SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2002
Commission File Number: 0-22423
HCB BANCSHARES, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Oklahoma 62-1670792
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(State or Other Jurisdiction of Incorporation (I.R.S. Employer
or Organization) Identification No.)
237 Jackson Street, Camden, Arkansas 71701-3941
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (870) 836-6841
--------------
Securities registered pursuant to Section (b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(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]
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, as of a
specified date within the past 60 days: $17,943,227 (1,192,241 shares at the
last sale price on August 31, 2002 ($15.05 per share); for this purpose,
directors, executive officers and 5% stockholders have been deemed to be
affiliates).
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 1,503,436 shares of common
stock as of August 31, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended June
30, 2002. (Parts II and IV)
2. Portions of Proxy Statement for the 2002 Annual Meeting of Stockholders.
(Part III)
PART I
ITEM 1. DESCRIPTION OF BUSINESS
--------------------------------
GENERAL
HCB BANCSHARES, INC. HCB BANCSHARES, INC. ("Bancshares") was incorporated
under the laws of the State of Oklahoma in December 1996 at the direction of the
Board of Directors of HEARTLAND Community Bank (the "Bank") for the purpose of
serving as a savings institution holding company of the Bank, upon the
acquisition of all of the capital stock issued by the Bank upon its conversion
from mutual to stock form, which was completed on April 30, 1997 (the
"Conversion"). The consolidated financial statements include the accounts of
Bancshares and the Bank and are collectively referred to as the "Company". All
significant intercompany balances and transactions have been eliminated in
consolidation.
Prior to the Conversion, Bancshares did not engage in any material
operations. Since the Conversion, Bancshares has had no significant assets other
than the outstanding capital stock of the Bank, a portion of the net proceeds of
the Conversion and notes receivable, one of which is from the Employee Stock
Ownership Plan ("ESOP"). Bancshares principal business is the business of the
Bank. At June 30, 2002, the Company had consolidated total assets of $276.4
million, deposits of $165.0 million and stockholders' equity of $26.7 million,
or 9.7% of total assets.
The holding company structure permits Bancshares to expand the financial
services currently offered through the Bank. As a holding company, Bancshares
has greater flexibility than the Bank to diversify its business activities
through existing or newly formed subsidiaries or through acquisition or merger
with other financial institutions. Bancshares is classified as a unitary savings
institution holding company and is subject to regulation by the Office of Thrift
Supervision ("OTS"). As long as Bancshares remains a unitary savings institution
holding company, under current law it can diversify its activities in such a
manner as to include any activities allowed by law or regulation to a unitary
savings institution holding company. See "Regulation -- Regulation of Bancshares
-- Activities Restrictions."
The Company's executive offices are located at 237 Jackson Street, Camden,
Arkansas 71701-3941, and its telephone number is (870) 836-6841.
HEARTLAND COMMUNITY BANK. HEARTLAND Community Bank was organized as a
federally chartered mutual savings and loan association named "First Federal
Savings and Loan Association of Camden" ("First Federal") in 1933, and in 1934
it became a member of the FHLB system and obtained federal deposit insurance. In
May 1996, First Federal acquired the former Heritage Bank, FSB, which retained
its separate federal savings bank charter and deposit insurance as a wholly
owned subsidiary of First Federal (in order to facilitate possible future branch
expansion, in the event the Bank ever becomes subject to Arkansas branching
restrictions, which at that time were based on the home office location of each
separately chartered banking institution), but whose business operations were
fully integrated with those of First Federal. In September 1996, First Federal
and Heritage changed their names to HEARTLAND Community Bank and HEARTLAND
Community Bank, F.S.B., respectively.
On February 23, 1998 the Bank sold all of the shares of stock of Heritage
Banc Holding, Inc., parent of its subsidiary savings bank, HEARTLAND Community
Bank, FSB ("FSB"), pursuant to an agreement between the Bank and the Bank of the
Ozarks, Inc. ("BOO"). Upon completion of the transaction and pursuant to the
terms of the agreement, the Bank acquired the loans and certain other assets and
non-deposit liabilities of the Little Rock, Arkansas branch of FSB and all
assets and liabilities of the Monticello, Arkansas branch and the Bryant,
Arkansas loan production office of FSB and BOO acquired the savings deposits and
premises and equipment of the Little Rock, Arkansas branch of FSB, as well as
FSB's holding company charter and stock. This transaction was substantively a
branch sale. Also at such time, Bancshares became a unitary rather than a
multiple savings institution holding company.
On March 7, 2002, the Company announced that its bank subsidiary, HEARTLAND
Community Bank had entered into a definitive Branch Purchase and Assumption
Agreement with Simmons First Bank of South Arkansas
2
("SFB"), a subsidiary of Simmons First National Corporation. Pursuant to such
agreement, the Bank would sell its Monticello, Arkansas branch office to SFB.
The sale was completed on July 19, 2002, and included approximately $8.3 million
in loans, $1.5 million in fixed assets, $0.2 million in other assets, and $13.2
million in deposits. The Bank recognized a premium on the deposits of
approximately $0.9 million and the difference was paid in cash to the buyer.
After the sale of the Monticello branch, the Bank operates through five
full-service banking offices located in Camden (2), Fordyce, Sheridan, and
Bryant, Arkansas. Historically, the principal business strategy of the Bank,
like most other savings institutions in Arkansas and elsewhere, has been to
accept savings deposits from residents of the communities served by the Bank's
branch offices and to invest those funds in single-family mortgage loans to
those and other local residents. In this manner, the Bank and countless other
independent community-oriented savings institutions operated safely and soundly
for generations. In recent years, however, as the banking business nationwide
and in the Bank's primary market area in particular has become more competitive,
smaller savings institutions like the Bank have come under increasing market
pressure either to grow and increase their profitability or to be acquired by a
larger institution. Moreover, during this period the Bank's market area
experienced only limited economic growth.
The Bank's current business strategy, as developed and adopted by all of
the Bank's directors, officers and employees, incorporates the following key
elements: (i) remaining a community-oriented financial institution by continuing
to provide the quality service that only a locally based institution and its
dedicated staff can deliver, including the possible retention of additional
executive officers in the future as the Bank's growth and other needs may
warrant; (ii) strengthening the Bank's core deposit base and decreasing interest
costs and increasing fee income by expanding the Bank's deposit facilities and
products, including the addition and expansion of branch offices, the
installation of ATMs, and an emphasis on attracting consumer demand deposits;
(iii) increasing loan yields and fee income while maintaining asset quality by
emphasizing the origination of higher yielding and shorter term loans,
especially commercial and multi-family real estate loans and consumer and
commercial business loans, for the Bank's portfolio while increasingly
originating lower yielding longer term single-family residential loans
principally for resale to investors; (iv) using the capital raised in the
Conversion to support the Bank's future growth; and, (v) complementing the
Bank's internally generated growth, by potentially acquiring one or more banking
institutions or other financial companies if attractive opportunities arise.
While it is expected that the Bank may experience especially high deposit and
loan growth in the relatively high income and growth segments of the Bank's
primary market area, particularly in the Sheridan, and Bryant areas, management
expects to find significant deposit growth and lending opportunities throughout
central and southern Arkansas.
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the OTS. The Bank's lending activities and other
investments must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance with various regulatory
requirements. The Federal Deposit Insurance Corporation ("FDIC") also has the
authority to conduct special examinations. The Bank must file reports with the
OTS describing its activities and financial condition and is also subject to
certain reserve requirements promulgated by the Board of Governors of the
Federal Reserve System ("Federal Reserve Board").
FORWARD-LOOKING STATEMENTS
When used in this Annual Report, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in the Company's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Company's market area, and competition that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.
3
The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
MARKET AREA
Management considers the Bank's primary market area to comprise the
following counties in Arkansas: Calhoun, Cleveland, Dallas, Grant, Ouachita and
Saline. To a lesser extent, the Bank accepts savings deposits and offers loans
throughout the remainder of central and southern Arkansas.
The year 2000 census data indicated that the population experienced growth
in Cleveland (10.2%), Grant (18.0%) and Saline (30.1%) Counties, while
population declined somewhat in Calhoun (-1.4%), Dallas (-4.2%) and Ouachita
(-5.8%) Counties over the past ten years. Median household income has been well
above the Arkansas average in Saline, Grant and Cleveland Counties, slightly
below the Arkansas average in Ouachita and Calhoun Counties, and well below the
Arkansas average in Dallas County, though the Arkansas average is below the
national average. With respect to unemployment rates, the Arkansas average has
tended to rise slightly above the national average, and while unemployment rates
have been well below the Arkansas average in Saline County, unemployment rates
have been moderately above the Arkansas average in Grant and Cleveland Counties,
and well above the Arkansas average in Calhoun, Dallas, and Ouachita Counties.
The economies in the Bank's primary market area include a variety of
industries, including manufacturing, government, services and retail trade.
Important employers include Georgia Pacific in the timber industry and Lockheed
Martin and Atlantic Research in the defense industry, and SAU Tech. In addition,
industries in the Bryant area include Bryant School District as the largest
employer, with Alcoa as the largest industrial business, and United Auto Group
as the second largest employer.
COMPETITION
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the originating of mortgage and other loans.
Direct competition for savings deposits comes from other savings
institutions, credit unions, and both regional and local commercial banks.
Significant competition for the Bank's other deposit products and services comes
from money market mutual funds and brokerage firms. The primary factors in
competing for loans are loan products, interest rates and the quality of
personal service. Competition for origination of real estate loans normally
comes from other savings institutions, commercial banks, credit unions and
mortgage companies.
The Bank's primary competition comes from institutions located in the
Bank's primary market area. Competing financial institutions offer a wide
variety of deposit and loan products. Management's principal competitive
strategy has been to emphasize quality customer service.
LENDING ACTIVITIES
The Bank's principal lending activity consists of the origination of loans
collateralized by mortgages on existing and on construction of single-family
residences in the Bank's primary market area, and commercial real estate and
multifamily properties in the State of Arkansas. The Bank also makes a variety
of consumer and commercial business loans. Management expects to continue to
expand on these types of lending.
With certain limited exceptions, the maximum amount that a savings
institution may lend to any borrower (including certain related entities of the
borrower) at one time may not exceed 15% of the unimpaired capital and surplus
of the institution, plus an additional 10% of unimpaired capital and surplus for
loans fully collateralized by readily marketable collateral. Savings
institutions are additionally authorized to make loans to one borrower, for any
purpose, in an amount not to exceed $500,000 or, by order of the Director of the
OTS, in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired
capital and surplus to develop residential housing, provided: (i) the purchase
price of each single-family dwelling in the development does not exceed
$500,000; (ii) the institution is in
4
compliance with its regulatory capital
requirements; (iii) the loans comply with applicable loan-to-value requirements,
and; (iv) the aggregate amount of loans made under this authority does not
exceed 150% of unimpaired capital and surplus. At June 30, 2002, the maximum
aggregate amount that the Bank could have lent to any one borrower under the 15%
limit was approximately $3.5 million. At such date, the largest aggregate amount
of loans that the Bank had outstanding to any one borrower was $3.8 million.
Although the aggregate loan balance as of June 30, 2002 exceeded the Bank's
lending limit at that date, the aggregate balance was within the lending limit
on the dates the loans were approved by the board and booked. Bancshares may
participate in loans to one borrower thereby permitting loans to one borrower to
be made by the Bank and Bancshares lending together that exceed the Bank's
regulatory loan limit. At June 30, 2002, the Bank and Bancshares' loans to the
borrower referred to above totaled approximately $4.5 million with Bancshares
carrying $0.7 million of the loans.
5
LOAN PORTFOLIO COMPOSITION. The following table sets forth information
regarding the composition of the Bank's loan portfolio by type of loan at the
dates indicated. At June 30, 2002, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
At June 30,
-----------------------------------------------------------------------
2002 2001 2000
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Amount % Amount % Amount %
----------- ------- ------------ ------ ------------ -----
Type of Loan
------------
Real estate loans:
One-to-four family residential $48,507,922 36.38% $ 57,001,679 38.97% $ 61,198,180 42.26%
Multi-family loans 6,355,028 4.77 6,810,198 4.66 9,220,931 6.37
Non-residential 41,334,937 31.00 49,736,511 34.01 48,756,744 33.67
Loans to facilitate sale of
foreclosed real estate -- -- -- -- -- --
Land and other mortgage loans 8,602,412 6.45 10,080,790 6.89 5,644,050 3.90
Consumer loans:
Loans secured by savings deposits 2,469,033 1.85 2,488,948 1.70 2,320,915 1.60
Home improvement 35,310 0.03 23,611 0.02 40,851 0.03
Auto 6,836,399 5.13 6,779,218 4.64 6,589,480 4.55
Other consumer 4,771,908 3.58 2,050,039 1.40 2,260,697 1.56
Commercial 14,406,499 10.81 11,289,519 7.71 8,769,131 6.06
------------ ------ ------------ ------ ------------ ------
Total $133,319,448 100.00% $146,260,513 100.00% $144,800,979 100.00%
------------ ------ ------------ ------ ------------ ------
Less:
Loans in process $ 7,663,698 $ 13,294,723 $ 8,100,982
Deferred loan costs (fees), net (149,663) (131,745) (158,217)
Allowance for loan losses 1,628,515 1,446,114 1,231,709
------------ ------------ ------------
Total $124,176,898 $131,651,421 $135,626,505
============ ============ ============
At June 30,
-----------------------------------------------
1999 1998
--------------------- -----------------------
Amount % Amount %
----------- ------- ------------ ------
Type of Loan
------------
Real estate loans:
One-to-four family residential $ 53,622,417 43.74% $ 49,267,399 44.75%
Multi-family loans 9,226,426 7.53 12,577,034 11.43
Non-residential 41,907,368 34.18 35,321,040 32.08
Loans to facilitate sale of
foreclosed real estate -- -- 473,476 0.43
Land and other mortgage loans 3,547,514 2.89 598,860 0.54
Consumer loans:
Loans secured by savings deposits 2,021,141 1.65 2,215,441 2.01
Home improvement 125,990 0.10 1,291,174 1.17
Auto 4,269,898 3.48 4,070,750 3.70
Other consumer 2,517,190 2.05 1,569,076 1.43
Commercial 5,367,611 4.38 2,708,927 2.46
------------ ------ ------------ ------
Total $122,605,555 100.00% $110,093,177 100.00%
============ ====== ============ ======
Less:
Loans in process $ 6,150,810 $ 3,921,787
Deferred loan costs (fees), net (37,339) 122,679
Allowance for loan losses 1,329,201 1,468,546
------------ ------------
Total $115,162,883 $104,580,165
============ ============
6
LOAN MATURITY SCHEDULES. The following table sets forth information
regarding dollar amounts of loans maturing in the Bank's portfolio based on
their contractual terms to maturity, at June 30, 2002. Demand loans, loans
having no stated schedule of repayments and no stated maturity and overdrafts
are reported as due in one year or less. The table does not include any estimate
of prepayments, which significantly shorten the average life of all mortgage
loans and may cause the Bank's repayment experience to differ from that shown
below.
Due After
Due Within One Through Due After
One Year Five Years Five Years Total
----------- ----------- ---------- -----
(In thousands)
Real estate loans:
One-to-four family mortgage
loans......................... $ 9,611 $ 10,871 $ 28,026 $ 48,508
Other mortgage loans............ 12,614 17,528 26,150 56,292
Commercial loans.................. 5,813 3,692 4,901 14,406
Consumer loans:
Loans secured by savings
deposits...................... 1,764 670 35 2,469
Other.......................... 832 7,881 2,931 11,644
------- -------- -------- --------
Total........................ $30,634 $ 40,642 $ 62,043 $133,319
======= ======== ======== ========
The following table sets forth as of June 30, 2002, dollar amounts of loans
due one year or more after June 30, 2002 that had predetermined interest rates
and that had adjustable interest rates at that date.
Predetermined Floating or
Rates Adjustable Rates Total
------------- ---------------- -----
(In thousands)
Real estate loans:
One-to-four family mortgage loans.... $ 34,571 $ 4,326 $ 38,897
Other mortgage loans................. 33,444 10,234 43,678
Commercial loans....................... 8,004 589 8,593
Consumer loans:
Loans secured by savings deposits.... 705 -- 705
Other consumer loans................. 10,812 -- 10,812
--------- --------- ---------
Total.............................. $ 87,536 $ 15,149 $ 102,685
========= ========= =========
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less than
their contractual terms because of prepayments. In addition, due-on-sale clauses
on loans generally give the Bank the right to declare a loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
7
LOAN ORIGINATIONS, PURCHASES AND SALES. The following table sets forth
information regarding the Bank's loan originations, purchases and sales during
the periods indicated.
Year Ended June 30,
------------------------------------------------
2002 2001 2000
------------- ------------- -------------
Loans originated:
Real estate loans:
One-to-four family residential............................ $ 42,880,138 $ 28,443,919 $ 46,925,450
Other mortgage loans...................................... 10,737,552 22,007,354 29,145,079
Commercial loans............................................ 14,547,306 4,465,227 7,973,954
Consumer loans.............................................. 11,231,892 9,659,572 13,515,847
------------- ------------- -------------
Total loans originated................................... $ 79,396,888 $ 64,576,072 $ 97,560,330
============= ============= =============
Loans purchased:
Real estate loans........................................... $ -- $ 40,000 $ 82,547
============= ============= =============
Loans sold.................................................... $ 27,117,741 $ 12,732,692 $ 10,160,826
============= ============= =============
The Bank has increased both its scope of loan products offered and its loan
origination efforts, including the addition of new consumer and commercial
business loan offerings with an increased emphasis on the origination of such
loans and commercial and multi-family real estate loans. However, lower interest
rates in the fiscal year ended June 30, 2002, and increased competition resulted
in the origination of fewer numbers and total amount of commercial and
multi-family real estate loans.
The Bank has purchased loans from established and reputable loan
originators from time to time to supplement the Bank's internally generated
originations. Historically, substantially all of the Bank's loan purchases have
been from one large homebuilder with which the Bank has a long-standing
relationship. The Bank's experience with its purchased loans has been
successful.
The Bank originates long term, fixed-rate, single-family loans and sells
them to investors in the secondary market. Management expects the Bank to
increase its origination of selected types of loans that do not meet the Bank's
loan portfolio needs, such as long-term fixed-rate residential mortgage loans
for sale to investors.
ONE-TO-FOUR FAMILY RESIDENTIAL LENDING. Historically, the Bank's principal
lending activity has been the origination of fifteen-year fixed-rate first
mortgage loans in the Bank's primary market area. The purchase price or
appraised value of most of such residences generally has been between $50,000
and $200,000, with the Bank's loan amounts averaging approximately $75,000. At
June 30, 2002, $48.5 million, or 36.4%, of the Bank's total loans were
collateralized by one-to-four family residences, substantially all of which were
existing, owner-occupied, single-family residences in the Bank's primary market
area.
While the Bank offers a variety of one-to-four family residential mortgage
loans with fixed or adjustable interest rates and terms of up to 30 years,
substantially all of the fixed-rate loans retained in the Bank's portfolio have
terms of 15 years or less. Despite the relatively low credit risks associated
with the Bank's 30-year one-to-four family portfolio loans, due to the interest
rate risks associated with such longer term loans, management has approved
shifting the Bank's one-to-four family residential lending emphasis in the
future away from the origination of such loans for the Bank's portfolio and
toward the origination of such loans for sale. Currently, it is the Bank's
policy to originate all 30-year term one-to-four family residential loans in
accordance with the investor's underwriting guidelines and to sell all such
originations promptly to investors, servicing released. Such loan originations
and sales have become significant. One-to-four-family residential loans
originated during the year totaled $42.9 million with $27.1 million or 63.2% of
originations sold or to be sold in the secondary market. The Bank will continue
to make non-conforming loans to be held in the Bank's portfolio. Management
expects to continue these policies in the future.
8
With respect to one-to-four family residential loans originated for
retention in the Bank's portfolio, the Bank's lending policies generally limit
the maximum loan-to-value ratio to 90% for owner-occupied properties and 80% for
non-owner-occupied properties. Loans originated expressly for sale are
originated in accordance with the lending policies and underwriting guidelines
of the investor.
From time to time, the Bank makes loans to individuals for construction of
one-to-four family owner-occupied residences located in the Bank's primary
market area, with such loans usually converting to permanent financing upon
completion of construction. At June 30, 2002, the Bank's loan portfolio included
$3.7 million of loans collateralized by one-to-four family properties under
construction, some of which were construction/permanent loans structured to
become permanent loans upon the completion of construction and some of which
were interim construction loans structured to be repaid in full upon completion
of construction and receipt of permanent financing. The Bank also offers loans
to qualified builders for the construction of one-to-four family residences
located in the Bank's primary market area. Because such homes are intended for
resale, such loans are generally not covered by permanent financing commitments
by the Bank. All construction loans are collateralized by a first lien on the
property under construction. Loan proceeds are disbursed in increments as
construction progresses and as inspections warrant. Construction/permanent loans
are underwritten in accordance with the same requirements as the Bank's
permanent mortgages, except the loans generally provide for disbursement in
stages during a construction period of up to nine months, during which period
the borrower may be required to make monthly interest payments. Borrowers must
satisfy all credit requirements that would apply to the Bank's permanent
mortgage loan financing prior to receiving construction financing for the
subject property. Construction financing generally is considered to involve a
higher degree of risk of loss than financing on existing properties. The Bank
has sought to minimize this risk by limiting construction lending to qualified
borrowers in the Bank's primary market area, and by requiring the involvement of
qualified builders.
COMMERCIAL AND MULTI-FAMILY REAL ESTATE LENDING. The Bank offers commercial
and multi-family real estate loans in order to benefit from the higher interest
rates than could be obtained from investment securities. The Bank has offered
commercial and multi-family loans for years and will continue to place emphasis
on the direct origination of commercial and multi-family real estate loans,
particularly in central Arkansas.
Most of the Bank's commercial and multi-family real estate loans are
collateralized by properties located in communities within Arkansas that have
experienced significant growth in recent years. The Bank's emphasis on
increasing this portfolio resulted in the addition to the Bank's staff of
commercial and multi-family real estate loan originators who work closely with
borrowers and various members of the commercial real estate industry throughout
Arkansas. As opportunities for originations of such loans have increased, the
Bank has been expanding its loan underwriting and servicing staff. All
commercial and multi-family loans above loan officers' approved lending
authorities are reviewed and approved by the Bank's lending committees at the
headquarters in Camden prior to any funding or the issuance of any binding
commitment by the Bank.
The Bank's commercial real estate loans may be collateralized by offices,
warehouses, shopping centers, land, nursing homes, single-family subdivision
developments and other income-producing and commercial properties. Multi-family
real estate loans are collateralized by greater than one-to-four family
residential properties. At June 30, 2002, the Bank had 241 commercial real
estate, construction commercial real estate, land, and multi-family loans, with
an average loan balance of approximately $228,000. At that date, 25 of these
loans totaling approximately $5.5 million were collateralized by properties
outside Arkansas, and none of these out-of-market loans were classified by
management as substandard, doubtful or loss or designated by management as
special mention. Management expects the Bank to continue making these
out-of-market loans from time to time as opportunities arise.
The Bank's commercial and multi-family real estate loans generally are
limited to loans not exceeding $3,500,000 on properties located either in
Arkansas or other areas selected by management and approved by the Board of
Directors, with terms of up to 20 years and loan-to-value ratios of up to 80%.
Interest rates may be fixed for up to 20 years. Under certain circumstances,
these longer-term loans may be match funded with similar term FHLB advances to
reduce interest rate risk.
Commercial and multi-family real estate lending entails significant
additional risks compared with one-to-four family residential lending. For
example, commercial and multi-family real estate loans typically involve large
loan
9
balances to single borrowers or groups of related borrowers, the payment
experience on such loans typically is dependent on the successful operation of
the real estate project, and these risks can be significantly impacted by supply
and demand conditions in the market for multi-family residential units and
commercial office, retail and warehouse space. These risks may be higher with
respect to loans collateralized by properties outside the Bank's primary market
area or outside the Bank's most historically active lending areas. The Bank's
recent and planned increases in commercial and multi-family lending also
introduce additional risk as demands on the Bank's loan origination and
administration increase and as the Bank's aggregate exposure to these types of
loans increases.
The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate
generally may not exceed 400% of the institution's capital.
CONSUMER LENDING. The Bank's consumer loans primarily consist of loans
collateralized by savings deposits at the Bank, and automobiles. These loans
totaled $2.5 million and $6.8 million, respectively, at June 30, 2002.
Management plans to continue the expansion of the Bank's consumer lending
activities in the future as part of management's plan to provide a wider range
of financial services while increasing the Bank's portfolio yields and improving
its asset/liability management.
The Bank makes certificate of deposit loans for up to 100% of the balance
of the account. The interest rate on these loans typically is fixed at least
three percentage points above the rate paid on a deposit at the Bank or four
percentage points above the rate paid on a deposit at another institution, with
the maturity and payment frequency matched to the terms of the deposit. The
account must be pledged as collateral to secure the loan.
The Bank makes home improvement loans collateralized by the borrower's
residence. These loans, combined with any higher priority mortgage loan, which
usually is from the Bank, generally are limited to 90% of the appraised value of
the residence. Home improvement loans generally have fixed interest rates and
terms of up to ten years.
The Bank's new and used automobile loans generally are underwritten in
amounts up to 90% of the purchase price, dealer cost or the loan value as
published by the National Automobile Dealers Association. The terms of such
loans generally do not exceed 60 months, with loans for older used cars
underwritten for shorter terms. The Bank requires that the vehicles be insured
and that the Bank be listed as loss payee on the insurance policy.
Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Further, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered. These loans may also give rise to claims and defenses by
a borrower against the Bank, and a borrower may be able to assert against the
Bank claims and defenses which it has against the seller of the underlying
collateral. In underwriting consumer loans, the Bank considers the borrower's
credit history, an analysis of the borrower's income, expenses and ability to
repay the loan and the value of the collateral. The Bank's recent and planned
increases in consumer lending also introduce additional risk as demands on the
Bank's loan origination and administration increase and as the Bank's aggregate
exposure to these types of loans increases.
COMMERCIAL BUSINESS LENDING. The Bank currently offers working capital
loans, floor plan loans to dealers of automobiles and recreational vehicles, and
business equipment loans. At June 30, 2002, the Bank's commercial business loans
totaled $14.4 million and primarily consisted of recreational vehicle floor plan
loans, inventory loans, and equipment loans. At that date, the Bank had one
commercial business loan with outstanding commitments exceeding $500,000. This
loan is collateralized by a floor plan of recreational vehicles.
Commercial business loans generally involve more risk than single family
residential loans. In underwriting commercial business loans, the Bank considers
the obligor's credit history, an analysis of the obligor's income, expenses and
ability to repay the obligation and the value of the collateral.
10
LOAN SOLICITATION AND PROCESSING. The Bank's loan originations are derived
from a number of sources, including referrals by realtors, builders, depositors,
borrowers and mortgage brokers as well as walk-in customers. The Bank's
solicitation programs consist of calls by the Bank's officers, branch presidents
and other responsible employees to local realtors, builders, commercial
businesses, and advertisements in local newspapers and billboards and radio
broadcasts. The Bank's loan officers, including corporate lending staff, as well
as branch presidents originate loans. Loan applications are accepted at each of
the Bank's offices and, depending on the loan type and amount, may be processed
and underwritten at the originating office or forwarded to the main office.
Upon receipt of a loan application from a prospective borrower, the Bank's
staff preliminarily reviews the information provided and makes an initial
determination regarding the qualification of the borrower. If not disapproved,
the application then is placed in processing, and a credit report and
verifications are ordered to verify specific information relating to the loan
applicant's employment, income and credit standing. It is the Bank's policy to
obtain an appraisal of the real estate intended to secure a proposed mortgage
loan from independent fee appraisers. It is the Bank's policy to obtain personal
guarantees from the principals on all loans. Except when the Bank becomes aware
of a particular risk of environmental contamination, the Bank generally does not
obtain a formal environmental report on the real estate at the time a loan is
made.
It is the Bank's policy to record a lien on the real estate securing the
loan and to obtain a title insurance policy that insures the property is free of
prior encumbrances. Borrowers must also obtain hazard insurance policies prior
to closing and, when the property is in a designated flood plain, paid flood
insurance policies.
The Board of Directors has the overall responsibility and authority for
general supervision of the Bank's loan policies. The Board has established
written lending policies for the Bank. The Bank's officers and loan committees
approve loans up to specified limits above which the approval of the Board is
required. Loan applicants are promptly notified of the decision of the Bank. It
has been management's experience that substantially all approved loans are
funded.
INTEREST RATES AND LOAN FEES. Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
primary market area and the Bank's minimum yield requirements. Mortgage loan
rates reflect factors such as prevailing market interest rate levels, the supply
of money available to the savings industry and the demand for such loans. These
factors are in turn affected by general economic conditions, the monetary
policies of the federal government, including the Federal Reserve Board, the
general supply of money in the economy, tax policies and governmental budget
matters.
The Bank receives fees in connection with loan commitments and
originations, loan modifications, late payments and changes of property
ownership and for miscellaneous services related to its loans. Loan origination
fees are calculated as a percentage of the loan principal. The excess, if any,
of loan origination fees over direct loan origination costs is deferred and
accreted into income over the contractual life of the loan using the level yield
method. If costs exceed fees, the excess is deferred and amortized to expense
over the loan's contractual life using the level yield method. If a loan is
prepaid, refinanced, or sold, all remaining deferred fees/costs with respect to
such loan are taken into income or recognized in expense at such time.
COLLECTION POLICIES. When a borrower fails to make a payment on a loan, the
Bank generally takes prompt steps to have the delinquency cured and the loan
restored to current status. Once the payment grace period has expired (in most
instances 15 days after the due date), a late notice is mailed to the borrower,
and a late charge is imposed, if applicable. If payment is not promptly
received, a second notice is sent 15 days after the expiration of the grace
period. If the loan becomes 30 days delinquent, the borrower is contacted, and
efforts are made to formulate an affirmative plan to cure the delinquency. If a
loan becomes 60 days delinquent, the loan is reviewed by the Bank's management,
and if payment is not made, management may pursue foreclosure, repossession, or
other appropriate action. If a loan remains delinquent 90 days or more, the Bank
generally initiates foreclosure proceedings.
ASSET CLASSIFICATION; ALLOWANCES FOR LOSSES AND NONPERFORMING ASSETS.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis. An asset is classified as substandard if it
is determined to be inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral
11
pledged, if any. An asset is classified as doubtful if full collection is highly
questionable or improbable. An asset is classified as loss if it is considered
uncollectible, even if a partial recovery could be expected in the future. The
regulations also provide for a special mention designation, described as assets
which do not currently expose an 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 an institution to establish general allowances
for loan losses. If an asset or portion thereof is classified loss, an
institution must either establish a specific allowance for loss in the amount of
the portion of the asset classified loss, or charge off such amount. Federal
examiners may disagree with an institution's classifications. If an institution
does not agree with an examiner's classification of an asset, it may appeal this
determination to the OTS Regional Director.
Management regularly reviews the Bank's assets to determine whether assets
require classification or re-classification, and the Board of Directors reviews
and approves all classifications. The Bank contracts with a third-party
professional to perform loan reviews generally on a semi-annual basis, including
classification of assets and an assessment of the adequacy of the loan loss
reserve. The most recent third party loan reviews were as of April 30, 2002, and
December 31, 2001. As of June 30, 2002, the Bank had $38,012 of assets
classified doubtful, $7,097,276 of assets classified substandard, and $4,563,625
of assets designated as special mention. The Bank's total adversely classified
assets represented approximately 2.6% of the Bank's total assets and 31.0% of
the Bank's tangible regulatory capital plus allowance for loan loss at June 30,
2002. At June 30, 2002, management did not expect the Bank to incur any loss in
excess of attributable existing allowances on any of the Bank's adversely
classified or designated assets.
Management also reviews the loss factors to determine whether they are
current and relevant. Differences between estimated and actual losses have been
insignificant for several years. However, if the losses experienced change
significantly, a determination is made as to which factors utilized should be
adjusted prospectively.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis. The
Company considers the characteristics of (1) one-to-four family residential
first mortgage loans; (2) automobile loans; and (3) consumer and home
improvement loans to permit consideration of the appropriateness of the
allowance for losses of each group of loans on a pool basis. The primary
methodology used to determine the appropriateness of the allowance for losses
includes segregating certain specific, poorly performing loans based on their
performance characteristics from the pools of loans as to type and then applying
a loss factor to the remaining pool balance based on several factors including
classification of the loans as to grade, past loss experience, inherent risks,
economic conditions in the primary market areas and other factors which usually
are beyond the control of the Company.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans and multi-family and commercial first
mortgage loans, but which differ in other characteristics to the extent that
valuation on a pool basis is not valid. After segregating specific, poorly
performing loans and applying the methodology as noted in the preceding
paragraph for such specific loans, the remaining loans are evaluated based on
payment experience, known difficulties in the borrower's business or geographic
area, loss experience, inherent risks and other factors usually beyond the
control of the Company. These loans are then graded and a factor, based on
experience, is applied to estimate the probable loss.
In extending credit, the Bank recognizes that losses will occur and that
the risk of loss will vary with, among other things, the type of credit being
extended, the creditworthiness of the obligor over the term of the obligation,
general economic conditions and, in the case of a collateralized obligation, the
quality of the security. It is management's policy to maintain adequate
allowances for losses based on management's assessment of the Bank's loan
portfolio. The Bank increases its allowance for losses by charging provisions
for losses against the Bank's income. Federal examiners may disagree with an
institution's allowance for losses and may require adjustment.
The Bank's methodology for establishing the allowance for losses takes into
consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a regular basis based on
an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio, delinquency trends,
12
current charge-off and loss experience, the state of the real estate market,
regulatory reviews conducted in the regulatory examination process and economic
conditions generally.
At the date of foreclosure or other repossession, the Bank records the
property at fair value less estimated costs to sell. Fair value is defined as
the amount in cash or cash-equivalent value of other consideration that a
property would yield in a current sale between a willing buyer and a willing
seller. Fair value is measured by market transactions. If a market does not
exist, fair value of the property is estimated based on selling prices of
similar properties in active markets or, if there are no active markets for
similar properties, by discounting a forecast of expected cash flows at a rate
commensurate with the risk involved. Fair value generally is determined through
an appraisal at the time of foreclosure. At June 30, 2002, the Bank held no
properties acquired in settlement of loans for which estimated market values
were unavailable. Any amount of cost in excess of fair value at foreclosure is
charged-off against the allowance for loan losses. Subsequent to acquisition,
the property is periodically evaluated by management and an allowance is
established if the estimated fair value of the property, less estimated costs to
sell, declines. If, upon ultimate disposition of the property, net sales
proceeds differ from the net carrying value of the property, a gain or loss on
sale of real estate is recorded.
The banking regulatory agencies, including the OTS, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for checking the reasonableness of an institution's allowance for loan
loss estimate compared to the average loss experience of the industry as a
whole.
Management actively monitors the Bank's asset quality and charges off loans
and properties acquired in settlement of loans against the allowances for losses
on such loans and such properties when appropriate and provides specific loss
allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
determinations as to the appropriateness of the allowance.
During the year ended June 30, 2002, in light of the Bank's loan portfolio
review and changes in the mix of loan types, the Bank made $330,000 in
provisions for loan losses bringing the total reserve for losses after net
charged-off loans to $1.6 million, or 1.22% of gross outstanding loans which
compares to 0.99% as of June 30, 2001. The provision was made in consideration
of reviews of individual loans and the fact that nonperforming loans as of June
30, 2002 as a percent of total loans increased to 1.44% from 0.81% as of June
30, 2001. In addition, total classified assets as a percent of the Bank's
tangible capital plus allowance for loan loss was 31.0% as of June 30, 2002,
which compares to 8.1% as of June 30, 2001. Part of this increase is due to an
increase in classified assets and part is due to the Bank paying Bancshares $9.0
million in dividends, thus reducing capital at the Bank. As of June 30, 2002,
the Bank had $7.1 million in assets classified substandard or doubtful as
compared to $2.5 million as of June 30, 2001.The following table sets forth an
analysis of the Bank's allowance for loan losses for the periods indicated.
13
Year Ended June 30,
--------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Balance at beginning of period ... $1,446,114 $1,231,709 $1,329,201 $1,468,546 $1,492,473
---------- ---------- ---------- ---------- ----------
Loans charged-off:
Real estate mortgage:
One-to-four family residential 2,407 19,982 4,960 26,883 5,466
Other mortgage loans ......... -- -- -- -- --
Commercial ....................... 77,500 25,811 50,047 37,742 --
Consumer ......................... 154,475 55,968 44,791 79,632 43,100
---------- ---------- ---------- ---------- ----------
Total charge-offs ................ 234,382 101,761 99,798 144,257 48,566
---------- ---------- ---------- ---------- ----------
Recoveries:
Real estate mortgage:
One-to-four family residential 6,407 1,617 -- 865 --
Other mortgage loans ......... -- -- -- -- --
Commercial ..................... 57,357 -- -- -- --
Consumer ....................... 23,019 18,549 2,306 4,047 639
---------- ---------- ---------- ---------- ----------
Total recoveries ................. 86,783 20,166 2,306 4,912 639
---------- ---------- ---------- ---------- ----------
Net loans charged-off ............ 147,599 81,595 97,492 139,345 47,927
---------- ---------- ---------- ---------- ----------
Provision for loan losses ........ 330,000 296,000 -- -- 24,000
---------- ---------- ---------- ---------- ----------
Balance at end of period ......... $1,628,515 $1,446,114 $1,231,709 $1,329,201 $1,468,546
========== ========== ========== ========== ==========
Ratio of net charge-offs to
average loans outstanding
during the period............... 0.11% 0.06% 0.08% 0.13% 0.05%
==== ==== ==== ==== ====
14
The following table allocates the allowance for loan losses by asset
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
At June 30,
----------------------------------------------------------------------
2002 2001 2000
---------------------- --------------------- ---------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
-------- ----------- ------- ----------- ------- -----------
Allocated to:
Real estate loans:
One-to-four family residential.... $ 321,538 36.4% $ 480,460 39.0% $ 440,709 42.3%
Multi-family, non-residential,
and land........................ 998,653 42.2 570,261 45.6 551,000 43.9
Consumer loans...................... 137,273 10.6 89,360 7.7 91,000 7.7
Commercial loans.................... 171,051 10.8 255,662 7.7 149,000 6.1
Unallocated......................... -- -- 50,371 -- -- --
----------- ----- ----------- ----- ----------- -----
Total........................ $ 1,628,515 100.0% $ 1,446,114 100.0% $ 1,231,709 100.0%
=========== ===== =========== ===== =========== =====
At June 30,
---------------------------------------------
1999 1998
--------------------- ---------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans Amount Total Loans
------- ----------- ------- -----------
Allocated to:
Real estate loans:
One-to-four family residential.... $ 422,000 43.7% $ 504,000 45.2%
Multi-family, non-residential,
and land........................ 603,000 44.6 557,000 44.0
Consumer loans...................... 101,000 7.3 123,000 8.3
Commercial loans.................... 82,000 4.4 72,000 2.5
Unallocated......................... 121,201 -- 212,546 --
----------- ----- ---------- -----
Total........................ $ 1,329,201 100.0% $1,468,546 100.0%
=========== ===== ========== =====
15
The Bank's increasing emphasis on the origination of commercial and
multi-family real estate loans and consumer and commercial business loans may
increase the Bank's risk of corresponding increases in loan loss provisions and
charge-offs. While management believes the Bank has established its existing
loss allowances in accordance with generally accepted accounting principles,
there can be no guarantee or assurance that such allowances are, or in the
future will be, adequate to absorb all loan losses or that regulators, in
reviewing the Bank's assets, will not require the Bank to increase its loss
allowance, thereby negatively affecting the Bank's reported financial condition
and results of operations.
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. For information regarding the
Bank's interest accrual practices, see the Notes to Consolidated Financial
Statements set forth in Item 8 herein.
At June 30
------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- -------- -------- --------
Loans accounted for on a nonaccrual basis:(1)
Real estate:
One-to-four family residential........... $1,176,095 $ 838,271 $655,988 $462,205 $648,012
Other mortgage loans..................... 3,838 -- -- 22,139 --
Consumer loans............................. 188,824 137,987 102,003 81,648 138,747
Commercial loans........................... 152,699 -- -- -- --
---------- ---------- -------- -------- --------
Total.................................... $1,521,456 $ 976,258 $757,991 $565,992 $786,759
========== ========== ======== ======== ========
Accruing loans which are contractually past
due 90 days or more:
Real estate:
One-to-four family residential........... $ 109,209 $ 38,816 $140,000 $ -- $ 41,770
Other mortgage loans..................... 251,333 -- -- -- --
Commercial loans........................... -- 161,926 -- -- --
Consumer loans............................. 35,953 13,400 21,524 -- --
---------- ---------- -------- -------- --------
Total.................................... $ 396,495 $ 214,142 $161,524 $ -- $ 41,770
========== ========== ======== ======== ========
Total nonperforming loans................ $1,917,951 $1,190,400 $919,515 $565,992 $828,529
========== ========== ======== ======== ========
Percentage of total loans.................... 1.44% 0.81% 0.64% 0.46% 0.75%
==== ==== ==== ==== ====
Other nonperforming assets (2)............... $ 623,114 $ 175,783 $ 52,919 $ 20,289 $ 17,001
========== ========== ======== ======== ========
Loans modified in troubled debt
restructurings............................. $4,678,247 $ -- $ -- $ -- $392,000
========== ========== ======== ======== ========
_____________
(1) Designated nonaccrual loan payments received are applied first to
contractual principal and interest income is recognized only when
contractually current.
(2) Other nonperforming assets includes foreclosed real estate.
During the years ended June 30, 2002 and 2001, gross interest income of
$127,763 and $80,541, respectively, would have been recorded on loans accounted
for on a nonaccrual basis if the loans had been current throughout the
respective periods. Interest on such loans included in income during such
respective periods amounted to $64,679 and $33,365, respectively.
At June 30, 2002, management had identified approximately $3.5 million of
loans which amount is not reflected in the preceding table but as to where known
information about possible credit problems of borrowers caused management to
have serious doubts as to the ability of such borrowers to comply with the
present loan repayment terms and which may result in future disclosure of such
loans in the table above. All of these loans were included in the Bank's
adversely classified asset amounts as of June 30, 2002. Of this aggregate
amount, approximately $429,000 was attributable to 15 one-to-four family
residential loans, $1,198,000 was attributable to 13 commercial loans,
$1,698,000 was attributable to 7 other mortgage loans, and $139,000 was
attributable to 14
16
consumer loans. At June 30, 2002, management did not expect the Bank to incur
any loss in excess of attributable existing allowances on any of the Bank's
assets.
INVESTMENT ACTIVITIES
GENERAL. The Bank is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, savings deposits at the FHLB of
Dallas, certificates of deposit in federally insured institutions, certain
bankers' acceptances and federal funds. It may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest
investment-rating categories of a nationally recognized credit rating agency,
and certain other types of corporate debt securities and mutual funds. Federal
regulations require the Bank to maintain an investment in FHLB stock and to
maintain a sufficient level of liquidity. The Bank has chosen to fulfill a
portion of this requirement by investing in securities which provide liquidity.
The Bank makes investments in order to maintain a sufficient level of
liquid assets as required by regulatory authorities and manage cash flow,
diversify its assets, obtain yield and, under prior federal income tax law,
satisfy certain requirements for favorable tax treatment. The investment
activities of the Bank consist primarily of investments in mortgage-backed
securities and other investment securities, consisting primarily of securities
issued or guaranteed by the U.S. government or agencies thereof and state and
municipal securities. Typical investments include federally sponsored agency
mortgage pass-through and federally sponsored agency and mortgage-related
securities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Bank's investment
policy. The Bank performs analyses on securities prior to purchase and on an
ongoing basis to determine the impact on earnings and market value under various
interest rate and prepayment conditions. Securities purchases are approved by
the Bank's Investment Committee, and the Board of Directors reviews all
securities transactions on a monthly basis.
Securities designated as "held to maturity" are those assets which the Bank
has the ability and intent to hold to maturity. The "held to maturity"
investment portfolio is carried at amortized cost. Securities designated as
"available for sale" are those assets which the Bank might not hold to maturity
and thus are carried at market value with unrealized gains or losses, net of tax
effect, recognized in stockholders' equity.
Mortgage-backed securities typically represent an interest in a pool of
fixed-rate or adjustable-rate mortgage loans, the principal and interest
payments on which are passed from the mortgage borrowers to investors such as
the Bank. Mortgage-backed security sponsors may be private companies or
quasi-governmental agencies such as FHLMC, FNMA and GNMA, which guarantee the
payment of principal and interest to investors. Mortgage-backed securities can
represent a proportionate participation interest in a pool of loans or,
alternatively, an obligation to repay a specified amount collateralized by a
pool of loans (commonly referred to as a "collateralized mortgage obligation,"
or "CMO"). Mortgage-backed securities generally increase the quality of the
Bank's assets by virtue of the credit enhancements that back them. They are more
liquid than individual mortgage loans and may be used to collateralize
borrowings or other obligations of the Bank. The Bank's mortgage-backed
securities portfolio primarily consists of seasoned securities either issued by
one of the quasi-governmental agencies or rated in one of the top two categories
by a recognized rating organization.
All of the Bank's privately issued securities were rated "AA" or higher by
a nationally recognized credit rating agency at the time of purchase. Management
regularly monitors the ratings of the Bank's privately issued holdings by
reference to nationally published rating media and by communication with the
issuer when necessary. At June 30, 2002, no privately issued securities were
rated below AA except as follows:
17
A Citicorp Mortgage, Inc. REMIC Pass-Through Class A Certificate was
rated "CAA1" by Moody. The grade reflects deterioration in the performance
of the mortgage pools underlying the security. At June 30, 2002, the Bank
estimated the value of the security at approximately $29,000 less than its
face value. The Bank's carrying value for this security at that date was
approximately $145,000 after recognition of impairment loss.
A DLJ Mortgage Acceptance Corp. Pass-Through Class A-3 Certificate
was rated "CAA2" by Moody. The grade reflects deterioration in the
performance of the mortgage pools underlying the security. As of June 30,
2002, the deterioration affected the credit support and not the principal
or interest of the security itself. At June 30, 2002, the Bank estimated
the value of the security at approximately $54,000 less than its face
value. The Bank's carrying value for this security at that date was
approximately $166,000 after recognition of impairment loss.
The Bank's privately issued securities consist of collateralized mortgage
obligations (CMOs) and mortgage pass-through securities. At June 30, 2002, all
of the privately issued securities had adjustable interest rates with a weighted
average yield of 5.70% and a weighted contractual average term to maturity of
17.8 years. The carrying value of the privately issued securities was
approximately $1,700,000 or 1.9% of the mortgage-backed securities and CMOs at
that date. None of the privately issued securities are insured or guaranteed by
FHLMC or FNMA.
The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the
mortgage-backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest rates, prepayments generally decrease. If the coupon
rate of the underlying mortgage significantly exceeds the prevailing market
interest rates offered for mortgage loans, refinancing generally increases and
accelerates the prepayment of the underlying mortgages. Prepayment experience is
more difficult to estimate for adjustable-rate mortgage-backed securities.
The following table sets forth information regarding carrying values of the
Company's investment securities at the dates indicated. All securities are held
as available for sale.
At June 30,
------------------------------------------------
2002 2001 2000
------------ ------------ ------------
Securities available for sale:
U.S. government and agencies............................... $ 1,530,945 $ 1,900,448 $ 5,880,903
Municipal securities....................................... 25,689,191 30,197,186 28,201,198
Other securities........................................... 1,995,000 -- --
Collateralized mortgage obligations........................ 11,310,152 12,159,483 11,805,058
Other mortgage-backed securities........................... 77,603,036 75,784,260 86,602,281
Equity securities.......................................... 70,240 40,800 53,625
------------ ------------ ------------
$118,198,564 $120,082,177 $132,543,065
============ ============ ============
The following table sets forth information regarding scheduled maturities
of the Company's investment portfolio at June 30, 2002. Yields on municipal
securities are not tax-effected.
One Year or Less One to Five Years Five to Ten Years
---------------------- --------------------- ---------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- ------- -------- ------- -------- -------
U.S. government and agencies $1,530,945 6.30% $ -- -- % $ -- -- %
Municipal securities -- -- -- -- -- --
Other securities -- -- -- -- -- --
Collateralized mortgage
obligations -- -- -- -- 525,260 7.22
Other mortgage-backed securities 5,903 9.50 3,573,506 6.58 8,833,926 5.60
---------- ---- ---------- ---- ---------- ----
Total $1,536,848 6.31% $3,573,506 6.58% $9,359,186 5.69%
========== ==== ========== ==== ========== ====
Equity securities
More than Ten Years Total Investment Portfolio
-------------------- --------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- -------- ------ -------
U.S. government and agencies $ -- -- % $ 1,530,945 $ 1,530,945 6.30%
Municipal securities 25,689,191 5.01 25,689,191 25,689,191 5.01
Other securities 1,995,000 2.92 1,995,000 1,995,000 2.92
Collateralized mortgage
obligations 10,784,892 6.00 11,310,152 11,310,152 6.06
Other mortgage-backed securities 65,189,701 6.07 77,603,036 77,603,036 6.04
------------ ---- ------------ ------------ ----
Total $103,658,784 5.74% $118,128,324 $118,128,324 5.77%
============ ==== ====
Equity securities 70,240 70,240
------------ ------------
$118,198,564 $118,198,564
============ ============
19
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for lending,
investment activities and general operational purposes. While the Bank, like
most independent savings institutions, historically has relied on certificates
of deposit for a substantial portion of its deposit base, management has
recently shifted the Bank's deposit gathering emphasis away from certificates of
deposit and toward transaction accounts with more favorable interest costs,
interest rate risk characteristics and opportunities for the Bank to perform
valued customer services that generate additional fee income, and it is expected
that management will continue this trend in the future. In addition to deposits,
the Bank derives funds from loan principal and interest repayments, maturities
of investment securities and interest payments thereon. Although loan repayments
are a relatively stable source of funds, deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used to compensate for reductions in the availability of
funds, or for general operational purposes. The Bank has access to advances from
the FHLB of Dallas.
DEPOSITS. The Bank attracts deposits principally from within its primary
market area by offering competitive rates on its deposit instruments, including
NOW accounts, money market accounts, statement savings accounts, Individual
Retirement Accounts and certificates of deposit which range in maturity from 90
days to three years. Deposit terms vary according to the minimum balance
required, the length of time the funds must remain on deposit and the interest
rate. The Bank on a periodic basis establishes maturities, terms, service fees
and withdrawal penalties for its deposit accounts. In determining the
characteristics of its deposit accounts, the Bank considers the rates offered by
competing institutions, lending and liquidity requirements, growth goals and
federal regulations. The Bank does not typically accept brokered deposits or pay
negotiated rates for jumbo certificates of deposits.
The Bank attempts to compete for deposits with other institutions in its
market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the Bank's
depositors are Arkansas residents who reside in the Bank's primary market area.
The following table sets forth information regarding interest-bearing
average deposit balances and rates during the periods presented.
Year Ended June 30,
-------------------------------------------------------------------------
2002 2001 2000
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------- ------- ------- -------- -------- --------
NOW accounts.......................... $ 30,164,006 1.87% $ 25,799,621 4.34% $ 8,824,013 2.77%
Money market savings deposits......... 6,191,033 1.90 6,967,070 3.72 16,093,630 3.84
Savings deposits - statement.......... 7,211,717 1.54 6,774,023 2.43 7,955,898 2.58
Certificates of deposit............... 112,568,794 4.36 106,806,416 5.76 104,443,704 5.21
------------- ---- ------------- ---- ------------- ----
Total............................. $ 156,135,550 3.65% $ 146,347,130 5.26% $ 137,317,245 4.74%
============= ==== ============= ==== ============= ====
20
The following table sets forth information regarding changes in dollar
amounts of deposits in various types of accounts offered by the Bank between the
dates indicated.
Balance at Balance at
June 30, % of Increase June 30, % of Increase
2002 Deposits (Decrease) 2001 Deposits (Decrease)
---------- -------- ---------- ---------- -------- ----------
Noninterest bearing deposits............ $ 8,889,867 5.39% $1,509,975 $ 7,379,892 4.58% $ 1,729,137
NOW accounts............................ 30,202,544 18.30 (472,884) 30,675,428 19.02 12,772,717
Money market savings deposits........... 5,911,715 3.58 177,850 5,733,865 3.56 (3,626,326)
Savings deposits - statement............ 8,010,973 4.85 1,107,937 6,903,036 4.28 (627,396)
Certificates of deposit................ 111,990,085 67.88 1,397,127 110,592,956 8.56 6,163,976
------------ ------ ---------- ------------ ------ -----------
$165,005,183 100.00% $3,720,004 $161,285,179 100.00% $16,412,108
============ ====== ========== ============ ====== ===========
Balance at
June 30, % of
2000 Deposits
---------- --------
Noninterest bearing deposits............ $ 5,650,755 3.90%
NOW accounts............................ 17,902,711 12.36
Money market savings deposits........... 9,360,191 6.46
Savings deposits - statement............ 7,530,432 5.20
Certificates of deposit................ 104,428,982 72.08
------------ ------
$144,873,071 100.00%
============ ======
21
The following table sets forth information regarding certificates of
deposits classified by rates at the dates indicated.
At June 30,
------------------------------------------------
2002 2001 2000
------------- ------------- ------------
1.50 - 3.24%...................... $ 58,571,151 $ -- $ --
3.25 - 5.99%...................... 44,465,650 77,451,889 68,258,761
6.00 - 7.99%...................... 8,953,284 33,141,069 36,170,221
------------- ------------- ------------
$ 111,990,085 $ 110,592,958 $104,428,982
============= ============= ============
The following table sets forth information regarding amounts and maturities
of certificates of deposits at June 30, 2002.
Balance Maturing 12-Months Ending June 30,
------------------------------------------------------------------------------
Rate 2003 2004 2005 Thereafter Total
---- ---- ---- ---- ---------- -----
1.50 - 3.24%................. $ 51,240,236 $ 7,312,659 $ 18,256 $ -- $ 58,571,151
3.25 - 5.99%................. 29,329,797 9,997,826 5,054,413 83,614 44,465,650
6.00 - 7.99%................. 6,249,878 2,683,406 20,000 -- 8,953,284
------------ ----------- ---------- -------- ------------
$ 86,819,911 $19,993,891 $5,092,669 $ 83,614 $111,990,085
============ =========== ========== ======== ============
The following table sets forth information regarding amounts of
certificates of deposit of $100,000 or more by time remaining until maturity at
June 30, 2002.
Certificates
Maturity Period of Deposit
--------------- -------------
Three months or less....................... $ 4,114,418
Over three through six months.............. 5,794,392
Over six through 12 months................. 6,267,803
Over 12 months............................. 3,172,581
------------
Total.................................. $ 19,349,194
============
The following table sets forth information regarding deposit activities of
the Bank for the periods indicated.
Year Ended June 30,
----------------------------------------------
2002 2001 2000
------------ ------------ ------------
Net increase (decrease) before
interest credited........................................ $ (831,186) $ 8,676,800 $ (8,032,919)
Interest credited........................................... 4,551,190 7,735,308 6,609,392
------------ ------------ ------------
Net increase (decrease) in
deposits............................................... $ 3,720,004 $ 16,412,108 $ (1,423,527)
============ ============ ============
BORROWINGS. Deposits historically have been the primary source of funds for
the Bank's lending, investments and general operating activities. The Bank is
authorized, however, to use advances from the FHLB of Dallas to supplement its
supply of lendable funds and to meet deposit withdrawal requirements. The FHLB
of Dallas functions as a central reserve bank providing credit for savings
institutions and certain other member financial institutions. As a member of the
FHLB System, the Bank is required to own stock in the FHLB of Dallas and is
authorized to apply for advances. Advances are pursuant to several different
programs, each with its own interest rate and range of maturities. Advances from
the FHLB of Dallas are collateralized by the Bank's stock in the FHLB of Dallas,
qualifying first mortgage loans and mortgage-backed investment securities.
22
The following table sets forth certain information regarding borrowings by
the Bank for the periods indicated. Averages are based on monthly balances. See
the Notes to Consolidated Financial Statements set forth in item 8 herein.
Year Ended June 30,
-----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Amounts outstanding at end of period:
FHLB advances............................................... $ 82,263,936 $ 91,915,694 $ 115,609,029
Weighted average rate....................................... 5.93% 5.88% 6.07%
Maximum amount of borrowings outstanding
at any month end:
FHLB advances............................................... $ 91,831,310 $ 114,694,903 $ 117,040,406
Approximate average borrowings during the year
outstanding with respect to:
FHLB advances............................................... $ 86,442,890 $ 105,619,861 $ 112,554,831
Weighted average rate....................................... 5.92% 6.03% 5.85%
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, the Bank is permitted to invest an
amount equal to 2% of its assets in non-savings institution service corporation
subsidiaries, with an additional investment of 1% of assets where such
investment serves primarily community, inner-city and community development
purposes. Under such limitations, as of June 30, 2002, on a consolidated basis
the Bank was authorized to invest up to approximately $5.5 million in the stock
of or loans to such subsidiaries, including the additional 1% investment for
community inner-city and community development purposes. The Bank has one
subsidiary service corporation, HCB Properties, Inc., which was formed in August
1996 to hold certain properties acquired by the Bank for possible future
expansion, because the properties are larger than the Bank's anticipated
expansion needs, and it is expected that portions of the properties eventually
will be sold. At June 30, 2002, the Bank's aggregate investment in, and loans
to, the subsidiary service corporation totaled $575,929. Subsequent to June 30,
2002, on July 19, 2002, the bank sold its Monticello branch and excess land held
for sale, which was held in HCB Properties, Inc., to SFB, which reduced the
bank's aggregate investment in, and loans to HCB Properties, Inc. to $261,740.
REGULATION OF THE BANK
GENERAL. As a federally chartered savings institution the Bank is subject
to extensive regulation by the OTS and the FDIC and to OTS regulations governing
such matters as capital standards, mergers, establishment of branch offices,
subsidiary investments and activities and general investment authority. The OTS
periodically examines the Bank for compliance with various regulatory
requirements. The FDIC also has the authority to conduct special examinations of
the Bank because its savings deposits are insured by the SAIF. The Bank must
file reports with the OTS describing its activities and financial condition and
also is subject to certain reserve requirements promulgated by the Federal
Reserve Board. This supervision and regulation is intended primarily for the
protection of depositors.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System,
which consists of 12 district FHLB's subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The FHLB's provide a central credit
facility primarily for member institutions. As a member of the FHLB of Dallas,
the Bank is required to acquire and hold shares of capital stock in the FHLB of
Dallas in an amount at least equal to 1% of the aggregate unpaid principal of
its home mortgage loans, home purchase contracts and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB of
Dallas, whichever is greater.
The FHLB of Dallas serves as a reserve or central bank for its member
institutions within its assigned district. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System.
23
It makes advances to members in accordance with policies and procedures
established by the FHLB and the Board of Directors of the FHLB of Dallas.
Long-term advances may only be made for the purpose of providing funds for
residential housing finance and small businesses, small farms and small
agri-businesses. At June 30, 2002, the Bank had $82.2 million in advances
outstanding with the FHLB of Dallas. See " -- Deposit Activity and Other Sources
of Funds -- Borrowings."
QUALIFIED THRIFT LENDER TEST. The Bank is subject to OTS regulations that
use the concept of a Qualified Thrift Lender to determine eligibility for
Federal Home Loan Bank advances and for certain other purposes. To qualify as a
Qualified Thrift Lender, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined to include total assets less intangibles, value of
property used by a savings institution in its business and liquidity investments
in an amount not exceeding 20% of assets. Qualified Thrift Investments consist
of (i) loans, equity positions or securities related to domestic, residential
real estate or manufactured housing, and educational, small business and credit
card loans, (ii) 50% of the dollar amount of residential mortgage loans subject
to sale under certain conditions, and (iii) stock issued by a Federal Home Loan
Bank. Subject to a 20% of portfolio assets limit, savings institutions are able
to treat as Qualified Thrift Investments 200% of their investments in loans to
finance "starter homes" and loans for construction, development or improvement
of housing and community service facilities or for financing small businesses in
"credit-needy" areas. To be qualified as a Qualified Thrift Lender, a savings
institution must maintain its status as a Qualified Thrift Lender for nine out
of every 12 months. Failure to qualify as a Qualified Thrift Lender results in a
number of sanctions, including the imposition of certain operating restrictions
imposed on national banks. Upon failure to qualify as a Qualified Thrift Lender
for two years, a savings institution must convert to a commercial bank.
A savings institution that does not meet the Qualified Thrift Lender test
must either convert to a bank charter or comply with the following restrictions
on its operations: (i) the institution may not engage in any new activity or
make any new investment, directly or indirectly, unless such activity or
investment is permissible for a national bank; (ii) the branching powers of the
institution shall be restricted to those of a national bank; and (iii) payment
of dividends by the institution shall be subject to the rules regarding payment
of dividends by a national bank. Upon the expiration of three years from the
date the institution ceases to be a Qualified Thrift Lender, it must cease any
activity, and not retain any investment not permissible for a national bank and
savings association.
REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of tangible
assets, "core" capital equal to at least 4.0% (or 3.0% if the institution is
rated CAMELS 1 under the OTS examination rating system) of adjusted total assets
and "total" capital (a combination of core and "supplementary" capital) equal to
at least 8.0% of "risk-weighted" assets. In addition, the OTS regulations impose
certain restrictions on institutions that have a total risk-based capital ratio
that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of
less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (or 3.0% if the institution is rated CAMELS 1 under the OTS
examination rating system). For purposes of these regulations, Tier 1 capital
has the same definition as core capital. See " -- Prompt Corrective Regulatory
Action." Core capital is defined as common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock and related surplus,
minority interests in the equity accounts of fully consolidated subsidiaries,
certain nonwithdrawable accounts and pledged savings deposits and "qualifying
supervisory goodwill." Core capital is generally reduced by the amount of an
institution's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital, but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
institution's intangible assets with only a limited exception for purchased
mortgage servicing rights.
Both core and tangible capital are further reduced by an amount equal to a
savings institution's debt and equity investments in subsidiaries engaged in
activities not permissible to national banks (other than subsidiaries engaged in
activities undertaken as agent for customers or in mortgage banking activities
and depository institutions or their holding companies). As of June 30, 2002,
the Bank had $575,929 investments in, or extensions of credit to, non-includable
subsidiaries.
24
Adjusted total assets are a savings institution's total assets as
determined under accounting principles generally accepted in the United States
of America, increased by certain goodwill amounts and by a pro rated portion of
the assets of unconsolidated includable subsidiaries in which the institution
holds a minority interest. Adjusted total assets are reduced by the amount of
assets that have been deducted from capital, the savings institution's
investments in unconsolidated includable subsidiaries, and, for purposes of the
core capital requirement, qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
institution's core capital. Supplementary capital is defined to include certain
preferred stock issues, nonwithdrawable accounts and pledged savings deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments, a portion of the institution's general loan loss
allowances and up to 45% of unrealized gains on equity securities. Total core
and supplementary capital are reduced by the amount of capital instruments held
by other depository institutions pursuant to reciprocal arrangements and equity
investments other than those deducted from core and tangible capital. At June
30, 2002, the Bank has $575,929 in equity investments for which OTS regulations
require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted
assets, which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one-to-four family first mortgages not more
than 90 days past due with loan-to-value ratios under 80% and average annual
occupancy rates of at least 80% and certain qualifying loans for the
construction of one-to-four family residences pre-sold to home purchasers are
assigned a risk weight of 50%. Consumer and residential construction loans are
assigned a risk weight of 100%. Mortgage-backed securities issued or fully
guaranteed as to principal and interest, by the FNMA or FHLMC are assigned a 20%
risk weight. Cash and U.S. Government securities backed by the full faith and
credit of the U.S. Government (such as mortgage-backed securities issued by
GNMA) are given a 0% risk weight.
The table below presents the capital position of the Bank relative to its
various regulatory capital requirements at June 30, 2002.
Percent of
Amount Assets(1)
------ ----------
(Dollars in thousands)
Tangible capital............................... $ 21,396 7.88%
Tangible capital requirement................... 4,073 1.50
--------- -----
Excess...................................... $ 17,323 6.38%
========= =====
Core capital................................... $ 21,396 7.88%
Core capital requirement....................... 10,861 4.00
--------- -----
Excess...................................... $ 10,535 3.88%
========= =====
Total capital.................................. $ 23,025 17.06%
Risk-based capital requirement................. 10,798 8.00
--------- -----
Excess..................................... $ 12,227 9.06%
========= =====
_________
(1) Based on adjusted total assets for purposes of the tangible capital and
core capital requirements and risk-weighted assets for purpose of the
risk-based capital requirement.
In addition to requiring generally applicable capital standards for savings
institutions, the Director of the OTS is authorized to establish the minimum
level of capital for a savings institution at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such institution in light of the particular circumstances of the institution.
Such circumstances would include a high degree of exposure of interest rate
risk, prepayment risk, credit risk and concentration of credit risk and certain
risks arising from non-traditional activities. The Director may treat the
failure of any savings institution to maintain capital at or above such level as
25
an unsafe or unsound practice and may issue a directive requiring any savings
institution which fails to maintain capital at or above the minimum level
required by the Director to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.
DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percentage of its insured savings deposits to the FDIC for insurance of its
savings deposits by the SAIF. Under the Federal Deposit Insurance Act, the FDIC
is required to set semi-annual assessments for SAIF-insured institutions at a
level necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured savings deposits or at a higher percentage of estimated
insured savings deposits that the FDIC determines to be justified for that year
by circumstances indicating a significant risk of substantial future losses to
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
The SAIF deposit insurance assessment rates set by the FDIC range from zero
for "well capitalized" institutions with the highest supervisory ratings to
0.27% of insured savings deposits for institutions in the highest risk-based
premium category. In addition, FDIC-insured institutions are required to pay
assessments to the FDIC to help fund interest payments on certain bonds issued
by the Financing Corporation ("FICO"), an agency of the federal government
established to finance takeovers of insolvent thrifts. Until December 31, 1999,
SAIF-insured institutions were required to pay FICO assessments at five times
the rate at which Bank Insurance Fund ("BIF") members were assessed. Since
December 31, 1999, both BIF and SAIF members have been assessed at the same rate
for FICO payments.
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries. Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level. The regulation further provides that in
considering applications that must be submitted to it by savings institutions,
the FDIC will take into account whether the institution is meeting with the Tier
1 capital requirement for state non-member banks of 4% of total assets for all
but the most highly rated state non-member banks.
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves equal to 3% on transaction accounts of up to $41.3 million plus 10% on
the remainder. This percentage is subject to adjustment by the Federal Reserve
Board. Because required reserves must be maintained in the form of vault cash or
in a noninterest-bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's
interest-earning assets.
26
DIVIDEND RESTRICTIONS. Under OTS regulations, the Bank is not permitted to
pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of the Conversion.
In addition, the Bank is required by OTS regulations to give the OTS 30 days'
prior notice of any proposed declaration of dividends.
OTS regulations require that savings institutions submit notice to the OTS
prior to making a capital distribution if (a) they would not be well-capitalized
after the distribution, (b) the distribution would result in the retirement of
any of the institution's common or preferred stock or debt counted as its
regulatory capital, or (c) the institution is a subsidiary of a holding company.
A savings institution must make application to the OTS to pay a capital
distribution if (x) the institution would not be adequately capitalized
following the distribution, (y) the institution's total distributions for the
calendar year exceeds the institution's net income for the calendar year to date
plus its net income (less distributions) for the preceding two years, or (z) the
distribution would otherwise violate applicable law or regulation or an
agreement with or condition imposed by the OTS. If neither the savings
institution nor the proposed capital distribution meet any of the foregoing
criteria, then no notice or application is required to be filed with the OTS
before making a capital distribution. The OTS may disapprove or deny a capital
distribution if in the view of the OTS, the capital distribution would
constitute an unsafe or unsound practice.
Under the OTS prompt corrective action regulations, the Bank would be
prohibited from making any capital distributions if, after making the
distribution, it would have: (i) a total risk-based capital ratio of less than
8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a Tier
1 (core) capital ratio of less than 4.0%. See " -- Prompt Corrective Regulatory
Action." The OTS, after consultation with the FDIC, however, may permit an
otherwise prohibited stock repurchase if made in connection with the issuance of
additional shares in an equivalent amount and the repurchase will reduce the
institution's financial obligations or otherwise improve the institution's
financial condition.
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to Bancshares without payment
of taxes at the then current tax rate on the amount of earnings removed from the
reserves for such distributions. See "Federal Income Taxation." Bancshares
intends to make full use of this favorable tax treatment afforded to the Bank,
and does not contemplate use of any post-Conversion earnings of the Bank in a
manner which would limit the Bank's bad debt deduction or create federal tax
liabilities.
TRANSACTIONS WITH RELATED PARTIES. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
institution. In a holding company context, the parent holding company of an
institution (such as Bancshares) 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 to an
amount equal to 20% of such 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 similar other types of transactions. In addition to the
restrictions imposed by Sections 23A and 23B, no savings institution may (i)
loan or otherwise extend credit to an affiliate, except for any affiliate which
engages only in activities which are permissible for bank holding companies, or
(ii) 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. Section 106 of the Bank Holding Company Act which
applies to the Bank, prohibits the Bank from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS.
Depository institutions like the Bank are also subject to the restrictions
contained in Section 22(h) and Section 22(g) of the Federal Reserve Act on loans
to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, executive officer
27
and to a greater than 10% stockholder of a depository institution and certain
affiliated interests of such persons, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the institution's
loans-to-one-borrower limit (generally equal to 15% of the institution's
unimpaired capital and surplus plus an additional 10% of such capital and
surplus for loans fully collateralized by certain readily marketable capital).
Section 22(h) also prohibits the making of loans above amounts prescribed by the
appropriate federal banking agency, to directors, executive officers and greater
than 10% stockholders of an institution, and their respective affiliates, unless
such loan is approved in advance by a majority of the board of directors of the
institution with any "interested" director not participating in the voting. The
Federal Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person) as to which such prior board of director
approval is required as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, Section 22(h) requires that loans to
directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons.
Section 22(h) also generally prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors.
Section 22(g) of the Federal Reserve Act requires that loans to executive
officers of depository institutions not be made on terms more favorable than
those afforded to other borrowers, requires approval for such extensions of
credit by the board of directors of a the institution, and imposes reporting
requirements for and additional restrictions on the type, amount and terms of
credits to such officers. In addition, Section 106 of the Bank Holding Company
Act prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable features.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an institution fails to satisfy
certain minimum capital requirements. All institutions, regardless of their
capital levels, are restricted from making any capital distribution or paying
any management fees that would cause the institution to become undercapitalized.
An institution that fails to meet the minimum level for any relevant capital
measure (an "undercapitalized institution") generally is: (i) subject to
increased monitoring by the appropriate federal banking regulator; (ii) required
to submit an acceptable capital restoration plan within 45 days; (iii) subject
to asset growth limits; and (iv) required to obtain prior regulatory approval
for acquisitions, branching and new lines of businesses. The capital restoration
plan must include a guarantee by the institution's holding company that the
institution will comply with the plan until it has been adequately capitalized
on average for four consecutive quarters, under which the holding company would
be liable up to the lesser of 5% of the institution's total assets or the amount
necessary to bring the institution into capital compliance as of the date it
failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
does not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on savings
deposits, asset growth and other activities, possible replacement of directors
and officers, and restrictions on capital distributions by any bank holding
company controlling the institution. Any company controlling the institution may
also be required to divest the institution or the institution could be required
to divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total assets
falls below the "critical capital level," the institution will be subject to
conservatorship or receivership within specified time periods.
Under the regulations jointly adopted by the federal banking regulators, a
savings institution's capital adequacy for purposes of the FDICIA prompt
corrective action rules is determined on the basis of the institution's total
risk-based capital ratio (the ratio of its total capital to risk-weighted
assets), Tier 1 risk-based capital ratio (the ratio of its core capital to
risk-weighted assets) and leverage ratio (the ratio of its Tier 1 or core
capital to adjusted total assets).
28
The following table shows the capital ratio requirements for each prompt
corrective action category:
Adequately Significantly
Well Capitalized Capitalized Undercapitalized Undercapitalized
---------------- ----------- ---------------- ----------------
Total risk-based
capital ratio 10.0% or more 8.0% or more Less than 8.0% Less than 6.0%
Tier 1 risk-based
capital ratio 6.0% or more 4.0% or more Less than 4.0% Less than 3.0%
Leverage ratio 5.0% or more 4.0% or more* Less than 4.0%* Less than 3.0%
________________
* 3.0% if the institution has a composite 1 CAMELS rating.
A "critically undercapitalized" savings institution is defined as an
institution that has a ratio of "tangible equity" to total assets of less than
2.0%. Tangible equity is defined as core capital plus cumulative perpetual
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory goodwill and certain purchased mortgage servicing rights. The OTS
may reclassify a well capitalized savings institution as adequately capitalized
and may require an adequately capitalized or undercapitalized institution to
comply with the supervisory actions applicable to institutions in the next lower
capital category (but may not reclassify a significantly undercapitalized
institution as critically-undercapitalized) if the OTS determines, after notice
and an opportunity for a hearing, that the savings institution is in an unsafe
or unsound condition or that the institution has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category. For information
regarding the position of the Bank with respect to the FDICIA prompt corrective
action rules, see Note 16 of Notes to Consolidated Financial Statements included
under Item 8 hereof.
SAFETY AND SOUNDNESS GUIDELINES. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the federal
banking agencies, including the OTS and Federal Reserve Board, released
Interagency Guidelines Establishing Standards for Safety and Soundness and
published a final rule establishing deadlines for submission and review of
safety and soundness compliance plans. The final rule and the guidelines went
into effect on August 9, 1995. The guidelines require depository institutions to
maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institution's
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk exposure, and asset
growth. The guidelines further provide that depository institutions should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as comparable compensation practices at
comparable institutions. If the appropriate federal banking agency determines
that a depository institution is not in compliance with the safety and soundness
guidelines, it may require the institution to submit an acceptable plan to
achieve compliance with the guidelines. A depository institution must submit an
acceptable compliance plan to its primary federal regulator within 30 days of
receipt of a request for such a plan. Failure to submit or implement a
compliance plan may subject the institution to regulatory sanctions. Management
believes that the Bank already meets substantially all the standards adopted in
the interagency guidelines, and therefore does not believe that implementation
of these regulatory standards will materially affect the Bank's operations.
Additionally, the federal banking agencies, including the OTS and Federal
Reserve Board, have issued guidelines relating to asset quality and earnings.
Under the guidelines, an FDIC insured depository institution should maintain
systems, commensurate with its size and the nature and scope of its operations,
to identify problem assets and prevent deterioration in those assets as well as
to evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves. Management believes that the asset
quality and earnings standards will not have a material effect on the Bank's
operations.
29
FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, legislation was
enacted which could have a far-reaching impact on the financial services
industry. The Gramm-Leach-Bliley ("G-L-B") Act authorizes affiliations between
banking, securities and insurance firms and authorizes bank holding companies
and national banks to engage in a variety of new financial activities. Among the
new activities that will be permitted to bank holding companies are securities
and insurance brokerage, securities underwriting, insurance underwriting and
merchant banking. The Federal Reserve Board, in consultation with the Secretary
of the Treasury, may approve additional financial activities. The G-L-B Act,
however, prohibits future acquisitions of existing unitary savings and loan
holding companies, like the Company, by firms which are engaged in commercial
activities and limits the permissible activities of unitary holding companies
formed after May 4, 1999.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions became
effective in July 2001.
The G-L-B Act contains significant revisions to the FHLB System. The G-L-B
Act imposes new capital requirements on the FHLBs and authorizes them to issue
two classes of stock with differing dividend rates and redemption requirements.
The G-L-B Act deletes the current requirement that the FHLBs annually contribute
$300 million to pay interest on certain government obligations in favor of a 20%
of net earnings formula. The G-L-B Act expands the permissible uses of FHLB
advances by community financial institutions (under $500 million in assets) to
include funding loans to small businesses, small farms and small
agri-businesses. The G-L-B Act makes membership in the FHLB voluntary for
federal savings associations.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time. Although the G-L-B Act reduces the range of companies
with which may acquire control of the Company, it may facilitate affiliations
with companies in the financial services industry.
REGULATION OF BANCSHARES
GENERAL. Bancshares is a savings and loan holding company as defined by the
Home Owners' Loan Act. As such, it is registered with the OTS and is subject to
OTS regulation, examination, supervision and reporting requirements. As a
subsidiary of a savings institution holding company, the Bank is subject to
certain restrictions in its dealings with Bancshares and affiliates thereof.
Bancshares also is required to file certain reports with, and otherwise comply
with the rules and regulations of, the Securities and Exchange Commission
("SEC") under the federal securities laws.
ACTIVITIES RESTRICTIONS. The Board of Directors of Bancshares presently
intends to continue operating as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
30
safety, soundness or stability of its subsidiary savings institution, the
Director of the OTS may impose such restrictions as deemed necessary to address
such risk including limiting: (i) payment of dividends by the savings
institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings institution
holding companies, if the savings institution subsidiary of such a holding
company fails to meet the QTL test, then such unitary holding company shall also
presently become subject to the activities restrictions applicable to multiple
holding companies and, unless the savings institution requalifies as a QTL
within one year thereafter, register as, and become subject to, the restrictions
applicable to a bank holding company. See "Regulation of the Bank -- Qualified
Thrift Lender Test."
If Bancshares were to acquire control of another savings institution, other
than through merger or other business combination with the Bank, Bancshares
would thereupon become a multiple savings and loan holding company. Except where
such acquisition is pursuant to the authority to approve emergency thrift
acquisitions and where each subsidiary savings institution meets the QTL test,
the activities of Bancshares and any of its subsidiaries (other than the Bank or
other subsidiary savings institutions) would thereafter be subject to further
restrictions. Among other things, no multiple savings and loan holding company
or subsidiary thereof which is not an institution shall commence or continue for
a limited period of time after becoming a multiple savings institution holding
company or subsidiary thereof, any business activity, 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 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
Federal Reserve Board as permissible for bank holding companies. A multiple
savings and loan holding company must obtain the approval of the OTS prior to
engaging in the activities described in (vii) above.
RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies may not
acquire, without prior approval of the Director of the OTS, (i) control of any
other savings institution or savings and loan holding company or substantially
all the assets thereof, or (ii) more than 5% of the voting shares of an
institution or holding company thereof which is not a subsidiary. Under certain
circumstances, a registered savings and loan holding company is permitted to
acquire, with the approval of the Director of the OTS, up to 15% of the voting
shares of an under-capitalized savings institution pursuant to a "qualified
stock issuance" without that savings institution being deemed controlled by the
holding company. In order for the shares acquired to constitute a "qualified
stock issuance," the shares must consist of previously unissued stock or
treasury shares, the shares must be acquired for cash, the savings and loan
holding company's other subsidiaries must have tangible capital of at least 6
1/2% of total assets, there must not be more than one common director or officer
between the savings and loan holding company and the issuing savings
institution, and transactions between the savings institution and the savings
and loan holding company and any of its affiliates must conform to Sections 23A
and 23B of the Federal Reserve Act. Except with the prior approval of the
Director of the OTS, no director or officer of an institution holding company or
person owning or controlling by proxy or otherwise more than 25% of such
company's stock, may also acquire control of any savings institution, other than
a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls an institution which operated a home or branch
office in the state of the institution to be acquired as of March 5, 1987; (ii)
the acquiror is authorized to acquire control of the savings institution
pursuant to the emergency acquisition provisions of the FDIC Act; or (iii) the
statutes of the state in which the institution to be acquired is located
specifically permit institutions to be acquired by state-chartered institutions
or savings and loan holding companies located in the state where the acquiring
entity is located (or by a holding company that controls such state-chartered
savings institutions).
31
OTS regulations permit federal savings institutions to branch in any state
or states of the United States and its territories. Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal institution may not establish an out-of-state
branch unless (i) the federal institution qualifies as a QTL or as a "domestic
building and loan association" under 7701(a)(19) of the Internal Revenue Code
and the total assets attributable to all branches of the institution in the
state would qualify such branches taken as a whole for treatment as a QTL or as
a domestic building and loan association and (ii) such branch would not result
in (a) formation of a prohibited multi-state multiple savings and loan holding
company or (b) a violation of certain statutory restrictions on branching by
savings institution subsidiaries of banking holding companies. Federal savings
institutions generally may not establish new branches unless the institution
meets or exceeds minimum regulatory capital requirements. The OTS will also
consider the institution's record of compliance with the Community Reinvestment
Act of 1977 in connection with any branch application.
FEDERAL SECURITIES LAW. Bancshares' Common Stock is registered with the SEC
under the Securities Exchange Act of 1934, as amended ("Securities Exchange
Act"). Bancshares is subject to the information, proxy solicitation, insider
trading restrictions and other requirements of the Securities Exchange Act.
FEDERAL INCOME TAXATION
Savings institutions such as the Bank are subject to the provisions of the
Internal Revenue Code of 1986, as amended (the "Internal Revenue Code") in the
same general manner as other corporations. Through tax years beginning before
December 31, 1995, institutions such as the Bank which met certain definitional
tests and other conditions prescribed by the Internal Revenue Code benefited
from certain favorable provisions regarding their deductions from taxable income
for annual additions to their bad debt reserve. For purposes of the bad debt
reserve deduction, loans are separated into "qualifying real property loans,"
which generally are loans collateralized by interests in certain real property,
and "nonqualifying loans," which are all other loans. The bad debt reserve
deduction with respect to nonqualifying loans must be based on actual loss
experience. The amount of the bad debt reserve deduction with respect to
qualifying real property loans was based upon actual loss experience (the
"experience method") or a percentage of taxable income determined without regard
to such deduction (the "percentage of taxable income method"). Under the
experience method, the bad debt deduction for an addition to the reserve for
qualifying real property loans was an amount determined under a formula based
generally on the bad debts actually sustained by a savings institution over a
period of years. Under the percentage of taxable income method, the bad debt
reserve deduction for qualifying real property loans was computed as 8% of a
savings institution's taxable income, with certain adjustments. The Bank
generally elected to use the method which has resulted in the greatest
deductions for federal income tax purposes in any given year.
Legislation that is effective for tax years beginning after December 31,
1995, requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan reserve that exceeds the pre-1988 tax
loan loss reserve. The Bank will no longer be allowed to use the reserve method
for tax loan loss provisions, but would be allowed to use the experience method
of accounting for bad debts. There will be no future effect on net income from
the recapture because the taxes on these bad debt reserves have already been
accrued as a deferred tax liability. The regulatory authorities have not
examined the Bank's federal income tax returns in the past five years.
For taxable years beginning after June 30, 1986, the Internal Revenue Code
imposes an alternative minimum tax at a rate of 20%. The alternative minimum tax
generally applies to a base of regular taxable income plus certain tax
preferences ("alternative minimum taxable income" or "AMTI") and is payable to
the extent such AMTI exceeds an exemption amount. The other items of tax
preference that constitute AMTI include (a) tax-exempt interest on newly-issued
(generally, issued on or after August 8, 1986) private activity bonds other than
certain qualified bonds and (b) for taxable years including 1987 through 1989,
50% of the excess of (i) the taxpayer's pre-tax adjusted net book income over
(ii) AMTI (determined without regard to this latter preference and prior to
reduction by net operating losses). For taxable years beginning after 1989, this
latter preference has been replaced by 75% of the excess (if any) of (i)
adjusted current earnings as defined in the Internal Revenue Code, over (ii)
AMTI (determined without regard to this preference and prior to reduction by net
operating losses). For any taxable
32
year beginning after 1986, net operating losses can offset no more than 90% of
AMTI. Certain payments of alternative minimum taxes may be used as credits
against regular tax liabilities in future years.
STATE INCOME TAXATION
The Bank is subject to Arkansas corporation income tax which is
approximately 6.5% of taxable earnings. Bancshares is incorporated under
Oklahoma law and qualified to do business in Arkansas as a foreign corporation,
and accordingly it incurs certain franchise and other taxes, which management
believes are not material.
EMPLOYEES
As of June 30, 2002, the Bank had 102 full-time equivalent employees, none
of whom was represented by a collective bargaining agreement. Management
considers the Bank's relationships with its employees to be good.
ITEM 2. PROPERTIES
-------------------
The following table sets forth information regarding the Bank's offices at
June 30, 2002.
YEAR OWNED OR APPROXIMATE
OPENED LEASED BOOK VALUE SQUARE FOOTAGE
------ -------- ---------- --------------
Main Office:
237 Jackson Street, SW 1933 Owned $ 234,467 12,000
Camden, Arkansas
Corporate Office:
313 Jefferson Street SW 2000 Leased -- 1,000
Camden, Arkansas
Branch Offices:
4937 Highway 5 North 2000 Owned $ 1,708,933 6,500
Bryant, Arkansas
1125 Fairview Road, SW
Suite 208 1981 Owned $ 135,805 1,200
Camden, Arkansas
610 West 4th Street 1969 Owned $ 755,236 3,500
Fordyce, Arkansas
473 Highway 425 North 1996 Owned $ 1,191,699 7,400
Monticello, Arkansas
108 South Main 1996 Owned $ 1,027,320 5,500
Sheridan, Arkansas
In addition to the offices described above, at June 30, 2002, the Bank held
four other properties located in various communities within the Bank's primary
market area. These properties were acquired for possible future construction of
additional offices and related facilities. At June 30, 2002, the aggregate net
book value of these properties totaled $1.2 million of which approximately
$300,000 was classified as held for resale. On July 19, 2002, the Bank sold its
Monticello branch, including the $300,000 land held for sale. It is anticipated
that in the future management may determine to expand the Bank's network of
banking facilities by installing ATMs in existing or new banking facilities, by
building branches or other facilities on the properties held by the Bank, by
acquiring other facilities or sites and/or by acquiring banks or other financial
companies with their own facilities.
33
The book value of the Bank's aggregate investment in properties, premises
and equipment totaled approximately $7.1 million at June 30, 2002. See Note 7 of
the Notes to Consolidated Financial Statements in the Annual Report to
Stockholders for June 30, 2002.
ITEM 3. LEGAL PROCEEDINGS
--------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At June 30, 2002, except as set forth below, there
were no legal proceedings to which the Company was a party, or to which any of
its property was subject, which were expected by management to result in a
material loss to the Company. In addition, there were no pending regulatory
proceedings to which the Company or any of its properties was a party, which
were expected to result in a material loss.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------------------------------------------------------------
There were no matters submitted to a vote of the security holders during
the fourth quarter of the fiscal year ended June 30, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
------------------------------------------------------------------------------
The information contained under the section "Market for Common Stock and
Related Stockholder Matters" in the Annual Report is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA
--------------------------------
The information contained in the table captioned "Selected Consolidated
Financial and Other Data" in the Annual Report is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
-------------------------------------------------------------------
The information contained in the section captioned "Market Risk" in the
Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------------------------------------
The financial statements contained in the Annual Report, which are listed
under Item 14 herein, are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
--------------------------------------------------------------------------------
The information required by this item was previously disclosed in the
Company's Current Report on Form 8-K filed with the Securities and Exchange
Commission (the "Commission") on November 9, 2001 (the "Form 8-K") and the
Company's Amendment No. 1 to the Form 8-K filed with the Commission on November
13, 2001.
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------
For information concerning the Board of Directors and executive officers of
the Company, the information contained under the section captioned "Proposal I -
Election of Directors" in the Company's definitive proxy statement for the
Company's 2002 Annual Meeting of Stockholders (the "Proxy Statement") which will
be filed within 120 days of the Company's fiscal year end and is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
--------------------------------
The information contained under the sections captioned "Director
Compensation" and "Executive Compensation" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------
(a) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
Information required by this item is incorporated herein by reference
to the sections captioned "Proposal I - Election of Directors --
Executive Compensation -- Securities Authorized for Issuance Under
Equity Compensation Plans" in the Proxy Statement.
(b) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Information required by this item is incorporated herein by reference
to the section captioned "Voting Securities and Beneficial Ownership"
in the Proxy Statement.
(c) SECURITY OWNERSHIP CERTAIN BENEFICIAL OWNERS
Information required by this item is incorporated herein by reference
to the sections captioned "Voting Securities and Beneficial Ownership"
in the Proxy Statement.
(d) CHANGES IN CONTROL
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
----------------------------------------------
(1) Financial Statements. The following consolidated financial
statements are incorporated by reference from Item 8 hereof:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of June
30, 2002 and 2001
35
Consolidated Statements of Income and Comprehensive Income
for the years ended June 30, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity for the
years ended June 30, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the years ended
June 30, 2002, 2001 and 2000
Notes to Consolidated Financial Statements for the years
ended June 30, 2002, 2001 and 2000
(2) Financial Statement Schedules. All schedules for which provision
is made in the applicable accounting regulations of the
Securities and Exchange Commission are omitted because of the
absence of conditions under which they are required or because
the required information is included in the Consolidated
Financial Statements and related Notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of
this Annual Report on Form 10-K and is also the Exhibit Index.
NO. DESCRIPTION
--- -----------
3.1 Articles of Incorporation of HCB Bancshares, Inc. *
3.2 Bylaws of HCB Bancshares, Inc. ****
4 Form of Common Stock Certificate of HCB Bancshares, Inc. *
10.1 Form of HCB Bancshares, Inc. 1997 Stock Option and Incentive Plan *+
10.2 Form of HCB Bancshares, Inc. Management Recognition Plan and Trust Agreement *+
10.3(a) Employment Agreements by and between Heartland Community Bank and Vida H. Lampkin
and Cameron D. McKeel *+
10.3(b) Employment Agreements by and between HCB Bancshares, Inc. and Vida H. Lampkin and
Cameron D. McKeel **+
10.4 Intentionally omitted.
10.5 Heartland Community Bank Directors' Retirement Plan, as amended*+
10.6(a) Change-in-Control Protective Agreement between Heartland Community Bank and Scott
A. Swain *****+
10.6(b) Change-in-Control Protective Agreement between HCB Bancshares, Inc. and Scott A.
Swain *****+
10.7(a) Employment Agreement by and between Heartland Community Bank and Charles Black +
10.7(b) Employment Agreement by and between HCB Bancshares, Inc. and Charles Black +
10.8 Standstill Agreement dated August 29, 2001, by and among HCB Bancshares, Inc. and
Stilwell Value Partners IV, L.P., Stilwell Associates, L.P., Stilwell Value LLC and
Joseph Stilwell***
13 Annual Report to Stockholders for the fiscal year ended June 30, 2002
36
21 Subsidiaries
23.1 Consent of BKD, LLP
23.2 Consent of Deloitte & Touche LLP
99 Certification
________________
* Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-19093).
** Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended June 30, 2000 (File No. 0-22423)
*** Incorporated by reference to the Company's Current Report on Form 8-K filed
on September 5, 2001 (File No. 0-22423).
**** Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2001 (File No. 0-22423)
*****Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended December 31, 2001 (File No. 0-22423)
+ Management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K. On April 26, 2002, the Registrant filed a Current
-------------------
Report on Form 8-K under item 5 to report the commencement of a stock repurchase
program.
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are
--------
either filed as part of this Annual Report on Form 10-K or incorporated by
reference herein.
(d) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. There
---------------------------------------------------------------
are no other financial statements and financial statement schedules which were
excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b) which
are required to be included herein.
37
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.
HCB BANCSHARES, INC.
Date: September 25, 2002 By: /s/ Cameron D. McKeel
---------------------------------------
Cameron D. McKeel
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
By: /s/ Cameron D. McKeel September 25, 2002
------------------------------------------------
Cameron D. McKeel
Director, President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Scott A. Swain September 25, 2002
------------------------------------------------
Scott A. Swain
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
By: /s/ Vida H. Lampkin September 25, 2002
------------------------------------------------
Vida H. Lampkin
Chairman of the Board
By: /s/ John G. Rich September 25, 2002
-------------------------------------------------
John G. Rich
Director
By: /s/ Bruce D. Murry September 25, 2002
-------------------------------------------------
Bruce D. Murry
Director
By: /s/ Carl E. Parker, Jr. September 25, 2002
-------------------------------------------------
Carl E. Parker, Jr.
Director
By: /s/ F. Michael Akin September 25, 2002
-------------------------------------------------
F. Michael Akin
Director
By: /s/ Clifford Steelman September 25, 2002
-------------------------------------------------
Clifford Steelman
Director
CERTIFICATION
I, Cameron D. McKeel, President and Chief Executive Officer of HCB
Bancshares, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of HCB Bancshares, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of material fact or omit to state a material fact necessary to
make the statement made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows on
the registrant as of, and for, the periods presented in this annual report.
Date: September 25, 2002
By: /s/ Cameron D. McKeel
----------------------------------
Cameron D. McKeel
Chief Executive Officer
(Principal Executive Officer)
CERTIFICATION
I, Scott A. Swain, Senior Vice President and Chief Financial Officer of HCB
Bancshares, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of HCB Bancshares, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of material fact or omit to state a material fact necessary to
make the statement made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows on
the registrant as of, and for, the periods presented in this annual report.
Date: September 25, 2002
By: /s/ Scott A. Swain
-------------------------------------------------
Scott A. Swain
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)