ITEM 1. BUSINESS - --------------------------------------------------------------------------------
GENERAL
In the following discussion, references to "Bankshares" relate to Community Savings Bankshares, Inc. together with its wholly-owned subsidiary, Community Savings, F. A. (the "Association").
COMMUNITY SAVINGS BANKSHARES, INC.
Bankshares is a Delaware-chartered stock holding company organized in August 1998. Bankshares' significant assets include cash and its investment in its wholly-owned subsidiary, the Association. On December 15, 1998, Bankshares completed its reorganization and stock offering (the "Reorganization") in connection with the conversion and reorganization of ComFed, M. H. C. (the "Holding Company"), a mutual holding company, and its mid-tier holding company, Community Savings Bankshares, Inc., a federal mid-tier stock holding company (the "Mid-Tier"). Bankshares sold 5,470,651 shares of common stock at $10.00 per share in a subscription and community offering (the "Offering") resulting in net proceeds of approximately $53.0 million. Bankshares also issued 5,078,233 shares of common stock to existing minority shareholders of the Mid-Tier (the "Exchange") at an exchange ratio of 2.0445 shares (the "Exchange Ratio") for each share of Mid-Tier common stock. The Reorganization was accounted for at historical cost in a manner similar to a pooling of interests. Therefore, all financial information has been presented as if Bankshares had been in existence for all periods presented in this report and the Exchange Ratio was applied to all stock-related data for comparability purposes.
At December 31, 1999, Bankshares had total assets of $893.0 million, total loans of $608.4 million, total deposits of $613.9 million, and total shareholders' equity of $115.7 million. At December 31, 1999, there were 9,319,873 shares of common stock outstanding which trades on The Nasdaq Stock Market under the symbol "CMSV".
Bankshares' executive office is located at 660 U.S. Highway One, North Palm Beach, Florida and its telephone number at that address is (561) 881-2212.
COMMUNITY SAVINGS, F. A.
The Association, founded in 1955, is a federally chartered savings and loan association headquartered in North Palm Beach, Florida and is the wholly-owned subsidiary of Bankshares. The Association's deposits are federally insured by the Federal Deposit Insurance Corporation ("FDIC") through the Savings Association Insurance Fund ("SAIF"). The Association has been a member of the Federal Home Loan Bank of Atlanta ("FHLB") since 1955. The Association is regulated by the Office of Thrift Supervision ("OTS").
On December 15, 1998, Bankshares became the holding company for the Association as a result of the completion of the Reorganization. In the course of the Reorganization, the Holding Company and the Mid-Tier were merged with and into the Association. Such mergers were accounted for in a manner similar to a pooling of interests and did not result in any significant accounting adjustments. Net proceeds from the Reorganization approximated $53.0 million which were initially invested in interest-earning deposits at December 31, 1998, and which have since been disbursed primarily to fund loan originations and securities purchases, and repurchases of Bankshares' common stock in the open market. This use of funds reflected the implementation of the Association's business plan to prudently deploy the capital raised in the Reorganization, without an increase in high risk lending or investment activities.
The Association is a community-oriented financial institution engaged primarily in the business of attracting deposits from the general public in the Association's market area (as described below) and using such funds, together with other borrowings, to invest in various residential and commercial real estate loans, consumer and commercial business loans, and mortgage-backed and related securities ("MBS") and investment securities. See "- Lending Activities" and "- Securities Portfolio". The Association's principal sources of funds are deposits, principal and interest payments on loans and securities, and FHLB advances. The principal source of income is interest received from loans and securities, while principal expenses are interest paid on deposits and borrowings and employee compensation and benefits. See "- Sources of Funds." The Association's strategy is to operate as a well-capitalized, profitable and
independent community-oriented savings and loan association. The Association has implemented this strategy by emphasizing retail deposits as its primary source of funds and investing a substantial part of such funds in locally originated residential first mortgage loans, in MBS and in liquid investment securities.
The Association's profitability is highly dependent on its net interest income. The components that determine net interest income are the amount of interest-earning assets and interest-bearing liabilities, together with the yields earned or rates paid on such instruments. The Association is sensitive to managing interest rate risk exposure by better matching asset and liability maturities and rates. This is accomplished while considering the inherent credit risk of assets. The Association maintains asset quality by utilizing comprehensive loan underwriting standards, effective collection efforts as well as by primarily originating or purchasing secured or guaranteed assets. The Association also uses leveraged transactions in which security purchases are funded with FHLB advances at an acceptable interest rate spread (the difference between the yield earned on the securities and the rate paid on the borrowings).
The Association's executive office is located at 660 U.S. Highway One, North Palm Beach, Florida, and its telephone number at that address is (561) 881-4800.
CHANGE OF FISCAL YEAR
In January 1997, the Board of Directors of the Association approved a change of the Association's fiscal year from September 30 to December 31, effective December 31, 1996. Bankshares' fiscal year end is also December 31.
YEAR 2000 CONSIDERATIONS
Bankshares completed the change to January 1, 2000 on all of its systems with no material problems. Management and staff will continue to monitor its systems and to test date sensitive calculations throughout 2000.
FORWARD-LOOKING STATEMENTS
Certain information in this Annual Report on Form 10-K (the "Form 10-K") may constitute forward-looking information that involves risks and uncertainties that could cause actual results to differ materially from those estimated. Persons are cautioned that such forward-looking statements are not guarantees of future performance and are subject to various factors which could cause actual results to differ materially from those estimated. These factors include, but are not limited to, changes in general economic and market conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, demand for loan and deposit products and the development of an interest rate environment that adversely affects the interest rate spread or other income from Bankshares' investments and operations.
MARKET AREA AND COMPETITION
Bankshares and the Association are headquartered in North Palm Beach, Florida. Because Bankshares' most significant asset is its ownership of all the issued and outstanding capital stock of the Association, the market area and competition are identical for both entities. The Association operates 21 offices in its market area in southeastern Florida, four of which are located in Martin County, thirteen of which are located in Palm Beach County, three of which are located in St. Lucie County and one of which is located in Indian River County.
As a result of the 1999 sales of the majority of the MacArthur Foundation land holdings in Palm Beach, Martin and St. Lucie Counties, major real estate development is scheduled to begin in Northern Palm Beach County during 2000. Developers have filed plans for residential and commercial projects with construction scheduled to begin in early 2000. The Association's lending staff will aggressively pursue lending opportunities during 2000 as a result of this development.
The competition for real estate and other loans comes principally from commercial banks, mortgage-banking companies, and other savings associations. The competition for loans has increased substantially in recent years as a result of the large number of institutions competing in the market area as well as the increased efforts by commercial banks to expand mortgage loan originations. The Association competes for loans primarily through competitive interest rates and the loan fees it charges and the efficiency and quality of services it provides borrowers, real estate brokers, and builders. Factors that affect competition include general and local economic conditions, current interest rate levels, and the volatility of the mortgage markets.
According to county projections from the University of Florida, the population of Palm Beach, Martin, St. Lucie, and Indian River counties was estimated to aggregate l.4 million for 1999. This study projects a 1.6% growth rate to 1.5 million by the end of the year 2000 and an additional 3.0% between 2000 and 2002. This population growth suggests increased demand for mortgage loans in the four county market. However, such estimates may not prove representative of actual experience for the remainder of 2000 or in 2001 and 2002. In addition, rising interest rates as experienced in the first quarter of 2000 may slow the demand for loans.
The counties in the Association's market area have experienced significant growth since the 1960s. Several of the counties are currently experiencing major redevelopment projects. In Palm Beach County, the City of West Palm Beach continues to implement a $375 million project called City Place which is designed to continue the revitalization of the downtown area with the addition of 600,000 square feet of leaseable retail space organized around cultural and entertainment activities. Also in Palm Beach County, construction continues on Abacoa, a new subdivision development which features a baseball stadium, a Florida Atlantic University honors campus, commercial office and retail space, as well as single-family and multi-family residential properties designed to accommodate up to 10,000 residents. TriRail, the commuter train service for southern Florida, will be extended northward to service this community. The western communities of Wellington, Royal Palm Beach, Loxahatchee and the Acreage are the fastest growing areas of Palm Beach County. Wellington Green, a 466-acre project under development in Wellington, will include a 1.2 million square-foot shopping mall, as well as a 300-unit adult living facility, a 400-unit multi-family residential community, a 125-room hotel and 350,000 square feet of office and retail space. The Association opened a branch office at the Shoppes of Ibis in late 1999 on one of the major roads into the western communities and has purchased a branch site at Andros Isle on another major artery leading to these same communities. (See "- Properties").
In St. Lucie County, the population of the city of Port St. Lucie has increased by an estimated 83,000 people, which is a 49.0% increase since 1990 and a 3.5% increase during 1999 making it the largest city in St. Lucie, Martin and Palm Beach counties. It is the third largest city in Florida in terms of land mass comprising between 80 to 85 square miles. Founded in 1961 as a retirement home community, it has grown into a diverse city. Planners expect significant growth to continue in the city, estimating the final population to be approximately 250,000 people. Also in St. Lucie County, redevelopment of downtown Ft. Pierce is expected to be completed by 2001. The redevelopment centers around the Sunrise Theater, the restoration of City Hall, and new construction in the Indian River Lagoon area including a new bridge and road improvements.
The economy in the Association's market area is service-oriented and is significantly dependent upon government, foreign trade, tourism, and its continued attraction as a retirement area. In Palm Beach and Martin counties, cooperative efforts between the counties and local municipalities are producing business growth and expansion in the counties. A variety of county-supported programs have been instituted to create new jobs and to encourage relocation or expansion of companies with an emphasis placed on high-technology and service industries. Consequently, commercial building vacancies are at a low level. During 1999, about 26,000 jobs were created in Palm Beach County, a growth rate of 5.2%. However, Palm Beach County's largest employer, Pratt and Whitney, announced that it is moving about 2,800 military jet engine jobs to Connecticut. Employees will be offered transfers to Connecticut, early retirement or termination by the end of 2000. The majority of the affected employees live in Palm Beach and Martin counties. This loss of jobs will be partially offset by the expansion of Pratt and Whitney's liquid space operations which will remain in Palm Beach County. In addition, other employers such as Wal-Mart have announced expansion plans for Palm Beach County in 2000 and 2001. Other major employers in Palm Beach County include Columbia Palm Beach Healthcare System, Inc., Motorola, Inc., Florida Power and Light Co., the Boca Raton Resort and Club, and Flo Sun, Inc. Martin County major employers include Martin Memorial Medical Center, Northrop Grumman Aircraft Systems, Inc., and Publix supermarkets. St. Lucie County major employers include Indian River Community College, Columbia Lawnwood Regional Medical, Publix supermarkets, and Staff Leasing. Indian River County major employers include Indian River Memorial Hospital, Publix supermarkets and New Piper Aircraft Corp.
Bankshares' market area in Southeast Florida has a large concentration of financial institutions, many of which are significantly larger and have greater financial resources than the Association, and all of which are competitors of the Association to varying degrees. As a result, the Association encounters strong competition both in attracting deposits and in originating real estate and other loans. Its most direct competition for deposits has come historically from commercial banks, securities broker-dealers, other savings associations, and credit unions in its market area. Continued strong competition from such financial institutions is expected in the foreseeable future. The
market area includes branches of several commercial banks that are substantially larger than the Association in terms of state-wide deposits. The Association competes for savings by offering depositors a high level of personal service and expertise together with a wide range of financial services as well as competitive pricing. In recent years many financial institutions have been aggressively expanding through the acquisition of branch locations or entire financial institutions, thereby further increasing competition.
Based on total assets as of December 31, 1999, the Association was the third largest financial institution headquartered in Palm Beach County. The Association held 2.0%, 6.4%, 2.9% and 0.9% of all bank and savings association deposits in Palm Beach, Martin, St. Lucie, and Indian River counties, respectively, at September 30, 1999.
LENDING ACTIVITIES
GENERAL. Historically, the principal lending activity of the Association has been the origination of fixed- and adjustable-rate mortgage loans collateralized by one- to four-family residential properties located in its primary market area. It is the Association's intention to offer varied products in the residential mortgage loan area. The Association currently emphasizes the origination of adjustable-rate residential mortgage ("ARM") loans, and fixed-rate residential mortgage loans with terms of 15 years or less, as well as residential mortgage loans which provide for a fixed-rate of interest during the first five or seven years and which thereafter converts to ARM loans, the interest rate of which adjusts annually. At times, it has been the Association's policy to sell in the secondary market on a servicing retained basis all fixed-rate mortgage loan originations with terms greater than 15 years. However, based on management's assessment of the market at a particular time and Board of Director established limits, the Association may periodically decide to retain such loans in the portfolio. There were no loans held for sale at December 31, 1999. Loans serviced for other institutions totaled $11.3 million at such date.
While the Association's primary emphasis is on residential real estate lending, the Association's policy is to meet demand for other types of loans by offering a wide variety of loan programs designed to meet customers' needs. In response to customer demand, the Association has expanded its commercial lending programs by adding new commercial loan officers and a credit analyst to its staff. The Association intends to continue to pursue the origination of such loans during 2000 in connection with providing services to its small business customers.
At December 31, 1999, the gross loan portfolio totaled $667.8 million. At such date, the weighted average remaining term to maturity of the loan portfolio was approximately 15.5 years. At December 31, 1999, $287.9 million, or 43.1% of the total gross loan portfolio consisted of loans with adjustable interest rates.
To supplement local loan originations, the Association also invests in MBS that directly or indirectly provide funds principally for residential home buyers in the United States. The Association has also purchased either participations in or whole residential real estate loans which are serviced by other institutions. Such loans totaled $31.0 million, net of premiums, at December 31, 1999. The Association also participates with other financial institutions in programs which provide residential mortgage loans to low-and moderate-income borrowers. During 2000, the Association intends to use its loan solicitors to continue the expansion of its lending activities, particularly one- to four-family residential loans and commercial real estate and business loans.
ANALYSIS OF LOAN PORTFOLIO. Set forth below is selected data relating to the composition of the loan portfolio by type of loan.
- -------------- (1) Includes participations or whole loans purchased of $30.6 million, $44.7 million, $19.5 million, $1.7 million, $1.8 million, and $2.2 million, at December 31, 1999, 1998, 1997, 1996, September 30, 1996, and 1995, respectively. (2) Includes construction loans for both single- and multi-family residential properties. (3) Includes participations of $505,000 and $360,000, at December 31, 1996, September 30, 1996, respectively. (4) Includes participations of $131,000, $146,000, $162,000, $190,000, $198,000, and $4.9 million, at December 31, 1999, 1998, 1997, 1996, September 30, 1996, and 1995, respectively. (5) Includes primarily home equity lines of credit, automobile loans, and loans secured by savings deposits. At December 31, 1999, the disbursed portion of home equity lines of credit totaled $8.3 million.
LOAN AND MORTGAGE-BACKED AND RELATED SECURITIES MATURITY AND REPRICING SCHEDULE. The following table sets forth certain information as of December 31, 1999, regarding the dollar amount of loans, net of loans in process ("LIP") and MBS maturing in the Association's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Adjustable- and floating-rate loans are included in the period in which interest rates are next scheduled to adjust rather than in which they contractually mature. Fixed-rate loans are included in the period in which the final contractual repayment is due. Fixed-rate MBS are assumed to mature in the period in which the final contractual payment is due on the underlying mortgage.
- -------------- (1) Includes construction loans. (2) Variable-rate equity lines of credit reprice on a monthly basis.
The following table sets forth at December 31, 1999, the dollar amount of all fixed-rate and adjustable-rate loans due after December 31, 2000 based on either the repricing date or the contractual maturity as described above.
Fixed Adjustable Total -------- ---------- -------- (Dollars in thousands) Real estate loans: One- to four-family residential $257,875 $ 54,083 $311,958 Commercial, multi-family and land 18,953 9,010 27,963 Consumer and commercial business 3,296 -- 3,296 -------- -------- -------- Total (net of LIP) $280,124 $ 63,093 $343,217 ======== ======== ========
Percentage of total loans (net of LIP) 45.86% 10.33% 56.19% ======== ======== ========
Mortgage-backed and related securities $ 61,430 $ -- $ 61,430 ======== ======== ========
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. The Association's primary lending activity consists of the origination of one- to four-family, owner-occupied, residential mortgage loans secured by properties located in its market area. Such loans are generally underwritten in conformity with the criteria established by Fannie Mae ("FNMA"), with the exception of loans exceeding applicable agency dollar limits and loans purchased through the Association's affiliation with a consortium of financial institutions which provides loans to low and moderate income borrowers (discussed below). The Association generally does not originate one- to four-family residential loans secured by properties outside of its market area although in recent periods it has purchased a modest amount of single-family residential loans secured by properties in the southeast United States and California. At December 31, 1999, $432.3 million, or 64.73%, of the gross loan portfolio consisted of one- to four-family residential mortgage loans. The weighted average contractual maturity of one- to four-family residential mortgage loans at the time they are originated is approximately 25 years. However, it has been the Association's experience that the average length of time which such loans remain outstanding is approximately 5 years.
The Association currently offers one- to four-family residential mortgage loans with terms typically ranging from 15 to 30 years, and with
adjustable or fixed interest rates. Originations of fixed-rate mortgage loans and ARM loans are monitored on an ongoing basis and are affected significantly by the level of market interest rates, customer preference, the Association's asset/liability strategy, and loan products offered by its competitors. In a rising interest rate environment, which existed throughout much of 1999, borrowers typically prefer fixed-rate loans to ARM loans. Nonetheless, the Association has continued to emphasize the origination of ARM loan products. ARM loan originations totaled $93.4 million, or 65.0%, of all one- to four-family loan originations during the year ended December 31, 1999. In connection with the Association's effort to increase mortgage lending, the Association offers residential mortgage loans which provide for a fixed-rate of interest during the first five or seven years of the term of the loans and which thereafter convert to ARM loans on which the interest rate adjusts annually. This loan product allows the Association to offer a loan with a relatively short period during which the interest rate is fixed but which typically provides for an initial interest rate which is greater than could be obtained on ARM loans originated in the local market. This loan product is generally offered with a term of between l5 and 30 years.
The Association currently offers ARM loans with an annual adjustment based on changes in the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of one year ("Treasury Index") plus a margin, usually 287.5 basis points. Previously, the Association's ARM loans were indexed to the National Monthly Median Cost of Funds plus a margin. Each ARM loan has an annual interest rate adjustment limitation of 200 basis points and a maximum lifetime adjustment of 600 basis points above the initial rate. ARM loans are originated with initial rates which are below the fully indexed rate, the amount of such discount varying depending upon market conditions. Management determines whether a borrower qualifies for an ARM loan based on the fully indexed rate of the ARM loan at the time the loan is originated. Negative amortization of the ARM loans is not allowed. One- to four-family residential ARM loans totaled $176.7 million at December 31, 1999.
The primary purpose of offering ARM loans is to make the loan portfolio more interest rate sensitive. However, because the interest income earned on ARM loans varies with prevailing interest rates, such loans do not offer as consistently a predictable stream of interest income as long-term, fixed-rate loans. ARM loans carry increased credit risk associated with potentially higher monthly payments by borrowers as general market interest rates increase. It is possible, therefore, that during periods of rising interest rates, the risk of default on ARM loans may increase due to the upward adjustment of interest costs to the borrower. To offset this risk, loans are underwritten as if the highest market rate which the borrower would be capable of paying under the terms of the loan was in effect.
Fixed-rate loans generally are originated and underwritten according to standards that permit sale in the secondary mortgage market. Whether management can or will sell fixed-rate loans in the secondary market, however, depends on a number of factors including the yields and the terms of the loans, market conditions, the Association's current interest rate sensitivity gap position and Board of Director established limits. The Association has followed varying policies with respect to retention in the portfolio of fixed-rate loans with contractual terms in excess of 15 years. Its current policy is to limit fixed-rate loans, including loans with 30 year terms, to a specified percentage of total assets. The Association's fixed-rate mortgage loans are amortized on a monthly basis with principal and interest due each month. One- to four-family residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option without prepayment penalties.
As an integral part of its community reinvestment activities, the Association participates with other financial institutions in local consortiums which are committed to provide financing of one- to four-family mortgage loans for low and moderate income borrowers. The consortiums underwrite and package the loans which are then either sold to the member institutions on a whole loan basis or closed and funded directly by the member institution. These loans are originated to borrowers within the Association's market area and provide for either fixed or adjustable rates of interest. The Association determines which loans it will purchase or fund directly after conducting its own due diligence review of the loan package offered. The Association closed approximately $1.2 million in consortium loans during 1999. It is the Association's intent, subject to market conditions, to continue to participate in consortiums of this nature in the future.
The Association also purchases single-family residential loans from other sources, such as mortgage origination companies, or brokers, under the same guidelines as described above. In addition, such loan purchases include a contract between the mortgage origination company and the Association, which contains an indemnification clause protecting the Association from loss resulting from misrepresentations in the loan applications or other information provided to the Association. During fiscal year 1999, $66,000 of such loans were purchased. It is management's intent, subject to market conditions, to continue purchasing such loans.
The Association may purchase participation interests or whole loans secured by one- to four-family residences when funds available for lending exceed the demand for residential loans in the local market or to facilitate funding of large projects. At December 31, 1999, the loan portfolio included $30.6 million of loan participations and whole loans secured by one- to four-family residences, none of which were purchased during 1999.
The Association's fixed-rate one- to four-family residential first mortgage loans customarily include due-on-sale clauses, which are provisions giving the Association the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as security for the loan. Due-on-sale clauses are an important means of adjusting the rates on the fixed-rate mortgage loan portfolio (and to a lesser extent ARM loans), and the Association has generally exercised its rights under these clauses.
Regulations limit the amount that a savings association may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Appraisals are generally performed by an independent outside appraiser. Such regulations permit a maximum loan-to-value ratio of 95% for loans secured by residential property and 80% for all other real estate loans. The Association's lending policies generally limit the maximum loan-to-value ratio on both fixed-rate and ARM loans without private mortgage insurance to 80% of the lesser of the appraised value or the purchase price of the property to serve as collateral for the loan. For one- to four-family real estate loans with loan-to-value ratios of between 80% and 95%, the borrower is generally required to obtain private mortgage insurance. An origination fee of between 1% and 2% of the total loan amount on all one- to four-family loans may be charged depending on the market conditions. Fire and casualty insurance (and flood insurance if the property is within a designated flood plain), as well as title insurance regarding good title, are required on all properties securing real estate loans made by the Association.
CONSTRUCTION AND LAND LOANS. At December 31, 1999, $95.7 million, or 14.33%, and $40.4 million, or 6.05%, of the gross loan portfolio consisted of one- to four-family residential construction loans and land loans, respectively. There were no non-residential construction loans at December 31, 1999. Fixed- and adjustable-rate residential construction loans are currently offered primarily for the construction of owner-occupied single-family residences in the Association's market area to builders who have a contract for sale of the property or to owners who have a contract for construction. Advances are made as each phase of construction is completed and verified by the Association. In addition, construction loans are also made to builders for single-family residences held for sale. Such loans totaled $10.6 million at December 31, 1999. Construction loans for owner-occupied single-family residences are generally structured to become permanent loans upon completion of construction, and are originated with terms of up to 30 years with an allowance of up to six months for construction during which period the borrower makes interest-only payments. Construction loans to builders for residences held for sale are generally originated for a term of up to one year and provide for interest-only payments.
At December 31, 1999, the Association's largest real estate construction loan was a $15.0 million line of credit, with disbursed funds of $12.9 million, which was within the Association's regulatory loans-to-one-borrower limit at the time of the origination of the loan. As a result of the Association's funding by dividend distribution of Bankshares' repurchase program of treasury stock, the lending relationship exceeded the loans-to-one-borrower capital limitation at December 31, 1999. A $5.0 million participation interest in the line of credit was sold by the Association to Bankshares subsequent to December 31, 1999 in order to comply with the regulation. This acquisition and construction line of credit is secured by single-family estate homes and condominiums located on the Atlantic Ocean in Indian River County.
Construction loans are also offered on multi-family and commercial real estate property. At December 31, 1999, multi-family construction loans totaled $15.0 million, or 2.25% of the gross loan portfolio. There were no commercial real estate construction loans at December 31, 1999.
In addition, loans are originated within the market area which are secured by individual unimproved or improved lots zoned primarily to become single-family residences, as well as commercial and agricultural properties. Land loans are currently offered as either one-year ARM loans or fixed-rate loans with terms of up to 15 years. The maximum loan-to-value ratio for such land loans is 75%. During 1999, the Association sold a $6.0 million participation interest in a $21.0 million loan secured by land to Bankshares in order to comply with the loans-to-one-borrower regulation. Bankshares recorded the transaction as a $6.0 million participation loan purchased.
Adjustable-rate single-family construction and land loans are currently offered at the Treasury Index plus a margin, usually between 287.5 and 400 basis points. Adjustable-rate construction loans and land loans have an annual interest rate cap of 200 basis points and a lifetime interest rate cap of 600 basis points over the initial interest rate. Initial interest rates may be below the fully indexed rate but the loan is underwritten at the fully indexed rate.
Construction lending generally involves a greater degree of credit risk than one- to four-family residential mortgage lending. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of value proves to be inaccurate, the Association may be confronted with a completed project which has a value which is insufficient to assure full repayment. Loans made on lots carry the risk of adverse zoning changes, environmental, or other restrictions on future use.
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. Loans secured by multi-family real estate constituted approximately $5.8 million, or 0.88%, of the gross loan portfolio at December 31, 1999. At December 31, 1999, a total of 38 loans were secured by multi-family residential properties. Multi-family residential loans are primarily secured by rental properties with between five and thirty-six units. At December 31, 1999, substantially all multi-family residential loans were secured by properties located within the Association's market area. At December 31, 1999, multi-family residential loans had an average principal balance of approximately $154,000. At such date, the largest multi-family residential loan had a principal balance of $553,000, and was performing in accordance with its terms. Multi-family residential loans are currently only offered with adjustable interest rates, although in the past, fixed-rate multi-family residential loans also were originated. Multi-family residential loans typically have adjustable interest rates tied to a market index and amortize over 20 to 25 years. An origination fee of between 1.5% to 2.0% is usually charged on multi-family residential loans. Multi-family residential loans are generally originated for amounts up to 75% of the appraised value of the property securing the loan. The initial interest rate on multi-family residential loans is currently priced using the Treasury Index plus a margin, usually between 325 and 375 basis points depending on the nature and size of the project. Originations of multi-family loans have been limited in recent years due to the limited demand for such projects in the Association's market area.
In its underwriting, the Association reviews the expected net operating income generated by the real estate to support the debt service, the age and condition of the collateral, the financial resources and income level of the borrower, the borrower's experience in owning or managing similar properties, and any financial reserves the borrower may have.
Loans secured by multi-family real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and may carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family property is typically dependent upon the successful operation of the related real estate property.
COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate constituted approximately $58.5 million, or 8.76 %, of the gross loan portfolio at December 31, 1999. Commercial real estate loans are secured by improved property such as offices, hotels, small business facilities, strip shopping centers, warehouses, commercial land and other non-residential buildings. At December 31, 1999, substantially all of the commercial real estate loans were secured by properties located within the Association's market area. At December 31, 1999, a total of 217 loans were secured by commercial real estate with an average principal balance of approximately $270,000. Commercial real estate loans are currently only offered with adjustable interest rates, although in the past the Association originated fixed-rate commercial real estate loans. The terms of each commercial real estate loan are negotiated on a case-by-case basis, although such loans typically have adjustable interest rates tied to a market index such as the prime rate plus a margin. An origination fee of up to 2% of the principal balance of the loan is typically charged on commercial real estate loans. Commercial real estate loans originated by the Association generally amortize over 15 to 20 years and have a maximum loan-to-value ratio of 75%.
The Association increased its commercial real estate loan originations in 1999. An experienced commercial lending manager, two commercial loan officers and a credit analyst are part of the Lending Division staff. During the year ended December 31, 1999, $26.1 million of commercial real estate loans were originated resulting in an aggregate total of such loans of $58.5 million. The
Association intends to continue to emphasize the origination of commercial real estate and business loans to its commercial customers in the future due to the return available to the Association on such loans.
At December 31, 1999, the largest commercial real estate loan relationship had an outstanding principal balance of $2.5 million, which is within the Association's regulatory loans-to-one-borrower limit. Collateral for the loan is two business parcels containing multiple retail stores, lumber yards and office buildings located in the Association's market area. The loan is currently performing in accordance with its terms.
In underwriting commercial real estate loans, the same underwriting standards and procedures are employed as are employed in underwriting multi-family real estate loans. Loans secured by commercial real estate generally involve a higher degree of risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired.
CONSUMER LOANS. As of December 31, 1999, consumer loans totaled $13.5 million, or 2.02%, of the gross loan portfolio. The principal types of consumer loans offered are home equity lines of credit, fixed-rate second mortgage loans, automobile loans, mobile home loans, boat loans, recreational vehicle loans, unsecured personal loans, and loans secured by deposit accounts. Consumer loans are offered primarily on a fixed-rate basis with maturities generally of five years or less. Home equity lines of credit are secured by the borrower's principal residence. Consumer loans are underwritten using the Association's customary lending standards. The Association anticipates that its involvement in consumer lending will continue but recognizes that local competition for consumer loans may limit the Association's ability to significantly increase the total of its consumer loan portfolio.
Consumer loans generally have shorter terms and higher interest rates than traditional mortgage loans, but generally entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles, mobile homes, boats, and recreational vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the fluctuating demand for used automobiles.
COMMERCIAL BUSINESS LOANS. The Association currently offers commercial business loans to finance small businesses in its market area. Commercial business loans are primarily offered as a customer service to business account holders. Such loans may include commercial lines of credit, loans on inventory, equipment, receivables, or other collateral and unsecured loans. The Association emphasizes its activities in the commercial business lending market as part of its overall increased commercial lending activity. At December 31, 1999, the 62 commercial business loans outstanding had an aggregate balance of $6.5 million and an average loan balance of approximately $105,000. Commercial business loans originated during the year ended December 31, 1999 totaled $1.9 million. Commercial business loans are offered with both fixed- and adjustable-interest rates. Adjustable-rates on commercial business loans are priced against the Citibank, N.A. or WALL STREET JOURNAL prime rate, plus a margin. The loans are offered with terms of up to five years and are underwritten using the Association's customary underwriting standards.
At December 31, 1999, the largest commercial business loan was a line of credit secured by accounts receivable, contract rights, inventory, equipment, furniture and personal property. The $2.5 million line of credit had an outstanding principal balance of $1.3 million. It is currently performing in accordance with its terms.
Commercial business loans generally bear higher interest rates than residential loans, but they also may involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower's business. Personal guarantees from the borrower or a third party are generally obtained as a condition to originating its commercial business loans.
LOAN ORIGINATIONS, SOLICITATION, PROCESSING, COMMITMENTS, AND PURCHASES. Loan originations are derived from a number of sources such as real estate broker referrals, existing customers, developers and walk-in customers. In the case of a real estate loan, an independent appraiser approved by the Association appraises the real estate intended to secure the proposed loan.
Outside members of the Board of Directors, the Chairman of the Board of Directors, the President, certain other officers, and branch managers have been granted the authority to approve loans in various amounts depending on the types of loans involved. In addition, the Association has a Loan Committee which consists of at least one outside director and the President, the Division Director of Lending and the New Loan Operations Manager. Larger loans must be approved by one or more of such members of the Loan Committee depending on the size of the loan. Loans in excess of $2.5 million may only be approved by any three members of the Large Loan Committee. The members of the Large Loan Committee include five of the outside directors, the President, the Division Director of Lending and the New Loan Operations Manager. At December 31, 1999, commitments to originate loans, excluding the undisbursed portion of loans in process, totaled $5.3 million.
If the loan is approved, the commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. Fire and casualty insurance is required at the time the loan is made and throughout the term of the loan, and upon request of the Association, flood insurance may be required. Title insurance is required on all loans secured by real property.
In addition to originations, the Association also purchases loans secured by one- to four-family residences from consortiums, mortgage origination companies, or brokers, as previously discussed in "One- to Four-Family Residential Real Estate Loans." In addition, the Association may purchase participation loans when funds available for lending exceed the demand for loans in the local market or to facilitate funding of larger projects. All of such purchased loans, which totaled $30.6 million at December 31, 1999, are secured by residential real estate loans. Substantially all of such loans are whole loans; however, participation interests account for approximately $790,000 of the $30.6 million.
ORIGINATION, PURCHASE AND SALE OF LOANS. The table below shows the loan origination, purchase and sales activity for the periods indicated.
- -------------------------------------- (l) Includes loans to finance the construction of one- to four-family residential properties, and loans originated for sale in the secondary market. (2) Includes a $6.0 million participation interest in a $21.0 million loan secured by land sold by the Association to Bankshares in order to comply with the loans-to-one-borrower regulation.
LOAN ORIGINATION FEES AND OTHER INCOME. In addition to interest earned on loans, the Association may receive loan origination fees. To the extent that loans are originated or acquired for the portfolio, Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" ("SFAS No. 91") requires that loan origination fees and costs be deferred and amortized as an adjustment of yield over the life of the loan by use of the level yield method. ARM loans originated below the fully-indexed interest rate will have a substantial portion of the deferred amount recognized as income in the initial adjustment period. Fees and costs deferred under SFAS No. 91 are recognized into income immediately upon the prepayment or the sale of the related loan. At December 31, 1999, unearned discounts and premiums and deferred loan origination fees and costs totaled $1.5 million. Loan origination fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets which, in turn, respond to the demand and availability of funds.
In addition to loan origination fees, the Association also receives servicing income and other fees that consist primarily of servicing fees, late charges, and other miscellaneous fees. Such fees totaled $387,000, $198,000 and $269,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
LOAN SERVICING. While the Association primarily originates loans for its own portfolio, it also has sold fixed-rate loans to Freddie Mac ("FHLMC") and to FNMA. At December 31, 1999, the unpaid principal balances of loans sold totaled approximately $11.3 million. The Association services such loans, receiving a fee of between 0.25% and 0.375% per loan. The Association does not purchase loan servicing from other sources.
LOANS-TO-ONE BORROWER. Savings and loan associations are subject to the same loans-to-one borrower limits as those applicable to national banks. Under current regulations, loans to one borrower are restricted to an amount equal to 15% of unimpaired capital and unimpaired surplus on an unsecured basis, and an additional amount equal to 10% of unimpaired capital and unimpaired surplus if the loan is secured by readily marketable collateral (generally, financial instruments and bullion, but not real estate). The 15% limitation resulted in a dollar limitation of approximately $14.5 million at December 31, 1999. A partially funded lending relationship had exceeded the loans-to-one borrower limits at December 31, 1999. A $5.0 million participation interest in the loan was sold subsequent to December 31, 1999 in order to comply with the regulation.
The following table presents the five largest lending relationships at December 31, 1999:
At December 31, 1999, all of the aforementioned loans were performing in accordance with their terms.
ASSET QUALITY
DELINQUENCIES. The Association's collection procedures provide that when a loan is 15 days past due, a computer-generated late charge notice is sent to the borrower requesting payment. If the delinquency continues at 30 days, a delinquent notice is sent and personal contact efforts are attempted, either in person or by telephone. Also, plans to arrange a repayment plan are made at this point. If a loan becomes 60 days past due and no progress has been made in resolving the delinquency, a 10-day demand letter is sent and personal contact again is attempted. The loan also becomes subject to possible legal action if suitable arrangements to repay have not been made. In addition, the borrower is advised that he or she may obtain access to consumer counseling services, to the extent required by regulations of the Department of Housing and Urban Development ("HUD"). When a loan continues in a delinquent status for 90 days or more, and a repayment schedule has not been made or kept by the borrower, generally a notice of intent to foreclose is sent to the borrower, giving the borrower 10 days to repay all outstanding interest and principal. If the delinquency is not cured, foreclosure proceedings are initiated.
DELINQUENT LOANS. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. In addition, loans are placed on non-accrual status when either principal or interest is 90 days or more past due, or if less than 90 days, in the event that the loan has been referred to the Association's legal counsel for foreclosure. Interest accrued and unpaid at the time a loan is placed on a non-accrual status is charged against interest income.
The following table sets forth information with respect to loans past due 60 to 89 days in the loan portfolio at the dates indicated.
At December 31, --------------------------------- 1999 1998 1997 ------- ------- ------- (In thousands) Loans past due 60-89 days: One- to four-family residential $ 426 $ 695 $ 469 Commercial and multi-family real estate - - - Consumer and commercial business - 100 54 Land - - - ------- ------- ------- Total loans past due 60-89 days $ 426 $ 795 $ 523 ======= ======= =======
NON-PERFORMING ASSETS. At December 31, 1999, non-performing assets (non-performing loans and real estate owned ("REO")) totaled $1.5 million, and the ratio of non-performing assets to total assets was 0.17%. Real estate acquired by the Association as a result of foreclosure or by deed in lieu of foreclosure is classified as substandard until such time as it is sold. REO is recorded at cost which is the estimated fair value of the property at the time the loan is foreclosed. Subsequent to foreclosure, these properties are carried at lower of cost or fair value less estimated costs to sell.
The following table sets forth information regarding non-accrual loans delinquent 90 days or more, and real estate acquired or deemed acquired by foreclosure at the dates indicated. When a loan is delinquent 90 days or more, all accrued interest thereon is fully reserved and the loan ceases to accrue interest thereafter. For all the dates indicated, there were no material restructured loans within the meaning of SFAS 15 (as amended by SFAS No. 121).
- -------------- (1) The other non-performing asset at September 30, 1996 represented a deposit account due to the Association whose recovery was in doubt. All funds were recovered in the subsequent periods. (2) Net of specific valuation allowances.
The largest non-performing asset at December 31, 1999 was a REO property consisting of a single-family house located in St. Lucie county with a recorded balance of $243,000, and an appraised value of $340,000. There are currently no immediate prospects for the sale of the property.
During the year ended December 31, 1999, gross interest income of $61,000 would have been recorded on non-performing loans accounted for on a non-accrual basis if the loans had been current throughout the period. No interest income on non-accrual loans was included in income during such period.
The following table sets forth information regarding delinquent loans, REO and loans to facilitate the sale of REO at December 31, 1999.
At December 31, 1999 -------------------- Balance Number -------- ------ (Dollars in thousands) Residential real estate: Loans 60 to 89 days delinquent $ 426 8 Loans more than 89 days delinquent 1,015 13 Commercial and multi-family real estate:
Loans 60 to 89 days delinquent -- -- Loans more than 89 days delinquent 5 1 Consumer and commercial business: Loans 60 to 89 days delinquent -- -- Loans more than 89 days delinquent 12 2 Land: Loans 60 to 89 days delinquent -- -- Loans more than 89 days delinquent 7 1 REO 494 5 Other repossessed assets -- -- Loans to facilitate sale of REO 234 4 -------- ------ Total $ 2,193 34 ======== ======
CLASSIFICATION OF ASSETS. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by OTS to be of lesser quality as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the savings institution will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard, with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated special mention by management.
When a savings institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When a savings institution classifies problem assets as loss, it is required either to establish a specific allowance for losses equal to 100% of the amount of the assets so classified, or to charge off such amount. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which can order the establishment of additional general or specific loss allowances. Problem loans in the portfolio are regularly reviewed to determine whether any of such loans require classification in accordance with applicable regulations.
The following table sets forth the aggregate amount of the Association's classified assets at the dates indicated.
At December 31, ---------------------------------- 1999 1998 1997 -------- -------- -------- (In thousands)
Substandard assets (1) $ 3,052 $ 3,056 $ 3,056 Doubtful assets -- -- -- Loss assets 6 291 547 -------- -------- -------- Total classified assets $ 3,058 $ 3,347 $ 3,603 ======== ======== ========
- -------------- (1) Includes three loans aggregating $1.1 million which were performing according to their terms at December 31, 1999, but which management had determined to classify as substandard due to future doubt about the collectibility of such loans.
ALLOWANCE FOR LOAN LOSSES. Management's policy is to provide for estimated losses on the loan portfolio based on management's evaluation of the potential losses that may be incurred. Provisions for losses, which increase the allowances for loan losses, are established by charges to income. Such allowances represent the amounts which, in management's judgment, are adequate to absorb charge-offs of existing loans which may become uncollectible. The adequacy of the allowance is determined by management's monthly evaluation of the loan portfolio and related collateral, in light of past loss experience, the volume and type of lending engaged in by the Association, present economic conditions and other factors considered relevant by management. Anticipated changes in economic factors which may influence the level of the allowances are considered in the evaluation by management if the changes can be readily determined.
Management continues to review the entire loan portfolio to determine the extent, if any, to which further additional loan loss provisions may be deemed necessary. Management believes that the current allowance for loan losses is adequate, however, there can be no assurance that the allowance for loan losses will be adequate to cover losses that may in fact be realized in the future or that additional provisions for loan losses will not be required.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES. The following table sets forth the analysis of the allowance for loan losses for the periods indicated.
- -------------- (1) The charge off of real estate loans for September 30, 1996 includes a $1.2 million charge off of a commercial real estate loan for which the provision for loss was recorded in 1994. (2) Net of specific reserves.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES. The following table sets forth the allocation of allowance for loan losses by loan category for the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance by category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
SECURITIES PORTFOLIO.
The Association's primary focus is the origination of loans. However, during past periods when mortgage loan demand was moderate and the Association had de-emphasized the origination of fixed-rate loans, management invested excess liquidity in investment securities, including mutual funds, and in mortgage-backed and related securities rather than purchasing whole loans or loan participations. At December 31, 1999, the Association's securities portfolio totaled $183.6 million. Such securities are subject to classification based on the intentions of management. Securities purchased for the portfolio are classified as either held to maturity or as available for sale. The Association has no securities classified as trading.
The Association maintains an Investment Committee which meets on a monthly basis to review the securities portfolio and make recommendations to be carried out by management. All investments must be rated BBB or higher by a recognized rating service. The Investment Committee consists of the Association's President and Chief Executive Officer, Senior Vice President, Chief Financial Officer and Treasurer, and Senior Vice President of Lending.
Investments purchased are comprised primarily of United States Government and agency obligations, mutual funds that invest in mortgage-backed securities and government and agency obligations, MBS, corporate debt securities, interest-earning deposits at the FHLB, and FHLB stock. Some of such investments allow the issuer to call the securities at predetermined times during the life of the security. Such calls totaled $5.0 million for 1999. Principal repayments on amortizing securities totaled $29.5 million in 1999. The repayments are a general reflection of lower market rates of interest which cause certain securities to pay off more rapidly.
The Association is required under federal regulations to maintain a minimum amount of liquid assets that may be invested in specified short-term securities and certain other investments. The Association generally has maintained a portfolio of liquid assets that exceeds regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management's projections as to the short term demand for funds to be used in loan origination and other activities. For further information regarding the securities portfolio see Notes 1, 2 and 3 to the Notes to Consolidated Financial Statements contained in Bankshares' Annual Report to Shareholders for the Year Ended December 31, 1999 (the "Annual Report") attached hereto as Exhibit 13.
SECURITIES PORTFOLIO MATURITIES. The following table sets forth the scheduled maturities, carrying values, market values and average yields for the securities portfolio at December 31, 1999.
MORTGAGE-BACKED AND RELATED SECURITIES. The Association invests in MBS which are included in the securities portfolio and are classified as either available for sale or held to maturity. At December 31, 1999, net MBS totaled $74.9 million, or 8.4%, of total assets. Of this amount, $18.3 million and $56.6 million were classified as held to maturity and available for sale, respectively. At December 31, 1999, the market value of the net MBS portfolio totaled approximately $74.6 million. Management primarily invests in fixed-rate MBS with weighted average lives of five to seven years. Management believes that investing in short-term MBS limits the Association's exposure to higher interest rates. During fiscal year 1999, $29.7 million of MBS were purchased, using funds provided by public funds deposits, odd-term certificates of deposit and FHLB advances instead of excess liquidity as in previous years.
CMOs are typically issued by a special-purpose entity (in the Association's case, private issuers), which may be organized in a variety of legal forms, such as a trust, a corporation, or a partnership. The entity aggregates pools of pass-through securities, which are used to collateralize the CMO. Once combined, the cash flows are divided into "tranches" or "classes" of individual bonds, thereby creating more predictable average durations for each bond than the underlying pass-through pools. Accordingly, under the CMO structure, all principal paydowns from the various mortgage pools are allocated to a CMO's first class until it has been paid off, then to a second class until such class has been paid off, and then to the next classes in order of priority. Substantially all of the CMOs held in the securities portfolio consist of senior sequential tranches, primarily investments in one of the first three tranches of the CMO. By purchasing senior sequential tranches, management is attempting to ensure the cash flow associated with such an investment. Generally, such tranches have stated maturities ranging from 6.5 years to 30 years; however, because of prepayments, the expected weighted average life of these securities is less than the stated maturities. While non-agency private issues are somewhat less liquid than CMOs issued or guaranteed by Government National Mortgage Association ("GNMA"), FNMA or FHLMC, they generally have a higher yield than agency insured or guaranteed CMOs, such higher yield reflecting in part the lack of such guarantee or protection.
SECURITIES HELD TO MATURITY. At December 31, 1999, investment securities held to maturity totaled $38.8 million and included United States Government and agency obligations totaling $14.6 million, MBS totaling $18.3 million and corporate debt issues totaling $5.9 million.
Included in corporate debt issues at December 31, 1998 and 1997, are two asset-backed securities issued by the Auto Bonds Receivable Corporation (the "Auto Bonds"), which were purchased during fiscal year 1994, and are secured by automobile loan receivables. The Auto Bonds totaled $413,000 at December 31, 1999. During 1999, management determined that the decline in fair value on the Association's investment in the Auto Bonds was other than temporary resulting in a write down of $138,000 and a reclassification from held to maturity to available for sale.
The following tables set forth the carrying value of, and activity in the securities held to maturity at the dates indicated. At December 31, 1999, the market value of the investments was approximately $41.3 million.
Year Ended December 31, -------------------------------- 1999 1998 1997 -------- -------- -------- (In thousands) Securities held to maturity Balance, beginning of period $ 52,619 $ 67,801 $ 75,544 Purchases -- -- -- Calls -- (1,427) -- Sales -- -- -- Maturities -- (3,386) (300) Repayments (14,723) (12,067) (8,956) Discount and premium amortization 1,457 1,523 1,513 Transfer to available for sale (413) -- -- Write down of impaired security (138) -- -- Gain on calls -- 175 -- -------- -------- -------- Balance, end of period $ 38,802 $ 52,619 $ 67,801 ======== ======== ========
SECURITIES AVAILABLE FOR SALE. Securities available for sale are carried on the books at fair value as required by FASB No. 115 and totaled $144.8 million at December 31, 1999. Included in securities available for sale are equity securities totaling $50,000, mutual funds totaling $49.8 million, United States Government and agency obligations totaling $33.5 million, corporate debt issues totaling $4.9 million and MBS totaling $56.6 million.
Mutual fund investments include mutual funds that invest primarily in mortgage-backed securities and government and agency securities, and are classified as available for sale for accounting purposes. The mutual funds which invest in mortgage-backed securities have characteristics similar to the MBS in which they invest. Mutual fund investments include approximately $35.1 million in funds which invest in adjustable-rate mortgage-backed securities issued by FNMA, FHLMC and GNMA, as well as CMOs and real estate mortgage investment conduits and other securities collateralized by or representing interests in real estate mortgages, and approximately $14.7 million in funds which invest in asset-backed, corporate and CMO obligations.
The following tables set forth the carrying value of, and activity in, the securities available for sale at the dates indicated.
Year Ended December 31, ----------------------------------- 1999 1998 1997 --------- --------- --------- (In thousands) Securities available for sale: Balance, beginning of period $ 95,151 $ 142,269 $ 123,151 Purchases 73,314 25,086 46,311 Transfer from held to maturity 413 -- -- Calls (5,000) (40,323) (16,000) Sales -- -- (2,435) Maturities -- -- (3,000) Repayments (14,802) (31,955) (7,291) Discount and premium amortization 116 323 137 (Gain) loss on sales and calls -- -- (8) Increase (decrease) in market value (4,352) (249) 1,404 --------- --------- --------- Balance, end of period $ 144,840 $ 95,151 $ 142,269 ========= ========= =========
Included in corporate debt issues at December 31, 1999 are two asset-backed securities issued by the Auto Bonds Receivable Corporation, which were purchased during fiscal year 1994, and are secured by automobile loan receivables. At December 31, 1999, the Auto Bonds were in default with materially reduced payments occurring. Consequently, management determined that the decline in fair value on the Association's investment in the Auto Bonds was other than temporary resulting in a write down of $138,000 and a reclassification from held to maturity to available for sale, resulting in a balance of $413,000. At December 31, 1999, the trustee for the Auto Bonds had brought suit against the risk default insurance carrier to require payment of the principal balance and accrued interest on these bonds. Management cannot be certain as to the outcome of such litigation.
INTEREST-EARNING DEPOSITS AND FHLB OF ATLANTA STOCK. Excess funds are primarily invested on a daily basis in an interest-earning overnight account at the FHLB of Atlanta. The balance of this account was $21.4 million at December 31, 1999. In addition, interest-earning deposits totaling $1.8 million were held in other financial institutions at December 31, 1999. Such funds are available to provide liquidity to meet lending requirements and daily operations.
The Association is required to purchase and maintain FHLB of Atlanta stock based on the Association's asset size and outstanding total of FHLB advances. FHLB of Atlanta stock is not readily marketable as it is not traded on a registered security exchange.
The following table sets forth the carrying value of interest-earning deposits and FHLB of Atlanta stock at the dates indicated.
SOURCES OF FUNDS
GENERAL. Deposits are the major source of funds for lending and other investment purposes. In addition to deposits, funds are derived from the amortization and prepayment of loans and mortgage-backed and related securities, the maturity of investment securities, operations and, if needed, advances from the FHLB. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes. Although the Association periodically reviews the features and terms of its deposit products, the Association does not intend to materially change any of the deposit products or services it currently offers.
DEPOSITS. Consumer and commercial deposits are attracted principally from within the market area through the offering of a broad selection of deposit instruments including non-interest-bearing demand accounts, NOW accounts, passbook savings, money market deposit accounts, term certificate accounts and individual retirement accounts. While deposits of $100,000 or more are accepted, premium rates for such deposits are not currently offered. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. A management committee meets weekly to evaluate the internal cost of funds, survey rates offered by competing institutions, review the Association's cash flow requirements for lending and liquidity and the amount of certificates of deposit maturing in the upcoming weeks. This committee executes rate changes when deemed appropriate. Funds are not obtained through brokers, nor are funds solicited outside the Association's market area.
The following table sets forth information regarding interest rates, terms, minimum amounts and balances of deposits as of December 31, 1999.
- -------------- (1) IRA and KEOGH accounts are generally offered throughout all terms stated above with aggregate balances of $50.0 million and $1.0 million, respectively, at December 31, 1999.
The following tables sets forth the change in dollar amount in the various types of savings accounts offered between the dates indicated:
The following table sets forth the certificates of deposit classified by rates as of the dates indicated.
At December 31, ---------------------------------- 1999 1998 1997 -------- -------- -------- Rate (In thousands)
3.00% or less $ 286 $ 940 $ 1,436 3.01 - 3.99% 12 11 11 4.00 - 4.99% 135,880 74,835 35,699 5.00 - 5.99% 151,899 238,564 262,029 6.00 - 6.99% 67,028 33,983 39,186 7.00 - 7.99% 8,571 8,856 8,717 -------- -------- -------- $363,676 $357,189 $347,078 ======== ======== ========
The following table sets forth the amount and maturities of certificates of deposit at December 31, 1999.
The following table indicates the amount of negotiable certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 1999.
Certificates of Deposit of $100,000 Remaining Maturity or More ------------------ ------------ (In thousands)
Three months or less $ 12,007 Three through six months 7,118 Six through twelve months 19,815 Over twelve months 23,360 --------- Total $ 62,300 =========
Deposits are used to fund loan originations, the purchase of securities and for general business purposes. The deposit growth in fiscal year 1999 of $19.5 million reflected the use of odd-term and promotional certificate of deposit products, as well as increased retail deposits generated by aggressive, competitive pricing of such products in the market area. The Association also continues to emphasize commercial checking accounts for small local businesses.
The following table sets forth the net changes in the deposit activities for the periods indicated.
Year Ended December 31, ------------------------------------ 1999 1998 1997 ---------- ---------- ---------- (In thousands)
Deposits $2,875,680 $2,737,244 $2,433,375 Withdrawals 2,875,669 2,715,239 2,416,860 ---------- ---------- ---------- Net increase before interest credited 11 22,005 16,515 Interest credited 19,532 21,687 20,484 ---------- ---------- ---------- Net increase in deposits $ 19,543 $ 43,692 $ 36,999 ========== ========== ==========
BORROWINGS. Savings deposits are the primary source of funds for lending and investment activities and for general business purposes. If the need arises, advances from the FHLB may be used to supplement the supply of lendable funds and to meet deposit withdrawal requirements as well as in leveraged transactions used to purchase securities. Advances from the FHLB typically are collateralized by the Association's stock in the FHLB and a blanket floating lien on the Association's one- to four-family first mortgage loans. At December 31, 1999, $140.2 million of FHLB advances were outstanding with a weighted average interest rate of 5.59%.
The FHLB functions as a central reserve bank providing credit for the Association and other member savings institutions and financial institutions. As a member, the Association is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally, securities that are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of a member institution's net worth or on the FHLB's assessment of the institution's creditworthiness. Although advances may be used on a short-term basis for cash management needs, FHLB advances have not been, nor are they expected to be, a significant long-term funding source for the Association, although the Association periodically utilizes its ability to access advances in order to take advantage of investment opportunities which may arise, or to fund loan originations if liquidity is low.
On September 30, 1983, the Association sold two of its branches to another financial institution. Under terms of the sale, the Association issued a 10.94%, 30-year term mortgage-backed bond (the "Bond") for approximately $41.6 million. A discount was recorded on the Bond which is being accreted on the interest method of accounting over the life of the Bond. The Bond bears an interest rate that is adjustable semi-annually on each April 1 and October 1 to reflect changes in the average of the United States 10-year and 30-year long-term bond rates. At December 31, 1999, the net outstanding balance of the Bond was $14.5 million with an effective rate of 10.09%. For further information on the Bond, see Note 10 to the Notes to the Consolidated Financial Statements in the Annual Report attached hereto as Exhibit 13.
On October 24, 1994, in connection with the Association's Plan of Reorganization into a mutual holding company, the Association established an Employee Stock Ownership Plan ("ESOP") for all eligible employees. The ESOP is funded by two loans from Bankshares. ESOP Loan I was used to purchase 389,248 (as adjusted by the Exchange Ratio of 2.0445) shares of common stock in the open market. The loan is being repaid from the Association's contributions to the ESOP over a period of up to seven years and had an outstanding balance of $637,000 at December 31, 1999. The loan has a fixed interest rate of 8.50%. ESOP Loan II was used to permit the ESOP to purchase an additional 437,652 shares. The loan is being repaid over 15 years and the loan had an outstanding balance of $4.1 million at December 31, 1999 and has a fixed interest rate of 7.75%. For further information, see Note 13 to the Notes to the Consolidated Financial Statements in the Annual Report attached hereto as Exhibit 13.
The following table sets forth the source, balance, and rate of borrowings for the years ended December 31, 1999, 1998 and 1997.
- -------------- (1) Computed on the basis of month-end balances.
SUBSIDIARY ACTIVITIES
The Association currently has two active subsidiaries.
ComFed, Inc. ("ComFed") was formed in February 1971 for the purpose of operating an insurance agency, Community Insurance Agency, which sells mortgage life insurance. ComFed also receives income and incurs related expenses from the sale of third party mutual funds and annuities. Such third party mutual funds and annuities include products widely marketed to the investing public and have investment advisors that are not affiliated with ComFed. For the year ended December 31, 1999, ComFed reported net income of $130,000. At December 31, 1999, the Association had an equity investment in ComFed of $338,000.
Palm River Development Co., Inc. ("Palm River") was formed in July 1999 to engage in a real estate development joint venture. Palm River purchased 117 acres of land located in Indian River County which is being developed by the joint venture as 17 single-family lots, 48 condominiums, 22 carriage homes and 116 patio homes. A $15.0 million inter-company line of credit from the Association is used by Palm River to fund the joint venture as needed. For the year ended December 31, 1999, Palm River reported a net loss of $166,000. At December 31, 1999, the Association had an equity loss in Palm River of $166,000 and the balance of the inter-company loan was $11.8 million.
PERSONNEL
As of December 31, 1999, Bankshares had no separately compensated employees. Officers of Bankshares are employees of the Association and receive all compensation from the Association. Because Bankshares' primary activity is holding the stock of the Association, employees of the Association perform limited duties for Bankshares.
As of December 31, 1999, the Association had 247 full-time and 41 part-time employees. None of such employees is represented by a collective bargaining group. The Association believes it has a good relationship with its employees.
REGULATION
Set forth below is a brief description of certain laws and regulations which are applicable to Bankshares and the Association. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
GENERAL
The Association, as a federally chartered savings institution, is subject to federal regulation and oversight by the OTS extending to all aspects of its operations. The Association also is subject to regulation and examination by the FDIC, which insures the deposits of the Association to the maximum extent permitted by law, and requirements established by the Federal Reserve Board. Federally chartered savings institutions are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and FDIC. The investment and lending authority of savings institutions are prescribed by federal laws and regulations, and such institutions are prohibited from engaging in any activities not permitted by such laws and regulations. Such regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting shareholders.
BANKSHARES
HOLDING COMPANY ACQUISITIONS. In December 1998, Bankshares became a unitary savings and loan holding company within the meaning of the Home Owners' Loan Act, as amended ("HOLA"), and has registered with the OTS. The HOLA and OTS regulations generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring, directly or indirectly, the ownership or control of any other savings institution or savings and loan holding company, or all, or substantially all, of the assets or more than 5% of the voting shares thereof. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings institution not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS.
HOLDING COMPANY ACTIVITIES. Bankshares operates as a unitary savings and loan holding company. Generally, there are only limited restrictions on the activities of a unitary savings and loan holding company which applied to become or were a unitary savings and loan holding company prior to May 4, 1999 and its non-savings institution subsidiaries. Under the enacted Gramm-Leach-Bliley Act of 1999 (the "GBLA"), companies which applied to the OTS to become unitary savings and loan holding companies will be restricted to engaging in those activities traditionally permitted to multiple savings and loan holding companies. If the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the Director may impose such restrictions as deemed necessary to address such risk, including limiting (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Notwithstanding the above rules as to permissible business activities of grandfathered unitary savings and loan holding companies under the GBLA, if the savings institution subsidiary of such a holding company fails to meet the QTL test, as discussed under "-The Association - Qualified Thrift Lender Test," then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. See "-The Association - Qualified Thrift Lender Test."
The HOLA requires every savings institution subsidiary of a savings and loan holding company to give the OTS at least 30 days' advance notice of any proposed dividends to be made on its guarantee, permanent or other nonwithdrawable stock, or else such dividend will be invalid. See "- The Association - Capital Distributions."
AFFILIATE RESTRICTIONS. Transactions between a savings institution and its "affiliates" are subject to quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act and OTS regulations. Affiliates of a savings institution include, among other entities, the savings institution's holding company and companies that are controlled by or under common control with the savings institution.
In general, Sections 23A and 23B and OTS regulations issued in connection therewith limit the extent to which a savings institution or its subsidiaries may engage in certain "covered transactions" with affiliates to an amount equal to 10% of the institution's capital and surplus, in the case of covered transactions with any one affiliate, and to an amount equal to 20% of such capital and surplus, in the case of covered transactions with all affiliates. In addition, a savings institution and its subsidiaries may engage in covered transactions and certain other transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the savings institution or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" is defined to include a loan or extension of credit to an affiliate; a purchase of investment securities issued by an affiliate; a purchase of assets from an affiliate, with certain exceptions; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; or the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, under OTS regulations, a savings institution may not make a loan or extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies; a savings institution may not purchase or invest in securities of an affiliate other than shares of a subsidiary; a savings institution and its subsidiaries may not purchase a low-quality asset from an affiliate; and covered transactions and certain other transactions between a savings institution or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. With certain exceptions, each loan or extension of credit by a savings institution to an affiliate must be secured by collateral with a market value ranging from 100% to 130% (depending on the type of collateral) of the amount of the loan or extension of credit.
OTS regulations generally exclude all non-bank and non-savings institution subsidiaries of savings institutions from treatment as affiliates, except to the extent that the OTS or the Federal Reserve Board decides to treat such subsidiaries as affiliates. The regulations also require savings institutions to make and retain records that reflect affiliate transactions in reasonable detail, and provides that certain classes of savings institutions may be required to give the OTS prior notice of affiliate transactions.
THE ASSOCIATION
INSURANCE OF ACCOUNTS. The deposits of the Association are insured to the maximum extent permitted by the SAIF, which is administered by the FDIC, and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action.
On September 30, 1996, new legislation required all SAIF member institutions to pay a one-time special assessment to recapitalize the SAIF, with the aggregate amount to be sufficient to bring the reserve ratio to 1.25% of insured deposits.
Currently, FDIC deposit insurance rates generally range from zero basis points to 27 basis points, depending on the assessment risk classification assigned to the depository institution. From 1998 through 1999, SAIF members paid approximately 6.0 basis points, while BIF member institutions paid approximately 1.3 basis points.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Association, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Association's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. The OTS capital requirements consist of a "tangible capital requirement," a "leverage capital requirement" and a "risk-based capital requirement." The OTS is also authorized to impose capital requirements in excess of those standards on individual institutions on a case-by-case basis.
Under the tangible capital requirement, a savings association must maintain tangible capital in an amount equal to at least 1.5% of adjusted total assets. Tangible capital is defined as core capital less all intangible assets (including supervisory goodwill), plus a specified amount of purchased mortgage servicing rights.
Under the leverage capital requirement adopted by the OTS, savings associations maintain "core capital" in an amount equal to at least 4% of adjusted total assets. Core capital is generally defined as common stockholders' equity, including retained earnings. At December 31, 1999, the Association's ratio of core capital to total adjusted assets was 9.20%.
Under the risk-based capital requirement, a savings association must maintain total capital (which is defined as core capital plus supplementary capital) equal to at least 8.0% of risk-weighted assets. A savings association must calculate its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors, which range from 0% for cash and securities issued by the United States Government or its agencies to 100% for repossessed assets or loans more than 90 days past due. Qualifying one- to four-family residential real estate loans and qualifying multi-family residential real estate loans (not more than 90 days delinquent and having an 80% or lower loan-to-value ratio), are weighted at a 50% risk factor. Supplementary capital may include, among other items, general allowances for loan losses. The allowance for loan losses includable in supplementary capital is limited to 1.25% of risk-weighted assets. Supplementary capital is limited to 100% of core capital.
Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and non-residential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. However, in calculating regulatory capital, institutions can add back unrealized losses and deduct unrealized gains net of taxes, on debt securities reported as a separate component of GAAP capital.
OTS regulations establish special capitalization requirements for savings associations that own service corporations and other subsidiaries, including subsidiary savings associations. According to these regulations, certain subsidiaries are consolidated for capital purposes and others are excluded from assets and capital. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks, engaged solely in mortgage-banking activities, or engaged in certain other activities solely as agent for its customers are "includable" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership, including the assets of includable subsidiaries in which the association has a minority interest that is not consolidated for GAAP purposes. For excludable subsidiaries, the debt and equity investments in such subsidiaries are deducted from assets and capital. At December 31, 1999, the Palm River investment was subject to a deduction from tangible capital.
The OTS amended its risk-based capital requirements that would require institutions with an "above normal" level of interest rate risk to maintain additional capital. A savings association is considered to have a "normal" level of interest rate risk if the decline in the market value of its portfolio equity after an immediate 200 basis point increase or decrease in market interest rates (whichever leads to the greater decline) is less than two percent of the current estimated market value of its assets. The market value of portfolio equity is defined as the net present value of expected cash inflows and outflows from an association's assets, liabilities and off-balance sheet items. The amount of additional capital that an institution with an above normal interest rate risk is required to maintain (the "interest rate risk component") equals one-half of the dollar amount by which its measured interest rate risk exceeds the normal level of interest rate risk. The interest rate risk component is in addition to the capital otherwise required to satisfy the risk-based capital requirement. Implementation of this component has been postponed by the OTS. The final rule was to be effective as of January 1, 1994, subject however to a three quarter lag time in implementation. However, because of continuing delays by the OTS, the interest rate risk component has never been operative.
At December 31, 1999, the Association exceeded all of its regulatory capital requirements, with tangible, core and risk-based capital ratios of 9.20%, 9.20%, and 17.84%, respectively. See Note 14 to the Notes to Consolidated Financial Statements included in the Annual Report, attached hereto as Exhibit 13.
The OTS and the FDIC generally are authorized to take enforcement action against a savings association that fails to meet its capital requirements, which action may include restrictions on operations and banking
activities, the imposition of a capital directive, a cease-and-desist order, civil money penalties or harsher measures such as the appointment of a receiver or conservator or a forced merger into another institution. In addition, under current regulatory policy, an association that fails to meet its capital requirements is prohibited from paying any dividends.
PROMPT CORRECTIVE ACTION. Under the prompt corrective action regulations of the OTS, an institution is deemed to be (i) "well-capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized," (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less that 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain circumstances),(iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Under specified circumstances, a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized).
An institution generally must file a written capital restoration plan which meets specified requirements with its appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the agency. An institution which is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. In addition, undercapitalized institutions are subject to various regulatory restrictions, and the appropriate federal banking agency also may take any number of discretionary supervisory actions.
At December 31, 1999, the Association was in the "well capitalized" category for purposes of the above regulations and as such is not subject to the above mentioned restrictions.
SAFETY AND SOUNDNESS GUIDELINES. The OTS and the other federal bank regulatory agencies have established guidelines for safety and soundness, addressing operational and managerial standards, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The OTS and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. The Association believes that it is in compliance with these guidelines and standards.
LIQUIDITY REQUIREMENTS. All savings institutions are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings institutions. At the present time, the required minimum liquid asset ratio is 4%. For the month ended December 31, 1999, the Association's average liquidity ratio was 12.2%.
CAPITAL DISTRIBUTIONS. OTS regulations govern capital distributions by savings institutions, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings institution to make capital distributions.
A savings institution must file an application for OTS approval of the capital distribution if either (1) the total capital distributions for the applicable calendar year exceed the sum of the institution's net income for that year to date plus the institution's retained net income (which takes into account capital distributions made) for the preceding two years, (2) the institution would not be at least adequately capitalized following the distribution, (3) the distribution would violate any applicable statute, regulation, agreement or OTS-imposed condition, or (4) the institution is not eligible for expedited treatment of its filings. If an application is not required to be filed, savings institutions which are a subsidiary of a holding
company (as well as certain other institutions) must still file a notice with the OTS at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.
BRANCHING BY FEDERAL SAVINGS INSTITUTIONS. OTS policy permits interstate branching to the full extent permitted by statute (which is essentially unlimited). Generally, federal law prohibits federal savings institutions from establishing, retaining or operating a branch outside that state in which the federal institution has its home office unless the institution meets the IRS' domestic building and loan test (generally, 60% of a thrift's assets must be housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (i) the branch(es) result(s) from an emergency acquisition of a troubled savings institution (however, if the troubled savings institution is acquired by a bank holding company, does not have its home office in the state of the bank holding company bank subsidiary and does not qualify under the IRS Test, its branching is limited to the branching laws for state-chartered banks in the state where the savings institution is located); (ii) the law of the state where the branch would be located would permit the branch to be established if the federal savings institution was chartered by the state in which its home office is located; or (iii) the branch was operated lawfully as a branch under the state law prior to the savings institution's conversion to a federal charter.
Furthermore, the OTS will evaluate a branching applicant's record of compliance with the Community Reinvestment Act of 1977 ("CRA"). An unsatisfactory CRA record may be the basis for denial of a branching application.
COMMUNITY REINVESTMENT ACT AND THE FAIR LENDING LAWS. Savings institutions have a responsibility under the CRA and related regulations of the OTS to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act (together, the "Fair Lending Laws") prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution's failure to comply with the provisions of CRA could, at a minimum, result in regulatory restrictions on its activities, and failure to comply with the Fair Lending Laws could result in enforcement actions by the OTS, as well as other federal regulatory agencies and the Department of Justice.
QUALIFIED THRIFT LENDER TEST. All savings institutions are required to meet a QTL test to avoid certain restrictions on their operations. Under Section 2303 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996, a savings institution can comply with the QTL test by either qualifying as a domestic building and loan association as defined in the Code or by meeting the second prong of the QTL test set forth in the HOLA. A savings institution that does not meet the QTL test must either convert to a bank charter or comply with the following restrictions on its operation. Upon the expiration of three years from the date the savings institution ceases to be a QTL, it must cease any activity and not retain any investment not permissible for a national bank and immediately repay any outstanding FHLB advances (subject to safety and soundness considerations).
Currently, the portion of the QTL test that is based on the HOLA rather than the Code requires that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing; home equity loans; mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing); stock issued by the FHLB; and direct or indirect obligations of the FDIC. In addition, small business loans, credit card loans, student loans and loans for personal, family and household purposes are allowed to be included without limitation as qualified investments. The following assets, among others, also may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination; 100% of consumer and educational loans (limited to 10% of total portfolio assets); and stock issued by the FHLMC or the FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and other intangible assets, (ii) property used by the savings institution to conduct its business, and (iii) liquid assets up to 20% of the institution's total assets. At December 31, 1999, the qualified thrift investments of the Association were approximately 74.2% of its portfolio assets.
FEDERAL HOME LOAN BANK SYSTEM. The Association is a member of the FHLB of Atlanta, which is one of 12 regional FHLBs that administer the home financing credit function or savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (I.E. advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB. At December 31, 1999, the Association had $140.2 million of FHLB advances. See Note 9 to Notes to Consolidated Financial Statements in the Annual Report.
As a member, the Association is required to purchase and maintain stock in the FHLB of Atlanta in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year. At December 31, 1999, the Association had $7.0 million in FHLB stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB stock in the future. The dividend yield on the Association's FHLB stock was 7.57%, 7.25% and 7.25% for the fiscal years ended December 31, 1999, 1998, and 1997, respectively.
FEDERAL RESERVE SYSTEM. Federal Reserve Board regulations require all depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At December 31, 1999, the Association was in compliance with the reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
For federal income tax purposes, Bankshares files a consolidated federal income tax return with the Association on a fiscal year basis.
On May 13, 1997, permission was received from the Internal Revenue Service ("IRS") to change the accounting period, for federal income tax purposes, from September 30th to December 31st, effective December 31, 1996.
Bankshares and the Association are subject to the rules of federal income taxation generally applicable to corporations under the Code. Most corporations are not permitted to make deductible additions to bad debt reserves under the Code. However, prior to the effective date of legislation passed in 1996, savings and loan associations and savings associations such as the Association, which met certain tests prescribed by the IRS may have benefited from favorable provisions provided for in Section 593 of the code regarding deductions for taxable income for annual additions to the bad debt reserve.
During 1996, effective for years beginning after December 31, 1995, legislation was passed that repealed section 593 of the Code. Section 593 allowed thrift institutions, including the Association, to use the percentage-of-taxable income bad debt accounting method, if more favorable than the specific charge-off method, for federal income tax purposes. The excess reserves (deduction based on the percentage-of-taxable income less the deduction based on the specific charge-off method) accumulated post-1987 are required to be recaptured ratably over a six year period beginning in 1996. The excess reserve as of December 31, 1996 was approximately $435,000. The same legislation forgave the tax liability on pre-1987 accumulated bad debt reserves which would have penalized any thrift choosing to adopt a bank charter because the tax would have become due and payable. The unrecorded potential liability that was forgiven approximated $4.3 million. See Note 11 to the Notes to the Consolidated Financial Statements in the Annual Report, attached hereto as Exhibit 13.
Deferred income taxes arise from the recognition of certain items of income and expense for tax purposes in years different from those in which they are recognized in the financial statements. In February 1992, the FASB issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS 109 was implemented by Bankshares retroactively, effective October 1, 1993. The liability method accounts for deferred income taxes by applying the enacted statutory rates in effect at the balance sheet date to differences between the book cost and the tax cost of assets and liabilities. The resulting deferred tax liabilities and assets are adjusted to reflect changes in tax laws.
Bankshares is subject to the corporate alternative minimum tax which is imposed to the extent it exceeds Bankshares' regular income tax for the year. The alternative minimum tax will be imposed at the rate of 20% of a specially computed tax base. Included in this base will be a number of preference items, including the interest on certain tax-exempt bonds issued after August 7, 1986. In addition. for purposes of the alternative minimum tax, the amount of alternative minimum taxable income that may be offset by net operating losses is limited to 90% of alternative minimum taxable income.
The Association was audited by the IRS for the tax year 1990 during fiscal year 1994. Based upon the audit, the Association received a "no-change" letter from the IRS. Bankshares has not been audited by the IRS. See Notes 1 and 11 to the Notes to the Consolidated Financial Statements in the Annual Report.
STATE TAXATION
Under the laws of the State of Florida, Bankshares and its subsidiary are generally subject to 5.5% tax on net income. The tax may be reduced by a credit of up to 65% of the tax due as a result of certain intangible taxes. The tax is deductible by Bankshares in determining its federal income tax liability. Bankshares has not been audited by the State of Florida.
ITEM 2.
ITEM 2. PROPERTIES - --------------------------------------------------------------------------------
Bankshares owns no property independently from the Association. The Association conducts its business through its home office located in North Palm Beach, Florida, and 21 full-service branch offices located in Palm Beach, Martin, St. Lucie, and Indian River Counties. The following table sets forth certain information concerning the home office and each branch office of the Association at December 31, 1999. The aggregate net book value of the Association's premises and equipment and real estate held for investment was $24.9 million and $1.9 million at December 31, 1999, respectively. Real estate held for investment represents a pro-rata portion of the Association's office building located on Port St. Lucie Blvd. which is leased to tenants and a parcel of land held for future sale located adjacent to the Association's Maplewood office. For additional information regarding the Association's properties, see Note 6 to the Notes to the Consolidated Financial Statements in the Annual Report. In addition, the Association owns or has placed earnest funds on four parcels of real estate for use as possible future branch sites. The Association's total investment in such other properties totaled $2.9 million at December 31, 1999 which is included in the aggregate net book value of the Association's premises and equipment set forth above.
- -------------- (1) A branch office is also located at the same site. (2) A portion of land was taken by the State of Florida during late 1999 under the doctrine of eminent domain. To solve a temporary parking problem, the land is being leased back from the State on a six-month lease which expires May 1, 2000. The lease may then be extended on a month-to-month basis until the State begins construction. (3) This lease expires on December 31, 2000 and provides for a renewal option which runs through December 31, 2015. (4) This lease expires on August 8, 2001 and provides for a renewal option which runs through August 8, 2003. (5) This lease expires on October 31, 2001 and provides for a renewal option which runs through October 31, 2016. (6) This lease expires on June 25, 2004 and provides for a renewal option which runs through June 25, 2014. (7) This lease expires on September 1, 2000 and provides for a renewal option which runs through August 31, 2002. (8) This lease expires on April 30, 2000. The facility, which was previously used by the Association as a loan production office, is currently being sub-leased to another tenant. The lease will not be renewed by the Association.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------------------------------------------------------------
There are various claims and lawsuits in which Bankshares is periodically involved incident to its business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.
The Association reached a final settlement with its insurance company during the first quarter of 1999 on a claim related to a defalcation by a former employee. The Association recorded a partial recovery of the previously recorded allowance for loss.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------------------------------------
Bankshares held its Special Meeting of Shareholders on December 21, 1999. Of the 10,051,873 shares eligible to vote, 9,091,159 shares or 90.4%, were represented in person or by proxy at the meeting.
The shareholders acted on the following matter at the Special Meeting, approving such matter.
1. The approval of the amendment of the Community Savings Bankshares, Inc. 1999 Stock Option Plan, the 1999 Recognition and Retention Plan and Trust Agreement, the 1995 Stock Option Plan and the 1995 Recognition and Retention Plan for Employees and Outside Directors.
For Against Abstain Not Voted --- ------- ------- --------- Number of Votes 7,961,143 1,051,268 78,748 960,714
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS - --------------------------------------------------------------------------------
For information concerning the market for Bankshares' common stock, see "The Association - Capital Distributions" and the section captioned "Corporate Information" in Bankshares' Annual Report attached as Exhibit 13 hereto and which is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA - --------------------------------------------------------------------------------
The "Financial Highlights" section of Bankshares' Annual Report is incorporated herein by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------
The "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of Bankshares' Annual Report is incorporated herein by reference.
ITEM 7 - A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK - --------------------------------------------------------------------------------
Information with respect to quantitative and qualitative disclosures about market risk are incorporated by reference to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk Analysis, and - Market Value of Portfolio Equity" in the Annual Report.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA - --------------------------------------------------------------------------------
The financial statements identified in Item 14(a)(1) hereof are incorporated by reference to Bankshares' Annual Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------------
Information required by this section is incorporated herein by reference from Bankshares' definitive Proxy Statement for the Annual Meeting of Shareholders filed March 24, 2000 (the "Proxy Statement"), specifically the section captioned "Ratification of Appointment of Independent Accountants".
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------------------------------------
Information concerning Directors and Executive Officers of Bankshares is incorporated herein by reference from the Proxy Statement, specifically the section captioned "Information with Respect to Nominees for Directors, Directors Whose Term Continues and Executive Officers".
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - --------------------------------------------------------------------------------
Information concerning executive compensation is incorporated herein by reference from the Proxy Statement, specifically the section captioned "Executive Compensation".
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - --------------------------------------------------------------------------------
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Proxy Statement, specifically the section captioned "Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management".
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------------------------------
Information concerning relationships and transactions is incorporated herein by reference from the Proxy Statement, specifically the section captioned "Executive Compensation - Indebtedness of Management and Affiliated Transactions."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------------
The exhibits and financial statement schedules filed as a part of this Form 10-K are as follows:
(a)(1) FINANCIAL STATEMENTS
Independent Auditors' Report Consolidated Statements of Financial Condition, December 31, 1999, and 1998 Consolidated Statements of Operations, Years Ended December 31, 1999, 1998, and 1997 Consolidated Statements of Shareholders' Equity, Years Ended December 31, 1999, 1998 and 1997 Consolidated Statements of Cash Flows, Years Ended December 31, 1999, 1998 and 1997 Notes to Consolidated Financial Statements
(a)(2) FINANCIAL STATEMENT SCHEDULES
No financial statement schedules are filed because the required information is not applicable or is included in the consolidated financial statements or related notes.
(a)(3) EXHIBITS
3.1 Certificate of Incorporation of Community Savings Bankshares, Inc.*
3.2 Bylaws of Community Savings Bankshares, Inc.*
4.0 Form of Stock Certificate of Community Savings Bankshares, Inc.*
10.1 Amended and Restated 1995 Stock Option Plan**
10.3 Amended and restated 1995 Recognition and Retention Plan for Employees and Outside Directors**
10.3 Amended and Restated 1999 Stock Option Plan**
10.4 Amended and Restated 1999 Recognition and Retention Plan and Trust Agreement**
10.5 Employment Agreement between Community Savings Bankshares, Inc., Community Savings, F. A. and James B. Pittard, Jr.
10.6 Change in Control Agreement between Community Savings Bankshares, Inc., Community Savings, F. A. and James B, Pittard, Jr.
10.7 Change in Control Agreement with Larry J. Baker, CPA, Cecil F. Howard, Jr., Mary L. Kaminske, Michael E. Reinhardt and certain non-executive officers, and Community Savings Bankshares, Inc. and Community Savings, F. A.
13 1999 Annual Report to Shareholders
21 Subsidiaries of the Registrant - Reference is made to Item 1 "Business" for the required information.
23 Consent of Crowe Chizek and Company LLP
27 Financial Data Schedule
* Incorporated by reference from the Registration statement on Form S-1 (333-62069) first filed with the SEC on August 21, 1998.
** Incorporated by reference from Bankshares' definitive proxy statement dated November 10, 1999 filed with the SEC on said date.
(b) REPORTS ON FORM 8-K:
None.
(c) The exhibits listed under (a)(3) above are filed herewith.
(d) Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
COMMUNITY SAVINGS BANKSHARES, INC.
Date: March 24, 2000 By: /s/ JAMES B. PITTARD, JR. ------------------------------ James B. Pittard, Jr. President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: /s/ JAMES B. PITTARD, JR. By: /s/ LARRY J. BAKER, CPA --------------------------- -------------------------- James B. Pittard, Jr., President Larry J. Baker, CPA, Senior and Chief Executive Officer Vice President, Chief Financial (Principal Executive Officer) Officer and Treasurer (Principal Financial and Accounting Officer)
Date: March 24, 2000 Date: March 24, 2000
By: /s/ FREDERICK A. TEED By: /s/ FOREST C. BEATY ---------------------------- -------------------------- Frederick A. Teed, Chairman of Forest C. Beaty, Jr., Director the Board
Date: March 24, 2000 Date: March 24, 2000
By: /s/ ROBERT F. CROMWELL By: /s/ KARL D. GRIFFIN ----------------------------- -------------------------- Robert F. Cromwell, Director Karl D. Griffin, Director
Date: March 24, 2000 Date: March 24, 2000
By: /s/ HAROLD I. STEVENSON ----------------------------- Harold I. Stevenson, CPA, Director
Date: March 24, 2000