EXHIBIT 13
PROFILE
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The Company
State Financial Services Corporation (the "Company"), is a Wisconsin
corporation headquartered in Xxxxx Corners, Wisconsin. The Company is the parent
holding company for State Financial Bank (Wisconsin) ("SFB"), State Financial
Bank - Waterford ("SFBW"), State Financial Bank (Illinois) ("Richmond"), and
Home Federal Savings and Loan Association of Elgin ("Home") serving Southeastern
Wisconsin and Northeastern Illinois with 16 full service office locations. In
addition, the Company operates State Financial Mortgage Company ("SFMC"), which
originates adjustable and fixed rate mortgages, selling them into the secondary
market service released; State Financial Investments, Inc.("SFII"), which
conducts various brokerage activities; State Financial Insurance Agency
("SFIA"), which sells commercial and retail insurance products; and Lokken,
Chesnut, & Cape ("LCC"), which provides professional asset management to
commercial and retail customers.
Corporate Philosophy
The Company has positioned itself as a one-stop, full service provider of
financial products and services to its customers and markets, rooted in the
traditions of community banking and attentive to personalized service and
individualized attention. The Company operates a successful community bank
meeting the needs of our area with a wide range of quality products and
services. Our goal is to provide our customers with a single source for all of
their financial needs. Our customers have direct access to professionals to meet
their banking, insurance, brokerage, and asset management needs through our
sixteen branch office locations in Southeastern Wisconsin and Northeastern
Illinois, as well as our asset management operation in LaCrosse, Wisconsin.
Table of Contents
Financial Highlights Page 1
Letter to Shareholders Page 2
Selected Consolidated Financial Data Page 6
Management's Discussion and Analysis of Financial Page 7
Condition and Results of Operations
Report of Management Page 25
Report of Independent Auditors Page 25
Consolidated Balance Sheets Page 26
Consolidated Statements of Income Page 27
Consolidated Statements of Stockholders' Equity Page 28
Consolidated Statements of Cash Flows Page 30
Notes to Consolidated Financial Statements Page 31
Investor Information Page 48
Directors and Officers
FINANCIAL HIGHLIGHTS
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Dollars in thousands except per share data.
1998 1998 1997 % Change 1
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Exclusive of
Operating Results As Stated merger-related charges
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Net income $ 1,157 $ 7,093 $ 7,217 (1.72)
Return on average assets 0.15 % 0.89 % 1.09 % (18.35)
Return on average equity 0.86 % 5.25 % 5.39 % (2.60)
Net interest margin 4.36 % 4.75 % (8.21)
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Per Share Information
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Earnings - basic $ 0.12 $ 0.74 $ 0.75 (1.33)
Earnings - diluted 0.12 0.73 0.74 (0.01)
Dividends2 0.48 0.40 20.00
Stated book value at year end 13.36 13.19
Tangible book value at year end 12.40 12.41
Market value at year end 15.38 22.40
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Financial Condition
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Total assets $ 828,369 $ 773,873 7.04
Net loans 607,949 563,174 7.95
Total deposits 652,905 617,995 5.65
Shareholder's equity 134,637 133,763 0.65
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1. The percentage change is calculated comparing the amounts "Exclusive of
merger-related charge" in 1998 to 1997 actual amounts. If no information
is set forth as "Exclusive of merger-related charge", the percentage
change is calculated comparing the 1998 "as stated" amounts to the
amounts for 1997.
2. All dividends represent the amount per share declared by the Company for
each period presented. April 1999
[GRAPHICS OMITTED]
TO OUR SHAREHOLDERS
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Dear Shareholders:
It's been an historical year for State Financial Services Corporation, a
year which brought significant changes to our company, preparing us to compete
in the financial services industry of the future. The clock is ticking to the
next millennium, something you'll hear a great deal about this coming year. The
year 2000 introduces many challenges for the financial services industry. For
our corporation, it marks the 90th anniversary of our first location in Xxxxx
Corners, Wisconsin. 1998 confirmed our commitment in developing a unique model
for growth among community banks, one we believe will keep us strong.
We began the year the same way we completed it, in Illinois. January 1,
1998, was our first full day serving the Northern Illinois marketplace with the
acquisition of State Financial Bank (Illinois). This acquisition included two
offices and provides an opportunity to explore new markets while enhancing our
community banking philosophy.
In June, State Financial Services Corporation expanded the insurance
capabilities brought to us with the acquisition of State Financial Bank
(Illinois). We added two experienced agents in commercial and personal insurance
lines to State Financial Insurance Agency to grow this service through all of
our banking markets. State Financial Insurance Agency provides a full product
line for businesses and individuals.
We followed in September with the acquisition of Lokken, Chesnut, & Cape,
an asset management company based in LaCrosse, Wisconsin. Both State Financial
Insurance Agency and Lokken, Chesnut, & Cape signal our continued evolution in
the financial services marketplace. To continue our success and position
ourselves for the future, we must recognize the scope of the financial services
industry. We understand the importance of providing our customers with options
for all of their financial needs. Our banking customers have an established
relationship with our company, and when their needs change, we want to serve
them with an expanded line of products and services.
The most significant step we took in 1998 was our merger with Home
Bancorp of Elgin, Inc. and its subsidiary, Home Federal Savings and Loan
Association of Elgin. The merger with Home in December was the largest in our
company's history, doubling our size. Home Federal has built a strong customer
base delivering first residential mortgages, retail deposit products, and
superior customer service. We look forward to the contributions the five
locations of Home Federal Savings will make to our continued growth and welcome
the new shareholders who have joined us as a result of the merger.
Because the Home merger was accounted for using the pooling-of-interest
method of acquisitions accounting, all of the financial information presented in
this report has been restated to include Home's figures for all periods.
1999 will be another significant year for our company. The acquisitions
of the past year bring the responsibility of maximizing their potential. We have
a depth of expertise in all of these companies to realize the opportunities now
available and will work hard to ensure we maximize their potential. We will
continue to shape State Financial Services Corporation and will explore
additional opportunities for growth and to strategically deploy the capital
which came with the Home merger. In addition to an expanded product line for
Home Federal Savings, including home equity lines of credit and commercial
banking products, we will experience a number of improvements within our data
and communications systems.
As we addressed in the beginning of this letter, the year 2000 poses a
significant challenge for all companies serving the financial services industry.
You probably have heard many stories about the Year 2000 issue and its impact on
computer systems worldwide. We would like to take this opportunity to assure you
that at State Financial Services Corporation, we have been actively addressing
the Year 2000 for quite some time. Our evaluation included an assessment of key
vendors, service
2
suppliers, large credit customers, and other parties material to our operations.
We are testing enhancements provided by these vendors and are developing
contingency plans for all critical systems.
The acquisition of State Financial Bank (Illinois), the merger with Home
Federal Savings and the year 2000 also present opportunities for improvements in
all data processing and communications systems throughout our organization. A
team of employees representing all financial institutions and departments of our
company completed a thorough review of data processing systems and unanimously
selected a data services partner for the entire corporation. New tools such as
data warehousing will give us better management information. A new wide area
network will improve communications within our organization by joining voice and
data over a shared network, as well as enhancing our communications with our
customers.
The long term decisions we have made in 1998 are strategic objectives
with an eye toward the future. The diversification of our product line expands
the potential of products and services available to our customers. Integrating
these new products and services and translating our efforts into increased sales
will be a primary focus for the short and long term. The investment of necessary
resources has been made with the expectation of their contribution toward
enhancing our future operating performance.
As we proceed, our dedication to community banking remains strong, rooted
in superior customer service and individual attention in an ever changing
industry. We believe community banking is more about philosophy than size. Today
our customers interact with our banks in many different ways including PC
banking, telephone banking, and loan by phone, along with one way to bank we do
not think will ever change, person to person. Knowing our customers,
understanding their needs, and providing the products and services to meet those
needs will be our focus.
This year our long range strategic plan continues to evolve. On March 12,
1999, we announced the pending acquisition of First Waukegan Corporation and its
subsidiary, Bank of Northern Illinois, N.A. In addition, we will open two new
branch locations in Wisconsin. State Financial Bank (Wisconsin) will open a new
location in Waukesha and State Financial Bank - Waterford, will open its third
location in Elkhorn.
The acquisition of First Waukegan continues our expansion into the
Illinois market and will put out company over the $1 billion mark in total
assets. It provides us with three additional components to further the business
plan undertaken with our merger with Home Federal Savings of Elgin -
complimentary locations, the addition of trust services, and the ability to
leverage our balance sheet. First Waukegan is a $212 million national bank with
five offices located in Waukegan, Gurnee, Libertyville, and Glenview (which has
two offices). The transaction is subject to regulatory approval and at the time
of this writing, the transaction is expected to close no later than third
quarter 1999.
Throughout 1999 we look forward to further integrating our recent
acquisitions, the new expansions at our Wisconsin banks, and further development
of our new financial products. We appreciate your support of our long term
perspective.
Sincerely,
/s/X.X. Xxxx /s/Xxxxxxx X. Xxxxx
X.X. Xxxx Xxxxxxx X. Xxxxx
Chairman of the Board President and Chief Executive Officer
3
GROWTH, DIVERSIFICATION AND SERVICE
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What is Superior Customer Service?
The definition of "superior customer service" has been evolving for many
years and is different for each customer. At one time, customer service in banks
was most often measured by the amount of time you waited in a teller line.
Today, speed of service remains an important criteria, but has expanded to
include a variety of technology-based products and services. As we respond to
the technological opportunities exploding in our industry, we continue to shape
the meaning of customer service, which is rooted in a tradition of community
banking that we believe sets us apart.
Clearly, State Financial Services Corporation experienced a historical
year in 1998. It was a year of unparalleled growth. The addition of Home Federal
Savings, the expansion of State Financial Insurance Company, Lokken, Chesnut, &
Cape, and the introduction of new technology was all made possible by our
shareholders, employees, and customers.
Well Beyond Checking Accounts
The Financial Services Industry is changing. We have all heard before,
"time is the currency of the 90's" and we find that to be true with the services
our customers request. At State Financial Services Corporation we need to
respond to that market demand. Services like PC Banking, Loan by Phone, the
Access Line, providing 24-hour telephone banking and cash management services
for businesses are all designed to help our customers save time.
1998 confirmed our commitment in developing a unique model for growth
among community banks, one we believe will keep us strong. By diversifying our
products to include insurance and asset management, we can now assist our
customers more fully. These services are natural complements to the traditional
banking products we offer.
As customers' needs change, we can be there to help with solutions to
every day life events. For example, we can now offer suggestions to a new
lending customer needing insurance, a couple whose family is expanding or a long
time customer who is attempting to invest a recent inheritance. Through a
partnership with our customers, we can build on their trust in us.
4
"In an industry guided more by technology than ever before, our goal of
personalized customer service and individual attention remains steadfast."
The Marketing of a Growing Company
The growth we're experiencing must be carefully assimilated with the need
to promote our banks, our products and our services to distinct markets. Media
alternatives and competitive circumstances are different for each of our banks.
The local flavor and the desire to remain a "community bank" requires a clear
knowledge of the markets we serve. We continue our goal to have decision makers
at each of our offices. This is an important distinction. Our customers can walk
into any one of our offices and have their needs met.
Involvement in each community and an understanding of its needs continues
to be very important. Within our marketing communications plan, we must balance
the priorities of the different banks while maximizing efficiencies. In
Wisconsin, we continue our work with the NBC television affiliate in Milwaukee,
and sponsorships of various promotions to build our name and position as a
dominant community banking organization. Given the broad reach of these
programs, their benefit crosses state lines and augments the name recognition of
State Financial Bank in Illinois as well. In Illinois, our primary goal is the
marketing of an expanded product line and the income potential it brings.
Where People Always Come First
In an industry guided more by technology than ever before, our goal of
personalized customer service and individual attention remains steadfast. There
are many new ways to bank today, and you'll find them with State Financial
Services Corporation along with one way to bank we know will never change,
person to person.
5
MANAGEMENT'S DISCUSSION
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Selected Consolidated Financial Data
The following table sets forth selected financial data of State Financial
Services Corporation (hereinafter referred to as the "Company") and its
subsidiaries on a consolidated basis for the last five years (dollars in
thousands, except per share data).
As of or for the years ended December 31,1
1998 1997 1996 1995 1994
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Condensed Income Statement:
Total interest income (taxable equivalent) 2 $ 58,397 $ 49,743 $ 45,935 $ 42,707 $ 40,370
Total interest expense 25,923 20,072 19,633 18,186 15,257
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Net interest income 32,474 26,671 26,302 24,521 25,113
Provision for loan losses 690 450 330 370 360
Other income 6,965 4,664 4,281 3,631 5,592
Other expense 34,801 22,195 22,732 18,529 18,580
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Income before income tax 3,948 11,690 7,521 9,253 11,765
Income tax 1,981 3,961 2,420 3,191 4,127
Less taxable equivalent adjustment 810 512 453 419 473
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Net income $ 1,157 $ 7,217 $ 4,648 $ 5,643 $ 7,165
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Per share data 3:
Basic earnings per share 4 $ 0.12 $ 0.75 $ 0.48 $ n/a $ n/a
Diluted earnings per share 4 0.12 0.74 0.48 n/a n/a
Cash dividends declared 5 0.48 0.40 0.33 0.28 0.24
Book value 13.36 13.19 14.10 n/a n/a
Balance sheet totals (at period end):
Total assets 828,369 773,873 657,557 589,558 560,534
Loans, net of unearned discount 607,949 563,174 460,369 450,196 401,294
Allowance for loan losses 4,485 4,370 3,552 3,537 2,632
Deposits 652,905 617,995 508,464 508,049 475,440
Borrowed funds 29,117 9,850 8,000 7,300 0
Subordinated debentures and long-term debt 6,750 5,300 962 5,062 115
Shareholders' equity 134,637 133,763 135,408 69,064 60,488
Financial and Regulatory Ratios:
Asset growth 7.04% 17.69% 11.53% 5.18% (0.09)%
Return on average assets 0.15 1.09 0.76 1.02 1.30
Return on average equity 0.86 5.40 5.05 8.63 12.39
Dividend payout ratio 457.40 49.80 27.10 17.10 11.40
Allowance for loan losses to non-performing
loans 131.87 124.15 106.44 153.52 114.34
Non-performing assets to total assets 0.47 0.58 0.64 0.55 0.54
Net charge-offs to average loans 0.10 0.06 0.07 0.05 0.16
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1. All financial data has been restated to reflect the Company's acquisition
of Home Bancorp of Elgin, Inc. and its subsidiary, Home Federal Savings
and Loan Association of Elgin, using the pooling-of-interests method of
accounting. Amounts include balances and results of operations of LCC
since the effective date of its acquisition by the Company on September
8, 1998. Amounts include balances and results of operations of Richmond
since the effective date of its acquisition by the Company on December
31, 1997. Amounts include balances and results of operations of SFBW
since the effective date of its acquisition by the Company on August 24,
1995. See Note 2 to the Consolidated Financial Statements.
2. Taxable-equivalent adjustments to interest income involve the conversion
of tax-exempt sources of interest income to the equivalent amounts of
interest income that would be necessary to derive the same net return if
the investments had been subject to income taxes. A 34% incremental
income tax rate, consistent with the Company's historical experience, is
used in the conversion of tax-exempt interest income to a
taxable-equivalent basis.
3. All per share information presented in this report has been retroactively
restated to give effect to the 6 for 5 stock split declared in January
1998; the 6 for 5 stock split, declared in January 1997; and the 20%
stock dividend, declared in January 1996, as if each had occurred as of
January 1, 1994.
4. Per share information is excluded from presentation as of and for the
years ended December 31, 1995 and 1994 because Home did not issue stock
until September 26, 1996.
5. All dividends represent the amount per share declared by the Company for
each period presented.
6
Selected Quarterly Financial Data
The following table sets forth certain unaudited income and expense data
on a quarterly basis for the periods indicated (dollars in thousands, except per
share data).
1998 1997
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12/31 9/30 6/30 3/31 12/31 9/30 6/30 3/31
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Interest income $ 14,451 $ 14,479 $ 14,415 $ 14,242 $ 12,494 $ 12,376 $ 12,286 $ 12,075
Interest expense 6,597 6,568 6,401 6,357 5,156 5,154 4,954 4,808
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Net interest income 7,854 7,911 8,014 7,885 7,338 7,222 7,332 7,267
Provision for loan losses 172 173 172 173 113 113 112 112
Other income 1,771 1,856 1,718 1,620 1,201 1,147 1,094 1,223
Other expense 14,634 6,595 6,724 6,851 5,697 5,623 5,538 5,338
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Income (loss) before income tax (5,181) 2,999 2,836 2,481 2,729 2,633 2,776 3,040
Income tax (975) 1,068 1,008 881 911 941 1,002 1,107
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Net income (loss) $ (4,206) $ 1,931 $ 1,828 $ 1,600 $ 1,818 $ 1,692 $ 1,774 $ 1,933
=============================================================================================================================
Net income (loss) per
share - basic $ (0.44) $ 0.20 $ 0.19 $ 0.17 $ 0.19 $ 0.18 $ 0.18 $ 0.20
Net income (loss) per
share - diluted (0.44) 0.20 0.19 0.16 0.19 0.17 0.18 0.20
Dividends per share 1 0.12 0.12 0.12 0.12 0.10 0.10 0.10 0.10
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1. All dividends represent the amount per share declared by the Company for
each period presented.
2. All financial data has been restated to reflect the Company's acquisition of
Home Bancorp of Elgin, Inc. using the pooling-of-interests method of
accounting.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
General
The following discussion is intended as a review of the significant
factors affecting the Company's financial condition and results of operations as
of and for the year ended December 31, 1998, as well as providing comparisons
with previous years. This discussion should be read in conjunction with the
Consolidated Financial Statements and accompanying notes and the selected
financial data presented elsewhere in this annual report.
The financial discussion that follows refers to the impact of the
Company's business combination activity detailed below and in Note 2 of the
notes to the consolidated financial statements. In particular, on December 15,
1998, the Company completed its acquisition of Home Bancorp of Elgin, Inc., the
parent company of Home, a $383.2 million federally chartered thrift. The
acquisition was accounted for using the pooling-of-interests method of
accounting. Accordingly, all financial data presented herein has been restated
to include the balances and results of Home as of and for the periods presented.
On September 8, 1998, the Company completed its acquisition of LCC. The
acquisition was accounted for as a purchase. The Company's Consolidated
Statements of Income, and related schedules in Management's Discussion and
Analysis of Financial Condition and Results of Operations include LCC's results
for the period September 8, 1998 through December 31, 1998.
On December 31, 1997, the Company completed its cash acquisition of
Richmond, SFII, and SFIA. Accounted for as a purchase, the Company's
Consolidated Statements of Income and related schedules in Management's
Discussion and Analysis of Financial Condition and Results of Operations include
results for Richmond, SFII, and SFIA for the year ended December 31, 1998 only.
On August 24, 1995, the Company acquired SFBW. Accounted for as a
purchase, the Company's Consolidated Statements of Income, and related schedules
in Management's Discussion and Analysis of Financial Condition and Results of
Operations include SFBW's results for the full year in 1998, 1997, 1996 and from
August 24 through December 31 in 1995.
Income Statement Analysis
Net Interest Income
Net interest income equals the difference between interest earned on
assets and the interest paid on liabilities and is a measurement of the
Company's effectiveness in managing its interest rate sensitivity. For the year
ended December 31, 1998, taxable-equivalent net interest income increased
$2,803,000 (9.4%) to $32,474,000.
7
MANAGEMENT'S DISCUSSION
The inclusion of Richmond accounted for $2,848,000 of this change.
Excluding Richmond, taxable-equivalent net interest income decreased $46,000
(0.1%) for the year ended December 31, 1998. Changes in the volume of
outstanding interest-earning assets and interest-bearing liabilities accounted
for $3,828,000 of the 1998 improvement in taxable-equivalent net interest
income. This was offset by a reduction of $1,025,000 resulting mainly from
intense commercial loan pricing competition and mortgage loan refinancing
activity during the year.
Volume changes most fundamentally impacted the components of the
Company's consolidated taxable-equivalent net interest income in 1998.
Taxable-equivalent total interest income increased $8,654,000 in 1998 due to a
$120,951,000 (19.4%) increase in the volume of average total outstanding
interest-earning assets resulting from the inclusion of Richmond and internal
growth at the other banks. As a result of the volume increase, total interest
income improved $9,431,000 for the year ended December 31, 1998. Interest rate
changes offset the volume improvement by $777,000 as the Company experienced
rate declines in each category of interest-earning assets, with the exception of
interest-earning deposits. This was due to the general reduction in one to five
year market interest rates over the preceding twelve months and intense loan
pricing competition. The combined impact of these changes resulted in a decrease
in the Company's taxable-equivalent yield on interest- earning assets to 7.84%
in 1998 from 7.97% in 1997. The inclusion of Richmond, and its slightly higher
yield on interest-earning assets, in the Company's 1998 operating results,
partially offset further yield contraction in the Company's interest-earning
assets. Exclusive of Richmond, the Company's interest-earning asset yield in
1998 was 7.79%.
The Company experienced an increase in its funding costs during 1998 to
4.46% from 4.32% for the year ended December 31, 1997. The increased funding
cost resulted mainly from incorporating Richmond's relatively higher cost of
funds, primarily in time deposits, into the Company's consolidated operations.
Exclusive of Richmond, the Company reported a cost of funds of 4.37%, a 5 basis
point increase over 1997 due to comparatively higher short-term interest rates
in 1998, and a greater percentage of interest-bearing liabilities in higher cost
categories specifically; Money market accounts and time deposits, in 1998 as
compared to 1997. Due to the general increase in short-term interest rates, the
cost of money market accounts in 1998 rose to 4.38% consolidated and 4.41%
exclusive of Richmond from 4.37% in 1997. For the year ended December 31, 1998,
average money market accounts comprised 18.8% of the Company's average
interest-bearing liabilities compared to 18.6% for 1997. Costs of time deposits
increased to 5.79% in 1998 from 5.70% due to the inclusion of Richmond's higher
priced portfolio during the year. Exclusive of Richmond, the average rate
incurred on time deposits was 5.69% in 1998. Additionally, a greater percentage
of the Company's funding came from this higher cost source in 1998 (44.9%) as
compared to 1997 (43.03%).
The Company's net yield on interest-earning assets (net interest margin)
contracted to 4.36% for the year ended December 31, 1998 from 4.75% for the year
ended December 31, 1997 as a result of the aforementioned changes.
For the year ended December 31, 1997, taxable-equivalent net interest
income increased $3,370,000 (12.8%) compared to the year ended December 31,
1996. The increase was primarily due to a $51,000,000 growth in average
interest-earning assets outstanding. As a result of this volume increase,
taxable-equivalent total interest income increased $3,924,000 in 1997 over 1996.
Offsetting the loan volume improvement was a $116,000 contraction in the return
on interest-earning assets resulting mainly from a 10 basis point reduction in
loan yields due to relatively lower rates on mortgage loans during the year. For
the year ended December 31, 1997, the Company reported 7.97% total
taxable-equivalent yield on interest-earning assets compared to 8.02% for 1996.
The Company's 1997 cost of funds increased to 4.32% from 4.28% for the
year ended December 31, 1996, mainly due to increased rates paid on money market
accounts and a slightly higher percentage mix of interest-bearing liabilities in
money market and time deposits in 1997 compared to 1996 (61.6% vs. 60.4%). As a
result, the net interest rate spread contracted to 3.65% in 1997 from 3.74% in
1996. Although the spread contracted, the net yield on interest-earning assets
improved to 4.75% in 1997 from 4.59% in 1996 due to the Company's increased
level of average capital outstanding in 1997 resulting from Home's stock
offering in September, 1996.
[GRAPHIC OMITTED]
8
The following table sets forth average balances, related interest income
and expense, and effective interest yields and rates for the years ended
December 31, 1998, 1997, and 1996 (dollars in thousands).
1998 1997 1996
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Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
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ASSETS
Interest-earning assets:
>
Loans 1,2,3 $ 585,479 $ 48,822 8.34% $491,482 $ 41,679 8.48% $ 456,936 $ 39,201 8.58%
Taxable investment securities 71,801 4,381 6.10 81,671 5,044 6.18 70,483 4,005 5.68
Tax-exempt investment securities 3 29,683 2,040 6.87 17,354 1,272 7.33 15,535 1,150 7.40
Other short-term investments 8,004 459 5.73 1,542 90 5.84 2,952 170 5.76
Interest-earning deposits 38,342 2,062 5.38 29,287 1,510 5.16 22,175 1,164 5.25
Federal funds sold 11,692 633 5.41 2,714 148 5.45 4,666 245 5.28
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Total interest-earning assets 745,002 58,397 7.84 624,051 49,743 7.97 572,748 45,935 8.02
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Non-interest-earning assets:
Cash and due from banks 23,031 19,964 19,686
Premises and equipment, net 13,521 12,061 11,939
Other assets 18,473 9,791 9,153
Less allowance for loan losses (4,475) (3,672) (3,636)
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TOTAL $ 795,552 $662,195 $ 609,890
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LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
NOW accounts $ 82,778 $ 1,890 2.28% $ 65,453 $ 1,323 2.02% $ 65,341 $ 1,332 2.04%
Money market accounts 109,509 4,794 4.38 86,354 3,770 4.37 79,344 3,291 4.15
Savings deposits 106,543 3,007 2.82 102,080 2,951 2.89 108,546 3,186 2.94
Time deposits 261,032 15,105 5.79 200,082 11,409 5.70 198,019 11,395 5.75
Notes payable 2,053 143 6.97 679 46 6.77 1,033 71 6.87
FHLB borrowings 10,417 519 4.98 2,917 174 5.97 667 37 5.55
Federal funds purchased 61 4 6.56 1,822 105 5.76 377 22 5.84
Securities sold under
agreement to repurchase 8,690 460 5.29 5,559 293 5.27 5,737 299 5.21
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Total interest-bearing liabilities 581,083 25,922 4.46 464,946 20,071 4.32 459,064 19,633 4.28
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Non-interest-bearing liabilities:
Demand deposits 72,684 58,687 54,601
Other 6,767 4,747 4,265
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Total liabilities 660,534 528,380 517,930
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Shareholders' equity 135,018 133,815 91,960
TOTAL $ 795,552 $662,195 $609,890
Net interest earnings and
interest rate spread $ 32,475 3.38% $ 29,672 3.65% $ 26,302 3.74%
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Net yield on interest-earning assets 4.36% 4.75% 4.59%
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1. For the purpose of these computations, nonaccrual loans are included in
the daily average loan amounts outstanding.
2. Interest earned on loans includes loan fees (which are not material in
amount) and interest income, which has been received from borrowers whose
loans were removed from nonaccrual during the period indicated.
3. Taxable-equivalent adjustments are made in calculating interest income
and yields using a 34% rate for all years presented.
9
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
The following table presents the amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities (dollars in thousands). The table distinguishes
between the changes related to average outstanding balances (changes in volume
holding the initial rate constant) and the changes related to average interest
rates (changes in average rate holding the initial balance constant). Change
attributable to the combined impact of volume and rate have been allocated
proportionately to change due to volume and change due to rate.
1998 Compared to 1997 1997 Compared to 1996
Increase/(Decrease) Due to Increase/(Decrease) Due to
-------------------------------------------------------------------------------------------------------------------------
Volume Rate Net Volume Rate Net
-------------------------------------------------------------------------------------------------------------------------
Interest earned on:
Loans 1,2 $ 7,842 $ (699) $ 7,143 $ 2,939 $ (461) $ 2,478
Taxable investment securities (606) (57) (663) 674 365 1,039
Tax-exempt investment securities 2 853 (85) 768 133 (11) 122
Other short-term investments 371 (2) 369 (82) 2 (80)
Interest-earnings deposits 485 67 552 366 (20) 346
Federal funds sold 486 (1) 485 (106) 9 (97)
-------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 9,431 (777) 8,654 3,924 (116) 3,808
Interest paid on:
NOW accounts 382 185 567 2 (11) (9)
Money market accounts 1,015 9 1,024 299 180 479
Savings deposits 128 (72) 56 (192) (43) (235)
Time deposits 3,533 163 3,696 116 (102) 14
Notes payable, mortgage payable, federal
funds purchased and securities sold under
agreement to repurchase 545 (37) 508 178 11 189
------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 5,603 248 5,851 403 35 438
------------------------------------------------------------------------------------------------------------------------
Net interest income $ 3,828 $ (1,025) $ 2,803 $ 3,540 $ (171) $ 3,370
========================================================================================================================
1. Interest earned on loans includes loan fees (which are not material in
amount) and interest income, which has been received from borrowers whose
loans were removed from nonaccrual during the period indicated.
2. Taxable-equivalent adjustments are made in calculating interest income
and yields using a 34% rate for all years presented.
Provision for Loan Losses
The provision for loan losses charged to earnings results from a
quarterly analysis of the Company's loan portfolio, including the amount of net
charge-offs incurred during the period, collateral value, the remaining balance
in the allowance, and management's analysis of risk inherent in the portfolio.
Management's risk analysis incorporates loan classifications assigned by lending
personnel and as the result of examinations conducted by the Company's internal
loan review officer. The Company's lending personnel and internal loan review
officer review all significant nonhomogeneous loans for adverse situations that
may affect the borrower's ability to repay. If it appears probable that the
borrower will be unable to make scheduled principal and interest payments, an
allowance is established based on the difference between the carrying value and
the anticipated cash flows discounted at the loan's initial effective interest
rate or the fair value of the collateral for collateral dependent loans. For
homogeneous loans, the allowance is based on the loan classification and
historical loss experience for each classification. The provisions for loan
losses were $690,000, $450,000, and $330,000, for the years ended December 31,
1998, 1997, and 1996, respectively. The increase in 1998 provisions was solely
the impact of the full year inclusion of Richmond in the Company's operating
results. For the year ended December 31, 1997, the Company increased its
provision for loan losses $120,000 to recognize the general growth in the
Company's loan portfolio.
Other Income
In 1998, other income increased $2,301,000 (49.3%). The first year
inclusion of Richmond in 1998 accounted for $1,224,000 of this increase, and the
inclusion of LCC from September 1998 accounted for $168,000 of this increase.
Exclusive of Richmond and LCC, other income increased $909,000 (19.5%) due to
investment security gains realized at State Financial Services Corporation,
increases in mortgage origination gains, and the implementation of ATM
surcharges at the Banks during the fourth quarter of 1997. Other income
increased $383,000 (8.9%) in 1997 as compared to 1996 due to increased gains
from mortgage originations resulting from volume growth and the curtailment of
Home's defined benefit pension plan.
For the year ended December 31, 1998, service charges on deposit accounts
increased $285,000 (17.1%) compared to 1997, of
10
The composition of other income is shown in the following table (dollars
in thousands).
Years ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------------------------
Service charges on deposit accounts $ 1,956 $ 1,671 $ 1,828
Merchant services 1,270 1,161 1,033
Building rent 279 310 284
ATM service charges 760 491 433
Security transaction commissions 370 122 150
Asset management commissions 164 0 0
Gains on mortgage origination sales 962 225 76
Investment securities gains (losses) 421 (1) 0
Other 783 685 477
-------------------------------------------------------------------------------
Total other income $ 6,965 $ 4,664 $ 4,281
===============================================================================
which $301,000 was due to the inclusion of Richmond's results. Exclusive of
Richmond, service charges on deposit accounts decreased $16,000 (1.0%) the
majority of which was due to reduced income from service charges to business
deposit accounts. Service charges on deposit accounts for the year ended
December 31, 1997 decreased $157,000 (8.6%) as compared to the year ended
December 31, 1996 due to reduced service charge income at Home resulting from
changes made to NOW account pricing structures and ATM transaction fees for
competitive purposes.
Merchant services are the fees the Company charges businesses for
processing credit card payments. Income in this category increased $109,000
(9.4%) in 1998 and $128,000 (12.4%) in 1997. Both the 1998 and 1997 increases
were due to volume increases and rate adjustments during each respective year.
Building rent income decreased $31,000 (10.0%) in 1998 due to a reduction
in space occupied at the Company's Greenfield office of SFB which was previously
sublet to an unrelated tenant. As a result of this space reduction, the Company
no longer sublets any space at its Greenfield office. In August, 1998, the
Company sublet approximately one-third of the space at SFBW's Burlington office
to an unrelated party, partially offsetting the decline in rental income at the
Greenfield location. Building rental income increased $26,000 (9.2%) in 1997
compared to 1996 mainly due to a full year inclusion of the rental property
acquired in May 1996.
ATM service charges are the terminal usage fees charged to non-customers
for their use of the Company's ATMs and the fees received from other
institutions resulting from their customers' usage of the Company's automated
teller machines. The Company began charging terminal usage fees to non-customers
in November 1997. For the year ended December 31, 1998, ATM service charges
increased $299,000 (64.9%) in total and $232,000 (50.3%) exclusive of Richmond
due to the implementation of the terminal usage fees at the end of 1997. For the
year ended December 31, 1997, ATM service charges increased $28,000 (6.5%), all
of which was related to the new terminal usage fees.
Security transaction commissions are the fees received from the Company's
investment services and brokerage activities. In 1998, security transaction
commissions increased $248,000 which included $182,000 from Richmond. Exclusive
of Richmond, security transaction commissions increased $66,000 (54.1%) due to
increased volume at SFB and SFBW. For the year ended December 31, 1997, security
transaction commissions decreased $28,000 (18.7%).
Asset management commissions represent the fees charged by LCC for its
services, and for 1998 represents the amounts collected from the effective date
of LCC's acquisition (September 8, 1998) by the Company.
Gains on mortgage origination sales increased $737,000 (327.6%) in 1998
compared to 1997. The inclusion of Richmond accounted for $467,000 of this
increase. Absent Richmond, mortgage origination gains increased $270,000
(119.6%) due to the continued growth of SFMC impacted by the Company's marketing
efforts and the favorable mortgage refinancing market experienced during 1998.
For the year ended December 31, 1997, mortgage origination gains increased
$149,000 (196.1%) due to the first full year of operation of SFMC.
For the year ended December 31, 1998, the Company realized $400,000 in
gains from the sale of marketable equity securities and $21,000 in gains from
investment security sales. During 1997, the Company incurred a small loss on the
sale of two investment securities to help fund the Richmond acquisition.
Other income increased $98,000 (14.3%) in 1998 and $208,000 (43.6%) in
1997. The increase in 1998 was mainly due to the inclusion of Richmond's
$144,000 in other income, which included $90,000 in insurance commissions from
SFIA. Exclusive of Richmond, other income decreased $46,000. This net decrease
was comprised primarily of an increase of $147,000 related to the sale of SFB's
& SFBW's credit card portfolio and $16,000 in increased dividends on corporate
life insurance in 1998. These were offset by a decline of $27,000 in other real
estate gains and $182,000 in excess funds realized from the curtailment of
Home's defined benefit pension plan in 1997. The $208,000 increase in other
income during 1997 was mainly the result of the $182,000 increase realized at
Home from the pension curtailment, a $15,000 increase in corporate life
dividends, and a $14,000 increase in other real estate gains.
11
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
Other Expense
Other expense increased $12,606,000 (56.8%) for the year ended December
31, 1998 which included $3,731,000 for expenses at Richmond and $7,917,000 in
merger-related charges related to the Home acquisition. Exclusive of Richmond
and the merger-related charges, other expense was $23,154,000, an increase of
$958,000 (4.3%) from the year ended December 31, 1997. For the year ended
December 31, 1997, other expense decreased $537,000 (2.4%). The major components
of other expense are detailed in the following table (dollars in thousands).
Years ended December 31,
-------------------------------------------------------------------------------
1998 1997 1996
-------------------------------------------------------------------------------
Salaries and employee benefits $ 12,907 $ 10,195 $ 9,403
Occupancy and equipment 4,004 3,713 3,616
Data processing 1,978 1,698 1,599
Legal and professional 1,141 994 543
Merchant services 949 917 871
ATM 630 621 619
Advertising 901 806 746
Goodwill amortization 633 151 156
Merger-related charge 7,917 0 0
Other 3,742 3,101 5,180
-------------------------------------------------------------------------------
Total other expense $ 34,802 $ 22,196 $ 22,733
===============================================================================
Salaries and employee benefits increased $2,712,000 in 1998, of which the
inclusion of Richmond comprised $1,795,000. Exclusive of Richmond, salaries and
employee benefits increased $918,000 (9.0% ) in 1998. This increase was due to
normal salary adjustments, the full year inclusion of personnel costs of SFBW's
Burlington office, increased costs for Home's ESOP, Recognition and Retention
Plan, and rate increases on employee medical and dental insurance benefits. For
the year ended December 31, 1997, salaries and employee benefits increased
$792,000 (8.4%) due to increased costs related to Home's implementation of its
Recognition and Retention Plan and the opening of SFBW's Burlington office in
May, 1997 and the additional staffing related thereto.
Occupancy and equipment expense increased $291,000 in 1998, of which the
inclusion of Richmond accounted for $458,000 of the increase. Without the
Richmond impact, occupancy and equipment expense decreased $168,000 (4.5%) for
the year ended 1998 due to lower rent expense resulting from reduced space
occupied by SFB's Greenfield office. For the year ended December 31, 1997,
occupancy and equipment expense increased $98,000 (2.7%) due to the opening of
SFBW's Burlington office and increases in real estate taxes and equipment
maintenance expenses.
During 1998, data processing expense increased $280,000 in total and
$127,000 (7.5%) exclusive of Richmond due to rate adjustments from the Company's
service provider and increased services utilized by SFB and SFBW during the
year. For the year ended December 31, 1997, data processing expense increased
$99,000 (6.2%) due to rate adjustments from the Company's service provider,
additional costs incurred related to converting ATM cards to debit cards, and
additional costs related to the introduction of PC Banking products.
Legal and professional fees increased $147,000 in 1998, of which Richmond
and LCC accounted for $101,000 of the increase. Exclusive of Richmond and LCC,
legal and professional fees increased $46,000 (4.6%) mainly due to increased
legal costs incurred at the Banks during 1998 and additional outside consulting
services used by Home. For the year ended December 31, 1997, legal and
professional fees increased $451,000 (83.1%) in 1997, virtually all of which was
due to additional costs incurred by Home related to their first full year
operating as a publicly traded company.
Merchant services expense results from providing the Company's business
customers the ability to accept credit cards in payment for goods and services.
The $32,000 (3.5%) increase in 1998 and the $46,000 (5.3%) increase in 1997 were
the result of growth in the Company's customer base in this product line and
rate adjustments enacted by the Company's service provider during each year.
ATM expense are the fees charged by the Company's service provider for
the Company's customers use of automated teller machines that are not owned by
the Company. For the year ended December 31, 1998, ATM expense increased $9,000
(1.4%) compared to the year ended December 31, 1997. ATM expense increased
$2,000 (0.3%) in 1997 compared to 1996. The modest increases in both years are
due to increased volume and increased rates by the service provider.
12
Advertising expense increased $95,000 in 1998, of which $81,000 was due
to the inclusion of Richmond and LCC. Absent acquisition impacts, advertising
expense increased $14,000 (1.7%) in 1998 mainly due to additional marketing to
business customers during the year. For the year ended December 31, 1997,
advertising expense increased $60,000 (8.0%) due to increased television
advertising to enhance SFB's name recognition and promotions related to opening
the Burlington office.
Goodwill amortization increased $482,000 in 1998 due to a full year
amortization related to the Richmond acquisition and four months of amortization
related to the LCC acquisition. Xxxxxxxx accounted for $424,000 of this increase
with LCC representing the remaining $58,000. Both Xxxxxxxx's and LCC's goodwill
is being written off over 15 years.
In 1998, the Company recognized $7,918,000 in merger-related charges
related to its acquisition of Home. The merger-related charge represented costs
incurred for legal, professional, and investment banking fees of $2,638,000,
dissolution of Home's Recognition and Retention Plan of $3,149,000, payments
made under severance agreements of $1,297,000, and $834,000 in various expenses
associated with merging the two companies. This included adjustments made to
conform Home with the Company's accounting methods, regulatory filing fees, and
various costs associated with each company's special shareholders' meeting held
to consider the merger. The Company and Home had estimated merger-related
charges at $12,497,000. This estimate included $4,498,000 in expenses related to
the termination of Home's Employee Stock Ownership Plan. No expense for this
termination was recognized in 1998 as the ESOP had not yet terminated as of
December 31, 1998, which is the main reason that merger-related expenses
recognized in 1998 were less than projected. Additionally, estimates for the
termination of Home's Recognition and Retention Program ("RRP") and severance
payments on employment contracts were $300,000 and $803,000, respectively, less
than the amounts actually incurred. The expense for the RRP termination was
based on the Company's market value per share at the time of termination. Actual
expense for the RRP termination was less than projected due to the decline in
the Company's per share market value at the time of termination compared to the
value assumed in the estimate. The expense for severance payments were less than
projected as the Company assumed that three senior executives would be paid on
their employment agreements whereas only two executives retired effective with
the merger. Additionally, the Company assumed these payments would require a
gross-up adjustment to indemnify the executives for income tax implications
arising under the terms of their respective employment agreements and Section
280(g) of the Internal Revenue Code. The Company has requested a ruling from the
IRS regarding the requirement to gross-up these payments pursuant to Section
280(g). Based upon the advice of its counsel and its own research, the Company
believes that it is not required to gross-up these severance payments due to the
facts and circumstances surrounding the merger between the Company and Home.
Accordingly, the expense recognized did not adjust for the potential gross-up
implications resulting from the payments made under the employment agreements.
In the event that the IRS denies the Company's ruling request, the Company will
be required to indemnify the two executives by grossing-up their severance
payments for amounts resulting from application of IRS Section 280(g). In this
event, the Company would recognize an additional $625,000 in expense related to
these severance payments at the time the IRS delivers its ruling. The Company
expects the IRS to rule in favor of the Company's request.
Professional fees and other expenses related to the merger were
$1,021,000 greater than projected, offsetting the benefits described in the
preceding paragraph. Expenses for legal, professional, and investment banking
fees came in $188,000 greater than projected. Additionally, the Company did not
include in its estimate of merger-related charges any of the various expenses
associated with merging the two companies. This included adjustments made to
conform Home with the Company's accounting methods, regulatory filing fees, and
various costs associated with each company's special shareholders meeting held
to consider the merger which accounts for another $834,000 in expenses actually
recognized compared to amounts projected.
Management of the Company currently expects that the Home ESOP will sell
a sufficient number of shares to repay the Home ESOP debt of $3,970,000 in the
first quarter of 1999, which may result in additional compensation expense.
Shares remaining in the Home ESOP after repayment of the ESOP debt will be
allocated to Home ESOP participants. The amount of the additional expense will
be dependent upon the market value of the Company's common stock at the time the
Home ESOP is dissolved. Management estimates the amount of the additional
compensation expense related to the termination will range between $1,000,000
and $1,500,000, based on an estimated range of market value of State Financial
stock of $13.625 and $15.00, respectively.
Additional employment severance payments, not recorded as of December 31,
1998, and ranging from $835,000 to $1,100,000 may be incurred should five
certain Home employees who have contractual severance arrangements all choose to
terminate their employment with the Company prior to December 15, 2000. The
actual amount of expense incurred, if any, is dependent upon the number of these
employees choosing to terminate their employment with the Company and the point
in time at which this election is made. The amount of payment actually paid to
any one of these five employees will be reduced by the applicable employee's pro
rata monthly salary multiplied by the number of months between the merger date
(December 15, 1998) and the month in which the employee notifies the Company if
his/her desire to terminate their employment. The Company will recognize any
expense resulting from these severance agreements as additional merger-related
charges in the period notification is received from one of these Home employees.
The Company has received no notice from the employees that they intend to
terminate their employment with the Company.
13
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
Other expense increased $641,000 in 1998, including $162,000 in expenses
at Richmond and LCC. Exclusive of Richmond and LCC, other expense increased
$479,000 (15.4%) due to increases in correspondent bank fees due to reduced
compensating balances maintained by the Banks, postage and delivery cost
increases at SFB related to volume increases during the year, increased
telephone expense related to the Company's geographic expansion, and increased
regulatory assessments resulting from deposit growth over the preceding year.
For the year ended December 31, 1997, other expenses decreased $2,079,000,
virtually all of which was due to reduced regulatory assessment costs from 1996,
as 1996 included additional FDIC insurance assessments in resolution of the
agency's funding of the Savings Association Insurance Fund.
Income Tax
The Company's consolidated income tax rate varies from statutory rates
principally due to interest income from tax-exempt securities and loans.
Additionally, 1998's consolidated income tax rate was impacted by approximately
$2.7 million of the merger-related charges which were not deductible for income
tax purposes. The Company recorded provisions for income tax of $1,981,000 in
1998, $3,961,000 in 1997, and $2,420,000 in 1996. Income tax expense decreased
$1,980,000 in 1998 as the Company's pre-tax income declined $8,040,000, mainly
due to the recognition of the merger-related charges associated with the Home
acquisition. Income tax expense increased $1,541,000 in 1997 due to a $4,111,000
increase in the Company's pretax income. The Company's effective tax rate for
1998 was 63.1% compared to 35.4% for 1997. The Company's higher effective tax
rate in 1998 was due to the nondeductibility of certain merger-related charges
associated with the Home acquisition. Exclusive of the merger-related charges,
and the related tax implications, the Company reported a 35.8% effective tax
rate in 1998.
Net Income and Dividends
For the years ended December 31, 1998, 1997, and 1996, the Company
reported net income of $1,157,000, $7,217,000, and $4,647,000, respectively.
Impacting 1998 earnings were $7.9 million in merger-related charges associated
with the Company's Home acquisition. Excluding these charges on a tax-effected
basis, the Company reported net income of $7,093,000 for the year ended 1998.
The Company's return on average assets for the years ended December 31, 1998,
1997, and 1996 was 0.15%, 1.09%, and 0.76%, respectively. Return on average
equity for the same periods was 0.86%, 5.39%, and 5.05%. Exclusive of the
tax-effected merger-related charges, return on average assets and return on
average equity were 0.89% and 5.25%, respectively, for the year ended December
31, 1998. On a per share basis, basic earnings were $0.12 as stated and $0.74
exclusive of the merger-related charge for 1998, $0.75 for 1997, and $0.48 for
1996. The Company paid per share dividends of $0.48, $0.40, and $0.33 for the
years ended December 31, 1998, 1997, and 1996. These dividend rates do not
include the amounts paid by Home in each respective year, prior to its
acquisition by the Company.
[GRAPHIC OMITTED]
Balance Sheet Analysis
The composition of assets and liabilities are generally the result of
strategic management decisions influenced by market forces. At December 31, 1998
and 1997, the Company reported total assets of $828,369,000 and $773,873,000
respectively. This $54,496,000 (7.0%) increase in total assets was due to
internal growth over the preceding twelve months. Between 1996 and 1997, total
assets increased $116,316,000 (17.7%), of which $93,413,000 was due to the
Richmond acquisition. Exclusive of Richmond, the Company's total assets
increased $22,903,000 (3.5%) in 1997 due to internal growth and the opening of
SFBW's new Burlington office in May, 1997.
Lending Activities
The Company's largest single asset category continues to be loans. The
Company's gross loans, as a percentage of total deposits, were 93.8% at December
31, 1998 compared to 91.8% at December 31, 1997.
14
The following table shows the Company's loan portfolio composition on the
dates indicated (dollars in thousands).
At December 31,
----------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------------------------------------------------------------------------------------------------------------------------
Commercial $ 56,675 9.2% $ 56,030 9.9% $ 44,088 9.5% $ 46,323 10.2% $ 39,231 9.4%
Real Estate 506,844 82.8 461,700 81.4 375,985 81.0 372,399 82.1 346,922 83.1
Installment 37,519 6.1 37,496 6.6 30,619 6.6 22,624 5.0 19,733 4.7
Other 11,395 1.9 12,318 2.1 13,230 2.9 12,387 2.7 11,616 2.8
----------------------------------------------------------------------------------------------------------------------------
Total Loans $ 612,433 $ 567,544 $ 463,922 $ 453,733 $ 417,502
============================================================================================================================
Total loans outstanding increased $44,889,000 (7.9%) in 1998 mainly due
to Home's mortgage loan growth during the year.
Real estate loans represent the Company's largest loan category,
comprising 82.8% of the loan portfolio at December 31, 1998. Real estate loans
increased $45,144,000 (9.8%) from year end 1997 to 1998. Home experienced
$50,045,000 in loan growth during 1998. All of Home's mortgage loans are secured
by 1-4 family owner-occupied residential mortgages. A decrease of $5,000,000 in
Richmond's mortgage loans offset the growth in Home's loan portfolio as the
Company tightened Richmond's underwriting standards following the acquisition.
Historically, Home wrote its 1-4 family mortgage loans on both adjustable
and fixed rate terms with amortization terms of up to 30 years, retaining all
loan originations in portfolio. The Company writes its residential real estate
mortgages on balloon notes, generally up to five year maturities with
amortization periods of up to thirty years. As part of integrating Home into the
Company's operations, management desires to modify Home's mortgage activities by
selling off new fixed rate originations into the secondary market and retaining
the servicing rights, as well as beginning to offer terms similar to those
offered at SFB, SFBW, and Richmond. Additionally, management wishes to diversify
Home's lending activities into commercial and consumer loans to enhance the
yield on Home's loan portfolio and diversify lending concentrations. To the
extent allowable, the Company will also look to sell off a portion of Home's
previous mortgage originations into the secondary market, servicing retained.
[GRAPHIC OMITTED]
The Company continues to emphasize commercial real estate lending.
Commercial real estate activity was relatively flat during 1998 due to intense
pricing competition in the Company's markets during the year. The Company's
commercial real estate loans continue to be generally secured by owner occupied,
improved property such as office buildings, warehouses, small manufacturing
operations, and retail facilities located in the Company's primary market areas
subject to a maximum 75% loan to value ratio pursuant to its loan policy. Loans
for construction and land development are generally secured by the property
under construction or development up to a maximum loan value of 75% of estimated
cost or appraisal value of the completed project, whichever is less. The Company
further monitors construction and land development credits by disbursing draws
under the credit commitment upon satisfactory title company inspections of
construction progress and evidence of proper lien waivers. The borrower's
creditworthiness and the economic feasibility and cash flow abilities of the
project are fundamental concerns in the Company's commercial real estate and
construction/land development lending. Loans secured by commercial property,
whether existing or under construction, and land development are generally
larger in size and involve greater risks than residential mortgage loans because
payments on loans secured by commercial property are dependent upon the
successful operation and management of these properties, businesses, or
developments. As a result, the value of properties securing such loans are
likely to be subject to the local real estate market and general economic
conditions, including movements in interest rates. The Company generally writes
commercial real estate loans for maturities up to five years although the total
amortization period may be as long as twenty years, amortized monthly. The
Company generally writes construction and land development loans on terms up to
a maximum of 24 months and requires the borrower to make defined principal
reductions at stated intervals during that term. The Company additionally
attempts to have construction credits further supported by end mortgage
commitments wherever possible. The Company will generally reserve credit
extensions for land development projects for experienced, strong borrowers with
adequate outside liquidity to support the project in the event the actual
project performance is slower than projection.
15
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
The Company's real estate loans, like all of the Company's loans, are
underwritten according to its written loan policy. The loan policy sets forth
the term, debt service capacity, credit extension, and loan to value guidelines
which the Company considers acceptable to recognize the level of risk associated
with each specific loan category. The following table sets forth the percentage
composition of the real estate loan portfolio as of December 31, 1998.
--------------------------------------------------------------------------------
Commercial real estate 13.28%
1-4 family first liens on residential real estate 77.40
Multifamily residential 2.89
1-4 family junior liens on residential real estate
(including home equity lines of credit) 4.16
Construction, land development, and farmland 2.27
--------------------------------------------------------------------------------
Commercial loans increased $645,000 (1.2%) in 1998. Commercial loans are
also underwritten according to the Company's loan policy which sets forth the
amount of credit which can be extended based upon the borrower's cash flow, debt
service capacity, and discounted collateral value. Commercial loans are
typically made on the basis of the borrower's ability to make repayment from the
cash flow of the business. As a result, the availability of funds for the
repayment of commercial loans may be dependent on the success of the business
itself, which, in turn, is likely to be dependent upon the general economic
environment. In recognition of this risk, the Company emphasizes capacity to
repay the loan, adequacy of the borrower's capital, an evaluation of the
industry conditions affecting the borrower, and current credit file
documentation. The Company's commercial loans are typically secured by the
borrower's business assets such as inventory, accounts receivable, fixtures, and
equipment. Generally, commercial loans carry the personal guaranties of the
principals.
Installment loans remained virtually unchanged in 1998 compared to 1997
as indirect auto loan originations were impacted by reduced car sales resulting
mainly from various work stoppages encountered by auto manufacturers during the
year. The Company cultivates installment loans primarily through the purchase of
loan contracts from its network of auto dealers developed over the years. The
Company continues to pursue additional auto dealer contacts to build this
network of loan referrals. The Company's indirect auto loan underwriting
emphasizes the purchase of the highest quality loan contracts to minimize risk
of loss in this lending activity.
Other loans decreased $923,000 (7.5%) in 1998 as the Company sold off its
$3.3 million credit card portfolio in July, 1998 due to the competitive nature
of and risk associated with that product line. An increase of $2.4 million in
municipal loans and industrial revenue bond financing offset the decline in
other loans related to the credit card portfolio sale.
The following table shows the maturity of loans (excluding residential
mortgages on one-to-four-family residences, installment loans, and lease
financing) outstanding as of December 31, 1998 (dollars in thousands). Also
provided are the amounts due after one year classified according to the
sensitivity to changes in interest rates.
After One
Within But Within After
One Year Five Years Five Years Total
--------------------------------------------------------------------------------
Commercial $ 30,705 $ 24,190 $ 1,013 $ 55,909
Real Estate 27,467 55,089 4,781 87,337
--------------------------------------------------------------------------------
$ 58,172 $ 79,279 $ 5,795 $ 143,246
================================================================================
Loans Maturing
after one year with:
Fixed Interest Rates $ 71,084 $ 3,836
Variable Interest Rates 8,431 1,958
--------------------------------------------------------------------------------
TOTAL $ 79,515 $ 5,795
================================================================================
Risk Elements in the Loan Portfolio
Certain risks are inherent in the lending function. These risks include a
borrower's subsequent inability to pay, insufficient collateral coverage, and
changes in interest rates. The Company attempts to reduce these risks by
adherence to a written set of loan policies and procedures. Included in these
policies and procedures are underwriting practices covering debt-service
coverage, loan-to-value ratios, and loan term. Evidence of a specific repayment
source is required on each credit extension, with documentation of the
borrower's repayment capacity. Generally, this repayment source is the
borrower's cash flow, which must demonstrate the ability to service the debt
based upon historical results and conservative projections of future
performance.
Management maintains the allowance for loan losses (the "Allowance") at a
level considered adequate to provide for future loan losses. The Allowance is
increased by provisions charged to earnings, and is reduced by charge-offs, net
of recoveries. At December 31, 1998, the Allowance was $4,485,000, an increase
of $115,000 from the balance at December 31, 1997 due to loan loss provisions
exceeding net charge-offs during the year. As a percentage of total loans, the
allowance was 0.73% at the end of 1998 compared to 0.79% at the end of 1997. The
lower percentage was due to the overall growth in Home's loan portfolio during
1998. Historically, Home has experienced a very low incidence of charge-offs
from its loan originations. Based on its analyses, management considers the
Allowance adequate to recognize the risk inherent in the consolidated loan
portfolio at December 31, 1998.
16
The allowance for loan losses is composed of specific and general
valuation allowances. The Company establishes specific valuation allowances on
commercial and income-producing real estate loans considered impaired. A loan is
considered impaired (and a specific valuation allowance established for an
amount equal to the impairment) when the carrying amount of the loan exceeds the
present value of the expected future cash flows, discounted at the loan's
original effective interest rate, or the fair value of the underlying
collateral. General valuation allowances are based on an evaluation of the
various risk components that are inherent in the credit portfolio.
The risk components that are evaluated include past loan loss experience;
the level of nonperforming and classified assets; current economic conditions;
volume, growth and composition of the loan portfolio; adverse situations that
may affect the borrower's ability to repay; the estimated value of any
underlying collateral; peer group comparisons; regulatory guidance; and other
relevant factors. The allowance is increased by provisions charged to earnings
and reduced by charge-offs, net of recoveries. Management may transfer reserves
between specific and general valuation allowances as considered necessary. The
adequacy of the allowance for loan losses is approved quarterly by the Company's
board of directors. The allowance reflects management's best estimate of the
reserves needed to provide for the impairment of commercial and income-producing
real estate loans, as well as other credit risks of the Banks and is based on a
risk model developed and implemented by management and approved by the Company's
board of directors. However, actual results could differ from this estimate and
future additions to the allowance may be necessary based on unforeseen changes
in economic conditions. In addition, federal regulators periodically review the
Banks' allowance for loan losses. Such regulators have the authority to require
the Banks to recognize additions to the allowance at the time of their
examination.
A substantial portion of the Banks' loans are to customers located in
Southeastern Wisconsin and Northeastern Illinois. Accordingly, the ultimate
collectibility of a substantial portion of the Banks' loan portfolio is
susceptible to changes in market conditions in that area.
The balance of the Allowance and actual loan loss experience for the last
five years is summarized in the following table (dollars in thousands).
Years ended December 31,
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 4,370 $ 3,553 $ 3,537 $ 2,632 $ 2,493
Charge-offs:
Commercial 146 123 122 70 115
Real estate 39 40 100 82 59
Installment 465 71 46 82 68
Other 149 147 118 78 38
--------------------------------------------------------------------------------------------------------------------------
Total charge-offs 799 381 386 312 280
--------------------------------------------------------------------------------------------------------------------------
Recoveries:
Commercial 79 8 19 58 18
Real estate 59 29 2 12 0
Installment 60 16 26 34 24
Other 26 17 25 9 17
--------------------------------------------------------------------------------------------------------------------------
Total recoveries 224 70 72 113 59
--------------------------------------------------------------------------------------------------------------------------
Net charge-offs 575 311 314 199 221
Balance of acquired allowance at date of acquisition 0 678 0 734 0
Additions charged to operations 690 450 330 370 360
--------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 4,485 $ 4,370 $ 3,553 $ 3,537 $ 2,632
--------------------------------------------------------------------------------------------------------------------------
Ratios:
Net charge-offs to average loans outstanding 0.10% 0.06% 0.07% 0.05% 0.16%
Net charge-offs to total allowance 12.82 7.12 8.84 5.63 11.14
Allowance to year end loans outstanding 0.73 0.77 0.77 0.78 0.63
--------------------------------------------------------------------------------------------------------------------------
17
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
When in the opinion of management, serious doubt exists as to the
collectibility of a loan, the loan is placed on nonaccrual status. At the time a
loan is classified as nonaccrual, interest previously credited to income in the
current year is reversed and interest income accrued in the prior year is
charged to the Allowance. The Company generally does not recognize income on
loans past due 90 days or more.
[GRAPHICS OMITTED]
The following table summarizes non-performing assets on the dates
indicated (dollars in thousands).
At or for the years ended December 31,
---------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------------------------------------------------------------------------------------------------------------
Nonaccrual loans $ 3,245 $ 3,500 $ 3,300 $ 2,302 $ 2,297
Accruing loans past due 90 days or more 106 20 38 2 5
---------------------------------------------------------------------------------------------------------------------
Total non-performing 3,351 3,520 3,338 2,304 2,302
---------------------------------------------------------------------------------------------------------------------
Other real estate owned 572 620 895 956 733
---------------------------------------------------------------------------------------------------------------------
Total non-performing assets $ 3,923 $ 4,140 $ 4,233 $ 3,260 $ 3,035
=====================================================================================================================
Ratios:
Non-performing loans to total loans 0.55% 0.62% 0.72% 0.51% 0.55%
Allowance to non-performing loans 133.84 124.15 106.44 153.52 114.34
Non-performing assets to total assets 0.47 0.58 0.64 0.55 0.54
Interest income that would have been recorded
on nonaccrual loans under original terms $ 286 $ 270 $ 309 $ 288 $ 312
Interest income recorded during the period on
nonaccrual loans 158 145 145 141 147
=====================================================================================================================
Effective January 1, 1996, the Company adopted Financial Accounting
Standards Board Statement No. 114, "Accounting by Creditors for Impairment of a
Loan" ("Statement No. 114"). Under the new standard, the 1998, 1997, and 1996
allowance for loan losses related to loans that are identified for evaluation in
accordance with Statement No. 114 is primarily based on the fair value of the
collateral for certain collateral dependent loans. For certain noncollateral
dependent loans, the Allowance is established based on the expected cash flows
discounted at the loan's initial effective interest rate. Prior to 1996, the
allowance for loan losses related to these loans was based on undiscounted cash
flows or the fair value of the collateral for collateral dependent loans. At
December 31, 1998, the Company identified approximately $407,000 in loans which
are considered impaired. These loans are included as part of the nonaccrual
loans set forth in the table above and represent 0.07% of the Company's gross
loan portfolio. Based upon the analysis of the underlying collateral value of
these loans and the low percentage of these loans in relation to the gross loan
portfolio, management believes the allowance is adequately funded to provide for
the inherent risk associated with these loans.
At December 31, 1998, there were no loans to borrowers where available
information would indicate that such loans were likely to later be included as
nonaccrual, impaired (as defined in SFAS No. 114), past due, or restructured.
18
Investment Activities
Debt securities that the Company has both the positive intent and ability
to hold to maturity are carried at amortized cost. Debt securities that the
Company does not have either the positive intent and/or the ability to hold to
maturity and all marketable equity securities must be classified as
available-for-sale or trading and carried at their respective fair market value.
Unrealized holding gains and losses on securities classified as
available-for-sale, net of related tax effects, are carried as a component of
shareholders' equity. The company has no assets classified as trading. See note
4 to the Consolidated Financial Statements for more information.
Total investment securities outstanding at December 31, 1998 increased
$6,966,000. The Banks deployed these funds and 1998 investment maturities
primarily in obligations of states and political subdivisions and
mortgage-related securities to take advantage of the comparatively more
attractive yields on these investment securities as opposed to U.S. Treasury and
agency obligations. The following table presents the combined amortized cost of
the Company's held-to-maturity and available-for-sale investment securities on
the dates indicated (dollars in thousands).
At December 31,
--------------------------------------------------------------------------------------------------------
1998 1997 1996
--------------------------------------------------------------------------------------------------------
U.S. Treasury securities and obligations
of U.S. government agencies $ 41,200 39.9% $ 46,822 48.6% $ 87,946 70.8%
Obligations of states and
political subdivisions 30,828 29.8 25,922 26.9 15,015 12.1
Mortgage-related securities 21,792 21.1 17,242 17.9 16,753 13.5
Other securities 9,509 9.2 6,377 6.6 4,516 3.6
--------------------------------------------------------------------------------------------------------
TOTAL $ 103,329 $ 96,363 $ 124,230
========================================================================================================
The composition of the Company's investment securities has been
influenced by the general market conditions prevalent during 1998. U.S. Treasury
securities and obligations of U.S. government agencies ("Treasuries/Agencies")
decreased $5,622,000 in 1998 due to the Company's decision to increase the
amount of investments deployed in obligations of states and political
subdivisions and mortgage-related securities to take advantage of the
comparatively higher yields available on these investment products. As a result
of this decline, the percentage of the Company's investment portfolio invested
in Treasuries/Agencies decreased to 39.9% at December 31, 1998 from 48.6% at
December 31, 1997.
Obligations of states and political subdivisions increased $4,906,000 at
December 31, 1997 compared to December 31, 1996 due to the Company reinvesting
Treasuries/Agencies maturities in municipal investments to enhance its portfolio
yield. At December 31, 1998, obligations of states and political subdivisions
increased to 29.8% of the Company's investment portfolio from 26.9% at December
31, 1997.
[GRAPHIC OMITTED]
During 1998, balances in mortgage-related securities increased $4,550,000
as maturing Treasuries/Agencies were reinvested in this category. The Company's
mortgage-related securities represent balances outstanding on fixed-rate
collateralized-mortgage obligations ("CMOs") supported by one-to-four family
residential mortgage securities issued by the Federal National Mortgage
Association ("FNMA")or the Federal Home Loan Mortgage Corporation ("FHLMC"). To
avoid exposure to prepayments, wide market value fluctuations, and
recoverability, the Company purchases only the conservative early trances of the
respective CMOs. These investments closely resemble treasury securities in their
shorter maturities, marketability, and repayment predictability, and,
accordingly are the least volatile to the impact of market interest rate
fluctuations. At December 31, 1998, the remaining average life of the Company's
mortgage-related securities was slightly less than three years. Due to the short
remaining assumed maturities of these investments and its historical experience
with these investments, management does not consider the Company to be exposed
to significant interest rate risk or recoverability related to these
investments. At December 31, 1998, mortgage-related securities accounted for
21.1% of the Company's investment portfolio compared to 17.93% at December 31,
1997.
Other securities increased $3,132,000 in 1998, mainly due to the
Company's purchase of additional marketable equity securities during the year
and $638,000 in increased investments in Federal Reserve Bank stock and Federal
Home Loan Bank stock. In October, 1998, the Company took advantage of the
relative weakness in bank and thrift stocks by investing approximately $3
million in the stock of ten different financial institutions. Also during 1998,
the Company sold approximately $506,000 in marketable equity securities to take
advantage of price appreciation in these securities. At December 31, 1998, other
securities represented 9.2% of the Company's investment portfolio compared to
6.6% at December 31, 1997.
19
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
The maturities and weighted-average yield of the Company's investment
securities at December 31, 1998 are presented in the following table (dollars in
thousands, Equity Securities are included in the "within one year" column).
Taxable-equivalent adjustments (using a 34% rate) have been made in calculating
the yields on obligations of states and political subdivisions.
After One After Five
Within But Within But Within Within
One Year Five Years Ten Years Ten Years
-----------------------------------------------------------------------------------------------------------
Xxxxxx Xxxxx Xxxxxx Xxxxx Xxxxxx Xxxxx Xxxxxx Xxxxx
-----------------------------------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of U.S.
government agencies $ 7,168 6.21% $ 26,533 5.91% $ 7,499 6.17% $ 0 0.00%
Obligations of states and
political subdivisions 3,597 6.06 14,728 6.68 11,721 7.20 782 8.02
Mortgage-related securities 3,077 6.81 18,715 6.28 0 0.00 0 0.00
Other securities 7,509 3.55 1,800 6.68 200 8.90 0 0.00
-----------------------------------------------------------------------------------------------------------
TOTAL $21,351 5.33% $ 61,776 6.26% $ 19,420 6.82% $ 782 8.02%
===========================================================================================================
At December 31, 1998, the Company had $189,000 in net unrealized gains on
its held-to-maturity securities and $1,666,000 in net unrealized gains on its
available-for-sale securities. Of the unrealized gain on the Company's
available-for-sale securities at December 31, 1998, $465,000 was the result of
price appreciation on marketable equity securities acquired at the beginning of
1997 and in the fourth quarter of 1998, and $1,201,000 was the result of price
appreciation on the investment securities. Unrealized gains and losses resulting
from marketable equity securities are impacted by the current market price
quoted for the underlying security in relation to the price at which the
security was acquired by the Company. Unrealized gains and losses on investment
securities are the result of changes in market interest rates and the
relationship of the Company's investments to those rates for comparable
maturities. Unrealized gains generally result from the interest rates on the
Company's portfolio of investment securities exceeding market rates for
comparable maturities. Conversely, unrealized losses generally result from the
interest rates on the Company's portfolio of investment securities falling below
market rates for comparable maturities. If material, unrealized losses could
negatively impact the Company's future performance as earnings from these
investments would be less than alternative investments currently available and
may not provide as wide a spread between earnings and funding costs. The Company
does not consider its investment portfolios exposed to material adverse impact
to future operating performance resulting from market interest rate
fluctuations.
Deposits
Deposits are the Company's principal funding source. Deposit inflows and
outflows are significantly influenced by general interest rates, money market
conditions, market competition, and the overall condition of the economy. For
the year ended December 31, 1998, total average deposits increased $119,890,000
(23.4%) due to the inclusion of Richmond and internal deposit growth at SFB,
SFBW, & Home. As the Richmond acquisition was consummated on December 31, 1997,
no averages for Richmond are included in any average deposit information for the
years 1997 and 1996.
The following table sets forth the average amount of and the average rate
paid by the Company on deposits by deposit category (dollars in thousands).
Years ended December 31,
---------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------------------------------------------------------------------
Average Average % of Average Average % of Average Average % of
Amount Rate Total Amount Rate Total Amount Rate Total
---------------------------------------------------------------------------------------------------------------------------
Demand deposits $ 72,684 0.00% 11.5% $ 58,687 0.00% 11.4% $ 54,601 0.00% 10.8%
NOW accounts 82,778 2.28 13.1 65,453 2.02 12.8 65,341 2.04 12.9
Money market deposits 109,509 4.38 17.3 86,354 4.37 16.8 79,344 4.15 15.7
Savings 106,543 2.82 16.8 102,080 2.89 19.9 108,546 2.94 21.5
Time deposits 261,032 5.79 41.3 200,082 5.70 39.0 198,019 5.75 39.1
---------------------------------------------------------------------------------------------------------------------------
TOTAL $ 632,546 3.92% $ 512,656 3.79% $ 505,851 3.80%
===========================================================================================================================
For the year ended December 31, 1998, average non-interest bearing demand
deposits increased $13,997,000 (23.9%). The first year inclusion of Richmond in
the Company's averages accounted for $7,026,000 of this increase. Exclusive of
Richmond, average non-interest bearing demand deposits increased $6,971,000
(11.9%) mainly due to internal growth in both personal and business account
relationships during the year. Non-interest bearing demand deposits represent
11.5% of the Company's average deposit portfolio at December 31, 1998 compared
to 11.4% at December 31, 1997.
[GRAPHIC OMITTED]
Average NOW accounts increased $17,325,000 (26.5%) for the year ended
December 31, 1998 over 1997. Xxxxxxxx accounted for $17,138,000 of this
increase. Exclusive of Richmond, average NOW accounts increased $187,000 (0.3%).
At December 31, 1998, NOW accounts represent 13.1% of the Company's average
total deposits compared to 12.8% at December 31, 1997.
Average money market deposits increased $23,155,000 (26.8%) in total and
$20,236,000 (23.4%) exclusive of Richmond for the year ended December 31, 1998.
The Company continues to experience growth from this funding source due to the
popularity of the Money Market Index Account. At December 31, 1998, average
money market balances of the Company, represent 17.3% of average total deposits
compared to 16.8% at December 31, 1997.
Average savings balances increased $4,463,000 (4.4%). The inclusion of
Richmond added $8,072,000 to the Company's average savings balances. Exclusive
of Richmond, average savings balances decreased $3,609,000 (3.5%) due to the
declining popularity of this deposit instrument given customers' desire for more
attractive interest rates which the Company offers in money market and time
deposit accounts. Average savings balances represent 16.8% of average total
deposits at December 31, 1998 compared to 19.9% at December 31, 1997.
Average time deposit balances increased $60,950,000 (30.5%) in total, and
$20,994,000 (10.5%) exclusive of Richmond for the year ended December 31, 1998
compared to the year ended December 31, 1997. This increase was mainly due to
time deposit growth at Home during the year. At December 31, 1998, average time
deposits represent 41.3% of average total deposits compared to 39.0% at December
31, 1997.
Maturities of time certificates of deposit and other time deposits of
$100,000 or more outstanding at December 31, 1998 are summarized as follows
(dollars in thousands).
--------------------------------------------------
3 months or less $ 18,736
Over 3 through 6 months 6,096
Over 6 through 12 months 9,035
Over 12 months 11,744
--------------------------------------------------
TOTAL $ 45,611
--------------------------------------------------
Approximately 5.5% of the Company's total assets at December 31, 1998
were supported by time deposits with balances in excess of $100,000 as compared
to 7.2% at December 31, 1997.
Liquidity
The primary functions of asset/liability management are to assure
adequate liquidity and to maintain an appropriate balance between
interest-earning assets and interest-bearing liabilities. Liquidity management
involves the ability to meet the cash flow requirements of depositors and
borrowers.
The Company's primary funding sources are deposits, loan principal
repayments, and maturities of loans and investment securities. Contractual
maturities and amortization of loans and investments are a predictable funding
source, whereas deposit flows and loan prepayments are impacted by market
interest rates, economic conditions, and competition.
The Company's primary investment activity is loan origination. For the
year ended December 31, 1998, the Company reported a $45,465,000 increase in net
loans. Advances from the Federal Home Loan Bank funded $20,000,000 of the net
loan increase with the balance funded by deposit growth. Deposits increased
$34,910,000 in total, of which $25,465,000 went to fund loan growth. The
remaining $9,445,000 in 1998 deposit growth combined with $6,454,000 in cash
provided by operating activities and $1,245,000 in net notes payable proceeds,
repayments on the Company's ESOP and proceeds from stock option exercises to
fund $6,685,000 in net investment securities increases, purchase treasury stock
at Home, pay cash dividends, and net increases in cash and cash equivalents.
Additionally, the Company issued $2,410,000 in its common stock to fund the LCC
acquisition in September, 1998.
For the year ended December 31, 1997, the Company reported a $52,933,000
net increase in loans exclusive of the Richmond acquisition. Funding for the
1997 loan increase came from $54,103,000 in net investment security maturities
during the year.
21
MANAGEMENT'S DISCUSSION
--------------------------------------------------------------------------------
The residual investment maturities combined with deposit growth, cash
provided by operating activities and increases in securities sold under
agreements to repurchase were used to reduce federal fund borrowing, purchase
additional shares for the Company's ESOP, pay dividends, payoff the installment
notes payable incurred in 1995 with the Waterford acquisition, and purchase
fixed assets. In 1997, the Company completed its cash acquisition of Richmond,
funding the transaction through a combination of cash, investment securities
maturities and sales, and notes payable advances.
Cash and cash equivalents are generally the Company's most liquid assets.
The Company's level of operating, financing, and investing activities during a
given period impact the resultant level of cash and cash equivalents reported.
The Company had liquid assets of $82,230,000 and $80,585,000 at December 31,
1998 and 1997, respectively. Liquid assets in excess of necessary cash reserves
are generally invested in short-term investments such as federal funds sold,
commercial paper, and interest-earning deposits.
Interest Rate Sensitivity
Interest rate risk is an inherent part of the banking business as
financial institutions gather deposits and borrow other funds to finance earning
assets. Interest rate risk results when repricing of rates paid on deposits and
other borrowing does not coincide with the repricing of interest-earning assets.
Interest rate sensitivity management seeks to avoid fluctuating net interest
margins and to enhance consistent growth of net interest income through periods
of changing interest rates. The following table shows the estimated maturity and
repricing structure of the Company's interest-earning assets and
interest-bearing liabilities for three different independent and cumulative time
intervals as of December 31, 1998 (dollars in millions). For purposes of
presentation in the following table, the Company used the national deposit decay
rate assumptions published by its regulators as of December 31, 1998, which, for
NOW accounts, money market accounts, and savings deposits in the one year or
less category were 59%, 65%, and 80%, respectively. The table does not
necessarily indicate the impact general interest rate movements may have on the
Company's net interest income as the actual repricing experience of certain
assets and liabilities, such as loan prepayments and deposit withdrawals, is
beyond the Company's control. As a result, certain assets and liabilities may
reprice at intervals different from the maturities assumed in the following
table given the general movement in interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates.
Total
0-30 31-90 91-365 0-365
Days Days Days Days
------------------------------------------------------------------------------------------------
ASSETS
Loans
Fixed $ 17.2 $ 10.6 $ 42.1 $ 69.9
Variable 103.7 0.0 0.0 103.7
Investments 23.5 6.1 11.7 41.3
Federal funds 8.5 0.0 0.0 8.5
------------------------------------------------------------------------------------------------
Total $ 152.9 $ 16.7 $ 53.8 $ 223.4
------------------------------------------------------------------------------------------------
LIABILITIES
Savings deposits $ 7.0 $ 14.1 $ 63.3 $ 84.4
NOW deposits 4.6 9.2 41.5 55.3
Time deposits 21.2 42.2 107.7 171.1
Money market deposits 6.5 13.0 58.6 78.2
Other interest-bearing liabilities 25.0 2.5 6.8 34.3
------------------------------------------------------------------------------------------------
Total $ 64.4 $ 81.0 $ 277.8 $ 423.2
------------------------------------------------------------------------------------------------
Interest sensitivity gap $ 88.6 $ (64.3) $ (224.0) $ (199.8)
Cumulative interest sensitivity gap 88.6 24.2 (199.8) (199.8)
Cumulative interest sensitivity gap as a
percentage of total earning assets 11.6% 3.2% (26.1)% (26.1)%
Cumulative total interest-earning assets
as a percentage of cumulative
interest-bearing liabilities 237.4 116.6 52.8 52.8
------------------------------------------------------------------------------------------------
At December 31, 1998, interest-sensitive assets and interest-sensitive
liabilities subject to repricing within one year, as a percentage of total
assets were 26.7% and 51.1%, respectively. Variable rate and maturing fixed rate
loans are the primary interest-sensitive assets repricing within one year. Time
deposits are the most significant liabilities subject to repricing within one
year on the funding side of the balance sheet. The table above demonstrates the
Company is liability-sensitive at December 31, 1998, which would normally
indicate that the Company's net interest margin would improve if rates decreased
and contract if interest rates increased. The consolidation with Home increased
the Company's liability sensitive position due to the concentration of Home's
loan portfolio in long-term, fixed-rate mortgage loans.
22
MANAGEMENT'S DISCUSSION
Previously, Home retained all of its fixed rate mortgage originations in
its loan portfolio. The Company expects to reduce the average maturity of Home's
loan portfolio by selling newly originated mortgages into the secondary market,
and by diversifying its lending practices into commercial and consumer loans
which will add variable rate loan products to Home's portfolio and reduce the
average loan maturity of the fixed rate portfolio.
Capital Resources
Total shareholders' equity increased $873,000 in 1998, decreased
$1,644,000 in 1997, and increased $66,343,000 in 1996. The increase in 1998 was
mainly due to the retirement of Home's Recognition and Retention Plan
commensurate with the merger and the annual allocation of ESOP shares in both
State's and Home's respective plans. Total shareholders' equity decreased in
1997 due to Home's acquisition of treasury shares and the formation of the
Recognition and Retention Plan exceeding the amount of net earnings retention
during the year. The 1996 increase was primarily the result of the capital Home
raised in its conversion from a mutual to a stock organization. The following
table illustrates historical internal growth trends for the years indicated.
Years ended December 31,
-----------------------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------------------
Exclusive of
merger-related
As stated charge
-----------------------------------------------------------------------------------------
Return on assets 0.15% 0.89% 1.09% 0.76%
Return on equity 0.86 5.25 5.40 5.05
Earnings retained (357.40) 25.40 50.20 72.90
Dividend payout ratio 457.40 74.60 49.80 27.10
Average equity to average assets 16.97 20.21 15.08
Asset growth 7.04 17.69 11.53
-----------------------------------------------------------------------------------------
There are certain regulatory constraints which affect the Company's
capital levels. At December 31, 1998, the Company exceeded all of the regulatory
capital requirements. See Note 9 and Note 12 to the consolidated financial
statements for additional explanation of these regulatory constraints.
Impact of Inflation and Changing Prices
The Company's Consolidated Financial Statements have been prepared in
conformity with generally accepted accounting principles which require the
measurement of financial position and operating results in terms of historical
dollars without consideration of changes in the relative purchasing power of
money over time impacted by inflation. The impact of inflation is reflected in
the company's other expenses which tend to rise during periods of general
inflation. The majority of the Company's assets and liabilities are monetary in
nature and therefore differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories.
Consequently, interest rates have a greater impact on the Company's performance
than do the general levels of inflation. Management believes the most
significant impact on the Company's financial results is its ability to react to
interest rate changes and endeavors to maintain an essentially balanced position
between interest sensitive assets and liabilities in order to protect against
wide fluctuations in the Company's net interest margin.
Impact of Year 2000
At midnight on December 31, 1999, unless the proper modifications have
been made, the program logic in many computer systems will start to produce
erroneous results because, among other things, the systems will incorrectly read
the date "01/01/00" as being January 1 of the year 1900 or another incorrect
date. In addition, certain systems may fail to detect that the year 2000 is a
leap year. Problems can also arise earlier than January 1, 2000 as dates in the
next millennium are entered into non-Year 2000 compliant programs (collectively,
such issues are referred to herein as the "Year 2000 Problem"). Like most
financial service providers, the Company may be significantly affected by the
Year 2000 Problem due to the nature of financial information.
Compliance Program. In order to address the Year 2000 Problem and to
minimize its potential adverse impact, in 1997 the Company initiated a corporate
wide project to address the impact of the Year 2000 Problem on its computer
application systems, information technology ("IT") related equipment, system
software, building controls, and non-IT embedded systems found in such equipment
as security systems, currency counters, and elevators. The evaluation of Year
2000 issues included an assessment of the potential impact of the Year 2000
Problem on the Company, including monitoring significant customers, key vendors,
service suppliers and other parties material to the Company's operations testing
changes provided by these vendors; and developing contingency plans for any
critical systems that are not effectively reprogrammed. In the course of this
evaluation, the Company has sought written assurances from such third parties as
to their state of Year 2000 readiness. The Company's Year 2000 Compliance
Program is divided into five phases: (1) awareness; (2) assessment; (3)
renovation; (4) validation; and (5) implementation.
23
MANAGEMENT'S DISCUSSION
The Company's State of Readiness. Work on the Year 2000 Compliance
Program has been prioritized in accordance with risk. The highest priority has
been assigned to activities that would disrupt the accuracy and delivery of the
Company's banking services to its customers; next is an assessment of the
potential credit risk to the Company resulting from its credit customers' state
of Year 2000 readiness, or lack thereof, and the potential impact of those
efforts on the customers' ability to meet contractual payment obligations; the
lowest priority has been assigned to activities that would cause inconvenience
or productivity loss in normal business operations such as issues related to
internal office machinery, heating and air conditioning systems, and elevators.
The Company has substantially completed the first two phases of the plan
and is currently working internally and with external vendors on the final three
phases. Because the Company outsources its data processing, a significant
component of the Year 2000 Compliance Program is working with external vendors
to test and certify that their systems are Year 2000 compliant. During the
weekend of October 3, 1998, the Company's primary data service provider
converted State Financial Bank (Wisconsin) and State Financial Bank - Waterford
to its Year 2000-ready platform. As part of the conversion, the Company
performed a variety of tests to determine the proper functionality of the new
platform. No problems were encountered. The Company's other external vendors
have surveyed their programs to inventory the necessary changes and have begun
correcting the applicable computer programs and replacing equipment so that the
Company's information systems will be Year 2000 compliant prior to March 31,
1999. This will enable the Company to devote substantial time to the testing of
the upgraded systems prior to the arrival of the new millennium. The Company
expects to complete its timetable for carrying out its plans to address Year
2000 issues, and to finish initial testing by March 31, 1999.
The Company has also conducted a survey of its significant credit
customers to determine their state of Year 2000 readiness. Surveys were mailed
to all customers whose outstanding loan balance or loan commitment exceeded
$200,000. In addition, as part of its ongoing credit underwriting practices, all
new and renewed loans must have a Year 2000 risk assessment completed and
reported as part of the loan approval process. Based upon the information
received from these surveys, the Company does not expect to experience any
material collection problems resulting from its customers' Year 2000 readiness,
or lack thereof.
Cost to Address Year 2000 Compliance Issues. Managing the Year 2000
Compliance Program will result in additional direct and indirect costs to the
Company. Based upon current internal studies, as well as recently solicited bids
from various computer hardware and software vendors, the Company estimates that
the total direct cost of resolving the Year 2000 Problem will not exceed
$900,000. This estimate includes approximately $471,100 in hardware purchases
that the Company expects to capitalize. To date, the Company has incurred
approximately $324,000 in costs related to addressing the Year 2000 Problem. The
majority of the remaining costs related to resolving the Year 2000 Problem are
expected to be incurred in 1999. The Company expects to fund these expenditures
through internal sources.
The estimated costs of, and timetable for, becoming Year 2000 compliant
constitute "forward looking statements" as defined in the Private Securities
Litigation Reform Act of 1995. Investors are cautioned that such estimates are
based on numerous assumptions by management, including assumptions regarding the
continued availability of certain resources, the accuracy of representations
made by third parties concerning their compliance with Year 2000 issues, and
other factors. The estimated costs of Year 2000 compliance also do not give
effect to any future corporate acquisitions made by the Company or its
subsidiaries.
Risk of Non-Compliance and Contingency Plans. The major applications
which pose the greatest risk to the Company if the implementation of the Year
2000 Compliance Program is not successful are the Company's data services
systems supported by third party vendors, loan customers ability to meet
contractual payment obligations in the event the Year 2000 Problem has a
significant negative impact on their business, internal computer networks, and
items processing equipment which renders customers' bank statements and banking
transactions. The potential problems which could result from the inability of
these applications to correctly process the Year 2000 are the inaccurate
calculation of interest income and expense, service delivery interruptions to
the Company's banking customers, credit losses resulting from the Company's loan
customers inability to make contractual credit obligations, interrupted
financial data gathering, and poor customer relations resulting from inaccurate
or delayed transaction processing.
Although the Company intends to complete all Year 2000 remediation and
testing activities by March 31, 1999, and although the Company has initiated
Year 2000 communications with significant customers, key vendors, service
providers, and other parties material to the Company's operations and is
diligently monitoring the progress of such third parties in their Year 2000
compliance, such third parties nonetheless represent a risk that cannot be
assessed with precision or controlled with certainty. For that reason, the
Company intends to develop contingency plans to address alternatives in the
event that Year 2000 failures of automatic systems and equipment occur.
Preliminary discussions have been held regarding the contingency plan and a
final contingency plan is scheduled to be completed by the end of the second
quarter of 1999.
Pending Accounting Changes
Pending accounting changes for 1999 are set forth in detail as Note 1 to
the Notes to the Consolidated Financial Statements contained herein.
Forward Looking Statements
When used in this report, the words "believes," "expects," and similar
expressions are intended to identify forward-looking statements. The Company's
actual results may differ materially from those described in the forward-looking
statements. Factors which could cause such a variance to occur include, but are
not limited to, changes in interest rates, levels of consumer bankruptcies,
customer loan and deposit preferences, and other general economic conditions.
24
REPORT OF MANAGEMENT AND INDEPENDENT AUDITORS
--------------------------------------------------------------------------------
Report of Management
The management of State Financial Services Corporation is responsible for
the preparation and integrity of the Consolidated Financial Statements and other
financial information included in this Annual Report. The financial statements
have been prepared in accordance with generally accepted accounting principles
and include amounts that are based upon informed judgements and estimates by
management. The other financial information in this Annual Report is consistent
with the financial statements.
The Company maintains a system of internal accounting controls.
Management believes that the internal accounting controls provide reasonable
assurance that transactions are executed and recorded in accordance with Company
policy and procedures and that the accounting records may be relied on as a
basis for preparation of the financial statements and other financial
information.
The Company's independent auditors were engaged to perform an audit of
the Consolidated Financial Statements, and the auditor's report expresses their
opinion as to the fair presentation of the consolidated financial statements in
conformity with generally accepted accounting principles.
The Audit Committee of the Board of Directors, comprised of directors who
are not employees of the Company, meets periodically with management, the
internal auditors, and the independent auditors to discuss the adequacy of the
internal accounting controls. Both the independent auditors and the internal
auditors have full and free access to the Audit Committee.
Xxxxxxx X. Xxxxx Xxxxxxx X. Xxxxxx
/s/Xxxxxxx X. Xxxxx /s/Xxxxxxx X. Xxxxxx
President and Chief Executive Officer Senior Vice President, Controller,
and Chief Financial Officer
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Shareholders
State Financial Services Corporation
We have audited the accompanying consolidated balance sheets of State
Financial Services Corporation and subsidiaries (the Company) as of December 31,
1998 and 1997, and the related consolidated statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the financial statements of
Home Federal Savings and Loan Association of Elgin for the year ended December
31, 1998, or the consolidated financial statements of Home Bancorp of Elgin,
Inc. and subsidiary for the years ended December 31, 1997 and 1996, which
statements reflect total assets of $383,231,000 in 1998 and $352,595,000 in
1997, and total interest income of $24,359,000 in 1998, $25,029,000 in 1997 and
$23,059,000 in 1996. Those statements were audited by other accountants whose
reports have been furnished to us, and our opinion, insofar as it relates to
data included for Home Federal Savings and Loan Association of Elgin and Home
Federal Bancorp, Inc. and subsidiary, is based solely on the reports of other
accountants.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the reports of KPMG Peat Marwick
LLP, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of the Company at December 31,
1998 and 1997, and the consolidated results of its operations and cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
/S/ERNST & YOUNG LLP
January 22, 1999, except for Note
2, as to which the date is March 12, 1999.
25
FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
December 31,
1998 1997
--------------------------------------
Assets
Cash and due from banks $ 31,028,203 $ 34,358,642
Interest-bearing bank balances 29,793,241 34,952,407
Federal funds sold 8,508,387 11,273,835
Commercial Paper 12,900,000 -
--------------------------------------
Cash and cash equivalents 82,229,831 80,584,884
Investment securities:
Held-to-maturity (fair value of $10,479,
402-1998 and $21,301,412-1997) 10,290,241 21,088,641
Available-for-sale (at fair value) 94,704,827 76,616,660
Loans (net of allowance for loans losses of
$4,484,504-1998 and $4,370,209-1997) 607,948,900 563,174,035
Premises and equipment 13,333,369 14,027,570
Accrued interest receivable 4,485,332 4,380,576
Other assets 15,376,023 14,000,545
--------------------------------------
$828,368,523 $773,872,911
======================================
Liabilities and shareholders' equity Deposits:
Demand $ 81,540,940 $ 75,205,534
Savings 199,266,311 189,641,548
Money market 120,297,093 106,531,817
Time deposits in excess of $100,000 45,610,283 32,137,325
Other time deposits 206,190,258 214,478,505
--------------------------------------
Total deposits 652,904,885 617,994,729
Notes payable 6,750,000 5,300,000
Securities sold under agreement to repurchase 4,116,677 4,850,000
Federal Home Loan Bank advances 25,000,000 5,000,000
Accrued expenses and other liabilities 3,270,762 4,934,465
Accrued interest payable 1,688,920 2,030,367
--------------------------------------
Total liabilities 693,731,244 640,109,561
Shareholders' equity:
Preferred stock $1 par value; authorized-100,000
shares; issued and outstanding-none - Common stock,
$ 0.10 par value; authorized-25,000,000 shares;
10,076,017 shares issued and outstanding in 1998
and 10,279,007 issued and 10,138,753 outstanding
in 1997 1,007,602 1,027,901
Additional paid-in capital 94,153,564 96,718,054
Retained earnings 43,748,273 47,882,792
Accumulated other comprehensive income 1,080,549 888,649
Unearned shares held by ESOP (5,352,709) (6,385,962)
Unearned shares acquired by Recognition and
Retention Plan - (3,898,482)
Treasury stock - (2,469,602)
--------------------------------------
Total shareholders' equity 134,637,279 133,763,350
--------------------------------------
$ 828,368,523 $773,872,911
======================================
See accompanying notes.
26
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31,
1998 1997 1996
-----------------------------------------------
Interest Income:
Loans $ 48,705,672 $41,599,154 $ 39,138,477
Investment securities:
Taxable 6,902,230 6,644,283 5,338,766
Tax-exempt 1,346,350 839,358 758,689
Interest-bearing bank balances:
Federal funds sold and other short-term investments 632,586 148,152 246,412
-----------------------------------------------
Total interest income 57,586,838 49,230,947 45,482,344
Interest expense:
Deposits 24,795,930 19,453,399 19,203,627
Notes payable and other borrowings 1,126,660 618,079 429,593
-----------------------------------------------
Total interest expense 25,922,590 20,071,478 19,633,220
-----------------------------------------------
Net interest income 31,664,248 29,159,469 25,849,124
Provision for loan losses 690,000 450,000 330,000
-----------------------------------------------
Net interest income after provision for loan losses 30,974,248 28,709,469 25,519,124
Other income:
Service charges on deposit accounts 1,955,905 1,670,515 1,827,563
ATM service charges 760,362 490,708 432,984
Gain on sale of loans 961,517 225,108 76,314
Merchant services 1,270,240 1,160,692 1,032,587
Building rent 278,418 310,014 284,456
Security transaction commissions 534,462 122,382 150,611
Investment securities gains (losses), net 420,817 (649) -
Other 783,007 685,489 476,265
-----------------------------------------------
6,964,728 4,664,259 4,280,780
Other expenses:
Salaries and employee benefits 12,907,315 10,194,853 9,402,692
Net occupancy expense 1,216,761 1,213,368 1,052,363
Equipment rentals, depreciation and maintenance 2,786,845 2,500,073 2,563,398
Data Processing 1,977,794 1,698,200 1,599,132
Legal and professional 1,140,723 993,799 543,428
ATMfees 630,449 620,345 618,792
Merchant services 948,651 917,216 871,237
Merger-related charges 7,917,613 - -
Advertising 900,604 806,037 745,690
Goodwill amortization 632,837 151,426 155,765
Other 3,741,876 3,100,526 5,180,404
-----------------------------------------------
34,801,468 22,195,843 22,732,901
-----------------------------------------------
Income before income taxes 3,137,508 11,177,885 7,067,003
Income taxes 1,980,595 3,961,080 2,419,712
-----------------------------------------------
Net income $ 1,156,913 $ 7,216,805 $ 4,647,291
===============================================
Basic earnings per share $ .12 $ .75 $ .48
Diluted earnings per share .12 .74 .48
===============================================
See accompanying notes.
27
FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Unearned Shares
Acquired by
Accumulated Recognition
Additional Other Unearned and
Common Paid-In Retained Comprehensive Shares Held Retention Treasury
Stock Capital Earnings Income by ESOP Plan Stock Total
------------------------------------------------------------------------------------------------------------------------------------
Balances at January 1, 1996 $ 264,912 $28,568,137 $ 40,870,220 $ (114,357) $ (524,893) $ - $ - $69,064,019
Comprehensive income:
Net income - - 4,647,291 - - - - 4,647,291
Other comprehensive income -
Change in net unrealized
gain on securities available
-for-sale, net
of income taxes of $91,255 - - - 177,085 - - - 177,085
------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income - - 4,647,291 177,085 - - - 4,824,376
Cash dividends declared by pooled
companies:
State Financial - $0.12 per
share - - (1,260,273) - - - - (1,260,273)
Issuance of 16,092 shares under
stock plans 1,610 172,801 - - - - - 174,411
Issuance of 6,406,455 shares in
stock conversion of Home 640,645 67,333,737 - - (5,607,400) - - 62,366,982
ESOP shares earned - 49,066 - - 188,813 - - 237,879
Six-for-five stock split 53,304 (53,304) - - - - - -
------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 960,471 96,070,437 44,257,238 62,728 (5,943,480) - - 135,407,394
Comprehensive income:
Net income - - 7,216,805 - - - - 7,216,805
Other comprehensive income -
Change in net unrealized
gain onsecurities
available-for-sale, net
of income taxes
of $421,151 - - - 825,921 - - - 825,921
------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income - - 7,216,805 825,921 - - - 8,042,726
See accompanying notes.
28
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
Unearned Shares
Acquired by
Accumulated Recognition
Additional Other Unearned and
Common Paid-In Retained Comprehensive Shares Held Retention Treasury
Stock Capital Earnings Income by ESOP Plan Stock Total
------------------------------------------------------------------------------------------------------------------------------------
Cash dividends declared by pooled
companies:
State Financial - $0.12 per
share $ - $ - $(1,519,166) $ - $ - $ - $ - $(1,519,166)
Home Bancorp - $0.10 per share - - (2,072,085) - - - - (2,072,085)
Issuance of 17,007 shares under
stock plans 1,700 137,608 - - - - _ 139,308
Issuance of 11,868 shares under
Dividend Reinvestment Plan 1,187 203,630 - - - - - 204,817
Purchase of 140,254 shares of
treasury stock - Home Bancorp - - - - - - (2,469,602) (2,469,602)
Purchase of Recognition and
Retention Plan stock - - - - - (4,498,249) - (4,498,249)
Amortization of award of
Recognition and Retention Plan
stock - - - - - 599,767 - 599,767
ESOP shares earned - 370,922 - - 626,268 - - 997,190
Acquisition of additional
unearned ESOP shares - - - - (1,068,750) - - (1,068,750)
Six-for-five stock split 64,543 (64,543) - - - - - -
------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 1,027,901 96,718,054 47,882,792 888,649 (6,385,962) (3,898,482) (2,469,602) 133,763,350
Comprehensive income:
Net income - - 1,156,913 - - - - 1,156,913
Other comprehensive income -
Change in net unrealized gain
on securities available-for-
sale, net of income taxes of - - - 191,900 - - - 191,900
$132,068
------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income - - 1,156,913 191,900 - - - 1,348,813
Cash dividends declared by pooled
companies:
State Financial - $0.12 per
share - - (2,581,561) - - - - (2,581,561)
Home Bancorp - $0.10 per share - - (2,709,871) - - - (2,709,871)
Issuance of 22,360 shares under
stock plans 2,236 237,417 - - - - _ 239,653
Issuance of 113,241shares in
acquisition of LCC 11,324 2,398,875 - - - - - 2,410,199
Purchase of 198,338 shares of
Treasury stock - Home Bancorp - - - - - - (3,287,456) (3,287,456)
Retirement of 338,593 shares of
Treasury stock - Home Bancorp (33,859) (5,723,199) - - - - 5,757,058 -
Earned Recognition and Retention
Plan stock - - - - - 3,898,482 - 3,898,482
ESOP shares earned - 522,417 - - 1,033,253 - - 1,555,670
------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 $1,007,602 $94,153,564 $43,748,273 $1,080,549 $(5,352,709) $ - $ - $134,637,279
====================================================================================================================================
See accompanying notes.
29
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
1998 1997 1996
-------------------------------------------------------------------------------------------------------------
Operating activities
Net income $ 1,156,913 $ 7,216,805 $ 4,647,291
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 690,000 450,000 330,000
Provision for depreciation 1,539,644 1,425,949 1,501,376
Amortization of investment securities
premiums and accretion of discounts, net 139,712 (558,770) (101,766)
Amortization of goodwill 632,837 151,426 155,765
Amortization of branch acquisition premium - 49,442 29,665
Deferred income tax provision (25,653) (157,006) 39,014
Market adjustment for committed ESOP shares 522,417 370,922 49,066
Cost of Recognition and Retention Plan 3,898,481 599,767 -
Decrease (Increase) in interest receivable (104,756) 84,666 (266,835)
Increase (Decrease) in interest payable (341,447) 235,551 (248,386)
Realized investment securities losses (gains) (420,817) 649 -
Other (1,232,918) (566,195) (844,157)
--------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 6,454,413 $ 9,303,206 $ 5,291,033
Investing activities
Proceeds from maturity or principal payments of
held-to-maturity investment securities 10,757,979 64,644,921 14,461,261
Purchases of held-to-maturity investment
securities - - (49,225,323)
Purchases of securities available-for-sale (53,575,276) (27,550,247) (28,578,265)
Maturities and sales of securities available-for-sale 36,132,603 17,008,319 10,571,805
Net increase in loans before business acquisition (45,464,865) (52,932,908) (10,535,774)
Net purchases of premises and equipment (777,257) (1,065,555) (2,043,248)
Business acquisition, net of cash and cash equivalents
acquired of $1,400 and
$7,673,036 in 1998 and 1997:
Loans - (50,340,430) -
Investment securities available-for-sale - (25,627,465) -
Premises and equipment (68,186) (2,131,733) -
Goodwill (2,584,691) (6,258,137) -
Deposits - 79,921,649 -
Notes payable 204,902 1,400,000 -
Other, net 39,176 (156,310) -
--------------------------------------------------------------------------------------------------------------
Net cash used by investing activities $(55,335,615) $(3,087,896) $(65,349,544)
See accompanying notes.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended December 31,
1998 1997 1996
--------------------------------------------------------------------------------------------------------------------
Financing activities
Net increase in deposits before business acquisitions $ 34,910,317 $29,609,088 $ 414,352
Repayment of notes payable (204,902) (961,844) (100,000)
Proceeds of notes payable 1,450,000 3,900,000 -
Net decrease (increase) in guaranteed ESOP obligation 1,033,253 (442,482) 188,813
Net change in securities sold under agreements to repurchase (733,483) 2,450,000 (900,000)
Increase (decrease) in Federal Home Loan Bank advances 20,000,000 5,000,000 (4,000,000)
Cash dividends (5,291,432) (3,591,252) (1,260,272)
Proceeds (repayments) of federal funds purchased - (5,600,000) 5,600,000
Purchase of Recognition and Retention Plan stock - (4,498,248) -
Shares issued in acquisition 2,410,199 - -
Purchase of treasury stock (3,287,457) (2,469,602) -
Issuance of common stock under Dividend Reinvestment Plan - 204,818 -
Proceeds from sale of stock - - 62,366,982
Proceeds from exercise of stock options 239,654 126,183 174,409
--------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 50,526,149 23,726,661 62,484,284
--------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 1,644,947 29,941,971 2,425,773
Cash and cash equivalents at beginning of year 80,584,884 50,642,913 48,217,140
--------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 82,229,831 $80,584,884 $ 50,642,913
====================================================================================================================
Supplementary information:
Interest paid $ 26,265,360 $19,836,509 $ 19,881,232
Income taxes paid 2,403,500 3,450,040 2,910,975
Non cash transactions - Retirement of treasury stock 5,757,058 - -
See accompanying notes.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-DECEMBER 31, 1998
1. Accounting Policies
The accounting policies followed by State Financial Services Corporation
(the Company) and the methods of applying those principles which materially
affect the determination of its financial position, cash flows or results of
operations are summarized below.
Organization
The Company is a multibank holding company headquartered in Xxxxx
Corners, Wisconsin. Through its wholly owned banking subsidiaries; State
Financial Bank (Wisconsin), State Financial Bank - Waterford, State Financial
Bank (Illinois) and Home Federal Savings and Loan Association of Elgin,
(collectively, the Banks), the Company provides retail and commercial banking
services, brokerage activities and mortgage lending services through its 16
branch locations. The Banks have 9 branch locations in Wisconsin serving
Milwaukee, Waukesha and Racine counties and 7 branch locations in Illinois
serving XxXxxxx, Lake and Cook counties. The Company is also the parent holding
company of State Financial Mortgage Company, which originates fixed and variable
rate secondary market mortgage loans selling them service released; State
Financial Insurance Agency, a subsidiary of State Financial Bank (Illinois)
which sells retail and commercial property and casualty insurance; and Xxxxxx,
Xxxxxxx & Cape which provides asset management and financial planning services
to the Banks' customers and markets.
The Banks and the Company's other subsidiaries are subject to competition
from other financial institutions and financial service providers and are
subject to the regulations of certain federal, State of Wisconsin and State of
Illinois agencies and undergo periodic banking examinations by those regulatory
agencies.
Consolidation
The consolidated financial statements include the accounts of the parent
company and its subsidiaries. All significant intercompany balances and
transactions have been eliminated.
Business Combinations
In business combinations accounted for using the purchase method of
accounting, the net assets of the companies acquired are recorded at fair value
at the date of acquisition. Goodwill is amortized on a straight-line basis over
the estimated periods benefited generally 15 years. The results of operations of
acquired companies are included since the date of acquisition.
31
FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Accounting Policies (continued)
In business combinations accounted for as poolings-of-interests, the
financial position and results of operations and cash flows of the respective
companies are restated as though the companies were combined for all historical
periods. Certain amounts for 1997 and 1996 have been restated to conform with
the 1998 presentation.
Use of Estimates
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statement of cash flows, cash and cash equivalents
include cash and due from banks, interest-bearing bank balances, federal funds
sold and other commercial paper investments with an original maturity of three
months or less.
Share Data
Share data and per share information have been restated for all periods
to give effect to the January 28, 1997, six-for-five stock split and the January
27, 1998, six-for-five stock split.
Investment Securities
Debt securities that the Company does not have a positive intent and
ability to hold to maturity and equity securities are classified as
available-for-sale and are carried at estimated fair value, with unrealized
gains and losses, net of tax, reported as a separate component of shareholders'
equity.
The amortized cost of debt securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-related securities, over the
estimated life of the security. Such amortization is calculated using the
level-yield method, adjusted for prepayments, and is included in interest income
from investments. Realized gains and losses, and declines in value judged to be
other than temporary are included in net securities gains and losses. The cost
of securities is based on the specific identification method.
Interest on Loans
Interest income on loans is accrued and credited to operations based on
the principal amount outstanding. The accrual of interest income is generally
discontinued when a loan becomes 90 days past due as to principal or interest
and/or when, in the opinion of management, full collection is unlikely. When
interest accruals are discontinued, unpaid interest credited to income in the
current year is reversed and unpaid interest accrued in the prior year is
charged to the allowance for loan losses. Management may elect to continue the
accrual of interest when the loan is in the process of collection and the fair
value of collateral is sufficient to cover the principal balance and accrued
interest. Interest received on nonaccrual loans is either applied against
principal or reported as interest income according to management's judgment
regarding the collectibility of principal. Generally, loans are restored to
accrual status when the obligation is brought current, has performed in
accordance with the contractual terms for a reasonable period of time and the
ultimate collectibility of the total contractual principal and interest is no
longer in doubt.
Loan Fees and Related Costs
Loan origination and commitment fees and certain direct loan origination
costs are deferred and the net amounts are amortized as an adjustment of the
related loan's yield. The Company is generally amortizing these amounts using
the level-yield method over the contractual life of the related loans. Fees
related to standby letters of credit are recognized over the commitment period.
Allowance for Loan Losses
The allowance for loan losses is composed of specific and general
valuation allowances. The Company establishes specific valuation allowances on
income-producing real estate loans considered impaired. A loan is considered
impaired (and a specific valuation allowance established for an amount equal to
the impairment) when the carrying amount of the loan exceeds the present value
of the expected future cash flows, discounted at the loans original effective
interest rate, or the fair value of the underlying collateral.
General valuation allowances are based on an evaluation of the various
risk components that are inherent in the credit portfolio.
The risk components that are evaluated include past loan loss experience;
the level of nonperforming and classified assets; current economic conditions;
volume, growth and composition of the loan portfolio; adverse situations that
may affect the borrower's ability to repay; the estimated value of any
underlying collateral; peer group comparisons; regulatory guidance; and other
relevant factors. The allowance is increased by provisions charged to earnings
and reduced by charge-offs, net of recoveries. Management may transfer reserves
between specific and general valuation allowances as considered necessary. The
adequacy of the allowance for loan losses is approved quarterly by the Company's
board of directors. The allowance reflects management's best estimate of the
reserves needed to provide for the impairment of commercial and income-producing
real estate loans, as well as other credit risks of the Banks and is based on a
risk model developed and implemented by management and approved by the Company's
board of directors. However, actual results could differ from this estimate and
future additions to the allowance may be necessary based on unforeseen changes
in economic conditions. In addition, federal regulators periodically review the
Banks' allowance for loan losses. Such regulators have the authority to require
the Banks to recognize additions to the allowance at the time of their
examination.
32
1. Accounting Policies (continued)
A substantial portion of the Banks' loans are to customers located in
Southeastern Wisconsin and Northeastern Illinois. Accordingly, the ultimate
collectibility of a substantial portion of the Banks' loan portfolios is
susceptible to changes in market conditions in that area.
Premises and Equipment
Land is carried at cost. Premises and equipment are carried at cost less
accumulated depreciation. The provision for depreciation is computed using both
accelerated and straight-line methods over the estimated useful lives of the
respective assets. Leasehold improvements are amortized using both accelerated
and straight-line methods over the shorter of the useful life of the leasehold
asset or lease term.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the
weighted-average common shares outstanding less unearned ESOP shares. Diluted
earnings per share is computed by dividing net income by the weighted-average
common shares outstanding less unallocated ESOP shares plus the assumed
conversion of all potentially dilutive securities. Weighted-average shares
outstanding for 1996 assume that Home Bancorp of Elgin, Inc. shares were
outstanding for the entire year.
The denominators for the earnings per share amounts are as follows.
1998 1997 1996
------------------------------------------------------------------------
Basic:
Weighted-average number
of shares outstanding 10,109,059 10,193,642 10,236,643
Less: weighted-average
number of unearned
ESOP shares (503,182) (553,635) (566,580)
------------------------------------------------------------------------
Denominator for basic
earnings per share 9,605,877 9,640,007 9,670,063
========================================================================
Fully diluted:
Denominator for basic
earnings per share 9,605,877 9,640,007 9,670,063
Add: assumed conversion
of stock options using
the treasury stock method 74,089 89,832 39,326
Denominator for fully diluted
earnings per share 9,679,966 9,729,839 9,709,389
========================================================================
Income Taxes
The Company accounts for income taxes using the liability method. Deferred
income tax assets and liabilities are adjusted regularly to amounts estimated to
be receivable or payable based on current tax law and the Company's tax status.
Valuation allowances are established for deferred tax assets for amounts for
which it is more likely than not that they will be realized.
Stock Option Plan
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation," permits entities to recognize as expense over the
vesting period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 allows entities to apply the provisions of APB
Opinion No. 25 and provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants made as if the fair value based
method defined in SFAS No. 123 had been applied. The Company accounts for its
stock option plans in accordance with the provisions of Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. As such, compensation expense is recorded for stock
options only to the extent that the current market price of the underlying stock
exceeded the exercise price on the date of grant. The Company elected to apply
the provisions of APB Opinion No. 25 because the alternative requires use of
option valuation models that were not developed for use in valuing employee
stock options similar to the Company's. The fair value of the stock options
granted was not material for the years ended December 31, 1998 and 1997.
Employee Stock Ownership Plan (ESOP)
Compensation expense under the ESOP is equal to the fair value of common
shares released or committed to be released to participants in the ESOP in each
respective period. Common stock purchased by the ESOP and not committed to be
released to participants is included in the consolidated balance sheet at cost
as a reduction of shareholders' equity.
Accounting Changes
The Company adopted SFAS No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," as of January 1, 1997,
which provides new accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on a
consistent application of the financial-components approach that focuses on
control. There was no material impact on the financial statements of the
Company.
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." Statement No.
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of this Statement had no impact on the
Company's net income or shareholders' equity. Statement No. 130 requires
unrealized gains or losses on the Company's available-for-sale securities, which
prior to adoption were reported separately in shareholders' equity, to be
included in other comprehensive income. Prior year financial statements have
been reclassified to conform to the requirements of Statement No. 130.
33
FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. Accounting Policies (continued)
Effective January 1, 1998, the Company adopted Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information." Statement
No. 131 establishes standards for the reporting of financial information from
operating segments in annual and interim financial statements. This Statement
requires that financial information be reported on the basis that it is reported
internally for evaluating segment performance and deciding how to allocate
resources to segments. Because this Statement addresses how supplemental
financial information is disclosed in annual and interim reports, the adoption
had no material impact on the financial statements. The Company evaluates
segment performance based on geographic location - State Financial Bank
(Wisconsin), State Financial Bank - Waterford, State Financial Bank (Illinois)
and Home Federal Savings and Loan Association of Elgin.
Pending Accounting Changes
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities," provides a comprehensive and consistent standard for the
recognition and measurement of derivatives and hedging activities. The new
Statement resolves inconsistencies that currently exist with respect to
derivatives accounting and dramatically changes the way many derivative
transactions and hedged items are reported. Statement No. 133 is effective for
years beginning after June 15, 1998. The Statement is not expected to have an
impact on the Company.
2. Acquisitions
On December 15, 1998, the Company merged with Home Bancorp of Elgin, Inc.
(Home Bancorp). During the combination, Home Bancorp was merged into State
Financial Services Corporation and its wholly owned subsidiary bank, Home,
became a wholly owned subsidiary of the Company. Each outstanding share of Home
Bancorp common stock was converted into and exchanged for .914 shares of the
Company's common stock, resulting in the issuance of 6,067,862 shares. The
acquisition was accounted for as a pooling-of-interests and, accordingly, all
historical financial information and share data for the Company has been
restated to include Home for all periods presented herein. Certain
reclassifications were made to the Home financial statements to conform to the
Company's presentations. Charges totaling $201,245 were recorded to conform
Home's accounting policies for fixed assets and contributions.
In connection with the merger, the Company recorded charges of $7,917,613
for merger-related costs. Management of the Company currently expects that the
Home ESOP will sell a sufficient number of shares to repay the ESOP debt of
$3,970,000 in the first quarter of 1999, which may result in additional
compensation expense. Shares remaining in the Home ESOP after repayment of the
ESOP debt will be allocated to Home ESOP participants. The amount of the
additional expense will be dependent upon the market value of the Company's
common stock at the time the ESOP is dissolved. Management estimates the amount
of the additional compensation expense related to the termination will range
between $1,000,000 and $1,500,000, based on an estimated range of market value
of the Company's stock of $13.625 and $15.00, respectively.
Additional employment severance payments, not recorded as of December 31,
1998, and ranging from $835,000 to $1,100,000, may be incurred should five
certain Home employees who have contractual severance arrangements all choose to
terminate their employment with the Company prior to December 15, 2000. The
actual amount of expense incurred, if any, is dependent upon the number of these
employees choosing to terminate their employment with the Company and the point
in time at which this election is made. The amount of payment actually paid to
any one of these five employees will be reduced by the applicable employee's pro
rata monthly salary multiplied by the number of months between the merger date
(December 15, 1998) and the month in which the employee notifies the Company if
higher desire to terminate employment. The Company will recognize any expense
resulting from these severance agreements as additional merger-related charges
in the period notification is received from one of these Home employees. The
Company has received no notice from the employees that they intend to terminate
their employment with the Company. Details of the merger-related costs follow:
1998
Provision
-------------
Legal, accounting and professional fees $ 2,638,342
RRPtermination 3,148,773
Severance 1,297,498
Other 833,000
-------------
$ 7,917,613
=============
The pretax impact of the merger-related charges on basic and diluted
earnings per share was $0.62 in 1998 of the $7,917,613 in merger-related charges
recognized in 1998, $7,517,477 was actually paid during the year. The remaining
$400,136 of merger-related expenses recognized in 1998 will be paid in 1999.
On September 8, 1998, the Company completed its acquisition of Xxxxxx,
Xxxxxxx and Cape (LCC), an asset management firm located in La Crosse,
Wisconsin. The Company purchased the outstanding common stock of LCC in exchange
for 113,241 shares of its common stock valued at $21.19 per share on the
transaction date. An additional 28,310 shares of common stock may be issued on
January 31, 2000, subject to LCC meeting or exceeding certain operating
performance targets in 1999, 2000 and 2001. Such additional shares will be
recorded as an adjustment of the purchase price. The acquisition was recorded as
a purchase. Proforma data to include LCC financial results is not presented as
the effect is immaterial.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Acquisitions (continued)
On December 31, 1997, the Company completed its acquisition of Richmond
Bancorp, Inc. (Bancorp), Richmond, Illinois. The Company purchased the
outstanding common stock of Bancorp for $10,787,495 in cash. In connection with
the acquisition, the Company borrowed $3,900,000 on its line of credit and
assumed $1,400,000 of Bancorp's outstanding debt. The acquisition was recorded
using purchase accounting.
On a pro forma basis, total income, net income, basic earnings per share
and diluted earnings per share for the year ended December 31, 1997, after
giving effect to the acquisition of Richmond as if it occurred on January 1,
1997, follow.
Total income $ 61,664
Net income 6,539
Basic earnings per share 0.68
Diluted earnings per share 0.67
==========
On March 12, 1999, the Company entered into a definitive agreement to
acquire all of the outstanding stock of First Waukegan Corporation in exchange
for $28 million in cash. First Waukegan Corporation is the parent company of
Bank of Northern Illinois, N.A., a $212 million national bank headquartered in
Waukegan, Illinois. The merger will be accounted for as a purchase and is
expected to close no later than the third quarter of 1999.
3. Restrictions on Cash and Due From Bank Accounts
The Banks are required to maintain reserve balances with the Federal
Reserve Bank. The average amount of reserve balances for the years ended
December 31, 1998 and 1997, was approximately $4,169,000 and $3,384,000,
respectively.
4. Investment Securities
The amortized cost and estimated fair value of investments in debt
securities follow.
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------------------------------------------------------------
Held-to-Maturity
December 31, 1998:
U.S. Treasury securities and obligations
of U.S. government agencies $5,340,509 $ 58,263 $ (5,672) $ 5,393,100
Obligations of state and political subdivisions 4,449,732 131,333 (823) 4,580,242
Other securities 500,000 11,520 (5,460) 506,060
------------------------------------------------------------------
$10,290,241 $ 201,116 $ (11,955) $ 10,479,402
==================================================================
December 31, 1997:
U.S. Treasury securities and obligations of U.S.
government agencies $11,941,993 $ 90,289 $ (5,672) $ 12,026,610
Obligations of state and political subdivisions 8,646,648 129,717 (823) 8,775,542
Other securities 500,000 4,720 (5,460) 499,260
-----------------------------------------------------------------
$21,088,641 $ 224,726 $ (11,955) $ 21,301,412
=================================================================
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
------------------------------------------------------------------
Available-for-Sale
December 31, 1998:
U.S. Treasury securities and obligations of U.S.
government agencies $35,859,284 $ 539,153 $ (61,131 )$36,337,306
Obligations of state and political subdivisions 26,378,209 544,358 (7,286) 26,915,281
Mortgage-related securities 21,792,307 201,250 (15,178) 21,978,379
Other securities 9,008,946 464,915 - 9,473,861
------------------------------------------------------------------
$93,038,746 $1,749,676 $ (83,595) $ 94,704,827
===================================================================
December 31, 1997:
U.S. Treasury securities and obligations of U.S.
government agencies $34,880,814 $ 167,423 $ (61,131 )$34,987,106
Obligations of state and political subdivisions 17,275,223 183,048 (7,286) 17,450,985
Mortgage-related securities 17,242,183 158,676 (15,178) 17,385,681
Other securities 5,876,327 916,561 - 6,792,888
------------------------------------------------------------------
$75,274,547 $1,425,708 $ (83,595) $ 76,616,660
------------------------------------------------------------------
35
FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. Investment Securities (continued)
The amortized cost and estimated fair value of investment securities at
December 31, 1998, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities because borrowers or issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties. Equity Securities are included in the "Due in one year or less" line.
Held-to-Maturity Available-for-Sale
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
--------------------------------------------------------------------
Due in one year or less $ 6,386,253 $ 6,427,893 $14,964,743 $ 15,392,742
Due after one year through five years 1,794,646 1,814,818 59,981,838 60,885,020
Due after five years through ten years 1,657,475 1,754,105 17,762,165 18,095,425
Due after ten years 451,867 482,586 330,000 331,640
--------------------------------------------------------------------
$10,290,241 $ 10,479,402 $93,038,746 $ 94,704,827
====================================================================
The Company's investments in mortgage-related securities have been
allocated to the various maturity categories based on expected maturities using
current prepayment estimates.
Proceeds from sales of investments in debt and marketable equity
available-for-sale securities were $13,308,960 and $980,565 during 1998 and
1997, respectively. Gross gains of $420,817 and no losses were realized on the
1998 sales. Gross losses of $649 and no gains were realized on the 1997 sales.
No investment securities were sold during 1996.
1998
---------------------------------------
Before Tax Net-of-
Tax (Benefit) Tax
Amount Expense Amount
---------------------------------------
Unrealized gains on available-for-sale securities $ 744,785 $ 297,070 $ 447,715
Less: reclassification adjustment for gains
realized in net income (420,817) (165,002) (255,815)
---------------------------------------
Net unrealized gains $ 323,968 $ 132,068 $ 191,900
=======================================
1997
---------------------------------------
Before Tax Net-of-
Tax (Benefit) Tax
Amount Expense Amount
---------------------------------------
Unrealized gains on available-for-sale securities $1,246,423 $ 420,897 $ 825,526
Less: reclassification adjustment for gains
realized in net income 649 254 395
---------------------------------------
Net unrealized gains $ 1,247,072 $ 421,151 $ 825,921
=======================================
1996
---------------------------------------
Before Tax Net-of-
Tax (Benefit) Tax
Amount Expense Amount
---------------------------------------
Unrealized gains on available-for-sale securities $ 268,310 $ 91,225 $ 177,085
Less: reclassification adjustment for gains
realized in net income - - -
---------------------------------------
Net unrealized gains $ 268,310 $ 91,225 $ 177,085
=======================================
At December 31, 1998 and 1997, investment securities with a carrying
value of $25,430,899 and $29,981,479, respectively, were pledged as collateral
to secure public deposits and for other purposes.
36
5. Loans
A summary of loans outstanding at December 31, 1998 and 1997, follows.
1998 1997
------------------------------------
Commercial $ 56,675,361 $ 56,029,636
Consumer 37,518,890 37,496,793
Real estate mortgage 506,844,544 461,699,947
Other 11,394,609 12,317,868
------------------------------------
$ 612,433,404 $567,544,244
====================================
6. Allowance for Loan Losses
Changes in the allowance for loan losses for the three years ended December 31,
1998, are as follows.
1998 1997 1996
-------------------------------------------------
Balance at beginning of year $ 4,370,209 $ 3,552,378 $ 3,537,073
Allowance from
acquired bank - 678,235 -
Provision for loan losses 690,000 450,000 330,000
Charge-offs (799,609) (381,037) (385,714)
Recoveries 223,904 70,633 71,019
-------------------------------------------------
Net charge-offs (575,705) (310,404) (314,695)
-------------------------------------------------
Balance at end of year $ 4,484,504 $ 4,370,209 $ 3,552,378
=================================================
Total nonaccrual loans were $3,245,065 and $3,500,405 at December 31,
1998 and 1997, respectively.
7. Loans to Related Parties
In the ordinary course of business, loans are granted to related parties,
which include bank officers, principal shareholders, directors and entities in
which such persons are principal shareholders. Loans outstanding at December 31,
1998 and 1997, to such related parties were approximately $13,542,228 and
$11,467,427, respectively. During 1998, approximately $7,413,316 of new loans
were made and repayments totaled approximately $5,338,515. Loans to related
parties were made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
unrelated persons and do not involve more than the normal risk of
collectibility.
8. Premises and Equipment
A summary of premises and equipment at December 31, 1998 and 1997, is as
follows.
1998 1997
---------------------------------
Buildings $ 14,000,208 $14,017,910
Furniture and equipment 12,063,683 11,084,986
Leasehold improvements 2,385,413 2,315,889
---------------------------------
28,449,304 27,418,785
Less accumulated depreciation (17,751,796) (16,027,076)
Land 2,635,861 2,635,861
---------------------------------
$ 13,333,369 14,027,570
=================================
9. Notes Payable
The Company has a $10,000,000 line of credit available through April 30,
1999, at 90-day LIBOR plus 1.35% (6.94% at December 31, 1998). As of December
31, 1998, $6,750,000 is outstanding on the line. As of December 31, 1997,
$3,900,000 was outstanding on the line. The Company had a revolving credit
agreement which had an outstanding balance of $1,400,000 at December 31, 1997.
This loan was paid and the revolving credit agreement terminated on January 14,
1998.
At December 31, 1998 and 1997, advances from the Federal Home Loan Bank
of Chicago totaled $25,000,000 and $5,000,000, respectively, which were due on
demand under an open line of credit of $63,430,000. The interest rate on the
advances at December 31, 1998 and 1997, was 5.13% and 6.92%, respectively. The
Company has a collateral pledge agreement whereby it agrees to keep on hand,
free of all other pledges, loans and encumbrances, performing loans with unpaid
principal balances aggregating no less than 167% of the outstanding secured
advances. All stock in the Federal Home Loan Bank of Chicago is also pledged as
additional collateral for advances.
10. Employee Benefit Plans
The Company has a noncontributory money purchase pension plan covering
substantially all employees who meet certain minimum age and service
requirements. Annual contributions are fixed based on compensation of
participants. Home employees became eligible to participate in the plan upon
consummation of the business combination. Home employees received full credit
for service with Home for purposes of eligibility and are treated as new hires
for purposes of vesting. The Company's contribution to the pension plan for each
participant is an amount equal
37
FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Employee Benefit Plans (continued)
to 4% of the participant's total eligible compensation plus an additional 2% of
the participant's eligible compensation in excess of $20,000. Home sponsored a
noncontributory pension plan which was terminated by the board of directors of
Home effective August 31, 1996. Plan benefits ceased to accrue on June 20, 1996.
Upon termination, all benefits became 100% vested and all persons entitled to
benefits were entitled to request an immediate lump-sum settlement of the
benefit entitlement. The Company recorded a pension curtailment expense of
$837,000 in 1996 in conjunction with the termination of the Home Pension Plan.
The Home Pension Plan was liquidated in January, 1997, and $182,000 in excess
funds reverted back to the Company. The Company's funding policy is to
contribute annually the maximum amount that can be deducted for federal income
tax purposes. Exclusive of the Home Pension curtailment expense, Company
contributions are made annually at the discretion of the board of directors and
amounted to $128,965 in 1998, $150,334 in 1997 and $309,788 in 1996. Plan assets
are invested in a diversified portfolio of high-quality debt and equity
investments.
The Company sponsors a 401(k) savings plan which covers all full-time
employees who have completed one year of service and are at least 21 years old.
Home employees became participants of the plan upon consummation of the merger
and received credit for prior service for purposes of eligibility and vesting.
Company contributions are discretionary. The Company has not made any
contributions for 1998, 1997 and 1996.
The Company has an Employees' Stock Ownership Plan (ESOP) for the benefit
of employees meeting certain minimum age and service requirements. Company
contributions to the ESOP trust, which was established to fund the plan, are
made on a discretionary basis and are expensed to operations in the year
committed. The number of shares released to participants is determined based on
the annual contribution amount plus any dividends paid on unearned shares
divided by the market price of the stock at the contribution date.
In addition, Home had an ESOP formed in September 1996. The Home ESOP
covers substantially all Home employees that are age 21 or over with at least
1,000 hours of service. The Home ESOP borrowed $5,607,400 from Home Bancorp and
purchased 512,516 common shares. Home committed to make discretionary
contributions to the Home ESOP sufficient to meet debt service requirements of
the loan over a period of ten years. During the years ended December 31, 1998,
1997 and 1996, 85,587, 51,252 and 12,813 shares were allocated, respectively.
On December 15, 1998, in connection with the merger of Home Bancorp with
the Company, common shares held by the Home ESOP were converted into an
equivalent number of shares of the Company using the merger exchange ratio of
.914 per share. As discussed in Note 2, management of the Company currently
expects that the Home ESOP will sell a sufficient number of shares to repay the
ESOP debt. Subsequent to the Home ESOP debt repayment the Home ESOP will be
merged into the Company 401(k) plan.
The aggregate activity in the number of unearned ESOP shares follows.
1998 1997 1996
-----------------------------------
Balance at beginning of year $ 545,976 $ 550,658 $ 60,472
Shares committed to be released (100,280) (64,682) (22,330)
Additional shares purchased - 60,000 512,516
-----------------------------------
Balance at end of year $ 445,696 $ 545,976 $550,658
===================================
At December 31, 1998, the fair value of unearned ESOP shares is
$6,685,445. Total ESOP expense recognized for the years ended December 31, 1998,
1997 and 1996, was $1,069,000, $932,000 and $189,000, respectively.
Recognition and Retention Plan (RRP)
On April 17, 1997, Home adopted an RRP. The fair value of the Home
Bancorp shares on the grant date is amortized to compensation expense as Home's
employees and directors become vested in those shares. The aggregate purchase
price of all shares acquired by the RRP is reflected as a reduction of
shareholders' equity. Shares vested at a rate of 20% per year with the first
vesting period ending May 1, 1998.
As provided for under the plan provisions, all RRP shares granted became
fully vested on November 5, 1998, the date the shareholders' of Home Bancorp
approved Home Bancorp's merger with the Company. The accelerated vesting
resulted in additional compensation expense of $3,148,773 for the year ended
December 31, 1998, which is classified as part of the merger-related charges.
For the years ended December 31, 1998 and 1997, RRP expense totaled $3,898,481
and $599,766, respectively. All shares which were granted under the RRP were
distributed to employees during the year ended December 31, 1998.
11. Income Taxes
The Company and its subsidiaries file a consolidated federal income tax
return. The subsidiaries provide for income taxes on a separate-return basis and
remit to the Company amounts determined to be currently payable or realize the
benefit they would be entitled to on such a basis. The Company and subsidiaries
file separate state income tax returns for Wisconsin and a combined State Return
for Illinois.
38
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. Income Taxes (continued)
Significant components of the provision for income taxes attributable to
continuing operations are as follows.
1998 1997 1996
----------------------------------------
Current:
Federal $ 2,890,595 $3,537,080 $2,028,712
State 591,000 581,000 352,000
----------------------------------------
3,481,595 4,118,080 2,380,712
Deferred (credit):
Federal (1,205,000) (133,000) 55,000
State (296,000) (24,000) (16,000)
----------------------------------------
(1,501,000) (157,000) 39,000
----------------------------------------
$ 1,980,595 $3,961,080 $2,420,712
========================================
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities of December 31,
1998 and 1997, are as follows.
1998 1997
--------------------------------
Deferred tax assets:
Federal net operating loss carryforward $ 169,000 $ 207,000
State net operating loss carryforward 330,000 315,000
Accumulated depreciation - 68,000
Recognition and Retention Plan 1,399,000 247,000
Unearned income 265,000 -
Deferred loan fees 304,000 495,000
Other 378,000 376,000
--------------------------------
2,845,000 1,708,000
Valuation allowance for deferred tax assets (491,000) (518,000)
--------------------------------
Net deferred tax assets 2,354,000 1,190,000
Deferred tax liabilities:
FHLB dividends 157,000 164,000
Accumulated depreciation 49,000 -
Allowance for loan losses 79,000 477,000
Unrealized gain on investment securities 585,000 453,000
Net deferred tax liabilities - other 397,000 378,000
--------------------------------
Total deferred tax liabilities 1,267,000 1,472,000
--------------------------------
Net deferred tax asset (liability) $ 1,087,000 $ (282,000)
================================
The income tax expense differs from that computed at the federal
statutory corporate tax rate as follows.
1998 1997 1996
-------------------------------------
Income before income taxes $3,137,508 $ 11,177,885 $7,067,003
=====================================
Income tax expense at the federal
statutory rate of 34% $1,066,753 $ 3,800,515 $2,402,935
Increase (decrease) resulting from:
Tax-exempt interest income (532,000) (322,000) (280,000)
State income taxes, net of federal
income tax benefit 195,000 367,569 231,999
Nondeductible merger-related
expenses 932,000 - -
Goodwill amortization 291,000 - -
Increase (decrease) in valuation
allowance for deferred
tax assets (35,000) 39,000 (20,000)
Other 62,842 75,996 84,778
-------------------------------------
$1,980,595 $ 3,961,080 $2,419,712
=====================================
At December 31, 1998, the Company had federal net operating loss
carryforwards of approximately $431,000 and state net operating loss
carryforwards of approximately $6,810,000. The federal net operating loss
carryforwards and $431,000 of state net operating loss carryforwards are subject
to an annual limitation of approximately $100,000 and are available to reduce
future tax expense through the year ending December 31, 2009. The remaining
state net operating loss carryforwards expire in years 1999 through 2013.
Retained earnings at December 31, 1998 and 1997, include $4,798,000 for
which no provision for federal income tax has been made. Home qualified under
provisions of the Internal Revenue Code that permitted it to deduct from taxable
income an allowance for bad debts that differed from the provision for losses
charged to income for financial reporting purposes. If income taxes had been
provided, the deferred tax liability would have been approximately $1,800,000.
12. Restrictions on Subsidiaries' Dividends, Loans or Advances
Dividends are paid by the Company from its assets, which are mainly
provided by dividends from the Banks. However, certain restrictions exist
regarding the ability of the Banks to transfer funds to the Company in the form
of cash dividends, loans or advances. Approval of the regulatory authorities is
required to pay dividends in excess of certain levels of the Banks' retained
earnings.
39
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 1998, the Banks had net retained earnings of
$4,665,000, which are available for distribution to the Company as dividends
without prior regulatory approval.
Under Federal Reserve Bank regulations, the Banks are limited as to the
amount they may loan to their affiliates, including the Company, unless such
loans are collateralized by specified obligations. At December 31, 1998, the
maximum amount available for transfer from the Banks to the Company in the form
of loans approximated 10% of the Banks' consolidated net worth.
The Office of Thrift Supervision (OTS) imposes limitations upon all
capital distributions by savings institutions, including cash dividends. An
institution that exceeds all fully phased-in capital requirements before and
after a proposed capital distribution (Tier1 Association), and has not been
advised by the OTS that it is in need of more than normal supervision, could,
after prior notice but without the approval of the OTS, make capital
distributions during a calendar year up to the higher of (i) 100% of its net
income to date during the calendar year, plus the amount that would reduce by
one-half its surplus capital ratio (the excess capital over its fully phased-in
capital requirements) at the beginning of the calendar year; or (ii) 75% of its
net income over the most recent four-quarter period. Any additional capital
distributions would require prior regulatory approval. The OTS has the ability
to object to a capital distribution notice on safety and soundness grounds.
13. Financial Instruments With Off-Balance-Sheet Risk
Loan commitments are made to accommodate the financial needs of the
Company's customers. Standby letters of credit commit the Company to make
payments on behalf of customers when certain specified future events occur. Both
arrangements have credit risk essentially the same as that involved in extending
loans to customers and are subject to the Company's normal credit policies.
Collateral is obtained based on management's credit assessment of the customer.
The Company's maximum exposure to credit loss for loan commitments
(unfunded loans and unused lines of credit) and standby letters of credit
outstanding at December 31, 1998, were $63,343,000 and $1,360,000, respectively.
All such arrangements expire in 1999. Loan commitments and standby letters of
credit were $39,963,000 and $714,000, respectively, at December 31, 1997.
14. Leases
The Company rents space for banking facilities under operating leases.
Certain leases include renewal options and provide for the payment of building
operating expenses and additional rentals based on adjustments due to inflation.
Rent expense under operating leases totaled approximately $453,583, $563,720 and
$483,289 in 1998, 1997 and 1996, respectively.
Future minimum payments for the years indicated under noncancellable
operating leases with initial terms of one year or more consisted of the
following at December 31, 1998.
1999 $ 428,000
2000 437,000
2001 397,000
2002 397,000
2003 392,000
Thereafter 1,772,000
-----------
$ 3,823,000
===========
40
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. Regulatory Capital
The Company and subsidiary Banks are subject to various regulatory
capital requirements administered by state and federal banking agencies. Failure
to meet minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary, actions by regulators, that, if undertaken,
could have a direct material effect on the Company's and subsidiary Banks'
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and subsidiary Banks must
meet specific capital guidelines that involve quantitative measures of the
Company's and subsidiary Banks' assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Company and subsidiary Banks' capital amounts and classification are also
subject to qualitative judgements by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and subsidiary Banks to maintain minimum amounts
and ratios (set forth in the table on the next page) of total and Tier I capital
(as defined in the regulations) to risk-weighted assets (as defined), and of
Tier I capital (as defined) to average assets (as defined). Management believes,
as of December 31, 1998, that the Company and subsidiary Banks meet all capital
adequacy requirements to which they are subject.
15. Regulatory Capital (continued)
41
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 1998, the most recent notification from state
regulators categorized the Company and subsidiary Banks as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized, the Company and subsidiary Banks must maintain minimum
total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in
the table. There are no conditions or events since that notification that
management believes have changed the institutions' category.
The Company's and subsidiary Banks' actual, minimum and well capitalized
capital amounts and ratios are also presented in the table (dollars in
thousands).
To Be Well
Capitalized Under
For Capital Prompt Corrective
Adequacy Purposes Action Provisions Actual
--------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------
As of December 31, 1998
Total Capital (to Risk Weighted Assets):
Consolidated $41,674 8 % $52,092 10 % $128,371 24.6%
State Financial Bank (Wisconsin) 15,908 8 19,885 10 24,951 12.5
State Financial Bank - Waterford 2,950 8 3,687 10 4,348 11.8
State Financial Bank (Illinois) 3,732 8 4,665 10 6,933 14.9
Home Federal Savings 18,046 8 22,558 10 73,604 32.6
Tier I Capital (to Risk Weighted Assets):
Consolidated 20,837 4 31,255 6 123,897 23.8
State Financial Bank (Wisconsin) 7,954 4 11,931 6 22,888 11.5
State Financial Bank - Waterford 1,475 4 2,212 6 3,886 10.5
State Financial Bank (Illinois) 1,866 4 2,799 6 6,349 13.6
Home Federal Savings N/A N/A 13,535 6 72,425 32.1
Tier I Capital (to Average Assets):
Consolidated 32,538 4 40,673 5 123,896 15.2
State Financial Bank (Wisconsin) 11,174 4 13,968 5 22,889 8.2
State Financial Bank - Waterford 2,103 4 2,628 5 3,887 7.4
State Financial Bank (Illinois) 3,133 4 3,916 5 6,370 8.1
Home Federal Savings 11,502 3 19,170 5 72,425 18.9
As of December 31, 1997
Total Capital (to Risk Weighted Assets):
Consolidated $37,485 8 % $46,857 10 % $33,034 7.1%
State Financial Bank (Wisconsin) 15,278 8 19,098 10 24,686 12.9
State Financial Bank - Waterford 2,477 8 3,097 10 4,110 13.3
State Financial Bank (Illinois) 4,193 8 5,241 10 6,576 12.5
Home Federal Savings 15,100 8 18,874 10 70,272 37.2
Total Capital (to Risk Weighted Assets):
Consolidated 18,743 4 28,114 6 29,728 6.3
State Financial Bank (Wisconsin) 7,639 4 11,459 6 22,596 11.8
State Financial Bank - Waterford 1,239 4 1,858 6 3,721 12.0
State Financial Bank (Illinois) 2,096 4 3,145 6 5,921 11.3
Home Federal Savings N/A N/A 11,324 6 69,208 36.7
As of December 31, 1997
Tier I Capital (to Average Assets):
Consolidated 26,792 4 33,490 5 29,728 4.4
State Financial Bank (Wisconsin) 10,608 4 13,260 5 22,596 8.5
State Financial Bank - Waterford 1,865 4 2,332 5 3,721 8.0
State Financial Bank (Illinois) 3,218 4 4,022 5 5,921 7.4
Home Federal Savings 9,946 3 16,663 5 69,208 20.9
42
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. Stock Plans and Options
The Company's board of directors adopted the 1990 Stock Option/Stock
Appreciation Rights and Restricted Stock Plan for Key Officers and Employees,
and the 1990 Director Stock Option Plan (collectively, the 1990 Stock Plans).
At the Annual Shareholders' Meeting held on May 13, 1998, the
shareholders approved the 1998 Stock Incentive Plan allowing for the grant of
restricted stock, incentive stock options and non-qualified option to officers,
directors, and key consultants of the Company (the 1998 Plan). The 1998 Plan
replaced the 1990 Stock Plans.
The Company has reserved 425,000 shares of its common stock as of
December 31, 1998, for the exercise of options and issuance of shares under the
1998 Plan. Options are exercisable at a price equal to the fair market value of
the shares at the time of the grant. Options must be exercised within ten years
after grant.
Stock Option Plan
On April 17, 1997, Home, adopted a stock option plan (Home Plan) pursuant
to which Home's board of directors may grant stock options to directors,
officers and employees of Home. Substantially all options were granted in 1997.
Options vest at a rate of 20% per year. The exercise price is equal to the fair
market value of the common stock at the date of grant, and the option term
cannot exceed ten years. On December 15, 1998, in connection with the merger of
Home with the Company, all common stock options under the plan became fully
vested and were converted into an equivalent number of options to purchase
shares of the Company using the merger exchange ratio of .914 per share. On an
adjusted basis, options to purchase 640,645 shares were authorized under the
Home Plan.
A summary of all restricted stock and stock option transactions follows.
Number of
Shares of Number Total
Restricted of Stock Number
Stock Price Options Price of Shares
---------------------------------------------------------------------
Balance at December 31, 1995 11,163 $5.07 - $ 8.11 108,296 $ 3.85 - $ 9.26 119,459
Granted - - 8,165 9.55 - 13.05 8,165
Vested restricted stock (2,074) 6.87 - 7.52 - - (2,074)
Exercised - - (23,420) 3.85 - 8.11 (23,420)
Canceled - - (726) 5.07 - 6.87 (726)
---------------------------------------------------------------------
Balance at December 31, 1996 9,089 5.07 - 8.11 92,315 3.85 - 13.03 101,404
Granted 600 21.87 646,712 14.15 - 21.87 647,312
Vested restricted stock (7,517) 5.07 - 8.11 - - (7,517)
Exercised - - (20,113) 4.22 - 8.11 (20,113)
Canceled - - (1,555) 5.07 - 8.25 (1,555)
---------------------------------------------------------------------
Balance at December 31, 1997 2,172 5.07 - 21.87 717,359 3.85 - 21.87 719,531
Granted - - 7,000 15.53 7,000
Vested restricted stock (519) 22.00 - (519)
Exercised - - (22,637) 4.23 - 14.15 (22,637)
Canceled - - (774) 8.11 - 13.03 (774)
---------------------------------------------------------------------
Balance at December 31, 1998 1,653 $5.07 - $22.00 700,948 $3.85 - $21.87 702,601
---------------------------------------------------------------------
42
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. Fair Values of Financial Instruments
Fair value information about financial instruments, whether or not
recognized in the balance sheet, for which it is practicable to estimate that
value follows. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows.
In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. Certain fin-ancial instruments and
all nonfinancial instruments are excluded from the following disclosures.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.
The Company does not routinely measure the market value of financial
instruments, because such measurements represent point-in-time estimates of
value. It is not the intent of the Company to liquidate and therefore realize
the difference between market value and carrying value and, even if it were,
there is no assurance that the estimated market values could be realized. Thus,
the information presented is not particularly relevant to predicting the
Company's future earnings or cash flows.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and Due From Banks,
Federal Funds Sold and Commercial Paper
The carrying amounts reported in the balance sheet for cash, federal
funds sold and other short-term investments approximate those assets' fair
values.
Investment Securities
Fair values for investment securities are based on quoted market prices,
where available.
Loans Receivable
For variable-rate mortgage loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values. The
fair values for commercial real estate loans and fixed-rate mortgage, consumer
and other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.
Deposits
The fair values disclosed for interest and noninterest checking accounts,
savings accounts and money market accounts are, by definition, equal to the
amount payable on demand at the reporting date (i.e., their carrying amounts).
The fair values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected monthly maturities
of the outstanding certificates of deposit.
Securities Sold Under Agreement to Repurchase and Federal Funds Purchased
The carrying amounts of securities sold under agreement to repurchase and
federal funds purchased approximate their fair value.
Accrued Interest Receivable and Payable
The carrying amounts reported in the balance sheet for accrued interest
receivable and payable approximate their fair values.
Notes Payable
The carrying values of the Company's notes payable approximate fair
value.
Off-Balance-Sheet Instruments
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and generally require payment of a fee. As a consequence, the estimated fair
value of the commitments is approximately equal to the related fee received,
which is nominal.
The carrying amounts and fair values of the Company's financial
instruments consist of the following at December 31, 1998 and 1997.
1998 1997
-----------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-----------------------------------------------------------------
Xxxx and due from banks $31,028,203 $31,028,203 $34,358,642 $ 34,358,642
Federal funds sold 8,508,387 8,508,387 11,273,835 11,273,835
Other short-term investments 12,900,000 12,900,000 - -
Interest-bearing bank balances 29,793,241 29,793,241 34,952,407 34,952,407
Investment securities 104,995,068 105,184,229 97,705,301 97,918,072
Accrued interest receivable 4,485,332 4,485,332 4,380,576 4,380,576
Loans 612,433,404 614,101,163 567,544,244 571,892,343
Deposits 652,904,886 656,566,765 617,994,567 602,088,064
Securities sold under agreement to repurchase 4,116,677 4,116,677 4,850,000 4,850,000
Federal funds purchased 25,000,000 25,000,000 5,000,000 5,000,000
Notes payable 6,750,000 6,750,000 5,300,000 5,300,000
Accrued interest payable 1,688,920 1,688,920 2,030,367 2,030,367
-----------------------------------------------------------------
43
18. Segment Information
Description of Reportable Segments
The Company evaluates segment performance for each subsidiary bank, which
is differentiated primarily by geographic location. The Company has four
reportable segments: State Financial Bank (Wisconsin), State Financial Bank -
Waterford, State Financial Bank (Illinois) and Home Federal Savings and Loan
Association of Elgin. Each State Financial Bank provides a full range of retail
and commercial banking services. Additionally, State Financial Bank (Illinois)
provides insurance brokerage services. Home provides primarily one - to
four-family residential mortgage lending funded by retail deposits.
Measurement of Segment Profit or Loss
Management evaluates the after-tax performance of each of the subsidiary
banks based on that bank's actual earning assets, nonearning assets and funding
sources. Each subsidiary bank has its own net interest income, provision for
loan losses, other income, noninterest expense and income tax provision as
captured by the bank's accounting systems. The accounting policies of the
reportable segments are the same as those disclosed on the summary of
significant accounting policies. The "all other" category includes primarily the
results of the parent company. Intercompany and other amounts, which are
included in "all other," are not material.
Segment Profit and Loss Statements and
Other Information
The following tables contain profit (loss) statements for each of the
subsidiary banks for the years ended December 31, 1998 and 1997.
Year ended December 31, 1998
------------------------------------------------------------------------------------------------
Home Federal
State State State Savings and
Financial Financial Financial Loan
Bank Bank - Bank Association
(Wisconsin) Waterford (Illinois) of Elgin All Other Consolidated
------------------------------------------------------------------------------------------------
Interest income $20,935,463 $ 3,823,423 $ 6,240,364 $ 26,562,628 $ 24,960 $ 57,586,838
Interest expense 8,591,552 1,841,284 3,496,908 11,876,189 116,657 25,922,590
------------------------------------------------------------------------------------------------
Net interest income 12,343,911 1,982,139 2,743,456 14,686,439 (91,697) 31,664,248
Provision for loan losses 300,000 30,000 240,000 120,000 - 690,000
------------------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 12,043,911 1,952,139 2,503,456 14,566,439 (91,697) 30,974,248
Other income 3,669,152 400,772 1,223,697 1,138,617 532,490 6,964,728
Merger-related charges 222,830 - - 6,834,058 860,725 7,917,613
Other noninterest expense 9,248,979 1,736,632 3,731,499 11,566,242 600,503 26,883,855
------------------------------------------------------------------------------------------------
Income (loss) before income
taxes 6,241,254 616,279 (4,346) (2,695,244) (1,020,435) 3,137,508
Income taxes 1,994,411 198,192 95,526 (230,043) (77,491) 1,980,595
------------------------------------------------------------------------------------------------
Net income $ 4,246,843 $ 418,087 $ (99,872) $ (2,465,201) $ (942,944) $ 1,156,913
================================================================================================
Total assets $279,299,451 $ 60,856,396 $ 83,346,810 $397,382,333 $ 7,483,533 $828,368,523
================================================================================================
Year ended December 31, 1997
------------------------------------------------------------------------------------------------
Interest income $ 20,628,960 $ 3,308,064 $ - $ 25,028,958 $ 264,965 $ 49,230,947
Interest expense 8,091,190 1,484,181 - 10,549,507 (53,400) 20,071,478
------------------------------------------------------------------------------------------------
Net interest income 12,537,770 1,823,883 - 14,479,451 318,365 29,159,469
Provision for loan losses 300,000 30,000 - 120,000 - 450,000
------------------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 12,237,770 1,793,883 - 14,359,451 318,365 28,709,469
Other income 3,145,508 227,268 - 1,288,280 3,203 4,664,259
Merger-related charges - - - - - -
Other noninterest expense 9,012,511 1,455,127 - 11,002,914 725,291 22,195,843
------------------------------------------------------------------------------------------------
Income (loss) before income
taxes 6,370,767 566,024 - 4,644,817 (403,723) 11,177,885
Income taxes 2,095,845 186,246 - 1,802,176 (123,187) 3,961,080
------------------------------------------------------------------------------------------------
Net income $ 4,274,922 $ 379,778 $ - $ 2,842,641 $ (280,536) $ 7,216,805
================================================================================================
Total assets $273,971,650 $ 51,125,022 $ 93,413,383 $352,594,858 $ 2,767,998 $773,872,911
================================================================================================
1. No operating results are presented for State Financial Bank (Illinois)
due to its purchase by the Company effective December 31, 1997.
44
NOTES TO CONDOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. State Financial Services Corporation (Parent Company only) Financial
Information
Financial statements of the Company at December 31, 1998 and 1997, and
for the three years ended December 31, 1998, follow.
BALANCE SHEETS
December 31,
1998 1997
--------------------------------
Assets
Xxxx and cash equivalents $ 14,608,694 $ 22,042,980
Investments:
Available-for-sale 3,927,711 1,917,988
Held-to-maturity 100,000 100,000
Investment in State Financial Bank (Wisconsin) 23,462,124 23,157,881
Investment in State Financial Bank - Waterford 5,231,692 5,153,146
Investment in State Financial Mortgage Company 344,305 167,295
Investment in State Financial Bank (Illinois) 12,392,445 10,865,462
Investment in Home Federal Savings and Loan
Association of Elgin 72,424,604 69,207,245
Investment in Xxxxxx, Xxxxxxx & Cape 2,362,175 -
Loans receivable from subsidiaries 4,207,063 4,906,475
Recoverable income taxes 2,643,893 678,345
Fixed assets 173,309 111,060
Other assets 478,992 480,289
--------------------------------
Total assets $142,357,007 $138,788,166
================================
Liabilities
Accrued expenses and other liabilities $ 969,728 $ 1,124,816
Notes payable 6,750,000 3,900,000
Shareholders' equity
Common stock 1,007,602 1,027,901
Additional paid-in capital 94,153,564 96,718,054
Retained earnings 43,748,273 47,882,792
Accumulated other comprehensive income 1,080,549 888,649
Unearned shares held by ESOP (5,352,709) (6,385,962)
Unearned shares acquired by Recognition and
Retention Plan - (3,898,482)
Treasury stock - (2,469,602)
--------------------------------
Total shareholders' equity 134,637,279 133,763,350
--------------------------------
Total liabilities and shareholders' equity $142,357,007 $138,788,166
================================
45
NOTES TO COSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. State Financial Services Corporation (Parent Company only) Financial
Information (continued)
STATEMENTS OF INCOME
Year ended December 31,
1998 1997 1996
-------------------------------------------
Income:
Dividends $ 4,575,000 $ 4,225,000 $ 5,400,000
Interest 1,387,670 2,179,353 900,464
Management fees 1,161,625 781,870 753,851
Other 431,402 36,260 32,578
-------------------------------------------
7,555,697 7,222,483 7,086,893
Expenses:
Interest 130,222 120,283 111,542
Other 9,650,631 3,049,862 1,562,849
-------------------------------------------
9,780,853 3,170,145 1,674,391
Income (loss) before income tax
credit and equity in undistributed
net income of subsidiaries (2,225,156) 4,052,338 5,412,502
Income (taxes) credit 1,528,092 33,988 (35,673)
-------------------------------------------
(697,064) 4,086,326 5,376,829
Equity in undistributed net income
(excess of net income of
subsidiaries over dividends) 1,853,977 3,130,479 (624,049)
-------------------------------------------
Net income $ 1,156,913 $ 7,216,805 $ 4,752,780
===========================================
46
NOTES TO COSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS
State Financial Services Corporation (Parent Company only)
Financial Information (continued)
Year ended December 31,
1998 1997 1996
---------------------------------------------------
Operating activities
Net income $ 1,156,913 $ 7,216,805 $ 4,752,780
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed income (1,853,977) (3,130,479) 624,049
Provision for depreciation 52,236 60,285 64,740
Increase in recoverable income taxes (1,965,548) (48,892) (3,324)
Accretion of discounts 0 (210,166) (237,526)
Cost of Recognition and Retention Plan Stock 3,898,481 599,767 0
Realized investment securities losses (gains)- net (399,104) 649 0
Other 903 (157,259) (49,477)
---------------------------------------------------
Net cash provided by operating activities 889,904 4,330,710 5,151,242
Investing activities
Purchase of investment securities 0 0 (24,538,919)
Maturities of investment securities 0 26,150,000 1,150,000
Purchases of securities available for sale (3,390,082) (395,548) (3,808,860)
Maturities of securities available for sale 0 1,550,000 500,000
Sales of securities available for sale 1,294,466 979,915 0
Decrease (increase) in loans receivable from subsidiaries 699,412 560,740 (5,467,215)
Purchases of premises and equipment (114,485) (24,463) (33,276)
Acquisition of subsidiaries (2,423,609) (10,865,462) 0
Additional investment in subsidiaries (1,407,711) (100,000) (28,380,791)
---------------------------------------------------
Net cash provided (used) by investing activities (5,342,009) 17,855,182 (60,579,061)
Financing activities
Proceeds (repayment) of notes payable 2,850,000 2,938,156 (100,000)
Decrease (increase) in guaranteed ESOP obligation 96,855 (1,003,222) 48,628
Cash dividends (5,291,432) (3,591,252) (1,260,271)
Purchased Recognition and Retention Plan stock 0 (4,498,248) 0
Purchase of treasury stock (3,287,456) (2,469,602) 0
Issuance of common stock in acquisition 2,410,199 0 0
Proceeds from sale of common stock 0 0 62,366,982
Proceeds from exercise of stock options 239,653 344,126 174,408
---------------------------------------------------
Net cash provided (used) by financing activities (2,982,181) (8,280,042) 61,229,747
---------------------------------------------------
Increase (decrease) in cash and cash equivalents (7,434,286) 13,905,850 5,801,928
Cash and cash equivalents at beginning of year 22,042,980 8,137,130 2,335,202
---------------------------------------------------
Cash and cash equivalents at end of year $ 14,608,694 $ 22,042,980 $ 8,137,130
===================================================
47
INVESTOR INFORMATION
--------------------------------------------------------------------------------
Market Price and Dividends for Common Stock
At March 15, 1999, there were approximately 1,282 shareholders of record
and 4,903 estimated additional beneficial shareholders for an approximate total
of 6,185 shareholders of the Company's Common Stock.
Holders of Common Stock are entitled to receive dividends as may be
declared by the Company's Board of Directors and paid from time to time out of
funds legally available therefore. The Company's ability to pay dividends
depends upon its subsidiary Banks' ability to pay dividends which is regulated
by banking statutes. The declaration of dividends by the Company is
discretionary and will depend on operating results, financial condition,
regulatory limitations, tax considerations, and other factors. See Note 12 to
the Consolidated Financial Statements for information concerning restrictions on
the payment of dividends. Although the Company has regularly paid dividends
since its inception in 1984, there can be no assurance that such dividends will
be paid in the future.
The following table sets forth the historical price of and dividends
declared with respect to Common Stock since January 1, 1997. All figures have
been restated to give effect to the 6 for 5 stock splits declared in January
1998 and January 1997 as if each had occurred as of January 1, 1997.
Price Cash
Quarter Ended High Low Dividend
------------------------------ -------- -------- ----------
March 31, 1997 $16.04 $13.14 $0.10
June 30, 1997 18.13 14.79 0.10
September 30, 1997 19.17 16.46 0.10
December 31, 1997 23.23 19.17 0.10
March 31, 1998 $29.27 $25.75 $0.12
June 30, 1998 26.00 20.94 0.12
September 30, 1998 23.50 15.50 0.12
December 31, 1998 20.00 14.75 0.12
============================== ======== ======== ==========
Stock Listing
State Financial Services Corporation's Common Stock is traded on the
Nasdaq National Market tier of the Nasdaq Stock Market ("Nasdaq") under the
symbol "SFSW." Nasdaq is a highly-regulated electronic securities market
comprised of competing Market Makers whose trading is supported by a
communications network linking them to quotation dissemination, trade reporting,
and order execution systems. This market also provides specialized automation
services for screen-based negotiations of transactions, on-line comparison of
transactions, and a range of informational services tailored to the needs of the
securities industry, investors, and issuers. Nasdaq is operated by The Nasdaq
Stock Market, Inc., a wholly-owned subsidiary of the National Association of
Securities Dealers, Inc.
The Company's stock appears in the Wall Street Journal, the Milwaukee
Journal/Sentinel, and other publications usually as State Financial.
Dividend Reinvestment Plan
The Company has a Dividend Reinvestment Plan (the "DRP") for the benefit
of all shareholders. The DRP is administered by Firstar Trust Company. Under the
DRP, registered shareholders of the Company can elect to have their dividends
reinvested to purchase additional shares of the Company's Common Stock. To
receive information on the DRP, please contact Xxxxxxx X. Xxxxxx, Senior Vice
President, Controller, and Chief Financial Officers, State Financial Services
Corporation, 00000 Xxxx Xxxxxxxxxx Xxxx, Xxxxx Xxxxxxx, Xxxxxxxxx 00000, or call
(000) 000-0000.
Form 10-K
The Company's annual report on Form 10-K for the year ended December 31,
1998 as filed with the Securities and Exchange Commission is available upon
request without charge to shareholders of record. Please contact Xxxxxxx X.
Xxxxxx, Senior Vice President, Controller, and Chief Financial Officer, State
Financial Services Corporation, 00000 Xxxx Xxxxxxxxxx Xxxx, Xxxxx Xxxxxxx,
Xxxxxxxxx 00000, or call (000) 000-0000.
Annual Meeting
The annual meeting of shareholders of State Financial Services
Corporation will be held at 4:00 P.M. (CDT) on Wednesday, May 5, 1999 at the
Midway Hotel, 0000 Xxxxxxxx Xxxx, Xxxxxxxxxx, XX.
Financial Information
Xxxxxxx X. Xxxxxx
Senior Vice President, Controller, and Chief Financial Officer
State Financial Services Corporation
00000 Xxxx Xxxxxxxxxx Xxxx, Xxxxx Xxxxxxx, Xxxxxxxxx 00000
(000) 000-0000
Transfer Agent
First Bank, Milwaukee, N.A.
Trust Division
0000 Xxxxx XxxxxXxxxxx Xxxxx, Xxxxxxxxx, XX 00000
(000) 000-0000
(000) 000-0000
48
DIRECTORS AND OFFICERS
State Financial Services Corporation
DIRECTORS
Xxxxxxx X. Xxxxx, President and CEO
Xxxxxx X. Xxxx, Chairman of the Board
Xxxxxxx X. Xxxx-Xxxx
Xxxxxxx X. Xxxx
Xxxxx Xxxxx, Xx.
Xxxxx X. Xxxxx
OFFICERS
Xxxx X. Xxxx, Human Resources Officer
Xxxx X. Xxxxxxxx, Senior Vice President
Xxxxx X. Xxxxxxxx, Vice President and
Director of Marketing
Xxxxxx X. Xxxxxxxx, Loan Review Officer
Xxxxxxx X. Xxxxxxx, Assistant Vice President
and Assistant Controller
Xxxxxxx X. Xxxxx, President and CEO
Xxxxxx X. Xxxx, Chairman of the Board and
Vice President
Xxxxxx X. Xxxxxx, Senior Vice President
Xxxxxxx X. Xxxxxx, Auditor
Xxxxxxx X. Xxxxxx, Senior Vice President,
Controller and Chief
Financial Officer;
Secretary/Treasurer
Xxxxxx X. Xxxxxxxx, Senior Vice President
Banking Subsidiaries
State Financial Bank (Wisconsin)
DIRECTORS
Xxxxx Xxxxx
Xxxx X. Xxxxxxxx, President
Xxxxxxx X. Xxxxx, Vice Chairman and CEO
Xxxxxxx Xxxxx
Xxxxxx X. Xxxx, Chairman of the Board
Xxxxxxx X. Xxxx
Xxxxxx Xxxx-Xxxxxxx
Xxxxxxx X. Xxxx-Xxxx
Xxxxxx X. Xxxxxx
Xxxxx X. Xxxxxx
Xxxxxx X. Xxxxxxxxxx
Xxxxxxxxx Xxxxxx
Xxxxxx X. Xxxxxxx
Xxxxx X. Xxxxx
DIRECTOR EMERITUS
Xxxxxx Xxxxxxxx
Xx. Xxxxxxx Xxxxxx
Xxxxx Xxxxxx
OFFICE LOCATIONS
Brookfield (000) 000-0000
Glendale (000) 000-0000
Greenfield (000) 000-0000
Xxxxx Corners (000) 000-0000
Milwaukee/University (000) 000-0000
Muskego (000) 000-0000
Waukesha (000) 000-0000
State Financial Bank - Waterford
DIRECTORS
Xxxxxxx X. Xxxxx
Xxxxxx X. Xxxx
Xxxxxxx X. Xxxxxx
Xxxxxx X. Xxxxx, President and CEO
Xxxx Xxxxxxx
Xxxxxx X. Xxxxxxx, Chairman of the Board
DIRECTOR EMERITUS
Xxxxxxx X. Xxxx
OFFICE LOCATIONS
Burlington (000) 000-0000
Waterford (000) 000-0000
State Financial Bank (Illinois)
DIRECTORS
Xxxxx X. Xxxx, President
Xxxxxx X. Xxxxxxx
Xxxxxxx X. Xxxxx
Xxxxxx X. Xxxx
Xxxxxx X. Xxxxxxxx, Chairman of the Board and CEO
Xxxxxxx X. Xxxxxxxxx
OFFICE LOCATIONS
Libertyville (000) 000-0000
Richmond (000) 000-0000
Home Federal Savings and Loan Association of Elgin
DIRECTORS
Xxxxxxx X. Xxxxx, Chairman of the Board
Xxxxx X. Xxxxxxxx
Xxxxx X. Xxxxx
Xxxxxx X. Xxxx
Xxxxxx X. Xxxxx
Xxxxx X. X'Xxxxxx
Xxxxxx X. Xxxxx
Xxxxxxx X. Xxxxxxxx
Xxxxxx X. Xxxxxxxx, President and CEO
OFFICE LOCATIONS
Xxxxxxxx (000) 000-0000
Crystal Lake (000) 000-0000
Elgin (000) 000-0000
Roselle (000) 000-0000
South Elgin (000) 000-0000
Other Subsidiaries
State Financial Investments, Inc.
Xxxx X. Xxxxxxxx, President
Xxxx X. Xxxxxx, Vice President
Telephone (000) 000-0000
State Financial Insurance Agency
Xxxx X. Xxxxxxxx, President
Xxxx X. Xxxxxxx, Vice President
Xxxxxx X. Xxxxxxx, Vice President
Telephone (000) 000-0000
State Financial Mortage Company
Xxxxxx X. Xxxxx, President
Xxxxx X. Xxxxxxxx, Vice President
Telephone (000) 000-0000
Lokken, Chesnut, & Cape
Xxxxxxx X. Xxxxxx, CEO
Xxxxx X. Xxxxxx, President
Xxxx X. Xxxxxxxx, Secretary/Treasurer
Telephone (000) 000-0000
