in an equitable manner in employee benefits applicable to executive personnel. Pursuant to the terms of the Agreement and Plan of Merger dated as of November 3, 1997 by and between Advantage Bancorp, Inc. and Marshall & Ilsley Corporation, Messrs. Gergen and Stampfl have each entered into an agreement with Marshall & Ilsley Corporation to amend the terms of their respective employment agreements with the Company to clarify certain terms of the agreements. Salary Continuation Agreements During 1987, the Bank entered into salary continuation agreements with Messrs. Gergen and Stampfl. In general, the agreements provide for the payment of an annual retirement benefit (in an annual amount of approximately $42,000 for Mr. Gergen and $22,000 for Mr. Stampfl) for up to 25 years after retirement at age 65 provided that the employee remains available for consulting services. The agreements also provide that the employee's designated beneficiary receive a death benefit in the event the employee dies before receiving the full retirement benefit. In the event the employee voluntarily resigns from his employment with the Bank prior to age 65, the amount of the payments are reduced on a generally pro-rata basis. Stock Options The Company has in effect stock option plans pursuant to which options to purchase Common Stock may be granted to key employees (including officers) of the Company and its subsidiaries. No stock options were granted to or exercised by the named executive officers under the Company's stock option plans during fiscal 1997. The following table sets forth information regarding the fiscal year-end value of unexercised options held by the named executive officers. Value of Unexercised Nunber of Securities In-the-Money Underlying Unexercised Options at Options at Fiscal Fiscal Year-End Name (All Exercisable) (All Exercisable)(1) Paul Gergen 90,625 $4,331,875 John Stampfl 54,463 $2,589,784 (1) The dollar values are calculated by determining the difference between the fair market value of the underlying Common Stock and the exercise price of the options. Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth information as of November 21, 1997 regarding beneficial ownership of Common Stock by (i) each director, (ii) each of the executive officers, and (iii) all of the directors and executive officers of the Company as a group. The table also sets forth certain information as to those other persons believed by management to be beneficial owners of more than 5% of the outstanding shares of Common Stock as of November 21, 1997.
Amount and Nature of Beneficial Ownership Voting Power Investment Power Aggregate Number % of Name of Beneficial Owner Sole Shared Sole Shared of Shares Class MANAGEMENT AND DIRECTORS Paul Gergen . . . . . . . . . 152,256 33,581 160,375 0 185,837(1) 5.59% John Stampfl . . . . . . . . 57,981 30,011 69,763 7,919 87,992(2) 2.67% Ben-Ami Chemerow . . . . . . 20,605 0 20,605 0 20,605(3) (8) Rita Petretti . . . . . . . . 14,826 0 14,826 0 14,826(3) (8) Eugene Snarski . . . . . . . 32,565 0 32,565 0 32,565(3)(4) (8) Dennis Troha . . . . . . . . 15,114 0 15,114 0 15,114(3) (8) Michael Wells . . . . . . . . 23,002 0 23,002 0 23,002(3) (8) All directors and executive officers as a group (12 persons) . . . . . . . . . . 386,977 121,915 426,091 25,811 508,891(5) 14.08% OTHER BENEFICIAL OWNERS Advantage Bancorp, Inc. Employee Stock Ownership Plan and Trust("ESOP") . . . 152,768 177,232 152,768 177,232 330,000(6) 10.20% 5935 Seventh Avenue Kenosha, WI 53140 Advantage Bancorp, Inc. Employees' Profit-Sharing and Savings Retirement Plan and Trust ("Savings Plan") . . 0 183,877 0 183,877 183,877(7) 5.68% 5935 Seventh Avenue Kenosha, WI 53140 Marshall & Ilsley Corporation . . . . . . . . . 0 0 0 0 634,930(9) 16.6% 770 North Water Street Milwaukee, WI 53202 (1) Includes a total of 90,625 shares subject to stock options granted under the Advantage Bancorp, Inc. 1991 Stock Option and Incentive Plan (the "1991 Stock Option Plan") which were exercisable on November 21, 1997 and 17,634 restricted shares granted under the Bank Incentive Plan and Trusts ("BIPs") over which the holder has sole voting but no investment power. Mr. Gergen's address is 5935 Seventh Avenue, Kenosha, Wisconsin 53140. (2) Includes a total of 54,463 shares subject to stock options granted under the 1991 Stock Option Plan which were exercisable on November 21, 1997 and 3,518 restricted shares granted under the BIPs over which the holder has sole voting but no investment power. (3) Includes 14,726 shares (7,363 shares for Mr. Snarski) which may be acquired by each outside director pursuant to exercisable options under the 1991 Stock Option Plan and the 1996 Non- Employee Director Stock Option Plan. (4) Includes 3,625 shares held in a spousal trust and spousal IRA over which Mr. Snarski has disclaimed beneficial ownership. (5) Includes an aggregate of 269,578 shares subject to options granted under the 1991 Stock Option Plan and the 1996 Non- Employee Director Stock Option Plan which were exercisable on November 21, 1997 and 25,176 restricted shares granted under the BIPs over which the holders have sole voting but no investment power. (6) The Personnel Committee of the Board administers the ESOP. EMJAY Corporation is the trustee for the ESOP (the "ESOP Trustee") as approved by the Board. The Personnel Committee may instruct the ESOP Trustee regarding investment of funds contributed to the ESOP. The ESOP Trustee, subject to its fiduciary duty, must vote all allocated shares held in the ESOP in accordance with the instructions of the participating employees. As of the September 30, 1997, 177,232 shares of Common Stock were released for allocation to participating employees. Under the ESOP, unallocated shares held in the suspense account will be voted by the ESOP Trustee, subject to its fiduciary duty, in a manner calculated to most accurately reflect the instructions it has received from the participants regarding allocated shares. (7) The Plan Administration Committee, appointed by the Board, administers the Savings Plan. EMJAY Corporation is the trustee for the Savings Plan (the "Savings Plan Trustee") as approved by the Board. The Plan Administration Committee may instruct the Savings Plan Trustee regarding investment of funds contributed to the Savings Plan. The Savings Plan Trustee, subject to its fiduciary duty, must vote all shares held in the Savings Plan in accordance with the instructions of the participating employees. (8) Less than one percent (1%) of shares outstanding. (9) Marshall & Ilsley Corporation ("M&I") and the Company entered into a Stock Option Agreement dated as of November 3, 1997 pursuant to which the Company granted an option (the "Option") to M&I to purchase up to 643,930 shares of Common Stock (subject to adjustment, but in no event in excess of 19.9% of the issued and outstanding shares of Common Stock), at an exercise price of $56.00 per share. The Option is exercisable upon the occurrence of certain triggering and exercise events generally relating to competing transactions for control of the Company. None of such events has occurred as of the date of filing of this Annual Report on Form 10-K.
Item 13. Certain Relationships and Related Transactions Since the beginning of the 1997 fiscal year, certain directors and executive officers of the Company and the Bank have entered into new loans or had loans outstanding with the Bank. Pursuant to the Bank's current policy, all such loans were made in the ordinary course of business and on substantially (except as disclosed below) the same terms and conditions (including interest rates and collateral) as those of comparable transactions prevailing at the time, and do not involve more than the normal risk of collectability or present other unfavorable features. All loans outstanding during such period to immediate family members of directors and executive officers of the Company and the Bank were also made in accordance with such terms. The Bank has made nine loans to a non-profit organization involved in rehabilitating low-income housing. Mr. Gergen serves as a director and officer of this non-profit organization. Mr. Gergen has personally guaranteed one of these loans with a balance of $30,000 as of September 30, 1997. This loan is a line of credit and bears interest at a rate of prime plus one percent. The highest amount outstanding on this loan since October 1, 1996 was $30,000. The total balance of all nine loans was $642,000 as of September 30, 1997. All loans made to this non-profit organization were made in the ordinary course of business and under terms substantially the same as those of comparable transactions prevailing at the time and do not involve more than the normal risk of collectability or present other unfavorable risks. The Bank has also made a loan to another non-profit organization which provides services to inner city residents. Mr. Gergen serves as a director and officer of this non-profit organization. Mr. Gergen has personally guaranteed this loan. This loan is a line of credit and bears interest at 8.50%. The highest amount oustanding on this loan since October 1, 1997 was $20,000 and there was no balance outstanding at September 30, 1997. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements The following consolidated financial statements of the Company and its subsidiaries, together with the report thereon of Ernst & Young, LLP, dated October 31, 1997 are incorporated herein by reference to Item 8 of this Annual Report on Form 10-K: Consolidated Balances Sheets as of September 30, 1996 and 1997 Consolidated Statements of Income for each year in the three-year period ended September 30, 1997 Consolidated Statements of Stockholders' Equity for each year in the three-year period ended September 30, 1997 Consolidated Statements of Cash Flows for each year in the three-year period ended September 30, 1997 Notes to Consolidated Financial Statements Independent Auditors' Report (a)(2) Financial Statement Schedules All schedules are omitted because they are not required or are not applicable or the required information is shown in the consolidated financial statements or notes thereto. (a)(3) Exhibits The following exhibits are either filed as part of this Report on Form 10-K or are incorporated herein by reference: Exhibit No. 2 Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession: 2.1 Agreement and Plan of Merger, dated as of November 3, 1997, between Marshall & Ilsley Corporation and Advantage Bancorp, Inc. (incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K, dated November 3, 1997, and filed on November 4, 1997) 2.2 Stock Option Agreement, dated as of November 3, 1997, between Marshall & Ilsley Corporation and Advantage Bancorp, Inc. (incorporated herein by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K, dated November 3, 1997, and filed on November 4, 1997) Exhibit No. 3. Certificate of Incorporation and Bylaws: 3.1 Articles of Incorporation of Advantage Bancorp, Inc. (incorporated herein by reference to Exhibit 3.1 of Registrant's Form S-1 Registration Statement, as amended, filed on December 11, 1991, Registration No. 33-44492) 3.2 Bylaws of Advantage Bancorp, Inc. (incorporated herein by reference to Exhibit 3.2 of Annual Report on Form 10-K for the fiscal year ended September 30, 1994 filed on December 27, 1994) Exhibit No. 10. Material Contracts: 10.1* Advantage Bancorp, Inc. 1991 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 4.1 of Registrant's Form S-8 Registration Statement, filed on December 30, 1993, Registration No. 33-73664) 10.2* Advantage Bancorp, Inc. 1995 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.2 of Annual Report on Form 10-K for the fiscal year ended September 30, 1994 filed on December 27, 1994) 10.3* Advantage Bancorp, Inc. Employees' Profit-Sharing and Savings Retirement Plan (incorporated herein by reference to Exhibit 10.2 of Registrant's Form S-1 Registration Statement, as amended, filed on December 11, 1991, Registration No. 33- 44492) 10.4* Advantage Bancorp, Inc. Bank Incentive Plan and Trust (incorporated herein by reference to Exhibit B to the Proxy Statement for the First Annual Meeting of Shareholders held on January 19, 1993) 10.5* Advantage Bancorp, Inc. Employee Stock Ownership Plan (incorporated herein by reference to Exhibit 10.4 of Registrant's Form S-1 Registration Statement, as amended, filed on December 11, 1991, Registration No. 33-44492) 10.6* Employment Agreement between the Bank and Paul P. Gergen; Employment Agreement between the Bank and John Stampfl (incorporated herein by reference to Exhibit 10.5 of Registrant's Form S-1 Registration Statement, as amended, filed on December 11, 1991, Registration No. 33-44492) 10.7* Amendment of Employment Agreement, dated as of November 3, 1997, between Advantage Bancorp, Inc., Advantage Bank, F.S.B., Paul P. Gergen and Marshall & Ilsley Corporation (incorporated herein by reference to Exhibit 99.1 to the Registrant's Current Report on Form 8-K, dated November 3, 1997, and filed on November 4, 1997) 10.8* Amendment of Employment Agreement, dated as of November 3, 1997, between Advantage Bancorp, Inc., Advantage Bank, F.S.B., John Stampfl and Marshall & Ilsley Corporation (incorporated herein by reference to Exhibit 99.2 to the Registrant's Current Report on Form 8-K, dated November 3, 1997, and filed on November 4, 1997) 10.9* Advantage Bank, FSB Executive Salary Continuation Agreement with Paul P. Gergen dated March 13, 1987 (incorporated herein by reference to Exhibit 10.6 of Annual Report on Form 10-K for the fiscal year ended September 30, 1993 filed on December 27, 1993) 10.10* Advantage Bank, FSB Executive Salary Continuation Agreement with John Stampfl dated December 30, 1987 (incorporated herein by reference to Exhibit 10.7 of Annual Report on Form 10-K for the fiscal year ended September 30, 1993 filed on December 27, 1993) 10.11* Description of Advantage Bank, FSB Senior Officer Incentive Compensation Program (incorporated by reference to Exhibit 10.9 of Annual Report on Form 10-K for the fiscal year ended September 30, 1994 filed on December 27, 1994) 10.12* 1994 Amendments to the Advantage Bancorp, Inc. Employees' Profit-Sharing and Savings Retirement Plan (incorporated by reference to Exhibit 10.10 of Annual Report on Form10-K for the fiscal year ended September 30, 1994 filed on December 27, 1994) 10.13* Amity Bancshares, Inc. 1991 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 4.1 of Registrant's Form S-8 Registration Statement filed on February 6, 1995, Registration No. 33-89114) 10.14* Advantage Bancorp, Inc. 1996 Non-Employee Director Stock Option Plan (incorporated by reference to Exhibit 4.1 of the Registrant's Form S-8 Registration Statement filed on May 3, 1996, Registration No. 333-4444) 10.15* Form of Director Deferred Compensation Agreement (incorporated by reference to Exhibit 10.13 of Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1995 filed on December 26, 1995) * A management contract or compensatory plan or arrangement. Exhibit No. 11. Statement re: Computation of Per Share Earnings The statement regarding computation of per share earnings for fiscal year 1996 is as follows: Primary Fully Diluted 1. Net income . . . . . . . . . . . . . . $ 3,032,537 $ 3,032,537 ========== ========== 2. Weighted average common shares outstanding . . . . . . . . . . . . . . 3,433,886 3,433,886 3. Common stock equivalents due to dilutive effect of stock options . . . 227,947 222,461 ---------- ---------- 4. Total weighted average common shares and equivalents outstanding . . . . . . 3,661,833 3,656,347 ========== ========== 5. Earnings per share . . . . . . . . . . $0.83 $0.83 ========== ========== The statement regarding computation of per share earnings for fiscal year 1997 is as follows: Primary Fully Diluted 1. Net income . . . . . . . . . . . . . . . $10,687,879 $10,687,879 ========== ========== 2. Weighted average common shares outstanding 3,252,389 3,252,389 3. Common stock equivalents due to dilutive effect of stock options . . . . . . . . 211,113 250,632 ---------- ---------- 4. Total weighted average common shares and equivalents outstanding . . . . . . . . 3,463,502 3,503,021 ========== ========== 5. Earnings per share . . . . . . . . . . . $3.09 $3.05 ===== ===== Exhibit No. 21. Subsidiaries of the registrant As of the date of this Annual Report the only subsidiary of the Company is Advantage Bank, FSB, which is a federally-chartered savings bank. The subsidiaries of the Bank are Advantage Real Estate Services, Inc. (incorporated in Wisconsin), Advantage Investments, Inc.(incorporated in Nevada) and Advantage Financial Services and Insurance, Inc. (incorporated in Wisconsin). Exhibit No. 23. Consent of Independent Auditors Consent of Independent Auditors to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-73664, 33-89114, 33-46975, 333- 4444 and 333-4448) pertaining to the Advantage Bancorp, Inc. 1991 Stock Option and Incentive Plan, the Amity Bancshares, Inc. Stock Option Plan and Incentive Plan, the Advantage Bancorp, Inc. Employees' Profit Sharing and Savings Retirement Plan, the Advantage Bancorp, Inc. 1996 Non-Employee Director Stock Option Plan, and the Advantage Bancorp, Inc. 1995 Equity Incentive Plan, of auditors' report dated October 31, 1997, with respect to the consolidated financial statements of Advantage Bancorp, Inc. included in the Annual Report (Form 10-K) for the year ended September 30, 1997. Exhibit No. 27. Financial Data Schedule (Edgar version only) (b) Forms 8-K No reports on Form 8-K were filed during the last quarter of fiscal 1997. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Advantage Bancorp, Inc. (registrant) By: /s/ Paul P. Gergen Paul P. Gergen Chairman of the Board Director Date: December 4, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Paul P. Gergen Paul P. Gergen Chairman of the Board Chief Executive Officer President Date: December 4, 1997 By: /s/ Robert J. Muth Robert Muth Senior Vice President Date: December 4, 1997 By: /s/ John Stampfl John Stampfl Chief Financial Officer Secretary-Treasurer Date: December 4, 1997 By: /s/ Ben-Ami Chemerow Ben-Ami Chemerow Director Date: December 4, 1997 By: /s/ Rita Petretti Rita Petretti Director Date: December 4, 1997 By: /s/ Eugene Snarski Eugene Snarski Director Date: December 4, 1997 By: /s/ Dennis Troha Dennis Troha Director Date: December 4, 1997 By: /s/ Michael Wells Michael Wells Director Date: December 4, 1997 INDEX TO ATTACHED EXHIBITS Advantage Bancorp, Inc. Form 10-K Year Ended September 30, 1997 Exhibit No. Exhibit Description 23 Consent of Independent Auditors 27 Financial Data Schedule (Edgar version only) EX-23 2 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8) pertaining to the Advantage Bancorp, Inc. 1991 Stock Option and Incentive Plan, the Amity Bancshares, Inc. Stock Option Plan and Incentive Plan, the Advantage Bancorp, Inc. Employees' Profit Sharing and Savings Retirement Plan, the Advantage Bancorp, Inc. 1996 Non-Employee Director Stock Option Plan and the Advantage Bancorp, Inc. 1995 Equity Incentive Plan, of our report dated October 31, 1997, with respect to the consolidated financial statements of Advantage Bancorp, Inc. incorporated by reference in the Annual Report (Form 10-K) for the year ended September 30, 1997 /s/ Ernst & Young LLP Ernst & Young LLP December 3, 1997 Milwaukee, Wisconsin EX-27 3
9 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF ADVANTAGE BANCORP. INC. AS OF AND FOR THE TWELVE MONTHS ENDED SEPTEMBEER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS SEP-30-1997 OCT-01-1996 SEP-30-1997 42,908 509 0 0 160,676 226,773 230,572 571,056 5,797 1,037,462 670,775 72,115 12,020 176,360 0 0 38,569 60,435 1,037,462 48,275 26,925 1,467 76,667 30,473 45,714 30,953 360 627 22,272 16,641 16,641 0 0 10,688 3.09 3.05 7.84 3,161 0 0 0 5,773 807 471 5,797 5,797 0 0
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