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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2003
Commission File Number: 000-50015
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TierOne Corporation
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(Exact name of registrant as specified in its charter)
Wisconsin 04-3638672
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(State or Other Jurisdiction of Incorporation (I.R.S. Employer
or Organization) Identification Number)
1235 "N" Street
Lincoln, Nebraska 68508
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (402) 475-0521
Securities registered pursuant to Section 12(b) of the Act:
Common Stock,
Par Value $.01 Per Share NASDAQ
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(Title of Each Class) (Name of Each Exchange on
Which Registered)
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 and (2) has been subject to such filing requirements for
the past 90 days. YES |X| NO |_|
Indicate by check mark whether the Registrant is an accelerated filer as defined
in Rule 12b-2 of the Securities Exchange Act of 1934. 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 the 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|
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was $441,342,716 as of June 30, 2003. As of February 29, 2004, there
were 20,317,568 issued and outstanding shares of the Registrant's common stock.
Item 1. Business.
General
TierOne Corporation (the "Company") is a Wisconsin corporation
headquartered in Lincoln, Nebraska. TierOne Corporation became the holding
company for TierOne Bank (the "Bank"), a federally chartered stock savings bank,
in connection with the mutual to stock conversion of TierOne Bank which was
completed in October 2002. TierOne Bank operates from 57 banking offices located
in Nebraska, Iowa and Kansas, three loan production offices located in Colorado
and one loan production office located in Minnesota. The executive office of the
Company is located at 1235 `N' Street, Lincoln, Nebraska 68508.
As used in this report, unless the context otherwise requires, the terms
"we," "us," or "our" refer to TierOne Corporation and its wholly owned
subsidiary, TierOne Bank.
The assets of the Company, on an unconsolidated basis, primarily consist
of 100% of the Bank's common stock. The Company has no significant independent
source of income and therefore depends almost exclusively on cash distributions
from the Bank to meet its funding requirements.
The Company began repurchasing its common stock in October 2003 in
connection with a Board of Directors authorized stock repurchase program. For
the year ended December 31, 2003, the Company repurchased 2,257,507 shares of
its common stock at an average cost of $23.75 per common share. The Bank pays
cash distributions to the Company on a periodic basis primarily to fund the
Company's common stock repurchases and pay dividends. The Company did not
declare or pay any dividends during the years ended December 31, 2003 and 2002.
The Company also incurs operating expenses primarily related to shareholder and
stock related expenditures such as annual report, proxy, corporate filing fees
and assessments and other costs directly associated to the holding company.
Our principal business is gathering deposits from the general public in
the market areas surrounding our 57 banking offices and investing those
deposits, together with funds generated from operations and borrowings, in
loans, investment securities and mortgage-backed securities. In the mid-1990's,
we revised our management strategy and implemented a plan to evolve into a
community bank. Highlights of our revised management strategy, which is designed
to increase our profitability, include:
o increasing our emphasis on higher yielding and/or shorter term loans in
order to reduce our exposure to interest rate risk but doing so in a
manner designed to maintain high credit quality;
o growing our core deposits and reducing our costs of funds;
o increasing other income through increased transaction fees, gains on loan
sales and fee income from non-traditional products such as annuities and
securities;
o building a strong corporate brand and identity; and
o continuing our controlled growth and expanding our franchise.
In recent years, we have increased our emphasis on construction, second
mortgage residential, consumer, commercial real estate and land, business and
multi-family residential
2
loans and warehouse mortgage lines of credit. These loans typically have higher
yields compared to single-family residential first mortgage loans and/or
expected shorter terms to maturity. At December 31, 2003, our portfolio of
second mortgage residential, multi-family residential, commercial real estate
and land, construction, business and consumer loans and warehouse mortgage lines
of credit amounted to $1.7 billion in the aggregate or 74.8% of our total loan
portfolio compared to an aggregate of $1.4 billion or 71.3% of our total loan
portfolio at December 31, 2002. The remainder of our loan portfolio consisted of
one-to-four family residential first mortgage loans which amounted to $559.1
million, or 25.2% of the total loan portfolio and $547.6 million, or 28.7% of
the total loan portfolio, at December 31, 2003 and 2002, respectively.
We originate loans to customers located in Nebraska, Iowa, Kansas,
Colorado and Minnesota. However, due to relatively limited demand for certain
loan products in this five-state market area, we also purchase loans and loan
participation interests from financial institutions, loan correspondents and
mortgage bankers located throughout the United States. We define our primary
lending market area as Nebraska, Iowa, Kansas and Colorado. At December 31, 2003
and 2002, approximately 53.2% and 60.4%, respectively, of our loan portfolio
consisted of loans secured by properties or made to individuals located outside
our primary lending market area. We purchase adjustable-rate single-family
residential first mortgage loans for our portfolio while selling substantially
all newly originated fixed-rate single-family residential first mortgage loans
in the secondary market (with servicing retained). Our loan sales produce
noninterest income in the form of gains on sales and loan servicing fees. During
2003, we purchased $301.9 million of fixed-rate second mortgage residential
loans as a means of growing our loan portfolio with loans exhibiting higher
yields and/or shorter expected lives. We also have developed relationships with
several financial institutions from which we purchase commercial real estate and
construction loans or participation interests in such loans. In addition, we
originate warehouse mortgage lines of credit with a number of mortgage brokerage
firms located throughout the United States.
In order to effectively manage our diversifying loan portfolio, we have
employed a number of additional loan officers in recent years with experience in
construction, commercial real estate, business and consumer lending. We endeavor
to ensure that all of our loans, whether originated by us or purchased, are in
compliance with our own underwriting standards or standards which are
substantially similar to ours.
In addition to our loan activities, we focus on our deposit products,
particularly core deposits such as checking accounts, and the sale of other
products such as annuities and securities.
Our revenues are derived principally from interest on our loans, and to a
lesser extent, noninterest income and interest and dividends on our investment
and mortgage-backed securities. Our primary sources of funds are principal and
interest payments on loans, proceeds from the sale of loans, advances from the
Federal Home Loan Bank ("FHLB"), deposits and principal and interest payments on
investment and mortgage-backed securities.
3
Forward-Looking Statements
In the normal course of business, the Company, in an effort to help keep
our shareholders and the public informed about the Company's operations, we may
from time to time issue or make certain statements, either in writing or orally,
that are or contain forward-looking statements, as that term is defined in the
federal securities laws. Generally, these statements relate to business plans or
strategies, projected or anticipated benefits from potential acquisitions,
projections involving anticipated revenues, earnings, profitability or other
aspects of the Company's operating results or other future developments in the
Company's affairs or the industry in which the Company conducts business. These
forward-looking statements, which are based on various assumptions (some of
which are beyond our control), may be identified by reference to a future period
or periods or by the use of forward-looking terminology such as "anticipate,"
"believe," "commitment," "consider," "continue," "could," "encourage,"
"estimate," "expect," "intend," "in the event of," "may," "plan," "present,"
"propose," "prospect," "update," "whether," "will," "would," future or
conditional verb tenses, similar terms, variations on such terms or negatives of
such terms. Although the Company believes that the anticipated results or other
expectations reflected in such forward-looking statements are based on
reasonable assumptions, we can give no assurance that those results or
expectations will be attained. Actual results could differ materially from those
indicated in such statements due to risks, uncertainties and changes with
respect to a variety of factors, including, but not limited to, the following:
competitive pressure among depository and other financial institutions may
increase significantly; changes in the interest rate environment may reduce
interest margins and net interest income, as well as adversely affect loan
originations and sales activities and the value of certain assets, such as
investment securities; general economic or business conditions, either
nationally or in regions in which we do business, may be less favorable than
expected, resulting in, among other things, a deterioration in credit quality or
a reduced demand for credit; legislation or changes in regulatory requirements,
including without limitation, capital requirements, or accounting standards may
adversely affect us and the business in which we are engaged; adverse changes
may occur in the securities markets; our competitors may have greater financial
resources and develop products and technology that enable those competitors to
compete more successfully than us; and the growth and profitability of our
noninterest income may be less than expected.
We undertake no obligation to update forward-looking statements to reflect
events or circumstances occurring after the date of this Annual Report on Form
10-K.
4
Available Information
The Company is a public company and files annual, quarterly and special
reports, proxy statements and other information with the Securities and Exchange
Commission ("SEC"). Our SEC filings are available to the public at the SEC's web
site at http://www.sec.gov. Members of the public may also read and copy any
document we file at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You can request copies of these documents by writing to
the SEC and paying a fee for the copying cost. Please call the SEC at
1-800-SEC-0330 for more information about the operation of the Public Reference
Room. In addition, our stock is listed for trading on the Nasdaq National Market
and trades under the symbol "TONE." You may find additional information
regarding TierOne Corporation at www.nasdaq.com. In addition to the foregoing,
we maintain a web site at www.tieronebank.com. We make available on our Internet
web site copies of our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K, Code of Conduct and Ethics and any amendments
to such documents as soon as reasonably practicable after we file such material
with or furnish such documents to the SEC.
Market Area and Competition
We are a community-oriented bank offering a variety of financial products
and services to meet the needs of the customers we serve. Our deposit gathering
is concentrated in the communities surrounding our 57 banking offices located in
Nebraska, seven counties in southwest Iowa and two counties in northern Kansas.
In addition to loans generated through our banking offices, our lending efforts
have been expanded to include one Minnesota and three Colorado loan production
offices whose sole purpose is to originate commercial real estate and land and
construction loans in their respective states. Although in the past we have
invested primarily in residential loans secured by mortgages on properties
located in our primary lending market area of Nebraska, Iowa, Kansas and
Colorado, in recent years we have increased our investment in commercial real
estate and land and construction loans secured by properties located in other
parts of the United States. The five largest concentrations of loans outside our
primary lending market area (excluding warehouse mortgage lines of credit) are
California ($206.2 million or 9.3% of the total loan portfolio), South Carolina
($91.4 million or 4.1%), New York ($87.9 million or 4.0%), Florida ($65.0
million or 2.9%) and the State of Washington ($60.6 million or 2.7%).
Our corporate headquarters is located in Lincoln, Nebraska, which is the
state capital and home of the University of Nebraska-Lincoln. The primary
banking market area in which our banking offices are located was once dominated
by agriculture, but now consists of a diverse blend of industries, urban centers
and significant corporate investment. The region's population is 1.9 million
persons and more than 90% of the individuals in our primary banking market area
live in Nebraska. Population growth continues in the region and according to the
latest Census Bureau estimates, Nebraska tied Minnesota as exhibiting the
strongest 2002-2003 population growth rate of all states in the northern Great
Plains area. The region's main metropolitan areas of Omaha and Lincoln, as well
as other mid-sized regional growth centers scattered throughout our primary
banking market area, lead the balance of the region in net population growth. On
an income basis, the 2000 Census disclosed the median household income in
Nebraska was approximately $37,900, while the per capita income was
approximately $19,800, in each case more than 45% higher than the amounts at the
time of the 1990 Census.
5
The nation's steady economic recovery during 2003 contributed to
Nebraska's growing economic momentum despite a sizable state budget deficit and
a continued severe drought which has impacted several states throughout the
Midwest. Nebraska non-farm employment growth has been relatively consistent and
continues to experience modest gains. Strong growth in the education/health
care, professional/business and financial services sectors combined with a large
and growing retail trade workforce has helped to offset continued declines in
the manufacturing and food service industries. Unemployment rates in Nebraska
have historically been two to three percentage points below national averages
and currently run below 4%. Sales of existing homes in Nebraska's two leading
urban markets (Omaha and Lincoln) continue to exhibit record activity with major
developments of new home construction underway in both communities. Median sales
prices of existing single-family homes at the quarter ended September 30, 2003
were $132,300 and $135,900 for Omaha and Lincoln, respectively, and are well
below national levels of $177,000 and significantly less than the Minneapolis
($208,300), Chicago ($249,100), Denver ($250,800) and San Francisco ($568,200)
metropolitan areas. Major capital developments along Omaha's riverfront and in
Lincoln's downtown area and continued corporate expansion of leading regional
businesses combined with other investment projects scattered throughout the
primary banking market region are expected to contribute to a modest, but
growing regional economy for the foreseeable future.
In addition to our Denver, Colorado loan production office which was
opened in January 2003, we expanded our loan production capabilities in June
2003 with the opening of a loan production office in the Minneapolis suburb of
Maple Grove, Minnesota and a third Colorado loan production office in early 2004
in Fort Collins. These additional loan production offices were established to
build upon our growing commercial real estate and construction lending business
and were located in metropolitan areas known for economic growth and vitality.
The Minneapolis metro area is rated as the 15th largest metropolitan area in the
United States with a 2000 Census population of nearly 3.3 million people. Home
to 17 of the nation's Fortune 500 companies, Minneapolis/St.Paul is economically
diverse and consists of a wide range of companies involved in manufacturing,
super computers, electronics, medical instruments, milling, machine
manufacturing, food processing and graphic arts. Minneapolis/St.Paul also has
over 1,300 technology-based firms contributing to one of the highest
concentrations of high technology business in the nation. More than 1.7 million
people are employed in the Minneapolis/St.Paul area with the latest November
2003 unemployment figures at 4.1%; approximately two percentage points below
national levels. Fort Collins, Colorado, just 62 miles north of Denver, is
Colorado's third largest metropolitan area with a 2000 Census population of over
251,000 residents. Fort Collins ranked as the fastest growing metro area along
Colorado's Front Range during the 1990's with a population growth rate of 35.1%.
Together with nearby Loveland, Fort Collins is the primary regional growth
center of north central Colorado. Colorado State University is the area's
largest employer and leads a diverse mix of education, health, retail and
banking industries. Unemployment in mid-2003 was 5.5%; moderately below the
national unemployment rate of 6.2%.
We face significant competition, both in generating loans as well as in
attracting deposits. Our primary banking market area is highly competitive and
we face direct competition from a significant number of financial service
providers, many with a state-wide or regional presence and, in some cases, a
national presence. In recent years, our market area has experienced continued
consolidation of the banking industry as locally based institutions have been
acquired by large regional and nationally based financial institutions.
6
Many of these financial service providers are significantly larger than us
and have greater financial resources. Our competition for loans comes
principally from commercial banks, savings banks, credit unions, mortgage
brokers, mortgage-banking companies and insurance companies. Our most direct
competition for deposits has historically come from savings associations,
commercial banks and credit unions. In addition, we face increasing competition
for deposits from non-bank institutions such as brokerage firms and insurance
companies in such instruments as short-term money market funds, corporate and
government securities funds, equity securities, mutual funds and annuities.
Lending Activities
Loan Portfolio Composition. A significant amount of our loan portfolio
continues to consist of one-to-four family residential loans. At December 31,
2003, our total loans receivable amounted to $2.2 billion, of which $559.1
million or 25.2% consisted of one-to-four family residential loans.
Implementation of our lending strategy has caused us to increase our emphasis on
construction, second mortgage residential, consumer, commercial real estate and
land, business and multi-family residential loans as well as warehouse mortgage
lines of credit. Our emphasis in higher yielding and/or shorter term loans has
also allowed us to reduce the weighted average contractual maturity of our loan
portfolio. At December 31, 2003, more than 64.9% of our total loan portfolio had
contractual maturities of 10 years or less and more than 63.0% of our total loan
portfolio had adjustable interest rates.
During 2003 we increased our investment in second mortgage residential
loans due to higher expected yields and lower expected average lives of these
loans. Second mortgage residential loans grew to $258.1 million or 11.6% of our
total loan portfolio at December 31, 2003 compared to $25.6 million or 1.3% of
the total loan portfolio at December 31, 2002. Aggregate construction loans
(including undisbursed loans in process) have increased from $299.3 million or
15.7% of our total loan portfolio at December 31, 2002 to $400.0 million or
18.0% of our total loan portfolio at December 31, 2003. Our investment in
commercial real estate and land loans has also increased from $398.1 million at
December 31, 2002 to $449.2 million at December 31, 2003. Outstanding warehouse
mortgage lines of credit decreased from $236.5 million at December 31, 2002 to
$78.8 million at December 31, 2003. We have established additional relationships
with individual mortgage brokers during 2003 in an attempt to increase our
volume due to decreased refinancing activity caused by the stabilization of
interest rates during the second half of 2003. Warehouse mortgage lending
advances in the aggregate totaled $5.5 billion in 2003 compared to $4.4 billion
in 2002.
The types of loans that we may purchase and originate are subject to
federal and state laws and regulations. The interest rates we charge on loans
are affected by the demand for such loans and the supply of money available for
lending purposes and the rates offered by competitors. These factors are, in
turn, affected by, among other things, economic conditions, monetary policies of
the Federal Government, including the Board of Governors of the Federal Reserve
System ("Federal Reserve Board") and legislative tax policies.
7
Loan Portfolio Composition. The following table shows the composition of our
loan portfolio by type of loan at the dates indicated.
December 31,
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2003 2002 2001 2000
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(Dollars in thousands) Amount % Amount % Amount % Amount %
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Real estate loans:
One-to-four family residential (1) $ 559,134 25.20% $ 547,619 28.66% $ 487,015 32.10% $ 541,711 44.79%
Second mortgage residential 258,121 11.63 25,590 1.34 15,487 1.03 23,730 1.96
Multi-family residential 99,078 4.47 79,953 4.18 74,209 4.89 67,025 5.54
Commercial real estate and land 449,152 20.25 398,076 20.83 258,277 17.03 210,654 17.42
Residential construction 245,782 11.08 156,322 8.18 113,300 7.47 77,421 6.40
Commercial construction 154,247 6.95 143,020 7.49 95,614 6.30 46,187 3.82
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Total real estate loans 1,765,514 79.58 1,350,580 70.68 1,043,902 68.82 966,728 79.93
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Business loans 64,522 2.91 33,375 1.75 12,193 0.80 2,755 0.23
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Warehouse mortgage lines of credit 78,759 3.55 236,492 12.38 224,067 14.77 37,173 3.07
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Consumer loans:
Home equity 33,874 1.53 37,522 1.96 45,398 2.99 57,264 4.74
Home equity line of credit 117,899 5.31 94,801 4.96 61,839 4.08 38,700 3.20
Home improvement 74,915 3.38 82,081 4.30 76,555 5.05 76,015 6.29
Automobile 67,351 3.04 60,707 3.18 42,547 2.80 22,496 1.86
Other 15,621 0.70 15,131 0.79 10,486 0.69 8,283 0.68
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Total consumer loans 309,660 13.96 290,242 15.19 236,825 15.61 202,758 16.77
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Total loans 2,218,455 100.00% 1,910,689 100.00% 1,516,987 100.00% 1,209,414 100.00%
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Unamortized premiums, discounts
and deferred loan fees 10,790 3,998 (232) (768)
Undisbursed portion of construction
and land loans in process (193,063) (123,331) (109,852) (70,625)
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Net loans 2,036,182 1,791,356 1,406,903 1,138,021
Allowance for loan losses (19,586) (17,108) (13,464) (9,947)
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Net loans after allowance for
loan losses $2,016,596 $1,774,248 $1,393,439 $1,128,074
===========================================================================================================================
(1) Includes loans held for sale $ 7,083 $ 8,504 $ 14,373 $ 3,712
December 31,
--------------------
1999
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(Dollars in thousands) Amount %
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Real estate loans:
One-to-four family residential (1) $ 521,165 51.03%
Second mortgage residential 30,964 3.03
Multi-family residential 61,140 5.99
Commercial real estate and land 152,768 14.96
Residential construction 41,558 4.07
Commercial construction 6,800 0.66
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Total real estate loans 814,395 79.74
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Business loans 1,956 0.19
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Warehouse mortgage lines of credit 24,420 2.39
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Consumer loans:
Home equity 43,683 4.28
Home equity line of credit 34,716 3.40
Home improvement 73,441 7.19
Automobile 20,966 2.05
Other 7,733 0.76
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Total consumer loans 180,539 17.68
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Total loans 1,021,310 100.00%
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Unamortized premiums, discounts
and deferred loan fees (92)
Undisbursed portion of construction
and land loans in process (23,484)
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Net loans 997,734
Allowance for loan losses (8,860)
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Net loans after allowance for
loan losses $ 988,874
==========================================================
(1) Includes loans held for sale $ 2,042
8
Contractual Terms to Final Maturities. The following table shows the
scheduled contractual maturities of our loans as of December 31, 2003, before
giving effect to net items. Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less. The amounts shown below do not take into account loan prepayments.
One-to-
Four Second Multi- Commercial
Family Mortgage Family Real Estate Residential Commercial
(Dollars in thousands) Residential Residential Residential and Land Construction Construction
------------------------------------------------------------------------------------------------------------------------------
Amounts due after December 31, 2003 in:
One year or less $ 306 $ 45 $ 7,247 $ 56,287 $190,974 $ 15,569
After one year through two years 666 549 10,945 37,958 38,858 31,747
After two years through three years 946 2,384 3,376 19,891 -- --
After three years through five years 11,940 11,535 26,935 64,520 -- 43,331
After five years through ten years 20,935 53,847 43,363 241,470 -- 63,600
After ten years through fifteen years 30,168 113,273 7,212 25,068 -- --
After fifteen years 494,173 76,488 -- 3,958 15,950 --
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Total (1) $559,134 $258,121 $ 99,078 $449,152 $245,782 $154,247
==============================================================================================================================
Warehouse
Mortgage
Business Line of
(Dollars in thousands) Loans Credit Consumer Total
-----------------------------------------------------------------------------------------------------
Amounts due after December 31, 2003 in:
One year or less $ 21,060 $ 78,759 $ 22,951 $ 393,198
After one year through two years 5,433 -- 16,407 142,563
After two years through three years 14,970 -- 43,188 84,755
After three years through five years 15,887 -- 192,298 366,446
After five years through ten years 7,022 -- 22,297 452,534
After ten years through fifteen years 150 -- 11,809 187,680
After fifteen years -- -- 710 591,279
-----------------------------------------------------------------------------------------------------
Total (1) $ 64,522 $ 78,759 $309,660 $2,218,455
=====================================================================================================
(1) Gross of unamortized premiums, discounts and deferred loan fees, loans in
process and allowance for loan losses.
The following table shows the dollar amount of all loans, including loans
held for sale, before net items, due after one year from December 31, 2003 as
shown in the preceding table, which have fixed interest rates or which have
floating or adjustable interest rates.
Floating or
(Dollars in thousands) Fixed-Rate Adjustable-Rate Total
--------------------------------------------------------------------------------
One-to-four family residential $ 77,231 $ 481,597 $ 558,828
Second mortgage residential 244,853 13,223 258,076
Multi-family residential 42,392 49,439 91,831
Commercial real estate and land 73,042 319,823 392,865
Residential contruction 15,793 39,015 54,808
Commercial construction 63,142 75,536 138,678
Business 22,663 20,799 43,462
Consumer 182,102 104,607 286,709
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Total $721,218 $1,104,039 $1,825,257
===============================================================================
9
Origination, Purchase, Sale and Servicing of Loans. Our lending activities
are subject to underwriting standards and loan origination procedures
established by our Board of Directors and management. Applications for mortgages
and other loans are taken at our banking and loan production offices. In the
past, we relied on a network of loan correspondents and brokers to originate a
substantial part of our loans. In recent years we have substantially expanded
our capacity to originate loans in-house through the employment of a number of
experienced loan originators. We continue to use loan correspondents to
originate single-family residential loans to supplement our origination efforts.
A substantial portion of such loans consists of fixed-rate single-family
residential mortgage loans which we sell into the secondary market with
servicing retained.
Although we originate both adjustable-rate and fixed-rate loans, our
ability to originate and purchase fixed or adjustable-rate loans is dependent
upon the relative customer demand for such loans, which is affected by the
current and expected future level of interest rates. The decline in interest
rates during 2002 and 2003 increased our customer demand for fixed-rate loans.
In order to implement our strategy of building a mortgage loan portfolio that
consists primarily of adjustable-rate loans, our purchase activity has increased
in recent years. During the year ended December 31, 2003, we purchased a total
of $331.3 million of adjustable-rate one-to-four family and second mortgage
residential loans while we originated an aggregate of $15.9 million of such
loans. The loans purchased for retention during this period consisted primarily
of pools of adjustable-rate jumbo single-family residential mortgage loans
(loans in excess of secondary market size limits of $333,700), second mortgage
residential, construction, consumer (primarily home improvement loans and
indirect automobile financing), commercial real estate and land (including
participation interests), business and multi-family residential loans.
Generally, we originate adjustable-rate mortgage loans for retention in
our portfolio. While we have in the past retained fixed-rate single-family
loans, it is currently our policy to sell substantially all the single-family
fixed-rate residential first mortgage loans we originate or purchase.
Substantially all of the loans sold are sold to either Fannie Mae ("FNMA") or
the Federal Home Loan Mortgage Corporation ("FHLMC") or the FHLB pursuant to the
Mortgage Partnership Finance program. Upon receipt of an application to make a
fixed-rate loan, we typically enter into agreements to sell such loans to FNMA,
FHLMC or the FHLB pursuant to forward sale commitments, with delivery being
required in approximately 90 days. We generally agree to deliver a somewhat
smaller dollar amount of loans in the event that not all the loans for which
applications are submitted actually close. Loans are delivered pursuant to such
sale contracts upon their origination or purchase and are not aggregated for
sale as loan packages. As a result, we typically do not have a significant
amount of loans held for sale at any given point in time. We recognize, at the
time of disposition, the gain or loss on the sale of the loans. The gain or loss
is based on the difference between the net proceeds received and the carrying
value of the loans sold. During 2002 and 2003, we increased our purchases of
fixed-rate single-family residential first mortgage loans for immediate sale as
we continued to increase the size of our loan servicing portfolio. While we
purchased $15.6 million of such loans in 2000, in 2001, 2002 and 2003 such
purchases increased to $195.4 million, $339.0 million and $324.1 million,
respectively.
10
In recent years, we have developed lending relationships with several
financial institutions and mortgage bankers pursuant to which we have purchased
whole loans or loan participation interests secured by properties located
outside our primary lending market area. Our purchases have consisted of second
mortgage residential; construction loans or participation interests in such
loans, both residential and commercial, as well as commercial real estate and
land, and were originated under underwriting guidelines substantially identical
to our own guidelines. For loans in which we hold a participation interest we
generally require the lead lender to maintain anywhere from 5% to 50% interest
in the loans. Prior to entering into such relationships, we conduct on-site due
diligence of each lender, including document review as well as management
interviews. We also conduct on-site inspections of selected properties and of
the market areas in which the properties are located. In addition, we apply our
own underwriting standards to each loan or loan participation we purchase. We
also review and underwrite, with respect to construction loans, the individual
builders to whom loans are being extended, establishing a limit as to the total
amount that we will lend to each such builder. We engage local inspectors to
inspect the progress of construction on properties securing such loans. We also
generally visit the lenders every three to six months to conduct follow-up
inspections of the lenders' operations as well as to review the collateral
property securing the loans or participations purchased by us. The following
primary lending relationships existed at December 31, 2003:
Charleston and Columbia, South Carolina. Of the primary relationships, the
first is with a mortgage banker in the Charleston and Columbia, South
Carolina markets. Pursuant to the relationship with this mortgage banker,
we have purchased loans made to local builders to finance the construction
of residential properties. Under the terms of our arrangement we service
these loans and the mortgage banker shares 50% of any losses incurred. As
of December 31, 2003, this relationship consisted of 492 individual loans
with an aggregate balance of $96.3 million. The outstanding loan balance
under this relationship (disbursed loan proceeds) was $51.3 million as of
December 31, 2003.
Maitland (Orlando) Florida. The second relationship is with a mortgage
banker in the Maitland (Orlando), Florida area and began in April 2003.
Pursuant to this relationship, we have purchased loans made to individual
borrowers to finance the construction of single-family residential
properties. Under the terms of this relationship, all loans purchased are
pre-approved for permanent financing following the construction phase.
Disbursements are made on the purchased loans as the construction phase
progresses. These disbursements are based on inspection of the property by
a qualified third party inspector. As of December 31, 2003, this
relationship encompassed 288 individual loans with an aggregate balance of
$40.8 million. The outstanding loan balance under this relationship
(disbursed loan proceeds) was $17.1 million at December 31, 2003.
Birmingham, Alabama. The third relationship is with a financial
institution headquartered in Birmingham, Alabama and involves the purchase
of generally a 50% loan participation interest in residential construction
loans and commercial real estate and land loans extended to builders. To
date, the loans have been secured by properties located in Birmingham,
Alabama; Atlanta, Georgia; Las Vegas, Nevada and Jacksonville,
11
Florida. At December 31, 2003, this relationship had an aggregate balance
of $24.8 million with $16.4 million outstanding at such date.
At December 31, 2003 and 2002, we were servicing $956.7 million and $730.1
million, respectively, of loans for others, primarily consisting of one-to-four
family residential loans sold by us to investors. In recent years, we began
selling substantially all loans with servicing retained in order to develop
additional sources of noninterest income. Loan servicing includes collecting and
remitting loan payments, accounting for principal and interest, contacting
delinquent borrowers, supervising foreclosures and property dispositions in the
event of unremedied defaults, remitting certain insurance and tax payments on
behalf of the borrowers and generally administering the loans. The gross
servicing fee income from loans sold is generally 0.25% to 0.50% of the total
balance of each loan serviced.
Loans-to-One Borrower Limitations. As a federal savings bank, we are
limited in the amount of loans we can make to any one borrower. This amount is
equal to 15% of our unimpaired capital and surplus (this amount was
approximately $39.4 million at December 31, 2003), although we are permitted to
lend up to an additional 10% of unimpaired capital and surplus if the loans are
secured by readily marketable securities. Our aggregate loans to any one
borrower have been within these limits for the year ended December 31, 2003. At
December 31, 2003, our four largest credit relationships with an individual
borrower and related entities consisted of loans that total $25.7 million, $20.5
million and two at $20.0 million, respectively. A brief summary of these four
relationships follows:
o The largest credit is a $25.7 million relationship collateralized by a 364
unit apartment complex located in Colorado Springs, Colorado. This
relationship consists of two loans: a $12.85 million one-year
adjustable-rate loan with a five-year term and a $12.85 million fixed-rate
loan with a five-year term. These loans are classified as multi-family
residential loans in the loan composition table.
o The second largest credit relationship consists of a $17.5 million 10-year
adjustable-rate loan and a $3.0 million adjustable-rate operating line of
credit secured by a 59 bed acute care hospital located in Lincoln,
Nebraska dedicated to heart surgeries and procedures. The $17.5 million
loan is classified as a commercial real estate and land loan in the loan
composition table. The $3.0 million adjustable-rate operating line of
credit is classified as a business loan in the loan composition table.
o The next largest credit relationship consists of two $10.0 million
business revolving lines of credit secured by real estate and other
business assets to a borrower who owns an excavation and construction
company in Lincoln, Nebraska. One $10.0 million line is intended to
finance work-in-process, accounts receivable and inventory. The other
$10.0 million line is intended to finance equipment. Both loans have
adjustable rates and mature in September 2005. At December 31, 2003, the
total outstanding balance for both lines of credit aggregated $300,000.
These lines of credit are classified as business loans in the loan
composition table.
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o We also have a $20.0 million credit relationship to participate in the
construction financing of a 442,576 square foot retail center located in
Omaha, Nebraska. We are one of three financial institutions participating
in this $71.1 million construction project. At December 31, 2003, a total
of $7.4 million had been disbursed under this credit relationship. This
loan is classified as a commercial construction loan in the loan
composition table.
Each of these relationships was performing in accordance with its terms and
conditions as of December 31, 2003.
13
The following table shows total loans originated, purchased, sold and repaid
during the periods indicated.
Year Ended December 31,
-------------------------------------------------
(Dollars in thousands) 2003 2002 2001
----------------------------------------------------------------------------------------------------
Net loans after allowance for loan losses,
beginning of period $ 1,774,248 $ 1,393,439 $ 1,128,074
----------------------------------------------------------------------------------------------------
Loan originations:
One-to-four family residential:
Adjustable-rate 14,055 14,591 14,356
Fixed-rate 363,606 224,502 190,901
Second mortgage residential 2,787 1,084 794
Multi-family residential 42,309 6,243 14,360
Commercial real estate and land 99,426 75,889 54,017
Residential construction 154,695 100,599 73,539
Commercial construction 59,075 69,793 66,270
Business 99,198 38,340 14,701
Warehouse mortgage lines of credit (1) 5,491,777 4,427,554 3,841,872
Consumer 147,069 133,379 99,086
----------------------------------------------------------------------------------------------------
Total loan originations 6,473,997 5,091,974 4,369,896
----------------------------------------------------------------------------------------------------
Loan purchases:
One-to-four family residential:
Adjustable-rate 328,644 302,148 133,713
Fixed-rate (2) 324,107 339,040 195,362
Second mortgage residential 304,593 31,984 1,577
Multi-family residential 13,500 19,696 --
Commercial real estate and land 43,949 120,291 22,208
Residential construction 184,126 97,949 41,413
Commercial construction 45,568 14,200 9,655
Business 21,326 -- --
Consumer 67,526 85,249 73,891
----------------------------------------------------------------------------------------------------
Total loan purchases 1,333,339 1,010,557 477,819
----------------------------------------------------------------------------------------------------
Total loan originations and purchases 7,807,336 6,102,531 4,847,715
----------------------------------------------------------------------------------------------------
Sales and loan principal repayments:
Loan sales:
One-to-four family residential (627,525) (565,585) (359,010)
Consumer (6,519) (2,129) (1,171)
Loan principal repayments:
Mortgage, business and consumer (1,215,568) (725,674) (524,983)
Warehouse mortgage lines of credit (1) (5,649,510) (4,415,441) (3,654,978)
----------------------------------------------------------------------------------------------------
Total loan sales and principal
repayments (7,499,122) (5,708,829) (4,540,142)
----------------------------------------------------------------------------------------------------
Decrease due to other items (3) (65,866) (12,893) (42,208)
----------------------------------------------------------------------------------------------------
Net loans after allowance for loan losses,
end of period $ 2,016,596 $ 1,774,248 $ 1,393,439
====================================================================================================
(1) Reflects amounts advanced and repaid under such lines of credit during the
periods presented.
(2) Substantially all of these loans were acquired from mortgage bankers and
sold to Fannie Mae, Freddie Mac and the Federal Home Loan Bank with
servicing retained.
(3) Other items consist of unamortized premiums, discounts and deferred loan
fees, loans in process and the allowance for loan losses.
================================================================================
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One-to-Four Family Residential Mortgage Lending. We offer both fixed-rate
and adjustable-rate loans with maturities of up to 30 years secured by
single-family residences. Single-family mortgage loan originations are generally
obtained from our in-house loan representatives, from existing or past
customers, from mortgage bankers and through referrals from members of our local
communities. Due to the limited demand at the present time in our primary
lending market area for adjustable-rate loans, we have determined to maintain
the portfolio's size while increasing its interest sensitivity through the
purchase of pools of adjustable-rate mortgage loans. At December 31, 2003, our
one-to-four family residential mortgage loans totaled $559.1 million or 25.2% of
total loans. Of such amount, $397.0 million, or 71.0%, related to loans secured
by properties located outside our primary lending market area and approximately
86.1% had adjustable rates. The average loan size of our one-to-four family
residential mortgage portfolio was $125,000 at December 31, 2003. A total of
$1.5 million or 0.26% of our one-to-four family residential mortgage loans at
December 31, 2003 were 90 days or more delinquent compared to $981,000 or 0.18%
at December 31, 2002. During the years ended December 31, 2003 and 2002, we
charged-off an aggregate of $6,000 and $16,000 of one-to-four family residential
mortgage loans, respectively.
We currently originate or purchase adjustable-rate single-family
residential mortgage loans with terms of up to 30 years and interest rates which
generally adjust one to seven years from the outset of the loan and thereafter
annually for the duration of the loan. The interest rates for such
adjustable-rate loans are generally tied to indices such as the U.S. Treasury
CMT or Libor, plus a margin. Our adjustable-rate loans generally provide for
periodic caps (not more than 2.0%) on the increase or decrease in the interest
rate at any adjustment date. The maximum amount the rate can increase or
decrease from the initial rate during the life of the loan is 5% to 6%.
The origination or purchase of adjustable-rate residential mortgage loans
helps reduce our exposure to increases in interest rates. However,
adjustable-rate loans generally pose credit risks not inherent in fixed-rate
loans, primarily because as interest rates rise, the underlying payments of the
borrower rise, thereby increasing the potential for default. Periodic and
lifetime caps on interest rate increases help to reduce the risks associated
with adjustable-rate loans but also limit the interest rate sensitivity of such
loans.
Generally, we originate single-family residential mortgage loans in
amounts up to 80% of the lower of the appraised value or the selling price of
the property and up to 100% if private mortgage insurance is obtained. Mortgage
loans originated by us generally include due-on-sale clauses which provide us
with the contractual right to deem the loan immediately due and payable in the
event the borrower transfers ownership of the property without our consent. We
require fire, casualty, title and, in certain cases, flood insurance on
properties securing real estate loans made by us.
15
Second Mortgage Residential Lending. During 2003 we increased our
investment in second mortgage residential loans. Second mortgage loans grew to
$258.1 million or 11.6% of the total loan portfolio at December 31, 2003
compared to $25.6 million or 1.3% of the total loan portfolio at December 31,
2002. The growth in such loans was primarily achieved through the purchase of
fixed-rate loans. Although the purchase for retention in our portfolio of
fixed-rate second mortgage residential loans is contrary to our general policy
of pursuing adjustable-rate loans, the expected yields and lives of the
fixed-rate loans we purchased during 2003 justified their inclusion in our loan
portfolio. At December 31, 2003, $244.3 million, or 94.7%, related to loans
secured by properties located outside our primary lending market area. The
average loan size of our second mortgage residential loan portfolio was $38,000
at December 31, 2003. Of the second mortgage residential loans outstanding at
December 31, 2003, approximately 94.9% were fixed-rate loans. At December 31,
2003, $224,000 or 0.09% were 90 or more days delinquent compared to $180,000, or
0.70%, at December 31, 2002. During the years ended December 31, 2003 and 2002,
we charged-off an aggregate of $107,000 and $21,000, respectively, of second
mortgage residential loans.
Multi-Family Residential Real Estate. We invest in multi-family
residential loans that are secured by multi-family housing units located in our
primary lending market area. At December 31, 2003, our multi-family residential
loan portfolio totaled $99.1 million or 4.5% of the total loan portfolio
compared to $80.0 million or 4.2% of the total loan portfolio at December 31,
2002. At December 31, 2003, 82.8% of the multi-family residential loans were
secured by properties located in our primary lending market area. The average
loan size of our multi-family residential loan portfolio was $1.8 million at
December 31, 2003 and 52.3% of our multi-family residential loans had adjustable
rates of interest. At December 31, 2003 and 2002 we had no multi-family
residential loans 90 or more days delinquent. We had no charge-offs of
multi-family residential loans during the years ended December 31, 2003 and
2002.
The largest multi-family residential credit at December 31, 2003 is a
$25.7 million relationship collateralized by a 364 unit class A apartment
complex located in Colorado Springs, Colorado. This relationship consists of two
loans: a $12.85 million one-year adjustable-rate loan with a five-year term and
a $12.85 million fixed-rate loan with a five-year term. These loans were
performing in accordance with their loan terms at December 31, 2003.
Commercial Real Estate and Land Lending. We invest in commercial real
estate loans that are secured by properties generally used for business
purposes, such as office buildings and retail facilities, and land being held
for commercial and residential development. The properties securing these loans
are located primarily in Lincoln and Omaha, Nebraska and in selected areas
outside of our primary lending market area. We have increased our involvement in
this lending category as part of our strategy to increase our investment in
higher yielding and/or loans with shorter expected average lives. We have also
increased our capacity to originate such loans internally with the hiring of
several experienced commercial real estate lenders as well as the opening of new
commercial real estate loan production offices in Colorado Springs, Denver and
Fort Collins, Colorado and Minneapolis, Minnesota.
Our underwriting procedures provide generally that commercial real estate
loans (as well as multi-family, land and commercial construction loans) may be
made in amounts up to 80% of the value of the property if it is located within
our primary lending market area and 75% of the value if it is outside our
primary lending market area. Any loan exceeding such loan-to-value ratio must be
supported by documentation of the relevant factors justifying the deviation
which is
16
reviewed by the Board of Directors on a quarterly basis. The following is a
summary of lending guidelines concerning our commercial real estate lending:
o The total of commercial real estate loans exceeding established
loan-to-value limits may not exceed 30% of our risk-based capital. At
December 31, 2003, we were in compliance with established guidelines
related to risk-based capital as these loans totaled 13.0% of our
risk-based capital.
o The total of all commercial real estate loans, land loans related to
commercial development, multi-family residential loans and commercial
construction loans cannot exceed 50% of our total loan portfolio. At
December 31, 2003, 30.7% of our total loan portfolio consisted of such
loans. Furthermore, no more than 40% of such loans can be secured by
properties located outside of our primary lending market area. At December
31, 2003, the state outside of our primary lending market area with the
highest concentration of such loans was the State of Washington (6.8%).
o Such loans are currently originated with various indices such as U.S.
Treasury CMT or Libor, plus a margin, with terms of nine or ten years and
with interest rates which initially adjust three or five years after
origination and every three or five years thereafter. The majority of
these loans have 20 or 25 year amortization schedules and require payment
of the remaining principal at maturity. Our adjustable-rate loans do not
have any periodic limits on the increases or decreases in the interest
rate that may be effected at the time of the adjustment other than
lifetime floor and ceiling limits.
o All commercial real estate and multi-family residential loans are
underwritten by our centralized loan underwriting department. In
underwriting these loans, we consider all aspects of the credit profile of
each borrower's ability to repay the debt. We consider the borrower's
income, probable continuation of income and credit history.
o Loans in excess of $10.0 million must be presented to and approved by our
Board of Directors.
o We have generally required that the properties securing these real estate
loans have debt service coverage ratios (the ratio of earnings before debt
service to debt service) of at least 125%. Personal guarantees are
generally required. In addition, we require that security instruments
contain affirmative language concerning the prospective borrower's
responsibility for compliance with laws and regulations (including
environmental, health and safety) and for protecting the environmental
conditions of the security property. A phase one environmental assessment
report, prepared in conformance with our environmental risk policy, is
normally obtained if the loan is in excess of $1.0 million or if there is
any indication of possible contamination at the security property.
17
Our commercial real estate and land loan portfolio at December 31, 2003 was
$449.2 million or 20.3% of total loans compared to $398.1 million or 20.8% of
total loans at December 31, 2002. At December 31, 2003, $234.3 million, or
52.2%, related to loans secured by properties located within our primary lending
market area. The average loan size of our commercial real estate loan portfolio
at December 31, 2003 was $1.3 million. At December 31, 2003, 80.2% of our
commercial real estate and land loans had adjustable rates. We had no commercial
real estate and land loans 90 or more days delinquent at December 31, 2003
compared to $3.8 million which were 90 or more days delinquent at December 31,
2002. During the years ended December 31, 2003 and 2002, we charged-off an
aggregate of $330,000 and $0, respectively, of commercial real estate and land
loans.
The largest commercial real estate loan outstanding at December 31, 2003 is a
$17.5 million 10-year adjustable-rate loan secured by a 59 bed acute care
hospital located in Lincoln, Nebraska dedicated to heart surgeries and
procedures. This loan was performing in accordance with its terms at December
31, 2003.
In recent periods we have increased our lending to finance the acquisition of
land for residential and commercial real estate projects. Such land loans
totaled $96.0 million, or 4.3%, of total loans at December 31, 2003 ($69.9
million of which had been disbursed at such date). The average size of our land
loans at December 31, 2003 was $820,000.
During 2003, we refinanced a land development loan and a revolving line of
credit loan aggregating $20.0 million which are secured by a 572 acre parcel of
land in Lincoln, Nebraska. At December 31, 2003, a total of $11.3 million had
been disbursed to the borrower. The loans were performing in accordance with
their terms at December 31, 2003.
Loans secured by commercial real estate and multi-family residential real
estate properties generally involve larger principal amounts and a greater
degree of risk than single-family residential mortgage loans. 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 and a concentration of loans in a geographic region may be subject
to greater risk because of the potential for adverse economic conditions
affecting that region. We seek to minimize these risks through our underwriting
standards.
Construction Lending. We offer residential construction loans for either
pre-sold houses (a purchase contract has been signed) or speculative houses
(properties for which no buyer yet exists). We are also involved in commercial
real estate construction lending as well as purchasing participation interests
in such loans. Approximately 60% of our residential construction loans are for
pre-sold houses. As part of the increased emphasis on construction lending, we
have, in recent years, hired several experienced loan originators in order to
increase our capabilities in this lending area.
We originate our residential construction loans within our primary lending
market area typically through direct contact with home builders. Most of such
loans involve properties located in the Omaha and Lincoln, Nebraska metropolitan
areas. During the past few years, we have become involved in purchasing
residential construction loans and participation interests in such loans secured
by properties located outside our primary lending market area, generally in
18
more densely populated cities in South Carolina, Georgia, Alabama, Nevada,
Minnesota and Florida. The following is a summary of our lending guidelines for
residential construction loans:
o Whether we originate or purchase residential construction loans, we review
all plans, specifications and cost estimates and require that the
contractor be known by us to be reputable.
o The amount of construction advances to be made, together with the sum of
previous disbursements, may not exceed the percentage of completion of the
construction.
o Such loans generally have terms not exceeding 18 months, have
loan-to-value ratios of 90% or less of the appraised value upon completion
and do not require the amortization of the principal during the term of
the loan.
o The loans are generally made with adjustable rates of interest based on
the Wall Street Journal prime rate.
At December 31, 2003, residential construction loans (including
participation interests) totaled $245.8 million (including undisbursed loans in
process), or 11.1%, of our total loan portfolio. Of such amount, $156.3 million
related to loans secured by properties located outside our primary lending
market area. The average loan size of our residential construction loans was
$203,000 at December 31, 2003. A total of 70.4% of our residential construction
loans had adjustable rates of interest at December 31, 2003. At December 31,
2003 and 2002, we had $1.0 million and $106,000, respectively, of residential
construction loans 90 or more days delinquent. During the years ended December
31, 2003 and 2002, we charged-off an aggregate of $13,000 and $0, respectively,
of residential construction loans.
We have increased significantly our involvement in commercial construction
lending during the last three years. Most of such loans are extended to build
office buildings, retail centers or apartment buildings. As a result of such
efforts, commercial construction loans totaled $154.2 million (including
undisbursed loans in process) at December 31, 2003 or 7.0% of total loans
compared to $143.0 million and $95.6 million, or 7.5% and 6.3%, of total loans
at December 31, 2002 and 2001, respectively. The average loan size of our
commercial construction loan portfolio was $4.1 million at December 31, 2003. At
December 31, 2003, $18.6 million of our commercial construction loans were
secured by properties located outside our primary lending market area. Of the
commercial construction loans outstanding at December 31, 2003, approximately
58.6% had adjustable rates. At December 31, 2003 and 2002, we had no commercial
construction loans 90 or more days delinquent. Additionally, there were no
commercial construction loans charged-off during the years ended December 31,
2003 and 2002.
At December 31, 2003, our largest commercial construction loan was a $20.0
million loan to finance the construction of a 442,576 square foot retail center
located in Omaha, Nebraska. We are one of three financial institutions
participating in this $71.1 million construction project. At December 31, 2003,
a total of $7.4 million had been disbursed under this credit relationship. This
loan was performing in accordance with its terms at December 31, 2003.
19
Risk of loss on a construction loan is dependent largely upon the accuracy
of the initial estimate of the property's value at completion of construction or
development compared to the estimated cost (including interest) of construction
and other assumptions, including the estimated time to sell residential
properties. If the estimate of value proves to be inaccurate, we may be
confronted with a project, when completed, having a value which is insufficient
to assure full repayment.
Warehouse Mortgage Lines of Credit. In recent years, we have become
actively involved in originating revolving lines of credit to mortgage brokers.
The lines are drawn upon by such companies to fund the origination of
single-family residential loans. Prior to funding the advance, the mortgage
broker must have an approved commitment for the purchase of the loan which in
turn reduces credit exposure associated with the line. The lines are repaid upon
completion of the sale of the mortgage loan to third parties which usually
occurs within 30 days of origination of the loan. In connection with extending
the line of credit to the mortgage broker, we enter into agreements with each
company to which such mortgage broker intends to sell loans which are being
funded with the line of credit from us. Under such agreements, the loan
purchaser agrees to hold the mortgage documents issued by the mortgage brokers
on behalf of and for our benefit until such time that the purchasers remit to us
the purchase price for such loans. The lines are structured with adjustable
rates tied to the Wall Street Journal prime rate plus or minus a margin. We fund
a portion of the advances using short-term borrowings from the FHLB. Maximum
amounts permitted to be advanced by us under existing warehouse mortgage lines
of credit range in amount from $2.5 million to $65.0 million. With respect to
our largest line of credit ($65.0 million), we arranged participation interests
aggregating $17.0 million to two other financial institutions and $10.0 million
to the Company before extending a $38.0 million line of credit to the Bank in
order to limit our risk and to ensure compliance with our loans-to-one borrower
regulatory limitation. At December 31, 2003, the largest outstanding amount
under an individual warehouse mortgage line was $14.5 million. This lending area
increased during 2002 due to the strength of the mortgage market resulting in
large part from the low interest rate environment. Outstanding balances under
warehouse mortgage lines of credit totaled $236.5 million and $224.1 million or
12.4% and 14.8% of the total loan portfolio at December 31, 2002, and 2001,
respectively. During the second half of 2003 we experienced a stabilization of
interest rates and a significant reduction in mortgage refinancing activity. As
a result, outstanding balances under warehouse mortgage lines of credit declined
to $78.8 million, or 3.6% of the total loan portfolio at December 31, 2003.
Additionally, at December 31, 2003, unused warehouse mortgage lines of credit
totaled $493.1 million compared to unused lines of $183.0 million at December
31, 2002. Line of credit advances totaled $5.5 billion for the year ended
December 31, 2003 compared to $4.4 billon for the year ended December 31, 2002,
which is the result of a high level of refinancing activity during the first
half of 2003 and an increased number of brokers with which we do business. The
increase in the unused portion of warehouse mortgage lines of credit is
reflective of the decreased mortgage refinancing activity and additional broker
relationships established during 2003. At December 31, 2003, there were no
warehouse mortgage lines of credit 90 or more days delinquent. During the years
ended December 31, 2003 and 2002, we charged-off an aggregate of $110,000 and
$0, respectively, of warehouse mortgage lines of credit. As part of the
structure of the lines of credit, the mortgage brokers are required to maintain
commercial deposits with us, with the amount of such deposits depending upon the
amount of the line and other factors.
Business Lending. Business loans are made predominantly to small to
mid-sized businesses located within our primary lending market area. We are
increasing our focus on such
20
lending in conjunction with our overall increased emphasis on loans with higher
yields and/or shorter expected lives. At December 31, 2003, we had $64.5 million
in business loans which amounted to 2.9% of total loans receivable compared to
$33.4 million or 1.8% of total loans receivable at December 31, 2002. Of the
business loans outstanding at December 31, 2003, approximately 57.6% had
adjustable rates. At December 31, 2003 and 2002, we had $219,000 and $0,
respectively, of business loans 90 or more days delinquent. For the years ended
December 31, 2003 and 2002, we charged-off an aggregate of $5,000 and $99,000,
respectively, of business loans.
The largest credits consist of two $10.0 million business revolving lines
of credit secured by real estate and other business assets to a borrower who
owns an excavation and construction company in Lincoln, Nebraska. One $10.0
million line is intended to finance work-in-process, accounts receivable and
inventory. The other $10.0 million line is intended to finance equipment. Both
loans have adjustable rates and mature in September 2005. At December 31, 2003,
the total outstanding balance for both lines of credit aggregated $300,000.
Consumer and Other Lending. Consumer loans, consisting primarily of home
equity, home improvement and automobile loans amounted to $309.7 million or
14.0% of our total loan portfolio at December 31, 2003. We generally offer home
equity loans and lines of credit in amounts up to $100,000 with a term of 15
years or less and a loan-to-value ratio up to 100% of value. We also offer home
improvement loans in amounts up to $100,000 with a term of 15 years or less and
a loan-to-value ratio up to 100% of value. A substantial portion of our home
improvement loans consist of participation interests we have purchased from a
third party. Under the terms of our arrangement with this third party, if any
loan becomes more than 120 days past due, we can require the seller to
repurchase such loan at a price equal to our total investment in the loan,
including any uncollected and accrued interest. During 2003, we purchased $25.8
million of such loans and at December 31, 2003, we held $58.3 million of loans
purchased under such arrangement. We also offer automobile loans in amounts up
to $50,000 with maximum 72 month and 60 month terms for new and used cars,
respectively, and purchase price ratios of generally not more than 95% and 85%
for new and used cars, respectively. Most of our automobile loans are obtained
through a network of 67 new and used automobile dealers located primarily in
Lincoln and Omaha, Nebraska. During 2003, we purchased approximately $26.4
million of such loans. Although employees of the automobile dealership take the
application, the loans are made pursuant to our own underwriting standards and
must be approved by one of our authorized loan officers. Upon closing of the
loan by the dealer, the loan is purchased by us. Our consumer loan portfolio
also includes recreational vehicle, boat, motorcycle and other unsecured loans.
Unsecured loans and loans secured by rapidly depreciating assets, such as
automobiles, entail greater risks than single-family residential mortgage loans.
In such cases, repossessed collateral, if any, for a defaulted loan may not
provide an adequate source of repayment of the outstanding loan balance.
Further, consumer loan collections on these loans are dependent on the
borrower's continuing financial stability and, therefore, are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Finally, the application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans in the event of a default. At December 31, 2003 and
2002, our consumer loans 90 days or more delinquent totaled $700,000 and
$427,000, respectively. For the years ended December 31, 2003 and 2002, we
charged-off $1.4 million and $1.0 million, respectively, of consumer loans.
21
Loan Commitments. At December 31, 2003, we had issued commitments totaling
$781.4 million, excluding the undisbursed portion of loans in process, to fund
and purchase loans, extend credit on commercial and consumer unused lines of
credit and to extend credit under unused warehouse mortgage lines of credit.
These outstanding loan commitments to extend credit do not necessarily represent
future cash requirements since many of the commitments may expire without being
drawn. We anticipate that normal amortization and prepayments of loan principal
will be sufficient to fund these loan commitments. See "Liquidity and
Commitments" in Management's Discussion and Analysis in our 2003 Annual Report
to Shareholders ("Annual Report") and attached as Exhibit 13 hereto.
Derivative Financial Instruments. The Company enters into commitments to
fund loans in which the interest rate on the loan is set prior to funding (rate
lock commitments). Rate lock commitments on mortgage loans that are intended to
be sold are considered to be derivatives under SFAS No. 133 and are recorded at
their fair value in other assets on the Consolidated Balance Sheets. Changes in
fair value are recorded in net gain on loans held for sales on the Consolidated
Statements of Income. Fair value is based on a quoted market price that closely
approximates the gain that would have been recognized if the loan commitment was
funded and sold at December 31, 2003. In measuring the fair value of rate lock
commitments, the amount of the expected servicing rights is included in the
valuation. The measurement of fair value is also adjusted for anticipated
fallout of commitments that will never be funded. Rate lock commitments expose
the Company to interest rate risk.
The Company manages the interest rate risk by entering into forward sales
commitments, which are also defined as derivatives under SFAS No. 133, and are
recorded at their fair value in other liabilities on the Consolidated Balance
Sheets, with changes in fair value reported in net gain on loans held for sale
on the Consolidated Statement of Income. Their fair value is based on a quoted
pair-out premium or penalty that would be received or paid if we exited the
forward position at December 31, 2003.
Loan Approval Procedures and Authority. Our Board of Directors establishes
lending policies and procedures. All general lending policies are set on an
ongoing basis by the Asset/Liability Committee composed of the following
officers of TierOne Bank: Chief Executive Officer; Chief Operating Officer;
Directors of: Lending, Administration, Retail Banking and Finance; Marketing
Officer; Controller and Financial Analysis Manager. Under policies established
by the Board of Directors, various officers or combinations of officers have
loan approval authority, the specific amounts and requirements being set forth
for each loan type. For loan amounts in excess of $10.0 million, approval of our
Board of Directors is required.
Delinquent Loans, Classified Assets and Real Estate Owned
Delinquencies and Classified Assets. Reports listing all delinquent
accounts are generated and reviewed by management on a monthly basis. These
reports include information regarding all loans 30 days or more delinquent and
all real estate owned. These reports are also provided to the Board of
Directors. The procedures we take with respect to delinquencies vary depending
on the nature of the loan, period and cause of delinquency and whether the
borrower is habitually delinquent. When a borrower fails to make a required
payment on a loan, we take a number of steps to have the borrower cure the
delinquency and restore the loan to current status. We generally send the
borrower a written notice of non-payment after the loan is first past due.
22
Our loan recovery guidelines provide that telephone, written correspondence
and/or face-to-face contact will be attempted to ascertain the reasons for
delinquency and the prospects of repayment. When contact is made with the
borrower at any time prior to foreclosure, we will attempt to obtain full
payment, work out a repayment schedule with the borrower to avoid foreclosure
or, in some instances, accept a deed in lieu of foreclosure. In the event
payment is not then received or the loan not otherwise satisfied, additional
letters and telephone calls generally are made. If the loan is still not brought
current or satisfied and it becomes necessary for us to take legal action, which
typically occurs after a loan is 90 days or more delinquent, we will commence
foreclosure proceedings against any real property that secures the loan. If a
foreclosure action is instituted and the loan is not brought current, paid in
full, or refinanced before the foreclosure sale, the property securing the loan
generally is sold at foreclosure and, if purchased by us, becomes real estate
owned.
Federal regulations and our Asset Classification Policy require that we
utilize an internal asset classification system as a means of reporting problem
and potential problem assets. We have incorporated the Office of Thrift
Supervision's ("OTS") internal asset classifications as a part of our credit
monitoring system. All assets are subject to classification. Asset quality
ratings are divided into three asset classifications: Pass (unclassified),
special mention and classified (adverse classification). Additionally, there are
three adverse classifications: "substandard", "doubtful" and "loss". A pass
asset is considered to be of sufficient quality to preclude a special mention or
an adverse rating. The special mention asset has potential weaknesses that
deserve management's close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the asset
or in our credit position at a future date. Problem assets receive an adverse
classification. An asset is considered "substandard" if it is inadequately
protected by the current net worth and paying capacity of the borrower or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that we 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.
When we classify one or more assets, or portions thereof, as
"substandard", "doubtful" or "loss", we establish a valuation allowance for loan
losses in an amount deemed prudent by management based on the specific facts of
the asset. In addition to these specific valuation allowances, we establish a
general valuation allowance to absorb losses which exist in the loan portfolio
but which have not been specifically identified. To quantify this general
valuation allowance, we segregate the loan portfolio by loan type and apply loss
factors to develop our allowance levels. These loss factors are developed using
our historical loan loss experience for each group of loans as further adjusted
for specific documented factors, including the following:
o Trends and levels of delinquent or "impaired" loans;
o Trends and levels of charge-offs;
o Trends in volume and underwriting terms or guarantees for the loans;
o Impact of changes in underwriting standards, risk tolerances, or other
changes in lending practices;
o Changes in qualifications or experience of the lending staff;
23
o Changes in local or national economic or industry conditions; and
o Changes in credit concentration.
Although management believes that, based on information currently
available to us at this time, our allowance for loan losses is maintained at a
level which covers all known and inherent losses that are both probable and
reasonably estimable at each reporting date, actual losses are dependent upon
future events and, as such, further additions to the level of allowances for
loan losses may become necessary.
The Asset Classification Committee is composed of the following officers
of TierOne Bank: Chief Executive Officer; Chief Operating Officer; Chief Credit
Officer; Directors of Lending and Finance; Assistant Director of Lending;
Controller; Financial Analysis Manager and Regulatory Reporting Accountant. The
Asset Classification Committee reviews and classifies assets no less frequent
than quarterly and the Board of Directors reviews the results of the reports on
a quarterly basis. At December 31, 2003 and 2002, we had $10.4 million and $7.5
million, respectively, of assets classified as "substandard" which consisted of
real estate owned, single-family residential mortgage, residential construction,
business and consumer loans. Non-accrual loans are those loans 90 days or more
delinquent. At December 31, 2003 and 2002, substandard assets included in loans
90 days or more delinquent were $3.6 million and $5.5 million, respectively. At
such dates, we had no loans classified as "doubtful" or "loss." In addition, as
of December 31, 2003 and 2002, we had $35.3 million and $18.1 million,
respectively, of loans designated "special mention."
24
Delinquent Loans. The following table shows the delinquencies in our loan
portfolio as of the dates indicated.
December 31, 2003 December 31, 2002
------------------------------------------------- -----------------------
30-89 90 or More 30-89
Days Overdue Days Overdue Days Overdue
------------------------------------------------- -----------------------
Number of Principal Number of Principal Number of Principal
(Dollars in thousands) Loans Balance Loans Balance Loans Balance
---------------------------------------------------------------------------------------------------------------
One-to-four family residential 23 $1,844 11 $1,461 24 $3,677
Second mortgage residential 26 1,051 4 224 2 86
Multi-family residential -- -- -- -- -- --
Commercial real estate and land 2 142 -- -- -- --
Residential construction 15 2,501 3 1,012 2 258
Commercial construction -- -- -- -- -- --
Business 2 126 1 219 -- --
Warehouse mortgage lines of credit -- -- -- -- -- --
Consumer loans 255 2,945 60 700 209 2,499
---------------------------------------------------------------------------------------------------------------
Total delinquent loans 323 $8,609 79 $3,616 237 $6,520
===============================================================================================================
Delinquent loans as a percentage of
total loans 0.39% 0.16% 0.34%
===============================================================================================================
December 31, 2002
-------------------------
90 or More
Days Overdue
-------------------------
Number of Principal
(Dollars in thousands) Loans Balance
----------------------------------------------------------------
One-to-four family residential 7 $ 981
Second mortgage residential 4 180
Multi-family residential -- --
Commercial real estate and land 2 3,795
Residential construction 1 106
Commercial construction -- --
Business -- --
Warehouse mortgage lines of credit -- --
Consumer loans 39 427
----------------------------------------------------------------
Total delinquent loans 53 $5,489
================================================================
Delinquent loans as a percentage of
total loans 0.29%
================================================================
25
Non-Accrual Loans and Real Estate Owned. The following table sets forth
information regarding non-accrual loans and real estate owned. At December 31,
2003, nonperforming loans consisted of 15 single-family residential loans with
an average balance of $112,000, three residential construction loans with an
average balance of $337,000, one business loan with a balance of $219,000 and 60
consumer loans with an average balance of $12,000. At such date, real estate
owned totaled $678,000 consisting of five single-family residential properties,
one business loan and repossessed automobiles. Troubled debt restructurings
consisted of 11 loans with an average balance of $43,000 at December 31, 2003.
Such restructured loans were performing in accordance with their terms at such
date. It is our policy to cease accruing interest on loans 90 days or more past
due and to charge-off all accrued interest. For the years ended December 31,
2003 and 2002, the amount of interest income not recognized on non-accrual loans
was $308,000 and $290,000, respectively. Total impaired loans amounted to
approximately $864,000 ($396,000 of performing warehouse mortgage lines of
credit and $468,000 of troubled debt restructurings) and $4.0 million ($3.8
million of commercial real estate and land loans and $209,000 of troubled debt
restructurings) at December 31, 2003 and 2002, respectively.
The following table shows the amounts of our nonperforming assets at the
dates indicated. We did not have any accruing loans 90 days or more past due at
the dates shown.
December 31,
-----------------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------
Non-accruing loans:
One-to-four family residential $1,461 $ 981 $ 895 $1,009 $1,199
Second mortgage residential 224 180 3 -- 113
Multi-family residential -- -- -- -- --
Commercial real estate and land -- 3,795 -- 2,703 --
Residential construction 1,012 106 -- 380 --
Commercial construction -- -- -- -- --
Business 219 -- -- -- --
Warehouse mortgage lines of credit -- -- -- -- --
Consumer 700 427 767 416 239
----------------------------------------------------------------------------------------------------
Total non-accruing loans 3,616 5,489 1,665 4,508 1,551
Real estate owned, net (1) 678 1,967 168 807 352
----------------------------------------------------------------------------------------------------
Total nonperforming assets 4,294 7,456 1,833 5,315 1,903
Troubled debt restructurings 468 209 345 185 127
----------------------------------------------------------------------------------------------------
Total nonperforming assets and
troubled debt restructurings $4,762 $7,665 $2,178 $5,500 $2,030
====================================================================================================
Total nonperforming loans as a
percent of net loans 0.18% 0.31% 0.12% 0.40% 0.16%
----------------------------------------------------------------------------------------------------
Total nonperforming assets as a
percent of total assets 0.19% 0.38% 0.12% 0.39% 0.15%
----------------------------------------------------------------------------------------------------
Total nonperforming assets and
troubled debt restructurings
as a percent of total assets 0.22% 0.39% 0.14% 0.40% 0.16%
----------------------------------------------------------------------------------------------------
(1) Real estate owned balances are shown net of related loss allowances.
Includes both real property and other reposessed collateral consisting
primarily of automobiles.
26
When we acquire property through foreclosure or deed in lieu of
foreclosure, it is initially recorded at the lower of the recorded investment in
the corresponding loan or the fair value of the related assets at the date of
foreclosure, less costs to sell. Thereafter, if there is a further deterioration
in value, we provide for a specific valuation allowance and charge operations
for the diminution in value. It is our policy to obtain an appraisal or broker's
price opinion on all real estate subject to foreclosure proceedings prior to the
time of foreclosure. It is our policy to require appraisals on a periodic basis
on foreclosed properties as well as conduct inspections on such properties.
Allowance for Loan Losses. A provision for loan losses is charged to
income when it is determined by management to be required based on its analysis.
The allowance is maintained at a level to cover all known and inherent losses in
the loan portfolio that are both probable and reasonable to estimate at each
reporting date. Management reviews the loan portfolio no less frequently than
quarterly in order to identify those inherent losses and to assess the overall
collection probability of the portfolio. Management's review includes a
quantitative analysis by loan category, using historical loss experience,
classifying loans pursuant to a grading system and consideration of a series of
qualitative loss factors. The evaluation process includes, among other things,
an analysis of delinquency trends, nonperforming loan trends, the level of
charge-offs and recoveries, prior loss experience, total loans outstanding, the
volume of loan originations, the type, size, terms and geographic concentration
of loans held by us, the value of collateral securing the loan, the number of
loans requiring heightened management oversight and general economic conditions.
This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available or as
future events change.
The allowance for loan losses consists of two elements. The first element
is an allocated allowance established for specific loans identified by the
credit review function that are evaluated individually for impairment and are
considered to be impaired. A loan is considered impaired when, based on current
information and events, it is probable that we will be unable to collect the
scheduled payments of principal and interest when due according to the
contractual terms of the loan agreement. Impairment is measured by (i) the fair
value of the collateral if the loan is collateral dependent, (ii) the present
value of expected future cash flows, or (iii) the loan's observable market
price. The second element is an estimated allowance established for losses which
are probable and reasonable to estimate on each category of outstanding loans.
While management uses available information to recognize probable losses on
loans inherent in the portfolio, future additions to the allowance may be
necessary based on changes in economic conditions and other factors. In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review our allowance for loan losses. Such agencies may
require us to recognize additions to the allowance based on their judgment of
information available to them at the time of their examination.
27
The following table shows changes in our allowance for loan losses during
the periods presented.
At or For the Year Ended December 31,
------------------------------------------------------------
(Dollars in thousands) 2003 2002 2001 2000 1999
------------------------------------------------------------------------------------------------------------------
Allowance for loan losses, beginning of period $ 17,108 $ 13,464 $ 9,947 $ 8,860 $ 7,834
------------------------------------------------------------------------------------------------------------------
Charge-offs:
One-to-four family residential (6) (16) (37) (61) (4)
Second mortgage residential * (107) (21) -- -- --
Multi-family residential -- -- -- -- --
Commercial real estate and land (330) -- (1) -- --
Residential construction (13) -- -- -- --
Commercial construction -- -- -- -- --
Business (5) (99) -- -- --
Warehouse mortgage lines of credit (110) -- -- -- --
Consumer (1,368) (1,018) (458) (137) (117)
------------------------------------------------------------------------------------------------------------------
Total charge-offs (1,939) (1,154) (496) (198) (121)
Recoveries on loans previously charged-off 146 103 16 12 15
Provision for loan losses 4,271 4,695 3,997 1,273 1,132
------------------------------------------------------------------------------------------------------------------
Allowance for loan losses, end of period $ 19,586 $ 17,108 $ 13,464 $ 9,947 $ 8,860
==================================================================================================================
Allowance for loan losses as a percent of net loans 0.96% 0.96% 0.96% 0.87% 0.89%
Allowance for loan losses as a
percent of nonperforming loans 541.65% 311.68% 808.65% 220.65% 571.24%
Ratio of net charge-offs during the period as a
percent of average loans outstanding during
the period 0.10% 0.08% 0.04% 0.02% 0.01%
==================================================================================================================
* Second mortgage residential loans are disclosed for 2003 and 2002 only due
to increased investment in such loans during 2003.
28
The following table shows how our allowance for loan losses is allocated
by type of loan at each of the dates indicated.
December 31,
--------------------------------------------------------------------------------
2003 2002 2001
--------------------------------------------------------------------------------
Loan Loan Loan
Category as Category as Category as
Amount of a% of Total Amount of a% of Total Amount of a% of Total
(Dollars in thousands) Allowance Loans Allowance Loans Allowance Loans
-------------------------------------------------------------------------------------------------------------------
One-to-four family residential $ 1,069 25.20% $ 1,071 30.00% $ 976 33.13%
Second mortgage residential * 2,343 11.63 -- -- -- --
Multi-family residential 2,002 4.47 1,740 4.18 1,715 4.89
Commercial real estate and land 5,482 20.25 6,343 20.83 3,876 17.03
Residential construction 1,570 11.08 1,051 8.18 597 7.47
Commercial construction 1,011 6.95 1,259 7.49 586 6.30
Business 788 2.91 400 1.75 146 0.80
Warehouse mortgage lines
of credit 207 3.55 473 12.38 448 14.77
Consumer 5,003 13.96 4,771 15.19 4,736 15.61
Unallocated 111 -- -- -- 384 --
-------------------------------------------------------------------------------------------------------------------
Total $ 19,586 100.00% $ 17,108 100.00% $ 13,464 100.00%
===================================================================================================================
December 31,
------------------------------------------------------
2000 1999
------------------------------------------------------
Loan Loan
Category as Category as
Amount of a% of Total Amount of a% of Total
(Dollars in thousands) Allowance Loans Allowance Loans
-----------------------------------------------------------------------------------------
One-to-four family residential $ 813 46.75% $ 899 54.06%
Second mortgage residential * -- -- -- --
Multi-family residential 1,395 5.54 1,440 5.99
Commercial real estate and land 3,316 17.42 2,723 14.96
Residential construction 353 6.40 214 4.07
Commercial construction 235 3.82 40 0.66
Business 33 0.23 14 0.19
Warehouse mortgage lines
of credit 74 3.07 56 2.39
Consumer 3,447 16.77 3,474 17.68
Unallocated 281 -- -- --
-----------------------------------------------------------------------------------------
Total $ 9,947 100.00% $ 8,860 100.00%
=========================================================================================
* Second mortgage residential loans disclosed separately for 2003 as we
began analyzing this portfolio seperately in 2003 due to our increased
investment in such loans.
29
Investment Activities
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, time deposits of insured banks and
savings institutions, 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. Historically, we have maintained liquid assets at a level considered
to be adequate to meet our normal daily activities.
Our investment policy, as approved by the Board of Directors, requires
management to maintain adequate liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk and to
complement our lending activities. We primarily utilize investments in
securities for liquidity management and as a method of deploying excess funding
not utilized for loan originations and purchases. We have invested primarily in
U.S. Government and agency securities, corporate commercial paper, mutual funds,
U.S. Government sponsored agency issued mortgage-backed securities and
collateralized mortgage obligations. As required by SFAS No. 115, we have
established an investment portfolio of securities that are categorized as held
to maturity or available for sale. We do not currently maintain a portfolio of
securities categorized as held for trading. The majority of our investment
securities are purchased for the available for sale portfolio which totaled
$43.5 million or 2.0% of total assets at December 31, 2003. At such date, we had
net unrealized gains with respect to such securities of $142,000. At December
31, 2003, the held to maturity securities portfolio totaled $142,000.
At December 31, 2003, our mortgage-backed security portfolio (all of which
were classified as available for sale) totaled $15.7 million or 0.7% of total
assets, a decrease of $14.7 million from $30.4 million at December 31, 2002. Of
such amount, $8.3 million were issued by FNMA, $7.0 million were issued by the
Government National Mortgage Association ("GNMA"), $395,000 were issued by the
FHLMC and $4,000 were collateralized mortgage obligations ("CMOs"). Of the $15.7
million of mortgage-backed securities, $13.4 million had adjustable-rates with
interest rate adjustments of 1.0% to 2.0% annually and 4.5% to 10.4% over the
life of the security. During the quarter ended March 31, 2003, we purchased two
FNMA fixed-rate mortgage-backed securities totaling $84.0 million in an effort
to grow our mortgage-backed securities portfolio and further diversify our asset
base. Due to higher than projected prepayment speeds which resulted in negative
yields for these two FNMA securities, these two pools were sold during the
quarter ended September 30, 2003. We realized a gain of $25,000 on one FNMA
mortgage-backed security and a loss of $25,000 on the other FNMA mortgage-backed
security. Investments in mortgage-backed securities involve a risk that actual
prepayments will be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby changing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities or in the event such securities are redeemed by
the issuer. In addition, the market value of such securities may be adversely
affected by changes in interest rates.
The GNMA is a government agency within the Department of Housing and Urban
Development which is intended to help finance government-assisted housing
programs. GNMA securities are backed by loans insured by the Federal Housing
Administration, or guaranteed by
30
the Veterans Administration. The timely payment of principal and interest on
GNMA securities is guaranteed by GNMA and backed by the full faith and credit of
the U.S. Government. FHLMC is a private corporation chartered by the U.S.
Government. FHLMC issues participation certificates backed principally by
conventional mortgage loans. FHLMC guarantees the timely payment of interest and
the ultimate return of principal on participation certificates. FNMA is a
private corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for mortgage loans. FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the U.S. Government, but because FHLMC
and FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks.
The following table sets forth certain information relating to our
investment securities portfolio at the date listed.
December 31,
--------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Carrying Market Carrying Market Carrying Market
(Dollars in thousands) Value Value Value Value Value Value
----------------------------------------------------------------------------------------------------------------
U.S. Government agency obligations $ 12,877 $ 12,886 $ 2,000 $ 2,000 $ 26,691 $ 26,691
Corporate securities 24,496 24,660 23,418 22,546 12,214 11,833
Municipal obligations 142 142 157 157 221 221
Asset Management Fund - ARM Fund 6,000 5,969 6,000 6,000 6,000 6,000
----------------------------------------------------------------------------------------------------------------
Total investment securities 43,515 43,657 31,575 30,703 45,126 44,745
Federal Home Loan Bank stock 37,143 37,143 21,459 21,459 14,836 14,836
----------------------------------------------------------------------------------------------------------------
Total investment securities and
Federal Home Loan Bank stock $ 80,658 $ 80,800 $ 53,034 $ 52,162 $ 59,962 $ 59,581
================================================================================================================
31
The following table sets forth the amount of investment securities which
mature during each of the periods indicated and the weighted average yields for
each range of maturities at December 31, 2003. No tax-exempt yields have been
adjusted to a tax-equivalent basis.
Over One Over Five
One Weighted Year Weighted Years Weighted
Year or Average Through Average Through Average
(Dollars in thousands) Less Yield Five Years Yield Ten Years Yield
--------------------------------------------------------------------------------------------------------------------------
Bonds and other debt securities:
U.S. Government agency obligations $ -- --% $ 996 3.09% $ 11,881 4.03%
Corporate securities -- -- 4,992 5.80 5,982 6.30
Municipal obligations -- -- -- -- 142 8.25
Equity securities:
Asset Management Fund - ARM Fund 6,000 2.22 -- -- -- --
Federal Home Loan Bank stock 37,143 3.50 -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
Total investment securities and
Federal Home Loan Bank stock $ 43,143 3.32% $ 5,988 5.35% $ 18,005 4.82%
==========================================================================================================================
Over Weighted Total 2003
Ten Average Amortized Fair
(Dollars in thousands) Years Yield Cost Value
------------------------------------------------------------------------------------------
Bonds and other debt securities:
U.S. Government agency obligations $ -- --% $ 12,877 $ 12,886
Corporate securities 13,522 3.90 24,496 24,660
Municipal obligations -- -- 142 142
Equity securities:
Asset Management Fund - ARM Fund -- -- 6,000 5,969
Federal Home Loan Bank stock -- -- 37,143 37,143
------------------------------------------------------------------------------------------
Total investment securities and
Federal Home Loan Bank stock $ 13,522 3.90% $ 80,658 $ 80,800
==========================================================================================
The following table sets forth the purchases, sales and principal
repayments of our investment securities portfolio during the periods indicated.
At or For the Year Ended December 31,
-----------------------------------------
(Dollars in thousands) 2003 2002 2001
------------------------------------------------------------------------------------------
Investment securities at beginning of period $ 30,703 $ 44,745 $ 85,130
Purchases 33,939 62,980 76,219
Maturities (22,000) (76,259) (116,750)
Principal repayments (15) (92) (12)
Sales -- -- --
Change in unrealized gain (loss), net 1,014 (491) 160
Amortizations of premiums and discounts, net 16 (180) (2)
------------------------------------------------------------------------------------------
Investment securities at end of period $ 43,657 $ 30,703 $ 44,745
==========================================================================================
Weighted average yield at end of period 4.25% 3.41% 5.01%
==========================================================================================
32
The following table sets forth the composition of our mortgage-backed
securities portfolio at the dates indicated.
December 31,
--------------------------------------------------------------------------------
2003 2002 2001
----------------------- ------------------------ -------------------------
Carrying Market Carrying Market Carrying Market
(Dollars in thousands) Value Value Value Value Value Value
---------------------------------------------------------------------------------------------- -------------------------
Fixed-rate:
FHLMC $ 102 $ 109 $ 148 $ 155 $ 233 $ 242
FNMA 2,179 2,234 4,132 4,283 6,228 6,331
FHLMC/FNMA CMOs -- -- -- -- 3,101 3,081
Private CMOs 4 4 3,492 3,603 7,582 7,664
--------------------------------------------------------------------------------------------------------------------------
Total fixed-rate 2,285 2,347 7,772 8,041 17,144 17,318
--------------------------------------------------------------------------------------------------------------------------
Adjustable-rate:
GNMA 7,001 7,030 12,786 12,911 4,608 4,750
FNMA 5,972 6,049 8,919 9,011 23,441 23,618
FHLMC 284 286 404 406 595 601
--------------------------------------------------------------------------------------------------------------------------
Total adjustable-rate 13,257 13,365 22,109 22,328 28,644 28,969
--------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities $ 15,542 $ 15,712 $ 29,881 $ 30,369 $ 45,788 $ 46,287
==========================================================================================================================
33
Information regarding the contractual maturities and weighted average
yield of our mortgage-backed securities portfolio at December 31, 2003 is
presented below. Due to repayments of the underlying loans, the actual
maturities of mortgage-backed securities generally are less than the scheduled
maturities.
Amounts at December 31, 2003 Which Mature In
-----------------------------------------------------------------------------------------------
Over One
Weighted Year Weighted Weighted Total
One Year Average Through Average Over Five Average Amortized
(Dollars in thousands) or Less Yield Five Years Yield Years Yield Cost
-----------------------------------------------------------------------------------------------------------------------------
Fixed-rate:
FHLMC $ -- --% $ -- --% $ 102 8.50% $ 102
FNMA -- -- 2,179 6.16 -- -- 2,179
Private CMOs -- -- 4 8.73 -- -- 4
-----------------------------------------------------------------------------------------------------------------------------
Total fixed-rate -- -- 2,183 6.17 102 8.50 2,285
-----------------------------------------------------------------------------------------------------------------------------
Adjustable-rate:
GNMA -- -- -- -- 7,001 3.04 7,001
FNMA -- -- -- -- 5,972 3.72 5,972
FHLMC -- -- -- -- 284 4.52 284
-----------------------------------------------------------------------------------------------------------------------------
Total adjustable-rate -- -- -- -- 13,257 3.38 13,257
-----------------------------------------------------------------------------------------------------------------------------
Total $ -- --% $ 2,183 6.17% $ 13,359 3.42% $ 15,542
=============================================================================================================================
2003
Fair
(Dollars in thousands) Value
------------------------------------------
Fixed-rate:
FHLMC $ 109
FNMA 2,234
Private CMOs 4
------------------------------------------
Total fixed-rate 2,347
------------------------------------------
Adjustable-rate:
GNMA 7,030
FNMA 6,049
FHLMC 286
------------------------------------------
Total adjustable-rate 13,365
------------------------------------------
Total $ 15,712
==========================================
The following table sets forth the purchases, sales and principal
repayments of our mortgage-backed securities during the periods indicated.
At or For the Year Ended December 31,
----------------------------------------
(Dollars in thousands) 2003 2002 2001
----------------------------------------------------------------------------------------------
Mortgage-backed securities at beginning of period $ 30,369 $ 46,287 $ 68,398
Purchases 83,979 19,706 11,627
Repayments (42,294) (35,484) (34,810)
Sales (53,775) -- --
Change in unrealized gain (loss), net (318) (11) 1,114
Amortizations of premiums and discounts, net (2,249) (129) (42)
----------------------------------------------------------------------------------------------
Mortgage-backed securities at end of period $ 15,712 $ 30,369 $ 46,287
==============================================================================================
Weighted average yield at end of period 3.80% 5.37% 6.14%
==============================================================================================
34
At December 31, 2003, all unrealized losses related to investment and
mortgage-backed securities are considered temporary in nature. An impairment is
deemed temporary if the positive evidence indicating that an investment's
carrying amount is recoverable within a reasonable time period outweighs
negative evidence to the contrary. Investment and mortgage-backed securities
with unrealized losses at December 31, 2003, are summarized below:
Less than 12 Months 12 Months or Longer Total
----------------------- ----------------------- ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Value Losses Value Losses
----------------------------------------------------------------------------------------------------------------------------
U.S. Government agency obligations $ 3,989 $ 4 $ -- $ -- $ 3,989 $ 4
Corporate securities 2,586 48 8,338 194 10,924 242
Asset Management Fund - ARM Fund 5,969 31 -- -- 5,969 31
Mortgage-backed securities 5,259 31 -- -- 5,259 31
============================================================================================================================
Total temporarily impaired securities $ 17,803 $ 114 $ 8,338 $ 194 $ 26,141 $ 308
============================================================================================================================
The investment securities available for sale in a continuous loss position
for 12 months or longer consisted of three equity securities with aggregate
unrealized losses totaling $194,000 and $889,000 at December 31, 2003 and 2002,
respectively. The unrealized loss on these securities resulted from market value
reductions caused by a decreasing interest rate environment. The stabilization
of interest rates during the second half of 2003 resulted in improvement of the
market prices of these three securities.
Sources of Funds
General. Deposits, loan repayments and prepayments, proceeds from sales of
loans, cash flows generated from operations and FHLB advances are the primary
sources of our funds for use in lending, investing and for other general
purposes.
Deposits. We offer a variety of deposit accounts with a range of interest
rates and terms. Our deposits consist of checking (both interest-bearing and
noninterest-bearing), money market, savings, time deposits and individual
retirement accounts.
The flow of deposits is influenced significantly by general economic
conditions, changes in money market rates, prevailing interest rates and
competition. Our deposits are obtained predominantly from the areas where our
banking offices are located. We have historically relied primarily on customer
service and long-standing relationships with customers to attract and retain
these deposits; however, market interest rates and rates offered by competing
financial institutions significantly affect our ability to attract and retain
deposits.
We use traditional means of advertising our deposit products, including
broadcast and print media. In recent years, we have expanded our marketing
efforts to include direct mailings in an effort to attract new checking
relationships. In 2000, we introduced our "High Performance" checking product
line which includes a number of product options for our customers including free
checking, interest-bearing checking and the "Wall Street" checking account. As a
result, the number and aggregate balance of our checking accounts increased from
35
approximately 36,700 and $157.5 million, respectively, at December 31, 2000 to
approximately 62,400 and $340.4 million, respectively, at December 31, 2003,
reflecting increases of 70.0% and 116.1%. Employees are offered incentives to
sell the products and customers receive gifts for opening new accounts as well
as referring other customers.
During 2003 we purchased $65.6 million of brokered time deposits at rates
which closely approximated the rates we were offering on time deposits through
our retail delivery system. We purchased these brokered time deposits as an
additional source of funds for our loan origination and purchase activity.
The following table shows the distribution of, and certain other
information relating to, our deposits by type of deposit, as of the dates
indicated.
December 31,
-----------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- -----------------------
(Dollars in thousands) Amount % Amount % Amount %
-----------------------------------------------------------------------------------------------------------------
Time deposits:
1.00% - 1.99% $ 253,465 20.83% $ 61,399 5.44% $ -- --%
2.00% - 2.99% 106,783 8.77 89,316 7.91 32,156 2.93
3.00% - 3.99% 89,183 7.33 124,186 11.00 178,062 16.25
4.00% - 4.99% 108,041 8.88 132,626 11.75 126,641 11.55
5.00% - 5.99% 28,070 2.31 99,786 8.84 158,226 14.43
6.00% - 6.99% 222 0.02 9,399 0.83 39,697 3.62
7.00% - 7.99% -- -- -- -- 547 0.05
8.00% or more -- -- 8 -- 7 --
-----------------------------------------------------------------------------------------------------------------
Total time deposits (1) 585,764 48.14 516,720 45.77 535,336 48.83
-----------------------------------------------------------------------------------------------------------------
Transaction accounts:
Savings 19,627 1.61 15,855 1.41 12,988 1.19
Money market 270,942 22.27 270,275 23.94 295,991 27.00
Interest-bearing checking 295,122 24.26 290,237 25.71 227,473 20.75
Noninterest-bearing checking 45,308 3.72 35,793 3.17 24,454 2.23
-----------------------------------------------------------------------------------------------------------------
Total transaction accounts 630,999 51.86 612,160 54.23 560,906 51.17
-----------------------------------------------------------------------------------------------------------------
Total deposits $1,216,763 100.00% $1,128,880 100.00% $1,096,242 100.00%
=================================================================================================================
(1) Includes $65.5 million, $0 and $0 , respectively, of brokered time
deposits at December 31, 2003, 2002 and 2001.
36
The following table shows the average balance of each type of deposit
and the average rate paid on each type of deposit for the periods indicated.
Year Ended December 31,
------------------------------------------------------------------------------
2003 2002
------------------------------------ ---------------------------------------
Average Interest Average Average Interest Average
(Dollars in thousands) Balance Expense Rate Paid Balance Expense Rate Paid
--------------------------------------------------------------------------------------------------------------------
Interest-bearing checking $ 294,712 $ 2,629 0.89% $ 269,274 $ 4,619 1.72%
Savings 18,491 90 0.49 14,811 179 1.21
Money market 274,737 3,289 1.20 284,399 5,533 1.95
Time deposits 533,903 16,824 3.15 524,911 20,759 3.95
--------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 1,121,843 22,832 2.04 1,093,395 31,090 2.84
--------------------------------------------------------------------------------------------------------------------
Noninterest-bearing checking 43,295 -- -- 29,901 -- --
--------------------------------------------------------------------------------------------------------------------
Total deposits $1,165,138 $22,832 1.96% $1,123,296 $31,090 2.77%
====================================================================================================================
Year Ended December 31,
------------------------------------
2001
------------------------------------
Average Interest Average
(Dollars in thousands) Balance Expense Rate Paid
--------------------------------------------------------------------------
Interest-bearing checking $ 177,984 $ 4,750 2.67%
Savings 11,296 171 1.51
Money market 305,987 10,551 3.45
Time deposits 570,846 31,685 5.55
--------------------------------------------------------------------------
Total interest-bearing deposits 1,066,113 47,157 4.42
--------------------------------------------------------------------------
Noninterest-bearing checking 22,234 -- --
--------------------------------------------------------------------------
Total deposits $1,088,347 $47,157 4.33%
==========================================================================
The following table shows our savings flows during the periods
indicated.
Year Ended December 31,
-----------------------------------------------
(Dollars in thousands) 2003 2002 2001
--------------------------------------------------------------------------------
Total deposits $ 6,835,487 $ 5,402,525 $ 5,327,227
Total withdrawals (6,768,171) (5,397,347) (5,320,688)
Interest credited 20,567 27,460 41,867
--------------------------------------------------------------------------------
Total increase in deposits $ 87,883 $ 32,638 $ 48,406
================================================================================
37
The following table presents, by various interest rate categories and
maturities, the amount of time deposits at December 31, 2003.
Balance at December 31, 2003
Maturing in the 12 Months Ending December 31,
--------------------------------------------------------------
(Dollars in thousands) 2004 2005 2006 Thereafter Total
----------------------------------------------------------------------------------------------
Time deposits:
1.00% - 1.99% $250,724 $ 2,741 $ -- $ -- $253,465
2.00% - 2.99% 16,941 57,616 32,221 5 106,783
3.00% - 3.99% 22,341 4,400 2,314 60,128 89,183
4.00% - 4.99% 12,102 11,019 69,481 15,439 108,041
5.00% - 5.99% 15,755 5,877 5,922 516 28,070
6.00% - 6.99% 44 122 2 54 222
7.00% - 7.99% -- -- -- -- --
8.00% or more -- -- -- -- --
-----------------------------------------------------------------------------------------------
Total time deposits (1) $317,907 $ 81,775 $109,940 $ 76,142 $585,764
===============================================================================================
(1) Includes brokered time deposits.
The following table shows the maturities of our time deposits of $100,000
or more at December 31, 2003 by the time remaining to maturity. There are no
brokered time deposits included in the following table as no individual brokered
time deposit amounted to $100,000 or more at December 31, 2003.
Weighted
(Dollars in thousands) Amount Average Rate
----------------------------------------------------------------------
Quarter ending:
March 31, 2004 $13,938 1.83%
June 30, 2004 7,748 1.85
September 30, 2004 11,091 2.60
December 31, 2004 8,305 2.47
After December 31, 2004 35,494 3.60
----------------------------------------------------------------------
Total time deposits with
balances of $100,000 or more $76,576 2.83%
======================================================================
Borrowings. We utilize advances from the FHLB as an alternative to retail
deposits to fund our operations as part of our operating strategy. These FHLB
advances are collateralized by our qualifying first mortgage residential, second
mortgage residential, multi-family residential, commercial real estate and land
and construction loans, and secondarily by our investment in capital stock of
the FHLB. FHLB advances are made pursuant to several different credit programs,
each of which has its own interest rate and range of maturities. The maximum
amount that the FHLB will advance to member institutions, including us,
fluctuates from time to time in accordance with the policies of the FHLB. At
December 31, 2003, we had $641.7 million in outstanding FHLB advances. For
additional information see "Regulation - Federal Home Loan Bank".
38
The following table shows certain information regarding our borrowings at
or for the dates indicated.
At or For the Year Ended December 31,
---------------------------------------------
(Dollars in thousands) 2003 2002 2001
--------------------------------------------------------------------------------------------------------
Federal Home Loan Bank advances:
Average balance outstanding $540,192 $268,473 $202,852
Maximum amount outstanding at any
month-end during the period $709,365 $418,082 $296,715
Balance outstanding at end of period $641,749 $418,082 $296,715
Average interest rate during period 3.34% 4.76% 4.91%
Weighted average interest rate at end of period 3.02% 3.81% 4.30%
--------------------------------------------------------------------------------------------------------
Fannie Mae note and other borrowings:
Average balance outstanding $ 1,770 $ 6,132 $ 1,015
Maximum amount outstanding at any
month-end during the period $ 3,947 $ 6,855 $ 6,600
Balance outstanding at end of period $ 3,947 $ 247 $ 6,600
Average interest rate during period 1.36% 5.77% 5.77%
Weighted average interest rate at end of period 1.24% 1.64% 5.77%
At December 31, 2003, our overnight line of credit amounted to $71.4
million with a weighted average rate of 1.15%. For more information regarding
our borrowings, see Note 13 included in our Annual Report attached hereto as
Exhibit 13.
Subsidiary Activities
The Bank is the wholly owned subsidiary of the Company. TMS Corporation of
the Americas is the wholly owned subsidiary of the Bank and holds all of the
stock of TierOne Investments and Insurance, Inc. and TierOne Reinsurance
Company. TierOne Investments and Insurance, Inc. provides a wide selection of
investment and insurance products, equity securities, mutual funds and
annuities. These products are made available to consumers via licensed
representatives in our banking offices. TierOne Reinsurance Company reinsures
credit life and disability insurance that is sold in conjunction with the
origination of consumer loans by the Bank. Fees generated through equity,
annuity, mutual fund and insurance sales and commissions contributed $2.0
million and $2.1 million in noninterest income during the years ended December
31, 2002 and 2003, respectively.
Personnel
As of December 31, 2003, we had 491 full-time employees and 77 part-time
employees. The employees are not represented by a collective bargaining unit and
we consider our relationship with our employees to be good.
39
REGULATION
Set forth below is a brief description of certain laws and regulations
which are applicable to the Company and the Bank. The description of these laws
and regulations, as well as descriptions of laws and regulations contained
elsewhere herein, does not purport to be complete and is qualified in its
entirety by reference to the applicable laws and regulations.
General
The Bank, as a federally chartered stock savings bank, is subject to
federal regulation and oversight by the OTS extending to all aspects of its
operations. The Bank is also subject to regulation and examination by the
Federal Deposit Insurance Corporation ("FDIC"), which insures the deposits of
the Bank to the maximum extent permitted by law and requirements established by
the Board of Governors of the Federal Reserve System. Federally chartered
savings institutions are required to file periodic reports with the OTS and are
subject to periodic examinations by the OTS and the FDIC. The investment and
lending authority of savings institutions is prescribed by federal laws and
regulations and such institutions are prohibited from engaging in any activities
not permitted by such laws and regulations. Such regulation and supervision
primarily is intended for the protection of depositors and not for the purpose
of protecting shareholders.
The OTS regularly examines the Bank and prepares reports for consideration
by its Board of Directors on any deficiencies that it may find in the Bank's
operations. The FDIC also has the authority to examine the Bank in its role as
the administrator of the Savings Association Insurance Fund ("SAIF"). The Bank's
relationship with its depositors and borrowers is also regulated to a great
extent by both federal, and to a lesser extent, state laws, especially in such
matters as the ownership of savings accounts and the form and content of the
Bank's mortgage requirements. The OTS enforcement authority over all savings
institutions and their holding companies includes, among other things, the
ability to assess civil money penalties, to issue cease and desist or removal
orders and to initiate injunctive actions. In general, these enforcement actions
may be initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Any change
in such laws or regulations, whether by the FDIC, the OTS or the Congress, could
have a material adverse impact on us and the Bank and our operations.
TierOne Corporation
The Company, a Wisconsin corporation and the holding company for the Bank,
is a registered savings and loan holding company under Section 10 of the Home
Owners' Loan Act ("HOLA"), as amended, and is subject to OTS examination and
supervision as well as certain reporting requirements. In addition, because the
Bank's deposits are insured by the SAIF and administered by the FDIC, the Bank
is, and will continue to be, subject to certain restrictions in dealing with the
Company and with other persons affiliated with the Bank.
40
We currently operate as a unitary savings and loan holding company.
Generally, the HOLA prohibits a savings and loan holding company, such as us,
directly or indirectly, from (1) acquiring control (as defined) of a savings
institution (or holding company thereof) without prior OTS approval, or (2)
acquiring more than 5% of the voting shares of a savings institution (or holding
company thereof) which is not a subsidiary, subject to certain exceptions,
without prior OTS approval, or (3) acquiring through a merger, consolidation or
purchase of assets of another savings institution (or holding company thereof)
or acquiring all or substantially all of the assets of another savings
institution (or holding company thereof) without prior OTS approval, or (4)
acquiring control of an uninsured institution. A savings and loan holding
company may not acquire as a separate subsidiary, a savings institution which
has its principal offices outside of the state where the principal offices of
its subsidiary institution is located, except (a) in the case of certain
emergency acquisitions approved by the FDIC, (b) if the holding company
controlled (as defined) such savings institution as of March 5, 1987, or (c)
when the laws of the state in which the savings institution to be acquired is
located specifically authorize such an acquisition. No director or officer of a
savings and loan holding company or person owning or controlling more than 25%
of such holding company's voting shares may, except with the prior approval of
the OTS, acquire control of any savings institution which is not a subsidiary of
such holding company.
TierOne Bank
Insurance of Accounts. The deposits of the Bank are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the U.S. Government. As insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, insured
institutions. It also may prohibit any insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious threat to
the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions after giving the OTS an opportunity to take such
action.
Under current FDIC regulations, SAIF-insured institutions are assigned to
one of three capital groups which are based solely on the level of an
institution's capital - "well capitalized," "adequately capitalized" and
"undercapitalized" - which are defined in the same manner as the regulations
establishing the prompt corrective action system discussed below. These three
groups are then divided into three subgroups which reflect varying levels of
supervisory concern, from those which are considered to be healthy to those
which are considered to be of substantial supervisory concern. The matrix so
created results in nine assessment risk classifications, with rates during the
last six months of 2003 ranging from zero for well capitalized, healthy
institutions, such as the Bank, to 27 basis points for undercapitalized
institutions with substantial supervisory concerns.
In addition, all institutions with deposits insured by the FDIC are
required to pay assessments to fund interest payments on bonds issued by the
Financing Corporation, a mixed-ownership government corporation established to
recapitalize the predecessor to the SAIF. The assessment rate for the fourth
quarter of 2003 was .0152% of insured deposits and is adjusted quarterly. These
assessments will continue until the Financing Corporation bonds mature in 2019.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging
41
in unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, order or any
condition imposed by an agreement with the FDIC. It also may suspend deposit
insurance temporarily during the hearing process for the permanent termination
of insurance, if the institution has no tangible capital. If insurance of
accounts is terminated, the accounts at the institution at the time of the
termination, less subsequent withdrawals, shall continue to be insured for a
period of six months to two years, as determined by the FDIC. Management is
aware of no existing circumstances which would result in termination of the
Bank's deposit insurance.
Regulatory Capital Requirements. The OTS capital requirements consist of a
"tangible capital requirement," a "leverage capital requirement" and a
"risk-based capital requirement." The OTS is authorized to impose capital
requirements in excess of those standards on individual institutions on a
case-by-case basis.
Under the tangible capital requirement, a savings bank must maintain
tangible capital in an amount equal to at least 1.5% of adjusted total assets.
Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), plus a specified amount of purchased mortgage
servicing rights.
Under the leverage capital requirement adopted by the OTS, savings banks
must maintain "core capital" in an amount equal to at least 3.0% of adjusted
total assets. Core capital is defined as common shareholders' equity (including
retained earnings), non-cumulative perpetual preferred stock, and minority
interests in the equity accounts of consolidated subsidiaries, plus purchased
mortgage servicing rights valued at the lower of 90% of fair market value, 90%
of original cost or the current amortized book value as determined under
generally accepted accounting principles, and "qualifying supervisory goodwill,"
less non-qualifying intangible assets.
Under the risk-based capital requirement, a savings bank must maintain
total capital (which is defined as core capital plus supplementary capital)
equal to at least 8.0% of risk-weighted assets. A savings bank must calculate
its risk-weighted assets by multiplying each asset and off-balance sheet item by
various risk factors, which range from 0% for cash and securities issued by the
United States Government or its agencies to 100% for repossessed assets or loans
more than 90 days past due. Qualifying one-to-four family residential real
estate loans and qualifying multi-family residential real estate loans (not more
than 90 days delinquent and having an 80% or lower loan-to-value ratio), which
at December 31, 2003 represented 31.4% of the total loans receivable of the
Bank, are weighted at a 50% risk factor. Supplementary capital may include,
among other items, cumulative perpetual preferred stock, perpetual subordinated
debt, mandatory convertible subordinated debt, intermediate-term preferred
stock, and general allowances for loan losses. The allowance for loan losses
includable in supplementary capital is limited to 1.25% of risk-weighted assets.
The amount of supplementary capital that can be included is limited to 100% of
core capital.
Certain exclusions from capital and assets are required to be made for the
purpose of calculating total capital, in addition to the adjustments required
for calculating core capital. Such exclusions consist of equity investments (as
defined by regulation) and that portion of land loans and non-residential
construction loans in excess of an 80% loan-to-value ratio and reciprocal
holdings of qualifying capital instruments. However, in calculating regulatory
capital, institutions can add back unrealized losses and deduct unrealized gains
net of taxes, on debt
42
securities reported as a separate component of capital calculated according to
generally accepted accounting principles.
OTS regulations establish special capitalization requirements for savings
banks that own service corporations and other subsidiaries, including subsidiary
savings banks. According to these regulations, certain subsidiaries are
consolidated for capital purposes and others are excluded from assets and
capital. In determining compliance with the capital requirements, all
subsidiaries engaged solely in activities permissible for national banks,
engaged solely in mortgage-banking activities, or engaged in certain other
activities solely as agent for its customers are "includable" subsidiaries that
are consolidated for capital purposes in proportion to the Bank's level of
ownership, including the assets of includable subsidiaries in which the Bank has
a minority interest that is not consolidated for generally accepted accounting
principles purposes. For excludable subsidiaries, the debt and equity
investments in such subsidiaries are deducted from assets and capital. At
December 31, 2003, the Bank had $1.2 million of investments subject to a
deduction from tangible capital.
Under currently applicable OTS policy, savings institutions must value
securities available for sale at amortized cost for regulatory capital purposes.
This means that in computing regulatory capital, savings institutions should add
back any unrealized losses and deduct any unrealized gains, net of income taxes,
on debt securities reported as a separate component of capital calculated
according to generally accepted accounting principles.
At December 31, 2003, the Bank exceeded all of its regulatory capital
requirements. See "Note 17 - Regulatory Capital Requirements" in the Company's
Annual Report, which is attached herein as Exhibit 13.
The OTS and the FDIC generally are authorized to take enforcement action
against a savings bank that fails to meet its capital requirements, which action
may include restrictions on operations and banking activities, the imposition of
a capital directive, a cease-and-desist order, civil money penalties or harsher
measures such as the appointment of a receiver or conservator or a forced merger
into another institution. In addition, under current regulatory policy, a
savings bank that fails to meet its capital requirements is prohibited from
paying any dividends.
Prompt Corrective Action. Under the Federal Deposit Insurance Corporation
Improvement Act of 1991, federal banking regulators are required to take prompt
corrective action if an insured depository institution fails to satisfy certain
minimum capital requirements including a leverage limit, a risk-based capital
requirement and any other measure of capital deemed appropriate by the federal
banking regulator for measuring the capital adequacy of an insured depository
institution. All institutions, regardless of their capital levels, are
restricted from making any capital distribution or paying management fees to
controlling persons if the institution would thereafter fail to satisfy the
minimum levels for any of its capital requirements.
Under the Federal Deposit Insurance Corporation Improvement Act, an
institution is deemed to be (a) "well capitalized" if it has total risk-based
capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more,
has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any
order or final capital directive to meet and maintain a specific capital level
for any capital measure, (b) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of
4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of "well
43
capitalized," (c) "undercapitalized" if it has a total risk-based capital ratio
that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%
or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain
circumstances), (d) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital
ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less
than 3.0%, and (e) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%. Under specified
circumstances, a federal banking agency may reclassify a well capitalized
institution as adequately capitalized and may require an adequately capitalized
institution or an undercapitalized institution to comply with supervisory
actions as if it were in the next lower category (except that the FDIC may not
reclassify a significantly undercapitalized institution as critically
undercapitalized).
An institution generally must file a written capital restoration plan
which meets specified requirements with its appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. A federal banking agency must provide the
institution with written notice of approval or disapproval within 60 days after
receiving a capital restoration plan, subject to extensions by the agency. An
institution which is required to submit a capital restoration plan must
concurrently submit a performance guaranty by each company that controls the
institution. In addition, undercapitalized institutions are subject to various
regulatory restrictions, and the appropriate federal banking agency also may
take any number of discretionary supervisory actions.
At December 31, 2003, the Bank was in the "well capitalized" category for
purposes of the above regulations.
Safety and Soundness Guidelines. The OTS and the other federal bank
regulatory agencies have established guidelines for safety and soundness,
addressing operational and managerial standards, as well as compensation matters
for insured financial institutions. Institutions failing to meet these standards
may be required to submit compliance plans to their appropriate federal
regulators. The OTS and the other agencies have also established guidelines
regarding asset quality and earnings standards for insured institutions. The
Bank believes that it is in compliance with these guidelines and standards.
Capital Distributions. OTS regulations govern capital distributions by
savings institutions, which include cash dividends, stock repurchases and other
transactions charged to the capital account of a savings institution to make
capital distributions. A savings institution must file an application for OTS
approval of the capital distribution if any of the following occur or would
occur as a result of the capital distribution (1) the total capital
distributions for the applicable calendar year exceed the sum of the
institution's net income for that year to date plus the institution's retained
net income for the preceding two years, (2) the institution would not be at
least adequately capitalized following the distribution, (3) the distribution
would violate any applicable statute, regulation, agreement or OTS-imposed
condition, or (4) the institution is not eligible for expedited treatment of its
filings. If an application is not required to be filed, savings institutions
which are a subsidiary of a holding company (as well as certain other
institutions) must still file a notice with the OTS at least 30 days before the
Board of Directors declares a dividend or approves a capital distribution.
44
Branching by Federal Savings Institutions. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the
Internal Revenue Service ("IRS") domestic building and loan test (generally, 60%
of a thrift's assets must be housing-related) ("IRS Test"). The IRS Test
requirement does not apply if: (a) the branch(es) result(s) from an emergency
acquisition of a troubled savings institution (however, if the troubled savings
institution is acquired by a bank holding company, does not have its home office
in the state of the bank holding company bank subsidiary and does not qualify
under the IRS Test, its branching is limited to the branching laws for
state-chartered banks in the state where the savings institution is located);
(b) the law of the state where the branch would be located would permit the
branch to be established if the federal savings institution were chartered by
the state in which its home office is located; or (c) the branch was operated
lawfully as a branch under state law prior to the savings institution's
reorganization to a federal charter.
Furthermore, the OTS will evaluate a branching applicant's record of
compliance with the Community Reinvestment Act of 1977. An unsatisfactory
Community Reinvestment Act record may be the basis for denial of a branching
application.
Community Reinvestment Act and the Fair Lending Laws. Savings institutions
have a responsibility under the Community Reinvestment Act and related
regulations of the OTS to help meet the credit needs of their communities,
including low- and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes. An institution's failure to comply with the provisions of the
Community Reinvestment Act could, at a minimum, result in regulatory
restrictions on its activities, and failure to comply with the fair lending laws
could result in enforcement actions by the OTS, as well as other federal
regulatory agencies and the Department of Justice.
Qualified Thrift Lender Test. All savings institutions are required to
meet a qualified thrift lender test to avoid certain restrictions on their
operations. Under Section 2303 of the Economic Growth and Regulatory Paperwork
Reduction Act of 1996, a savings institution can comply with the qualified
thrift lender test by either qualifying as a domestic building and loan bank as
defined in Section 7701(a)(19) of the Internal Revenue Code or by meeting the
second prong of the qualified thrift lender test set forth in Section 10(m) of
the HOLA. A savings institution that does not meet the qualified thrift lender
test must either convert to a bank charter or comply with the following
restrictions on its operations: (a) the institution may not engage in any new
activity or make any new investment, directly or indirectly, unless such
activity or investment is permissible for a national bank; (b) the branching
powers of the institution shall be restricted to those of a national bank; (c)
the institution shall not be eligible to obtain any new advances from its FHLB
other than special liquidity advances with the approval of the OTS; and (d)
payment of dividends by the institution shall be subject to the rules regarding
payment of dividends by a national bank. Upon the expiration of three years from
the date the savings institution ceases to be a qualified thrift lender, it must
cease any activity and not retain any investment not permissible for a national
bank and immediately repay any outstanding FHLB advances (subject to safety and
soundness considerations).
45
Currently, the portion of the qualified thrift lender test that is based
on Section 10(m) of the HOLA rather than the Internal Revenue Code requires that
65% of an institution's "portfolio assets" (as defined) consist of certain
housing and consumer-related assets on a monthly average basis in nine out of
every 12 months. Assets that qualify without limit for inclusion as part of the
65% requirement are loans made to purchase, refinance, construct, improve or
repair domestic residential housing and manufactured housing; home equity loans;
mortgage-backed securities (where the mortgages are secured by domestic
residential housing or manufactured housing); stock issued by the FHLB and
direct or indirect obligations of the FDIC. Small business loans, credit card
loans and student loans are also included without limitation as qualified
investments. In addition, the following assets, among others, may be included in
meeting the test subject to an overall limit of 20% of the savings institution's
portfolio assets: 50% of residential mortgage loans originated and sold within
90 days of origination; 100% of loans for personal, family and household
purposes (other than credit card loans and educational loans); and stock issued
by FNMA or FHLMC. Portfolio assets consist of total assets minus the sum of (a)
goodwill and other intangible assets, (b) property used by the savings
institution to conduct its business, and (c) liquid assets up to 20% of the
institution's total assets. At December 31, 2003, approximately 82.2% of the
portfolio assets of the Bank were qualified thrift investments.
Federal Home Loan Bank. The Bank is a member of the FHLB, which
administers the home financing credit function of savings institutions. Each
FHLB serves as a reserve or central bank for its members within its assigned
region. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System. It makes loans to members (i.e.,
advances) in accordance with policies and procedures established by its Board of
Directors. At December 31, 2003, the Bank had $641.7 million of FHLB advances.
As a member, the Bank is required to purchase and maintain stock in the
FHLB in an amount equal to at least 1% of its aggregate unpaid residential
mortgage loans, home purchase contracts or similar obligations at the beginning
of each year or 5% of the members' aggregate amount of outstanding advances. At
December 31, 2003, the Bank was required to hold $32.1 million in stock of the
FHLB.
The FHLB is required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future and could also result in the FHLB imposing higher interest rates
on advances to members. These contributions also could have an adverse effect on
the value of FHLB stock in the future.
Federal Reserve System. Federal Reserve Board regulations require all
depository institutions to maintain noninterest earning reserves against their
transaction accounts (primarily NOW and Super NOW checking accounts) and
non-personal time deposits. At December 31, 2003, the Bank was in compliance
with these 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.
Savings banks are authorized to borrow from a Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require savings banks
to exhaust other
46
reasonable alternative sources of funds, including FHLB advances, before
borrowing from a Federal Reserve Bank.
Affiliate Restrictions. Section 11 of the HOLA provides that transactions
between an insured subsidiary of a holding company and an affiliate thereof will
be subject to the restrictions that apply to transactions between banks that are
members of the Federal Reserve System and their affiliates pursuant to Sections
23A and 23B of the Federal Reserve Act.
Generally, Section 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings institution or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the institution's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates.
Section 23B applies to "covered transactions" and certain other transactions and
requires that all such transactions be on terms and under circumstances that are
substantially the same, or at least as favorable to the savings institution or
its subsidiary, as those prevailing at the time for comparable transactions with
nonaffiliated companies. A "covered transaction" is defined to include a loan or
extension of credit to an affiliate; a purchase of investment securities issued
by an affiliate; a purchase of assets from an affiliate, with certain
exceptions; the acceptance of securities issued by an affiliate as collateral
for a loan or extension of credit to any party; or the issuance of a guarantee,
acceptance or letter of credit on behalf of an affiliate. Section 23B
transactions also apply to the provision of services and the sale of assets by a
savings association to an affiliate.
In addition, under OTS regulations, a savings institution may not make a
loan or extension of credit to an affiliate unless the affiliate is engaged only
in activities permissible for bank holding companies; a savings institution may
not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings institution and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings institution or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings institution to an affiliate must be secured by collateral with a market
value ranging from 100% to 130% (depending on the type of collateral) of the
amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
institution subsidiaries of savings institutions from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
institutions to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings institutions may
be required to give the OTS prior notice of affiliate transactions.
Federal Securities Law
The Company's common stock is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and under OTS
regulations, and generally may not be deregistered for at least three years
after the initial public offering which was completed on October 1, 2002. We are
subject to the information, proxy solicitation, insider trading restrictions and
other requirements of the Exchange Act.
47
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002, ("Sarbanes-Oxley") implements a broad
range of corporate governance and accounting measures for public companies
(including publicly-held bank holding companies such as the Company) designed to
promote honesty and transparency in corporate America. Sarbanes-Oxley's
principal provisions, many of which have been interpreted through regulations
released in 2003, provide for and include, among other things:
o The creation of an independent accounting oversight board;
o Auditor independence provisions that restrict non-audit
services that accountants may provide to their audit clients;
o Additional corporate governance and responsibility measures,
including the requirement that the chief executive officer and
chief financial officer of a public company certify financial
statements;
o The forfeiture of bonuses or other incentive-based
compensation and profits from the sale of an issuer's
securities by directors and senior officers in the twelve
month period following initial publication of any financial
statements that later require restatement if such restatement
was due to corporate misconduct;
o An increase in the oversight of, and enhancement of certain
requirements relating to, audit committees of public companies
and how they interact with the Company's independent auditors;
o Requirements that audit committee members must be independent
and are barred from accepting consulting, advisory or other
compensatory fees from the issuer;
o Requirements that companies disclose whether at least one
member of the audit committee is a "financial expert" (as such
term is defined by the SEC) and if not, why the audit
committee does not have an audit committee financial expert;
o Expanded disclosure requirements for corporate insiders,
including accelerated reporting of stock transactions by
insiders and a prohibition on insider trading during pension
blackout periods;
o A prohibition on personal loans to directors and officers,
except certain loans made by insured institutions on
nonpreferential terms in compliance with other bank regulatory
requirements;
o Disclosure of a code of ethics and filing a Form 8-K for a
change or waiver of such code;
o Requirements that counsel is required to report evidence of a
material violation of the securities laws or a breach of
fiduciary duty by a company to its chief executive officer or
its chief legal officer and if such officer does not respond,
to report such matter to the audit committee or the Board of
Directors; and
o A range of enhanced penalties for fraud and other violations.
48
TAXATION
Federal Taxation
General. We are subject to federal income taxation in the same general
manner as other corporations with some exceptions listed below. The following
discussion of federal taxation is only intended to summarize certain pertinent
federal income tax matters and is not a comprehensive description of the
applicable tax rules. We were last audited by the IRS for tax year 1991 and by
the Nebraska Department of Revenue for tax year 1993.
We file a consolidated federal income tax return and accordingly, any cash
distributions made by us are treated as cash dividends, and not as a non-taxable
return of capital to shareholders for federal and state tax purposes.
Method of Accounting. For federal income tax purposes, we report income
and expenses on the accrual method of accounting and file our federal income tax
return on a calendar year basis.
Bad Debt Reserves. The Small Business Protection Act of 1996 eliminated
the use of the reserve method of accounting for bad debt reserves by savings
institutions, effective for taxable years beginning after 1995. Prior to that
time, we were permitted to establish a reserve for bad debts and to make
additions to the reserve. These additions could, within specified formula
limits, be deducted in arriving at taxable income. As a result of the Small
Business Protection Act of 1996, savings associations must use the specific
charge-off method in computing their bad debt deduction beginning with their
1996 federal tax return. In addition, federal legislation requires the recapture
(over a six year period) of the excess of tax bad debt reserves at December 31,
1995 over those established as of December 31, 1987.
Taxable Distributions And Recapture. Prior to the Small Business
Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were
subject to recapture into taxable income if we failed to meet certain thrift
asset and definitional tests. New federal legislation eliminated these
thrift-related recapture rules. However, to the extent that we make
"non-dividend distributions" that are considered as made (i) from the reserve
for losses on qualifying real property loans, or (ii) from the supplemental
reserve for losses on loans, then an amount based on the amount distributed will
be included in our taxable income. Non-dividend distributions include
distributions in excess of our current and accumulated earnings and profits,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of our current or accumulated earnings and
profits, as calculated for federal income tax purposes, will not be considered
to result in a distribution from our bad debt reserve. As a result, any
dividends that would reduce amounts appropriated to the bad debt reserve and
deducted for federal income tax purposes would create a tax liability for us.
At December 31, 2003, our total federal pre-1988 reserve was approximately
$7.7 million. The reserve reflects the cumulative effects of federal tax
deductions for which no federal income tax provisions have been made. We had
fully recaptured all reserves in excess of $7.7 million which were subject to
recapture as of December 31, 2003.
49
Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax
at a rate of 20% on a base of regular taxable income plus certain tax
preferences. The alternative minimum tax is payable to the extent such
alternative minimum tax income is in excess of an exemption amount. Net
operating losses, of which we have none, can offset no more than 90% of
alternative minimum tax income. However, net operating losses attributable to
years ending in 2002 or 2003 or carried forward from an earlier year into 2002
or 2003 can offset 100% of alternative minimum tax liability. Certain payments
of alternative minimum tax may be used as credits against regular tax
liabilities in future years. We have not been subject to the alternative minimum
tax nor do we have any such amounts available as credits for carryover.
Net Operating Loss Carryovers. We may carry back net operating losses to
the two preceding taxable years and forward to the succeeding 20 taxable years.
This provision applies to losses incurred in taxable years beginning before
August 6, 1997. For net operating losses in years beginning after August 5,
1997, such net operating losses can be carried back to the two preceding taxable
years and forward to the succeeding 20 taxable years. At December 31, 2003, we
had no net operating loss carry forwards for federal income tax purposes.
Corporate Dividends-Received Deduction. We may exclude from income 100% of
dividends received from a member of the same affiliated group of corporations.
The corporate dividends received deduction is 80% in the case of dividends
received from corporations which a corporate recipient owns less than 80%, but
at least 20% of the distribution corporation. Corporations which own less than
20% of the stock of a corporation distributing a dividend may deduct only 70% of
dividends received.
State and Local Taxation
Nebraska Taxation. Under Nebraska law, the Bank presently pays a franchise
tax in lieu of a corporate income tax. The franchise tax is the lesser of two
amounts computed based on our average deposits and net financial income,
respectively. Presently, the tax is $0.47 per $1,000 of average deposits but not
to exceed an amount determined by applying 3.81% to our net financial income.
Net financial income is our income as reported to the OTS, including our
subsidiaries, after ordinary and necessary expenses but before income taxes.
In addition, the Company is required to file a Nebraska income tax return
because we are doing business in Nebraska. For Nebraska tax purposes,
corporations are presently taxed at a rate equal to 7.81% of taxable income. For
this purpose, "taxable income" generally means Federal taxable income, subject
to certain adjustments (including addition of interest income on non-Nebraska
municipal obligations and excluding interest income from qualified U.S.
Governmental obligations).
Iowa, Kansas, Colorado and Minnesota Taxation. For Iowa, Kansas, Colorado
and Minnesota income tax purposes, we are taxed at a rate equal to 5.00%, 4.50%,
4.63% and 9.80%, respectively, of taxable income. For this purpose, "taxable
income" generally means federal taxable income, subject to certain adjustments
(including addition of interest income on state and municipal obligations).
50
Wisconsin Taxation. As a Wisconsin holding company, the Company is subject
to a Wisconsin franchise tax based on its net income on a separate (rather than
on a consolidated) basis. The Company's primary source of income is dividends
paid to it by its wholly owned subsidiaries. Accordingly, and because such
dividends are generally exempt from Wisconsin franchise tax, the Company pays
little or no Wisconsin franchise tax. The Company also files an annual report
with and pays a nominal filing fee to the State of Wisconsin.
For further information regarding taxes see "Note 14 - Income Taxes" in
the Company's Annual Report which is incorporated hereto as Exhibit 13.
51
Item 2. Properties.
Properties
We currently operate 57 banking offices in Nebraska (45), Iowa (9) and
Kansas (3) of which 41 were owned by us and 16 were under operating leases.
Additionally, we operate three loan production offices located in Colorado and
one loan production office located in Minnesota, all of which are under
operating leases. We own our corporate headquarters located in Lincoln,
Nebraska. During 2003, we closed our West Point, Nebraska office. See "Note 18 -
Lease Commitments" in the Company's Annual Report which is attached hereto as
Exhibit 13.
52
Item 3. Legal Proceedings.
Except litigation relating to certain goodwill claims against the United
States ("U.S.") described below, we are not involved in any pending legal
proceedings other than routine legal proceedings occurring in the ordinary
course of business. Such routine legal proceedings, in the aggregate, are
believed by management to be immaterial to the Company's consolidated financial
condition or consolidated results of operations.
In August 1995, we commenced litigation against the U.S. in the United
States Court of Federal Claims ("Claims Court") claiming that the U.S. breached
its contract with us and has unlawfully taken our property without just
compensation or due process of law. As described below, our claims arose from
changes to the rules for computing our regulatory capital that were required by
the adoption of the Financial Institutions Reform, Recovery and Enforcement Act
of 1989 ("FIRREA").
Pursuant to FIRREA, which became effective in August 1989, the OTS was
created as the successor to the Federal Home Loan Bank Board ("FHLBB") to
regulate federally-insured savings institutions. At such time, we had $30.0
million of supervisory goodwill remaining from three supervisory mergers we
completed in 1982. At the time of these mergers, the FHLBB agreed we could
include the supervisory goodwill as capital for purposes of meeting our
regulatory capital requirements. The regulatory goodwill was to be amortized
over a 25-year period. As a result of regulations adopted by the OTS
implementing FIRREA, we had to immediately exclude all of our supervisory
goodwill from the calculation of our tangible capital and had to phase out the
inclusion of this goodwill in the calculation of our core and risk-based capital
requirements over a five-year period. We believe that FIRREA and the adoption of
the capital regulations by the OTS implementing FIRREA constituted a breach by
the U.S. of its contractual commitment regarding the regulatory capital
treatment of our supervisory goodwill. As a result, we commenced litigation
against the U.S., as discussed below, seeking damages for this breach of
contract.
Our case was initially stayed pending resolution on appeal of a series of
cases (United States v. Winstar Corporation) (the "Winstar Cases"). In July
1996, the United States Supreme Court ruled in the Winstar Cases that when the
United States Congress changed the accounting for supervisory goodwill specified
in FIRREA, it breached FHLBB contractual agreements with these institutions
regarding the treatment of supervisory goodwill. The Claims Court issued a case
management order in all cases similar to the Winstar Cases, including ours.
Pursuant to the case management order, we filed a motion for partial summary
judgment with respect to the U.S.'s liability to us for breach of contract. The
U.S., in response, filed a motion for summary judgment denying any liability. On
November 19, 2002, Judge Sarah Wilson of the Claims Court entered an order
finding that genuine issues of material fact exist regarding liability and both
parties' cross-motions for partial summary judgment were denied.
On May 19, 2003, a four-day trial related solely to issues of liability
was held. On November 6, 2003, the Claims Court rendered a decision finding the
U.S. liable to the Bank for breach of contract with regard to one of three
claims and the Court dismissed the breach of
53
contract complaint on the remaining two claims. A Motion For Reconsideration of
the Courts Liability Decision with respect to the one claim was filed by the
U.S. on November 17, 2003 and has not been ruled upon at the present time by the
Claims Court. As of December 31, 2003, the issue of damages and the amount
thereof, if any, remains to be determined in subsequent judicial proceedings.
Discovery on the issue of damages has been completed, including the
submission of written opinions of expert witnesses for both the U.S. and us. We
are claiming damages under two alternative theories. First, we are claiming lost
profits damages of $66.7 million due to, among other things, lost profits, lost
franchise value and "wounded bank" damages. Alternatively, we have claimed
damages of $28.5 million for the cost of replacement capital. The U.S.'s experts
have countered, stating that we have not suffered any damages and in fact
benefited from FIRREA since we reduced the number of our banking offices and
took other steps which reduced our operating costs.
The U.S.'s current litigation strategy is to argue that no damages have
been suffered and therefore it will not settle any of the pending goodwill
cases. As a consequence, claimants, including us, plan to proceed to trial to
pursue our damage claims. There can be no assurance as to the type or amount of
damages, if any, that we may recover or the timing, if we are successful, for
receipt by us of any damages from the U.S. Government.
Item 4. Submission of Matters to a Vote of Security Holders.
Not Applicable.
54
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
The information required herein is incorporated by reference from the
inside back cover of the Company's Annual Report and from Part III, Item 12
hereof. Information with respect to the Company's repurchase of its equity
securities is not applicable.
Item 6. Selected Financial Data.
The information required herein is incorporated by reference from page 10
of the Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The information required herein is incorporated by reference from pages 11
to 24 of the Annual Report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information required herein is incorporated by reference from pages 13
to 15 of the Annual Report.
Item 8. Financial Statements and Supplementary Data.
The information required herein is incorporated by reference from pages 25
to 48 of the Annual Report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not Applicable.
Item 9a. Controls and Procedures.
Our management evaluated, with the participation of our Chief Executive
Officer and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based on such evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures are
designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the
55
time periods specified in the SEC's rules and regulations and are operating in
an effective manner.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by Item 10 of Form 10-K with respect to
identification of directors and executive officers is incorporated by reference
from "Information With Respect to Nominees for Director, Continuing Directors
and Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive Proxy Statement for the Annual Meeting
of Stockholders to be held May 4, 2004 (the "Proxy Statement"), which will be
filed with the Securities and Exchange Commission prior to April 30, 2004.
The Company has adopted a Code of Conduct and Ethics that applies to its
principal executive officer and principal financial officer, as well as other
officers and employees of the Company and the Bank. A copy of the Code of
Conduct and Ethics, (included as an exhibit to this Form 10-K and filed with the
Securities and Exchange Commission), may also be found on the Company's website
at www.tieronebank.com.
Item 11. Executive Compensation.
The information required by Item 11 of Form 10-K is incorporated by
reference from "Management Compensation", "Report of the Compensation Committee"
and "Performance Graph" in the Proxy Statement.
The reports of the Audit Committee and Compensation Committee included in
the Proxy Statement should not be deemed to be filed or incorporated by
reference into this filing or any other filing by the Company under the Exchange
Act or Securities Act of 1933 except to the extent the Company specifically
incorporates said reports herein or therein by reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The information required by Item 403 of Regulation S-K is incorporated by
reference from "Beneficial Ownership of Common Stock by Certain Beneficial
Owners and Management" in the Proxy Statement.
Equity Compensation Plan Information. The following table sets forth
certain information for all equity compensation plans and individual
compensation arrangements (whether with employees or non-employees, such as
directors), in effect as of December 31, 2003.
56
Remaining Available for
Number of Shares to be Weighted-Average Future Issuance
Issued Upon the Exercise of Exercise Price of (Excluding Shares
Outstanding Options, Outstanding Reflected in the First
Plan Category Warrants and Rights (1) Options Column)
----------------------------------------------------------------------------------------------------------------------------
Equity Compensation Plans
Plans Approved by 2,617,600 $ 17.83 542,911
Security Holders
Equity Compensation Plans
Not Approved by Security N/A N/A N/A
Holders
----------------------------------------------------------------------------------------------------------------------------
Total 2,617,600 $ 17.83 542,911
============================================================================================================================
(1) Included in such numbers are 764,850 shares which are subject to
restricted stock grants which were not vested as of December 31, 2003. The
weighted average exercise price excludes restricted stock grants.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 of Form 10-K is incorporated by
reference from "Management Compensation - Transactions with Certain Related
Persons" in the Proxy Statement.
Item 14. Principal Accounting Fees and Services.
The information required herein in incorporated by reference to
"Ratification of Appointment of Auditors" in the Proxy Statement.
57
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents filed as part of the Annual Report
(1) The following financial statements are incorporated by reference
from Item 8 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Income for the Years Ended December 31,
2003, 2002 and 2001
Consolidated Statements of Changes in Shareholders' Equity and
Comprehensive Income for the Years Ended December 31, 2003, 2002 and
2001
Consolidated Statements of Cash Flows for the Years Ended December
31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
(2) All schedules for which provision is made in the applicable
accounting regulations of the SEC are omitted because of the absence
of conditions under which they are required or because required
information is included in the consolidated financial statements and
related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K, and this
list includes the Exhibit Index.
58
No. Exhibits Location
-------- ------------------------------------------------------------------------ ---------------------
3.1 Articles of Incorporation of TierOne Corporation (1)
3.2 Bylaws of TierOne Corporation (1)
4.0 Forms of Stock Certificate of TierOne Corporation (1)
10.1 Employment Agreement between TierOne Bank and Gilbert G. Lundstrom* (1)
10.2 Employment Agreement between TierOne Bank and James A. Laphen* (1)
10.3 Form of Employment Agreement between TierOne Corporation and Gilbert (1)
G. Lundstrom*
10.4 Form of Employment Agreement between TierOne Corporation and James (1)
A. Laphen*
10.5 Supplemental Retirement Plan* (1)
10.6 Form of Change in Control Agreement between TierOne Bank and certain (1)
executive officers*
10.7 Form of Change in Control Agreement between TierOne Bank and certain (1)
executive officers*
10.8 Form of TierOne Bank Employee Severance Plan* (1)
10.9 Form of Employee Stock Ownership Plan Supplemental Executive (1)
Retirement Plan*
10.10 Form of 401(k) Plan Supplemental Executive Retirement Plan* (1)
10.11 Director's Deferred Compensation Plan* (1)
10.12 Amended and Restated Consultation Plan for Directors* (1)
10.13 TierOne Bank Management Incentive Compensation Plan* (2)
10.14 TierOne Bank Deferred Compensation Plan* (3)
10.15 2003 Stock Option Plan* (2)
10.16 2003 Management Recognition and Retention Plan and Trust Agreement (2)
13 Annual Report to Shareholders Filed Herewith
14 Code of Conduct and Ethics Filed Herewith
22 Subsidiaries of the Registrant - Reference is made to "Item 1. Business - --
Subsidiaries" of the Form 10-K for the required information
23 Consent of KPMG LLP Filed Herewith
31.1 Certification pursuant to Rule 13a-14 of the Securities Exchange Act of Filed Herewith
1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
31.2 Certification pursuant to Rule 13a-14 of the Securities Exchange Act of Filed Herewith
1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
32.1 Certification of Chief Executive Officer Filed Herewith
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Filed Herewith
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
---------------------------------------------------------------------------------------------------------------
* Denotes management compensation plan or arrangement.
(1) Incorporated by reference from TierOne Corporation's Registration
Statement on Form S-1, filed on April 3, 2002, as amended and
declared effective on August 12, 2002 (File No. 333- 85838).
(2) Incorporated herein by reference from TierOne Corporation's
definitive proxy statement filed by TierOne Corporation with the SEC
on March 11, 2003.
(3) Incorporated by reference from TierOne Corporation's Annual Report
and Form 10-K for the year ended December 31, 2002 filed by TierOne
Corporation with the SEC on March 28, 2003.
59
(b) Reports on Form 8-K
Date Item and Description
---------------- -------------------------------------------------------------
October 15, 2003 Item 9. On October 13, 2003, the Company issued a press
release announcing that the Company's Board of Directors has
authorized the repurchase of up to ten percent, or 2,257,508
shares, of the Company's outstanding common stock.
October 22, 2003 Item 12. On October 20, 2003, the Company issued a press
release reporting its earnings for the three and nine months
ended September 30, 2003.
(c) The exhibits listed under (a)(3) of this Item 15 are filed herewith.
(d) Not applicable.
60
SIGNATURES
Pursuant to the requirements 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.
TIERONE CORPORATION
Date: March 5, 2004 By: /s/ Gilbert G. Lundstrom
---------------------------------------------
Gilbert G. Lundstrom
Chairman of the Board and Chief Executive Officer
Date: March 5, 2004 By: /s/ Eugene B. Witkowicz
----------------------------------------------
Eugene B. Witkowicz
Executive Vice President and
Chief Financial Officer
61