-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L7uxMoOeOGmaYdF9Yh9UB4uPWXKcvW2/Y3drc2Kb7QgCcWq5ai4SUw5e+AwfU3vg goelU3C1kRh8Ib0I/gsvIw== 0001047469-98-035540.txt : 19980928 0001047469-98-035540.hdr.sgml : 19980928 ACCESSION NUMBER: 0001047469-98-035540 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980925 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HF FINANCIAL CORP CENTRAL INDEX KEY: 0000881790 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 460418532 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 033-44383 FILM NUMBER: 98715219 BUSINESS ADDRESS: STREET 1: 225 SOUTH MAIN AVE CITY: SIOUX FALLS STATE: SD ZIP: 57102 BUSINESS PHONE: 6053337556 10-K405 1 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED JUNE 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM _________________ TO ___________________________ 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 (I.R.S. Employer Identification No.) incorporation or organization) 225 South Main Avenue, Sioux Falls, South Dakota 57104 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (605) 333-7556 ----------------- 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 X NO . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of September 21, 1998 there were 4,749,180 issued and outstanding shares of the Registrant's Common Stock. The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such stock as of September 21, 1998 was $66.1 million (The exclusion from such amount of the market value of the shares 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 Form 10-K - Portions of the Proxy Statement for 1998 Annual Meeting of Stockholders. 1 PART I ITEM 1. BUSINESS THE COMPANY HF Financial Corp. (the "Company") was formed in November 1991, for the purpose of owning all of the outstanding stock of Home Federal Savings Bank ("Home Federal" or the "Bank") issued in the mutual to stock conversion of Home Federal (the "Conversion"). The Company acquired all of the outstanding stock of the Bank on April 8, 1992. In October 1994, the Company acquired and began operating a mortgage subsidiary as HomeFirst Mortgage Corp. ("Mortgage Corp."). This subsidiary ceased operations in fiscal year 1998. In May, 1996, the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of this entity. At June 30, 1998, the Company had total assets of $571.0 million and consolidated stockholders' equity of $56.6 million (or 9.91% of assets). 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. The activities of the Company itself have no significant impact on the results of operations on a consolidated basis. Unless otherwise indicated, all matters discussed herein relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank, Mortgage Corp. and HF Card Services. The executive offices of the Company, the Mortgage Corp. and HF Card Services are located at 225 South Main Avenue, Sioux Falls, South Dakota 57104. The Company's telephone number at that address is (605) 333-7556. THE BANK Home Federal is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota. Its deposits are insured up to applicable limits by the Savings Association Insurance Fund ("SAIF"), administered by the Federal Deposit Insurance Corporation ("FDIC"). Originally chartered in 1929, Home Federal serves 14 cities in eastern South Dakota through its main office in Sioux Falls and its network of 18 retail banking offices located throughout eastern South Dakota and one internet branch which is located at www.homefederal.com. 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, consumer, multi-family, commercial real estate, construction, agricultural, credit card and commercial business loans. The Bank's consumer loan portfolio includes, among other things, mobile home loans, automobile loans, home equity loans, credit card 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. Home Federal does not rely on any brokered deposits and does not hold any non-investment grade bonds (i.e., "junk bonds"). At June 30, 1998, the Bank's loan portfolio totalled $450.1 million, which consisted of $131.1 million of one- to four- family residential mortgage loans, $54.6 million of multi-family real estate loans, $38.0 million of commercial real estate loans, $12.8 million of construction and development loans, $156.2 million of consumer loans, $16.3 million of agricultural loans and $41.1 million of commercial business loans. On such date, the Bank had $39.6 million of mortgage-backed securities and $44.2 million of investment securities. MORTGAGE CORP. HomeFirst Mortgage Corp. is a South Dakota Corporation which had an office in Omaha, Nebraska. The Company ceased operations of the Mortgage Corp. during the first quarter of fiscal 1998. The Mortgage Corp. was a mortgage banking operation that originated one- to four-family residential loans which were sold into the secondary market. The Mortgage Corp. had assets of $1,000 at June 30, 1998. The Mortgage Corp. had a net loss of $11,000 during the year ended June 30, 1998. The primary exit costs involved were compensation costs of $28,000 and occupancy costs of $21,000. 2 HF CARD SERVICES In May, 1996 the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of the membership interest of this entity. HF Card Services was established to provide secured, partially-secured and unsecured credit cards nationwide to sub-prime credit customers who have either an insufficient credit history or a negative credit history and are unable to obtain a credit card from more traditional credit card issuers. HF Card Services had net income of $98,000 during fiscal year 1998. OTHER SUBSIDIARIES Home Federal, through its wholly-owned subsidiaries, Hometown Insurors, Inc. and Mid-America Service Corporation, offers credit-life, hazard and other insurance products and appraisal services. See "Subsidiary Activities." In addition, Home Federal's subsidiary, PMD, Inc., engages in the business of buying, selling and managing repossessed real estate properties of Home Federal. PMD, Inc. had no activity during fiscal year 1998. MARKET AREA Based on total assets at June 30, 1998, Home Federal is the largest thrift institution headquartered in South Dakota. During its 68-year existence, among its other lending activities, Home Federal served its customers located in eastern and central South Dakota, including the cities of Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Hartford, Canton, Parker, Lennox, Aberdeen, Mobridge, Brookings and Redfield, and the communities surrounding such communities through its network of 19 full service offices and one internet branch. The Bank's immediate market area features a variety of agri-business, banking, financial services, health care and light manufacturing firms. HF Card Services provides services to customers nationwide. LENDING ACTIVITIES GENERAL. Historically, the Bank has originated fixed-rate one- to four-family mortgage loans. Since 1984, however, the Bank has emphasized the origination of adjustable-rate mortgage ("ARM") loans and short-term loans for retention in its portfolio in order to increase the percentage of loans in its portfolio with more frequent repricing or shorter maturities, and in some cases higher yields, than fixed-rate mortgage loans. The Bank has continued to originate fixed-rate mortgage loans in response to customer demand. While the Bank sold fixed-rate loans with maturities of 15 years or greater and conventional ARM loans into the secondary market, during fiscal 1998 the Bank sold the majority of the loans with servicing released. While the Bank primarily focuses its lending activities on the origination of loans secured by first mortgages on owner-occupied one- to four-family residences as well as consumer loans, the Bank also originates multi-family residential and commercial real estate, construction, agricultural and commercial business loans in its primary market area. In addition, the Bank makes credit card loans to customers on a nationwide basis. The Bank originates residential and non-owner occupied construction loans that are presold to borrowers or held for sale by local builders and, on few occasions, makes land acquisition and development loans. The Bank's one- to four-family loans are primarily secured by homes located in its market area in South Dakota. At June 30, 1998, the Bank's net loan portfolio totalled $436.1 million. 3 LOAN PORTFOLIO COMPOSITION. The following table sets forth information concerning the composition of the Bank's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.
At June 30, ---------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------- ------- ------ ------- ------ ------- ------ ------- ------ --------- (Dollars In Thousands) REAL ESTATE LOANS: One- to four-family.......... $131,062 29.13% $165,573 36.50% $178,198 41.12% $163,379 42.99% $145,142 44.56% Multi-family................. 54,560 12.12 59,971 13.22 62,932 14.52 73,516 19.34 56,906 17.48 Commercial................... 38,002 8.44 34,252 7.55 26,130 6.03 22,400 5.89 18,710 5.74 Construction and development. 12,804 2.85 5,315 1.17 20,823 4.81 12,522 3.30 17,590 5.40 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total real estate loans...... 236,428 52.54 265,111 58.44 288,083 66.48 271,817 71.52 238,348 73.18 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ OTHER LOANS: Consumer Loans: Mobile home.................. 11,152 2.48 15,571 3.43 20,031 4.62 25,462 6.70 31,762 9.75 Automobiles.................. 66,044 14.67 66,483 14.66 48,181 11.12 32,583 8.57 22,586 6.93 Deposit account.............. 2,167 0.48 2,299 0.51 2,210 0.51 2,761 0.73 2,051 0.63 Student...................... 6,986 1.55 6,409 1.41 5,729 1.32 2,884 0.76 2,508 0.77 Junior liens................. 41,599 9.24 38,736 8.54 24,298 5.60 22,613 5.95 18,676 5.73 Credit cards................. 12,335 2.74 2,310 0.51 - - - 0.00 - - - 0.00 - - - 0.00 Other (1).................... 15,944 3.54 20,934 4.61 25,475 5.88 10,784 2.84 5,077 1.57 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total consumer loans......... 156,227 34.70 152,742 33.67 125,924 29.05 97,087 25.55 82,660 25.38 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Commercial business.............. 41,068 9.13 27,534 6.07 13,913 3.21 11,129 2.93 4,700 1.44 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Agricultural..................... 16,327 3.63 8,261 1.82 5,461 1.26 - - - 0.00 - - - 0.00 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total other loans........ 213,622 47.46 188,537 41.56 145,298 33.52 108,216 28.48 87,360 26.82 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total gross loans........ 450,050 100.00% 453,648 100.00% 433,381 100.00% 380,033 100.00% 325,708 100.00% ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ LESS: Loans in process............. (5,199) (4,272) (7,349) (10,934) (11,552) Deferred fees and discounts.. (1,514) (1,348) (1,480) (914) (909) Allowance for losses......... (7,199) (4,526) (4,129) (4,039) (4,899) -------- -------- -------- -------- -------- Total loans receivable, net $436,138 $443,502 $420,423 $364,146 $308,348 -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(1) Includes primarily second mortgage loans. 4 The following table shows the composition of the Bank's loan portfolio by fixed- and adjustable-rate loans at the dates indicated.
At June 30, ---------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------- ------- ------- --------- (Dollars In Thousands) FIXED-RATE LOANS: Real Estate: One- to four-family ........... $ 69,679 15.48% $ 72,198 15.91% $ 82,108 18.95% $ 73,460 19.33% $ 77,615 23.83% Multi-family, commercial & construction................ 19,729 4.38 18,463 4.07 24,706 5.70 18,821 4.95 18,929 5.81 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total real estate loans ..... 89,408 19.86 90,661 19.98 106,814 24.65 92,281 24.28 96,544 29.64 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Consumer (including mobile home loans).................... 116,409 25.87 124,054 27.35 114,434 26.40 94,955 24.99 79,899 24.53 Agricultural ..................... 982 0.22 1,293 0.29 - - - 0.00 - - - 0.00 - - - 0.00 Commercial business .............. 9,323 2.07 8,516 1.88 960 0.22 3,602 .95 2,283 0.70 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total fixed-rate loans ...... 216,122 48.02 224,524 49.50 222,208 51.27 190,838 50.22 178,726 54.87 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ ADJUSTABLE-RATE LOANS: Real estate: One- to four-family .......... 61,383 13.64 93,375 20.58 105,389 24.32 96,213 25.32 75,738 23.25 Multi-family, commercial & construction................ 85,637 19.03 81,075 17.87 75,880 17.51 83,323 21.92 66,067 20.29 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total real estate loans.. 147,020 32.67 174,450 38.45 181,269 41.83 179,536 47.24 141,805 43.54 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Consumer ......................... 39,818 8.85 28,688 6.32 16,951 3.91 2,132 .56 2,760 0.85 Agricultural ..................... 15,345 3.41 6,968 1.54 - - - 0.00 - - - 0.00 - - - 0.00 Commercial business .............. 31,745 7.05 19,018 4.19 12,953 2.99 7,527 1.98 2,417 0.74 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total adjustable-rate loans ................. 233,928 51.98 229,124 50.50 211,173 48.73 189,195 49.78 146,982 45.13 ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Total loans ............. 450,050 100.00% 453,648 100.00% 433,381 100.00% 380,033 100.00% 325,708 100.00% ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ ------- ------ -------- ------ ------- ------ ------- ------ -------- ------ Less: Loans in process ............. (5,199) (4,272) (7,349) (10,934) (11,552) Deferred fees and discounts .. (1,514) (1,348) (1,480) (914) (909) Allowance for loan losses .... (7,199) (4,526) (4,129) (4,039) (4,899) ------- -------- ------- ------- -------- Total loans receivable, net ................... $436,138 $443,502 $420,423 $364,146 $308,348 -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
5 The following schedule illustrates the scheduled principal contractual repayments of the Bank's loan portfolio at June 30, 1998. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
Real Estate Non-Real Estate ------------------------------------- -------------------------------------------------------- Due during years ending One- to Four- Multi- Credit Commercial June 30, Family Family Commercial (2) Consumer Cards Agricultural Business Total ------- ------- -------------- -------- ------ ------------ --------- ----- (Dollars in Thousands) 1999 (1).............. $ 3,148 $ 2,363 $ 3,590 $ 33,786 $ 12,335 $ 5,561 $ 28,144 $ 88,927 2000.................. 3,410 2,575 3,927 34,093 - - - 5,736 3,596 53,337 2001.................. 3,698 2,804 4,301 33,389 - - - 344 3,960 48,496 2002 and 2003......... 8,349 6,378 9,872 29,930 - - - 788 2,460 57,777 2004 to 2008.......... 27,816 21,626 24,739 5,662 - - - 2,630 2,908 85,381 2009 and following.... 84,641 18,814 4,377 7,032 - - - 1,268 - - - 116,132 ---------- -------- ---------- ---------- --------- --------- --------- -------- Total................. $ 131,062 $ 54,560 $ 50,806 $ 143,892 $ 12,335 $ 16,327 $ 41,068 $450,050 ---------- -------- ---------- ---------- --------- --------- --------- -------- ---------- -------- ---------- ---------- --------- --------- --------- --------
- ---------- (1) Includes demand loans, loans having no stated maturity and overdraft loans. (2) Includes construction loans. The total amount of loans due after June 30, 1999 which have predetermined interest rates is $176.7 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $184.4 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, however, when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgages are substantially higher than current mortgage loan rates. 6 ONE- TO FOUR-FAMILY RESIDENTIAL MORTGAGE LENDING. Residential loan originations of this type are generated by the Company's marketing efforts, its present customers, walk-in customers and referrals from real estate brokers and builders. Historically, 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. At June 30, 1998, the Company's one- to four-family residential mortgage loans totalled $131.1 million, or approximately 29.1% of the Company's gross loan portfolio. Historically, the Company has emphasized the origination of conventional ARM loans for retention in its portfolio and fixed-rate conforming loans suitable for sale in the secondary market. However, during fiscal 1998 the Company sold conventional ARM loans into the secondary market. Presently, the Company follows the practice of generally selling fixed rate conventional mortgage loans with maturities of 15 years or greater. See "Originations, Purchases, Sales and Servicing of Loans and Mortgage-Backed Securities." During the year ended June 30, 1998, the Company originated $25.6 million of adjustable-rate real estate loans, the majority of which were secured by one- to four-family residential real estate. During the same period, the Company originated $89.6 million of fixed-rate real estate loans, the majority of which were secured by one- to four-family residential real estate. The Bank's one- to four-family residential mortgage originations are primarily in its market area. The Company currently makes 15- and 30-year fixed and adjustable-rate one- to four-family residential mortgage loans in amounts up to 95% of the appraised value of the collateral property provided that private mortgage insurance is obtained in an amount sufficient to reduce the Company's exposure at or below the 80% level. The Company currently offers an ARM loan which has a fixed rate for the initial three years and converts to a one-year ARM loan for the remainder of the life of the loan. The Company also offers a one-year ARM loan with a rate below the Company's then current fixed-rate loan for a comparable 15- or 30-year term loan. These loans provide for up to a 2.0% annual cap and a lifetime cap of 6.0% over the fully-indexed rate. These ARM products have an interest rate margin generally 2.875% over the one-year Treasury Bill rate. These loans provide for up to a 2.0% annual cap and a lifetime cap of 6.0% over the fully-indexed rate calculated at the date of origination. As a consequence of using caps, the interest rates on these loans are not as rate sensitive as is the Company's cost of funds. The initial rate used for the loan is usually below the fully-indexed rate and is determined by the Company in accordance with market and competitive factors. In addition, the Company offers a 30-year balloon loan which has a fixed-rate for the first five or seven years of the loan term. 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. These loans are underwritten to conform to the Federal Home Loan Mortgage Corporation's ("FHLMC") secondary market standards. The Company also offers fixed-rate 15- through 30-year mortgage loans that conform to secondary market standards (i.e., Federal National Mortgage Bank ("FNMA"), Government National Mortgage Bank ("GNMA") and FHLMC 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. Most of these loans with maturities of 30 years are held for sale or sold in the secondary market. While the Company has generally retained servicing rights on such loans whenever possible, during fiscal 1998 the Company sold the majority of its loans with servicing released. The Bank also originates fixed-rate one- to four-family mortgage loans through the South Dakota Housing Development Authority ("SDHDA") program. These loans generally have terms not to exceed 30 years and are either insured by the FHA/VA or private mortgage insuror or must have no more than a 80% loan to value ratio. The Bank receives an origination fee of one percent of the loan amount from the borrower and a servicing fee currently three-eighths of one percent from the SDHDA for these services. The Bank is the largest servicer of loans for the SDHDA. At June 30, 1998, the Bank serviced $278.2 million of mortgage loans for the SDHDA. In underwriting one- to four-family residential real estate loans, Home Federal evaluates both the borrower's ability to make monthly payments and the value of the property securing the loan. These criteria are also applied to loans purchased. Most property securing real estate loans made by Home Federal is appraised by an appraiser employed by Mid-America Service Corporation, Home Federal's wholly-owned subsidiary. Other appraisals are performed by independent appraisers selected by Home Federal. Home Federal requires borrowers to obtain title, fire and casualty 7 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. 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 mid-western states. These lending activities may include existing property or new construction development. 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. The Bank presently originates adjustable-rate, short-term balloon payment, fixed-rate multifamily and commercial real estate loans. The Bank's multi-family and commercial real estate loan portfolio is secured primarily by apartment buildings and, to a lesser extent, churches, motels, strip shopping centers and nursing homes. 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 75% of the appraised value of the collateral property and with debt service coverage ratios of 115% 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 index which is generally the one-year Treasury Bill Rate. Fixed rate loans are generally made when advances from the Federal Home Loan Bank ("FHLB") of Des Moines can be used to fund the loan. 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 guaranties 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 Loans to One Borrower requirements which would require the sale of the loan. In return for servicing these loans for the participants, the Bank generally receives a fee of one-fourth to three-eighths of one percent. 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 independent appraisers selected by Home Federal and reviewed by Bank employees. At June 30, 1998, the Bank had $54.6 million of multi-family and $38.0 million of commercial real estate loans, which represented 12.1% and 8.4%, respectively, of the Bank's gross loan portfolio. At June 30, 1998, $719,000 of the Bank's multi-family and commercial real estate portfolio or 0.2% of the Bank's gross loan portfolio was non-performing. See "Non-Performing Assets and Classified Loans" for a discussion of the Bank's largest non-performing assets and items of concern and the allowance established for each. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") includes a provision that limits the Bank's non-residential real estate lending (i.e., commercial real estate lending, other than lending on certain multi-family residences) to no more than four times its total capital. This maximum limitation, which at June 30, 1998 was $176.8 million, has not materially limited the Bank's lending practices. See "Regulation - Regulatory Capital Requirements." Under FIRREA, the maximum amount which Home Federal may lend to any one borrower is 15% of Home Federal's unimpaired capital and surplus or $7.7 million at June 30, 1998. Loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to the same borrower if such loans are fully secured by readily marketable collateral. See "Regulation" for a discussion of the loans-to-one borrower rule. On June 30, 1998, the Bank did not have any loans exceeding the Loans to One Borrower requirements. 8 At June 30, 1998, Home Federal had no loans in excess of its present legal lending limit. On such date, the Bank had loans in excess of $1.0 million to 47 borrowers or groups of affiliated borrowers. 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 permanent loans at the end of the construction phase, which typically runs 6 to 12 months. These construction loans have rates and terms which match the one- to four-family permanent loans offered by the Bank. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans. At June 30, 1998, the Bank had $2.1 million of residential construction loans to borrowers intending to live in the properties upon completion of construction. The Bank has a line of credit for qualified builders. This product provides the builder flexibility while the Bank maintains its credit standards. The line of credit does not advance more than 75% of the approved value or cost on a construction project and a mortgage is filed on each construction project and interest is collected monthly. These lines provide for the payment of interest and loan fees, with interest rates of 1% to 2.5% over the prime rate adjusted on a monthly basis. 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 interest rates which float monthly based on a national designated index such as the prime rate. 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. At June 30, 1998, the Bank had no development loans outstanding. 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 accurate 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 annually based upon a national designated index. At June 30, 1998, the Bank had $1.3 million of multi-family residential construction loans. At June 30, 1998, all of the Bank's construction loans were performing in accordance with their terms. Construction loans are generally originated with a maximum loan-to-value ratio of 75% and land development loans are generally originated with a maximum loan-to-value ratio of 60%, 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 in-house and independent inspectors at the commencement of construction and prior to disbursement of funds during the term of the construction loan. 9 CONSUMER LENDING. 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, 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. For these reasons, Home Federal has continued to focus on the origination of consumer loans. Home Federal offers a variety of secured consumer loans, including home improvement and second mortgage loans, loans secured by savings deposits, home equity loans, mobile home loans and automobile loans. In addition, Home Federal offers student loans, boat and vacation loans and other secured and unsecured consumer loans. All secured consumer loans over $100,000 must be approved by the Bank's loan committee except for loans over $250,000 which must be approved by the Bank's Board of Directors. The Bank originates consumer loans on both a direct and indirect basis. Direct loans are made when the Bank extends credit directly to the borrower. Indirect loans are obtained when the Bank purchases loan contracts from retailers of goods or services which have extended credit to their customers. The only indirect lending by Home Federal, described below, is with selected automobile dealers located in the Bank's lending area. Most of the Bank's mobile home loans have been originated with fixed rates of interest and are generally made in amounts of up to a maximum of the lesser of 125% of the net invoice or 90% of the buyer's cost. The buyer's cost can include such items as freight, itemized set-up charges, physical damage insurance, sales tax and filing and recording fees. Home Federal is permitted by regulation to make mobile home loans for terms of up to 20 years, although most of the Bank's mobile home loans are for terms of 15 years or less. At June 30, 1998, mobile home loans amounted to $11.1 million or 2.5% of the Bank's gross loan portfolio. Home Federal currently purchases automobile conditional sales contracts from selected dealers within its market area as well as originating automobile loans directly. At June 30, 1998, automobile loans amounted to $66.0 million or 14.7% of the Bank's gross loan portfolio. Loans secured by second mortgages, together with loans secured by all prior liens, are limited to 100% or less of the appraised value of the property securing the loan and generally have maximum terms that do not exceed seven to ten years. As of June 30, 1998, such loans amounted to $41.6 million or 9.2% of the Bank's gross loan portfolio. The student loans originated by Home Federal are guaranteed as to principal and interest by the South Dakota Education Assistance Corporation. Upon the student nearing graduation, Home Federal sells such student loans with servicing rights released. At June 30, 1998, student loans amounted to $7.0 million or 1.6% of the Bank's gross loan portfolio. At June 30, 1998, the Bank's consumer loan portfolio totalled $156.2 million, or 34.7% of its gross loan portfolio. Of the consumer loan portfolio at June 30, 1998, 25.5% were adjustable-rate loans. Consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower. Home Federal offers both open- and closed-end credit. Overdraft lending is extended through lines of credit that are tied to a negotiated order of withdrawal ("NOW") account. The credit lines generally bear interest at 18% and are generally limited to no more than $5,000. Loans secured by deposit accounts at the Bank are currently originated for up to 90% of the account balance (although historically the Bank has loaned up to 100% 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% above the contract rate. The underwriting standards employed by the Bank for consumer loans, including mobile home 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. 10 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 mobile homes, 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. Although management believes that the level of delinquencies in the Bank's consumer loan portfolio, has generally been low (at June 30, 1998, $1.0 million) (excluding $140,000 of repossessed consumer collateral), or approximately 0.64% of the consumer loan portfolio, was non-performing, there can be no assurance that delinquencies will not increase in the future. CREDIT CARD LENDING. During fiscal year 1991, the Bank began offering VlSA/Mastercard card credit card services on an agency basis to its customers. The Bank does not retain or have any credit liability related to the credit which is extended in connection with such cards. The Bank is paid a fee for each card issued and receives a fee for each transaction completed on these cards. During fiscal 1997, the Company made a strategic decision to enter the credit card business in a more direct fashion and took a majority (51%) position in a newly formed subsidiary, HF Card Services, L.L.C. The target market for credit cards in this line of business is sub-prime credit customers who have either an insufficient credit history or a negative credit history and are unable to obtain a credit card from more traditional card issuers. The Bank manages the overall risk of the credit card program by its underwriting criteria that demands a recent history of acceptable performance on all accounts and product design and pricing which limits a new customer's available line of credit while providing an immediate revenue source. Examples include an unsecured product which starts with a $300 line of credit, but charges both a $50 annual fee and a $150 acceptance fee to the card, resulting in an initial $100 of available credit to the customer. The secured product also delivers a $300 line of credit to the customer, but charges a $50 annual fee and takes $225 cash advance against the card to be held as a security deposit, resulting in an initial $25 of available credit to the customer. The Company had approximately $12.3 million in credit card loans at June 30, 1998. The Bank added a new officer to its staff in fiscal year 1997 with 12 years of experience in the credit card industry. Credit card processing is being provided by independent third parties. The Bank will continue to explore new credit card product opportunities and relationships with other interested businesses who are able to demonstrate a sound financial position coupled with positive industry backgrounds and whose ownership and management is found to be acceptable. 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 commercial loans to local businesses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management". At June 30, 1998, approximately $41.1 million or 9.1% of the Bank's total loan portfolio was comprised of commercial business loans. Home Federal's commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory, equipment and business expansion within the Bank's market area. Virtually all of Home Federal's commercial business loans have been to borrowers in its primary lending areas. 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, Home Federal intends to continue to expand its commercial business lending, subject to market conditions. Interest rates on commercial business loans adjust or float with a designated national index plus a specified margin. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, is likely to be dependent upon the general economic environment). The Bank's commercial business loans are sometimes, but not always, secured by business assets, such as accounts receivable, equipment and inventory. 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. Virtually all of the Bank's commercial business loans include personal guarantees. At June 30, 1998, seven of the Bank's commercial business loans totaling $396,000 were non-performing. 11 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 Company established an agricultural lending department in fiscal year 1996. The Company employed experienced lenders to establish this department and to ensure a high quality portfolio. The agricultural division offers four types of loans to its consumers: (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 fund facilities and equipment for confinement enterprises. These loans typically will have personal guarantees, a first lien on the real estate, interest rates adjustable to the national prime rate, and require quarterly or monthly payments. All loans are secured by the operating assets of the borrower. The Bank had approximately $16.3 million of its loan portfolio in agricultural loans which was 3.6% of its loan portfolio at June 30, 1998. 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. At June 30, 1998, none of the agricultural loan portfolio was non-performing. ORIGINATIONS, PURCHASES, SALES AND SERVICING OF LOANS AND MORTGAGE-BACKED SECURITIES Real estate loans are originated by Home Federal's staff of salaried loan officers working in the Bank's retail banking offices. Loan applications are taken in each office, submitted to the main office for processing, for underwriting, and then, if the amount requested requires, to the loan committee for approval. Walk-in customers and referrals from real estate brokers and builders are important sources of loan originations. The Company originates both adjustable-rate and fixed-rate loans. Its ability to originate loans is dependent upon the relative customer demand for fixed-rate or ARM loans in its market, which is affected by the term structure (short-term compared to long-term) of interest rates as well as the current and expected future level of interest rates. Virtually all newly originated fixed-rate residential mortgage loans with maturities of 15 years or greater are originated pursuant to prior commitments for immediate sale in the secondary market. The Company sells loans to private investors as well as to FNMA and FHLMC. At June 30, 1998, the Company had $9.6 million of loans secured by one- to four-family residential real estate which were held for sale. See Notes 3 and 4 of the Notes to Consolidated Financial Statements. These loans are originated to satisfy customer demand and to generate fee income and are sold to achieve the goals in the Bank's asset/liability management program. In selling these fixed-rate mortgage loans, the Bank has historically retained the servicing rights whenever possible. However, during fiscal 1998 the Bank has sold the majority of these loans with servicing released. The Bank also occasionally sells loan participations in order to diversify risk and to comply with loans-to-one borrower requirements. Home Federal has had a substantial portfolio of fixed-rate and adjustable-rate mortgage-backed securities which it uses for investment and liquidity management. During fiscal 1998, the Bank purchased $16.6 million of mortgage-backed securities. At June 30, 1998, mortgage-backed securities totalled $39.6 million, or 8.1% of Home Federal's gross loans and mortgage-backed securities portfolio. Such mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity. For information regarding the carrying and market values of Home Federal's mortgage-backed securities portfolio, see Note 2 of the Notes to Consolidated Financial Statements. Under the risk-based capital requirement, GNMA mortgage-backed securities have a risk-weighting of 0% and FNMA and FHLMC mortgage-backed securities and mortgage-backed securities issued by U.S. Government sponsored agencies have a risk weighting of 20%, in contrast to the 50% risk weight carried by residential loans. While the Bank could exchange its long-term, fixed-rate mortgage loans for FHLMC participation certificates in order to achieve the same benefit of increased liquidity, to date, it has not elected to do so. Since 1982, the Bank has purchased mortgage servicing rights from other originators on loans of the SDHDA, a state agency that provides low-interest residential housing financing for first time home buyers in South Dakota. In return for servicing such portfolio, the Bank generally receives a fee of three-eighths of one percent from the SDHDA. At 12 June 30, 1998, the Bank serviced $364.3 million in loans for others (primarily the SDHDA). The contractual right to service mortgage loans has an economic value. The value results from the future income stream of the servicing fees, the availability of the cash balances associated with escrow funds collected monthly for real estate taxes and insurance, the availability of the cash from monthly principal and interest payments from the collection date to the remittance date, and the ability of the servicer to cross-sell other products and services. The actual value of a servicing portfolio is dependent upon such factors as the age and maturity of the loans in the portfolio, the average dollar balance of the loans, the location of the collateral property, the average amount of escrow funds held, the interest rates and delinquency experience on the loans, the types of loans and other factors. The unamortized cost of loan servicing rights was $1.4 million at June 30, 1998. Home Federal had no long-term capitalized excess servicing fees receivable as of that date. Home Federal has elected to amortize the servicing rights over the life of the loans using the interest method. Management reviews its amortization schedules at least quarterly to assure that the carrying value of mortgage servicing is fairly stated. From time to time, Home Federal has purchased whole loans and loan participations in accordance with its ongoing asset/liability management objectives. The following table shows the loan and mortgage-backed securities origination, purchase and repayment activities of the Company for the years indicated.
Years Ended June 30, -------------------------- 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) ORIGINATIONS BY TYPE: Adjustable rate: Real estate. . . . . . . . . . . . . . . . . $ 25,580 $ 44,899 $26,848 Non-real estate. . . . . . . . . . . . . . . 32,659 29,554 21,987 ------- ------- ------ Total adjustable rate. . . . . . . . . 58,239 74,453 48,835 -------- -------- ------- Fixed-rate: Real estate. . . . . . . . . . . . . . . . . 89,582 16,601 33,083 Non-real estate. . . . . . . . . . . . . . . 93,869 104,217 89,847 -------- -------- ------- Total fixed-rate. . . . . . . . . . . . . 183,451 120,818 122,930 -------- -------- ------- Total loans originated . . . . . . . . 241,690 195,271 171,765 -------- -------- ------- PURCHASES: Loan participations. . . . . . . . . . . . . 21,510 13,813 23,886 Mortgage-backed securities . . . . . . . . . 16,573 - - - 20,162 -------- -------- ------- Total purchased . . . . . . . . . . . . . 38,083 13,813 44,048 -------- -------- ------- SALES: Real estate loans. . . . . . . . . . . . . . 106,397 53,250 55,050 Mortgage-backed securities . . . . . . . . . 477 12,184 20,978 -------- -------- ------- Total sales . . . . . . . . . . . . . . . 106,874 65,434 76,028 PRINCIPAL REPAYMENTS 165,509 147,954 104,358 -------- -------- ------- Total reductions. . . . . . . . . . . . . 272,383 213,388 180,386 -------- -------- ------- Other, net . . . . . . . . . . . . . . . . . . (5,622) (1,938) (3,039) -------- -------- ------- Net increase (decrease) . . . . . . . . . $ 1,768 $ (6,242) $32,388 -------- -------- ------- -------- -------- -------
13 NON-PERFORMING ASSETS AND CLASSIFIED LOANS When a borrower fails to make a required payment on real estate secured loans within 10 to 15 days after the payment is due, the Bank generally institutes collection procedures by issuing a late notice. The customer is contacted again when the payment is 30 days past due. In the case of consumer loans, the borrower is sent a notice when a loan is 10 days past due and is contacted by telephone when a loan is 30 days past due. In most cases, delinquencies are cured promptly; however, if a loan has been delinquent for more than 30 days, the Bank attempts additional written as well as verbal contacts and, if necessary, personal contact with the borrower in order to determine the reason for the delinquency and to effect a cure, and, where appropriate, reviews the condition of the property and the financial circumstances of the borrower. Based upon the results of any such investigation, the Bank may: (i) accept a repayment program which under appropriate circumstances could involve an extension in the case of consumer loans for the arrearage from the borrower, (ii) seek evidence, in the form of a listing contract, of efforts by the borrower to sell the property if the borrower has stated that he is attempting to sell, or (iii) initiate foreclosure proceedings. When a loan payment is delinquent for 90 days, the Bank generally will initiate foreclosure proceedings unless management is satisfied the credit problem is correctable. Generally, when a loan becomes delinquent 90 days or more, the Bank will place the loan on a non-accrual status and, as a result, accrued interest income on the loan is taken out of income. Future interest income is recognized on a cash basis. The loan will remain on a non-accrual status until the borrower has brought the loan current. 14 The Company includes all loans considered impaired in nonaccrual loans. The amount of impaired loans was not material at June 30, 1998. The following table sets forth information concerning delinquent mortgage and other loans at June 30, 1998. The amounts presented represent the total remaining principal balances of the related loans, rather than the actual amounts which are overdue.
At June 30, 1998 (Dollars in Thousands) ------------------------------------------------------------------------------------- REAL ESTATE ------------------------------------------------------------------------------------- One- to four-family Commercial ------------------------------------------------------------------------------------- Percent Percent of Total of Total Number Amount Loans Number Amount Loans ------- ------ -------- ------- ------- ------ Loans delinquent for: 30-59 days....................... 21 $ 533 0.12% 1 $ 159 0.04% 60-89 days....................... 4 37 0.01 1 311 0.07 90 days and over................. 13 745 0.17 3 720 0.16 ---- -------- ----- --- -------- ------ Total delinquent loans ............ 38 $ 1,315 0.30% 5 $ 1,190 0.27% ---- -------- ----- --- -------- ------ ---- -------- ----- --- -------- ------ At June 30, 1998 (Dollars in Thousands) --------------------------------------- REAL ESTATE --------------------------------------- Consumer --------------------------------------- Percent of Total Number Amount Loans ------- ------ -------- Loans delinquent for: 30-59 days....................... 266 $ 1,967 0.44% 60-89 days....................... 43 364 0.08 90 days and over................. 52 544 0.12 ---- -------- ----- Total delinquent loans ............ 361 $ 2,875 0.64% ---- -------- ----- ---- -------- ----- At June 30, 1998 (Dollars in Thousands) ------------------------------------------------------------------------------------- NON REAL ESTATE ------------------------------------------------------------------------------------- Credit Card Business ------------------------------------------------------------------------------------- Percent Percent of Total of Total Number Amount Loans Number Amount Loans ------- ------ -------- ------- ------- ------ Loans delinquent for: 30-59 days....................... 3,502 $ 1,293 0.29% 9 $432 0.10% 60-89 days....................... 1,406 617 0.14 4 196 0.04 90 days and over................. 1,104 530 0.12 7 396 0.09 ----- -------- ----- ---- -------- ------ Total delinquent loans ............ 6,012 $ 2,440 0.55% 20 $1,024 0.23% ----- -------- ----- ---- -------- ------ ----- -------- ----- ---- -------- ------
- ---------- There were no construction and development loans delinquent at June 30, 1998. There were no agricultural loans delinquent at June 30, 1998. There were no multi-family loans delinquent at June 30, 1998. 15 The following table sets forth the amounts and categories of the Bank's non-performing assets. Loans are placed on non-accrual status when the collection of principal and/or interest become doubtful. Foreclosed assets include assets acquired in settlement of loans. The Bank did not have any material troubled debt restructurings at any of the dates presented.
At June 30, -------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (Dollars in Thousands) Non-accruing loans: One- to four-family . . . . . . . . . . . . . $ 623 $ 618 $ 682 $ 169 $ 263 Commercial real estate. . . . . . . . . . . . 719 154 556 710 717 Multi-family. . . . . . . . . . . . . . . . . - - - - - - - - - 1,611 1,718 Mobile homes. . . . . . . . . . . . . . . . . 31 52 58 198 122 Credit cards. . . . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Consumer(1) . . . . . . . . . . . . . . . . . 482 428 340 23 51 Commercial business . . . . . . . . . . . . . 396 - - - 427 - - - - - - Agricultural. . . . . . . . . . . . . . . . . - - - - - - - - - - - - - - - ------ ------ ------ ------ ------- Total. . . . . . . . . . . . . . . . . . . 2,251 1,252 2,063 2,711 2,871 ------ ------ ------ ------ ------- Accruing loans delinquent more than 90 days One- to four-family . . . . . . . . . . . . . - - - - - - - - - 143 60 Commercial real estate. . . . . . . . . . . . - - - - - - - - - - - - - - - Multi-family. . . . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Mobile homes. . . . . . . . . . . . . . . . . - - - - - - - - - 7 51 Credit cards. . . . . . . . . . . . . . . . . 530 - - - - - - - - - - - - Consumer(1) . . . . . . . . . . . . . . . . . - - - - - - - - - 2 10 Agricultural. . . . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Commercial business . . . . . . . . . . . . . - - - - - - - - - - - - - - - ------ ------ ------ ------ ------- Total. . . . . . . . . . . . . . . . . . . 530 - - - - - - 152 121 ------ ------ ------ ------ ------- Foreclosed assets: One- to four-family . . . . . . . . . . . . . 22 311 52 108 50 Commercial real estate. . . . . . . . . . . . - - - - - - 1 3 1,005 Multi-family. . . . . . . . . . . . . . . . . - - - - - - - - - - - - 150 Mobile homes. . . . . . . . . . . . . . . . . 67 124 88 38 152 Credit cards. . . . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Consumer(1) . . . . . . . . . . . . . . . . . 140 158 87 54 25 Agricultural. . . . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Commercial business . . . . . . . . . . . . . - - - - - - - - - - - - - - - ------ ------ ------ ------ ------- Total. . . . . . . . . . . . . . . . . . . 229 593 228 203 1,382 ------ ------ ------ ------ ------- Total non-performing assets(2) . . . . . . . . . . $3,010 $1,845 $2,291 $3,066 $4,374 ------ ------ ------ ------ ------- ------ ------ ------ ------ ------- Non-performing assets to total assets(3) . . . . . 0.53% 0.33% 0.41% 0.57% 0.89% ------ ------ ------ ------ ------- ------ ------ ------ ------ ------- Non-performing loans to total loans(4) . . . . . . 0.63% 0.28% 0.49% 0.79% 0.97% ------ ------ ------ ------ ------- ------ ------ ------ ------ -------
- ---------- (1) Consists of non-performing consumer loans exclusive of mobile home loans and credit card loans. (2) Non-performing assets includes non-accruing loans, accruing loans delinquent more than 90 days and foreclosed assets. (3) Percentage is calculated based upon total assets of the Company, the Bank, HF Card Services L.L.C. and the Mortgage Corp. on a consolidated basis. (4) Non-performing loans includes non-accruing loans and accruing loans delinquent more than 90 days. 16 For the year ended June 30, 1998, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to approximately $229,000. Income that was recorded on these non-accrual loans amounted to approximately $250,000 for the year ended June 30, 1998. NON-ACCRUING LOANS. As of June 30, 1998, the Bank had $2.3 million in net book value of non-accruing loans. Included in non-accruing loans at June 30, 1998 were ten loans totalling $623,000 secured by one- to four-family real estate, three loans in the amount of $719,000 secured by commercial real estate, seven commercial business loans totalling $396,000, five mobile home loans totalling $31,000, and thirty-three consumer loans (excluding mobile home loans) totalling $482,000. ACCRUING LOANS DELINQUENT MORE THAN 90 DAYS. At June 30, 1998 the Bank had $530,000 accruing credit card loans delinquent more than 90 days. When a loan becomes 90 days delinquent, except for credit card loans, the Bank places the loan on a non-accrual status and, as a result, accrued interest income on the loan is taken out of income. Future interest income is recognized on a cash basis. The loan will remain on a non-accrual status until the borrower has brought the loan current. Credit card loans remain in accrual status until 120 days, when accrued interest income on the loan is taken out of income. FORECLOSED ASSETS. As of June 30, 1998, the Bank had $229,000 of foreclosed assets. The balance of foreclosed assets at June 30, 1998 consisted of $140,000 in consumer (other than mobile homes) collateral, $67,000 in mobile homes and $22,000 in single-family residences. OTHER LOANS OF CONCERN. In addition to the non-performing assets set forth in the previous table, as of June 30, 1998 there were also an aggregate of $8.1 million in net book value of loans classified by the Bank with respect to which known information about the possible credit problems of the borrowers or the cash flows of the security properties have caused management to have some doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. CLASSIFIED ASSETS. Federal regulations provide for the classification of loans 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 savings association 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 thrift institution to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses, are required to be designated "Special Mention" by management. When a thrift institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in amounts deemed prudent by management. General allowances represent loss allowances which 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 thrift institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the association'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 Bank regularly reviews problem loans in its portfolio to determine whether any loans require classification in accordance with applicable regulations. On the basis of management's monthly review of its assets, at June 30, 1998, the Bank had classified $5.1 million of its assets as special mention (including certain loans discussed herein), $5.0 million as substandard (including certain loans discussed herein), and approximately $1.0 million as doubtful. Classified assets at June 30, 1998 consisted of the $3.0 million of non-performing assets, and the $8.1 million of other loans of concern discussed above. 17 ALLOWANCE FOR LOAN LOSSES. The current level of the allowance for loan losses is a result of management's assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on all commercial business, agricultural, construction, multi-family and commercial real estate loans, including purchased loans, that exceed $250,000 and a monthly credit review and reporting process on all types of loans that results in the calculation of guideline reserves based on the risk within the portfolio. This assessment of risk takes into account the composition of the loan portfolio, previous loan experience, current economic conditions and other factors that, in management's judgment, deserve recognition. In regard to credit card loans, the Company is providing a reserve in a range of 25% to 30% of the loan balance until the credit card portfolio becomes seasoned. As of June 30, 1998, $3.2 million of the $7.2 million allowance for loan losses was reserved for the credit card loan portfolio. Regulators have reviewed the Company's methodology for determining allowance requirements on the Company's loan portfolio and have made no recommendations for increases in the allowances during the five year period ended June 30, 1998. The Company has historically maintained a positive variance from the minimum estimated allowance for loan losses based on the analyses that are conducted by bank management and corporate credit personnel. Management has reviewed the allocations in the various classifications of loans and believes the allowance was adequate at all times during the five year period ended June 30, 1998. Real estate properties acquired through foreclosure are recorded at the lower of cost or fair value (less a deduction for disposition costs). Valuations are periodically updated by management and a specific provision for losses on such properties is established by a charge to operations if the carrying values of the properties exceed their estimated net realizable values. Although management believes that it uses the best information available to determine the allowances, unforeseen market conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations. Future additions to the Bank's allowances result from periodic loan, property and collateral reviews and thus cannot be predicted in advance. At June 30, 1998, the Bank had a total allowance for losses on loans of $7.2 million, or 1.62% of total loans. See Note 1 of the Notes to Consolidated Financial Statements for a description of the Bank's policy regarding the provision for losses on loans. 18 The following table sets forth information with respect to activity in the Bank's allowance for loan losses during the periods indicated.
Years Ended June 30, ----------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ----- ---- (Dollars in Thousands) Balance at beginning of period . . . . . . . $4,526 $4,129 $4,039 $4,899 $4,829 Charge-offs: One- to four-family. . . . . . . . . . . . . (95) (104) (23) (34) (61) Commercial. . . . . . . . . . . . . . . (173) (15) (35) - - - (40) Multi-family. . . . . . . . . . . . . . - - - - - - - - - (400) (322) Consumer. . . . . . . . . . . . . . . . (1,065) (757) (487) (264) (102) Agriculture . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Credit cards. . . . . . . . . . . . . . (906) (59) - - - - - - - - - Mobile homes. . . . . . . . . . . . . . (184) (186) (305) (265) (220) ------- ------- ------ ------ ------ Total charge-offs . . . . . . . . . . . (2,423) (1,121) (850) (963) (745) ------- ------- ------ ------ ------ Recoveries: One- to four-family . . . . . . . . . . 12 24 51 16 6 Commercial. . . . . . . . . . . . . . . - - - 493 58 90 359 Multi-family. . . . . . . . . . . . . . - - - 46 6 398 87 Commercial Business . . . . . . . . . . - - - 1 43 - - - - - - Consumer. . . . . . . . . . . . . . . . 184 194 100 54 40 Agriculture . . . . . . . . . . . . . . - - - - - - - - - - - - - - - Credit cards. . . . . . . . . . . . . . 179 19 - - - - - - - - - Mobile homes. . . . . . . . . . . . . . 32 48 92 60 48 ------- ------- ------ ------ ------ Total recoveries. . . . . . . . . . . . 407 825 350 618 540 ------- ------- ------ ------ ------ Net (charge-offs) . . . . . . . . . . . (2,016) (296) (500) (345) (205) ------- ------- ------ ------ ------ Additions (recoveries) charged to operations . . . . . . . . . . . . . . . . . 4,689 693 590 (515) 275 ------- ------- ------ ------ ------ Balance at end of period . . . . . . . . . . $7,199 $4,526 $4,129 $4,039 $4,899 ------- ------- ------ ------ ------ ------- ------- ------ ------ ------ Ratio of net (charge-offs) during the period to average loans outstanding during the period . . . . . . . . . . . . . . . . . (0.45)% (0.07)% (0.12)% (0.10)% (0.07)% ------- ------- ------ ------ ------ ------- ------- ------ ------ ------ Ratio of allowance for loan losses to total loans at end of period . . . . . . . . . . . 1.62% 1.02% 0.98% 1.11% 1.59% ------- ------- ------ ------ ------ ------- ------- ------ ------ ------ Ratio of allowance for loan losses to non- performing loans at end of period(1) . . . . 258.86% 361.50% 200.15% 141.08% 163.74% ------- ------- ------ ------ ------ ------- ------- ------ ------ ------
- ---------------------------- (1) Non-performing loans include non-accruing loans and accruing loans delinquent more than 90 days. 19 The distribution of the Bank's allowance for loan losses at the dates indicated is summarized as follows:
At June 30, ---------------------------------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Percent of Percent of Percent of Loans in Loans in Loans in Each Each Each Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans ------- ------------- ------ ----------- ------ ----------- (Dollars in thousands) One-to four-family(1). . . . . . $1,203 29.12% $1,540 36.50% $1,789 43.27% Commercial and multi-family real estate(1). . . . . . . 967 23.41 926 21.94 957 23.21 Mobile homes . . . . . . . . . . 102 2.48 145 3.43 191 4.62 Consumer(2). . . . . . . . . . . 1,219 29.49 1,254 29.73 1,060 25.69 Credit cards . . . . . . . . . . 3,181 2.74 329 0.51 - - - - - - Agricultural . . . . . . . . . . 150 3.63 77 1.82 - - - - - - Commercial business. . . . . . . 377 9.13 255 6.07 132 3.21 ------ ------ ------ ------ ------ ------- Total . . . . . . . . . . . $7,199 100.00% $4,526 100.00% $4,129 100.00% ------ ------ ------ ------ ------ ------- ------ ------ ------ ------ ------ ------- At June 30, ----------------------------------------------------------- 1995 1994 ----- ---- Percent of Percent of Loans in Loans in Each Each Category to Category to Amount Total Loans Amount Total Loans ------- ------------- ------ ----------- (Dollars in thousands) One-to four-family(1). . . . . . $910 44.64% $1,320 47.08% Commercial and multi-family real estate(1). . . . . . . 1,743 26.88 1,677 26.10 Mobile homes . . . . . . . . . . 608 6.70 908 9.75 Consumer(2). . . . . . . . . . . 644 18.85 901 15.63 Credit cards . . . . . . . . . . - - - - - - - - - - - - Agricultural . . . . . . . . . . - - - - - - - - - - - - Commercial business. . . . . . . 134 2.93 93 1.44 ------ ------ ------ ------ Total . . . . . . . . . . . $4,039 100.00% $4,899 100.00% ------ ------ ------ ------ ------ ------ ------ ------
- ---------- (1) Includes construction loans and credit card loans. (2) Excludes allowance for loan losses relating to mobile home loans and credit card loans. 20 MORTGAGE-BACKED SECURITIES Home Federal had maintained a substantial portfolio of mortgage-backed securities which it held for investment and liquidity purposes. Such mortgage-backed securities can serve as collateral for borrowings and, through repayments and sales, as a source of liquidity. During fiscal year 1998, the Bank had $477,000 of sales and repayments of $6.9 million. The Bank had $16.6 million of purchases of mortgage-backed securities during fiscal year 1998. For information regarding the carrying and market values of Home Federal's mortgage-backed securities portfolio, see Note 2 of the Notes to Consolidated Financial Statements. Under the Bank's risk-based capital requirement, mortgage-backed securities have a risk weight of 20% (or 0% in the case of GNMA securities) in contrast to the 50% risk weight carried by residential loans. See "Regulation." In order to reduce its risk-based capital requirement, Home Federal may consider securitizing a portion of its fixed-rate mortgage loan portfolio. However, securitizing mortgage loans may result in a reduction in yield. 21 The following table sets forth the contractual maturities (without any prepayment assumptions) of the Bank's mortgage-backed securities at June 30, 1998, at amortized cost.
DUE IN ----------------------------------------------------------------------------------- 6 Months 6 Months 1 to 3 3 to 5 5 to 10 Over 10 Total at or Less to 1 Year Years Years Years Years June 30, 1998 --------- --------- ------ ------- -------- ------- -------------- FIXED-RATE: Federal Home Loan Mortgage Corporation $- - - $- - - $3,903 $2,930 $ 882 $ - - - $ 7,715 Federal National Mortgage Association - - - - - - 2,118 3,522 6,565 989 13,194 Government National Mortgage Association - - - - - - - - - - - - - - - 102 102 Real Estate Mortgage Investment Conduit - - - - - - - - - - - - - - - 2,715 2,715 ------ ------ ------ ------- ------ --------- -------- Total Fixed-Rate - - - - - - 6,021 6,452 7,447 3,806 23,726 ------ ------ ------ ------- ------ --------- -------- VARIABLE-RATE: Resolution Trust Corporation - - - - - - - - - - - - - - - 733 733 Resolution Funding Mortgage Security - - - - - - - - - - - - - - - 1,210 1,210 Real Estate Mortgage Investment Conduit - - - - - - - - - - - - - - - 9,809 9,809 Federal Home Loan Mortgage Corporation - - - - - - - - - - - - - - - 2,307 2,307 Federal National Mortgage Association - - - - - - - - - - - - - - - 1,918 1,918 ------ ------ ------ ------- ------ --------- -------- Total Variable-Rate - - - - - - - - - - - - - - - 15,977 15,977 ------ ------ ------ ------- ------ --------- -------- Total $- - - $- - - $6,021 $6,452 $7,447 $19,783 $ 39,703 ------ ------ ------ ------- ------ --------- -------- ------ ------ ------ ------- ------ --------- --------
Based on historical experience, Home Federal believes that its mortgage-backed securities will be prepaid significantly in advance of the date of maturity as reflected in the table above. For information regarding prepayment assumptions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations and Asset/Liability Management". 22 INVESTMENT ACTIVITIES Home Federal is required under OTS regulation to maintain minimum levels of investments that qualify as 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. Historically, the Bank has maintained its liquid assets above the minimum requirements imposed by the OTS regulations and at a level believed by management adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. As of June 30, 1998, the Bank's liquidity ratio (liquid assets as a percentage of net withdrawable savings deposits and current borrowings) was 6.0%. See "Regulation - - Liquidity." 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, 1998, the Company had $12.0 million in interest-bearing deposits, and investment securities totalled $40.6 million, or 7.1% of its total assets. As of such date, the Bank also had a $3.7 million investment in the stock of the FHLB of Des Moines in order to satisfy the FHLB of Des Moines' requirement for membership. It is the Bank's general policy to purchase investment securities which are U.S. Government securities and federal agency obligations and other issues rated investment grade. At June 30, 1998, the average term to maturity or repricing of the investment securities portfolio was 0.54 years. 23 The following table sets forth the composition of the Company's and the Bank's investment portfolio at the dates indicated.
June 30, -------------------------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Amortized % of Amortized % of Amortized % of Cost Total Cost Total Cost Total ----- ------ ----- ------ ------ ----- (Dollar in Thousands) Interest-bearing deposits............... $12,000 21.36% $6,000 11.32% $ - - - - - -% ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Investment securities: U.S. government securities........ 2,994 5.33% 7,019 13.24% 14,280 22.91% Federal agency obligations........ 24,492 43.59 21,428 40.41 36,086 57.89 Federal Home Loan Bank............ 11,997 21.35 11,999 22.63 - - - - - - FHLMC preferred stock............. 500 0.89 500 0.94 508 0.81 FNMA common stock................. 8 0.01 8 0.02 8 0.01 Redwood Financial common stock.... - - - - - - 462 0.87 - - - - - - Tax free bonds.................... 540 0.96 385 0.73 565 0.91 Corporate bond.................... - - - - - - - - - - - - 6,222 9.99 ------- ------- ------- ------- ------- ------- Subtotal....................... 40,531 72.13 41,801 78.84 57,669 92.52 ------- ------- ------- ------- ------- ------- FHLB stock.............................. 3,657 6.51 5,222 9.84 4,665 7.48 ------- ------- ------- ------- ------- ------- Total investment securities and FHLB stock........................ $56,188 100.00% $53,023 100.00% $62,334 100.00% ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Average remaining life or term to repricing excluding FHLB stock, FHLMC Preferred Stock, Redwood .54 years .58 years 1.46 years Financial Common Stock
24 The composition and maturities of the investment securities portfolio, excluding FHLB of Des Moines stock, FNMA stock and FHLMC preferred stock are indicated in the following table.
At June 30, 1998 --------------------------------------------------------------------------------------- Less than 1 1 to 5 5 to 10 Over 10 Total Investment Year Years Years Years Securities ---------------------- Cost Cost Cost Cost Cost Market Value -------------- ---------- --------- -------- ------- ------------ (Dollars in Thousands) U.S. government securities . . . . . . . $ --- $ 2,994 $ --- $ --- $ 2,994 $ 3,018 Federal agency obligations . . . . . . . 1,998 34,491 --- --- 36,489 36,473 Tax Free Bonds . . . . . . . . . . . . . --- 110 45 385 540 573 ------- ------- ------ ------ ------- ------- Total investment securities. . . . . . . $ 1,998 $37,595 $ 45 $ 385 $40,023 $40,064 ------- ------- ------ ------ ------- ------- ------- ------- ------ ------ ------- ------- Weighted average yield . . . . . . . . . 5.62% 6.02% 7.63% 6.50% 6.01% ------- ------- ------ ------ ------- ------- ------- ------ ------ -------
The Company's investment securities portfolio at June 30, 1998 contained no tax-exempt securities in excess of 10% of the Company's stockholders' equity, excluding those issued by the United States Government or its agencies. The Company's investment securities portfolio also contained no non-investment grade or other corporate debt securities (i.e., "junk bonds"). In addition, the Company does not invest in derivatives as defined by SFAS #119. Home Federal's investment security portfolio is managed in accordance with a written investment policy adopted by the Board of Directors. Investments may be made by Home Federal officers within specified limits and approved in advance by the Board of Directors for transactions over these limits. At the present time, Home Federal does not have any investments that are held for trading purposes. At June 30, 1998, the Company has $44.2 million of securities available for sale, including FHLB stock of $3.7 million. See "Note 2 in the Notes to Consolidated Financial Statements". SOURCES OF FUNDS GENERAL. The Bank's primary sources of funds are deposits, amortization and prepayment of loan principal (including mortgage-backed securities), and, to a lesser extent, sales of mortgage loans, sales or maturities of investment securities, mortgage-backed securities, and short term investments. Borrowings, presently all from the FHLB of Des Moines, 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 in recent years has not relied on outside borrowings other than FHLB borrowings. The availability of funds from loan sales is influenced by general interest rates. DEPOSITS. Home Federal offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of statement savings accounts, NOW and checking accounts, money market and certificate accounts ranging in terms from 30 days to five years. The Bank's deposit products also include IRA certificates and Keogh plan retirement certificates. The Bank only solicits deposits from its market area and does not use brokers to obtain deposits. The Bank relies primarily on competitive pricing policies, advertising, and customer service to attract and retain these deposits. The flow of deposits is influenced significantly 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, NOW 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. 25 The following table sets forth the dollar amount of deposits in the various types of deposit accounts offered by the Company as of the dates indicated.
At June 30, ------------------------------------------------------------- 1998 1997 1996 -------------------- ------------------ ------------------ Percent of Percent of Percent of Amount Total Amount Total Amount Total ------ ----- ------ ----- ------ ----- (Dollars in Thousands) TRANSACTION ACCOUNTS: Savings Accounts weighted average rates of 2.02%, 2.44% and 2.48% at June 30, 1998, 1997 and 1996. . . . . . . . . . . . $61,266 13.72% $28,968 6.93% $31,445 7.90% NOW Accounts weighted average rates of 1.51%, 1.44% and 1.78% at June 30, 1998, 1997 and 1996. . . . . . . . . . . . 24,659 5.52 24,614 5.88 22,030 5.53 Non-interest bearing Accounts. . . . . . . . . . . . . . . . . . 33,403 7.48 20,973 5.02 11,293 2.84 Money Market Accounts weighted average rates of 4.03%, 2.90% and 3.% at June 30, 1998, 1997 and 1996. . . . . . . . . . . . . 43,868 9.84 34,421 8.23 34,339 8.62 -------- ------ -------- ------ -------- ------- Total Transaction Accounts . . . . . . . . . . . . . . . . . . . 163,196 36.56 108,976 26.06 99,107 24.89 -------- ------ -------- ------ -------- ------- CERTIFICATES OF DEPOSIT: 0.00 - 3.99%. . . . . . . . . . . . . . . . . . . . . . . . --- 0.00 322 0.08 191 0.01 4.00 - 4.99%. . . . . . . . . . . . . . . . . . . . . . . . 9,891 2.22 6,230 1.49 28,524 7.17 5.00 - 5.99%. . . . . . . . . . . . . . . . . . . . . . . . 150,856 33.79 175,399 41.94 152,678 38.36 6.00 - 6.99%. . . . . . . . . . . . . . . . . . . . . . . . 97,386 21.81 100,314 23.99 86,363 21.70 7.00 - 7.99%. . . . . . . . . . . . . . . . . . . . . . . . 23,983 5.37 25,819 6.17 29,551 7.42 8.00 - 8.99%. . . . . . . . . . . . . . . . . . . . . . . . 1,055 0.24 1,114 0.27 1,747 0.44 9.00% and greater . . . . . . . . . . . . . . . . . . . . . 57 0.01 12 0.00 5 0.01 ------- ------ -------- ------ -------- ------- Total Certificates of Deposit. . . . . . . . . . . . . . . . . . 283,228 63.44 309,210 73.94 299,059 75.11 -------- ------ -------- ------ -------- ------- Total Deposits . . . . . . . . . . . . . . . . . . . . . . . . . $446,424 100.00% $418,186 100.00% $398,166 100.00% -------- ------ -------- ------ -------- ------- -------- ------ -------- ------ -------- -------
26 The following table sets forth the savings flows at the Company during the periods indicated. Net increase (decrease) refers to the amount of deposits during a period less the amount of withdrawals during the period. The net deposits (withdrawals) before interest credited during the years ended June 30, 1998, 1997, and 1996 reflect management's strategy of pricing deposits to control the Bank's cost of funds. The Bank generally prices its deposits to remain competitive with other financial institutions, but does not necessarily seek to match the highest rates paid by competing institutions in its market area. Deposit flows at savings associations, however, may also be influenced by external factors such as governmental credit policies and, particularly in recent periods, depositors' perceptions of the adequacy of federal insurance of accounts.
Year Ended June 30, --------------------------------------- 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) Opening balance. . . . . . . . $418,186 $398,166 $400,675 Net deposits (withdrawals) . . 6,039 (763) (23,188) Interest credited. . . . . . . 22,199 20,783 20,679 -------- -------- ------- Ending balance . . . . . . . . $446,424 $418,186 $398,166 -------- --------- -------- -------- --------- -------- Net increase (decrease). . . . $28,238 $20,020 ($2,509) -------- -------- ------- -------- -------- ------- Percent increase (decrease). . 6.75% 5.03% (0.63%) ------- ------- ------- ------- ------- -------
27 The following table shows rate and repricing information for the Company's certificates of deposit as of June 30, 1998.
0.00- 5.00- 6.00- 7.00% 8.00% 9.00% Percent 4.99% 5.99% 6.99% 7.99% 8.99% or Greater Total of Total ------ ----- ---- ---- ---- ---------- ----- -------- (Dollars in Thousands) CERTIFICATES OF DEPOSIT MATURING IN QUARTER ENDING: September 30, 1998 . . . . $5,687 $ 31,688 $ 15,136 $ 49 $ 147 $ --- $52,707 18.61% December 31, 1998. . . . . 4,183 20,880 16,711 654 190 --- 42,618 15.05 March 31, 1999 . . . . . . 15 21,082 3,740 6,386 191 --- 31,414 11.09 June 30, 1999. . . . . . . 6 21,107 11,789 12,158 25 --- 45,085 15.92 September 30, 1999 . . . . --- 14,623 23,334 1,402 66 --- 39,425 13.92 December 31, 1999. . . . . --- 11,234 15,312 1,788 66 --- 28,400 10.03 March 31, 2000 . . . . . . --- 10,648 5,109 1,158 248 --- 17,163 6.06 June 30, 2000. . . . . . . --- 6,796 927 341 --- 57 8,121 2.87 September 30, 2000 . . . . --- 2,116 1,339 --- 72 --- 3,527 1.24 December 31, 2000. . . . . --- 4,790 97 2 21 --- 4,910 1.73 March 31, 2001 . . . . . . --- 1,025 166 25 --- --- 1,216 0.43 June 30, 2001. . . . . . . --- 611 378 --- --- --- 989 0.35 Thereafter . . . . . . . . --- 4,256 3,348 20 29 --- 7,653 2.70 ------ ------- ------- ------ ------ -------- -------- ------- Total. . . . . . . . . . . $9,891 $150,856 $97,386 $23,983 $1,055 $ 57 $283,228 100.00% ------ ------- ------- ------- ------ -------- -------- ------- ------ ------- ------- ------- ------ -------- -------- ------- Percent of Total . . . . . 3.49% 53.27% 34.38% 8.47% 0.37% 0.02% 100.00% ------ ------- ------- ------- ------ -------- -------- ------ ------- ------- ------- ------ -------- --------
28 The following table sets forth the amount of the Company's certificates of deposit and other deposits by time remaining until maturity as of June 30, 1998.
Maturity -------------------------------------------------------- Over Over 3 Months 3 to 6 6 to 12 Over or Less Months Months 12 months Total -------- ------- -------- --------- ------ (Dollars in Thousands) Certificates of deposit less than $100,000 . . . . . . . . . . . . . . . . . . . . . $39,755 $33,640 $64,437 $93,337 $231,169 Certificates of deposit of $100,000 or more . . . . . . . . . . . . . . . . . 4,417 5,283 8,631 17,793 36,124 Public funds(1). . . . . . . . . . . . . . . . . . 8,536 3,695 3,432 272 15,935 ------- ------- ------- -------- -------- Total certificates of deposit. . . . . . . . . . . $52,708 $42,618 $76,500 $111,402 $283,228 ------- ------- ------- -------- -------- ------- ------- ------- -------- --------
- -------------------- (1) Includes certificates of deposit of $100,000 or more from governmental and other public entities. The Bank solicits certificates of deposit of $100,000 or greater ("jumbo certificates") from various state, county and local government units which carry rates which are negotiated at the time of deposit. See Note 7 of Notes to Consolidated Financial Statements. Deposits at June 30, 1998 and 1997 include $38.3 million and $4.1 million, respectively of deposits from one local governmental entity, the majority of which are demand accounts. BORROWINGS. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings when they are a less costly source of funds or can be invested at a positive rate of return. Home Federal's borrowings consist primarily of advances from the FHLB of Des Moines upon the security of its capital stock of the FHLB of Des Moines and certain of its mortgage loans and mortgage-backed securities. Such advances can be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. At June 30, 1998, the Bank's FHLB advances totalled $50.1 million, representing 9.76% of total liabilities. The following table sets forth the maximum month-end balances and average balances of FHLB advances and other borrowings at the dates indicated.
Years Ended June 30, -------------------- 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) MAXIMUM BALANCE: FHLB advances. . . . $74,219 $87,516 $97,996 Other borrowings . . 524 600 600 AVERAGE BALANCE: FHLB advances. . . . $63,532 $77,629 $86,851 Other borrowings . . 524 562 600
29 The following table sets forth certain information as to the Bank's FHLB advances and other borrowings at the dates indicated.
Years Ended June 30, -------------------- 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) FHLB advances. . . . $ 50,111 $ 74,219 $ 89,523 Other borrowings . . 524 524 600 -------- -------- -------- Total borrowings . . $ 50,635 $ 74,743 $ 90,123 -------- -------- -------- -------- -------- -------- Weighted average interest rate of FHLB advances. . . . 5.69% 5.69% 5.59%
SUBSIDIARY ACTIVITIES As a federally chartered thrift institution, Home Federal is permitted by OTS regulations to invest up to 2% of its assets, or $11.4 million at June 30, 1998, in the stock of, or loans to, service corporation subsidiaries. As of such date, the net book value of Home Federal's investment in and loans to its service corporations was approximately $120,000. Home Federal may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. In addition to investments in service corporations, federal associations are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a federal association may engage in directly. Home Federal has three subsidiary corporations, Hometown Insurors, Inc. ("Hometown"), Mid-America Service Corporation ("Mid-America") and PMD, Inc. ("PMD"). Hometown, located in Sioux Falls, South Dakota, provides a full line of insurance products to customers of Home Federal and members of the general public in Home Federal's market area. Insurance products offered by Hometown include annuities and life, credit life, health, homeowners, and auto insurance and, to a lesser extent, certain commercial-related insurance products. Home Federal had a negative investment in Hometown of $18,000 at June 30, 1998. Hometown had a loss before tax of $122,000 for the 1998 fiscal year. In July, 1998, Home Federal infused capital of $50,000 into Hometown. Mid-America, is an appraisal company located in Sioux Falls, South Dakota, that provides appraisal services to Home Federal and other lenders in the Bank's market area. At June 30, 1998, the Bank had a $138,000 investment in Mid-America. Mid-America had income before tax of $46,000 for the 1998 fiscal year. PMD, located in Sioux Falls, South Dakota is engaged in the business of buying, selling and managing repossessed real estate properties. At June 30, 1998, the Bank had a $1,000 investment in PMD. PMD had no activity during fiscal year 1998. In May, 1996 the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of the membership interest of this entity. HF Card Services was established to provide secured, partially-secured and unsecured credit cards nationwide. At June 30, 1998, the Company had a negative investment in HF Card Services of $14,000. HF Card Services had net income of $98,000 for the 1998 fiscal year. HomeFirst Mortgage Corp. is a South Dakota Corporation which had office in Omaha, Nebraska. The Mortgage Corp. was a mortgage banking operation that originated one- to four- family residential loans which were sold into the secondary market. The Mortgage Corp. had assets of $1,000 at June 30, 1998. The Company ceased operations of the Mortgage Corp. during the first quarter of fiscal 1998. The Mortgage Corp. had a net loss of $11,000 during the year ended June 30, 1998. The primary exit costs involved were compensation costs of $28,000 and occupancy costs of $21,000. 30 COMPETITION Home Federal faces strong competition, both in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other commercial banks, credit unions and mortgage bankers making loans secured by real estate located in the Bank's market areas. Commercial banks and finance companies provide vigorous competition in consumer lending. The Bank competes for real estate and other loans principally on the basis of the quality of services it provides to borrowers, interest rates and loan fees it charges and the types of loans it originates. The Bank attracts all of its deposits through its retail banking offices, primarily from the communities in which those retail banking offices are located; therefore, competition for those deposits is principally from other commercial banks and credit unions located in the same communities. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, and convenient branch locations with interbranch deposit and withdrawal privileges at each. There are approximately 24 financial institutions which compete for deposits in Minnehaha County. According to information contained in reports prepared by the FDIC, the Bank is the third largest financial institution based on total deposits in Minnehaha County, excluding Citibank and Hurley State Bank. Management estimates that its deposit market share in Minnehaha County, where the majority of its deposits are located, is approximately 12%. EMPLOYEES At June 30, 1998, the Bank had a total of 292 employees including 23 employees of the Bank's service corporations. The Bank's employees are not represented by any collective bargaining group. Management considers its relations with its employee to be good. REGULATION GENERAL. The Bank is a federally chartered thrift institution, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations. The Bank is a member of the FHLB of Des Moines and is subject to certain limited regulation by the Federal Reserve Board. As the savings and loan holding company of the Bank, the Company also is subject to federal regulation and oversight. The purpose of the regulation of the Company and other holding companies is to protect subsidiary savings associations where deposits are federally insured. The Bank is a member of the Savings Association Insurance Fund (the "SAIF") and the deposits of the Bank are insured by the FDIC. Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document. The following discussion is intended to be a summary of the material statutes, regulations and policies applicable to savings associations and their holding companies, and it does not purport to be a comprehensive discussion of such statutes, regulations and policies. REGULATION OF FEDERAL SAVINGS ASSOCIATIONS. As an office of the Department of the Treasury, the OTS has extensive authority over the operations of federal savings associations, such as the Bank. Pursuant to this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last examination of the Bank by the OTS concluded on June 15, 1998. Examiners may require a federal savings association to provide for higher general or specific loan loss-reserves. ASSESSMENTS. The OTS has established a schedule for the assessment of fees upon all savings associations to fund the operations of the OTS. A schedule of fees has also been established for the various types of applications and filings made by savings associations with the OTS. In addition, the general assessment, paid on a semi-annual basis, is computed based upon the savings association's total assets, including consolidated subsidiaries, as reported in the association's latest quarterly thrift financial report. Savings associations (unlike the Bank) that are classified as "troubled" are required to pay a 50% premium over the standard assessment. The Bank's OTS assessment (standard assessment) for the fiscal year ended June 30, 1998 was approximately $131,000. The OTS has proposed amendments to its regulations that are intended to assess savings associations on a more 31 equitable basis. The proposed regulations would base the assessment for an individual savings association on three components: the size of the association, on which the basic assessment would be based; the association's supervisory condition, which would result in percentage increases for any savings institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination; and the complexity of the association's operations, which would result in percentage increases for a savings association that managed over $1 billion in trust assets, serviced for others loans aggregating more than $1 billion, or had certain off-balance sheet assets aggregating more than $1 billion. In order to avoid a disproportionate impact on the smaller savings institutions, the OTS is proposing to permit the portion of the assessment based on assets size either under the current regulations or under the amended regulations. Management believes that, assuming the proposed regulations are adopted as proposed, any change in its rate of OTS assessments will not be material. ENFORCEMENT. Under the Federal Deposit Insurance Act (the "FDI Act"), the OTS has primary enforcement responsibility over savings associations and has the authority to bring enforcement action against all "institution-affiliated parties," including any controlling stockholder or any stockholder, attorney, appraiser or accountant who knowingly or recklessly participates in any violation of applicable law or regulation or breach of fiduciary duty or certain other wrongful actions that causes or is likely to cause a more than a minimal loss or other significant adverse effect on an insured savings association. Civil penalties cover a wide range of violations and actions and range from $5,000 for each day during which violations of law, regulations, orders, and certain written agreements and conditions continue, up to $1 million per day for such violations if the person obtained a substantial pecuniary gain as a result of such violation or knowingly or recklessly caused a substantial loss to the institution. Criminal penalties for certain financial institution crimes include fines of up to $1 million and imprisonment for up to 30 years. In addition, regulators have substantial discretion to take enforcement action against an institution that fails to comply with its regulatory requirements, particularly with respect to its capital requirements. Possible enforcement actions range from the imposition of a capital plan and capital directive to receivership, conservatorship, or the termination of deposit insurance. Under the FDI Act, the FDIC has the authority to recommend to the Director of OTS that enforcement action be taken with respect to a particular savings association. If action is not taken by the Director of the OTS, the FDIC has authority to take such action under certain circumstances. BUSINESS ACTIVITIES. The Bank derives its lending and investment powers from the Home Owners' Loan Act, as amended (the "HOLA"), and the regulations of the OTS thereunder. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage. These investment powers are subject to various limitations, including (a) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories; (b) a limit of 400% of an association's capital on the aggregate amount of loans secured by non-residential real estate property; (c) a limit of 20% of an association's assets on the aggregate amount of commercial loans, with the amount of commercial loans in excess of 10% of assets being limited to small business loans; (d) a limit of 35% of an association's assets on the aggregate amount of consumer loans and acquisitions of certain debt securities; (e) a limit of 5% of assets on non-conforming loans (loans in excess of the specific limitations of the HOLA); and (f) a limit of the greater of 5% of assets or an association's capital on certain construction loans made for the purpose of financing what is or is expected to become residential property. Under the Homeowners Loan Act ("HOLA"), savings associations are generally subject to the same limits on Loans to One Borrower as are imposed on national banks. Generally, under these limits, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the association's unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily-marketable collateral. Such collateral is defined to include certain debt and equity securities and bullion, but generally does not include real estate. At June 30, 1998, the Bank's lending limit under this restriction was $7.7 million. In addition, the Bank may provide purchase money financing for the sale of any asset without regard to the loans-to-one borrower limitation so long as no new funds are advanced and the Bank is not placed in a more detrimental position than if it had held the asset. Home Federal is in compliance with the loans-to-one-borrower limitation. SAFETY AND SOUNDNESS STANDARDS. Pursuant to the FDI Act, as amended by FDICIA and the Riegle Community Development and Regulatory Improvement Act of 1994 (the "Community Development Act"), the OTS and the federal 32 bank regulatory agencies have adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice by the OTS that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of FDICIA. If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties. ACCOUNTING STANDARDS. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") requires the OTS to establish accounting standards to be applicable to all savings associations for purposes of complying with regulations, except to the extent otherwise specified in the capital standards. Such standards must incorporate generally accepted accounting standards to the same degree as is prescribed by federal banking agencies for banks, or may be more stringent than such requirements. INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC. The Bank is a member of the SAIF, which is administered by the FDIC. Savings deposits are insured up to $100,000 per insured member (as defined by law and regulation) by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition. On September 30, 1996, Congress passed and President Clinton signed into law The Deposit Insurance Funds Act of 1996 ("Funds Act") to resolve the deposit insurance premium disparity. The Funds Act also included extensive regulatory relief for banks and thrifts. The Funds Act included a one-time special assessment on SAIF deposits to be imposed to bring the fund's reserve ratio to the statutory required 1.25 percent. The assessment rate was 65.7 basis points on deposits as of March 31, 1995 resulting in an assessment of $2.6 million on the Bank's deposits as recorded of March 31, 1995 which was paid on November 29, 1996. In addition, the Funds Act includes the following items which affect SAIF members: (1) Pro-rata sharing of the Financing Corporation ("FICO") obligation among Bank Insurance Fund ("BIF) and SAIF members will begin by January 1, 2000. From 1997 through 1999, partial sharing will occur, with SAIF deposits assessed 6.44 basis points and BIF deposits 1.29 basis points (2) Through December 31, 1998, the assessment rate for SAIF deposits cannot be lower than the rate for BIF deposits (3) The FDIC is prohibited from setting the semi-annual assessment at a rate in excess of that needed to maintain or meet the required reserve ratio. Until the funds are merged, the FDIC is permitted to rebate or credit excess premiums to BIF members only (4) For a three-year period, the banking regulators are authorized to prevent SAIF insured institutions from "facilitating or encouraging" customers to shift their deposits to BlF-insured affiliates for the purpose of evading the SAIF premium (5) The BIF and SAIF insurance funds will merge to form the Deposit Insurance Fund on January 1, 1999, if there are no savings associations in existence on that date (6) Pro-rata FICO sharing will begin and the ban on deposit shifting will end on the earlier of January 1, 2000 or when the last savings association ceases to exist and (7) The Treasury Department was directed to report to Congress by March 31, 1997, with its recommendations on a common charter for banks and savings institutions. The 1997 decrease in the SAIF deposit assessment from 23 basis points to 6.44 basis points is a savings of approximately 72% to the Bank on an annual basis, exclusive of the one-time assessment, which will impact net income for the Bank and the Company on an ongoing basis in the future. FDICIA also authorizes the FDIC to implement a risk-based deposit insurance assessment system. Pursuant to this 33 requirement, the FDIC adopted a transitional risk-based assessment system, effective January 1, 1993, under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. The permanent system, adopted in June 1993 and effective January 1, 1994, continues the risk classification system established under the transitional rule. Under this system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy would pay the lowest premium while institutions that are less than adequately capitalized (i.e., core and Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern would pay the highest premium. Assessments currently range from 0.0% of deposits for institutions in the highest category to 0.27% of deposits for institutions in the lowest category. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period. The financing corporations created by FIRREA and the Competitive Equality Banking Act of 1987 are also empowered to assess premiums on savings associations to help fund the liquidation or sale of troubled savings associations. Such premiums cannot, however, exceed the amount of SAIF assessments and are paid in lieu thereof. The FDIC has adopted regulations that generally prohibit payments to directors, officers and employees contingent upon termination of their affiliation with an FDIC-insured institution or its holding company (i.e., "golden parachute payments") if the payment is received after or in contemplation of, among other things, insolvency, or a determination that the institution or holding company is in "troubled condition." Certain types of employee benefit plans are not subject to the prohibition. The regulations would also generally prohibit certain indemnification payments for civil money penalties or other enforcement action. REGULATORY CAPITAL REQUIREMENTS. Federally insured savings associations, such as the Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The capital regulations require tangible capital not less than 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained income, and certain noncumulative perpetual preferred stock and related earnings on withdrawable accounts and deposits that qualify as core capital. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights and other categories must be deducted from tangible capital. The OTS has proposed a rule which would limit the amount of purchased mortgage servicing rights, together with purchased credit card receivables, includable as tangible and core capital to 50% of such capital. No assurance can be given as to the final form of such regulation or the date of its effectiveness. At June 30, 1998, Home Federal had $1.4 million of unamortized loan servicing rights, none of which were required to be deducted from tangible capital. The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. Under 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 or engaged in certain other activities solely as agent for its customers such as mortgage banking activities 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. All subsidiaries of the Bank are includable subsidiaries. At June 30, 1998, the Bank had Tier I (Leverage) capital equal to $44.2 million, or 7.75% of adjusted total assets, which is $27.1 million above the minimum leverage ratio requirement of 3% as in effect on that date. The capital standards also require core capital equal to at least 3% of adjusted total assets (as defined by regulation). Core capital generally consists of tangible capital plus certain intangible assets, and up to 25% of other intangibles which meet certain separate salability and market valuation tests. At June 30, 1998, the Bank had $1.4 million in intangible assets which were subject to these tests. The amount of servicing rights includable as core capital is limited to 50% of such capital. 34 Effective December 31, 1990, national banks were required to maintain a ratio of core capital to adjusted total assets not less than 3%. Only those national banks that receive a composite rating of one (the highest rating) under the "CAMEL" rating system for commercial banks and that, in general, are considered strong banking organizations will qualify for the 3% requirement. All other national banks must maintain a core capital ratio of 3% plus an additional 100 to 200 basis points that would be established on a case-by-case basis. As required by federal law, the OTS has proposed a rule revising its minimum core capital requirement to be no less stringent than that imposed on national banks. The OTS has proposed that only those savings associations rated a composite one (the highest rating) under the MACRO rating system for savings associations will be permitted to operate at or near the regulatory minimum leverage ratio of 3%. All other savings associations will be required to maintain a minimum leverage ratio of 3% plus at least an additional 100 to 200 basis points. The OTS will assess each individual savings association through the supervisory process on a case-by-case basis to determine the applicable requirement. No assurance can be given as to the final form of any such regulation, the date of its effectiveness or the requirement applicable to the Bank. The OTS risk-based capital requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital up to 100% of core capital. At June 30, 1998, Home Federal had no capital instruments that qualified as supplementary capital and $7.2 million of general loss reserves, which was in excess of 1.25% of risk-weighted assets by $2.4 million. 35 Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. Home Federal had no such exclusions from capital and assets at June 30, 1998. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by the appropriate risk weight based on the risks inherent in the type of assets. The risk weights assigned by the OTS for principal categories of assets are (i) 0% for cash and securities issued by the U.S. Government or unconditionally backed by the full faith and credit of the U.S. Government, (ii) 20% for securities (other than equity securities) issued by U.S. Government sponsored agencies, high quality mortgage-backed securities and mortgage-backed securities issued by, or fully guaranteed as to principal and interest by, the FNMA or the FHLMC except for those classes with residual characteristics or stripped mortgaged-related securities, (iii) 50% for prudently underwritten permanent one- to four-family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by FNMA or FHLMC, and (iv) 100% for all other loans and investments, including consumer loans, commercial loans, repossessed and loans more than 90 days past due. On June 30, 1998, the Bank had total capital of $49.0 million (including $44.2 million in core capital and $4.8 million in qualifying supplementary capital) and risk-weighted assets of $386.8 million (including $2.3 million in converted off-balance sheet assets), or total capital of 12.76% of risk-weighted assets. This amount was $18.3 million above the 8.0% requirement in effect on that date. The following table sets forth Home Federal's compliance with its capital requirements at June 30, 1998.
PERCENT OF APPLICABLE AMOUNT ASSETS(1) ------ ----------- (DOLLARS IN THOUSANDS) GAAP capital . . . . . . . . . . . $44,191 7.75% ------- ------ ------- ------ Tier I (Leverage) capital. . . . . $44,201 7.75% Required(3). . . . . . . . . . . . 17,113 3.00 ------- ------ Excess over requirement. . . . . . $27,088 4.75% ------- ------ ------- ------ Risk based capital(4). . . . . . . $49,036 12.76% Required . . . . . . . . . . . . . 30,754 8.00 ------- ------ Excess over requirement. . . . . . $18,282 4.76% ------- ------ ------- ------
- --------------------- (1) Tier I (Leverage) capital figures are determined as a percentage of total adjusted assets; risk-based capital figures are determined as a percentage of risk-weighted assets. (2) The Bank's investment in its subsidiaries is included for purposes of calculating regulatory capital. 36 (3) The OTS is expected to adopt a core capital requirement for savings associations comparable to the requirement for national banks that became effective December 31, 1990. The OTS core capital requirement is anticipated to be at least 3% of total adjusted assets for thrifts that receive the highest supervisory rating for safety and-soundness, with a 4% to 5% core capital requirement for all other thrifts. No prediction can be made as to the exact nature of any new OTS core capital regulation, or the date of its effectiveness, and the core capital requirement to be applicable to the Bank under such regulation. (4) Includes qualifying supplementary capital of $4.8 million. Under FDICIA all the Federal banking agencies, including the OTS, must revise their risk-based capital requirements to ensure that such requirements account for interest rate risk, concentration of credit risk and the risks of non-traditional activities, and that they reflect the actual performance of and expected loss on multi-family loans. The OTS has adopted a final rule which requires every savings association with more than normal interest rate risk to deduct from total capital an amount equal to 50% of its interest-rate risk exposure multiplied by the market value of its assets. This exposure is a measure of the potential decline in the market value of portfolio equity of a savings association greater than 2%, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline) affecting on- and off-balance sheet assets and liabilities. Given Home Federal's capital position, this rule is not expected to have a material impact on its financial condition or results of operations. The OTS has delayed implementation of this Rule as of June 30, 1998. Pursuant to FDICIA, the federal banking agencies, including the OTS, have also proposed regulations authorizing the agencies to require a depository institution to maintain additional total capital to account for concentration of credit risk and the risk of non-traditional activities. No assurance can be given as to the final form of any such regulation. PROMPT CORRECTIVE ACTION STANDARDS. The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against any association that fails to meet its capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core ratio, a Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions, discussed below that are applicable to significantly undercapitalized associations. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements. Any savings association that fails to comply with its capital plan or is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be subject to one or more of the additional specified actions and operating restrictions mandated by FDICIA. These actions and restrictions include requiring the issuance of additional voting securities; limitations on asset growth; mandated asset reduction; changes in senior management; divestiture, merger or acquisition of the association; restrictions on executive compensation; and any other action the OTS deems appropriate. An association that becomes "critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is subject to further restrictions on its activities in addition to those applicable to significantly undercapitalized associations. The FDIC must restrict the activities of a critically undercapitalized association and, among other things, prohibit any material transaction outside the ordinary course of business or engaging in certain transactions with affiliates, without the approval of the FDIC. The OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. 37 Any undercapitalized association is also subject to other possible enforcement actions by the OTS or the FDIC. Such actions could include a capital directive, a cease-and-desist order, civil money penalties, the establishment of restrictions on all aspects of the association's operations or the appointment of a receiver or conservator or a forced merger into another institution. The grounds for appointment of a conservator or receiver include substantially insufficient capital and losses or likely losses that will deplete substantially all capital with no reasonable prospect for replenishment of capital without federal assistance. If the OTS determines that an association is in an unsafe or unsound condition or is engaged in an unsafe or unsound practice it is authorized to reclassify a well-capitalized association as an adequately capitalized association and if the association is adequately capitalized, to impose the restrictions applicable to an undercapitalized association. The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on the Bank's and the Company's operations and profitability and the value of the Company's Common Stock. The Company's shareholders do not have preemptive rights, and therefore, if the Company is directed by the OTS or the FDIC to issue additional shares of Common Stock, such issuance may result in the dilution in the percentage of ownership of the Company of those persons owning shares of the Company's Common Stock. LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. OTS regulations impose various restrictions or requirements on associations with respect to their ability to pay dividends or make other distributions of capital. OTS regulations prohibit an association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion. The OTS utilizes a three-tiered approach to permit associations, based on their capital level and supervisory condition, to make capital distributions which include dividends, stock redemptions or repurchases, cash-out mergers, and other transactions charged to the capital account. See "Regulatory Capital Requirements". Generally, Tier I associations, which are associations that before and after the proposed distribution meet their fully phased-in capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or the amount authorized for a Tier 2 association. However, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination. Tier 2 associations, which are associations that before and after the proposed distribution meet their current minimum capital requirements, may make capital distributions of up to 75% of net income over the most recent four-quarter period. Tier 3 associations (which are associations that do not meet current minimum capital requirements) that propose to make any capital distribution and Tier 2 associations that propose to make a capital distribution in excess of the noted safe harbor level must obtain OTS approval written prior to making such distribution. Tier 2 associations proposing to make a capital distribution within the safe harbor provisions and Tier 1 associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. The Bank is classified as a Tier I association. As a subsidiary of the Company, the Bank will also be required to give the OTS 30 days' notice prior to declaring any dividend on its stock. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. The OTS has proposed regulations that would simplify the existing procedures governing capital distributions by savings associations. Under the proposed regulations, the approval of the OTS would be required only for capital distributions by an association that is deemed to be in troubled condition or that is undercapitalized or would be undercapitalized after the capital distribution. A savings association would be able to make a capital distribution without notice to or approval of the OTS if it is not held by a savings association holding company, is not deemed to be 38 in troubled condition, has received either of the two highest composite supervisory ratings and would continue to be adequately capitalized after such distribution. Notice would have to be given to the OTS by any association that is held by a savings association holding company or that had received a composite supervisory rating below the highest two composite supervisory ratings. An association's capital rating would be determined under the prompt corrective action regulations. LIQUIDITY. All savings associations, including Home Federal, are required to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, specified United State Government, state or federal agency obligations, shares of certain mutual funds and certain corporate debt securities and commercial paper) in each calendar quarter 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. Furthermore, every savings association must maintain sufficient liquidity to ensure its safe and sound operation. For a discussion of what the Bank includes in liquid assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the minimum liquid asset ratio is 4%. Monetary penalties may be imposed upon associations for violations of the liquid asset ratio requirement. At June 30, 1998, the Bank was in compliance with the liquidity requirements, with the overall liquid asset ratio at 6.04%. ACCOUNTING FOR INVESTMENTS. An OTS policy statement applicable to all savings associations clarifies and re-emphasizes that the investment activities of a savings association must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with Generally Accepted Accounting Principles "GAAP". Under the policy statement, management must support its classification of and accounting for loans and securities (i.e., whether held for investment, sale or trading) with appropriate documentation. The Bank is in compliance with these rules. The OTS has adopted an amendment to its accounting regulations, which may be made more stringent than GAAP by the OTS, to require that transactions be reported in a manner that best reflects their underlying economic substance and inherent risk and that financial reports must incorporate any other accounting regulations or orders prescribed by the OTS. BRANCHING. Subject to certain limitations, the HOLA and the OTS regulations permit federally chartered savings associations to establish branches in any state of the United States. The authority to establish such branches is available (a) in states that expressly authorize branches of savings associations located in another state or (b) to an association that qualifies as a "domestic building and loan association" under the Internal Revenue Code of 1986, which imposes qualification requirements similar to those for a "qualified thrift lender" under the HOLA. See "QTL Test." The authority for a federal savings association to establish an interstate branch network would facilitate a geographic diversification of the association's activities. This authority under the HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings associations. COMMUNITY REINVESTMENT. Under the Community Reinvestment Act (the "CRA"), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings association, to assess the association's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Association received a "Satisfactory" CRA rating in its most recent examination. The CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the rating system focuses on three tests: (a) a lending test, to evaluate the institution's record of making loans in its assessment areas; (b) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (c) a 39 service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices. The amended CRA regulations also clarify how an institution's CRA performance would be considered in the application process. QUALIFIED THRIFT LENDER TEST. All savings associations, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (which consists of total assets less the sum of goodwill and other intangible assets, properties used to conduct the savings association's business and specified liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. At June 30, 1998, the Bank maintained 85.71% of its portfolio assets in qualified thrift investments, and thus met the test. The Bank has always met the QTL test since its effectiveness. Loans and mortgage-backed securities secured by domestic residential housing, FHLB stock, credit card loans, educational loans and certain small business loans as well as certain obligations of the FSLIC, the FDIC and certain other related entities may be included in qualifying thrift investments without limit. FHLMC and FNMA stock and certain other housing-related and non-residential real estate loans and investments, including loans to develop churches, nursing homes, hospitals and schools, and consumer loans and investments in subsidiaries engaged in housing-related activities may also be included, in varying amounts, not to exceed 20% of portfolio assets. Any savings association that fails to meet the QTL test must either convert to a national bank charter or operate under certain restrictions on its activities, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the Bank Insurance Fund. If an association that fails the test has not yet requalified and has not converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities and dispose of any investments not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. A savings association that has failed the QTL test may requalify under the QTL test and be free of such limitations, but it may do so only once. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "Holding Company Regulation." TRANSACTIONS WITH AFFILIATES. The Bank's authority to engage in transactions with its "affiliates" is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act (the "FRA"). In general, an affiliate of the Association is any company that controls the Association or any other company that is controlled by a company that controls the Association, excluding the Association's subsidiaries other than those that are insured depository institutions. The OTS regulations prohibit a savings association (a) from lending to any of its affiliates that is engaged in activities that are not permissable for bank holding companies under Section 4(c) of the BHC Act and (b) from purchasing the securities of any affiliate other than a subsidiary. Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings association and also limits the aggregate amount of transactions with all affiliates to 20% of the savings association's capital and surplus. Extensions of credit to affiliates are required to be secured by collateral in an amount and of a type described in Section 23A, and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the association as those prevailing at the time for comparable transactions with non-affiliated companies. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards, that in good faith would be offered to or would apply to non-affiliated companies. The Association's authority to extend credit to its directors, executive officers, and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not 40 less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of the association's capital. In addition, extensions of credit in excess of certain limits must be approved by the association's board of directors. Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as those for loans to unaffiliated individuals. REAL ESTATE LENDING STANDARDS. The OTS and the other federal banking agencies adopted regulations to prescribe standards for extensions of credit that (a) are secured by real estate or (b) are made for the purpose of financing the construction of improvements on real estate. The OTS regulations require each savings association to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying OTS guidelines, which include loan-to-value ratios for the different types of real estate loans. Associations are also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending situations in which exceptions to the loan-to-value standards are justified. HOLDING COMPANY REGULATION. The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is registered with and files reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings association subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. If the Company acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of the Company and any of its subsidiaries (other than the Bank or any other SAIF-insured savings association) would become subject to such restrictions unless such other associations each qualify as a QTL and were acquired in a supervisory acquisition. If the Bank fails the QTL test, the Company must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within one year of such failure the Company must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See "Qualified Thrift Lender Test." FEDERAL SECURITIES LAW. The stock of the Company is registered with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. Company stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period. FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). The FRB regulations generally require that reserves be maintained in the amount of 3% of the aggregate of transaction accounts up to $47.8 million. The amount of aggregate transaction accounts in excess of $47.8 million are currently subject to a reserve ratio of 10%, which ratio the FRB may adjust between 8% and 12%. The FRB regulations currently exempt $4.7 million of otherwise reservable balances from the reserve requirements, which exemption is adjusted by the FRB at the end of each year. At June 30, 1998, the Bank was in compliance with these 41 reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "Liquidity." Savings associations are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank. FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs, that administers the home financing credit function of savings associations. 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. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. As a member, Home Federal is required to purchase and maintain stock in the FHLB of Des Moines. At June 30, 1998, Home Federal had $3.7 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB stock. Over the past five fiscal years such dividends have averaged 7.34% and were 6.83% for fiscal year 1998. Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to low and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in Home Federal's capital. For the fiscal year ended June 30, 1998, dividends paid by the FHLB of Des Moines to Home Federal totalled approximately $337,000, which constitute a $31,000 decrease in the amount of dividends received in fiscal 1997. The $69,000 dividend received for the quarter ended June 30, 1998 reflects an annualized rate of 6.79% or 2.7% increase from the rate for the same period in fiscal 1997. FEDERAL AND STATE TAXATION The Company and subsidiaries file a consolidated federal income tax return on a fiscal year basis. In fiscal years prior to the 1997 fiscal year, the Bank was allowed a special bad debt deduction based on 8 percent of taxable income, or on specified experience formulas. The Bank used the percentage of taxable income method in 1996. Effective for fiscal year 1997, federal income tax laws changed to eliminate the percentage of taxable income and experience formulas for the Bank and only allow bad debt deductions based on actual charge-offs. The Bank is required to recapture into income the excess of its June 30, 1996 loan loss reserves for "qualifying" and "nonqualifying" loans over its June 30, 1988 loan loss reserves for "qualifying" and "nonqualifying" loans. This excess, which was $720,000 at June 30, 1998, is required to be recaptured ratably over a six year period. The onset of recapture was delayed in fiscal years 1998 and 1997 since the Bank met a residential loan origination requirement which allowed for a two year delay in recapture. At June 30, 1998, the Bank's recorded deferred tax liability of $245,000 provides for the recapture of the loan loss reserves and is netted against the deferred tax asset. In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. To the extent earnings appropriated to a savings association's bad debt reserves for "qualifying real property loans" and 42 deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). As of June 30, 1998, the Bank's Excess for tax purposes totalled approximately $4.8 million. The Bank and its consolidated subsidiaries have been audited by the IRS with respect to consolidated federal income tax returns through 1985. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, the Bank) would not result in a deficiency which could have a material adverse effect on the financial condition of the Bank and its consolidated subsidiaries. SOUTH DAKOTA TAXATION. The Bank is subject to the South Dakota franchise tax to the extent that such corporations are engaged in business in the state of South Dakota. South Dakota does not have a corporate income tax. The franchise tax will be imposed at a rate of 6% on franchise taxable income which is computed in the same manner as federal taxable income with some minor variations to comply with South Dakota law, other than the carryover of net operating losses which is not permitted under South Dakota law. A South Dakota return of franchise tax must be filed annually. NEBRASKA TAXATION. The Mortgage Corp. is subject to the Nebraska Corporate Income tax to the extent that such corporations are engaged in business in the state of Nebraska. The Corporate Income tax is imposed at rates of 5.58% to 7.81% on corporate taxable income which is computed in the same manner as federal taxable income with some minor variations to comply with Nebraska law. A Nebraska return of Corporate Income tax must be filed annually. DELAWARE TAXATION. As a Delaware holding company, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. The Company is also subject to an annual franchise tax imposed by the State of Delaware. EXECUTIVE OFFICERS OF THE COMPANY The following information as to the business experience during the past five years is supplied with respect to executive officers of the Company and the Bank. CURTIS L. HAGE - Mr. Hage, age 52, is Chairman, President and Chief Executive Officer of the Bank. He was elected Chairman of the Board of Directors of the Bank in September 1996 and has held the position of President and Chief Executive Officer of the Bank since February 1991. Prior to such time, Mr. Hage served as Executive Vice President of the Bank since 1986. Since joining the Association in 1968, he served in various capacities prior to being elected Executive Vice President. Mr. Hage received his M.B.A. from the University of South Dakota and attended the Graduate School of Savings Institution Management at the University of Texas. GENE F. UHER - Mr. Uher, age 50, is Executive Vice President/Chief Operations Officer, a position he has held since March 1997. He was employed as Executive Vice President for Packers Bank, Omaha, Nebraska from 1996 until joining Home Federal. Prior to that time, he was employed as Executive Vice President/Chief Operating Officer for Conservative Savings Bank, F.S.B., Omaha, Nebraska from 1989 to 1996. Mr. Uher received his B.A. degree from Lincoln School of Commerce, Lincoln, Nebraska. He is a graduate of the School of Executive Development at University of Connecticut. DONALD F. BERTSCH - Mr. Bertsch, age 59, is Senior Vice President/Chief Financial Officer, a position he has held since January 1991. Prior to joining Home Federal, Mr. Bertsch was employed for 27 years by First Bank System, a bank holding company located in Minneapolis, Minnesota, in a variety of management positions including Vice President/Administrative Services from 1984 to 1990. He also served as Senior Vice President and Cashier of the National Bank of South Dakota from 1972 to 1979. Mr. Bertsch has over 35 years experience in the banking industry and is a graduate of the University of Wisconsin Graduate School of Banking and holds a Bachelor of Science from Northern State University. 43 TERRY L. KAPPES - Mr. Kappes, age 44, is Senior Vice President/Retail Banking, a position he has held since June 1998. Prior to that time, he was employed with Bank One - Colorado, Grand Junction, Colorado from 1993 until joining Home Federal with his most recent position being Senior Vice President/Retail Market Manager. Mr. Kappes served as Senior Vice President for First Bank System, Billings, Montana from 1988 to 1991 and First Bank of South Dakota, Sioux Falls, South Dakota from 1977 to 1988. MARY F. HITZEMANN - Ms. Hitzemann, age 45, is Senior Vice President/Human Resources, a position she has held since October 1993. Ms. Hitzemann joined Home Federal in January 1993. Prior to that time, she was employed as Vice President of Human Resources for Rapid City Regional Hospital from May 1989 to May 1992. Ms. Hitzemann received her B.A. degree from Augustana College. JOHN B. "JACK" NEUROTH - Mr. Neuroth, age 63, is Senior Vice President/Senior Commercial Lending Officer, a position he has held since September 1996. Mr. Neuroth joined Home Federal in 1966. He is responsible for commercial real estate lending. Mr. Neuroth received his B.S. from the University of South Dakota. GEORGE D. ROBERTS - Mr. Roberts, age 51, is Senior Vice President/Hometown Insurors, Inc., a subsidiary of Home Federal Savings Bank. Mr. Roberts has held this position since October 1996. He was employed as Agency Manager for Principal Financial Group from 1987 until joining Hometown Insurors, Inc. Prior to that time, he was employed as a Brokerage Consultant for Bankers Life of Des Moines from 1983 to 1987. Mr. Roberts received his B.S. from the University of Nebraska, Omaha, Nebraska. He also holds the designation of LUTCF. JOHN E. ROERS - Mr. Roers, age 51, is Senior Vice President/Agricultural Lending, a position he has held since joining Home Federal on October 31, 1995. Prior to that time, he was employed as Agricultural Loan Officer and Department Manager for Western Bank, Sioux Falls (then First Bank) from June 1981 to October 1996 and for Western Bank, Marshall, Minnesota from February 1974 to May 1981. Mr. Roers received his Bachelor of Science and Masters of Science from North Dakota State University. MARK S. SIVERTSON - Mr. Sivertson, age 40, is Senior Vice President/Trust Officer, a position he has held since July 1996. He joined Home Federal in February 1995 as Vice President/Trust Officer. Prior to joining Home Federal, Mr. Sivertson was Vice President and Trust Officer in charge of the Investment Management and Trust Department at Western Bank. He holds a law degree from the University of North Dakota and the Certified Trust Financial Advisor designation from the American Bankers Association. MICHAEL H. ZIMMERMAN - Mr. Zimmerman, age 45, is Senior Vice President/Senior Retail Lending Officer, a position he has held since joining Home Federal in August 1996. Prior to that time, he was employed as Vice President/Mortgage Loan Manager for First Trust and Savings Bank, Cedar Rapids, Iowa from October 1995 to August 1996 and as Vice President/Eastern Regional Manager for Homeland Savings Bank FSB, Waterloo, Iowa from May 1995 to October 1995; and as Vice President/ Manager Real Estate Lending for Homeland Bank, N.A., Waterloo, Iowa from August 1992 to April 1995. Mr. Zimmerman received his B.A. from Dana College, Blair, Nebraska. RICHARD H.C. BEVERLEY - Mr. Beverley, age 55, is Vice President/Sales, a position he has held since joining the Bank in June 1996. Prior to that time, he was employed by Hauge Associates, Inc. as Director of Sales from September 1993 to May 1996 and Sears Roebuck and Co. from May 1966 to June 1993. Mr. Beverley attended Bradley University, Peoria, Illinois. MICHAEL R. BREIDENBACH - Mr. Breidenbach, age 50, is Vice President/Commercial Lending, a position he has held since June 1998. Mr. Breidenbach has held various positions since joining Home Federal in February 1992. Prior to that time, he was employed by the Resolution Trust Corporation from 1990 to February 1992 and by Metropolitan Federal Bank as Regional Sales Manager from 1979 to 1990. He is a graduate of the School for Executive Development at Arizona State University and holds a Bachelor of Science from Northern State University. CARTER V. BROTON - Mr. Broton, age 44, is Vice President/General Auditor, a position he has held since joining the Bank in February 1993. Prior to that time he was employed by Norwest Corporation as Professional Practices Manager of the Audit Department from 1990 to 1993, and by Citibank from 1983 to 1990. Mr. Broton received his 44 MBA degree from the University of South Dakota. MICHAEL J. ECHOLS - Mr. Echols, age 54, is Vice President/Loan Service, a position he has held since joining the Bank in June 1996. Prior to that time he was employed by South Dakota Housing Development Authority as Executive Director from 1974 to 1996. TED ELLINGER - Mr. Ellinger, age 50, is Vice President/Bank Coordinator. He joined Home Federal in July 1974 and was promoted to his present position in October 1993. Mr. Ellinger is responsible for the Brookings, Dell Rapids, Canton, Freeman, Lennox and Parker branches. RANDALL D. FINK - Mr. Fink, age 44, is Vice President/Mortgage Loan Production Manager, a position he has held since October 1995. In January 1983, Mr. Fink joined Home Federal and in 1989 was promoted to Vice President/Single Family Lending. IRA D. FRERICKS - Mr. Frericks, age 38, is Vice President/Controller of the Bank. He joined Home Federal in 1988 as an Internal Auditor and was promoted to Assistant Vice President/Internal Auditor in January 1990, Assistant Vice President/Controller in March 1991 and Vice President in January 1992. Prior to joining Home Federal, Mr. Frericks was employed by McGladrey & Pullen, a public accounting firm, from 1984 to 1988. He is a certified public accountant. Mr. Frericks received his B.S. Degree from the University of South Dakota and is a graduate of the University of Wisconsin Graduate School of Banking. HUGH R. FULLERTON, JR. - Mr. Fullerton, age 49, is Vice President/Credit Card Services, a position he has held since joining the Bank in November 1996. Prior to that time, he was employed by First Premier as Vice President-Merchant Services from 1992 to 1996 and by Citibank as Senior Account Manager from 1986 to 1992. He was employed by US West as Director of Credit Services from 1971 to 1986. Mr. Fullerton received his BS and MBA degrees from the University of South Dakota. GAIL G. GROTENHUIS - Ms. Grotenhuis, age 45, is Vice President/General Manager of Mid-America Service Corporation, a subsidiary of Home Federal Savings Bank. Ms. Grotenhuis joined Mid-America in 1993 and was appointed Vice President in 1997. DIANE HOVDA - Ms. Hovda, age 53, is Vice President/Financial Management, a position she has held since June of 1997. She joined Home Federal in May 1995 as Vice President/Bank Coordinator. Prior to that time, she was employed by Western Bank, Sioux Falls from 1974 to 1995, and for First National Bank and National Bank of South Dakota from 1966 to 1974. SHARON A. MANUEL - Ms. Manuel, age 48, is Vice President/Electronic Banking. She joined Home Federal in April 1994. Ms. Manuel is responsible for managing technology-oriented projects such as automated telephone banking, debit card, bill payment services and home banking. Prior to joining Home Federal, she was employed by Citibank for 13 years. GARY L. SMITH - Mr. Smith, age 44, is Vice President/Information Systems. He joined Home Federal in 1979 and was promoted to his present position in 1988. NATALIE A. SOLBERG - Ms. Solberg, age 35, is Vice President/ Retail Support, a position she has held since 1997. She joined Home Federal in February 1994 and was promoted to Vice President/In-Touch Banking in October 1995. Prior to joining Home Federal, she was the Customer Service Manager and various other positions for Bank of New York from October 1989 to October 1993. She received her BS from Northern State University. GARY G. SIEVERDING - Mr. Sieverding, age 34, is Vice President/Commercial Business Lending. He joined Home Federal in 1996 and was promoted to his present position in 1997. Prior to joining Home Federal, he was with First Savings Bank - Sioux Falls, First Bank of South Dakota, N.A. and Western Bank in various management capacities. Mr. Sieverding received his education from South Dakota State University, Brookings, SD and his ABA from the National Commercial Lending School, Norman, OK. 45 MARK SWENSON - Mr. Swenson, age 34, is Vice President/Bank Manager, a position he has held since joining Home Federal in May 1995. Prior to that time, he was employed as Managing Officer, Senior Personal Banking Officer, Marketing Specialist for Western Bank Northeast, Sioux Falls from 1986 to May 1996. Mr. Swenson received his BS from South Dakota State University and his MBA from the University of South Dakota. KENT WIGG - Mr. Wigg, age 51, is Vice President/Financial Management, a position he has held since joining Home Federal in September 1995. Prior to that time, he was employed by Western Bank, Sioux Falls (then First Bank) from August 1985 to September 1995. And for First National Bank, Sioux City, Iowa from May 1974 to August 1985. He received his BS from Iowa State University and his MBA from University of South Dakota. Additionally, he is a Graduate of Colorado School of Banking, a Certified Trust Specialist (CTS), a Certified Investment Specialist (CIS) and a Certified Financial Planner (CFS). ITEM 2. PROPERTIES The Company and the Bank conduct their business at their main office located at 225 S. Main at llth, Sioux Falls, South Dakota 57104. The Bank also conducts business from 18 other retail banking locations located in its primary market area. The Bank owns each of its offices, except for one office that it leases. The total net book value of the Company's premises and equipment (including land, building and leasehold improvements and furniture, fixtures and equipment) at June 30, 1998 was $14.3 million. See Note 6 of Notes to Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS The Company, Home Federal and its subsidiaries are involved as plaintiff or defendant in various legal actions arising in the normal course of their businesses. While the ultimate outcome of these proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing Home Federal and the Company in the proceedings, that the resolution of these proceedings should not have a material effect on the Company's consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended June 30, 1998. 46 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS STOCK LISTING The Company's Common stock is traded under the symbol "HFFC" on the NASDAQ National Market System. The following table sets forth the range of high and low sale prices for the Company's Common Stock for each of the fiscal quarters of the two years ended June 30, 1998 and 1997. Quotations for such periods are as reported by NASDAQ for National Market System issues. On April 24, 1998, the Company declared a three-for-two stock split in the form of a stock dividend on one-half share of common stock for each one share outstanding, payable to shareholders of record on May 8, 1998. The quotations for the periods listed below have been retroactively adjusted based upon the new shares outstanding after the effect of the three-for-two stock split for all periods presented.
FISCAL 1998 HIGH LOW -------------------------------------------- 1st Quarter $18.00 $14.17 2nd Quarter $18.17 $16.50 3rd Quarter $20.00 $18.00 4th Quarter $24.16 $19.75 FISCAL 1997 HIGH LOW -------------------------------------------- 1st Quarter $10.67 $10.00 2nd Quarter $11.67 $9.83 3rd Quarter $13.67 $11.17 4th Quarter $14.33 $12.50
As of September 15, 1998, the Company had 622 holders of record of its Common Stock. The transfer agent for the Company's Common Stock is Chemical Bank, Bank Window Church Street Station, New York, NY, 10015-4000. DIVIDENDS HF Financial Corp. paid quarterly cash dividends of $0.07 per share throughout fiscal year 1998. In addition, HF Financial Corp. paid quarterly cash dividends of $0.06 throughout fiscal year 1997. The Board of Directors intends to continue the payment of quarterly cash dividends, dependent on the results of operations and financial condition of HF Financial Corp., tax considerations, industry standards, economic conditions, general business practices and other factors the board of directors deems relevant. HF Financial Corp.'s ability to pay dividends is dependent on the dividend payments it receives from its subsidiary, Home Federal Savings Bank (the "Bank"), which are subject to federal and state regulations. SALES OF UNREGISTERED STOCK The Company has had no sales of unregistered stock within the last three fiscal years. 47 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data with respect to the Company for the periods indicated. This information should be read in conjunction with the Financial Statements and related notes appearing elsewhere herein and "Management's Discussion and Analysis of Financial Condition and results of Operations and Financial Conditions." The Company's selected financial statement and operations data for each of the years set forth below have been derived from financial statements which have been audited by McGladrey & Pullen LLP, independent public accountants.
At June 30, ---------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------------------------------------------------------------------- (Dollars in Thousands) Selected Statement of Financial Condition Data: Total assets $570,979 $562,114 $554,659 $535,682 $491,325 Loans receivable, net 426,522 440,019 413,143 360,007 306,306 Loans held for sale 9,616 3,483 7,280 4,139 2,042 Mortgage-backed securities ---- ---- ---- 83,384 74,894 Mortgage-backed securities available for sale 39,647 30,340 59,495 ---- ---- Investment securities ---- ---- ---- 28,932 74,737 Securities available or held for sale 44,232 46,940 41,168 33,402 6,459 Deposits 446,424 418,186 398,166 400,675 392,415 Advances from FHLB of Des Moines and other borrowings 50,635 74,743 90,123 73,695 42,860 Stockholders' equity 56,601 52,974 51,263 48,354 46,022 Years Ended June 30, ---------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------------------------------------------------------------------- (Dollars in Thousands) Interest and dividend income $ 46,201 $ 44,012 $ 43,465 $ 38,126 $ 36,692 Interest expense 25,449 24,832 25,761 24,008 20,221 -------- -------- -------- -------- -------- Net interest income 20,752 19,180 17,704 14,118 16,471 Provision (recoveries) for losses on loans 4,689 693 590 (515) 275 -------- -------- -------- -------- -------- Net interest income after provision (recoveries) for losses on loans 16,063 18,487 17,114 14,633 16,196 Loan servicing income 1,187 1,150 689 754 564 Loan fees and service charges 1,184 946 791 586 879 Gain (loss) on mortgage-backed securities, and securities available or held for sale, net 226 150 500 164 (156) Credit card fee income 6,163 613 ---- ---- ---- Other noninterest income 4,871 3,613 3,668 2,626 2,879 Noninterest expense (19,983) (19,703) (15,147) (13,855) (14,072) -------- -------- -------- -------- -------- Income before income taxes and cumulative effect of accounting changes 9,711 5,256 7,615 4,908 6,290 Income tax expense 3,238 1,582 2,893 1,803 2,465 -------- -------- -------- -------- -------- Income before cumulative effect of accounting changes 6,473 3,674 4,722 3,105 3,825 Cumulative effect of accounting changes ---- ---- ---- 93 2,000 -------- -------- -------- -------- -------- Net income $ 6,473 $ 3,674 $ 4,722 $ 3,198 $ 5,825 Earnings per share: (4) -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Income before cumulative effect of accounting changes Basic $ 1.46 $ 0.81 $ 1.03 $ 0.66 $ 0.82 Diluted $ 1.42 $ 0.79 $ 1.00 $ 0.66 $ 0.82 Net Income Basic $ 1.46 $0.81 $1.03 $0.68 $1.25 48 Diluted $1.42 $0.79 $1.00 $0.68 $1.25 Dividends per share (5) $0.28 $0.24 $0.22 $0.20 $0.17 Dividends payout ratio 19.28% 29.48% 21.41% 29.41% 13.40% Years Ended June 30, ---------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------------------------------------------------------------------- Other Data: Interest rate spread information: Average during period 3.40% 3.24% 2.88% 2.40% 3.21% End of period 3.41 3.36 3.01 2.36 3.15 Net interest margin (1) 3.80 3.64 3.31 2.80 3.55 Average interest-earning assets to average interest-bearing liabilities 1.09 1.08 1.09 1.08 1.08 Equity to total assets (end of period) 9.91 9.42 9.24 9.03 9.37 Equity-to-assets ratio (ratio of average equity to average total assets) 9.59 9.25 8.97 8.94 9.10 Nonperforming assets to total assets (end of period) (2) 0.53 0.33 0.41 0.57 0.89 Allowance for loan losses to nonperforming loans (end of period) (3) 258.86 361.50 200.15 141.08 163.74 Allowance for loan losses to total loans (end of period) 1.62 1.02 0.98 1.11 1.59 Nonperforming loans to total loans (end of period)(3) 0.63 0.28 0.49 0.79 0.97 Other noninterest expense to average total assets 3.47 3.55 2.71 2.64 2.89 Net interest income after provision (recoveries) for losses on loans to noninterest expense (end of period) 80.38 93.83 112.99 105.62 115.09 Return on assets (ratio of net income to average total assets) 1.13 0.66 0.85 0.61 1.20 Return on equity (ratio of net income to average equity) 11.73% 7.17% 9.43% 6.81% 13.14% Number of full-service offices 19 19 19 18 16
1) Net interest income divided by average interest-earning assets. 2) Nonperforming assets include nonaccruing loans, accruing loans delinquent more than 90 days and foreclosed assets. 3) Nonperforming loans include nonaccruing loans and accruing loans delinquent more than 90 days. 4) Earnings per share are retroactively adjusted for the two-for-one stock split in the form of a stock dividend payable to shareholders of record on January 10, 1996 and for the three-for-two stock split in the form of a stock dividend payable to shareholders of record on May 8, 1998. 5) Dividends per share are retroactively adjusted for the two-for-one stock split in the form of a stock dividend payable to shareholders of record on January 10, 1996 and for the three-for-two stock split in the form of a stock dividend payable to shareholders of record on May 8, 1998. 49 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL HF Financial Corp. ("Company") was incorporated under the laws of the State of Delaware in November 1991 for the purpose of owning all of the outstanding stock of Home Federal Savings Bank ("Bank") issued in the mutual to stock conversion of the Bank. The Company acquired all of the stock of the Bank on April 8, 1992. In October 1994, the Company acquired and began operating a new mortgage subsidiary as HomeFirst Mortgage Corp. ("Mortgage Corp."). The Company ceased operation of the Mortgage Corp. during fiscal 1998. In May 1996, the Company formed a Limited Liability Company named HF Card Services L.L.C. ("HF Card Services") and became the owner of 51% of this entity. The activities of the Company itself have no significant impact on the results of operations on a consolidated basis. Unless otherwise indicated, all activities discussed herein relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank, HF Card Services and the Mortgage Corp. The Bank has been, and intends to continue to be, a financial institution that offers a variety of financial services to meet the needs of families in the communities it serves. The Bank has focused on serving families located in its market area, generally defined as eastern South Dakota and including the cities and the communities surrounding the cities of Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Canton, Parker, Lennox, Aberdeen, Mobridge, Brookings, Hartford and Redfield, South Dakota. 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, consumer, multi-family, commercial real estate, agricultural, construction and commercial business loans. The Bank's consumer loan portfolio includes, among other things, mobile home loans, automobile loans, home equity loans, credit card 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 rely on any brokered deposits and does not hold any non-investment grade bonds (i.e. "junk bonds"). The Bank also receives loan servicing income on loans serviced for others. The Bank, through its wholly-owned subsidiaries, offers annuities, credit-life, health, life, hazard and other insurance products and appraisal services. HomeFirst Mortgage Corp. is a South Dakota Corporation that had an office in Omaha, Nebraska. The Mortgage Corp. was a mortgage banking operation that originated one- to four- family residential loans which were sold into the secondary market and to the Bank. The Company ceased operation of HomeFirst Mortgage Corp. during the first quarter of fiscal 1998. The Mortgage Corp had a net loss of $11,000 during fiscal year 1998. The primary exit costs involved were compensation costs of $28,000 and occupancy costs of $21,000. HF Card Services was established to provide secured, partially-secured and unsecured credit cards nationwide. The target market for HF Card Services is sub-prime credit customers who have either an insufficient credit history or a negative credit history and are unable to obtain a credit card from more traditional card issuers. The Company's net income is primarily dependent upon the difference (or "spread") between the average yield earned on loans, mortgage-backed securities and investments and the average rate paid on deposits and borrowings, as well as the relative amounts of such assets and liabilities. The interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. The Company, like other financial institutions, is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different times, or on a different basis, than its interest-earning assets. To better insulate itself from such risk, the Company has over the last few years, attempted to increase both numerically and on a percentage basis its holding of consumer and commercial loans. The Company has also decreased its ratio of fixed-rate to adjustable-rate loans. The Company's net income is also affected by, among other things, gains and losses on sales of foreclosed property, loans, securities, provision for losses on loans, service charge fees, credit card fees, subsidiary activities, operating expenses and income taxes. This discussion and analysis contains certain forward-looking terminology such as "believes," "anticipates," "will," and "intends," or comparable terminology. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Potential purchasers of the Company's securities are cautioned not to place undue reliance on such forward-looking statements which are qualified in their entirety by the cautions and risks described herein and in other reports filed by the Company with the Securities and Exchange Commission. 50 FINANCIAL CONDITION DATA At June 30, 1998, the Company had total assets of $571.0 million, an increase of $8.9 million from the level at June 30, 1997. The increase in assets was due primarily to an increase in cash and cash equivalents of $7.5 million and in mortgage-backed securities of $9.3 million. The increase in cash and cash equivalents and mortgage-backed securities was funded primarily by a decrease in loans receivable of $13.5 million, a decrease in securities available for sale of $2.7 million and an increase in deposits of $28.2 million from the levels at June 30, 1997. The remaining excess funds received from the loans receivable, securities available for sale and deposits were used to paydown advances from Federal Home Loan Bank ("FHLB") and other borrowings by $24.1 million from levels at June 30, 1997. In addition, stockholders' equity increased from $52.9 million at June 30, 1997 to $56.6 million at June 30, 1998, primarily due to net income of $6.5 million and the change in the net unrealized loss on securities available for sale of $213,000, which was offset by the payment of cash dividends of $1.2 million to the Company's stockholders and an increase in treasury stock of $2.1 million. The decrease in loans receivable of $13.5 million was due primarily to amortizations and prepayments of principal exceeding originations of principal. The increase in mortgage-backed securities of $9.3 million was primarily the result of purchases of $16.6 million exceeding sales, amortizations and prepayments of principal. The Bank's purchases of mortgage-backed securities were comprised primarily of thirty year, fixed-rate, mortgage-backed securities that have a principal payment balloon in the fifth or seventh year. The decrease in securities of $2.7 million from the level at June 30, 1997 is primarily due to sales and maturities of securities available for sale of $55.9 million exceeding purchases of $52.9 million during the year ended June 30, 1998. The Bank's purchases of securities available for sale were comprised primarily of U.S. Government agency securities which have a maturity of three years or less that have a call feature that varies from three months to one year. The increase in deferred tax assets of $1.6 million is due primarily to the increase in the allowance for credit card loan losses from $329,000 at June 30, 1997 to $3.2 million at June 30, 1998, an increase of $2.9 million which when tax effected resulted in an increase in deferred tax assets of $1.1 million. See "Notes to Consolidated Financial Statements Note 9" for further discussion on income taxes. The $28.2 million increase in deposits was primarily due to an increase in savings accounts of $32.3 million, an increase in now accounts and demand accounts of $12.5 million and an increase in money market accounts of $9.4 million which were offset by a decrease in certificates of deposit of $26.0 million. The number of demand, now and money market accounts increased from 18,925 at June 30, 1997 to 20,620 at June 30, 1998 for an 8.96% increase. These increases were primarily the result of a focused marketing campaign during the fiscal year. In addition, the average balance of accounts in this category increased from $4,228 at June 30, 1997 to $4,943 at June 30, 1998, for a 16.91% increase. The number of savings accounts decreased slightly from 19,008 at June 30, 1997 to 18,775 however the average balance of savings accounts increased from $1,524 at June 30, 1997 to $3,263 at June 30, 1998 for a 114.11% increase. The majority of the increase in savings accounts were from deposits from local governmental entities. Advances from the FHLB and other borrowings decreased $24.1 million for the year ended June 30, 1998 primarily due to the payment of $53.1 million on advances and other borrowings which were partially offset by the Company obtaining $29.0 million of advances and borrowings during the fiscal year. 51 ANALYSIS OF NET INTEREST INCOME Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. AVERAGE BALANCES, INTEREST RATES AND YIELDS. The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The table does not reflect any effect of income taxes. All average balances are monthly average balances and include the balances of nonaccruing loans. The yields and costs for the years ended June 30, 1998, 1997 and 1996 include fees which are considered adjustments to yield.
YEARS ENDED JUNE 30, --------------------------------------------------------------------------------------------- 1998 1997 1996 --------------------------------------------------------------------------------------------- Average Interest Average Interest Average Interest Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate Balance Paid Rate Balance Paid Rate ----------- -------- ------ ----------- ------- ------ ----------- -------- ------ (Dollars in thousands) Interest-earning assets: Loans receivable (1) $445,511 $40,154 9.01% $437,230 $38,596 8.83% $404,622 $35,628 8.81% Mortgage-backed securities 32,213 2,023 6.28% 41,119 2,668 6.49% 74,853 4,918 6.57% Other investment securities (2) 62,931 3,687 5.86% 42,953 2,380 5.54% 49,859 2,555 5.12% FHLB stock 4,940 337 6.82% 5,222 368 7.05% 5,051 364 7.21% -------- ------- ---- -------- ------- ---- -------- ------- ---- Total interest-earning assets $545,595 $46,201 8.47% $526,524 $44,012 8.36% $534,385 $43,465 8.13% ------- ---- ------- ---- ------- ---- Noninterest-earning assets 29,712 27,762 24,054 -------- -------- -------- Total assets $575,307 $554,286 $558,439 -------- -------- -------- -------- -------- -------- Interest-bearing liabilities: Deposits: Checking and money market $89,429 $ 2,273 2.54% $ 71,323 $ 1,794 2.52% $ 61,466 $ 1,646 2.68% Savings 53,260 1,904 3.57% 30,227 626 2.07% 33,140 699 2.11% Certificates of deposit 294,797 17,554 5.95% 306,085 17,969 5.87% 307,586 18,370 5.97% -------- ------- ---- -------- ------- ---- -------- ------- ---- Total deposits $437,486 $21,731 4.97% $407,635 $20,389 5.00% $402,192 $20,715 5.15% FHLB advances and other borrowings 64,350 3,718 5.78% 77,644 4,443 5.72% 88,129 5,046 5.73% -------- ------- ---- -------- ------- ---- -------- ------- ---- Total interest-bearing liabilities $501,836 $25,449 5.07% $485,279 $24,832 5.12% $490,321 $25,761 5.25% ------- ---- ------- ---- ------- ---- Other liabilities 18,278 17,740 18,021 -------- -------- -------- Total liabilities $520,114 $503,019 $508,342 Equity 55,193 51,267 50,097 -------- -------- -------- Total liabilities and equity $575,307 $554,286 $558,439 -------- -------- -------- -------- -------- -------- Net interest income; interest rate spread $20,752 3.40% $19,180 3.24% $17,704 2.88% ------- ---- ------- ---- ------- ---- Net interest margin (3) 3.80% 3.64% 3.31% ---- ---- ---- ---- ---- ---- - -----------------------------------------------------------------------------------------------------------------------------------
(1) Includes interest on accruing loans past due 90 days or more. (2) Includes primarily U.S. Government securities. (3) Net interest margin is net interest income divided by average interest-earning assets. 52 RATE/VOLUME ANALYSIS OF NET INTEREST INCOME The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increases and decreases due to fluctuating outstanding balances that are due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Years Ended June 30, Years Ended June 30, ------------------------------------------ --------------------------------------- 1998 vs 1997 1997 vs 1996 ------------------------------------------ --------------------------------------- (Dollars in Thousands) Increase Increase Increase Increase (Decrease) (Decrease) Total (Decrease) (Decrease) Total Due to Due to Increase Due to Due to Increase Volume Rate (Decrease) Volume Rate (Decrease) ---------- ---------- ---------- ---------- ---------- --------- Interest-earning assets: Loans receivable (1) $ 746 $812 $1,558 $2,878 $ 90 $2,968 Mortgage-backed securities (559) (86) (645) (2,189) (61) (2,250) Other investment securities (2) 1,170 137 1,307 (383) 208 (175) FHLB stock (19) (12) (31) 12 (8) 4 ------ ---- ------ ------ ------ ------ Total interest-earning assets $1,338 $851 $2,189 $ 318 $ 229 $ 547 ------ ---- ------ ------ ------ ------ ------ ---- ------ ------ ------ ------ Interest-bearing liabilities: Deposits: Checking and money market $ 460 $ 19 $ 479 $ 159 $ (11) $ 148 Savings 823 455 1,278 (60) (13) (73) Certificates of deposit (672) 257 (415) (88) (313) (401) ------ ---- ------ ------ ------ ------ Total deposits 611 731 1,342 11 (337) 326 FHLB advances and other borrowings (768) 43 (725) (600) (3) (603) ------ ---- ------ ------ ------ ------ Total Interest-bearing liabilities $ (157) $774 $ 617 $ (589) $ (340) $ (929) ------ ---- ------ ------ ------ ------ ------ ---- ------ ------ ------ ------ Net interest income increase $1,572 $1,476 ------ ------ ------ ------ - --------------------------------------------------------------------------------------------------------------------------------
(1) Includes interest on loans past due 90 days or more. (2) Includes primarily U.S. Government securities. 53 The following table presents the yields received on loans, investments, and other interest-earning assets, the rates paid on savings deposits and borrowings and the resultant rate spreads at the dates indicated.
At June 30, ----------------------------- 1998 1997 1996 ----------------------------- Weighted average yield on: Loans receivable 9.07% 8.85% 8.53% Mortgage-backed securities 6.10 6.32 6.32 Other investment securities (1) 6.21 5.82 5.40 FHLB stock 6.79 6.75 7.00 Combined weighted average yield on Interest-earning assets 8.47 8.45 8.04 Weighted average rate paid on: Deposits 4.95 4.99 4.92 FHLB advances 5.85 5.69 5.53 Combined weighted average rate paid on interest-bearing liabilities 5.06 5.09 5.03 Spread 3.41% 3.36% 3.01%
(1) Includes primarily U.S. Government and agency securities. ASSET QUALITY In accordance with the Bank's internal classification of assets policy, management evaluates the loan portfolio on a monthly basis to identify loss potential and determine the adequacy of the allowance for loan losses. The following table sets forth the amounts and categories of the Bank's nonperforming assets for the periods indicated.
At June 30, ------------------------ 1998 1997 1996 ------------------------ (Dollars in Thousands) Total nonaccruing loans $2,251 $1,252 $2,063 Total accruing loans delinquent more than 90 days 530 ---- ---- Total foreclosed assets 229 593 228 ------ ------ ------ Total nonperforming assets $3,010 $1,845 $2,291 ------ ------ ------ ------ ------ ------ Ratio of nonperforming assets to total assets 0.53% 0.33% 0.41% ------ ------ ------ ------ ------ ------ Ratio of nonperforming loans to total loans (1) 0.63% 0.28% 0.49% ------ ------ ------ ------ ------ ------
- --------------------------------------------------------------------- (1) Nonperforming loans include nonaccruing loans and loans delinquent more than 90 days. 54 When a loan becomes 90 days delinquent, except for credit card loans, the Bank places the loan on a non-accrual status and, as a result, accrued interest income on the loan is taken out of income. Future interest income is recognized on a cash basis. The loan will remain on a non-accrual status until the borrower has brought the loan current. Credit card loans remain in accrual status until 120 days, when accrued interest income on the loan is taken out of income. Nonperforming assets increased to $3.0 million at June 30, 1998 from $1.8 million at June 30, 1997, an increase of $1.2 million. In addition, the ratio of nonperforming assets to total assets, which is one indicator of credit risk exposure, increased to 0.53% at June 30, 1998 from 0.33% at June 30, 1997. Nonaccruing loans increased to $2.3 million at June 30, 1998 from $1.3 million at June 30, 1997, an increase of $1.0 million. Included in nonaccruing loans at June 30, 1998 were ten loans totaling $623,000 secured by one- to four-family real estate, three loans in the amount of $719,000 secured by commercial real estate, five mobile home loans totaling $31,000, seven commercial business loans totaling $396,000 and thirty-three consumer loans totaling $482,000. For the year ended June 30, 1998, gross interest income of $229,000 would have been recognized on loans accounted for on a non-accrual basis had such loans been current in accordance with their original terms. Gross interest income of $250,000 was recognized as income on loans accounted for on a non-accrual basis. Foreclosed assets decreased to $229,000 at June 30, 1998 from $593,000 at June 30, 1997, a decrease of $364,000. At June 30, 1998, the Bank had approximately $8.1 million of other loans of concern that management has determined need to be closely monitored because of possible credit problems of the borrowers or the cash flows of the secured properties. These loans were considered in determining the adequacy of the allowance for possible loan losses. The allowance for possible loan losses is established based on management's evaluation of the risks inherent in the loan portfolio and changes in the nature and volume of loan activity. Such evaluation, which includes a review of all loans for which full collectability may not be reasonably assured, considers the estimated fair market value of the underlying collateral, economic conditions, historical loan loss experience and other factors that warrant recognition in providing for an adequate loan loss allowance. Although the Bank's management believes that the June 30, 1998 recorded allowance for loan losses was adequate to provide for potential losses on the related loans, there can be no assurance that the allowance existing at June 30, 1998 will be adequate in the future. 55 The following table sets forth information with respect to activity in the Bank's allowance for loan losses during the periods indicated.
Years Ended June 30, ----------------------------------- 1998 1997 1996 ----------------------------------- (Dollars In Thousands) Balance at beginning of period $ 4,526 $ 4,129 $ 4,039 Total charge-offs (2,423) (1,121) (850) Total recoveries 407 825 350 ------- ------- ------- Net (charge-offs) (2,016) (296) (500) Additions charged to operations 4,689 693 590 ------- ------- ------- Balance at end of period $ 7,199 $ 4,526 $ 4,129 ------- ------- ------- ------- ------- ------- Ratio of net (charge-offs) during the period to average loans outstanding during the period (0.45)% (0.07)% (0.12)% ------- ------- ------- ------- ------- ------- Ratio of allowance for loan losses to total loans at end of period 1.62% 1.02% 0.98% ------- ------- ------- ------- ------- ------- Ratio of allowance for loan losses to nonperforming loans at end of period 258,86% 361.50% 200.15% ------- ------- ------- ------- ------- -------
The allowance for loan losses was $7.2 million at June 30, 1998 as compared to $4.5 million at June 30, 1997. The ratio of the allowance for losses on loans to total loans was 1.62% at June 30, 1998 and 1.02% at June 30, 1997. The Bank's management has considered nonperforming assets and other assets of concern in establishing the allowance for losses on loans. The Bank continues to monitor its allowance for possible loan losses and make future additions or reductions in light of the level of loans in its portfolio and as economic conditions dictate. The current level of the allowance for loan losses is a result of management's assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on all commercial business, agricultural, construction and multi-family and commercial real estate loans, including purchased loans, that exceed $250,000 and a monthly credit review and reporting process on all types of loans that results in the calculation of the guidelines reserves based on the risk within the portfolio. This assessment of risk takes into account the composition of the loan portfolio, previous loan experience, current economic conditions and other factors that in management's judgment deserve recognition. In regard to credit card loans, the Company is providing a reserve in a range of 25% to 30% of the loan balance until the credit card portfolio becomes seasoned. As of June 30, 1998, $3.2 million of the $7.2 million allowance for loan losses was reserved for the credit card loan portfolio. Regulators have reviewed the Company's methodology for determining allowance requirements on the Company's loan portfolio and have made no recommendations for increases in the allowances during the three year period ended June 30, 1998. The Company has historically maintained a positive variance from the minimum estimated allowance for loan losses based on the analyses that are conducted by bank management and corporate credit personnel. Management has reviewed the allocations in the various classifications of loans and believes the allowance was adequate at all times during the three year period ended June 30, 1998. 56 COMPARISON OF THE YEARS ENDED JUNE 30, 1998 AND JUNE 30, 1997 GENERAL. The Company's net income increased $2.8 million to $6.5 million for the year ended June 30, 1998 as compared to $3.7 million for the year ended June 30, 1997. As discussed in more detail below, this increase was due primarily to the increase in noninterest income of $7.2 million and an increase in net interest income of $1.6 million which were partially offset by an increase in the provision for losses on loans of $4.0 million and an increase in income tax expense of $1.7 million. INTEREST INCOME. Interest income increased $2.2 million from $44.0 million for the year ended June 30, 1997 to $46.2 million for the year ended June 30, 1998. This increase was primarily due to an increase in interest earned on loans and investment securities. The average yield on loans increased from 8.83% to 9.01% while the average balance of loans increased $8.3 million during this period due to originations and purchases exceeding amortizations, prepayments and sales during the year ended June 30, 1998. The increase in the yield is due primarily to the changing type of loans that comprise the portfolio of the Company to loans that have a higher yield than single-family real estate loans. Commercial business loans, agricultural loans and credit card loans comprise 15.50% of the total loan portfolio at June 30, 1998 as compared to 8.40% at June 30, 1997. In addition, one-to four-family loans comprise 29.13% of the total loan portfolio at June 30, 1998 as compared to 36.50% at June 30, 1997. The increase in interest earned on investment securities was primarily due to an increase in the average balance of investment securities of $20.0 million. During this period the average yield on investment securities increased from 5.54% to 5.86% due to current market rates being at a higher rate on new purchases as compared to the rates of matured investment securities. The increase in the average balance of investment securities was due to the Company's purchase of primarily U.S. Government securities which have a maturity of three years or less that have a call feature that varies from three months to one year. The increase in interest earned on loans and investment securities was partially offset by a decrease in interest earned on mortgage-backed securities primarily due to a decrease in the average balance of $8.9 million from the prior fiscal year. INTEREST EXPENSE. Interest expense increased $617,000 from $24.8 million for the year ended June 30, 1997 to $25.4 million for the year ended June 30, 1998. This increase was primarily due to an increase in the average balance of savings, demand, now and money market account balances and due to an increase in the average rate paid on savings which were partially reduced by a decrease in the average balance of certificates of deposit and FHLB advances and other borrowings. The average balance of savings accounts increased $23.0 million during the year ended June 30, 1998. In addition, the average rate paid on savings accounts increased from 2.07% for the year ended June 30, 1997 to 3.57% for the year ended June 30, 1998. The average balance of demand, now and money market accounts increased $18.1 million during the year ended June 30, 1998. The increase in the average balance of savings, demand, now and money market accounts of $41.1 million was used to reduce the average balance of FHLB advances by $13.3 million and to reduce the average balance of certificates of deposit by $11.3 million. The majority of the increase in savings, demand, now and money market accounts were from deposits from local governmental entities and commercial customers. See "Financial Condition Data" for further discussion. NET INTEREST INCOME. The Company's net interest income for the year ended June 30, 1998 increased $1.6 million, or 8.19%, to $20.8 million compared to $19.2 million for the same period ended June 30, 1997. The increase in net interest income reflects an overall increase in average net interest-earning assets during the period resulting from internal increases in the portfolio of loans and securities. The net interest spread on average interest-earning assets increased to 3.40% for the period ended June 30, 1998 from 3.24% for the same period in 1997. The increase in the net interest spread is due primarily to the increased yield on interest-earning assets due to a change in the loan portfolio mix during fiscal year 1998. During the fiscal years ended June 30, 1998 and 1997, the Company increased its origination of commercial, agricultural, credit card and consumer loans. The Company anticipates activity in this type of lending to continue in future years, subject to market demand. In addition, the Company sold the majority of conventional single-family residential real estate loan originations into the secondary market. Net interest income is expected to trend upward as a result of this lending activity as interest rate yields are generally higher on these types of loans compared to the yield provided by conventional single-family residential real estate loans. This lending activity is considered to carry a higher level of risk due to the nature of the collateral and the size of the individual loans. As such, the Company anticipates continued increases in its allowance for loan losses. PROVISION FOR LOSSES ON LOANS. The allowance for possible losses on loans is maintained at a level which is considered by management to be adequate to absorb possible loan losses on existing loans that may become uncollectible, based on an evaluation of the collectability of loans and prior loan loss experience. The evaluation takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. The allowance for possible loan losses is established through a provision for possible loan losses charged to expense. 57 During the year ended June 30, 1998, the Company recorded a provision for losses on loans of $4.7 million compared to $693,000 for the year ended June 30, 1997. The provision for losses on loans of $4.7 million for the year ended June 30, 1998 compared to the same period in fiscal 1997 is primarily to provide for future expected write-offs on credit card loans and to management's continued evaluation of the loan portfolio in light of general economic conditions. See "Asset Quality" for further discussion. The allowance for loan losses at June 30, 1998 was $7.2 million. The allowance increased from the June 30, 1997 balance primarily as a result of the provision for losses on loans of $4.7 million which was reduced by charge-offs exceeding recoveries by $2.0 million. The ratio of allowance for loan losses to nonperforming loans at June 30, 1998 was 258.86% compared to 361.50% at June 30, 1997. The allowance for losses on loans to total loans at June 30, 1998 was 1.62% compared to 1.02% at June 30, 1997. The Bank's management believes that the June 30, 1998 recorded allowance for loan losses was adequate to provide for potential losses on the related loans, based on its evaluation of the collectability of loans and prior loss experience. NONINTEREST INCOME. Noninterest income was $13.6 million for the year ended June 30, 1998 as compared to $6.5 million for the year ended June 30, 1997. Loan fees and service charges increased by $238,000 for the year ended June 30, 1998 as compared to the same period in the prior fiscal year. This increase was primarily due to an increase in mortgage loan activity of $53.7 million from $61.5 million during the year ended June 30, 1997 to $115.2 million for the year ended June 30, 1998. Gain on the sale of loans increased $733,000 to $1.1 million for the year ended June 30, 1998 from $352,000 for the year ended June 30, 1997. Loans originated for resale and sales of participation interest in loans that were sold during the year ended June 30, 1998 were $106.4 million as compared to $53.3 million in the year ended June 30, 1997. Fees on deposits increased $557,000 for the year ended June 30, 1998 as compared to the same period in the prior fiscal year. This increase was due to an increase in the number of transaction accounts that customers have with the Bank. See "Financial Condition Data" for further discussion. The increase in credit card income of $5.6 million for the year ended June 30, 1998 as compared to the same period in fiscal 1997 is primarily due to an increase in fees received on unsecured credit cards. This represents processing fees, interchange fees, annual fees, late fees and other miscellaneous fees. This credit card program was initiated in fiscal 1997. Interest income on credit card loans is included in interest income on loans. NONINTEREST EXPENSE. Noninterest expense increased $280,000 from $19.7 million for the year ended June 30, 1997 to $20.0 million for the year ended June 30, 1998. This increase was primarily from an increase in compensation and employee benefits of $494,000, an increase in other general and administrative expenses of $146,000, an increase in advertising of $252,000, and an increase in credit card processing expense of $2.4 million which were partially offset by a decrease in federal insurance premiums and assessments of $2.9 million. 58 The increase in compensation and employee benefits was due primarily to an increase in health insurance of $89,000, an increase in incentive compensation of $139,000, an increase in pension costs of $98,000, and an increase in compensation of $332,000 due to merit raises, which were partially offset by a reduction in temporary personnel costs of $118,000 and other employee benefits of $34,000. The decrease in the federal insurance premiums of $2.9 million is the result of the passage by Congress and the President of the United States of the Savings Association Insurance Fund "SAIF" legislation which resulted in a one time assessment of $2.6 million to the Bank in order to recapitalize the SAIF during the first quarter of fiscal 1997. This one time assessment was charged to the Bank on September 30, 1996. In addition, the quarterly assessment rate of the Bank was reduced from 23 basis points to 6.5 basis points which has resulted in a lower assessment expense to the Bank. There was an increase of $2.4 million in the cost of third party processors of credit cards. This represents costs for processing of applications, collecting loans, and marketing costs for the acquisition of credit cards for the unsecured credit card program. The increase in expense is due primarily to an increase in the number of credit cards from 10,651 as of June 30, 1997 to 50,512 as of June 30, 1998. The Company began offering credit cards in the second quarter of fiscal 1997. INCOME TAX EXPENSE. The Company's income tax expense for the year ended June 30, 1998 was $3.2 million compared to $1.6 million for the year ended June 30, 1997, an increase of $1.7 million. This increase was proportionate to the increase in the Company's income before income tax and due to the increase in the effective tax rate to 33.30% for the year ended June 30, 1998 as compared to 30.00% for the same period in the prior fiscal year. COMPARISON OF THE YEARS ENDED JUNE 30, 1997 AND JUNE 30, 1996 GENERAL. The Company's net income decreased $1.0 million from $4.7 million for the year ended June 30, 1996 to $3.7 million for the year ended June 30, 1997. As discussed in more detail below, this decrease was due primarily to the increase in noninterest expense of $4.6 million (including the $2.6 million SAIF assessment discussed below under the heading "Noninterest Expense" section) and an increase in the provision for losses on loans of $103,000 which were partially offset by an increase in net interest income of $1.5 million, an increase in noninterest income of $824,000 and a decrease in income tax expense of $1.3 million. INTEREST INCOME. Interest income increased $547,000 from $43.5 million for the year ended June 30, 1996 to $44.0 million for the year ended June 30, 1997. This increase was primarily due to an increase in interest earned on loans. The average yield on loans increased from 8.81% to 8.83% while the average balance of loans increased $32.6 million during this period due to originations and purchases exceeding amortizations, prepayments and sales during the year ended June 30, 1997. The increase in interest earned on loans was partially offset by a decrease in interest earned on mortgage-backed securities and investment securities primarily due to a decrease in the average balances of $33.7 million and $6.9 million, respectively from the prior fiscal year. INTEREST EXPENSE. Interest expense decreased $929,000 from $25.8 million for the year ended June 30, 1996 to $24.8 million for the year ended June 30, 1997. This decrease was largely attributable to a decrease in average rates paid on deposits and a decrease in the average balance of FHLB advances. The average rates on deposits decreased from 5.15% for the year ended June 30, 1996 to 5.00% for the year ended June 30, 1997. The average balance of FHLB advances decreased $10.5 million for the year ended June 30, 1997 as compared to the prior fiscal year. These decreases were partially offset by an increase in the average balance of deposits of $5.4 million for the year ended June 30, 1997 as compared to the same period in the prior fiscal year. NET INTEREST INCOME. The Company's net interest income for the year ended June 30, 1997 increased $1.5 million, or 8.33%, to $19.2 million compared to $17.7 million for the same period ended June 30, 1996. The increase in net interest income reflects an overall increase in the net interest spread on average interest earnings assets from 2.88% for the year ended June 30, 1996 to 3.24% for the year ended June 30, 1997. The increase in the net interest spread was primarily due to an increase in the yield on interest-earning assets increasing from 8.13% for the year ended June 30, 1996 to 8.36% for the year ended June 30, 1997. PROVISION FOR LOSSES ON LOANS. During the year ended June 30, 1997, the Company recorded a provision for losses on loans of $693,000 as compared to $590,000 for the year ended June 30, 1996. The provision for losses on loans of $693,000 for the year ended June 30, 1997 as compared to the same period in fiscal 1996 is primarily related to management's continued evaluation of the loan portfolio in light of general economic conditions. See "Asset Quality" for further discussion. NONINTEREST INCOME. Noninterest income was $6.5 million for the year ended June 30, 1997 as compared to $5.6 million for the year 59 ended June 30, 1996, an increase of $824,000. Loan servicing income increased $461,000 for the year ended June 30, 1997 as compared to the same period in fiscal 1996. This increase was primarily due to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage Servicing Rights" as of July 1, 1996. The Company recorded $200,000 of income as a result of adopting SFAS No. 122. In addition, the Company was able to reduce the amortization of loan servicing rights as a result of an increase in market rates during the first three quarters of fiscal 1997. Loan fees and service charges increased by $155,000 for the year ended June 30, 1997 as compared to the same period in the prior fiscal year. This increase was primarily due to an increase in late charge income of $175,000 as compared to the same period in the prior fiscal year. Gain on the sale of loans decreased $483,000 to $352,000 for the year ended June 30, 1997 from $835,000 for the year ended June 30, 1996. Loans originated for resale and sales of participation interest in loans that were sold during the year ended June 30, 1997 were $53.3 million as compared to $55.1 million in the year ended June 30, 1996. Fees on deposits increased $445,000 for the year ended June 30, 1997 as compared to the same period in the prior fiscal year. This increase was due to an increase in the number of transaction accounts that customers have with the Bank. Gain on sale of securities, net decreased $350,000 for the year ended June 30, 1997 as compared to the same period in fiscal 1996. This decrease is due to the Company selling $12.2 million of securities available for sale and mortgage-backed securities available for sale during fiscal 1997 compared to $33.6 million during the same period in the prior fiscal year which resulted in fewer gains on sales of securities. The increase in credit card income of $613,000 for the year ended June 30, 1997 as compared to the same period in fiscal 1996 is primarily due to an increase in fees received on unsecured credit cards of $613,000. This represents processing fees, interchange fees, annual fees and other miscellaneous fees. This unsecured credit card program is new in fiscal 1997. NONINTEREST EXPENSE. Noninterest expense increased $4.6 million from $15.1 million for the year ended June 30, 1996 to $19.7 million for the year ended June 30, 1997. This increase resulted primarily from an increase in compensation and employee benefits of $834,000, an increase in federal insurance premiums of $2.3 million, an increase in occupancy and equipment of $203,000, an increase in other general and administrative expenses of $387,000, an increase in credit card processing expense of $465,000 and an increase in amortization of intangible assets of $121,000 which were partially offset by a decrease in advertising of $133,000. The increase in compensation and employee benefits was due primarily to an increase in compensation paid to employees during the year ended June 30, 1997 as compared to the same period in the prior fiscal year of $738,000. The increase was primarily due to the number of employees for the Company increasing to 274 at June 30, 1997 from 246 at June 30, 1996. The increase in the federal insurance premiums of $2.3 million is the result of the passage by Congress and the President of the United States of the Savings Association Insurance Fund "SAIF" legislation which assessed a one time charge of $2.6 million to the Bank in order to recapitalize the SAIF. The increase in occupancy and equipment costs is due primarily to depreciation of the computer hardware and software system that was placed in operation in May, 1996. There was an increase of $465,000 in the cost of third party processors of credit cards. This represents costs for processing of applications, collecting loans, and marketing costs for the acquisition of credit cards for the unsecured credit card program which was new in fiscal 1997. There was an increase in amortization of intangible assets of $121,000. This increase was primarily the result of the write off of the intangible asset relating to the purchase of HomeFirst Mortgage Corp. This write off occurred in the fourth quarter of fiscal 1997. The write off was based upon the Company's intention to cease the operation of HomeFirst Mortgage Corp. in the first quarter of fiscal 1998. The increase in net losses, provision for losses and expenses on foreclosed real estate and other properties is primarily due to the Bank recording a gain of approximately $355,000 on the disposal of one property during the fourth quarter of fiscal 1996. The Bank did not 60 have such a gain during fiscal 1997. INCOME TAX EXPENSE. The Company's income tax expense for the year ended June 30, 1997 was $1.6 million compared to $2.9 million for the year ended June 30, 1996, a decrease of $1.3 million. This decrease was proportionate to the decrease in the Company's income before income tax and due to the decrease in the effective tax rate to 30% for the year ended June 30, 1997 as compared to 38% for the same period in the prior fiscal year. In fiscal 1997, the Company realized tax deductions related to stock compensation for which it had not been required to record an expense in its financial statements. These deductions are not expected to recur and the effective tax rate will increase in fiscal 1998. LIQUIDITY AND CAPITAL RESOURCES The Bank's primary sources of funds are deposits, amortization and prepayments of loan principal (including mortgage-backed securities) and, to a lesser extent, sales of mortgage loans, sales and/or maturities of securities, mortgage-backed securities, and short-term investments. While scheduled loan payments and maturing securities are relatively predictable, deposit flows and loan prepayments are more influenced by interest rates, general economic conditions, and competition. The Bank attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight funds. Federal regulations have historically required the Bank to maintain minimum levels of liquid assets. The required percentage has varied from time to time based upon economic conditions and savings flows and is currently 4% of net withdrawable savings deposits and current borrowings. Liquid assets for purposes of this ratio include cash, certain time deposits, U.S. Government and corporate securities and other obligations generally having remaining maturities of less than five years. The Bank has historically maintained its liquidity ratio at a level in excess of that required by these regulations. At June 30, 1998, the Bank's regulatory liquidity ratio was 6.04%. Liquidity management is both a daily and long-term responsibility of management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) the objectives of its asset/liability management program. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. During fiscal 1998, the Bank acquired funds that allowed it to reduce its borrowings with the FHLB by $24.1 million. See "Financial Condition Data" for further discussion. The Bank renewed its open line of credit with the FHLB in January 1998 at an amount of $10.0 million which will expire December 31, 1998. Management expects this line of credit to be renewed at this time. There were no outstanding advances on this line of credit at June 30, 1998. The Bank anticipates that it will have sufficient funds available to meet current loan commitments. At June 30, 1998, the Bank had outstanding commitments to originate or purchase loans of $39.7 million and to sell loans of $20.9 million. The Bank had outstanding commitments to purchase securities available for sale of $7.0 million. There was no commitment to sell mortgage-backed securities or securities available for sale. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings where the funds can be invested in either loans or securities at a positive rate of return or to use the funds for short term liquidity purposes. See "Financial Condition Data" for further analysis. In April of 1996, the Company initiated a stock buy back program in which up to 10% of the common stock of the Company may be acquired beginning May 1, 1996 through April 30, 1997. A total of 207,472 shares of common stock were purchased pursuant to this program. In April of 1997, the Company initiated another stock buy back program in which up to 10% of the common stock of the Company may be acquired beginning May 1, 1997 through April 30, 1998. A total of 111,750 shares of common stock were purchased pursuant to this program. In April of 1998, the Company initiated a third stock buy back program in which up to 10% of the common stock of the Company may be acquired beginning May 1, 1998 through April 30, 1999. In accordance with the provisions of the current stock buy back program, the Company had purchased 15,000 shares of common stock as of June 30, 1998. On December 20, 1995, the Company declared a two-for-one stock split in the form of a stock dividend of one share of common stock for each one share outstanding, payable to shareholders of record on January 10, 1996. Earnings and dividends per share have been retroactively adjusted based upon the new shares outstanding after the effect of the two-for-one stock split for all periods presented. The stockholders' equity of the Company was adjusted for the effect of the two-for-one stock split and $16,000 was transferred from additional paid-in capital to common stock. 61 On April 24, 1998, the Company declared a three-for-two stock split in the form of a stock dividend of one-half share of common stock for each one share outstanding, payable to shareholders of record on May 8, 1998. Earnings and dividends per share have been retroactively adjusted based upon the new shares outstanding after the effect of the three-for-two stock split for all periods presented. The stockholders' equity of the Company was adjusted for the effect of the three-for-two stock split and $16,000 was transferred from additional paid-in capital to common stock. Savings institutions insured by the Federal Deposit Insurance Corporation are required by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") to meet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure. Institutions not in compliance may apply for an exemption from the requirements and submit a recapitalization plan. Under these capital requirements, at June 30, 1998 the Bank met all current capital requirements. The Office of Thrift Supervision ("OTS") has adopted a core capital requirement for savings institutions comparable to the requirement for national banks. The OTS core capital requirement is 3% of total adjusted assets for thrifts that receive the highest supervisory rating for safety and soundness. The Bank had core capital of 7.75% at June 30, 1998. Pursuant to FDICIA, the federal banking agencies, including the OTS, have also proposed regulations authorizing the agencies to require a depository institution to maintain additional total capital to account for concentration of credit risk and the risk of non-traditional activities. No assurance can be given as to the final form of any such regulation. During the first quarter of fiscal 1997, the Small Business Job Protection Act of 1996 was signed into law which repealed the percentage of taxable income method of computing the bad debt deduction for savings institutions for tax years beginning after December 31, 1995. Beginning in fiscal year 1997, the Bank is required to recapture into income the excess of its June 30, 1996 loan loss reserves for "qualifying" and "nonqualifying" loans over its June 30, 1988 loan loss reserves for "qualifying" and "nonqualifying" loans. This excess, which was $720,000 at June 30, 1998, is required to be recaptured ratably over a six year period. The onset of recapture was delayed in fiscal years 1998 and 1997 since the Bank met a residential loan origination requirement which allowed for a two year delay in recapture. At June 30, 1998, the Bank's recorded deferred tax liability of $245,000 provides for the recapture of the loan loss reserves. At June 30, 1998 and 1997, securities with a fair value of $64.6 million and $35.5 million, respectively, were pledged as collateral for public deposits and other purposes. Deposits at June 30, 1998 and 1997 include $38.3 million and $4.1 million respectively, of deposits from one local governmental entity, the majority of which are demand accounts. 62 IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and Notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. EFFECT OF NEW ACCOUNTING STANDARDS The FASB issued SFAS No. 130, "Reporting Comprehensive Income". This Statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This Statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. This Statement is effective for fiscal years beginning after December 15, 1997. The FASB issued SFAS No. 131, "Disclosures about Segments of Enterprise and Related Information". This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This Statement is effective for financial statements for periods beginning after December 15, 1997. The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits". This Statement standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets, and eliminates certain disclosures that are no longer useful. This Statement also permits reduced disclosures for nonpublic entities. This Statement supersedes the disclosure requirements in FASB Statements No. 87, "Employers' Accounting for Pensions, No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". This Statement is effective for financial statements for periods beginning after December 15, 1997. The FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Earlier application of all of the provisions of this Statement is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance of this Statement. This Statement should not be applied retroactively to financial statements of prior periods. 63 YEAR 2000 The Year 2000 issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Bank is heavily dependent on computer processing in its business activities and the Year 2000 issue creates risk for the Bank from unforeseen problems in the Bank's computer system and from third parties with whom the Bank processes financial information. Such failures of the Bank's computer system and/or third parties computer systems could have a material impact on the Bank's ability to conduct its business. In May 1997, the Company developed a five step plan that follows the guidelines as specified by the Federal Financial Institutions Examination Councils. As new requirements are provided by this council, the plan is modified to reflect the new requirements. Management of the Company is updated at least monthly on the status of the plan and the Bank's Information Systems Steering Committee has changed from a quarterly meeting to a bi-monthly meeting to be more proactive on Year 2000. In addition, the Board of Directors of the Company are updated on the status of the Year 2000 project at each of its meetings. The five stages of the plan are as follows: awareness, assessment, renovation, validation and implementation. The awareness and assessment phases were completed by December 31, 1997. The assessment phase included hardware, software and third party vendors that provide a service to the Company (i.e. utility companies, alarm companies, payroll providers, electronic funds transfer providers, insurance providers, loan participation companies, mortgage loan secondary market agencies, and governmental agencies). The renovation, validation and implementation phases are currently in process and progressing as planned. Currently, systems that are known to be noncompliant with Year 2000 have already been replaced or are scheduled to be upgraded or replaced by December 31, 1998. In May 1996, the Bank installed new hardware and operations systems software which the vendor has represented to be Year 2000 compliant. All mission critical systems of the 1996 installation, both hardware and software, are scheduled to be tested in the first quarter of fiscal 1999. In addition, testing will be performed with service providers that are providing the capability to test with the Bank. The Company has included in its test plan various dates that have been required by regulatory agencies. The overall plan of the Company has a scheduled completion date of December 31, 1998. Based on the Bank's review of its computer systems, management believes the cost of the remediation effort to make the systems Year 2000 compliant is approximately $100,000. Approximately $20,000 was incurred in fiscal 1998 with the remaining $80,000 to be incurred in fiscal 1999. In addition, approximately 1,500 to 2,000 man hours are expected to be incurred by Bank personnel related to Year 2000 issues which have an estimated cost of $60,000. Management expects these costs to be incurred in fiscal 1999. Such costs will be charged against income as they are incurred. ASSET/LIABILITY MANAGEMENT The Bank, like other thrift institutions, is subject to interest rate risk to the extent that its interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets. As a continuing part of its financial strategy, the Bank considers methods of managing this asset/liability mismatch consistent with maintaining acceptable levels of net interest income. In order to properly monitor interest rate risk, the Board of Directors has created an Asset/Liability Committee composed principally of its President, Executive Vice President, Senior Vice Presidents, Vice President/Marketing and Vice President/Controller. The principal responsibilities of this Committee are to assess the Bank's asset/liability mix and recommend strategies to the Board that will enhance income while managing the Bank's vulnerability to changes in interest rates. In managing the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. The effect of this policy will generally be to reduce the Bank's one-year gap. The goal of this policy is to provide a relatively consistent level of net interest income in varying interest rate cycles and to minimize the potential for significant fluctuations from period to period. At June 30, 1998, the Bank's cumulative one-year gap as a percentage of total assets was a negative 11.89% and its one- to three-year gap as a percentage of total assets was a negative 6.57%. The following table sets forth the scheduled repricing or maturity of the Bank's assets and liabilities which mature or reprice within one year based on various assumptions on rates of repricing/prepayment that have been determined by the OTS and published in "Selected Asset and Liability Price Tables as of June 30, 1998". In preparing the following table, it has been assumed, consistent with the assumptions used by the OTS in assessing the interest rate sensitivity of savings institutions, that: (i) adjustable-rate first 64 mortgage loans will prepay at a rate of 10% per year; (ii) fixed-maturity deposits will not be withdrawn prior to maturity; and (iii) escrow accounts are assumed to reprice or be withdrawn in the first three month period. Savings accounts and transaction accounts are expected to reprice 100.00% within the first year. Using these classifications, fixed-rate mortgage loans and mortgage-backed securities are assumed to prepay annually as follows:
Weighted Average Prepayment Interest Rate Assumption ---------------- ---------- Less than 7.00% 11.00% 7.00 to 7.99% 18.00 8.00 to 8.99% 28.00 9.00% and over 34.00
The effect of these assumptions is to quantify the dollar amount of items that are interest-sensitive and can be repriced within each of the periods specified. Such repricing can occur in one of three ways: (i) the rate of interest to be paid on an asset or liability may adjust periodically on the basis of an index; (ii) an asset or liability such as a mortgage loan may amortize, permitting reinvestment of cash flows at the then-prevailing interest rates; or (iii) an asset or liability may mature, at which time the proceeds can be reinvested at current market rates. The following table does not necessarily indicate the impact of general interest rate movements on the Bank's net interest yield because the repricing of certain categories of assets and liabilities is subject to competitive and other pressures beyond the Bank's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period, may, in fact, mature or reprice at different times and at different volumes. The table does not include redeployment of funds from contractual amortization and the possible impact of annual ceilings on adjustable-rate loans and securities. 65
Maturing or Repricing ---------------------------------------------------------------------- Within Over 1-3 Over 3-5 Over One Year Years Years 5 Years Total ---------------------------------------------------------------------- (Dollars in Thousands) Interest-earning assets: Real estate loans (including mortgage-backed securities) $ 136,281 $ 79,981 $32,864 $27,005 $276,131 Consumer loans 95,170 33,109 27,539 409 156,227 Commercial business and agriculture loans 42,337 6,089 7,113 1,857 57,396 Investment securities and other 20,665 25,492 9,108 464 55,729 --------- --------- ------- ------- -------- Total interest-earning assets $ 294,453 $ 144,671 $76,624 $29,735 $545,483 --------- --------- ------- ------- -------- --------- --------- ------- ------- -------- Interest-bearing liabilities: Transaction accounts $ 101,930 $ ---- $ ---- $ ---- $101,930 Savings accounts 61,266 ---- ---- ---- 61,266 Certificates of deposit 171,824 103,751 7,575 78 283,228 Other borrowings 340 524 ---- ---- 864 FHLB advances 27,000 10,000 11,666 1,445 50,111 --------- --------- ------- ------- -------- Total interest-bearing liabilities $ 362,360 $ 114,275 $19,241 $ 1,523 $497,399 --------- --------- ------- ------- -------- Interest-earning assets less interest-bearing liabilities $(67,907) $ 30,396 $57,383 $28,212 $ 48,084 --------- --------- ------- ------- -------- Cumulative interest rate sensitivity gap $(67,907) $(37,511) $19,872 $48,084 --------- --------- ------- ------- Cumulative gap as a percent of interest-earning assets (12.45)% (6.88)% 3.64% 8.81% --------- --------- ------- ------- Cumulative gap as a percent of total assets (11.89)% (6.57)% 3.48% 8.42% --------- --------- ------- -------
66 Item 7A. Quantitative and Qualitative Disclosures About Market Risk Pages 6 through 8 of the attached 1998 Annual Report to Stockholders are herein incorporated by reference. Interest Rate Risk Management The Company 's net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that Interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income. In an attempt to manage its exposure to change in interest rates, management monitors the Company's interest rate risk. Since 1991, management's asset-liability committee has met monthly to review the Company's interest rate risk position and profitability, and to recommend adjustments for consideration by the Board of Directors. Management also reviews the Bank's securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the Board 's objectives in the most effective manner. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income. In adjusting the Company's asset/liability position, the Board and management attempt to manage the Company's interest rate risk while enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term Interest rates. Consistent with the asset/liability management philosophy described above, the Company has taken several steps to manage its interest rate risk. First, the Company has structured the security portfolio to shorten the lives of its interest-earning assets. The Company's recent purchases of mortgage-backed securities and securities available for sale have had either short or medium terms to maturity or adjustable interest rates. At June 30, 1998, the Company had securities available for sale of $39.6 million with contractual maturities of five years or less and adjustable rate mortgage-backed securities of $16.0 million. Mortgage-backed securities amortize and experience prepayments of principal; the Company has received average cash flows from principal paydowns, maturities, sales and calls of securities of $50.2 million annually over the past three fiscal years. The Company also controls interest rate risk reduction by emphasizing non-certificate depositor accounts. The Board and management believe that such accounts carry a lower cost than certificate accounts, and that a material portion of such accounts may be more resistant to changes in interest rates than are certificate accounts. At June 30, 1998, the Company had $61.3 million of regular savings accounts, $43.9 million of money market accounts and $58.1 million of NOW and demand accounts, representing 36.6% of total depositor accounts. One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. The following table sets forth, at June 30, 1998, an analysis of the Company's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (+ or - 400 basis points, measured in 100 basis point increments).
Estimated Increase (Decrease) in NPV ------------------ Change in Estimated Interest Rates NPV Amount Amount Percent -------------- ---------- ------ ------- Basis Points (Dollars in thousands) +400 $53,167 $(8,431) (14)% +300 56,299 (5,300) (9) +200 58,959 (2,640) (4) +100 60,826 (773) (1) --- 61,599 --- --- -100 62,783 1,184 2 -200 63,789 2,191 4 -300 66,326 4,727 8 -400 69,809 8,211 13
67 Certain assumptions utilized by the OTS in assessing the interest rate risk of thrift institutions were employed in preparing data for the Bank included in the preceding table. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under the various interest rate scenarios. It was also assumed that delinquency rates will not change as a result of changes in interest rates although there can be no assurance that this will be the case. Even if interest rates change in the designated amounts, there can be no assurance that the Company's assets and liabilities would perform as set forth above. In addition, a change in U. S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause significantly different changes to the NPV than indicated above. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. 68 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of the Company as of June 30, 1998, and 1997 together with the Independent Auditor's Report are included in this Form 10-K on the pages indicated below. HF FINANCIAL CORP. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Contents --------
-------------------------------------------------------------------------------- INDEPENDENT AUDITOR'S REPORT. . . . . . . . . . . . . . . . . . . . . . . . . 70 -------------------------------------------------------------------------------- CONSOLIDATED FINANCIAL STATEMENTS Statements of financial condition . . . . . . . . . . . . . . . . . . . . .71-72 Statements of income. . . . . . . . . . . . . . . . . . . . . . . . . . . .73-74 Statements of stockholders' equity. . . . . . . . . . . . . . . . . . . . . . 75 Statements of cash flows. . . . . . . . . . . . . . . . . . . . . . . . . .76-78 Notes to consolidated financial statements. . . . . . . . . . . . . . . . 79-109 69
INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders HF Financial Corp. Sioux Falls, South Dakota We have audited the accompanying consolidated statements of financial condition of HF Financial Corp. and subsidiaries as of June 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HF Financial Corp. and subsidiaries as of June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. /s/ McGladrey & Pullen, LLP McGLADREY & PULLEN, LLP Sioux Falls, South Dakota August 13, 1998 70 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, 1998 AND 1997 (DOLLARS IN THOUSANDS)
ASSETS 1998 1997 - -------------------------------------------------------------------------------------- Cash and cash equivalents $ 25,458 $ 17,957 Securities available for sale (Note 2) 44,232 46,940 Mortgage-backed securities available for sale (Note 2) 39,647 30,340 Loans receivable (Notes 3 and 8) 426,522 440,019 Loans held for sale (Note 3) 9,616 3,483 Accrued interest receivable (Note 5) 4,338 4,136 Foreclosed real estate and other properties 229 593 Office properties and equipment, at cost, net of accumulated depreciation (Note 6) 14,317 15,070 Prepaid expenses and other assets 1,999 870 Mortgage servicing rights (Note 4) 1,423 1,134 Deferred income taxes (Note 9) 3,198 1,569 Intangible assets - 3 ------------------------- $ 570,979 $ 562,114 ------------------------- -------------------------
See Notes to Consolidated Financial Statements. 71
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 - ------------------------------------------------------------------------------------------- Liabilities Deposits (Note 7) $ 446,424 $ 418,186 Advances from Federal Home Loan Bank and other borrowings (Note 8) 50,635 74,743 Advances by borrowers for taxes and insurance 4,792 4,074 Accrued interest payable 5,898 6,560 Other liabilities 6,629 5,577 ------------------------- TOTAL LIABILITIES 514,378 509,140 ------------------------- Commitments and Contingencies (Note 18) Stockholders' Equity (Notes 9, 10, 11, 12, 15 and 16) Preferred stock, $.01 par value, 500,000 shares authorized, none outstanding - - Series A Junior Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized, none outstanding - - Common stock, $.01 par value, 5,000,000 shares authorized, 4,730,276 and 4,701,795 shares outstanding at June 30, 1998 and 1997 47 31 Additional paid-in capital 14,863 14,695 Retained earnings, substantially restricted 46,561 41,336 Unearned compensation (340) (453) Net unrealized loss on securities available for sale (9) (222) Less cost of treasury stock, 1998 334,222 shares, 1997 222,472 shares (4,521) (2,413) ------------------------- 56,601 52,974 ------------------------- $ 570,979 $ 562,114 ------------------------- -------------------------
72 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Interest and dividend income: Loans receivable $ 40,154 $ 38,596 $ 35,628 Mortgage-backed securities 2,023 2,668 4,918 Investment securities and interest-bearing deposits 4,024 2,748 2,919 ---------------------------------------- 46,201 44,012 43,465 ---------------------------------------- Interest expense: Deposits 21,731 20,389 20,715 Advances from Federal Home Loan Bank and other borrowings 3,718 4,443 5,046 ---------------------------------------- 25,449 24,832 25,761 ---------------------------------------- NET INTEREST INCOME 20,752 19,180 17,704 Provision for losses on loans 4,689 693 590 ---------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR LOSSES ON LOANS 16,063 18,487 17,114 ---------------------------------------- Noninterest income: Loan servicing income 1,187 1,150 689 Loan fees and service charges 1,184 946 791 Fees on deposits 2,190 1,633 1,188 Commission and insurance income 749 699 780 Appraisal and inspection fees 369 461 576 Gain on sale of loans 1,085 352 835 Gain on sale of securities, net 226 150 500 Trust income 201 112 70 Credit card fee income 6,163 613 - Other 277 356 219 ---------------------------------------- 13,631 6,472 5,648 ----------------------------------------
See Notes to Consolidated Financial Statements. 73
1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Noninterest expense: Compensation and employee benefits $ 10,152 $ 9,658 $ 8,824 Occupancy and equipment 2,701 2,705 2,502 Federal insurance premiums (Note 7) 278 3,199 931 Advertising 650 398 531 Credit card processing expense 2,827 465 - Other general and administrative expenses 3,069 2,923 2,536 (Gains) losses and provision for losses and expenses on foreclosed real estate and other properties, net 303 206 (205) Reduction in cost of intangible assets 3 149 28 ---------------------------------------- 19,983 19,703 15,147 ---------------------------------------- INCOME BEFORE INCOME TAXES 9,711 5,256 7,615 Income tax expense (Note 9) 3,238 1,582 2,893 ---------------------------------------- Net income $ 6,473 $ 3,674 $ 4,722 ---------------------------------------- ---------------------------------------- Earnings per share (Note 12): Basic $ 1.46 $ 0.81 $ 1.03 Diluted $ 1.42 $ 0.79 $ 1.00
74 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED JUNE 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Common stock: Balance at beginning of year $ 31 $ 31 $ 15 Exercise of stock options (Note 16) - - - Stock split in the form of a stock dividend (Note 12) 16 - 16 ---------------------------------------- Balance at end of year $ 47 $ 31 $ 31 ---------------------------------------- ---------------------------------------- Additional paid-in capital: Balance at beginning of year $ 14,695 $ 14,480 $ 14,209 Additional paid-in capital from exercise of stock options (Note 16) 184 215 287 Stock split in the form of a stock dividend (Note 12) (16) - (16) ---------------------------------------- Balance at end of year $ 14,863 $ 14,695 $ 14,480 ---------------------------------------- ---------------------------------------- Retained earnings: Balance at beginning of year $ 41,336 $ 38,745 $ 35,034 Net income 6,473 3,674 4,722 Cash dividends paid ($.28, $.24 and $.22 per share in 1998, 1997 and 1996, respectively) (Note 12) (1,248) (1,083) (1,011) ---------------------------------------- Balance at end of year $ 46,561 $ 41,336 $ 38,745 ---------------------------------------- ---------------------------------------- Unearned compensation: Balance at beginning of year $ (453) $ (569) $ (719) Amortization of unearned compensation (Note 15) 113 116 150 ---------------------------------------- Balance at end of year $ (340) $ (453) $ (569) ---------------------------------------- ---------------------------------------- Net unrealized loss on securities available for sale: Balance at beginning of year $ (222) $ (622) $ (185) Change in unrealized loss during the year, net of related deferred taxes 213 400 (437) ---------------------------------------- Balance at end of year $ (9) $ (222) $ (622) ---------------------------------------- ---------------------------------------- Treasury stock: Balance at beginning of year $ (2,413) $ (802) $ - Purchase of treasury stock (Note 11) (2,108) (1,611) (802) ---------------------------------------- Balance at end of year $ (4,521) $ (2,413) $ (802) ---------------------------------------- ----------------------------------------
See Notes to Consolidated Financial Statements. 75 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 6,473 $ 3,674 $ 4,722 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on loans 4,689 693 590 Depreciation 1,653 1,378 721 Amortization of premiums and discounts, net: Securities available for sale (25) 68 218 Mortgage-backed securities available for sale 37 41 10 Reduction in cost of intangible assets 3 149 28 Reduction in mortgage servicing rights 216 139 360 Amortization of unearned compensation 113 116 150 FHLB stock dividends - - (102) Increase in deferred loan fees 166 282 570 Loans originated for resale (89,777) (45,553) (47,675) Proceeds from the sale of loans 90,862 45,905 48,510 (Gain) on sale of loans (1,085) (352) (835) Mortgage servicing rights capitalized (Note 4) (224) (200) - (Gain) on sale of securities, net (226) (150) (500) (Gains) losses and provision for losses on sales of foreclosed real estate and other properties, net 194 53 (345) (Gain) loss on disposal of office properties and equipment, net (7) 22 (1) Change in other assets and liabilities (Note 19) (2,659) 1,659 1,886 ---------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 10,403 7,924 8,307 ----------------------------------------
See Notes to Consolidated Financial Statements. 76
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Cash Flows From Investing Activities Loans purchased $ (21,510) $ (13,813) $ (23,886) Loans made to customers (151,913) (149,718) (124,090) Principal collected on loans 158,563 130,717 81,308 Sale of participation interests in loans 16,620 7,697 7,375 Mortgage-backed securities available for sale: Sales 477 12,184 20,978 Purchases (16,573) - (20,162) Repayments 6,939 17,234 23,050 Securities available for sale: Sales and maturities 55,934 15,056 32,257 Purchases (52,860) (20,446) (11,355) Securities held to maturity: Maturities - - 30 Proceeds from sale of office properties and equipment 55 709 2 Purchase of office properties and equipment (948) (2,133) (2,827) Purchase of mortgage servicing rights (281) (135) (95) Proceeds from sale of foreclosed real estate and other properties, net 919 645 2,176 ---------------------------------------- NET CASH (USED IN) INVESTING ACTIVITIES (4,578) (2,003) (15,239) ---------------------------------------- Cash Flows From Financing Activities Net increase (decrease) in demand deposit, NOW, savings accounts and certificates of deposit 28,238 20,020 (2,509) Proceeds of advances from Federal Home Loan Bank and other borrowings 29,000 34,000 90,582 Payments on advances from Federal Home Loan Bank and other borrowings (53,108) (49,380) (74,154) Increase (decrease) in advances by borrowers for taxes and insurance 718 (593) 199 Payment on other liabilities for purchase of property and equipment - (677) - Purchase of treasury stock (2,108) (1,611) (802) Proceeds from issuance of common stock 184 215 287 Cash dividends paid (1,248) (1,083) (1,011) ---------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 1,676 891 12,592 ----------------------------------------
77 HF FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED JUNE 30, 1998, 1997 AND 1996 (DOLLARS IN THOUSANDS)
1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- INCREASE IN CASH AND CASH EQUIVALENTS $ 7,501 $ 6,812 $ 5,660 Cash and Cash Equivalents Beginning 17,957 11,145 5,485 ---------------------------------------- Ending $ 25,458 $ 17,957 $ 11,145 ---------------------------------------- ---------------------------------------- Supplemental Disclosures of Cash Flows Information Cash payments for: Interest $ 26,111 $ 24,125 $ 24,331 Income and franchise taxes, net 4,376 1,576 1,839 Supplemental Schedule of Noncash Investing and Financing Activities Property and equipment additions included in other liabilities - - 677 Foreclosed real estate and other properties acquired in settlement of loans 749 1,295 2,878 Loans made in connection with the sale of foreclosed real estate and other properties 30 41 54 Transfer of securities classified as held to maturity to securities available for sale - - 100,667 Stock split in the form of a stock dividend 16 - 16 Change in unrealized loss on securities available for sale 302 604 (631) Deferred income taxes related to change in unrealized loss on securities available for sale (89) (204) 194
See Notes to Consolidated Financial Statements. 78 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of HF Financial Corp. (the Company) and subsidiaries conform to generally accepted accounting principles and to general practice within the industry. The following is a description of the more significant of those policies that the Company follows in preparing and presenting its consolidated financial statements. PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements include the accounts of the Company, its 51% owned subsidiary, HF Card Services, L.L.C., and its wholly-owned subsidiaries, HomeFirst Mortgage Corp. and Home Federal Savings Bank (the Bank) and the Bank's subsidiaries, Hometown Insurors, Inc., Mid-America Service Corporation and PMD, Inc. All intercompany balances and transactions have been eliminated in consolidation. The Company ceased operations of HomeFirst Mortgage Corp. during the first quarter of 1998, with no material affect on the consolidated financial statements. BASIS OF FINANCIAL STATEMENT PRESENTATION: The financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the year. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize possible losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. CASH AND CASH EQUIVALENTS: For purposes of reporting the statements of cash flows, the Company includes as cash equivalents all cash accounts, which are not subject to withdrawal restrictions or penalties and time deposits with original maturities of 90 days or less. The Company had $12,000 of cash equivalents at June 30, 1998 and $6,000 at June 30, 1997. TRUST ASSETS: Assets of the trust department, other than trust cash on deposit at the Bank, are not included in these financial statements because they are not assets of the Bank. SECURITIES: Management determines the appropriate classification of securities at the date individual securities are acquired and evaluates the appropriateness of such classifications at each balance sheet date. 79 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SECURITIES (CONTINUED): Securities held to maturity are those debt securities that the Company has both the positive intent and ability to hold to maturity and are stated at amortized cost. Securities available for sale are those debt or equity securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at market value and unrealized gains or losses are reported as increases or decreases in stockholders' equity, net of the related deferred tax effect. Premiums and discounts on securities are amortized over the contractual lives of those securities, except for mortgage-backed securities, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Gains and losses on the sale of securities are determined using the specific identification method. LOANS HELD FOR SALE: Loans receivable which the Bank may sell or intends to sell prior to maturity are carried at the lower of net book value or market value on an aggregate basis. Such loans held for sale include loans receivable that management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk or other similar factors. LOANS RECEIVABLE: Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, and net of deferred loan origination fees, costs and discounts. Discounts and premiums on loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for prepayments. Uncollectible interest on loans that are impaired or contractually past due is charged off based on management's periodic evaluation. The charge to interest income is equal to all interest previously accrued, and income is subsequently recognized only to the extent cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is no longer in doubt, in which case the loan is returned to accrual status. 80 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) LOANS RECEIVABLE (CONTINUED): The Company includes all loans considered impaired in its evaluation of the adequacy of the allowance for loan losses. A loan is impaired when it is probable the Bank will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans was not material at June 30, 1998 and 1997. The allowance for loan losses is increased by provisions charged to income and reduced by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the allowance for loan losses is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. LOAN ORIGINATION FEES AND RELATED DISCOUNTS: Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for prepayments. Annual credit card fees net of loan origination costs are deferred and amortized over the one year privilege period. Commitment fees and costs relating to commitments, the likelihood of exercise of which is remote, are recognized over the commitment period on a straight-line basis. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield. LOAN SERVICING: The cost allocated to mortgage servicing rights purchased or retained has been recognized as a separate asset and is being amortized in proportion to and over the period of estimated net servicing income. Mortgage servicing rights are periodically evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the rights are stratified by one or more predominant risk characteristics of the underlying loans. The Bank stratifies its capitalized mortgage servicing rights based on the interest rate of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed their fair value. FORECLOSED REAL ESTATE AND OTHER PROPERTIES: Real estate and other properties acquired through, or in lieu of, loan foreclosure are initially recorded at lower of cost or fair value less estimated costs to sell at the date of foreclosure. Costs relating to improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management, and charge-offs to operations are made if the carrying value of a property exceeds its estimated fair value less estimated costs to sell. 81 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) OFFICE PROPERTIES AND EQUIPMENT: Land is carried at cost. All other office properties and equipment are carried at cost, less accumulated depreciation and amortization. Buildings and improvements and leasehold improvements are depreciated primarily on the straight-line method over the estimated useful lives of the assets which is five to fifty years. Furniture, fixtures, equipment and automobile are depreciated using both the straight-line and declining balance methods over the estimated useful lives of the assets which is three to twelve years. INCOME TAXES: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. STOCK-BASED COMPENSATION: In fiscal year 1997, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 123, "Accounting for Stock-Based Compensation". The Statement established standards for accounting for stock-based compensation, but also allows companies to continue to account for stock-based compensation under the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and make certain additional disclosures in the notes to the financial statements. The Company continues to account for stock-based compensation in accordance with APB Opinion No. 25. FAIR VALUE OF FINANCIAL INSTRUMENTS: The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: CASH AND CASH EQUIVALENTS: The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate their fair values. SECURITIES: Fair values for investment securities are based on quoted market prices, except for stock in the Federal Home Loan Bank for which fair value is assumed to equal cost. LOANS: Approximately 52% and 51% of loans at June 30, 1998 and 1997, respectively, are variable-rate loans that reprice frequently and have no significant change in credit risk. Fair values on these loans are based on carrying values. The fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality or from quoted market prices of similar loans sold, adjusted for differences in loan characteristics. ACCRUED INTEREST RECEIVABLE: The carrying value of accrued interest receivable approximates its fair value. 82 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED): OFF-STATEMENT-OF-FINANCIAL-CONDITION INSTRUMENTS: Fair values for the Company's off-statement-of- financial-condition instruments (unused lines of credit and letters of credit), which are based upon fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and counterparties' credit standing, are not significant. DEPOSITS: The fair values for deposits with no defined maturities equal their carrying amounts which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on certificates of deposit. BORROWED FUNDS: The carrying amounts reported for variable rate advances approximate their fair values. Fair values for fixed-rate advances and other borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances and borrowings with corresponding maturity dates. ACCRUED INTEREST PAYABLE AND ADVANCES BY BORROWERS FOR TAXES AND INSURANCE: The carrying values of accrued interest payable and advances by borrowers for taxes and insurance approximate their fair values. 83 NOTE 2. INVESTMENTS IN SECURITIES The amortized cost and fair values of investments in securities at June 30, 1998, all of which are classified as available for sale according to management's intent, are as follows:
Gross Gross Amortized Unrealized Unrealized Cost Gains (Losses) Fair Value ------------------------------------------------------ Debt securities: U.S. Treasury issues $ 2,994 $ 24 $ - $ 3,018 U.S. government agencies and corporations 24,492 46 (37) 24,501 Federal Home Loan Bank 11,997 4 (29) 11,972 Municipal bonds 540 34 (1) 573 ------------------------------------------------------ 40,023 108 (67) 40,064 ------------------------------------------------------ Equity securities: FHLMC preferred stock 500 3 - 503 Stock in Federal Home Loan Bank of Des Moines 3,657 - - 3,657 FNMA common stock 8 - - 8 ------------------------------------------------------ 4,165 3 - 4,168 ------------------------------------------------------ Mortgage-backed securities: GNMA 102 8 - 110 REMIC 9,296 - (225) 9,071 FHLMC 10,022 65 (19) 10,068 Resolution Trust Corporation 733 - (3) 730 FNMA 15,112 163 (27) 15,248 Other triple A rated mortgage-backed securities 4,438 3 (21) 4,420 ------------------------------------------------------ 39,703 239 (295) 39,647 ------------------------------------------------------ $ 83,891 $ 350 $ (362) $ 83,879 ------------------------------------------------------ ------------------------------------------------------
84 NOTE 2. INVESTMENTS IN SECURITIES (CONTINUED) The amortized cost and fair values of debt securities as of June 30, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair Cost Value --------------------- Due in one year or less $ 1,998 $ 2,000 Due after one year through five years 37,595 37,600 Due after five years through ten years 45 45 Due after ten years 385 419 --------------------- 40,023 40,064 Mortgage-backed securities 39,703 39,647 --------------------- $ 79,726 $ 79,711 --------------------- ---------------------
Equity securities have been excluded from the maturity table above because they do not have contractual maturities associated with debt securities. The Bank, as a member of the Federal Home Loan Bank system, is required to maintain an investment in capital stock of the Federal Home Loan Bank. No ready market exists for the Bank stock, and it has no quoted market value. For disclosure purposes, such stock is assumed to have a fair value which is equal to cost. Proceeds from the sale of securities available for sale were $6,959, $56 and $12,644 and resulted in a net gain of $215, $8 and $140 in fiscal years 1998, 1997 and 1996, respectively. Proceeds from the sale of mortgage-backed securities available for sale were $477, $12,184 and $18,161 and resulted in a net gain of $11, $142 and $302 in fiscal years 1998, 1997 and 1996, respectively. In fiscal year 1996, the Bank sold held to maturity mortgage-backed securities resulting in proceeds of $2,817 and a net gain of $58. In connection therewith, all remaining securities classified as held to maturity securities with an amortized cost of $100,667 and a net unrealized loss of $193 were transferred to the available for sale classification in fiscal year 1996 to comply with the provisions of FASB Statement No. 115. At June 30, 1998 and 1997, securities with a fair value of $64,596 and $35,526, respectively, were pledged as collateral for public deposits and other purposes. 85 NOTE 2. INVESTMENTS IN SECURITIES (CONTINUED) The amortized cost and fair values of investments in securities at June 30, 1997, all of which are classified as available for sale according to management's intent, are as follows:
Gross Gross Amortized Unrealized Unrealized Cost Gains (Losses) Fair Value ------------------------------------------------------ Debt securities: U.S. Treasury issues $ 7,019 $ 9 $ (10) $ 7,018 U.S. government agencies and corporations 21,428 10 (102) 21,336 Federal Home Loan Bank 11,999 - (49) 11,950 Municipal bond 385 18 - 403 ------------------------------------------------------ 40,831 37 (161) 40,707 ------------------------------------------------------ Equity securities: FHLMC preferred stock 500 5 - 505 Stock in Federal Home Loan Bank of Des Moines 5,222 - - 5,222 Common stock: FNMA 8 - - 8 Other 462 36 - 498 ------------------------------------------------------ 6,192 41 - 6,233 ------------------------------------------------------ Mortgage-backed securities: GNMA 140 11 - 151 REMIC 10,061 - (478) 9,583 FHLMC 6,565 155 (29) 6,691 Resolution Trust Corporation 989 11 - 1,000 FNMA 6,976 173 (4) 7,145 FNMA REMIC 250 - (1) 249 Other triple A rated mortgage-backed securities 5,590 - (69) 5,521 ------------------------------------------------------ 30,571 350 (581) 30,340 ------------------------------------------------------ $ 77,594 $ 428 $ (742) $ 77,280 ------------------------------------------------------ ------------------------------------------------------
86 NOTE 3. LOANS RECEIVABLE AND LOANS HELD FOR SALE Loans receivable at June 30, 1998 and 1997 consist of the following:
1998 1997 ----------------------------- Loans secured by real estate: Residential: One-to-four family $ 121,446 $ 162,090 Multi-family 54,560 59,971 Commercial 38,002 34,252 Construction and development 12,804 5,315 Consumer and other loans: Automobile 66,044 66,483 Junior liens on mortgages 41,599 38,736 Commercial business 41,068 27,534 Agriculture 16,327 8,261 Credit card 12,335 2,310 Mobile home 11,152 15,571 Education 6,986 6,409 Loans on savings accounts 2,167 2,299 Other loans 15,944 20,934 ----------------------------- 440,434 450,165 Less: Undisbursed portion of loans in process 5,199 4,272 Deferred loan fees and unearned discounts and premiums, net 1,514 1,348 Allowance for loan losses 7,199 4,526 ----------------------------- $ 426,522 $ 440,019 ----------------------------- -----------------------------
Loans held for sale totaling $9,616 and $3,483 at June 30, 1998 and 1997, respectively, consist of one-to-four family fixed-rate loans. 87 NOTE 3. LOANS RECEIVABLE AND LOANS HELD FOR SALE (CONTINUED) Activity in the allowance for loan losses is summarized as follows for the years ended June 30:
1998 1997 1996 -------------------------------------- Balance, beginning $ 4,526 $ 4,129 $ 4,039 Provision charged to income 4,689 693 590 Charge-offs (2,423) (1,121) (850) Recoveries 407 825 350 -------------------------------------- Balance, ending $ 7,199 $ 4,526 $ 4,129 -------------------------------------- --------------------------------------
Nonaccrual loans for which interest has been reduced totaled approximately $2,251, $1,252 and $2,063 at June 30, 1998, 1997 and 1996, respectively. Interest income that would have been recorded under the original terms of such loans and the interest income actually recognized for the years ended June 30 are summarized below:
1998 1997 1996 ------------------------------------ Interest income that would have been recorded $ 479 $ 266 $ 457 Interest income recognized (250) (88) (379) ------------------------------------ Interest income foregone $ 229 $ 178 $ 78 ------------------------------------ ------------------------------------
88 NOTE 4. LOAN SERVICING Mortgage loans serviced for others (primarily the South Dakota Housing Development Authority) are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of mortgage loans serviced for others was $364,288 and $322,058 at June 30, 1998 and 1997, respectively. Custodial balances maintained in connection with the foregoing loan servicing, and included in deposits and advances by borrowers for taxes and insurance, were approximately $2,231 and $1,848 at June 30, 1998 and 1997, respectively. Mortgage servicing rights in the amount of $224 and $200 were capitalized during the years ended June 30, 1998 and 1997, respectively. The fair values of capitalized mortgage servicing rights were $298 and $174 at June 30, 1998 and 1997, respectively. The fair values of the mortgage servicing rights were estimated as the present value of the expected future cash flows using a discount rate of 15.0% for both periods. The Company recognized expense for amortization of the cost of mortgage servicing rights in the amount of $96 and $19 for the years ended June 30, 1998 and 1997, respectively. No valuation allowances were provided for mortgage servicing rights capitalized during the years ended June 30, 1998 and 1997. 89 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 5. ACCRUED INTEREST RECEIVABLE The following is a summary of accrued interest receivable at June 30, 1998 and 1997 by asset type:
1998 1997 -------------------------- Loans receivable and loans held for sale $ 3,414 $ 3,215 Securities available for sale 713 737 Mortgage-backed securities available for sale 211 184 -------------------------- $ 4,338 $ 4,136 -------------------------- --------------------------
Dividends receivable on investments are included with accrued interest receivable. NOTE 6. OFFICE PROPERTIES AND EQUIPMENT Office properties and equipment at June 30, 1998 and 1997 consist of the following:
1998 1997 -------------------------- Land $ 1,920 $ 1,852 Buildings and improvements 15,189 14,836 Leasehold improvements 303 303 Furniture, fixtures, equipment and automobile 8,241 7,929 -------------------------- 25,653 24,920 Less accumulated depreciation and amortization (11,336) (9,850) -------------------------- $ 14,317 $ 15,070 -------------------------- --------------------------
90 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 7. DEPOSITS Deposits at June 30, 1998 and 1997 consist of the following:
1998 1997 -------------------------- Savings accounts $ 61,266 $ 28,968 NOW accounts 24,659 24,614 Noninterest bearing accounts 33,403 20,973 Money market accounts 43,868 34,421 Certificates 283,228 309,210 -------------------------- $ 446,424 $ 418,186 -------------------------- --------------------------
Scheduled maturities of savings certificates are as follows:
Maturing in fiscal year: - -------------------------------------------------------------------------------- 1999 $ 171,824 2000 93,109 2001 10,642 2002 4,835 2003 2,740 Thereafter 78 ------------- $ 283,228 ------------- -------------
Eligible savings accounts are insured up to $100 by the Savings Association Insurance Fund (SAIF) under management of the Federal Deposit Insurance Corporation (FDIC). The aggregate amount of jumbo certificates of deposit with a minimum denomination of $100 was approximately $51,612 and $66,742 at June 30, 1998 and 1997, respectively. Deposits at June 30, 1998 and 1997 include $38,250 and $4,113, respectively, of deposits from one local governmental entity, the majority of which are demand accounts. On September 30, 1996, the President signed into law Savings Association Insurance Fund legislation which assessed a one time charge of approximately $2,600 to the Bank. An assessment was imposed on the Bank and other member institutions of the SAIF in order to recapitalize the SAIF and facilitate the future merger of the Bank Insurance Fund (BIF) and SAIF into the Deposit Insurance Fund. 91 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 8. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS Maturities of advances from the Federal Home Loan Bank of Des Moines at June 30, 1998 and 1997 are as follows:
1998 1997 -------------------------- Fixed-rate advances (with rates ranging from 4.5% to 6.6%): Due in one year or less $ 23,000 $ 33,000 Due after one through two years 10,000 16,000 Due after two years through five years 11,666 6,000 Due after five years 1,445 2,224 -------------------------- Total fixed-rate advances 46,111 57,224 -------------------------- Variable-rate advances (with rates ranging from 5.6% to 5.7%): Due in one year or less 4,000 12,995 Due after one year through two years - 4,000 -------------------------- Total variable-rate advances 4,000 16,995 -------------------------- $ 50,111 $ 74,219 -------------------------- --------------------------
Aggregate maturities of advances are as follows: 1999 $27,000; 2000 $10,000; 2001 $0; 2002 $1,000; 2003 $10,666; and thereafter $1,445. The Bank also has a $10,000 variable rate open line of credit with the Federal Home Loan Bank of Des Moines which expires December 31, 1998. There were no advances outstanding on this line of credit at June 30, 1998. Advances, including amounts advanced on the open line of credit, are secured by stock in the Federal Home Loan Bank of Des Moines and first mortgage loans with balances exceeding 130% of the amount of the advances. Other borrowings consist of a note payable to the South Dakota Housing Development Authority (SDHDA) which had balance of $524 at June 30, 1998 and 1997. The SDHDA loaned $600 to the Bank at 0% interest rate per annum. The funds are to be used by the Bank to originate $600 in qualified home improvement loans. The note is due on August 31, 2000. 92 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 9. INCOME TAX MATTERS The Company and subsidiaries file a consolidated federal income tax return on a fiscal year basis. In fiscal years prior to the 1997 fiscal year, the Bank was allowed a special bad debt deduction based on 8 percent of taxable income, or on specified experience formulas. The Bank used the percentage of taxable income method in 1996. Effective for fiscal year 1997, federal income tax laws changed to eliminate the percentage of taxable income and experience formulas for the Bank and only allow bad debt deductions based on actual charge-offs. The Bank is required to recapture into income the excess of its June 30, 1996 loan loss reserves for "qualifying" and "nonqualifying" loans over its June 30, 1988 loan loss reserves for "qualifying" and "nonqualifying" loans. This excess, which was $720 at June 30, 1998, is required to be recaptured ratably over a six year period. The onset of recapture was delayed in fiscal years 1998 and 1997 since the Bank met a residential loan origination requirement which allowed for a two year delay in recapture. At June 30, 1998, the Bank's recorded deferred tax liability of $245 provides for the recapture of the loan loss reserves and is netted against the deferred tax asset. The consolidated provision for income taxes consists of the following for the years ended June 30:
1998 1997 1996 --------------------------------------- Current: Federal $ 4,424 $ 1,577 $ 2,134 State 532 226 379 Deferred: Federal (benefit) (1,718) (221) 380 --------------------------------------- $ 3,238 $ 1,582 $ 2,893 --------------------------------------- ---------------------------------------
Income tax expense is different from that calculated at the statutory federal income tax rate. The reasons for this difference in the tax expense are as follows:
1998 1997 1996 --------------------------------------- Computed "expected" tax expense $ 3,399 $ 1,840 $ 2,665 Increase (decrease) in income taxes resulting from: Tax exempt interest income (55) (58) (67) Stock compensation deductible for tax (32) (155) (33) State taxes, net of federal benefit 346 149 250 Benefit of income taxed at lower rates (100) (53) (76) Other, net (320) (141) 154 --------------------------------------- $ 3,238 $ 1,582 $ 2,893 --------------------------------------- ---------------------------------------
93 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 9. INCOME TAX MATTERS (CONTINUED) The components of the net deferred tax asset as of June 30, 1998 and 1997 are as follows:
1998 1997 -------------------------- Deferred tax assets: Allowance for loan losses $ 2,326 $ 1,294 Deferred loan fees 260 323 Deferred credit card fees 881 193 Discounts on loans from acquired associations 147 193 Accrued expenses 171 111 Net unrealized loss on securities available for sale 3 92 Other 28 27 -------------------------- 3,816 2,233 Less valuation allowance (239) (239) -------------------------- 3,577 1,994 -------------------------- Deferred tax liabilities: FHLB stock dividends 148 234 Office properties and equipment 226 185 Other 5 6 -------------------------- 379 425 -------------------------- $ 3,198 $ 1,569 -------------------------- --------------------------
Retained earnings at June 30, 1998 and 1997, include approximately $4,805 related to the pre-1987 allowance for loan losses for which no deferred federal income tax liability has been recognized. These amounts represent an allocation of income to bad debt deductions for tax purposes only. If the Bank no longer qualifies as a bank, or in the event of a liquidation of the Bank, income would be created for tax purposes only, which would be subject to the then current corporate income tax rate. The unrecorded deferred income tax liability on the above amounts for financial statement purposes was approximately $1,634 at June 30, 1998 and 1997. 94 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 10. REGULATORY CAPITAL The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to total assets (as defined). Management believes, as of June 30, 1998, that the Bank meets all capital adequacy requirements to which it is subject. As of March 31, 1998, the most recent examination by the Office of Thrift Supervision (OTS) categorized the Bank as "well capitalized" under the regulatory framework for Prompt Corrective Action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I (core) capital ratios. There are no conditions or events since that notification that management believes have changed the Bank's category. The following table summarizes the Bank's compliance with its regulatory capital requirements at June 30, 1998:
Bank's Capital Required Capital Excess Capital ---------------------------------------------------- Amount Percent Amount Percent Amount Percent ---------------------------------------------------- As of June 30, 1998: Tier I (core) capital $ 44,201 7.75% $ 17,113 3.00% $ 27,088 4.75% Total risk-based capital 49,036 12.76 30,754 8.00 18,282 4.76 As of June 30, 1997: Tier I (core) capital 42,495 7.57 16,832 3.00 25,663 4.57 Total risk-based capital 47,021 12.87 29,224 8.00 17,797 4.87
95 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 11. STOCKHOLDERS' EQUITY AND DIVIDENDS RESTRICTIONS In April 1996, the Company initiated a stock buy back program. A total of 207,472 shares of common stock were purchased pursuant to this program. In April 1997, the Company initiated another stock buy back program. A total of 111,750 shares of common stock were purchased pursuant to this program. In April 1998, the Company initiated a third stock buy back program in which up to 10% of the common stock of the Company may be acquired beginning May 1, 1998 through April 30, 1999. A total of 15,000 shares of common stock were purchased pursuant to this program through June 30, 1998. During 1996, the Company approved the creation of 50,000 shares of Preferred Stock, designated as "Series A Junior Participating Preferred Stock" with a stated value of $1.00 per share. Outstanding shares of the Junior Preferred Stock are entitled to cumulative dividends. Such shares have voting rights of 100 votes per share and a preference in liquidation. The shares are not redeemable after issuance. During 1996, the Company also declared a dividend of one preferred share purchase right (Right) for each outstanding share of common stock of the Company. The dividend was paid on November 13, 1996 to the stockholders of record on such date. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock at a price of $65 per one-hundredth of a preferred share, subject to the complete terms as stated in the Rights Agreement. The Rights become exercisable immediately after the earlier of (i) ten business days following a public announcement that a person or group has acquired beneficial ownership of 20% or more of the outstanding common shares of the Company (subject to certain exclusions), (ii) ten business days following the commencement or announcement of an intention to make a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person or group of 20% or more of such outstanding common shares. The Rights expire on October 22, 2006, which date may be extended subject to certain additional conditions. Under current regulations, the Bank is not permitted to pay dividends on its stock if its regulatory capital would reduce below (i) the amount required for the liquidation account established to provide a limited priority claim to the assets of the Bank to qualifying depositors (Eligible Account Holders) at March 31, 1992 who continue to maintain deposits at the Bank after its conversion from a Federal mutual savings and loan association to a Federal stock savings bank pursuant to its Plan of Conversion (Plan) adopted August 21, 1991, or (ii) the Bank's regulatory capital requirements. As a "Tier 1" institution (an institution with capital in excess of its capital requirements, both immediately before the proposed capital distribution and after giving effect to such distribution), the Bank may make capital distributions without the prior consent of the Office of Thrift Supervision (OTS) in any calendar year. The capital distribution is equal to the greater of 100% of net income for the year to date plus 50% of the amount by which the lesser of the institution's tangible, core or risk-based capital exceeds its capital requirement for such capital commitment, as measured at the beginning of the calendar year or up to 75% of net income over the most recent four quarter period. On July 22, 1998, the Bank mailed written notification to the OTS of its intention to pay $1,223 in dividends to the Company. 96 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 12. EARNINGS PER SHARE Earnings (loss) per share are calculated in accordance with the provisions of FASB Statement No. 128, "Earnings Per Share", which was effective for fiscal year 1998. This Statement establishes standards for computing and presenting earnings (loss) per share (EPS). It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of an income statement for all entities with complex capital structures. All prior years' EPS data in this report have been recalculated to reflect the provisions of Statement No. 128. A reconciliation of the income and common stock share amounts used in the calculation of basic and diluted earnings per share for the fiscal years ended June 30, 1998, 1997 and 1996 follow.
Per Net Shares Share Income Amount ------------------------------------- 1998: Basic EPS $ 6,473 4,447,543 $ 1.46 Effect of dilutive securities: Exercise of stock options - 120,197 0.04 ------------------------------------- Diluted EPS $ 6,473 4,567,740 $ 1.42 ------------------------------------- ------------------------------------- 1997: Basic EPS $ 3,674 4,537,319 $ 0.81 Effect of dilutive securities: Exercise of stock options - 94,591 0.02 ------------------------------------- Diluted EPS $ 3,674 4,631,910 $ 0.79 ------------------------------------- ------------------------------------- 1996: Basic EPS $ 4,722 4,587,672 $ 1.03 Effect of dilutive securities: Exercise of stock options - 141,306 0.03 ------------------------------------- Diluted EPS $ 4,722 4,728,978 $ 1.00 ------------------------------------- -------------------------------------
97 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 12. EARNINGS PER SHARE (CONTINUED) On April 24, 1998, the Company declared a three-for-two stock split in the form of a stock dividend of one-half share of common stock for each one share outstanding, payable to shareholders of record on May 8, 1998. All data related to common shares has been retroactively adjusted based upon the new shares outstanding after the effect of the three-for-two stock split for all periods presented. The stockholders' equity of the Company was adjusted for the effect of the three-for-two stock split and $16 was transferred from additional paid-in capital to common stock. On December 20, 1995, the Company declared a two-for-one stock split in the form of a stock dividend of one share of common stock for each one share outstanding, payable to shareholders of record on January 10, 1996. All data related to common shares was retroactively adjusted based upon the new shares outstanding after the effect of the two-for-one stock split for all periods presented. The stockholders' equity of the Company was adjusted for the effect of the two-for-one stock split and $16 was transferred from additional paid-in capital to common stock. NOTE 13. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board and the Accounting Standards Executive Committee have issued certain Statements of Financial Accounting Standards and Statements of Position, respectively, which have required effective dates occurring after the Company's June 30, 1998 year end. The Company's financial statements, including the disclosures therein, are not expected to be materially affected by those accounting pronouncements. 98 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 14. DEFINED BENEFIT PLAN The Company has a noncontributory defined benefit pension plan covering all employees of the Company and its wholly-owned subsidiaries who have attained the age of twenty-one and have completed one year of service. The benefits are based on years of service and the employee's compensation of the highest five out of the past ten years. The Company's funding policy is to make the minimum annual required contribution plus such amounts as the Company may determine to be appropriate from time to time. One hundred percent vesting occurs after five years, and retirement with age 65. The components of pension cost for the years ended June 30 consist of the following:
1998 1997 1996 ------------------------------------- Service cost $ 277 $ 193 $ 162 Interest cost on projected benefit obligation 125 102 96 Actual return on plan assets (239) (176) (105) Net amortization and deferral 106 55 (2) ------------------------------------- $ 269 $ 174 $ 151 ------------------------------------- -------------------------------------
The following table sets forth the plan's funded status as of June 30, 1998 and 1997, respectively, and the amounts recognized in the accompanying statements of financial condition:
1998 1997 --------------------------- Actuarial present value of benefit obligations: Vested benefits $ 1,390 $ 1,337 --------------------------- --------------------------- Accumulated benefits $ 1,520 $ 1,419 --------------------------- --------------------------- Projected benefit obligation for services rendered to date $ (1,931) $ (1,742) Plan assets at fair value 2,014 1,651 --------------------------- Projected benefit obligation (in excess of) plan assets 83 (91) Unrecognized net loss 536 691 Unrecognized prior service cost (benefit) (312) (362) Unrecognized transitional obligation 97 109 --------------------------- Prepaid pension cost $ 404 $ 347 --------------------------- ---------------------------
The weighted-average post-retirement and pre-retirement discount rates used in determining the actuarial present value of the benefit obligations were 6.0% and 7.5% for both fiscal years 1998 and 1997. The rate of increase in future compensation levels used to determine the actuarial present value of the benefit obligations was 5.50% for both fiscal years 1998 and 1997. The expected long-term rate of return on plan assets was 8.0% for both fiscal years 1998 and 1997. 99 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 15. EMPLOYEE STOCK OWNERSHIP PLAN The Company has an employee stock ownership plan (ESOP) covering all full-time employees of the Company who have attained age 21 and completed one year of service during which they worked at least 1,000 hours. The ESOP includes an employee savings plan feature which provides for voluntary contributions by eligible employees on a tax-deferred basis with no matching contribution by the Company. All shares owned by the ESOP are included in earnings per share computations, with shares being allocated to eligible employees as the corresponding ESOP debt is repaid. At June 30, 1998, the ESOP holds 274,337 shares comprised of 180,666 shares which have been allocated to eligible employees and 93,671 shares remaining unallocated. Dividends on unallocated shares are used to fund the release of unallocated shares annually. Annual contributions are limited to the maximum tax-deductible amount and amounts necessary to ensure continued compliance with the Bank's regulatory capital requirements. During 1994, HF Financial Corp. made payments to the ESOP trust in the amount of $906 to enable the trust to pay off the ESOP debt. HF Financial Corp. recorded a receivable equal to the amounts paid which is reflected as a deduction from stockholders' equity (unearned compensation) in the accompanying consolidated statements of financial condition. The receivable is reduced as the Bank makes contributions to the Plan which in turn are used to repay the Company and the corresponding compensation expense is recorded. For financial statement purposes, expense for the ESOP is determined on the percentage of shares allocated to participants each period (allocations are based on principal and interest payments) times the original amount of the debt plus the interest incurred. The compensation cost charged to expense was $121, $129 and $122 for 1998, 1997 and 1996, respectively. The Company has elected not to adopt the accounting treatment for the ESOP shares provided by AICPA Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans", as all ESOP shares were held by the ESOP as of December 31, 1992 and are allowed to be accounted for under previously existing accounting standards. 100 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 16. STOCK-BASED COMPENSATION PLANS The Company has stock-based compensation plans which are described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for grants under the fixed stock option plan. Had compensation cost for the Company's stock-based compensation plans been determined based on the grant date fair values of awards (the method described in Statement No. 123), reported net income and earnings per common share would have been reduced to the pro forma amounts shown below:
1998 1997 1996 --------------------------------- Net income: As reported $ 6,473 $ 3,674 $ 4,722 Pro forma 6,383 3,630 4,721 Basic earnings per share: As reported 1.46 0.81 1.03 Pro forma 1.43 0.80 1.03 Diluted earnings per share: As reported 1.42 0.79 1.00 Pro forma 1.40 0.78 1.00
The pro forma effects of applying Statement No. 123 are not indicative of future amounts since, among other reasons, the pro forma requirements of the Statement have been applied only to options granted after June 30, 1995. Under the Company's stock option and incentive plan (Option Plan), stock options of 828,000 common shares may be granted to directors and officers of the Bank. Options granted under the Option Plan may be either options that qualify as Incentive Stock Options, as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the Code), or options that do not qualify. The Option Plan also provides for the award of stock appreciation rights, limited stock appreciation rights and restricted stock. In fiscal year 1997, the Option Plan was amended to increase the number of shares of the Company's common stock reserved for issuance under the Option Plan from 453,000 to 828,000. At June 30, 1998, 634,108 shares of common stock were reserved for issuance under the Option Plan. The options granted under the Option Plan expire ten years from the date of grant. 101 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 16. STOCK-BASED COMPENSATION PLANS (CONTINUED) The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in fiscal years 1998, 1997 and 1996, respectively: a dividend rate as a percentage of stock price of 1.30% in 1998 and 1.85% for years 1997 and 1996, respectively; price volatility of 18.0% in 1998 and 12.0% for years 1997 and 1996, respectively, risk-free interest rates of 6.34%, 6.79% and 6.89%, respectively, and expected lives of seven years for all three years. A summary of the status of the plan and changes during the years ended June 30 are as follows:
1998 1997 1996 -------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Fixed Options Shares Price Shares Price Shares Price - ---------------------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 207,883 $ 6.68 197,820 $ 5.13 287,139 $ 4.71 Granted 69,629 16.25 54,727 10.75 936 10.37 Forfeited (1,899) 13.95 - - (7,482) 7.99 Exercised (22,097) 4.09 (44,664) 4.83 (82,773) 3.47 -------------------------------------------------------------------------------- Outstanding at end of year 253,516 $ 9.48 207,883 $ 6.68 197,820 $ 5.13 ------- ------- ------- ------- ------- -------
Options for 157,298, 144,975 and 170,799 were exercisable at June 30, 1998, 1997 and 1996, respectively. The weighted average fair value of options granted were $5.21, $5.59 and $5.64 for the fiscal years ended June 30, 1998, 1997 and 1996, respectively. 102 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 16. STOCK-BASED COMPENSATION PLANS (CONTINUED) Fixed options outstanding at June 30, 1998 are summarized as follows:
Options Outstanding Options Exercisable ------------------------------------------------------ Remaining Number Number Contractu Exercise Outstanding Exercisable al Life Price ------------------------------------------------------ 68,055 68,055 3 years $ 3.33 10,191 10,191 6 years 5.04 7,500 7,500 5 years 7.33 35,010 28,008 6 years 8.17 10,191 10,191 4 years 8.75 600 360 7 years 9.92 42,410 16,963 8 years 10.21 336 202 7 years 11.17 10,770 2,154 8 years 13.00 68,453 13,674 9 years 16.25 -------------------------- 253,516 157,298 -------------------------- --------------------------
Under the Management Recognition and Retention Plan (MRP), restricted stock awards covering shares representing an aggregate of up to two and one-half percent of outstanding common shares may be granted to directors and officers of the Bank. Further information concerning the MRP restricted stock awards is as follows:
Outstanding Awards ----------- June 30, 1996 4,500 Awards granted -- Awards canceled -- Awards vested (3,750) ----------- June 30, 1997 750 Awards granted -- Awards canceled -- Awards vested (750) ----------- June 30, 1998 -- ----------- -----------
103 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 16. STOCK-BASED COMPENSATION PLANS (CONTINUED) Awards vest at the rate of 25% per year of continuous service with the Bank. The unearned compensation under the MRP is recorded as a reduction of stockholders' equity and is amortized to operations as the shares vest. During the year ended June 30, 1997, the Company approved a Director Restricted Stock Plan (Plan) which provides that awards of restricted shares of the Company's common stock be made to outside directors of the Company. The Plan is designed to allow for payment of the annual retainer fee in shares of the Company's common stock, with the inclusion of an annual cost of living adjustment based on the Consumer Price Index. Each outside director is entitled to all voting, dividend and distribution rights during the restriction period. The effective date of the Plan is July 1, 1997. The Plan has 75,000 shares allocated to it and is in effect for a period of ten years. During fiscal year 1998, 6,405 shares were awarded and $94 of expense was incurred under the Plan as the annual retainer for the Company's Board of Directors for the year ending June 30, 1998. On July 1, 1998, 4,046 shares were awarded under the Plan as the annual retainer for the year ended June 30, 1999. 104 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 17. FINANCIAL INSTRUMENTS The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Unless noted otherwise, the Bank does not require collateral or other security to support financial instruments with credit risk. Estimated fair values of the Company's financial instruments are as follows:
June 30, --------------------------------------------------------------- 1998 1997 --------------------------------------------------------------- Carrying Carrying Amount Fair Value Amount Fair Value --------------------------------------------------------------- Financial Assets Cash and cash equivalents $ 25,458 $ 25,458 $ 17,957 $ 17,957 Securities 83,879 83,879 77,280 77,280 Loans 436,138 439,146 443,502 446,009 Accrued interest receivable 4,338 4,338 4,136 4,136 Financial Liabilities Deposits 446,424 445,368 418,186 416,145 Borrowed funds 50,635 50,303 74,743 74,200 Accrued interest payable and advances by borrowers for taxes and insurance 10,690 10,690 10,634 10,634
105 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 18. COMMITMENTS, CONTINGENCIES AND CREDIT RISK The Bank originates first mortgage and consumer loans primarily in eastern South Dakota and holds residential and commercial real estate loans which were purchased from other originators of loans located throughout the United States. The Bank issues, through third parties, primarily unsecured credit cards nationwide to a target customer market consisting of sub-prime credit customers who have either an insufficient credit history or a negative credit history. The Bank has established specific underwriting standards for credit card loans. Collateral for substantially all noncredit card consumer loans are security agreements and/or Uniform Commercial Code (UCC) filings on the purchased asset. At June 30, 1998 and 1997, the Bank has approximately $344 and $428 of loans sold with recourse to the Federal National Mortgage Association (FNMA). The collateral securing these loans are one-to-four family mortgage loans which are seasoned. Unused lines of credit and letters of credit amounted to $38,359 and $1,918 at June 30, 1998 and $32,943 and $718 at June 30, 1997, respectively, and are collateralized in substantially the same manner as loans receivable. The Bank had outstanding commitments to originate or purchase and sell loans of approximately $39,662 and $20,930, respectively, at June 30, 1998. The portion of commitments to originate or purchase fixed rate loans totaled $21,182 with a range in interest rates of 5.11% to 10.50%. At June 30, 1998, the Bank had outstanding commitments to purchase investments of $7,000. No losses are expected to be sustained in the fulfillment of any of these commitments. The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based upon consultation with legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position. NOTE 19. CASH FLOW INFORMATION Changes in other assets and liabilities at June 30, 1998, 1997 and 1996 consist of:
1998 1997 1996 ------------------------------- (Increase) in accrued interest receivable $ (202) $ (134) $ (466) (Increase) decrease in prepaid expenses and other assets (1,129) (360) 699 (Increase) decrease in deferred income taxes (1,718) (221) 380 Increase in accrued interest payable and other liabilities 390 2,374 1,273 ------------------------------- $ (2,659) $ 1,659 $ 1,886 ------------------------------- -------------------------------
106 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 20.FINANCIAL INFORMATION OF HF FINANCIAL CORP. (PARENT ONLY) The Company's condensed balance sheets as of June 30, 1998 and 1997 and related condensed statements of income and cash flows for each of the years in the three year period ended June 30, 1998 are as follows: CONDENSED BALANCE SHEETS
1998 1997 --------------------- Assets Cash, all with Home Federal Savings Bank $ 11,711 $ 9,295 Investments, marketable securities 503 1,003 Investments in subsidiaries 44,518 43,011 Other 8 114 --------------------- $ 56,740 $ 53,423 --------------------- --------------------- Liabilities $ 139 $ 449 Stockholders' equity 56,601 52,974 --------------------- $ 56,740 $ 53,423 --------------------- ---------------------
CONDENSED STATEMENTS OF INCOME
1998 1997 1996 --------------------------------- Interest income $ 543 $ 495 $ 543 Equity in earnings of subsidiaries 6,038 3,531 4,683 Other income 491 58 - Expenses (321) (314) (486) Income tax expense (278) (96) (18) --------------------------------- Net income $ 6,473 $ 3,674 $ 4,722 --------------------------------- ---------------------------------
107 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 20. FINANCIAL INFORMATION OF HF FINANCIAL CORP. (PARENT ONLY) (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS
1998 1997 1996 ----------------------------------------- Cash Flows From Operating Activities Net income $ 6,473 $ 3,674 $ 4,722 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of unearned compensation 113 116 150 Equity in earnings of subsidiaries (6,038) (3,531) (4,683) Cash dividends received from subsidiaries 4,531 2,839 3,307 (Gain) on sale of securities, net (194) - - Increase (decrease) in liabilities (310) 7 175 Other, net 357 93 (92) ----------------------------------------- Net cash provided by operating activities 4,932 3,198 3,579 ----------------------------------------- Cash Flows From Investing Activities Purchase of investment securities - - (5,507) Proceeds from maturities and sales of securities 656 1,056 5,200 Investment in HF Card Services, L.L.C. - (43) (8) Investment in HomeFirst Mortgage Corp. - - (250) ----------------------------------------- Net cash provided by (used in) investing activities 656 1,013 (565) ----------------------------------------- Cash Flows From Financing Activities Purchase of treasury stock (2,108) (1,611) (802) Cash dividends paid (1,248) (1,083) (1,011) Proceeds from issuance of common stock 184 215 287 ----------------------------------------- Net cash (used in) financing activities (3,172) (2,479) (1,526) ----------------------------------------- Increase in cash 2,416 1,732 1,488 Cash at Beginning of Period 9,295 7,563 6,075 ----------------------------------------- Cash at End of Period $ 11,711 $ 9,295 $ 7,563 ----------------------------------------- -----------------------------------------
108 HF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) - -------------------------------------------------------------------------------- NOTE 21. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (Dollars in thousands except earnings per share)
Year Ended June 30, 1998 ---------------------------------------- First Second Third Fourth ---------------------------------------- Total interest income $ 12,004 $ 11,620 $ 11,402 $ 11,175 Net interest income 5,344 5,140 5,207 5,061 Provision for losses on loans 526 804 898 2,461 Net income 1,684 1,622 1,416 1,751 Earnings per share: Basic 0.38 0.36 0.32 0.40 Diluted 0.37 0.35 0.31 0.38 Year Ended June 30, 1997 ---------------------------------------- First Second Third Fourth ---------------------------------------- Total interest income $ 11,147 $ 10,956 $ 10,813 $ 11,096 Net interest income 4,865 4,766 4,687 4,862 Provision for losses on loans 90 64 166 373 Net income (loss) (378) 1,265 1,308 1,479 Earnings (loss) per share: Basic (0.08) 0.28 0.29 0.33 Diluted (0.08) 0.27 0.28 0.32
109 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There has been no Current Report on Form 8-K filed within 24 months prior to the date of the most recent financial statements reporting a change of accountants and/or reporting disagreements on any matter of accounting principle or financial statement disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding untimely filings pursuant to Section 16 of the Securities Exchange Act of 1934, as amended, is incorporated herein by reference from the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year. DIRECTORS Information concerning Directors of the Company is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year. EXECUTIVE OFFICERS Information regarding the business experience of the executive officers of the Company and the Bank contained in Part I of this Form 10-K is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, except for information contained under the headings "Board Compensation Committee Report on Executive Compensation" and "Stockholder Return Performance Presentation", a copy of which will be filed not later than 120 days after the close of the fiscal year. 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 definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, a copy of which will be filed not later than 120 days after the close of the fiscal year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in 1998, except for information contained under the headings "Board Compensation Committee Report on Executive Compensation" and "Stockholder Return Performance Presentation", a copy of which will be filed not later than 120 days after the close of the fiscal year. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents filed with this report. (1) See index to consolidated financial statements on page 69 of this report. (2) All supplemental schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the Consolidated Financial Statements or notes thereto. 110 (a) (3) EXHIBITS
REFERENCE SEQUENTIAL TO PAGE NUMBER PRIOR WHERE ATTACHED FILING EXHIBITS ARE OR EXHIBIT LOCATED IN REGULATION NUMBER THIS S-K EXHIBIT ATTACHED FORM 10-K NUMBER DOCUMEN HERETO REPORT 3(i) Articles of Incorporation (1) Not Applicable 3(ii) By-Laws (1) Not Applicable 4.0 Rights Agreement (5) Not Applicable 10.1 Employment contracts between the Bank (1) Not Applicable and Curtis L. Hage and Donald F. Bertsch 10.2 Amendment to employment contract (4) Not Applicable between the Bank and Curtis L. Hage 10.3 Amendment to employment contract (4) Not Applicable between the Bank and Donald F. Bertsch 10.4 1991 Stock Option and Incentive Plan (2) Not Applicable 10.5 Articles of Incorporation of HF Card (4) Not Applicable Services L.L.C. 10.6 Amendment to 1991 Stock Option and (6) Not Applicable Incentive Plan 10.7 1996 Director Restricted Stock Plan (6) Not Applicable 10.8 Employment Contract between the Bank (6) Not Applicable and Gene F. Uher 10.9 Employment Contract between the Bank 10.9 Page and Mark S. Sivertson 10.10 Employment Contract between the Bank 10.10 Page and Michael H. Zimmerman 10.11 Change in Control Contract between 10.11 Page the Bank and Gene F. Uher 10.12 Change in Control Contract between 10.12 Page the Bank and Mark S. Sivertson 10.13 Change in Control Contract between 10.13 Page the Bank and Michael H. Zimmerman 21 Subsidiaries of Registrant 21 Page 23 Consents of Experts and Counsel 23 Page 27 Financial Data Schedule 27 Page
_____________ (1) Filed as exhibits to the Company's Form S-1 registration statement filed on December 6, 1991 (File No. 33-44383) pursuant to Section 5 of the Securities Act of 1933. (2) Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1993. (3) Filed as exhibits to the Company's Annual Report on Form 10K for the fiscal year ended June 30, 1994. (4) Filed as exhibits to the Company's Annual Report on Form 10k for the fiscal year ended June 30, 1996. 111 (5) Filed as Exhibit I to the Company's filing on Form 8-A, filed on October 28, 1996. (6) Filed as exhibits to the Company's Annual Report on Form 10k for the fiscal year ended June 30, 1997. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K. (b) REPORTS ON FORM 8-K No current reports on Form 8-K were filed by the Company during the quarter ended June 30, 1998. 112 SIGNATURES Pursuant to the requirements of Section 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. HF FINANCIAL CORP. By /s/ Curtis L. Hage -------------------------------- Curtis L. Hage, Chairman, President and Chief Executive Officer Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated. /s/ Curtis L. Hage /s/ Donald F. Bertsch - ------------------------------------- ---------------------------------- Curtis L. Hage, Chairman, President Donald F. Bertsch, Senior Vice and Chief Executive Officer President and Chief Financial (PRINCIPAL EXECUTIVE AND OPERATING Officer (PRINCIPAL FINANCIAL AND OFFICER) ACCOUNTING OFFICER) Date: 9/16/98 Date: 9/16/98 -------------------------------- ----------------------------- /s/ Thomas L. Van Wyhe /s/ Paul J. Hallem - ------------------------------------- -------------------------------- Thomas L. Van Wyhe, Director Paul J. Hallem, Director Date: 9/16/98 Date: 9/16/98 -------------------------------- --------------------------- /s/ Jeffrey G. Parker /s/ Robert L. Hanson - ------------------------------------- -------------------------------- Jeffrey G. Parker, Director Robert L. Hanson, Director Date: 9/16/98 Date: 9/16/98 -------------------------------- --------------------------- /s/ William G. Pederson /s/ JoEllen G. Koerner - ------------------------------------- -------------------------------- William. G. Pederson, Director JoEllen G. Koerner, Ph.D., Director Date: 9/18/98 Date: 9/17/98 -------------------------------- --------------------------- /s/ Kevin T. Kirby - ------------------------------------- Kevin T. Kirby, Director Date: 9/16/98 -------------------------------- 113 INDEX TO EXHIBITS
Exhibit Number ------------ 10.9 Employment Contract between the Bank and Mark S. Sivertson 10.10 Employment Contract between the Bank and Michael H. Zimmerman 10.11 Change in Control Contract between the Bank and Gene F. Uher 10.12 Change in Control Contract between the Bank and Mark S. Sivertson 10.13 Change in Control Contract between the Bank and Michael H. Zimmerman 21 Subsidiaries of Registrant 23 Consents of Experts and Counsel 27.1 Financial Data Schedule 27.2 Financial Data Schedule Restated 27.3 Financial Data Schedule Restated
114
EX-10.9 2 EMPLOYMENT CONTRACT WITH MARK S. SIVERTSON EXHIBIT 10.9 HOME FEDERAL SAVINGS BANK EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made and entered into as of this 8th day of April, 1998, contemporaneously with the Change-in-Control Agreement, by and between HOME FEDERAL SAVINGS BANK, a South Dakota corporation (hereinafter referred to as the "Bank"), P. O. Box 5000, Sioux Falls, South Dakota 57117-5000 and Mark S. Sivertson (the "Employee"), 4708 South Shields Avenue, Sioux Falls, South Dakota 57103. RECITALS A. The Employee is currently serving as Senior Vice President/Trust Officer. B. The Board of Directors of the Bank recognizes the important service that the Employee provides and will continue to provide for the Bank. C. The Board of Directors of the Bank has approved and authorized the execution of this Agreement with the Employee to take effect as stated in Section 4 hereof. D. The Board of Directors of the Bank has approved and authorized the execution of a Change-in-Control Agreement with the Employee on contemporaneous basis with this Agreement. COVENANTS NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein contained and further contained in the Change-in-Control Agreement between the parties executed contemporaneously herewith, the parties agree as follows: 1. EMPLOYMENT. (a) The Employee will be employed by the Bank as Senior Vice President/Trust Officer. As Senior Vice President, Employee shall have all such authority, powers, duties and responsibilities customarily afforded to the office of Senior Vice President/Trust Officer. The Employee shall continue to devote his best efforts and substantially all his business time and attention to the business and affairs of the Bank and its subsidiaries and affiliated companies, if any. The Employee shall not, during the term of this Agreement, engage in any other business activity without the Bank's prior written consent. (b) Nothing in the preceding paragraph shall preclude the Employee from (i) serving on the Boards of Directors of other for-profit or of non-profit corporations, as long as service on the same does not conflict with the Employee's obligations to provide his full-time, best efforts employment to the Bank, and (ii) devoting time to "passive investments" not related to service performed on behalf of the Bank. "Passive investments" shall mean investments which do not require any substantial services on behalf of the Employee to the entity which constitutes the investment, which will not detract from the Employee's performance under this Agreement and in which the Employee will invest only his personal funds and/or those of his family. 2. COMPENSATION. (a) BASE SALARY. The Bank agrees to pay the Employee a base salary of NINETY THOUSAND SIX HUNDRED AND 00/100 DOLLARS ($90,600) per year during the term of this Agreement subject to any increases as provided below ("Base Salary"). The Employee's base salary shall be reviewed annually. (b) SHORT-TERM INCENTIVE BONUS. Employee shall be entitled to participate in the Bank's Value-Added Short-Term Incentive Plan and shall receive whatever award is provided for Employee under that Plan. (c) EXPENSES. During the term of his employment hereunder, the Employee shall be entitled to receive prompt reimbursement of all reasonable expenses incurred by him (in accordance with the policies and procedures at least as favorable to the Employee as those presently applicable to the Bank's Executive Officers) in performing services hereunder, provided that the Employee properly accounts therefor in accordance with the Bank policy. 1 3. BENEFITS. (a) PARTICIPATION IN RETIREMENT AND EMPLOYEE BENEFIT PLANS. The Employee shall be entitled while employed hereunder to participate equitably in, and receive benefits under, all plans relating to stock options, stock purchases, pension, salary deferral, thrift, profit-sharing, group life insurance, medical coverage, tuition reimbursement, annual bonus, disability, and other retirement or employee benefits or combinations thereof, that are now or hereafter maintained for the benefit of the Bank's Executive Officers of the same ranking or for its employees generally. (b) FRINGE BENEFITS. The Employee shall be eligible while employed hereunder to participate in, and receive benefits under, any other fringe benefits, which are or may become applicable to the Bank's Executive Officers of the same ranking or to its employees generally. 4. TERM. The term of employment under this Agreement shall be a period of three (3) years commencing on the date this Agreement was executed by both parties (the "Commencement Date"), subject to earlier termination as provided herein. The term of employment under this Agreement shall be extended under the same terms for a period of one year unless at least three months prior to the expiration of the initial term or any renewal term, either the Employee gives written notice to the Chief Executive Officer or the Chief Executive Officer gives notice to the Employee that it intends to terminate the Agreement at the end of its initial term or renewal thereof. Such notice shall be in writing. Reference herein to the term of this Agreement shall refer to both such initial term and any extensions thereof. 5. PERSONAL TIME OFF. The Employee shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment under this Agreement, all such voluntary absences to count as Personal Time Off ("PTO"), provided that: (a) The Employee shall be entitled to PTO, in the amount accrued under the Home Federal Savings Bank's Personal Time Off Policy and Procedures (the "PTO Policy"). (b) The Employee shall utilize any PTO benefit in accordance with the PTO Policy. (c) The Employee shall schedule the timing of PTO in a manner, which does not interfere with the Bank's ability to effectively deliver quality service. 6. TERMINATION OF EMPLOYMENT. (a) TERMINATION FOR CAUSE. The Chief Executive Officer may terminate the Employee's employment at any time for Cause. Upon Termination for Cause, Employee shall be entitled to compensation and benefits up to the date of employment termination, but shall be entitled to no additional compensation or benefits. CAUSE. Termination by the Bank of Employee's employment for "Cause" shall mean termination upon (i) the willful and continued failure by Employee to substantially perform Employee's duties with the Bank (other than any such failures resulting from Employee's disability or from Employee's termination for Good Reason), after a demand for substantial performance is delivered to Employee which specifically identifies the manner in which the Bank believes that Employee has not substantially performed his duties, and Employee has failed to resume substantial performance of those duties on a continuous basis within 14 days of receiving such demand; (ii) Employee's willful engaging in conduct which is demonstrably and materially injurious to the Bank, monetarily or otherwise; (iii) Employee's conviction of a felony which impairs his ability substantially to perform Employee's duties with the Bank; (iv) the Employee's personal dishonesty, incompetence, breach of fiduciary duty for personal profit or willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease and desist order; or (v) the Employee's material breach of this Agreement. For purposes of this Subsection, no act, or failure to act, on the part of the Employee shall be deemed "willful" unless done, or omitted to be done, by Employee not in good faith and without reasonable belief that Employee's action or omission was in the best interest of the Bank. Failure to perform duties with the Bank during any period of disability shall not constitute Cause. (b) EMPLOYMENT AT WILL. Both parties recognize that the Employee is an "at will" employee and that either party may terminate the employment relationship at any time with or without reason. To terminate the employment relationship, either party shall give one month written notice of such termination, or in the alternative, pay the Employee compensation at his normal rate of pay for the notice period. 2 If the employment of the Employee is involuntarily terminated, and such termination is not for Cause, the Employee shall be entitled to receive compensation and benefits through the last day of active employment. 7. REIMBURSEMENT OF ATTORNEY'S FEES. (a) TERMINATION FOR CAUSE. In the event the Bank purports to terminate the Employee for Cause, but it is determined by a court of competent jurisdiction that Cause did not exist for such termination, or if in any event it is determined by any such court that the Bank has failed to make timely payment of any amounts owed to the Employee under this Agreement, the Employee shall be entitled to reimbursement for all reasonable costs, including attorneys' fees, incurred in challenging such termination or collecting such amounts. Such reimbursement shall be in addition to all rights to which the Employee is otherwise entitled under this Agreement. 8. COVENANT NOT TO COMPETE. The Employee covenants and agrees that in the event he voluntarily terminates his employment under Section 6(b) hereof, for a period commencing at the Date of Termination and continuing for a period of 12 months thereafter, the Employee will not: (a) disclose any trade secrets owned by the Bank and learned by the Employee as a result of such employment; (b) solicit any customers who were customers of the Bank within the 12 months immediately preceding the Date of Termination for the benefit of any company or business described in (c) below; or (c) own any part of a Competitor(1) (other than a public company as to which Employee owns five percent or less of the outstanding Common Stock) or work on a full-time, part-time or consulting basis for any corporation, partnership, sole proprietorship, or any other legal entity which is a Competitor (irrespective of the actual location of the Competitor) within the continental United States. For purposes of this Agreement, the Employee's obligations of nonuse and nondisclosure set forth in this Section 8 shall not apply to any information which: (a) is or becomes part of the public domain otherwise than as a consequence of a breach by the Employee of his obligations under this Agreement; (b) was already known to the Employee prior to receipt from the Bank; (c) is lawfully disclosed by the Bank to any third party without restriction; or (d) is disclosed by a third party to the Employee without restriction. This covenant not to compete shall not apply to the Employee if his employment is terminated by the Bank for Cause. 9. CONFIDENTIAL INFORMATION. Employee acknowledges that as a result of employment with the Bank he has access to and knowledge of confidential, trade secret and proprietary information of the Bank. In exchange for the consideration set forth herein and for the consideration set forth in the Change-in-Control Agreement contemporaneously executed, Employee agrees not to disclose to anyone inside or outside the Bank or use for his own benefit or the benefit of others, any of this information without the express written consent of the Bank. Employee acknowledges an unauthorized disclosure or use of this information would be unfair and would cause the Bank irreparable harm. 10. NO SETOFF; MITIGATION; ATTORNEYS' FEES. The Bank's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Bank may have against the Employee or others without the Employee's consent. In no event shall the Employee be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Employee under any of the provisions of this Agreement. The Bank agrees to pay, to the full extent permitted by law, all legal fees and expenses which the Employee may reasonably incur as a result of any contest (regardless of the outcome thereof) by the Bank or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereunder (including as a result of any payment pursuant to Section 6(b) of this Agreement), plus in each case interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code. - --------------------------------- (1) For purposes of this Section 8, "Competitor" shall be defined as a business enterprise which competes with the Bank in offering the same products or services which, in the Bank's fiscal year ended prior to the Date of Termination generated 10% or more of the Bank's total revenues as reflected in the Bank's most recent annual audited financial statements. 3 11. NO ASSIGNMENTS. (a) This Agreement is personal to each of the parties hereto, and neither party may assign or delegate any of its rights or obligations hereunder without first obtaining the written consent of the other party; provided, however, that the Bank will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of Bank, by an assumption agreement in form and substance satisfactory to the Employee in his sole discretion, to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Bank would be required to perform it if no such succession or assignment had taken place. Failure of the Bank to obtain such an assumption agreement prior to the effective date of any such succession or assignment shall be a breach of this Agreement. (b) This Agreement and all rights of the Employee hereunder shall inure to the benefit of and be enforceable by the Employee's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Employee should die while any amounts would still be payable to the Employee hereunder if the Employee had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Employee's devisee, legatee or other designee or if there is no such designee, to the Employee's estate. 12. NOTICE. For the purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or sent by certified mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth on the first page of this Agreement (provided that all notices to the Bank shall be directed to the attention of the Chief Executive Officer of the Bank with a copy to the Secretary of the Bank), or to such other address as either party may have furnished to the other in writing in accordance herewith. Notices shall be effective upon receipt. 13. AMENDMENTS. No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided. 14. PARAGRAPH HEADINGS. The paragraph headings used in this Agreement are included solely for convenience and shall not affect, or be used in connection with, the interpretation of this Agreement. 15. ENTIRE AGREEMENT/WAIVERS. This Agreement represents the entire agreement between the parties and supersedes all previous communications, representations, understandings and agreements, either oral or written, between the Bank and the Employee with respect to the employment of the Employee by the Bank. No waiver of the terms of this Agreement shall be binding upon either party unless in writing, signed by both parties. The waiver or failure of either party to enforce the terms of this Agreement in one instance shall not constitute a waiver of that party's rights under this Agreement with respect to other violations. 16. SEVERABILITY. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 17. GOVERNING LAW. This Agreement shall be governed by the laws of the United States to the extent applicable and otherwise by the laws of the State of South Dakota. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. EMPLOYEE HOME FEDERAL SAVINGS BANK /s/ Mark S. Sivertson /s/ Curtis L. Hage - --------------------------------- -------------------------------- Mark S. Sivertson By: Curtis L. Hage ----------------------------- Its: Chairman, President and ----------------------------- Chief Executive Officer ------------------------- 4 EX-10.10 3 EMPLOYMENT CONTRACT WITH MICHAEL H. ZIMMERMAN EXHIBIT 10.10 HOME FEDERAL SAVINGS BANK EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made and entered into as of this 8th day of April, 1998, contemporaneously with the Change-in-Control Agreement, by and between HOME FEDERAL SAVINGS BANK, a South Dakota corporation (hereinafter referred to as the "Bank"), P. O. Box 5000, Sioux Falls, South Dakota 57117-5000 and Michael H. Zimmerman (the "Employee"), 5505 South Seabrook Circle, Sioux Falls, South Dakota 57108. RECITALS A. The Employee is currently serving as Senior Vice President/Senior Retail Lending Officer. B. The Board of Directors of the Bank recognizes the important service that the Employee provides and will continue to provide for the Bank. C. The Board of Directors of the Bank has approved and authorized the execution of this Agreement with the Employee to take effect as stated in Section 4 hereof. D. The Board of Directors of the Bank has approved and authorized the execution of a Change-in-Control Agreement with the Employee on contemporaneous basis with this Agreement. COVENANTS NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein contained and further contained in the Change-in-Control Agreement between the parties executed contemporaneously herewith, the parties agree as follows: 1. EMPLOYMENT. (a) The Employee will be employed by the Bank as Senior Vice President/Senior Retail Lending Officer. As Senior Vice President, Employee shall have all such authority, powers, duties and responsibilities customarily afforded to the office of Senior Vice President/Senior Retail Lending Officer. The Employee shall continue to devote his best efforts and substantially all his business time and attention to the business and affairs of the Bank and its subsidiaries and affiliated companies, if any. The Employee shall not, during the term of this Agreement, engage in any other business activity without the Bank's prior written consent. (b) Nothing in the preceding paragraph shall preclude the Employee from (i) serving on the Boards of Directors of other for-profit or of non-profit corporations, as long as service on the same does not conflict with the Employee's obligations to provide his full-time, best efforts employment to the Bank, and (ii) devoting time to "passive investments" not related to service performed on behalf of the Bank. "Passive investments" shall mean investments which do not require any substantial services on behalf of the Employee to the entity which constitutes the investment, which will not detract from the Employee's performance under this Agreement and in which the Employee will invest only his personal funds and/or those of his family. 2. COMPENSATION. (a) BASE SALARY. The Bank agrees to pay the Employee a base salary of NINETY-ONE THOUSAND NINE HUNDRED NINETY-SIX AND 00/100 DOLLARS ($91,996) per year during the term of this Agreement subject to any increases as provided below ("Base Salary"). The Employee's base salary shall be reviewed annually. (b) SHORT-TERM INCENTIVE BONUS. Employee shall be entitled to participate in the Bank's Value-Added Short-Term Incentive Plan and shall receive whatever award is provided for Employee under that Plan. (c) EXPENSES. During the term of his employment hereunder, the Employee shall be entitled to receive prompt reimbursement of all reasonable expenses incurred by him (in accordance with the policies and procedures at least as favorable to the Employee as those presently applicable to the Bank's Executive Officers) in performing services hereunder, provided that the Employee properly accounts therefor in accordance with the Bank policy. 1 3. BENEFITS. (a) PARTICIPATION IN RETIREMENT AND EMPLOYEE BENEFIT PLANS. The Employee shall be entitled while employed hereunder to participate equitably in, and receive benefits under, all plans relating to stock options, stock purchases, pension, salary deferral, thrift, profit-sharing, group life insurance, medical coverage, tuition reimbursement, annual bonus, disability, and other retirement or employee benefits or combinations thereof, that are now or hereafter maintained for the benefit of the Bank's Executive Officers of the same ranking or for its employees generally. (b) FRINGE BENEFITS. The Employee shall be eligible while employed hereunder to participate in, and receive benefits under, any other fringe benefits, which are or may become applicable to the Bank's Executive Officers of the same ranking or to its employees generally. 4. TERM. The term of employment under this Agreement shall be a period of three (3) years commencing on the date this Agreement was executed by both parties (the "Commencement Date"), subject to earlier termination as provided herein. The term of employment under this Agreement shall be extended under the same terms for a period of one year unless at least three months prior to the expiration of the initial term or any renewal term, either the Employee gives written notice to the Chief Executive Officer or the Chief Executive Officer gives notice to the Employee that it intends to terminate the Agreement at the end of its initial term or renewal thereof. Such notice shall be in writing. Reference herein to the term of this Agreement shall refer to both such initial term and any extensions thereof. 5. PERSONAL TIME OFF. The Employee shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment under this Agreement, all such voluntary absences to count as Personal Time Off ("PTO"), provided that: (a) The Employee shall be entitled to PTO, in the amount accrued under the Home Federal Savings Bank's Personal Time Off Policy and Procedures (the "PTO Policy"). (b) The Employee shall utilize any PTO benefit in accordance with the PTO Policy. (c) The Employee shall schedule the timing of PTO in a manner, which does not interfere with the Bank's ability to effectively deliver quality service. 6. TERMINATION OF EMPLOYMENT. (a) TERMINATION FOR CAUSE. The Chief Executive Officer may terminate the Employee's employment at any time for Cause. Upon Termination for Cause, Employee shall be entitled to compensation and benefits up to the date of employment termination, but shall be entitled to no additional compensation or benefits. CAUSE. Termination by the Bank of Employee's employment for "Cause" shall mean termination upon (i) the willful and continued failure by Employee to substantially perform Employee's duties with the Bank (other than any such failures resulting from Employee's disability or from Employee's termination for Good Reason), after a demand for substantial performance is delivered to Employee which specifically identifies the manner in which the Bank believes that Employee has not substantially performed his duties, and Employee has failed to resume substantial performance of those duties on a continuous basis within 14 days of receiving such demand; (ii) Employee's willful engaging in conduct which is demonstrably and materially injurious to the Bank, monetarily or otherwise; (iii) Employee's conviction of a felony which impairs his ability substantially to perform Employee's duties with the Bank; (iv) the Employee's personal dishonesty, incompetence, breach of fiduciary duty for personal profit or willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease and desist order; or (v) the Employee's material breach of this Agreement. For purposes of this Subsection, no act, or failure to act, on the part of the Employee shall be deemed "willful" unless done, or omitted to be done, by Employee not in good faith and without reasonable belief that Employee's action or omission was in the best interest of the Bank. Failure to perform duties with the Bank during any period of disability shall not constitute Cause. (b) EMPLOYMENT AT WILL. Both parties recognize that the Employee is an "at will" employee and that either party may terminate the employment relationship at any time with or without reason. To terminate the employment relationship, either party shall give one month written notice of such termination, or in the alternative, pay the Employee compensation at his normal rate of pay for the notice period. 2 If the employment of the Employee is involuntarily terminated, and such termination is not for Cause, the Employee shall be entitled to receive compensation and benefits through the last day of active employment. 7. REIMBURSEMENT OF ATTORNEY'S FEES. (a) TERMINATION FOR CAUSE. In the event the Bank purports to terminate the Employee for Cause, but it is determined by a court of competent jurisdiction that Cause did not exist for such termination, or if in any event it is determined by any such court that the Bank has failed to make timely payment of any amounts owed to the Employee under this Agreement, the Employee shall be entitled to reimbursement for all reasonable costs, including attorneys' fees, incurred in challenging such termination or collecting such amounts. Such reimbursement shall be in addition to all rights to which the Employee is otherwise entitled under this Agreement. 8. COVENANT NOT TO COMPETE. The Employee covenants and agrees that in the event he voluntarily terminates his employment under Section 6(b) hereof, for a period commencing at the Date of Termination and continuing for a period of 12 months thereafter, the Employee will not: (a) disclose any trade secrets owned by the Bank and learned by the Employee as a result of such employment; (b) solicit any customers who were customers of the Bank within the 12 months immediately preceding the Date of Termination for the benefit of any company or business described in (c) below; or (c) own any part of a Competitor (1)(other than a public company as to which Employee owns five percent or less of the outstanding Common Stock) or work on a full-time, part-time or consulting basis for any corporation, partnership, sole proprietorship, or any other legal entity which is a Competitor (irrespective of the actual location of the Competitor) within the continental United States. For purposes of this Agreement, the Employee's obligations of nonuse and nondisclosure set forth in this Section 8 shall not apply to any information which: (a) is or becomes part of the public domain otherwise than as a consequence of a breach by the Employee of his obligations under this Agreement; (b) was already known to the Employee prior to receipt from the Bank; (c) is lawfully disclosed by the Bank to any third party without restriction; or (d) is disclosed by a third party to the Employee without restriction. This covenant not to compete shall not apply to the Employee if his employment is terminated by the Bank for Cause. 9. CONFIDENTIAL INFORMATION. Employee acknowledges that as a result of employment with the Bank he has access to and knowledge of confidential, trade secret and proprietary information of the Bank. In exchange for the consideration set forth herein and for the consideration set forth in the Change-in-Control Agreement contemporaneously executed, Employee agrees not to disclose to anyone inside or outside the Bank or use for his own benefit or the benefit of others, any of this information without the express written consent of the Bank. Employee acknowledges an unauthorized disclosure or use of this information would be unfair and would cause the Bank irreparable harm. 10. NO SETOFF; MITIGATION; ATTORNEYS' FEES. The Bank's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Bank may have against the Employee or others without the Employee's consent. In no event shall the Employee be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Employee under any of the provisions of this Agreement. The Bank agrees to pay, to the full extent permitted by law, all legal fees and expenses which the Employee may reasonably incur as a result of any contest (regardless of the outcome thereof) by the Bank or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereunder (including as a result of any payment pursuant to Section 6(b) of this Agreement), plus in each case interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code. - ------------------------------- (1) For purposes of this Section 8, "Competitor" shall be defined as a business enterprise which competes with the Bank in offering the same products or services which, in the Bank's fiscal year ended prior to the Date of Termination generated 10% or more of the Bank's total revenues as reflected in the Bank's most recent annual audited financial statements. 3 11. NO ASSIGNMENTS. (a) This Agreement is personal to each of the parties hereto, and neither party may assign or delegate any of its rights or obligations hereunder without first obtaining the written consent of the other party; provided, however, that the Bank will require any successor or assign (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of Bank, by an assumption agreement in form and substance satisfactory to the Employee in his sole discretion, to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Bank would be required to perform it if no such succession or assignment had taken place. Failure of the Bank to obtain such an assumption agreement prior to the effective date of any such succession or assignment shall be a breach of this Agreement. (b) This Agreement and all rights of the Employee hereunder shall inure to the benefit of and be enforceable by the Employee's personal and legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Employee should die while any amounts would still be payable to the Employee hereunder if the Employee had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Employee's devisee, legatee or other designee or if there is no such designee, to the Employee's estate. 12. NOTICE. For the purposes of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or sent by certified mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth on the first page of this Agreement (provided that all notices to the Bank shall be directed to the attention of the Chief Executive Officer of the Bank with a copy to the Secretary of the Bank), or to such other address as either party may have furnished to the other in writing in accordance herewith. Notices shall be effective upon receipt. 13. AMENDMENTS. No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided. 14. PARAGRAPH HEADINGS. The paragraph headings used in this Agreement are included solely for convenience and shall not affect, or be used in connection with, the interpretation of this Agreement. 15. ENTIRE AGREEMENT/WAIVERS. This Agreement represents the entire agreement between the parties and supersedes all previous communications, representations, understandings and agreements, either oral or written, between the Bank and the Employee with respect to the employment of the Employee by the Bank. No waiver of the terms of this Agreement shall be binding upon either party unless in writing, signed by both parties. The waiver or failure of either party to enforce the terms of this Agreement in one instance shall not constitute a waiver of that party's rights under this Agreement with respect to other violations. 16. SEVERABILITY. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 17. GOVERNING LAW. This Agreement shall be governed by the laws of the United States to the extent applicable and otherwise by the laws of the State of South Dakota. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. EMPLOYEE HOME FEDERAL SAVINGS BANK /s/ Michael H. Zimmerman /s/ Curtis L. Hage - ------------------------------- --------------------------------- Michael H. Zimmerman By: Curtis L. Hage ----------------------------- Its: Chairman, President and ----------------------------- Chief Executive Officer ------------------------ 4 EX-10.11 4 CHANGE IN CONTROL CONTRACT WITH GENE F. UHER EXHIBIT 10.11 HOME FEDERAL SAVINGS BANK CHANGE-IN-CONTROL AGREEMENT This Change-in-Control Agreement (the "Agreement") is entered into as of this 3rd day of March, 1997 by and between Home Federal Savings Bank, a federally-chartered savings bank (the "Bank") and Gene F. Uher (the "Employee"), currently residing at 4915 Caraway Drive, Sioux Falls, South Dakota 57106. WHEREAS, the Employee is currently serving as a vice president of the Bank, holding the title of Executive Vice President and Chief Operations Officer; and WHEREAS, the Bank is a wholly-owned subsidiary of HF Financial Corp., (the Holding Company"), and the Holding Company offers its common stock for sale to the public and is subject to supervision by the Securities and Exchange Commission ("SEC"); and WHEREAS, both the Bank and the Holding Company are subject to supervision by the Office of Thrift Supervision (the "OTS"); and WHEREAS, the Board of Directors of the Bank recognizes that, as is the case with publicly held corporations generally, the possibility of a change-in-control of the Holding Company may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of key management personnel to the detriment of the Bank, the Holding Company and its stockholders; and WHEREAS, the Board of Directors of the Bank believes it is in the best interests of the Bank to enter into this Agreement with the Employee in order to assure continuity of management of the Bank and to reinforce and encourage the continued attention and dedication of the Employee to his assigned duties without distraction in the face of potentially disruptive circumstances arising from the possibility of a change-in-control of the Holding Company, although no such change is now known of; and WHEREAS, the Board of Directors of the Bank has approved and authorized the execution of this Agreement with the Employee to take effect as stated in Section 1 hereof; NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein contained, it is agreed as follows: 1. TERM OF AGREEMENT. This Agreement will commence on March 3, 1997 and shall continue in effect until the third anniversary of that date; and, commencing on the first anniversary of the date hereof and on each anniversary thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than 90 days prior to any such date of automatic extension of this Agreement, the Bank shall have given notice that the Agreement will not be so extended; provided, however, if a Change-in-Control shall have occurred during the original or any extended term of this Agreement, this Agreement shall in all events continue in effect for a period of 24 months following a Change-in-Control; provided, further, that if Employee becomes entitled to payments in accordance with Section 4 of this Agreement (or asserts a claim for such payments) during the term of this Agreement as heretofore described, this Agreement will thereafter survive indefinitely to ensure that Employee receives all payments and benefits to which Employee is entitled pursuant to the terms hereof. 2. CHANGE-IN-CONTROL. No benefits shall be payable hereunder unless there shall have been a Change-in-Control, as set forth below. For purposes of this Agreement, a "Change-in-Control" shall mean: 1 a. a change-in-control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Holding Company is then subject to such reporting requirement; or b. the public announcement (which, for purposes of this definition, shall include, without limitation, a report filed pursuant to Section 13(d) of the Exchange Act) by the Holding Company or any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) that such person has become the "beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, of securities of the Holding Company (i) representing 20% or more, but not more than 50%, of the combined voting power of the Holding Company's then outstanding securities unless the transaction resulting in such ownership has been approved in advance by the Continuing Directors (as hereinafter defined) or (ii) representing more than 50% of the combined voting power of the Holding Company's then outstanding securities (regardless of any approval by the Continuing Directors); provided, however, that notwithstanding the foregoing, no Change-in-Control shall be deemed to have occurred for purposes of this Agreement by reason of the ownership of 20% or more of the total voting capital stock of the Holding Company then issued and outstanding by the Holding Company, any subsidiary of the Holding Company or any employee benefit plan of the Holding Company or of any subsidiary of the Holding Company or any entity holding shares of the Common Stock organized, appointed or established for, or pursuant to the terms of, any such plan (any such person or entity described in this clause is referred to herein as a "Company Entity"); or c. any acquisition of control as defined in 12 Code of Federal Regulations Section 574.4, or any successor regulation, of the Holding Company which would require the filing of an application for acquisition of control or notice of change in control in a manner which is set forth in 12 CFR Section 574.3, or any successor regulation; or d. the Continuing Directors (as hereinafter defined), cease to constitute a majority of the Holding Company's Board of Directors; or e. the shareholders of the Holding Company approve (i) any consolidation or merger of the Holding Company in which the Holding Company is not the continuing or surviving Holding Company or pursuant to which shares of Holding Company stock would be converted into cash, securities or other property, other than a merger of the Holding Company in which shareholders immediately prior to the merger have the same proportionate ownership of stock of the surviving Holding Company immediately after the merger; (ii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Holding Company; or (iii) any plan of liquidation or dissolution of the Holding Company. For purposes of this definition, "Continuing Director" shall mean any person who is a member of the Board of Directors of the Holding Company, while such person is a member of the Board of Directors, who is not an Acquiring Person (as defined below) or an Affiliate or Associate (as defined below) of an Acquiring Person, or a representative of an Acquiring Person or of any such "Affiliate" or Associate, and who (i) was a member of the Board of Directors on the date of this Agreement as first written above or (ii) subsequently becomes a member of the Board of Directors, if such person's initial nomination for election or initial election to the Board of Directors is recommended or approved by a majority of the Continuing Directors. For purposes of this definition, "Acquiring Person" shall mean any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) who or which, together with all Affiliates and Associates of such person, is the "beneficial owner" (as defined in Rule 1 3d-3 promulgated under the Exchange Act) directly or indirectly, of securities of the Holding Company representing 20% or more of the combined voting power of the Holding Company's then outstanding securities, but shall not include the Investors or any Holding Company Entity; and "Affiliate" and Associate" shall have their respective meanings ascribed to such terms in Rule 12b-2 promulgated under the Exchange Act. 3. TERMINATION FOLLOWING A CHANGE-IN-CONTROL. If a Change-in-Control shall have occurred, Employee shall be 2 entitled to the benefits provided in Section 4(a) hereof upon any termination of Employee's employment within 24 months of such Change-in Control unless such termination is (i) because of Employee's death, (ii) by the Bank for Cause (as defined below) or (iii) by Employee other than for Good Reason (as defined below): a. CAUSE. Termination by the Bank of Employee's employment for Cause" shall mean termination upon (i) the willful and continued failure by Employee to substantially perform Employee's duties with the Bank (other than any such failures resulting from Employee's disability or from Employee's termination for Good Reason), after a demand for substantial performance is delivered to Employee which specifically identifies the manner in which the Bank believes that Employee has not substantially performed his duties, and Employee has failed to resume substantial performance of those duties on a continuous basis within 14 days of receiving such demand, (ii) Employee's willful engaging in conduct which is demonstrably and materially injurious to the Bank, monetarily or otherwise, (iii) Employee's conviction of a felony which impairs his ability substantially to perform Employee's duties with the Bank, (iv) the Employee's personal dishonesty, incompetence, breach of fiduciary duty for personal profit or willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease and desist order, or (v) the Employee's material breach of this Agreement. For purposes of this Subsection, no act, or failure to act, on the part of the Employee shall be deemed "willful" unless done, or omitted to be done, by Employee not in good faith and without reasonable belief that Employee's action or omission was in the best interest of the Bank. Failure to perform duties with the Bank during any period of disability shall not constitute Cause. Notwithstanding the foregoing, Employee shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Employee written notice from the Chief Executive Officer stating that in the good faith opinion of the Chief Executive Officer the Employee was guilty of conduct constituting "Cause" as set forth above and specifying the particulars thereof. b. GOOD REASON. Employee's termination of employment for "Good Reason" shall mean termination by the Employee upon the occurrence, without his express written consent, within 24 months following a Change-in-Control of any one or more of the following: i) the assignment to the Employee of any duties inconsistent in any respect with Employee's position (including status, office, titles, and reporting requirements), authorities, duties, or other responsibilities as in effect immediately prior to the Change-in-Control or any other action of the Bank which results in a diminishment in such position, authority, duties, or responsibilities, other than an insubstantial and inadvertent action which is remedied by the Bank promptly after receipt of notice thereof given by Employee; ii) a reduction by the Bank in Employee's base salary as in effect on the date hereof or as the same shall be increased from time to time; iii) the Bank's requiring Employee to be based at a location outside of Sioux Falls, South Dakota; iv) the failure by the Bank to (a) continue in effect any material compensation or benefit plan, program, policy or practice in which Employee was participating at the time of the Change-in-Control or (b) provide the Employee with compensation and benefits at least equal (in terms of benefit levels and/or reward opportunities) to those provided for under each employee benefit plan, program, policy and practice as in effect immediately prior to the Change-in-Control (or as in e ffect following the Change-in-Control, if greater); v) the failure of the Bank to obtain a satisfactory agreement from any successor to the Bank to assume and agree to perform this Agreement, as contemplated in Section 7 hereof; and vi) any purported termination by the Bank of the Employee's employment that is not effected pursuant to a Notice of Termination (as defined below); The Bank's right to terminate Employee's employment pursuant to this Subsection shall not be affected by the Employee's incapacity due to physical or mental illness. The Employee's continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstance constituting Good Reason hereunder. Employee's Termination of employment for Good Reason as defined in this Subsection 3(b) shall constitute termination for Good Reason for all purposes of this Agreement, notwithstanding that the Employee may also thereby be deemed to have "retired" under any applicable 3 retirement programs of the Bank. c. NOTICE OF TERMINATION. Any purported termination of the Employee's employment by the Bank or by the Employee (other than by reason of the Employee's death) within 24 months following the month in which a Change-in-Control occurs, shall be communicated by Notice of Termination to the other party hereto in accordance with Section 8 hereof. No purported termination of the Employee's employment by the Bank shall be effective if it is not pursuant to a Notice of Termination. Failure by the Employee to provide Notice of Termination shall not limit any of the Employee's rights under this Agreement except to the extent the Bank can demonstrate that it suffered actual damages by reason of such failure. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement which was relied upon and the Date of Termination (as defined below) and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Employee's employment under the provision so indicated. d. DATE OF TERMINATION. "Date of Termination" shall mean the date specified in the Notice of Termination (except in the case of the Employee's death, in which case Date of Termination shall be the date of death); provided, however, that if the Employee's employment is terminated by the Bank, the date specified in the Notice of Termination shall be at least 30 days from the date the Notice of Termination is given to the Employee and if the Employee terminates his employment for Good Reason, the date specified in the Notice of Termination shall not be more than 60 days from the date the Notice of Termination is given to the Bank. 4. COMPENSATION UPON TERMINATION. Following a Change-in-Control, upon termination of employment during the term of this Agreement the Employee shall be entitled to the following benefits: a. If employment by the Bank shall be terminated (A) by the Bank for any reason other than Cause, or (B) by the Employee for Good Reason, the Employee shall be entitled to the benefits, to be funded from the general assets of the Bank, provided below: i) the Bank shall pay the Employee full base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given; ii) the Bank will pay as severance benefits to the Employee, not later than 30 days following the Date of Termination, a lump sum severance payment equal to 299% of the sum of (A) the Employee's annual base salary in effect at the time Notice of Termination is given or immediately prior to the date of the Change-in-Control, whichever is greater, and (B) the greater of incentive compensation payments which were potentially available to the Employee at the time Notice of Termination is given or immediately prior to the date of the Change-in-Control and, in either case, annualized for the entire fiscal year (or if there is no such incentive payment, the amount earned in the last fiscal year prior to the Change-in-Control); iii) for a 24-month period after the Date of Termination, the Bank will arrange to provide the employee with welfare benefits (including life and health insurance benefits), perquisites and other employee benefits of substantially similar design and cost to the Employee as the welfare benefits, perquisites and other employee benefits available to the Employee immediately prior to the Notice of Termination; but benefits otherwise receivable by the Employee pursuant to this Subsection (iii) shall be discontinued if the Employee obtains full-time employment providing welfare benefits during the 24-month period following the Date of Termination. Further the Bank shall permit the Employee and his family to continue on its health and welfare employee benefit plans for a period not to exceed three years with Employee responsible for paying premiums at the COBRA premium rate. iv) the full amount of any long-term cash incentive award for any plan periods then in progress to the extent not provided for in such plan or plans; and v) individual out-placement counseling services for the Employee. b. The payments provided for in Section 4(a) above shall be made not later than 30 days following the Date of Termination; provided, however, that if the amounts of such payments 4 cannot be finally determined, on or before such day, the Bank shall pay to the Employee on such day an estimate as determined in good faith by the Bank of the minimum amount of such payments and shall pay the remainder of such payments (together with interest from the date of such estimated payment at the rate provided in Section 1274(b)(2)(B) of the Internal Revenue Code of 1986, as amended (the "Code")) as soon as the amount thereof can be determined but in no event later than 45 days after the Date of Termination. In the event that the amount of the estimated payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Bank to the Employee payable no later than 30 days after demand by the Bank (together with interest from the date of such estimated payment at the rate provided in Section 1274(b)(2)(B) of the Code. c. The Bank shall also pay to the Employee any legal fees and expenses incurred by the Employee (i) as a result of successful litigation against the Bank for nonpayment of any benefit hereunder or (ii) in connection with any dispute with any Federal, state or local governmental agency with respect to benefits claimed under this Agreement. If the Employee utilizes arbitration to resolve any such dispute, the Bank will pay any legal fees and expenses incurred by the Employee in connection therewith. d. The Employee shall not be required to mitigate the amount of any payment provided for in this Section 4 by seeking other employment or otherwise, nor shall the amount of any payment provided for in this Section 4 be reduced by any compensation earned by the Employee as the result of employment by another employer after the Date of Termination, or otherwise, except as set forth in Section 4a(iii) hereof. e. Notwithstanding anything in this Agreement to the contrary, no payments may be made pursuant to Section 4 hereof without the prior approval of the OTS if following such payment the Bank would not be in compliance with its fully phased-in capital requirements as defined in OTS regulations. Further, any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with 12 USC Section 1828(k) and any regulations promulgated thereunder. f. Any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon this compliance with 12 USC Sec.1828(k) and any regulations promulgated thereunder. 5. CERTAIN REDUCTION OF PAYMENTS by the Bank. Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Bank to or for the benefit of the Employee (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment") would be nondeductible (in whole or part) by the Bank for Federal income tax purposes because of Section 280G of the Code, then the aggregate present value of amounts payable or distributable to or for the benefit of the Employee pursuant to this Agreement (such amounts payable or distributable pursuant to this Agreement are hereinafter referred to as "Agreement Payments") shall be reduced to the Reduced Amount. The "Reduced Amount" shall be an amount, not less than zero, expressed in present value which maximizes the aggregate present value of Agreement Payments without causing any Payment to be nondeductible by the Bank because of Section 280G of the Code. For purposes of this Section 5, present value shall be determined in accordance with Section 280G(d)(4) of the Code. 6. NONEXCLUSIVITY RIGHTS. Nothing in this Agreement shall prevent or limit the Employee's continuing or future participation in any benefit, bonus, incentive, retirement or other plan or program provided by the Bank and for which the Employee may qualify, nor, except as provided in Section 13, shall anything herein limit or reduce such rights as the Employee may have under any other agreement with, or plan, program, policy or practice of, the Bank. Amounts which are vested benefits or which the Employee is otherwise entitled to receive under any agreement with, or plan, program, policy or practice of, the Bank (including, without limitation, the cashout of unused vacation days upon termination of employment) shall be payable in accordance with such agreement, plan, program, policy or practice, except as explicitly modified by this Agreement. 5 7. SUCCESSORS a. The Bank will require any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all or substantially all of the business and/or assets of the Bank or of any division or subsidiary thereof employing the Employee to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Bank would be required to perform if no such succession had taken place. Failure of the Bank to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Employee to compensation from the Bank in the same amount and on the same terms as he would be entitled hereunder if his employment were terminated for Good Reason following a Change-in Control, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination and Notice of Termination shall be deemed to have been given on such date. b. This Agreement shall inure to the benefit of and be enforceable by the Employee's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Employee should die while any amount would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement, to his devisee, legatee or other designee or, if there is no such designee, to his estate or, if no estate, in accordance with applicable law. 8. NOTICE. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, postage prepaid, addressed to the other party as follows: If to the Bank, to: Home Federal Savings Bank Attention: Corporate Secretary 225 South Main Avenue Sioux Falls, SD 57117 If to Employee, to: Gene F. Uher 4915 Caraway Drive Sioux Falls, South Dakota 57106 6 Either party to this Agreement may change its address for purposes of this Section 8 by giving 15 days' prior notice to the other party hereto. 9. MISCELLANEOUS. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Employee and such officer as may be specifically designated by the Board to sign on behalf of the Bank. The validity, interpretation, construction, and performance of this Agreement shall be governed by the laws of the State of South Dakota. 10. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 11. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 12. ARBITRATION. If the Employee so elects, any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that the Employee shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. If the Employee does not elect arbitration, he may pursue any and all legal remedies available to him. 13. EMPLOYMENT AGREEMENT. Reference is hereby made to that certain Agreement, dated contemporaneously with this Agreement, by and between the Bank and the Employee. The termination of the Employment Agreement shall have no effect on the term of this Agreement. All terms and conditions of the Employment Agreement shall continue in full force and effect (until termination of the Employment Agreement in accordance with its terms), including following a Change in Control, except as expressly modified by this Section. The mutual promises in this Agreement and in the Employment Agreement shall serve as consideration for each agreement contemporaneously executed. In the event of a Change-in-Control which triggers the payment of compensation to the Employee pursuant to Section 4 of this Agreement, this Agreement shall supersede and override any rights to payment under the Employment Agreement between the parties executed contemporaneously with this Agreement. 14. EFFECTIVE DATE. This Agreement shall become effective as of the date first set forth in Section 1 hereof. 15. EMPLOYMENT. This Agreement does not constitute a contract of employment or impose on the Bank any obligation to retain the Employee as an employee, to continue his current employment status or to change any employment policies of the Bank. 16. AMENDMENTS. No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided. 17. SEVERABILITY. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or unenforceability of the other provisions hereof. 7 IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. HOME FEDERAL SAVINGS BANK By /s/ Curtis L. Hage ------------------------ Its Chairman/President/CEO ------------------------ EMPLOYEE /s/Gene F. Uher ------------- Gene F. Uher 8 EX-10.12 5 CHANGE IN CONTROL CONTRACT WITH MARK S. SIVERTON EXHIBIT 10.12 HOME FEDERAL SAVINGS BANK CHANGE-IN-CONTROL AGREEMENT This Change-in-Control Agreement (the "Agreement") is entered into as of this 8th day of April, 1998, by and between Home Federal Savings Bank, a federally-chartered savings bank (the "Bank") and Mark S. Sivertson (the "Employee"). WHEREAS, the Employee is currently serving as a senior vice president of the Bank, holding the title of Senior Vice President/Trust Officer; and WHEREAS, the Bank is a wholly-owned subsidiary of HF Financial Corp., (the Holding Company"), and the Holding Company offers its common stock for sale to the public and is subject to supervision by the Securities and Exchange Commission ("SEC"); and WHEREAS, both the Bank and the Holding Company are subject to supervision by the Office of Thrift Supervision (the "OTS"); and WHEREAS, the Board of Directors of the Bank recognizes that, as is the case with publicly held corporations generally, the possibility of a change-in-control of the Holding Company may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of key management personnel to the detriment of the Bank, the Holding Company and its stockholders; and WHEREAS, the Board of Directors of the Bank believes it is in the best interests of the Bank to enter into this Agreement with the Employee in order to assure continuity of management of the Bank and to reinforce and encourage the continued attention and dedication of the Employee to his assigned duties without distraction in the face of potentially disruptive circumstances arising from the possibility of a change-in-control of the Holding Company, although no such change is now known of; and WHEREAS, the Board of Directors of the Bank has approved and authorized the execution of this Agreement with the Employee to take effect as stated in Section 1 hereof. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein contained, it is agreed as follows: 1. TERM OF AGREEMENT. This Agreement will commence on the date hereof and shall continue in effect until the third anniversary of the date hereof; and, commencing on the first anniversary of the date hereof and on each anniversary thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than 90 days prior to any such date of automatic extension of this Agreement, the Bank shall have given notice that the Agreement will not be so extended; provided, however, if a Change-in-Control shall have occurred during the original or any extended term of this Agreement, this Agreement shall in all events continue in effect for a period of 24 months following a Change-in-Control; provided, further, that if Employee becomes entitled to payments in accordance with Section 4 of this Agreement (or assert a claim for such payments) during the term of this Agreement as heretofore described, this Agreement will thereafter survive indefinitely to ensure that Employee receives all payments and benefits to which Employee is entitled pursuant to the terms hereof. 2. CHANGE-IN-CONTROL. No benefits shall be payable hereunder unless there shall have been a Change-in-Control, as set forth below. For purposes of this Agreement, a "Change-in-Control" shall mean: a. a change-in-control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Holding Company is then subject to such reporting requirement; or b. the public announcement (which, for purposes of this definition, shall include, without limitation, a report filed pursuant to Section 13(d) of the Exchange Act) by the Holding Company or any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) that such person has become the "beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, 1 of securities of the Holding Company (i) representing 20% or more, but not more than 50%, of the combined voting power of the Holding Company's then outstanding securities unless the transaction resulting in such ownership has been approved in advance by the Continuing Directors (as hereinafter defined); or (ii) representing more than 50% of the combined voting power of the Holding Company's then outstanding securities (regardless of any approval by the Continuing Directors); provided, however, that notwithstanding the foregoing, no Change-in-Control shall be deemed to have occurred for purposes of this Agreement by reason of the ownership of 20% or more of the total voting capital stock of the Holding Company then issued and outstanding by the Holding Company, any subsidiary of the Holding Company or any employee benefit plan of the Holding Company or of any subsidiary of the Holding Company or any entity holding shares of the Common Stock organized, appointed or established for, or pursuant to the terms of, any such plan (any such person or entity described in this clause is referred to herein as a "Company Entity"); or c. any acquisition of control as defined in 12 Code of Federal Regulations Section 574.4, or any successor regulation, of the Holding Company which would require the filing of an application for acquisition of control or notice of change in control in a manner which is set forth in 12 CFR Section 574.3, or any successor regulation; or d. the Continuing Directors (as hereinafter defined), cease to constitute a majority of the Holding Company's Board of Directors; or e. the shareholders of the Holding Company approve (i) any consolidation or merger of the Holding Company in which the Holding Company is not the continuing or surviving Holding Company or pursuant to which shares of Holding Company stock would be converted into cash, securities or other property, other than a merger of the Holding Company in which shareholders immediately prior to the merger have the same proportionate ownership of stock of the surviving Holding Company immediately after the merger; (ii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Holding Company; or (iii) any plan of liquidation or dissolution of the Holding Company. For purposes of this definition, "Continuing Director" shall mean any person who is a member of the Board of Directors of the Holding Company, while such person is a member of the Board of Directors, who is not an Acquiring Person (as defined below) or an Affiliate or Associate (as defined below) of an Acquiring Person, or a representative of an Acquiring Person or of any such Affiliate or Associate, and who (i) was a member of the Board of Directors on the date of this Agreement as first written above; or (ii) subsequently becomes a member of the Board of Directors, if such person's initial nomination for election or initial election to the Board of Directors is recommended or approved by a majority of the Continuing Directors. For purposes of this definition, "Acquiring Person" shall mean any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) who or which, together with all Affiliates and Associates of such person, is the "beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange Act) directly or indirectly, of securities of the Holding Company representing 20% or more of the combined voting power of the Holding Company's then outstanding securities, but shall not include the Investors or any Holding Company Entity; and "Affiliate" and Associate" shall have their respective meanings ascribed to such terms in Rule 12b-2 promulgated under the Exchange Act. 3. TERMINATION FOLLOWING A CHANGE-IN-CONTROL. If a Change-in-Control shall have occurred, Employee shall be entitled to the benefits provided in Section 4(a) hereof upon any termination of Employee's employment during the term of this Agreement unless such termination is (i) because of Employee's death; (ii) by the Bank for Cause (as defined below); or (iii) by Employee other than for Good Reason (as defined below): a. CAUSE. Termination by the Bank of Employee's employment for "Cause" shall mean termination upon (i) the willful and continued failure by Employee to substantially perform Employee's duties with the Bank (other than any such failures resulting from Employee's disability or from Employee's termination for Good Reason), after a demand for substantial performance is delivered to Employee which specifically identifies the manner in which the Bank believes that Employee has not substantially performed his duties, and Employee has failed to resume substantial performance of those duties on a continuous basis 2 within 14 days of receiving such demand; (ii) Employee's willful engaging in conduct which is demonstrably and materially injurious to the Bank, monetarily or otherwise; (iii) Employee's conviction of a felony which impairs his ability substantially to perform Employee's duties with the Bank; (iv) the Employee's personal dishonesty, incompetence, breach of fiduciary duty for personal profit or willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease and desist order; or (v) the Employee's material breach of this Agreement. For purposes of this Subsection, no act, or failure to act, on the part of the Employee shall be deemed "willful" unless done, or omitted to be done, by Employee not in good faith and without reasonable belief that Employee's action or omission was in the best interest of the Bank. Failure to perform duties with the Bank during any period of disability shall not constitute Cause. b. GOOD REASON. Employee's termination of employment for "Good Reason" shall mean termination by the Employee upon the occurrence, without his express written consent, within 24 months following a Change-in-Control of any one or more of the following: i) the assignment to the Employee of any duties inconsistent in any respect with Employee's position (including status, offices, titles, and reporting requirements), authorities, duties, or other responsibilities as in effect immediately prior to the Change-in-Control or any other action of the Bank which results in a diminishment in such position, authority, duties, or responsibilities, other than an insubstantial and inadvertent action which is remedied by the Bank promptly after receipt of notice thereof given by Employee; ii) a reduction by the Bank in Employee's base salary as in effect on the date hereof or as the same shall be increased from time to time; iii) the Bank's requiring Employee to be based at a location outside of Sioux Falls, South Dakota; iv) the failure by the Bank to (a) continue in effect any material compensation or benefit plan, program, policy or practice in which Employee was participating at the time of the Change-in-Control, or (b) provide the Employee with compensation and benefits at least equal (in terms of benefit levels and/or reward opportunities) to those provided for under each employee benefit plan, program, policy and practice as in effect immediately prior to the Change-in-Control (or as in effect following the Change-in-Control, if greater); v) the failure of the Bank to obtain a satisfactory agreement from any successor to the Bank to assume and agree to perform this Agreement, as contemplated in Section 7 hereof; and vi) any purported termination by the Bank of the Employee's employment that is not effected pursuant to a Notice of Termination (as defined below); The Bank's right to terminate Employee's employment pursuant to this Subsection shall not be affected by the Employee's incapacity due to physical or mental illness. The Employee's continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstance constituting Good Reason hereunder. Employee's termination of employment for Good Reason as defined in this Subsection 3(b) shall constitute termination for Good Reason for all purposes of this Agreement, notwithstanding that the Employee may also thereby be deemed to have "retired" under any applicable retirement programs of the Bank. c. NOTICE OF TERMINATION. Any purported termination of the Employee's employment by the Bank or by the Employee (other than by reason of the Employee's death) within 24 months following the month in which a Change-in-Control occurs, shall be communicated by Notice of Termination to the other party hereto in accordance with Section 8 hereof. No purported termination of the Employee's employment by the Bank shall be effective if it is not pursuant to a Notice of Termination. Failure by the Employee to provide Notice of Termination shall not limit any of the Employee's rights under this Agreement except to the extent the Bank can demonstrate that it suffered actual damages by reason of such failure. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and the Date of Termination (as defined below) and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Employee's employment under the provision so indicated. d. DATE OF TERMINATION. "Date of Termination" shall mean the date specified in the Notice of Termination (except in the case of the Employee's death, in which case Date of Termination shall be the date 3 of death); provided, however, that if the Employee's employment is terminated by the Bank, the date specified in the Notice of Termination shall be at least 30 days from the date the Notice of Termination is given to the Employee and if the Employee terminates his employment for Good Reason, the date specified in the Notice of Termination shall not be more than 60 days from the date the Notice of Termination is given to the Bank. 4. COMPENSATION UPON TERMINATION. Following a Change-in-Control, upon termination of employment during the term of this Agreement the Employee shall be entitled to the following benefits: a. If employment by the Bank shall be terminated (A) by the Bank for any reason other than Cause, or (B) by the Employee for Good Reason, the Employee shall be entitled to the benefits, to be funded from the general assets of the Bank, provided below: i) the Bank shall pay the Employee full base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given; ii) the Bank will pay as severance benefits to the Employee, not later than 30 days following the Date of Termination, a lump sum severance payment equal to 1.5 times the sum of (A) the Employee's annual base salary in effect at the time Notice of Termination is given or immediately prior to the date of the Change-in-Control, whichever is greater, and (B) annual incentive compensation payments which were potentially available to the Employee at the time Notice of Termination is given or immediately prior to the date of the Change-in-Control, whichever is greater (or if there is no such incentive payment, the amount earned in the last fiscal year prior to the Change-in-Control); iii) for a 18-month period after the Date of Termination, the Bank will arrange to provide the Employee with welfare benefits (including life and health insurance benefits), perquisites and other employee benefits of substantially similar design and cost to the Employee as the welfare benefits, perquisites and other employee benefits available to the Employee immediately prior to the Notice of Termination; but benefits otherwise receivable by the Employee pursuant to this Subsection (iii) shall be discontinued if the Employee obtains full-time employment providing welfare benefits during the 18-month period following the Date of Termination; iv) the full amount of any long-term cash incentive award for any plan periods then in progress to the extent not provided for in such plan or plans; and v) the Bank shall pay for individual out-placement counseling services for the Employee. b. The payments provided for in Section 4(a) above shall be made not later than 30 days following the Date of Termination; provided, however, that if the amounts of such payments cannot be finally determined, on or before such day, the Bank shall pay to the Employee on such day an estimate as determined in good faith by the Bank of the minimum amount of such payments and shall pay the remainder of such payments (together with interest from the date of such estimated payment at the rate provided in Section 1274(b)(2)(B) of the Internal Revenue Code of 1986, as amended (the "Code")) as soon as the amount thereof can be determined but in no event later than 45 days after the Date of Termination. In the event that the amount of the estimated payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Bank to the Employee payable no later than 30 days after demand by the Bank (together with interest from the date of such estimated payment at the rate provided in Section 1274(b)(2)(B) of the Code. c. The Bank shall also pay to the Employee any legal fees and expenses incurred by the Employee (i) as a result of successful litigation against the Bank for nonpayment of any benefit hereunder, or (ii) in connection with any dispute with any Federal, state or local governmental agency with respect to benefits claimed under this Agreement. If the Employee utilizes arbitration to resolve any such dispute, the Bank will pay any legal fees and expenses incurred by the Employee in connection therewith. d. The Employee shall not be required to mitigate the amount of any payment provided for in this Section 4 by seeking other employment or otherwise, nor shall the amount of any payment provided for in this Section 4 be reduced by any compensation earned by the Employee as the result of employment by another employer after the Date of Termination, or otherwise, except as set forth in Section 4a(iii) hereof. 4 e. Notwithstanding anything in this Agreement to the contrary, no payments may be made pursuant to Section 4 hereof without the prior approval of the OTS if following such payment the Bank would not be in compliance with its fully phased-in capital requirements as defined in OTS regulations. Further, any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with 12 USC Section 1828(k) and any regulations promulgated thereunder. 5. CERTAIN REDUCTION OF PAYMENTS BY THE BANK. Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Bank to or for the benefit of the Employee (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment") would be nondeductible (in whole or part) by the Bank for Federal income tax purposes because of Section 280G of the Code, then the aggregate present value of amounts payable or distributable to or for the benefit of the Employee pursuant to this Agreement (such amounts payable or distributable pursuant to this Agreement are hereinafter referred to as "Agreement Payments") shall be reduced to the Reduced Amount. The "Reduced Amount" shall be an amount, not less than zero, expressed in present value which maximizes the aggregate present value of Agreement Payments without causing any Payment to be nondeductible by the Bank because of Section 280G of the Code. For purposes of this Section 5, present value shall be determined in accordance with Section 280G(d)(4) of the Code. 6. NONEXCLUSIVITY RIGHTS. Nothing in this Agreement shall prevent or limit the Employee's continuing or future participation in any benefit, bonus, incentive, retirement or other plan or program provided by the Bank and for which the Employee may qualify, nor, except as provided in Section 13, shall anything herein limit or reduce such rights as the Employee may have under any other agreement with, or plan, program, policy or practice of, the Bank. Amounts which are vested benefits or which the Employee is otherwise entitled to receive under any agreement with, or plan, program, policy or practice of, the Bank (including, without limitation, the cashout of unused vacation days upon termination of employment) shall be payable in accordance with such agreement, plan, program, policy or practice, except as explicitly modified by this Agreement. 7. SUCCESSORS a. The Bank will require any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all or substantially all of the business and/or assets of the Bank or of any division or subsidiary thereof employing the Employee to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Bank would be required to perform if no such succession had taken place. Failure of the Bank to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Employee to compensation from the Bank in the same amount and on the same terms as he would be entitled hereunder if his employment were terminated for Good Reason following a Change-in-Control, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination and Notice of Termination shall be deemed to have been given on such date. b. This Agreement shall inure to the benefit of and be enforceable by the Employee's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Employee should die while any amount would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement, to his devisee, legatee or other designee or, if there is no such designee, to his estate or, if no estate, in accordance with applicable law. 8. NOTICE. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, postage prepaid, addressed to the other party as follows: IF TO THE BANK, TO: Home Federal Savings Bank Attention: Corporate Secretary 225 South Main Avenue Sioux Falls, SD 57117 5 IF TO EMPLOYEE, TO: Mark S. Sivertson 4708 South Shields Avenue Sioux Falls, SD 57103 Either party to this Agreement may change its address for purposes of this Section 8 by giving 15 days' prior notice to the other party hereto. 9. MISCELLANEOUS. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Employee and such officer as may be specifically designated by the Board to sign on behalf of the Bank. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of South Dakota. 10. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 11. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 12. ARBITRATION. If the Employee so elects, any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that the Employee shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. If the Employee does not elect arbitration, he may pursue any and all legal remedies available to him. 13. EMPLOYMENT AGREEMENT. Reference is hereby made to that certain Agreement, dated contemporaneously with this Agreement, by and between the Bank and the Employee. The termination of the Employment Agreement shall have no effect on the term of this Agreement. All terms and conditions of the Employment Agreement shall continue in full force and effect (until termination of the Employment Agreement in accordance with its terms), including following a Change-in-Control, except as expressly modified by this Section. The mutual promises in this Agreement and in the Employment Agreement shall serve as consideration for each agreement contemporaneously executed. 14. EFFECTIVE DATE. This Agreement shall become effective as of the date first set forth above. 15. EMPLOYMENT. This Agreement does not constitute a contract of employment or impose on the Bank any obligation to retain the Employee as an employee, to continue his current employment status or to change any employment policies of the Bank. 16. AMENDMENTS. No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided. 17. SEVERABILITY. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or unenforceability of the other provisions hereof. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. HOME FEDERAL SAVINGS BANK /s/ Curtis L. Hage ---------------------------------------- By: Curtis L. Hage ----------------------------------- Its: Chairman, President and ----------------------------------- Chief Executive Officer ------------------------------ 6 EMPLOYEE /s/ Mark S. Sivertson ---------------------------------------- Mark S. Sivertson 7 EX-10.13 6 CHANGE IN CONTROL CONTRACT WITH MICHAEL H. ZIMMERM EXHIBIT 10.13 HOME FEDERAL SAVINGS BANK CHANGE-IN-CONTROL AGREEMENT This Change-in-Control Agreement (the "Agreement") is entered into as of this 8th day of April, 1998, by and between Home Federal Savings Bank, a federally-chartered savings bank (the "Bank") and Michael H. Zimmerman (the "Employee"). WHEREAS, the Employee is currently serving as a senior vice president of the Bank, holding the title of Senior Vice President/Senior Retail Lending Officer; and WHEREAS, the Bank is a wholly-owned subsidiary of HF Financial Corp., (the Holding Company"), and the Holding Company offers its common stock for sale to the public and is subject to supervision by the Securities and Exchange Commission ("SEC"); and WHEREAS, both the Bank and the Holding Company are subject to supervision by the Office of Thrift Supervision (the "OTS"); and WHEREAS, the Board of Directors of the Bank recognizes that, as is the case with publicly held corporations generally, the possibility of a change-in-control of the Holding Company may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of key management personnel to the detriment of the Bank, the Holding Company and its stockholders; and WHEREAS, the Board of Directors of the Bank believes it is in the best interests of the Bank to enter into this Agreement with the Employee in order to assure continuity of management of the Bank and to reinforce and encourage the continued attention and dedication of the Employee to his assigned duties without distraction in the face of potentially disruptive circumstances arising from the possibility of a change-in-control of the Holding Company, although no such change is now known of; and WHEREAS, the Board of Directors of the Bank has approved and authorized the execution of this Agreement with the Employee to take effect as stated in Section 1 hereof. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein contained, it is agreed as follows: 1. TERM OF AGREEMENT. This Agreement will commence on the date hereof and shall continue in effect until the third anniversary of the date hereof; and, commencing on the first anniversary of the date hereof and on each anniversary thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than 90 days prior to any such date of automatic extension of this Agreement, the Bank shall have given notice that the Agreement will not be so extended; provided, however, if a Change-in-Control shall have occurred during the original or any extended term of this Agreement, this Agreement shall in all events continue in effect for a period of 24 months following a Change-in-Control; provided, further, that if Employee becomes entitled to payments in accordance with Section 4 of this Agreement (or assert a claim for such payments) during the term of this Agreement as heretofore described, this Agreement will thereafter survive indefinitely to ensure that Employee receives all payments and benefits to which Employee is entitled pursuant to the terms hereof. 2. CHANGE-IN-CONTROL. No benefits shall be payable hereunder unless there shall have been a Change-in-Control, as set forth below. For purposes of this Agreement, a "Change-in-Control" shall mean: a. a change-in-control of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Holding Company is then subject to such reporting requirement; or b. the public announcement (which, for purposes of this definition, shall include, without limitation, a report filed pursuant to Section 13(d) of the Exchange Act) by the Holding Company or any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) that such person has become the "beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, of securities of the Holding Company (i) representing 20% or more, but not more than 50%, of the combined 1 voting power of the Holding Company's then outstanding securities unless the transaction resulting in such ownership has been approved in advance by the Continuing Directors (as hereinafter defined); or (ii) representing more than 50% of the combined voting power of the Holding Company's then outstanding securities (regardless of any approval by the Continuing Directors); provided, however, that notwithstanding the foregoing, no Change-in-Control shall be deemed to have occurred for purposes of this Agreement by reason of the ownership of 20% or more of the total voting capital stock of the Holding Company then issued and outstanding by the Holding Company, any subsidiary of the Holding Company or any employee benefit plan of the Holding Company or of any subsidiary of the Holding Company or any entity holding shares of the Common Stock organized, appointed or established for, or pursuant to the terms of, any such plan (any such person or entity described in this clause is referred to herein as a "Company Entity"); or c. any acquisition of control as defined in 12 Code of Federal Regulations Section 574.4, or any successor regulation, of the Holding Company which would require the filing of an application for acquisition of control or notice of change in control in a manner which is set forth in 12 CFR Section 574.3, or any successor regulation; or d. the Continuing Directors (as hereinafter defined), cease to constitute a majority of the Holding Company's Board of Directors; or e. the shareholders of the Holding Company approve (i) any consolidation or merger of the Holding Company in which the Holding Company is not the continuing or surviving Holding Company or pursuant to which shares of Holding Company stock would be converted into cash, securities or other property, other than a merger of the Holding Company in which shareholders immediately prior to the merger have the same proportionate ownership of stock of the surviving Holding Company immediately after the merger; (ii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Holding Company; or (iii) any plan of liquidation or dissolution of the Holding Company. For purposes of this definition, "Continuing Director" shall mean any person who is a member of the Board of Directors of the Holding Company, while such person is a member of the Board of Directors, who is not an Acquiring Person (as defined below) or an Affiliate or Associate (as defined below) of an Acquiring Person, or a representative of an Acquiring Person or of any such Affiliate or Associate, and who (i) was a member of the Board of Directors on the date of this Agreement as first written above; or (ii) subsequently becomes a member of the Board of Directors, if such person's initial nomination for election or initial election to the Board of Directors is recommended or approved by a majority of the Continuing Directors. For purposes of this definition, "Acquiring Person" shall mean any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) who or which, together with all Affiliates and Associates of such person, is the "beneficial owner" (as defined in Rule 13d-3 promulgated under the Exchange Act) directly or indirectly, of securities of the Holding Company representing 20% or more of the combined voting power of the Holding Company's then outstanding securities, but shall not include the Investors or any Holding Company Entity; and "Affiliate" and Associate" shall have their respective meanings ascribed to such terms in Rule 12b-2 promulgated under the Exchange Act. 3. TERMINATION FOLLOWING A CHANGE-IN-CONTROL. If a Change-in-Control shall have occurred, Employee shall be entitled to the benefits provided in Section 4(a) hereof upon any termination of Employee's employment during the term of this Agreement unless such termination is (i) because of Employee's death; (ii) by the Bank for Cause (as defined below); or (iii) by Employee other than for Good Reason (as defined below): a. CAUSE. Termination by the Bank of Employee's employment for "Cause" shall mean termination upon (i) the willful and continued failure by Employee to substantially perform Employee's duties with the Bank (other than any such failures resulting from Employee's disability or from Employee's termination for Good Reason), after a demand for substantial performance is delivered to Employee which specifically identifies the manner in which the Bank believes that Employee has not substantially performed his duties, and Employee has failed to resume substantial performance of those duties on a continuous basis within 14 days of receiving such demand; (ii) Employee's willful engaging in conduct which is demonstrably and materially injurious to the Bank, monetarily or otherwise; (iii) Employee's conviction of a felony which 2 impairs his ability substantially to perform Employee's duties with the Bank; (iv) the Employee's personal dishonesty, incompetence, breach of fiduciary duty for personal profit or willful violation of any law, rule or regulation (other than traffic violations or similar offenses) or final cease and desist order; or (v) the Employee's material breach of this Agreement. For purposes of this Subsection, no act, or failure to act, on the part of the Employee shall be deemed "willful" unless done, or omitted to be done, by Employee not in good faith and without reasonable belief that Employee's action or omission was in the best interest of the Bank. Failure to perform duties with the Bank during any period of disability shall not constitute Cause. b. GOOD REASON. Employee's termination of employment for "Good Reason" shall mean termination by the Employee upon the occurrence, without his express written consent, within 24 months following a Change-in-Control of any one or more of the following: i) the assignment to the Employee of any duties inconsistent in any respect with Employee's position (including status, offices, titles, and reporting requirements), authorities, duties, or other responsibilities as in effect immediately prior to the Change-in-Control or any other action of the Bank which results in a diminishment in such position, authority, duties, or responsibilities, other than an insubstantial and inadvertent action which is remedied by the Bank promptly after receipt of notice thereof given by Employee; ii) a reduction by the Bank in Employee's base salary as in effect on the date hereof or as the same shall be increased from time to time; iii) the Bank's requiring Employee to be based at a location outside of Sioux Falls, South Dakota; iv) the failure by the Bank to (a) continue in effect any material compensation or benefit plan, program, policy or practice in which Employee was participating at the time of the Change-in-Control, or (b) provide the Employee with compensation and benefits at least equal (in terms of benefit levels and/or reward opportunities) to those provided for under each employee benefit plan, program, policy and practice as in effect immediately prior to the Change-in-Control (or as in effect following the Change-in-Control, if greater); v) the failure of the Bank to obtain a satisfactory agreement from any successor to the Bank to assume and agree to perform this Agreement, as contemplated in Section 7 hereof; and vi) any purported termination by the Bank of the Employee's employment that is not effected pursuant to a Notice of Termination (as defined below); The Bank's right to terminate Employee's employment pursuant to this Subsection shall not be affected by the Employee's incapacity due to physical or mental illness. The Employee's continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstance constituting Good Reason hereunder. Employee's termination of employment for Good Reason as defined in this Subsection 3(b) shall constitute termination for Good Reason for all purposes of this Agreement, notwithstanding that the Employee may also thereby be deemed to have "retired" under any applicable retirement programs of the Bank. c. NOTICE OF TERMINATION. Any purported termination of the Employee's employment by the Bank or by the Employee (other than by reason of the Employee's death) within 24 months following the month in which a Change-in-Control occurs, shall be communicated by Notice of Termination to the other party hereto in accordance with Section 8 hereof. No purported termination of the Employee's employment by the Bank shall be effective if it is not pursuant to a Notice of Termination. Failure by the Employee to provide Notice of Termination shall not limit any of the Employee's rights under this Agreement except to the extent the Bank can demonstrate that it suffered actual damages by reason of such failure. For purposes of this Agreement, a "Notice of Termination" shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and the Date of Termination (as defined below) and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Employee's employment under the provision so indicated. d. DATE OF TERMINATION. "Date of Termination" shall mean the date specified in the Notice of Termination (except in the case of the Employee's death, in which case Date of Termination shall be the date of death); provided, however, that if the Employee's employment is terminated by the Bank, the date specified in the Notice of Termination shall be at least 30 days from the date the Notice of Termination is given to the Employee and if the Employee terminates his employment for Good Reason, the date specified 3 in the Notice of Termination shall not be more than 60 days from the date the Notice of Termination is given to the Bank. 4. COMPENSATION UPON TERMINATION. Following a Change-in-Control, upon termination of employment during the term of this Agreement the Employee shall be entitled to the following benefits: a. If employment by the Bank shall be terminated (A) by the Bank for any reason other than Cause, or (B) by the Employee for Good Reason, the Employee shall be entitled to the benefits, to be funded from the general assets of the Bank, provided below: i) the Bank shall pay the Employee full base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given; ii) the Bank will pay as severance benefits to the Employee, not later than 30 days following the Date of Termination, a lump sum severance payment equal to 2.99 times the sum of (A) the Employee's annual base salary in effect at the time Notice of Termination is given or immediately prior to the date of the Change-in-Control, whichever is greater, and (B) annual incentive compensation payments which were potentially available to the Employee at the time Notice of Termination is given or immediately prior to the date of the Change-in-Control, whichever is greater (or if there is no such incentive payment, the amount earned in the last fiscal year prior to the Change-in-Control); iii) for the remaining term of the Agreement after the Date of Termination, the Bank will arrange to provide the Employee with welfare benefits (including life and health insurance benefits), perquisites and other employee benefits of substantially similar design and cost to the Employee as the welfare benefits, perquisites and other employee benefits available to the Employee immediately prior to the Notice of Termination; but benefits otherwise receivable by the Employee pursuant to this Subsection (iii) shall be discontinued if the Employee obtains full-time employment providing welfare benefits during the remaining term of the Agreement following the Date of Termination; iv) the full amount of any long-term cash incentive award for any plan periods then in progress to the extent not provided for in such plan or plans; and v) the Bank shall pay for individual out-placement counseling services for the Employee. b. The payments provided for in Section 4(a) above shall be made not later than 30 days following the Date of Termination; provided, however, that if the amounts of such payments cannot be finally determined, on or before such day, the Bank shall pay to the Employee on such day an estimate as determined in good faith by the Bank of the minimum amount of such payments and shall pay the remainder of such payments (together with interest from the date of such estimated payment at the rate provided in Section 1274(b)(2)(B) of the Internal Revenue Code of 1986, as amended (the "Code")) as soon as the amount thereof can be determined but in no event later than 45 days after the Date of Termination. In the event that the amount of the estimated payment exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Bank to the Employee payable no later than 30 days after demand by the Bank (together with interest from the date of such estimated payment at the rate provided in Section 1274(b)(2)(B) of the Code. c. The Bank shall also pay to the Employee any legal fees and expenses incurred by the Employee (i) as a result of successful litigation against the Bank for nonpayment of any benefit hereunder, or (ii) in connection with any dispute with any Federal, state or local governmental agency with respect to benefits claimed under this Agreement. If the Employee utilizes arbitration to resolve any such dispute, the Bank will pay any legal fees and expenses incurred by the Employee in connection therewith. d. The Employee shall not be required to mitigate the amount of any payment provided for in this Section 4 by seeking other employment or otherwise, nor shall the amount of any payment provided for in this Section 4 be reduced by any compensation earned by the Employee as the result of employment by another employer after the Date of Termination, or otherwise, except as set forth in Section 4a(iii) hereof. e. Notwithstanding anything in this Agreement to the contrary, no payments may be made pursuant to Section 4 hereof without the prior approval of the OTS if following such payment the Bank would not be in compliance with its fully phased-in capital requirements as defined in OTS regulations. 4 Further, any payments made to the Employee pursuant to this Agreement, or otherwise, are subject to and conditioned upon their compliance with 12 USC Section 1828(k) and any regulations promulgated thereunder. 5. CERTAIN REDUCTION OF PAYMENTS BY THE BANK. Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Bank to or for the benefit of the Employee (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment") would be nondeductible (in whole or part) by the Bank for Federal income tax purposes because of Section 280G of the Code, then the aggregate present value of amounts payable or distributable to or for the benefit of the Employee pursuant to this Agreement (such amounts payable or distributable pursuant to this Agreement are hereinafter referred to as "Agreement Payments") shall be reduced to the Reduced Amount. The "Reduced Amount" shall be an amount, not less than zero, expressed in present value which maximizes the aggregate present value of Agreement Payments without causing any Payment to be nondeductible by the Bank because of Section 280G of the Code. For purposes of this Section 5, present value shall be determined in accordance with Section 280G(d)(4) of the Code. 6. NONEXCLUSIVITY RIGHTS. Nothing in this Agreement shall prevent or limit the Employee's continuing or future participation in any benefit, bonus, incentive, retirement or other plan or program provided by the Bank and for which the Employee may qualify, nor, except as provided in Section 13, shall anything herein limit or reduce such rights as the Employee may have under any other agreement with, or plan, program, policy or practice of, the Bank. Amounts which are vested benefits or which the Employee is otherwise entitled to receive under any agreement with, or plan, program, policy or practice of, the Bank (including, without limitation, the cashout of unused vacation days upon termination of employment) shall be payable in accordance with such agreement, plan, program, policy or practice, except as explicitly modified by this Agreement. 7. SUCCESSORS a. The Bank will require any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all or substantially all of the business and/or assets of the Bank or of any division or subsidiary thereof employing the Employee to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Bank would be required to perform if no such succession had taken place. Failure of the Bank to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Employee to compensation from the Bank in the same amount and on the same terms as he would be entitled hereunder if his employment were terminated for Good Reason following a Change-in-Control, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination and Notice of Termination shall be deemed to have been given on such date. b. This Agreement shall inure to the benefit of and be enforceable by the Employee's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Employee should die while any amount would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement, to his devisee, legatee or other designee or, if there is no such designee, to his estate or, if no estate, in accordance with applicable law. 8. NOTICE. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, postage prepaid, addressed to the other party as follows: IF TO THE BANK, TO: Home Federal Savings Bank Attention: Corporate Secretary 225 South Main Avenue Sioux Falls, SD 57117 5 IF TO EMPLOYEE, TO: Michael H. Zimmerman 5505 Seabrook Circle Sioux Falls, SD 57108 Either party to this Agreement may change its address for purposes of this Section 8 by giving 15 days' prior notice to the other party hereto. 9. MISCELLANEOUS. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Employee and such officer as may be specifically designated by the Board to sign on behalf of the Bank. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of South Dakota. 10. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 11. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 12. ARBITRATION. If the Employee so elects, any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that the Employee shall be entitled to seek specific performance of his right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement. If the Employee does not elect arbitration, he may pursue any and all legal remedies available to him. 13. EMPLOYMENT AGREEMENT. Reference is hereby made to that certain Agreement, dated contemporaneously with this Agreement, by and between the Bank and the Employee. The termination of the Employment Agreement shall have no effect on the term of this Agreement. All terms and conditions of the Employment Agreement shall continue in full force and effect (until termination of the Employment Agreement in accordance with its terms), including following a Change-in-Control, except as expressly modified by this Section. The mutual promises in this Agreement and in the Employment Agreement shall serve as consideration for each agreement contemporaneously executed. 14. EFFECTIVE DATE. This Agreement shall become effective as of the date first set forth above. 15. EMPLOYMENT. This Agreement does not constitute a contract of employment or impose on the Bank any obligation to retain the Employee as an employee, to continue his current employment status or to change any employment policies of the Bank. 16. AMENDMENTS. No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided. 17. SEVERABILITY. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or unenforceability of the other provisions hereof. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. HOME FEDERAL SAVINGS BANK /s/ Curtis L. Hage --------------------------------------------- By: Curtis L. Hage ---------------------------------------- Its: Chairman, President and ---------------------------------------- Chief Executive Officer ----------------------------------- 6 EMPLOYEE /s/ Michael H. Zimmerman --------------------------------------------- Michael H. Zimmerman 7 EX-21 7 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT
PERCENTAGE STATE OF INCORPORATION PARENT SUBSIDIARY OF OWNERSHIP OR ORGANIZATION ------ ---------- ------------ --------------------- HF Financial Corp. Home Federal Savings Bank 100% Delaware HF Financial Corp. HomeFirst Mortgage Corp. 100% South Dakota HF Financial Corp. HF Card Services L.L.C. 51% South Dakota Home Federal Savings Bank Hometown Insurors, Inc. 100% South Dakota Home Federal Savings Bank Mid-America Service Corporation 100% South Dakota Home Federal Savings Bank PMD, Inc. 100% South Dakota
The financial statements of HF Financial Corp. are consolidated with those of its subsidiaries. 1
EX-23 8 CONSENTS OF EXPERTS AND COUNSEL EXHIBIT 23 EXHIBIT 23.0 ACCOUNTANT'S CONSENT We consent to the incorporation by reference in the Registration Statements on Form S-8 of HF Financial Corp., pertaining to the HF Financial Corp. 1991 Stock Option and Incentive Plan and the 1996 Director Restricted Stock Plan, of our report dated August 13, 1998, accompanying the consolidated financial statements included in the Form 10-K Annual Report of HF Financial Corp. for the fiscal year ended June 30, 1998. /s/ McGLADREY & PULLEN, LLP McGLADREY & PULLEN, LLP Sioux Falls, South Dakota September 24, 1998 1 EX-27.1 9 FINANCIAL DATA SCHEDULE
9 1,000 YEAR JUN-30-1998 JUL-01-1997 JUN-30-1998 13,458 12,000 0 0 83,879 0 0 443,337 7,199 570,979 446,424 0 17,319 50,635 0 0 14,910 41,691 570,979 40,154 6,047 0 46,201 21,731 25,449 20,752 4,689 226 19,983 9,711 9,711 0 0 6,473 1.46 1.42 8.47 2,251 530 0 0 4,526 2,423 407 7,199 7,199 0 0
EX-27.2 10 FINANCIAL DATA SCHEDULE
9 1,000 YEAR YEAR 3-MOS 6-MOS 9-MOS JUN-30-1997 JUN-30-1996 JUN-30-1997 JUN-30-1997 JUN-30-1997 JUL-01-1996 JUL-01-1995 JUL-01-1996 JUL-01-1996 JUL-01-1996 JUN-30-1997 JUN-30-1996 SEP-30-1996 DEC-31-1996 MAR-31-1997 11,957 11,145 12,351 12,838 14,158 6,000 0 6,000 0 12,000 0 0 0 0 0 0 0 0 0 0 77,280 100,663 83,112 78,758 82,907 0 0 0 0 0 0 0 0 0 0 448,028 424,552 434,019 442,979 433,340 4,526 4,129 4,183 4,564 4,493 562,114 554,659 554,139 552,735 561,287 418,186 398,166 407,818 413,686 418,226 0 0 0 0 0 16,211 15,107 18,487 13,765 17,691 74,743 90,123 78,025 74,102 73,768 0 0 0 0 0 0 0 0 0 0 14,726 14,511 14,613 14,625 14,625 38,248 36,752 35,196 36,557 36,977 562,114 554,659 554,139 552,735 561,287 38,596 35,628 9,685 19,354 28,822 5,416 7,837 1,462 2,749 4,094 0 0 0 0 0 44,012 43,465 11,147 22,103 32,916 20,389 20,715 5,036 10,103 15,192 24,832 25,761 6,282 12,472 18,598 19,180 17,704 4,865 9,631 14,318 693 590 90 154 320 150 500 2 2 150 19,703 15,147 6,828 11,117 15,513 5,256 7,615 (663) 1,252 3,111 5,256 7,615 (663) 1,252 3,111 0 0 0 0 0 0 0 0 0 0 3,674 4,722 (378) 887 2,195 0.81 1.03 (0.08) 0.20 0.49 0.79 1.00 (0.08) 0.19 0.47 8.36 8.13 8.45 8.41 8.34 1,252 2,063 2,926 2,685 1,999 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 4,129 4,039 4,129 4,129 4,129 1,121 850 140 383 717 825 350 104 664 761 4,526 4,129 4,183 4,564 4,493 4,526 4,129 4,183 4,564 4,493 0 0 0 0 0 0 0 0 0 0
EX-27.3 11 FINANCIAL DATA SCHEDULE
9 1,000 3-MOS JUN-30-1998 JUL-01-1997 SEP-30-1997 11,309 9,000 0 0 88,642 0 0 447,759 4,822 574,889 434,582 0 18,403 67,719 0 0 14,848 39,337 574,889 10,475 1,529 0 12,004 5,664 6,660 5,344 526 5 4,781 2,566 2,566 0 0 1,684 0.38 0.37 8.65 2,456 0 0 0 4,526 427 197 4,822 4,822 0 0
-----END PRIVACY-ENHANCED MESSAGE-----