UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-K

 

ý                                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended June 30, 2005

 

Commission File Number 0-19972

 

 

HF FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

Delaware		46-0418532
(State or other jurisdiction of incorporation		(I.R.S. Employer Identification No.)
or organization)
225 South Main Avenue, Sioux Falls, SD		57104
(Address of principal executive offices)		(Zip Code)

 

(605) 333-7556

(Registrant’s telephone number, including area code)

 

Securities Registered Pursuant to Section 12(b) of the Act:

None

 

Securities Registered Pursuant to Section 12(g) of the Act:

 

Common Stock, par value $.01 per share

(Title of class)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days.

YES  ý  NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)

YES  o  NO  ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)

YES  o  NO  ý

 

As of September 23, 2005, there were 3,498,645 issued and outstanding shares of the registrant’s common stock.

 

The aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such common equity as of December 31, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, was $66.2 million.  (The exclusion from such amount of the market value of the common equity owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of Annual Report on Form 10-K - Portions of the Proxy Statement for 2005 Annual Meeting of Stockholders.

 

 

Annual Report on Form 10-K

Table of Contents

 

PART I
Item 1.	Business
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.	Selected Financial Data
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk
Item 8.	Financial Statements and Supplementary Data
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.	Controls and Procedures
Item 9B.	Other Information
PART III
Item 10.	Directors and Executive Officers of the Registrant
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.	Certain Relationships and Related Transactions
Item 14.	Principal Accounting Fees and Services
PART IV
Item 15.	Exhibits and Financial Statement Schedules

 

 

Forward-Looking Statements

 

This Annual Report on Form 10-K (“Form 10-K”) and other reports issued by HF Financial Corp. (the “Company”), including reports filed with the Securities and Exchange Commission (the”SEC”), contain “forward-looking statements” that deal with future results, expectations, plans and performance.  In addition, the Company’s management may make forward-looking statements orally to the media, securities analysts, investors or others.  These forward-looking statements might include one or more of the following:

 

•                  Projections of income, loss, revenues, earnings or losses per share, dividends, capital expenditures, capital structure, tax benefit or other financial items.

•                  Descriptions of plans or objectives of management for future operations, products or services, transactions, investments and use of subordinated debentures payable to trusts.

•      Forecasts of future economic performance.

•      Use and descriptions of assumptions and estimates underlying or relating to such matters.

 

Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.  They often include words such as “optimism,” “look-forward,” “bright,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”

 

Forward-looking statements about the Company’s expected financial results and other plans are subject to certain risks, uncertainties and assumptions.  These include, but are not limited to the following: possible legislative changes and adverse economic, business and competitive conditions and developments (such as shrinking interest margins and continued short-term rate environments); deposit outflows; reduced demand for financial services and loan products; changes in accounting policies or guidelines, or in monetary and fiscal policies of the federal government; changes in credit and other risks posed by the Company’s loan portfolios; the ability or inability of the Company to manage interest rate and other risks; unexpected or continuing claims against the Company’s self-insured health plan; the Company’s use of trust preferred securities; the ability or inability of the Company to successfully enter into a definitive agreement for and close anticipated transactions; technological, computer-related or operational difficulties; adverse changes in securities markets; results of litigation; or other significant uncertainties.

 

Forward-looking statements speak only as of the date they are made.  The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

 

PART I

 

Item 1.  Business

 

This section should be read in conjunction with the following parts of this Form 10-K: Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” and Part II, Item 8, “Financial Statements and Supplementary Data”.

 

The Company

 

HF Financial Corp., a unitary thrift holding company, was formed in November 1991, for the purpose of owning all of the outstanding stock of Home Federal Bank (the “Bank”) issued in the mutual to stock conversion of the Bank.  The Company acquired all of the outstanding stock of the Bank on April 8, 1992.  The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law.  Unless otherwise indicated, all matters discussed in this Form 10-K relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank.  See “Subsidiary Activities” for further information regarding the subsidiary operations of the Company and the Bank.

 

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The executive offices of the Company and its direct and indirect subsidiaries are located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.  The Company’s telephone number is (605) 333-7556.

 

Website and Available Information

 

The website for the Company and the Bank is located at www.homefederal.com.  Information on this website does not constitute part of this Form 10-K.

 

The Company makes available, free of charge, its Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as soon as reasonably practicable after such forms are filed with or furnished to the SEC.  Copies of these documents are available to stockholders upon request addressed to the Secretary of the Company at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.

 

The Bank

 

The Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota.  The Bank provides full-service consumer and commercial business banking, including an array of financial products, to meet the needs of its market place.  The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one- to four-family residential, commercial business, consumer, multi-family, commercial real estate, construction and agricultural loans.  The Bank’s consumer loan portfolio includes, among other things, automobile loans, home equity loans, loans secured by deposit accounts and student loans.  The Bank also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments.  The Bank does not hold any non-investment grade bonds (i.e., “junk bonds”).  The Bank receives loan servicing income on loans serviced for others and commission income from credit-life insurance on consumer loans.  The Bank, through its wholly-owned subsidiaries, offers annuities, mutual funds, life insurance and other financial products and equipment leasing services.

 

The Bank’s deposits are insured up to applicable limits by the Savings Association Insurance Fund (“SAIF”), which is administered by the Federal Deposit Insurance Corporation (“FDIC”), and the Bank is subject to primary regulation and examination by the Office of Thrift Supervision (“OTS”).

 

Segments

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance.  The Company’s reportable segments are “banking” (including leasing activities) and “other”.  The “banking” segment is conducted through the Bank and Mid America Capital Services, Inc. (“Mid America Capital”) and the “other” segment is composed of smaller nonreportable segments, the Company and inter-segment eliminations.  For financial information by segment see Note 1 of “Notes to Consolidated Financial Statements”, which is included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K.

 

Subsidiary Activities

 

In addition to the Bank, the Company had six other wholly-owned subsidiaries as of June 30, 2005:  HF Financial Group, Inc. (“HF Group”), HF Financial Capital Trust I (“Trust I”), HF Financial Capital Trust II (“Trust II”), HF Financial Capital Trust III (“Trust III”), HF Financial Capital Trust IV (“Trust IV”) and HomeFirst Mortgage Corp. (the “Mortgage Corp.”).

 

In August 2002, the Company formed HF Group, a South Dakota corporation.  Pursuant to a marketing license service agreement, HF Group has the exclusive right to market “Syben Services” for the Minneapolis-based corporation, Syben Holdings, Inc., to business customers within the three-state territory that includes South Dakota, Minnesota and Iowa.  “Syben Services” are internet based services that utilize proprietary software developed to facilitate employee benefits administration, payroll processing and management and governmental reporting. Syben Services assists employers with the management of their employer sponsored compensation and benefit programs.  HF Group has an approved line of credit of $100,000, with no funds advanced by the Company as of June 30, 2005.

 

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Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

 

In November 2001, the Company formed Trust I for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust I.

 

In July 2002, the Company formed Trust II for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust II.

 

In December 2002, the Company formed Trust III for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust III.

 

In September 2003, the Company formed Trust IV for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust IV.

 

The Mortgage Corp., a South Dakota corporation was previously engaged in the business of originating one- to four-family residential mortgage loans, which were sold into the secondary market.  The Mortgage Corp. had no activity during fiscal year 2005.

 

As a federally chartered thrift institution, the Bank is permitted by OTS regulations to invest up to 2.00% of its assets in the stock of, or loans to, service corporation subsidiaries.  The Bank may invest an additional 1.00% of its assets in service corporations where such additional funds are used for inner-city or community development purposes.  The Bank currently has less than 1.00% of its assets in investments in its subsidiary service corporations as defined by the OTS.  In addition to investments in service corporations, the Bank is permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which the Bank may engage directly.

 

The Bank has five wholly-owned subsidiaries, Hometown Insurors, Inc. (“Hometown”), Mid America Capital, Home Federal Securitization Corp. (“HFSC”), Mid-America Service Corporation (“Mid-America”) and PMD, Inc. (“PMD”).

 

Hometown, a South Dakota corporation, provides financial and insurance products to customers of the Bank and members of the general public in the Bank’s market area.  Insurance products offered by Hometown primarily include annuities and life insurance products.  On August 8, 2003, the Company sold the property and casualty insurance book of business of Hometown to a third party for total proceeds of $375,000.  The sales agreement included a “covenant not to compete” clause prohibiting Hometown from directly or indirectly selling property or casualty insurance for three years in the state of South Dakota.  The transaction was effective as of July 31, 2003 and had an immaterial impact on the Company’s financial position and results of operations.  Hometown obtains its funding via a line of credit from the Bank.  Banking regulations do not limit the amount of funding provided to an operating subsidiary.  As of June 30, 2005, the Bank had advanced no funds on an approved line of credit of $100,000.  Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

 

Mid America Capital, a South Dakota corporation, specializes in equipment finance leasing.  Mid America Capital obtains its funding via a line of credit from the Bank.  Banking regulations do not limit the amount of funding provided to an operating subsidiary.  As of June 30, 2005, the Bank had advanced $27.9 million on an approved line of credit of $35.0 million.  Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

 

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HFSC, a Delaware corporation, exists for the sole purpose of buying motor vehicle installment loans from the Bank to be securitized.  See Note 3 of “Notes to Consolidated Financial Statements”, which is included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K, and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K for further discussion on consumer automobile loan securitization.

 

Mid-America, a South Dakota corporation, previously provided residential appraisal services to the Bank and other lenders in the Bank’s market area until the third quarter of fiscal 2002.  The cessation of operations of Mid-America had no material effect on the consolidated financial statements.  Mid-America had no activity during fiscal year 2005.

 

PMD, a South Dakota corporation, in the past was engaged in the business of buying, selling and managing repossessed real estate properties.  PMD had no activity during fiscal year 2005.

 

Market Area

 

Based on total assets at June 30, 2005, the Bank is the largest savings association headquartered in South Dakota.  The Bank has a total of 34 banking centers in its market area and one internet branch located at www.homefederal.com.  The Bank’s primary market area includes communities located in eastern and central South Dakota, including the cities of Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Hartford, Canton, Parker, Lennox, Mitchell, Aberdeen, Mobridge, Brookings, Redfield, Dakota Dunes, Colman, Crooks, Watertown and Yankton.  The Bank also has a branch in Marshall, Minnesota, which serves customers located in southwestern Minnesota, and its banking center located in Dakota Dunes, South Dakota which serves customers located in northwestern Iowa.  The Bank’s primary market area features a variety of agri-business, banking, financial services, health care and light manufacturing firms.  The internet branch allows access to customers beyond traditional geographical areas.

 

Mid America Capital provides services to customers primarily in a nine-state area in the upper Midwest, but originations can and have expanded nationwide based on relationships developed with existing Bank customers and other vendor relationships.

 

HF Group provides services to customers in the three-state region of South Dakota, Minnesota and Iowa.

 

Lending Activities

 

General.  The Bank originates a variety of loans including business banking loans, commercial and agricultural loans; mortgage lending, one- to four-family residential mortgages; and consumer loans, including loans for automobile purchases, home equity and home improvement loans and student loans.

 

Business Banking

 

Commercial Business Lending.  In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates adjustable- and fixed-rate commercial loans.  Interest rates on commercial business loans adjust or float with a designated national index plus a specified margin.  The Bank’s commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment and business expansion within the Bank’s market area.  The Bank originates commercial business loans directly and through programs sponsored by the Small Business Administration (“SBA”) of which a portion of such loans are also guaranteed in part by the SBA.  The Bank generally originates commercial business loans for its portfolio and retains the servicing with respect to such loans.  In the future, the Bank anticipates continued expansion and emphasis of its commercial business lending, subject to market conditions and the Home Owners’ Loan Act (“HOLA”) restrictions.    See “Regulation–Business Activities” below for HOLA restrictions.

 

Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, may be dependent

 

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upon the general economic environment).  The Bank’s commercial business loans are occasionally secured by the assets of the business, such as accounts receivable, equipment and inventory.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.  Whenever possible, the Bank’s commercial business loans include personal guarantees of the borrowers.  In addition, the loan officer may, on occasion, perform on-site visits, obtain financial statements and perform a financial review of the loan.

 

Multi-Family and Commercial Real Estate Lending.  The Bank engages in multi-family and commercial real estate lending primarily in South Dakota and the adjoining Midwestern states.  These lending activities may include existing property or new construction development or purchased loans.

 

Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower’s ability to repay the loan may be impaired. In addition, loans secured by property outside of the Bank’s primary market area may contain a higher degree of risk due to the fact that the Bank may not be as familiar with market conditions where such property is located.  The Bank does not have a material concentration of multi-family or commercial real estate loans outside of South Dakota and the adjoining Midwestern states.

 

The Bank presently originates adjustable-rate, short-term balloon payment, fixed-rate multi-family and commercial real estate loans.  The Bank’s multi-family and commercial real estate loan portfolio is secured primarily by apartment buildings and owner occupied and non-owner occupied commercial real estate.  The terms of such loans are negotiated on a case-by-case basis.  Commercial real estate loans generally have terms that do not exceed 25 years.  The Bank has a variety of rate adjustment features, call provisions and other terms in its multi-family and commercial real estate loan portfolio.  Generally, the loans are made in amounts up to 80.00% of the appraised value of the collateral property and with debt service coverage ratios of 115.00% or higher.  The debt service coverage is the ratio of net cash from operations before payment of debt service.  However, these percentages may vary depending on the type of security and the guarantor.  Such loans provide for a negotiated margin over a designated national index.  The Bank analyzes the financial condition of the borrower, the borrower’s credit history, the borrower’s prior record for producing sufficient income from similar loans, references and the reliability and predictability of the net income generated by the property securing the loan.  The Bank generally requires personal guarantees of borrowers.  Depending on the circumstances of the security of the loan or the relationship with the borrower, the Bank may decide to sell participations in the loan.  The sale of participation interests in a loan are necessitated by the amount of the loan or the limitation of Loans to One Borrower.  See “Regulation-Loans to One Borrower” for a discussion of the Loans to One Borrower regulations.  In return for servicing these loans for the participants, the Bank generally receives a fee of 0.25% to 0.38%.  Also, income is received at loan closing from loan fees and discount points.  Appraisals on properties securing multi-family and commercial real estate loans originated by the Bank are performed by appraisers approved pursuant to the Bank’s appraisal policy.

 

The HOLA includes a provision that limits the Bank’s non-residential real estate lending to no more than four times its total capital.  This maximum limitation, which at June 30, 2005 was $311.7 million, has not materially limited the Bank’s lending practices.

 

Under HOLA, the maximum amount which the Bank may lend to any one borrower is 15.00% of the Bank’s unimpaired capital and surplus or $11.7 million at June 30, 2005.  Loans in an amount equal to an additional 10.00% of unimpaired capital and surplus may be made to the same borrower if such loans are fully secured by readily marketable collateral.  The Bank may request a waiver from the OTS to exceed the 15.00% Loans to One Borrower limitation on a case by case basis.  The Bank is in compliance with the Loans to One Borrower limitation and had no borrowers in excess of the Loans to One Borrower requirements at June 30, 2005.  See “Regulation-Loans to One Borrower” for a discussion of the Loans to One Borrower regulations.

 

5

 

Construction and Development Lending.  The Bank makes construction loans to individuals for the construction of their residences as well as to builders and, to a lesser extent, developers for the construction of one- to four-family residences and condominiums and the development of one- to four-family lots in the Bank’s primary market area.

 

Construction loans to individuals for their residences are structured to be converted to mortgage loans at the end of the construction phase, which typically runs six to 12 months.  These construction loans have rates and terms which match the one- to four-family residential mortgage loans offered by the Bank.  Residential construction loans are generally underwritten pursuant to the same guidelines used for originating residential mortgage loans.

 

The Bank also makes loans to developers for the purpose of developing one- to four-family lots.  These loans typically have terms of one year and carry floating interest rates based on a national designated index.  Loan commitment and partial release fees are charged.  These loans generally provide for the payment of interest and loan fees from loan proceeds.  The principal balance of these loans is typically paid down as lots are sold.  Builder construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from the Bank, as well as broker referrals and direct solicitations of developers and builders.  The application process includes a submission to the Bank of plans, specifications and costs of the project to be constructed or developed.  These items are used as a basis to determine the appraised value of the subject property.  Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building).

 

The Bank makes loans for the construction of multi-family residential properties.  Such loans are generally made at adjustable rates, which adjust periodically based on the appropriate Treasury Note maturity.

 

Construction loans are generally originated with a maximum loan-to-value ratio of 80.00% and land development loans are generally originated with a maximum loan-to-value ratio of 60.00%, based upon an independent appraisal.  Because of the uncertainties inherent in estimating development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project.  Construction and development loans to borrowers other than owner occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.

 

Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property, or, for larger projects, both an appraisal and a study of the feasibility of the proposed project.  The Bank’s construction loan policy provides for the inspection of properties by independent in-house and outside inspectors at the commencement of construction and prior to disbursement of funds during the term of the construction loan.

 

Agricultural Loans.  In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates agricultural loans through its agricultural division.  The agricultural division offers loans to its customers such as: (1) operating loans which are used to fund operating expenses which typically have a one year term and are indexed to the national prime rate; (2) term loans on machinery, equipment and breeding stock that may have a term up to seven years and require annual payments; (3) agricultural farmland term loans which are used to fund land purchases or refinances; (4) specialized livestock loans to fund facilities and equipment for confinement enterprises; and (5) loans to fund ethanol plant development.  Agriculture real estate loans typically will have personal guarantees of the borrowers, a first lien on the real estate, interest rates adjustable to the national prime rate or Treasury Note rates, and annual, quarterly or monthly payments.  Operating and term loans are secured by farm chattels (crops, livestock, machinery, etc.), which are the operating assets of the borrower.  The Bank also originates agricultural loans directly and through programs sponsored by the Farmers Service Agency (“FSA”) of which a portion of such loans are also guaranteed in part by the FSA.

 

Loan customers are required to supply current financial statements, tax returns for the past three to five years, and cash flow projections which are updated on an annual basis.  In addition, on major loans, the loan officer will perform an annual farm visit, obtain financial statements and perform a financial review of the loan.

 

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Mortgage Lending

 

One- to Four-Family Residential Mortgage Lending.  One- to four-family residential mortgage loan originations are primarily generated by the Bank’s marketing efforts, its present customers, walk-in customers and referrals from real estate brokers and builders.  The Bank has focused its lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences.

 

The Bank currently makes 10-, 15- and 30-year fixed- and adjustable-rate (“ARM”) one- to four-family residential mortgage loans in amounts up to 95.00% of the appraised value of the collateral property provided that private mortgage insurance is obtained in an amount sufficient to reduce the Bank’s exposure at or below the 80.00% level.  The Bank generally offers an ARM loan having a fixed rate for the initial three to five years, which then converts to a one-year ARM loan for the remainder of the life of the loan.  The Bank also offers a one-year ARM loan with a rate below the Bank’s then current fixed-rate loan for a comparable 15- or 30-year term loan.  These loans provide for an annual cap and a lifetime cap at a set percent over the fully-indexed rate.

 

The Bank also offers a 30-year balloon loan, which is sold on the secondary market and has a fixed-rate for the first five or seven years of the loan.  At the end of the five- or seven-year period, the loan converts to a 23- or 25-year fixed-rate loan at the then current market rate provided that the borrower qualifies at the new rate.  If the borrower fails to qualify at the new rate, the loan becomes payable in full.  The Bank also offers a portfolio five- and seven-year balloon loan that is underwritten to secondary market standards but is fully payable at the end of the balloon term.

 

To meet the needs of the Bank’s borrowers and financial needs of the communities it serves, the Bank has developed two distinct types of loan programs.  The Integrity Mortgage Program is a limited documentation program that is generally available to the upper credit customer.  The Olympic Plus Program is a program for individuals that do not meet secondary market standards but are eligible for private mortgage insurance.  The program underwriting guidelines match those as established by the private mortgage insurance company.  Borrowers may choose from either an ARM or balloon product as a financing option.

 

The Bank also offers fixed-rate 10- to 30-year mortgage loans that conform to secondary market standards. Interest rates charged on these fixed-rate loans are competitively priced on a daily basis according to market conditions.  Residential loans generally do not include prepayment penalties.

 

The Bank also originates fixed-rate one- to four-family residential mortgage loans through the South Dakota Housing Development Authority (“SDHDA”) program.  These loans generally have terms not to exceed 30 years and are insured by the Federal Housing Administration (“FHA”), Veterans Administration (“VA”), Rural Development or private mortgage insurance.  The Bank receives an origination fee of 1.00% of the loan amount from the borrower and a servicing fee of generally 0.38% from the SDHDA for these services.  The Bank is the largest servicer of loans for the SDHDA.  At June 30, 2005, the Bank serviced $465.3 million of mortgage loans for the SDHDA.  See Note 6 of “Notes to Consolidated Financial Statements”, which is included in Part II, Item 8, “Financial Statements and Supplementary Data,” in this Form 10-K for information on loan servicing.

 

In underwriting one- to four-family residential mortgage loans, the Bank evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan.  The property that secures the real estate loans made by the Bank is appraised by an appraiser approved under the Bank’s appraisal policy.  The Bank requires borrowers to obtain title, fire and casualty insurance in an amount not less than the amount of the loan.  Real estate loans originated by the Bank contain a “due-on-sale” clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the collateral property.

 

In February 2005, the Bank introduced QuickClick^TM Online Mortgage Solutions, a service that allows customers to check rates, research loan options and complete mortgage applications via the Bank’s website.  This service is currently available to our branch locations in South Dakota and Minnesota with plans to expand to neighboring states.

 

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Consumer Lending

 

Other Consumer Lending.  The Bank’s management considers its consumer loan products to be an important component of its lending strategy.  Specifically, consumer loans generally have shorter terms to maturity and carry higher rates of interest than do one- to four-family residential mortgage loans.  In addition, the Bank’s management believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.

 

The Bank currently purchases automobile conditional sales contracts from selected dealers within its market area, as well as originating automobile loans directly.  The growth in indirect lending has provided securitization opportunities in the capital markets.  On January 31, 2003, the Bank sold approximately $40.1 million principal of indirect and $9.9 million principal of direct automobile receivables in a securitization transaction.  The proceeds were used in part to continue to service the demand of the Bank’s dealer network.  Securitization is a source of funds at a rate lower than other sources of funds, and it reduces the Bank’s capital requirements and credit risk to the Bank from the loans sold.  See Note 3 of  “Notes to Consolidated Financial Statements”, which is included in Part II, Item 8 “Financial Statements and Supplementary Data” of this Form 10-K, for details on the consumer automobile loan securitization.

 

Loans secured by second mortgages, together with loans secured by all prior liens, are limited to 100.00% or less of the appraised or assessed value of the property securing the loan and generally have maximum terms that do not exceed 10 to 15 years.

 

The student loans originated by the Bank are guaranteed as to principal and interest by the South Dakota Education Assistance Corporation.  The Bank sells such student loans with servicing rights released approximately 120 days after funds have been disbursed to the student.  The Bank receives a market premium on the sale of the loan amount.

 

Consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.  The Bank offers both open- and closed-end credit.  Overdraft lending is extended through lines of credit that are tied to a checking account.  The credit lines generally bear interest at 18.00% and are generally limited to no more than $2,000.  Loans secured by deposit accounts at the Bank are currently originated for up to 90.00% of the account balance (although historically the Bank has loaned up to 100.00% of the account balance), with a hold placed on the account restricting the withdrawal of the account balance.  The interest rate on such loans is typically equal to 2.00% above the contract rate.

 

The underwriting standards employed by the Bank for consumer loans include an application, a determination of the applicant’s payment history on other debts, and an assessment of the ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.

 

Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans, which are unsecured or are secured by rapidly depreciable assets, such as automobiles or boats.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

8

 

Leasing Activities

 

General. Through its wholly-owned subsidiary, Mid America Capital, the Bank originates commercial and municipal leases.  These products have a fixed interest rate for the duration of the lease with terms typically ranging from 24 – 60 months.  The leases generally are 100.00% financed with only the first or first and last months’ payments due at lease inception.  As a result of the 100.00% financing and fixed interest rate, the yield on leases is higher than similar type lending products.

 

Leases are originated generally in a nine-state area in the upper Midwest.  All leases are secured by the equipment leased, with personal guarantees of the borrowers normally obtained on commercial leases.

 

Commercial Leases.   In order to support the Bank and its customers and to improve the yield of its assets, Mid America Capital originates commercial leases to customers primarily in the upper Midwest.  Mid America Capital offers three types of commercial leases: capital, tax and Terminal Rental Adjustment Clause (“TRAC”) leases.  TRAC leases are generally for medium- to heavy-duty titled equipment, such as semi-tractors and trailers and medium- to heavy-duty trucks.  Leases may be structured with a contracted residual of as little as $1.00 up to 20.00-25.00% of the equipment cost.  Leases encompass a wide variety of equipment for a variety of commercial uses.   The customer base tends to be small- to medium-sized businesses that view leasing as another financing option that augments their overall operation.  Repayment terms tend to be monthly in nature.

 

As with commercial loans, commercial leases typically are made on the basis of the borrower’s ability to make repayment from the cash flow of their business.  As a result, the availability of funds for the repayment of commercial leases may be substantially dependent on the success of the business itself.  The collateral securing the leases will generally depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

 

Municipal Leases.   The Bank and Mid America Capital also originates leases to municipal entities such as cities, counties, and public schools.  The lessee must be a political subdivision of the state in order to qualify as a municipal lease.   Because the interest income earned on this type of lease is exempt from federal income taxes, the rate offered to the municipality is usually substantially lower than a comparable commercial lease.  Repayment terms generally are on a monthly, semi-annual or annual basis.  Residuals are $1.00 for municipal leases.

 

Repayment is based on the municipality’s ability to levy and collect taxes.  Assuming the municipality has a bond rating, that bond rating, together with audited financial statements are the basis for the lease.  On larger leases, bond ratings and financial statements will be reviewed annually.

 

9

 

Loan and Lease Portfolio Composition.  The following table sets forth information concerning the composition of the Company’s loan and lease portfolio from continuing operations in dollar amounts and in percentages (before deductions for the undisbursed portion of loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.  Balances related to discontinued credit card loan operations have been eliminated for all periods presented.

 

		At June 30,
		2005					2004					2003					2002					2001
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars In Thousands)
Real Estate Loans:
One- to four-family (1)		$	106,832		15.46	%	$	104,492		15.80	%	$	100,065		16.18	%	$	79,074		13.78	%	$	124,951		21.71	%
Multi-family		34,241			4.95		42,721			6.46		49,364			7.98		56,952			9.92		44,378			7.71
Commercial		98,243			14.22		89,538			13.54		93,405			15.10		89,111			15.53		73,720			12.81
Agricultural		23,954			3.47		20,449			3.09		18,002			2.91		12,722			2.22		12,753			2.21
Construction and development		15,454			2.24		15,044			2.28		9,083			1.47		12,738			2.22		28,419			4.94
Total real estate loans		278,724			40.34		272,244			41.17		269,919			43.64		250,597			43.67		284,221			49.38
Other Loans and Leases:
Consumer Loans:
Mobile home		563			0.08		848			0.13		1,468			0.24		2,365			0.41		3,920			0.68
Automobiles		108,621			15.72		101,669			15.38		74,066			11.98		84,782			14.77		78,082			13.57
Deposit account		1,253			0.18		1,489			0.22		1,463			0.24		1,597			0.28		1,917			0.33
Student (2)		400			0.06		324			0.05		7,745			1.25		7,340			1.28		6,831			1.19
Junior liens on mortgages		87,243			12.63		85,684			12.96		81,064			13.11		73,680			12.84		61,397			10.67
Other		5,405			0.78		4,900			0.74		6,035			0.98		8,529			1.49		10,939			1.90
Total consumer loans		203,485			29.45		194,914			29.48		171,841			27.80		178,293			31.07		163,086			28.34
Commercial business (3)		125,569			18.17		124,158			18.78		113,570			18.36		95,462			16.63		97,362			16.92
Equipment finance leases (3)		33,090			4.79		26,942			4.07		23,016			3.72		22,834			3.98		10,509			1.82
Agricultural		50,088			7.25		42,953			6.50		40,109			6.48		26,707			4.65		20,370			3.54
Total other loans and leases		412,232			59.66		388,967			58.83		348,536			56.36		323,296			56.33		291,327			50.62
Total gross loans and leases		$	690,956		100.00	%	$	661,211		100.00	%	$	618,455		100.00	%	$	573,893		100.00	%	$	575,548		100.00	%
Less:
Undisbursed portion of loans in process		(6,350		)			(7,338		)			(3,576		)			(4,678		)			(3,853		)
Deferred fees and discounts		1,289					1,029					364					504					(133		)
Allowance for losses		(5,076		)			(3,605		)			(3,842		)			(4,461		)			(5,509		)
Total loans and leases receivable, net		$	680,819				$	651,297				$	611,401				$	565,258				$	566,053

 

(1)          Includes one- to four-family loans held for sale

(2)          Includes student loans held for sale

(3)          Includes tax-exempt leases

 

10

 

The following table sets forth the composition of the Company’s loan and lease portfolio from continuing operations by fixed- and adjustable-rate in dollar amounts and in percentages (before deductions for the undisbursed portion of loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.  Balances related to discontinued credit card loan operations have been eliminated for all periods presented.  Variable loans are tied to various indices including prime rate and the treasury yield curve and have reset dates ranging from daily to several years.

 

		At June 30,
		2005					2004					2003					2002					2001
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars In Thousands)
Fixed-Rate Loans and Leases:
Real Estate:
One- to four-family (1)		$	65,605		9.49	%	$	70,895		10.72	%	$	72,472		11.72	%	$	45,804		7.98	%	$	78,350		13.61	%
Multi-family, commercial & construction		40,380			5.84		44,065			6.66		41,231			6.67		44,842			7.81		39,752			6.91
Agricultural		4,096			0.59		2,609			0.39		4,760			0.77		1,305			0.23		3,433			0.60
Total real estate loans		110,081			15.92		117,569			17.77		118,463			19.16		91,951			16.02		121,535			21.12
Consumer (2)		141,942			20.54		133,012			20.12		110,037			17.79		127,488			22.21		125,955			21.88
Agricultural		6,759			0.98		3,905			0.59		5,285			0.85		5,596			0.98		6,007			1.04
Equipment finance leases (3)		33,090			4.79		26,942			4.07		23,016			3.72		22,834			3.98		10,509			1.82
Commercial business (3)		29,741			4.30		26,631			4.03		23,839			3.85		21,463			3.74		25,983			4.52
Total fixed-rate loans and leases		321,613			46.53		308,059			46.58		280,640			45.37		269,332			46.93		289,989			50.38
Adjustable-Rate Loans:
Real estate:
One- to four-family (1)		41,227			5.97		33,597			5.08		27,593			4.46		33,270			5.80		46,601			8.10
Multi-family, commercial & construction		107,558			15.57		103,238			15.61		110,621			17.89		113,959			19.86		106,765			18.55
Agricultural		19,858			2.87		17,840			2.70		13,242			2.14		11,417			1.99		9,320			1.62
Total real estate loans		168,643			24.41		154,675			23.39		151,456			24.49		158,646			27.65		162,686			28.27
Consumer (2) (4)		61,543			8.92		61,902			9.37		61,804			10.00		50,805			8.85		37,131			6.45
Agricultural		43,329			6.27		39,048			5.91		34,824			5.63		21,111			3.68		14,363			2.50
Commercial business		95,828			13.87		97,527			14.75		89,731			14.51		73,999			12.89		71,379			12.40
Total adjustable-rate loans		369,343			53.47		353,152			53.42		337,815			54.63		304,561			53.07		285,559			49.62
Total loans and leases		$	690,956		100.00	%	$	661,211		100.00	%	$	618,455		100.00	%	$	573,893		100.00	%	$	575,548		100.00	%
Less:
Undisbursed portion of loans in process		(6,350		)			(7,338		)			(3,576		)			(4,678		)			(3,853		)
Deferred fees and discounts		1,289					1,029					364					504					(133		)
Allowance for loan losses		(5,076		)			(3,605		)			(3,842		)			(4,461		)			(5,509		)
Total loans and leases receivable, net		$	680,819				$	651,297				$	611,401				$	565,258				$	566,053

 

(1)          Includes one- to four-family loans held for sale

(2)          Includes mobile home loans

(3)          Includes tax-exempt leases

(4)          Includes student loans held for sale

 

11

 

The following schedule illustrates the scheduled principal contractual repayments of the Company’s loan and lease portfolio from continuing operations at June 30, 2005.  Mortgages which have adjustable or renegotiable interest rates are shown as maturing at the contractual maturity date.  The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 

		Real Estate															Non-Real Estate
		One- to Four- Family (1)			Multi- Family			Commercial			Agricultural			Construction & Development			Consumer (2)			Commercial Business (3)			Agricultural			Total
		(Dollars in Thousands)
Due in 1 year or less		$	14,077		$	1,864		$	14,005		$	1,175		$	12,454		$	42,940		$	76,040		$	38,313		$	200,868
After 1 to 5 years		23,663			9,859			38,256			4,613			3,000			157,661			64,044			8,296			309,392
Greater than 5 years		69,092			22,518			45,982			18,166			—			2,884			18,575			3,479			180,696
Total		$	106,832		$	34,241		$	98,243		$	23,954		$	15,454		$	203,485		$	158,659		$	50,088		$	690,956

 

(1) Includes one- to four-family loans held for sale.

(2) Includes demand loans, loans having no stated maturity, student loans held for sale and overdraft loans.

(3) Includes equipment finance leases and tax-exempt leases.

 

The total amount of loans due after June 30, 2006 which have predetermined interest rates is $244.0 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $246.1 million.

 

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets.  The average life of loans is substantially less than their average contractual terms because of prepayments.  In addition, due-on-sale clauses on loans generally give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.  The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and decrease when rates on existing mortgages are substantially higher than current mortgage loan rates.  The Company’s 2004 Annual Report on Form 10-K schedule for payments due within 1 year or less totaled $183.8 million.  The Company’s Consolidated Statement of Cash Flows for fiscal year 2005 displays total principal collected on loans and leases totaling $192.9 million.  The difference is due to prepayments of loans at June 30, 2004 and to contractual payments and prepayments for new loans in fiscal year 2005.

 

12

 

The following table sets forth the composition of the Company’s deferred fees and discounts on loans as of the dates indicated.

 

		At June 30,
		2005			2004			2003			2002			2001
		(Dollars in Thousands)
One- to four-family		$	(576	)	$	(561	)	$	(510	)	$	(554	)	$	(939	)
Multi-family, commercial real estate & construction		(278		)	(334		)	(407		)	(508		)	(579		)
Consumer		122			113			65			5			3
Agricultural		(32		)	(32		)	(16		)	(28		)	(20		)
Equipment finance leases		80			77			54			—			—
Commercial business		(15		)	(125		)	(164		)	(16		)	(18		)
Dealer reserve		1,988			1,891			1,342			1,605			1,420
Total deferred fees and discounts		$	1,289		$	1,029		$	364		$	504		$	(133	)

 

Deferred fees and discounts on loans have trended from net deferred revenue to net deferred costs due to several factors, including the following:

 

•                  An increasing amount of indirect automobile loans that include prepaid dealer reserves.  This increase was partially offset as a result of the sale of $50.0 million of automobile loans in January 2003, which resulted in a reduction of $1.0 million in prepaid dealer reserves at the time of the sale.

 

•                  The mortgage portfolio had a large turnover during 2002 through 2004 due to low interest rates and strong demand, which were booked with relatively higher origination costs compared to the origination fees charged, than those booked in prior years.

 

•                  During fiscal 2005, the Company experienced loan payoffs primarily in multi-family, commercial real estate and commercial business.  These payoffs are due to competitive factors, both in price competition and new competitors entering the market.

 

13

 

Potential Problem Loans

 

Nonperforming Assets.  See “Asset Quality” under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K for discussion.

 

Classified Assets.  Federal regulations provide for the classification of loans, leases and other assets, such as debt and equity securities considered by the OTS to be of lesser quality, as “substandard,” “doubtful” or “loss.” 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 Company 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 which do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses, are required to be designated “criticized” or “special mention” by management.

 

When the Company classifies problem assets as “loss, ” it is required either to establish a specific allowance for losses equal to 100.00% of that portion of the asset so classified or to charge-off such amount.  The Company’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Bank’s Regional Director at the regional OTS office, who may order the establishment of additional general or specific loss allowances.

 

In connection with the filing of its periodic reports with the OTS and in accordance with its classification of assets policy, the Company regularly reviews problem loans and leases in its portfolio to determine whether any loans or leases require classification in accordance with applicable regulations.  On the basis of management’s monthly review of its assets, at June 30, 2005, the Company had designated $10.6 million of its assets as special mention and $7.0 million of its assets as classified.  Other potential problem loans are included in criticized and classified assets.  See “Asset Quality” under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K for further discussion.

 

Allowance for Loan and Lease Losses. See “Application of Critical Accounting Policies” and “Asset Quality” under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K for discussion.

 

14

 

Investment Activities

 

The Bank is required under OTS regulation to maintain a sufficient amount of liquid assets.  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.

 

Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds.  Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

 

Generally, the investment policy of the Bank is to invest funds among various categories of investments and maturities based upon the Bank’s asset/liability management policies, investment quality and marketability, liquidity needs and performance objectives.

 

At June 30, 2005, the Company’s investments in mortgage-backed securities totaled $121.3 million, or 13.5% of its total assets. As of such date, the Bank also had a $7.7 million investment in the stock of the Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”) in order to satisfy the FHLB of Des Moines’ requirement for membership.

 

The composition and maturities of the investment securities portfolio, excluding equity securities, are indicated in the following table.

 

		At June 30, 2005
		1 Year or Less					After 1 to 5 Years					After 5 to 10 Years					Greater than 10 Years					Total Investment Securities
		Amortized Cost			Weighted Average Yield		Amortized Cost			Weighted Average Yield		Amortized Cost			Weighted Average Yield		Amortized Cost			Weighted Average Yield		Amortized Cost			Fair Value
		(Dollars in Thousands)
U.S. government agencies & corporations		$	—		—		$	3,000		3.16	%	$	2,000		3.99	%	$	—		—		$	5,000		$	4,986
Federal Home Loan Bank							2,474			4.63	%	1,500			3.99	%	—			—		3,974			3,996
Municipal bonds		1,201			2.18	%	1,784			2.34	%	100			3.65	%	—			—		3,085			3,069
Preferred term securities		—			—		—			—		—			—		9,000			4.89	%	9,000			9,056
Mortgage-backed securities							23			7.03	%	7,528			4.62	%	115,116			4.54	%	122,667			121,251
Total investment securities		$	1,201				$	7,281				$	11,128				$	124,116				$	143,726		$	142,358

 

The effective maturities for the Bank’s mortgage-backed securities is much shorter due to the combination of prepayments and the variable nature of $103.9 million of mortgage-backed securities.  The variable or hybrid (fixed for a period of time and then variable thereafter) structure gives the Bank flexibility in risk management of the balance sheet.

 

The Company’s investment securities portfolio did not contain non-investment grade bonds (i.e., “junk bonds”) or other corporate debt securities.

 

The Bank’s investment security portfolio is managed in accordance with a written investment policy adopted by the Board of Directors.  Investments may be made by the Bank’s officers within specified limits and approved in advance by the Board of Directors for transactions over these limits.  At the present time, the Bank does not have any investments that are held for trading purposes.  At June 30, 2005, the Company had $142.4 million of securities available for sale, including mortgage-backed securities of $121.3 million.  See Note 4 of “Notes to Consolidated Financial Statements,” which is included in Part II, Item 8 “Financial Statements and Supplementary Data” of this Form 10-K, for further information on the Company’s investment portfolio.

 

15

 

Sources of Funds

 

General.  The Company’s primary sources of funds are earnings, in-market deposits, FHLB advances and other borrowings, amortization and repayments of loan principal, mortgage-backed securities and callable agency securities.  Secondary sources include sales of mortgage loans, sales and/or maturities of securities, out-of-market deposits and short-term investments.

 

Borrowings of the Bank are primarily from the FHLB of Des Moines, and may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels, and may be used on a longer-term basis to support expanded lending activities.  The Bank has established collateral at the Federal Reserve Bank (“FRB”) as a contingent source of funding.  See Note 9 of the “Notes to Consolidated Financial Statements” which is included in Part II, Item 8 “Financial Statements and Supplementary Data “ of this Form 10-K, for further detail of the Company’s borrowings.

 

Deposits.  The Bank offers a variety of deposit accounts having a wide range of interest rates and terms.  The Bank’s deposits consist of statement savings accounts, checking accounts, money market and certificate accounts ranging in terms from 30 days to five years.  The Bank primarily solicits deposits from its market area.  The Bank relies primarily on customer service, competitive pricing policies and advertising to attract and retain these deposits.  Based on liquidity needs, the Bank may, from time to time, acquire out-of-market deposits.

 

The flow of deposits is influenced by general economic conditions, changes in money market and prevailing interest rates and competition.

 

The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand.  In recent years, the Bank has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious.  The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives.  Based on its experience, the Bank believes that its statement savings, money market, and checking accounts are stable sources of deposits.  However, the ability of the Bank to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.

 

16

 

The following table sets forth the dollar amount of deposits in the various types of deposit accounts offered by the Bank as of the dates indicated.

 

		At June 30,
		2005					2004					2003
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars in Thousands)
Transaction Accounts:
Noninterest bearing accounts		$	85,705		12.58	%	$	75,251		11.42	%	$	77,004		12.39	%
Interest bearing accounts weighted average rates of 0.52%, 0.18%, and 0.16% at June 30, 2005, 2004 and 2003		50,120			7.36		45,738			6.95		43,699			7.03
Savings accounts weighted average rates of 1.93%, 0.72% and  0.68% at June 30, 2005, 2004 and 2003		63,235			9.28		63,670			9.67		54,462			8.77
Money market accounts(1) weighted average rates of 2.80%, 1.40% and 1.41% at June 30, 2005, 2004 and 2003		209,116			30.70		211,928			32.17		178,113			28.66
Total transaction accounts		408,176			59.92		396,587			60.21		353,278			56.85
In-Market Certificates of Deposit:
0.00 - 3.99%		216,461			31.78		206,552			31.36		174,662			28.11
4.00 - 4.99%		19,356			2.84		16,102			2.44		21,112			3.40
5.00 - 5.99%		7,322			1.07		10,312			1.57		17,711			2.85
6.00 - 6.99%		1,605			0.24		12,335			1.87		18,040			2.90
7.00 - 7.99%		—			—		1,006			0.15		985			0.16
Total in-market certificates of deposit		244,744			35.93		246,307			37.39		232,510			37.42
Out-of-market certificates of deposit weighted average rate of    3.09%, 2.23% and 2.11% at June 30, 2005, 2004 and 2003		28,296			4.15		15,825			2.40		35,593			5.73
Total certificates of deposit		273,040			40.08		262,132			39.79		268,103			43.15
Total deposits		$	681,216		100.00	%	$	658,719		100.00	%	$	621,381		100.00	%

 

(1)     Includes out-of-market money market accounts in the amount of $1.9 million, $18.4 million and $14.1 million at June 30, 2005, 2004 and 2003, respectively.

 

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