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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
Annual Report Pursuant to Section 13 of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
Commission File No.: 0-19829
ARGO(R) BANCORP, INC.
(Name of small business issuer in its charter)
Delaware 36-3620612
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
7600 W. 63rd Street, Summit, Illinois 60501-1830
(Address of principal executive offices)
(708) 458-4800
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of Class)
Check whether the issuer (1) has filed all reports required to be filed by the
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the Registrant was required to file such
report(s), and (2) has been subject to such filing requirements for the past 90
days. Yes _X_ No ___.
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B and no disclosure will be contained, to the best of the
Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-KSB or any amendment to
this Form 10-KSB |_|
Issuer's revenue for its most recent fiscal year was $33,851,206.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, i.e., persons other than directors and executive officers of the
Registrant is $2,873,944 and is based upon the last sales price as quoted on
NASDAQ for March 25, 1998.
The Registrant had 497,644 shares outstanding as of March 25, 1998.
Transitional Small Business Disclosure Format (check one): Yes ___ No _X_.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December 31,
1997, are incorporated by reference into Part II of this Form 10-KSB.
Portions of the Proxy Statement for the 1997, Annual Meeting of Stockholders are
incorporated by reference into Part III of this Form 10-KSB.
INDEX
Part I Page No.
- ------ --------
Item 1. Description of Business.............................. 1
Item 2. Description of Property.............................. 43
Item 3. Legal Proceedings.................................... 43
Item 4. Submission of Matters to a Vote
of Security Holders.................................. 43
Part II
Item 5. Market for Registrant's Common
Equity and Related Stockholders Matters.............. 44
Item 6. Management's Discussion and Analysis
or Plan Operations................................... 44
Item 7. Financial Statements ................................ 44
Item 8. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure................................. 44
Part III
Item 9. Directors, Executive Officers, Promoters,
and Control Persons; Compliance with
Section 16(a) of the Exchange Act.................... 44
Item 10. Executive Compensation............................... 45
Item 11. Security Ownership of Certain
Beneficial Owners and Management..................... 45
Item 12. Certain Relationships and Related
Transactions......................................... 45
Item 13. Exhibits, Financial Statement
Schedules and Reports on Form 8-K.................... 45
SIGNATURES........................................... 48
BUSINESS OF ARGO(R) BANCORP, INC.
Item 1. Description of Business
Argo Bancorp, Inc. ("Argo Bancorp", "Holding Company", or "Company") was
incorporated in August 1987, for the purpose of acquiring Argo Federal Savings
Bank, FSB ("Argo Savings", or the "Savings Bank"). Argo Bancorp was originally
capitalized through the sale of 300 shares (which split in December of 1991 at
700/1) of common stock to three investors for total proceeds of $60,000. Argo
Bancorp acquired Argo Savings on November 17, 1987, for a capital infusion of
$1.1 million. On August 29, 1991, the Board of Directors of Dolton-Riverdale
Savings and Loan Association ("Dolton", or "Dolton-Riverdale Savings") and Argo
Savings adopted a Plan of Merger Conversion ("Plan"), whereby Dolton agreed to
convert from a state-chartered mutual association to a federally-chartered stock
association and merge with and into Argo Savings with Argo Savings as the
surviving entity. Pursuant to the Plan, shares of common stock of Argo Bancorp
were first sold to the members of Dolton in a Subscription Offering and the
shares not subscribed were then offered to the public in a Community Offering.
The Subscription and Community Offering were held concurrently and were
completed on April 27, 1992. Final regulatory approval was received on May 26,
1992, at which time the merger conversion was completed. The transaction was
accounted for under a pooling of interests method. There was no goodwill or
other intangible assets recorded as a result of the transaction. As part of the
merger conversion with Dolton-Riverdale Savings, the Company sold an additional
74,750 shares of common stock at a issuance price of $11.50. Net proceeds from
the merger conversion were $326,000 after the deduction of the conversion
expenses. The Company retained 50.0% of the net proceeds from the merger
conversion and injected the remaining 50.0% into Argo Savings. Prior to the
merger conversion, the Management Recognition Plan ("MRP") purchased 15,400
shares of Argo Bancorp's authorized but unissued common stock. The Company is a
unitary savings and loan holding company and is registered as such with the
Office of Thrift Supervision ("OTS"), Federal Deposit Insurance Corporation
("FDIC") and the Securities and Exchange Commission ("SEC").
On October 31, 1995, Argo Bancorp acquired On-Line Financial Services, Inc.
("On-Line"), an Oak Brook, Illinois based computer services bureau, serving bank
and thrift clients throughout the Midwest. The purchase transaction was
consummated through the use of a wholly-owned subsidiary, OLF Acquisition
Corporation, which acquired shares of three separate state chartered savings and
loan service corporations which owned, in the aggregate, 98.90% of the
outstanding shares of On-Line. Sale of the remaining 1.10% of On-Line shares was
made by a single institutional stockholder that held shares in the Company
directly. The intervening acquisition subsidiary and state chartered savings and
loan service corporations' shells were liquidated and merged by Argo Bancorp
during 1996.
Financial terms of the transaction included a cash sweep of On-Line funds
on hand to shareholders, less amounts necessary to establish certain agreed upon
escrows; a two (2) year asset note of $1,026,000, representing the closing date
net book value of On-Line assets; a twenty-six (26) month escrow note in the
amount of $460,000, representing funds held for future performance under a third
party computer lease; and a structured schedule of contingent payments based on
future revenues of On-Line over the next seven years. The total transaction
value, including asset notes and contingent payments, will not exceed $8.9
million.
1
On May 29, l996, Argo Savings incorporated a Tier I subsidiary, Margo
Financial Services, LLC ("Margo"). Margo is an Illinois chartered limited
liability corporation whose members are Argo Savings and Nip`n Tuck, Inc., an
Illinois corporation. Margo's primary objectives are to increase loan
origination volume and to serve as a wholesale mortgage banking operation using
a network of brokers, correspondents and conduits. Argo Savings has a 50.l%
interest in Margo.
On December 31, l996, Argo Bancorp entered into a stock purchase agreement
with The Deltec Banking Corporation Limited ("Deltec"), a banking corporation
organized under the laws of the Commonwealth of the Bahamas. Under the terms of
the agreement, Argo Bancorp agreed to issue and sell 111,564 shares of the
Company's authorized and unissued common stock to Deltec at a purchase price of
$38.00 per share. Total proceeds from this transaction were approximately
$4,239,000. A five (5.0%) percent investment advisory fee totaling $212,000 was
paid to Charles E. Webb and Company reducing the net proceeds of the transaction
to $4,027,000.
Unlike many savings and loan holding companies, Argo Bancorp is an active
holding company with only a portion of its future anticipated operating income
dependent upon the earnings of Argo Savings. As an operating company, Argo
Bancorp has assets, liabilities and income that are unrelated to the operations
of Argo Savings. Among the assets of Argo Bancorp is its investment in the
Empire/Argo Mortgage LLC, which engages in the purchase and disposition of
deeply discounted mortgage loans. Argo Bancorp's assets at December 31, 1997, on
an unconsolidated basis consisted of its investment in Argo Savings of $13.7
million, its investment in On-Line of $5.2 million, its investment in the
majority owned Empire/Argo Mortgage LLC of $1.5 million, securities available
for sale of $1.3 million, cash and other interest-earning deposits of $666,000,
and other assets of $1.7 million. Argo Bancorp also had outstanding borrowings
on an unconsolidated basis in the amount of $5.6 million at December 31, 1997,
incurred in connection with capital infusions to its subsidiaries. Argo Bancorp
is a Federal Housing Authority ("FHA") approved originator and servicer, a
licensed Illinois mortgage banker and an approved Federal National Mortgage
Association ("FNMA") servicer.
BUSINESS OF ON-LINE FINANCIAL SERVICES, INC.
On-Line is a third party provider of on-line, real time, electronic data
processing services to financial institutions located throughout the Midwest.
On-Line currently provides data processing services to thrifts, community banks,
savings banks, and mortgage brokers representing over 1.2 million customer
accounts in six Midwestern states. On-Line has historically marketed its
services to institutions with assets of less than $1.0 billion, where the
Company's orientation toward superior customer service and specialized products
allows it to effectively compete. On-Line's customer base include institutions
with total assets ranging from $13.0 million to $850.0 million, with an average
of approximately $95.0 million. The acquisition by Argo Bancorp will promote the
development and sale of technological advances in the systems, programs, and
services offered by On-Line, which include resale of software produced by
Information Technology Incorporated, integrated check and document imaging
systems, and computer output laser disc storage technology. These services are
in addition to new offerings by the Company in the planning and deployment of
wide area and local area network systems, the sale of all related hardware and
services, expanded technical and communications support, consultation and
training, and the maintenance of in-house systems. The Company's strategy to
implement and offer computer output laser disc storage technology and a full
line of document imaging services has been realized and is now being marketed to
a wide array of
2
users of advanced technology. Together with aggressive marketing to small and
mid-size commercial and community banks, On-Line's business plan to expand its
traditional thrift institution client base is being implemented.
BUSINESS OF ARGO(R) FEDERAL SAVINGS BANK, FSB
The discussion that follows relates primarily to the business of Argo
Savings, a federally chartered depository institution. Argo Savings undertakes
the primary lending activities of Argo Bancorp, accordingly, the discussion
under the caption "Lending Activities" materially relates only to Argo Savings.
Argo Bancorp does, however, have certain investments in loans on an
unconsolidated basis at the holding company level, as well as certain borrowings
unrelated to the activities of Argo Savings. Accordingly, there are certain
references to Argo Bancorp's activities under the section caption "Sources of
Funds and Borrowings." Unless otherwise stated, all other descriptions of the
business of Argo Bancorp that follow relate to the business of Argo Savings.
Argo Savings was originally chartered in 1908 as a mutual savings and loan
association in the State of Illinois. Argo Savings converted to a federal stock
charter in 1982 and was determined to be insolvent by the Federal Savings and
Loan Insurance Corporation ("FSLIC") in 1987. On November 17, 1987, the FSLIC
placed Argo Savings into receivership, whereupon Argo Bancorp acquired one
hundred percent of Argo Savings' issued and outstanding common stock (10,000
shares) in exchange for an injection of capital in the amount of $1.1 million
bringing Argo Savings into capital compliance. In June 1989, Argo Bancorp
infused an additional $1.5 million of capital into Argo Savings in order to
facilitate the acquisition of Federal National Mortgage Association ("FNMA")
mortgage servicing rights in July 1989. Argo Savings is a member of the Federal
Home Loan Bank ("FHLB") System and its deposits are insured by the FDIC under
the Savings Association Insurance Fund ("SAIF"). The principal executive offices
of Argo Bancorp and home office of Argo Savings are located at 7600 West 63rd
Street, Summit, Illinois. Argo Savings has four branch offices, located in Cook
and Lake County, Illinois.
Argo Savings' primary business is the solicitation of savings deposits from
the general public and the purchase or origination of loans secured by
residential real estate. Through its subsidiaries Argo Mortgage Corporation and
Margo Financial Services, LLC, Argo Savings has engaged in mortgage brokerage
activities that focus on the origination, purchase and sale of mortgage loans in
the secondary market. Argo Savings generates income by the sale of these
mortgage loans on a "servicing released" basis into the secondary market and
through investment in Purchased Mortgage Servicing Rights ("PMSRs"). To a lesser
extent, Argo Savings invests funds in securities approved for investment by
federal regulations, including obligations of the United States Government and
its agencies. Argo Savings continues to expand its operations to include
consumer lending, limited commercial real estate lending, commercial checking,
money market deposit accounts and additional consumer investment products. The
expansion into consumer lending and limited commercial real estate lending has
allowed Argo Savings to remain competitive in its primary market area. Such
lending, however, involves greater risk than one-to-four family residential
mortgage lending.
Through activities conducted by its Argo Mortgage Corporation subsidiary,
in recent years Argo Savings has acquired mortgage loans at a deep discount for
which the borrowers are either not current as to principal and interest payments
or there is doubt to the borrower's ability to pay in full
3
the contractual principal and interest outstanding. In determining the amount it
will bid to acquire such loans at private sales and auctions, the Company
estimates the amounts it will realize through foreclosure, collection efforts,
or other resolution of each loan and the length of time required to complete the
collection process. Investment in these assets has resulted in higher then
market interest yields and significant gains as a result of the ultimate sale of
properties acquired through these purchases. However, losses have also been
incurred from certain properties through other real estate owned activity.
During 1997, the Company began to focus its resources on traditional loans
receivable originated through its majority owned subsidiary Margo and began to
reduce its position in discounted loans receivable. As a result of the Company's
business strategy, the balance of the discounted loans receivable portfolio
decreased from $47.7 million or 20.8% of total assets to $30.6 million or 12.9%
of total assets at December 31, 1997.
Income is also derived from interest and fees generated in connection with
Argo Savings' lending and mortgage activities, as well as net fees generated
from investments in PMSRs. Argo Savings' principal expenses are interest paid on
savings deposits, borrowing and operating costs.
Market Area
Argo Savings considers its primary market area to be the greater Chicago
metropolitan area (hereinafter referred to as its "primary market area"). Argo
Savings maintains its headquarters in Summit with four branch offices in
Bridgeview, the near West side of Chicago, Dolton, and Gurnee, Illinois.
Argo Savings' primary market area is urban and is comprised of high-density
residential neighborhoods interspersed with mixed-use and heavily industrialized
areas. The primary market area is fully developed with a relatively large number
of generally older homes. Argo Savings' newest branch is located in Gurnee,
which is currently undergoing rapid growth and residential expansion. All branch
locations have excellent access to major transportation routes, including
Interstates 290, 294, 94 and 55, as well as public transportation, both rail and
bus.
Selected Consolidated Historical Financial Data
The following tables set forth selected consolidated historical financial
data for Argo Bancorp during the periods ended and at the dates indicated. This
information should be read in conjunction with the Consolidated Financial
Statements of Argo Bancorp and notes thereto in the 1997 Annual Report to
Shareholders, which is incorporated herein by reference.
4
SELECTED FINANCIAL DATA Year Ended December 31
-------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Financial Condition Data:
Loans receivable, net ....................................... $ 184,358 $ 173,429 $ 142,380 $ 118,063 $ 90,139
FHLB of Chicago Stock ....................................... 3,271 3,428 2,669 2,576 2,576
Securities .................................................. 4,974 5,788 7,573 12,491 15,009
Cash equivalents ............................................ 8,677 13,276 11,061 9,286 6,905
Purchased loan servicing rights ............................. 6,706 5,264 4,033 3,641 2,508
Foreclosed real estate ...................................... 4,251 3,913 2,234 359 554
Other assets ................................................ 24,061 24,186 16,518 9,601 8,038
--------- --------- --------- --------- ---------
Total assets ................................................ $ 236,298 $ 229,284 $ 186,468 $ 156,017 $ 125,729
Deposits .................................................... 172,469 150,627 123,484 100,697 88,220
Borrowed money .............................................. 34,156 50,879 38,181 30,820 9,064
Custodial escrow balances for loans serviced ................ 6,400 5,782 9,696 14,691 20,031
Other liabilities ........................................... 5,169 5,436 4,228 835 619
--------- --------- --------- --------- ---------
Stockholders' equity ........................................ $ 18,104 $ 16,560 $ 10,879 $ 8,974 $ 7,795
========= ========= ========= ========= =========
Year Ended December 31
-------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Selected Operating Data:
Interest income ............................................. $ 18,266 $ 16,074 $ 13,987 $ 10,282 $ 9,477
Interest expense ............................................ 11,286 9,083 8,341 5,012 3,822
--------- --------- --------- --------- ---------
Net interest income ....................................... 6,980 6,991 5,646 5,270 5,655
Provision for loan losses ................................... 210 248 55 48 270
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses ....... 6,770 6,743 5,591 5,222 5,385
Non-interest income ......................................... 15,585 3,083 2,643 1,838 1,738
Non-interest expense ........................................ 21,409 17,718 7,431 5,383 4,587
Income before income taxes ................................ 946 1,677 2,408 1,677 2,536
Income tax expense .......................................... 123 343 667 281 952
--------- --------- --------- --------- ---------
Income before extraordinary item
and cumulative effect of change in
accounting principle ...................................... 823 1,334 1,741 1,396 1,584
Cumulative effect of change in accounting for
income taxes .............................................. -- -- -- -- 460
Net income .................................................. $ 823 $ 1,334 $ 1,741 $ 1,396 $ 2,044
========= ========= ========= ========= =========
Basic earning
per share--before extraordinary item 1.70 4.26 5.88 4.62 5.27
Basic earning per share...................................... 1.70 4.26 5.88 4.62 6.80
Income per share - diluted before
extraordinary item ........................................ 1.56 $ 3.60 $ 4.96 $ 4.08 $ 4.81
========= ========= ========= ========= =========
Net income per share - diluted .............................. $ 1.56 $ 3.60 $ 4.96 $ 4.08 $ 6.21
========= ========= ========= ========= =========
At December 31
-------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Selected Financial Ratios and Other Data:
Return on average assets .................................... 0.35% 0.68% 1.00% 1.00% 1.59%
Return on average equity .................................... 4.62 10.89 17.09 16.17 27.88
Average equity to average assets ............................ 7.53 6.26 5.85 6.10 5.71
Equity to total assets ...................................... 7.66 7.22 5.83 5.75 6.20
Interest rate spread during period .......................... 3.81 4.61 3.69 4.25 4.82
Net interest margin ......................................... 3.54 4.44 3.65 4.24 4.93
Non-interest expense to average assets ...................... 9.05 9.83 4.40 3.86 3.58
Non-performing loans, to loans receivable,
and loans held for sale (1) ............................... 3.57 3.12 1.35 1.93 1.19
Non-performing assets to total assets (1) ................... 4.14 3.43 2.26 1.72 1.31
Allowance for loan losses to non-performing
loans (1) ................................................. 14.73 16.87 29.54 26.38 55.88
Average interest-earning assets to average
interest-bearing liabilities .............................. .95x .94x .99x 1.00x 1.03x
Book value per share ........................................ 36.98 37.11 36.72 30.91 27.38
Full-service customer service facilities .................... 5 5 5 4 3
(1) Excludes balances related to the portfolio of discounted loans receivable.
5
Lending Activities
General. Argo Savings' loans receivable, which includes loans held for
sale, portfolio loans receivable, and discounted loans receivable totaled $184.4
million, excluding accrued interest, at December 31, 1997, representing 78.0% of
its total assets. On that date, $177.5 million of total loans outstanding or
92.2% of its total gross loan portfolio, consisted of loans secured by first
mortgages on one-to-four family residential properties and $1.3 million, or .7%,
of total outstanding loans consisting of first lien loans secured by
multi-family properties. At December 31, 1997, Argo Savings had commercial real
estate loans outstanding in the amount of $2.0 million or 1.0% that are secured
by commercial buildings primarily in suburban Cook and Lake County.
Argo Savings has focused its lending activities on the generation of
profits from the sale of loans, as well as increasing the interest-rate
sensitivity of its loan portfolio. Argo Savings originates long-term, fixed-rate
mortgage loans with 15 and 30 year maturities for immediate sale in the
secondary mortgage market. Such loans are originated directly by Argo Savings,
as well as through its mortgage brokerage subsidiaries, Argo Mortgage
Corporation and Margo Financial Services, LLC. See "-- Subsidiaries."
Historically, Argo Savings' lending activity has also included the origination
and purchase of adjustable rate mortgages. The majority of the growth in the
Argo Savings' loan balances in the current year is due to the purchase and
origination of adjustable rate loans and seasoned fixed rate loans secured by
single family residences located throughout the country. Argo Savings originated
and purchased approximately $115.2 million of loans both for portfolio and for
sale, and $8.9 million of discounted loans receivable during 1997. Argo Savings'
policy of purchasing adjustable rate loans and seasoned higher yielding fixed
rate loans is intended to increase the interest rate sensitivity of its assets
without decreasing the yield on its interest-earning assets. See "-- Loan
Origination, Purchases and Sales."
Argo Savings is engaged in numerous community lending and development
activities. Argo Savings created the Heritage Corridor Community Development
Corporation ("CDC"), an Illinois not-for-profit corporation serving southwest
Cook County communities. Two other banks and a local municipality have invested
in CDC. The primary purpose of the CDC is to act as a catalyst to promote local
affordable housing and economic development projects through participation in
approved ventures. The CDC's first, and on-going project is the development and
operation of a loan fund for the revitalization of the Archer Road Business
District in Summit, Illinois. CDC has no activity in 1997 and 1996.
Additionally, Argo Savings is a member of CIC 2000, a revolving loan pool
organized by Community Investment Corporation to fund loans to rehabilitate
affordable housing in Chicago and Cook County through note sales. Single family
homeowners in Argo Savings' delineated service areas are also served under
several low down payment mortgage programs including the FannieMae Community
HomeBuyers program. Community outreach related to first time homebuyers
continues to include educational seminars and individual counseling on financing
a home purchase, in conjunction with local not-for-profit organizations. Using
Community Investment Program advances and Affordable Housing Program funds from
the FHLB, funding has been made available to expand the availability of funds
for single family mortgages and loans to small business customers within Argo
Savings' delineated services areas. Argo Savings is one of four participating
lenders in a $1.5 million line of credit to Harvey-based New Cities Community
Development Corporation, a not-for-profit corporation, to rehabilitate fifty
(50) homes for low
6
income families in the south suburbs. Argo Savings also participates in the City
of Chicago Mortgage Bond Program, the Illinois League of Financial Institutions
Affordable Housing Grant Program and the Chicago Homeowners Tax Savings Program
to enhance its ability to originate mortgages to low and moderate income
purchasers or targeted census tracts.
Analysis of Loan Portfolio. The following table sets forth the composition
of the mortgage and other loan portfolios and mortgage-backed securities
portfolio in dollar amounts and in percentages at the dates indicated.
7
At December 31,
-----------------------------------------------------------------
1993 1994 1995
-----------------------------------------------------------------
% of % of % of
Amt. Total Amt. Total Amt. Total
---- ----- ---- ----- ---- -----
(Dollars in Thousands)
Mortgage Loans:
One-to-four family.................... $ 80,059 86.92% $112,393 93.57% $144,518 93.49%
Multi-family.......................... 1,799 1.95 1,177 .98 1,180 .76
Commercial real estate................ 1,454 1.59 1,684 1.40 2,552 1.65
------ ------ ------ ------ ------- ------
Total mortgage loans............... 83,312 90.46 115,254 95.95 148,250 95.90
Other loans:
Automobile............................ 102 .11 28 .02 5 .00
Mobile home........................... 636 .69 472 .39 379 .25
Other (1)............................. 8,052 8.74 4,364 3.64 5,941 3.85
------ ------ ------ ------ ------- ------
Total other loans.................. 8,790 9.54 4,864 4.05 6,325 4.10
------ ------ ------ ------ ------- ------
Total loans receivable (2)......... 92,102 100.00% 120,118 100.00% 154,575 100.00%
====== ====== ======
Less:
Unearned discounts, premiums and
deferred loan fees, net............. 1,350 1,442 10,847
Allowance for loan losses............. 613 613 587
-------- ------- -------
Loans receivable, net................. 90,139 118,063 143,141
======== ======= =======
Mortgage-backed securities:
CMO................................... 23 .27 $ 5 0.08 -- --
FHLMC................................. 2,069 24.36 1,382 20.95 1,164 20.56
FNMA.................................. 6,017 70.84 4,901 74.29 4,339 76.65
GNMA.................................. 385 4.53 309 4.68 158 2.79
------ ------ ------ ------ ------- ------
Total mortgage-backed securities... 8,494 100.00% 6,597 100.00% 5,661 100.00%
====== ====== ======
Net premium (discount)............. 115 98 78
Unrealized loss on securities
available for sale............... -- (300) (27)
------- -------- -------
Net mortgage-backed
securities....................... $ 8,609 $ 6,395 $ 5,712
======= ======== =======
At December 31,
--------------------------------------------
1996 1997
--------------------------------------------
% of % of
Amt. Total Amt. Total
---- ----- ---- -----
(Dollars in Thousands)
Mortgage Loans:
One-to-four family.................... $177,345 92.50% $177,521 92.20%
Multi-family.......................... 1,468 .77 1,252 .65
Commercial real estate................ 4,523 2.36 1,951 1.01
-------- ------ --------- -------
Total mortgage loans............... 184,398 95.63 180,724 93.86
Other loans:
Automobile............................ 4 .00 4 .00
Mobile home........................... 248 .13 208 .11
Other (1)............................. 8,142 4.24 11,597 6.03
-------- ------ --------- -------
Total other loans.................. 8,394 4.37 11,809 6.14
-------- ------ --------- -------
Total loans receivable (2)......... 191,730 100.00% 192,533 100.00%
====== ======
Less:
Unearned discounts, premiums and
deferred loan fees, net............. 17,636 7,361
Allowance for loan losses............. 665 814
------- -------
Loans receivable, net................. 173,429 184,358
======= =======
Mortgage-backed securities:
CMO................................... -- -- -- --
FHLMC................................. 826 16.76 125 4.28
FNMA.................................. 3,949 80.15 2,798 95.72
GNMA.................................. 152 3.09 --- ---
-------- ------ --------- -------
Total mortgage-backed securities... 4,927 100.00% 2,923 100.00%
====== ======
Net premium (discount)............. 60 39
Unrealized loss on securities
available for sale............... (83) (35)
------- -------
Net mortgage-backed
securities....................... $ 4,904 $ 2,927
======= =======
- --------------------------------------------------------------------------------
(1) Consists primarily of home equity loans secured by one-to-four family
properties.
(2) Includes loans held for sale, portfolio loans receivable, and discounted
loans receivable.
8
Loan Maturity and Repricing. The following table shows the maturity or
period to repricing of Argo Savings' loans, discounted loans, and
mortgage-backed securities portfolio at December 31, 1997. Loans that have
adjustable rates are shown as being due in the period during which the interest
rates are next subject to change. The table does not include prepayments or
scheduled principal amortization. Prepayments and scheduled principal
amortization on mortgage loans totaled $35.9 million, $46.2 million, and $48.2
million for the years-ended December 31, 1995, 1996, and 1997, respectively.
Loans
---------------------------------------------------------------------------------------
One-to- Total Mortgage
four Multi- Commercial Other Loans backed
Family Family Real Estate Loans(1) Receivable Securities Total
------ ------ ----------- -------- ---------- ---------- -----
(In thousands)
Amounts Due:
Within one year ......................... $ 54,211 $ 78 $ 187 $ 8,465 $ 62,941 $ 2,923 $ 65,864
--------- --------- --------- --------- --------- --------- ---------
After one year:
One to three years ..................... 13,928 751 864 208 15,751 -- 15,751
Three to five years .................... 2,469 384 900 86 3,839 -- 3,839
Five to 10 years ....................... 12,381 39 -- 500 12,920 -- 12,920
10 to 20 years ......................... 17,738 -- -- 2,217 19,955 -- 19,955
Over 20 years .......................... 76,794 -- -- 333 77,127 -- 77,127
--------- --------- --------- --------- --------- --------- ---------
Total due after one year ................. 123,310 1,174 1,764 3,344 129,592 -- 129,592
--------- --------- --------- --------- --------- --------- ---------
Total amounts due ........................ $ 177,521 $ 1,252 $ 1,951 $ 11,809 $ 192,533 $ 2,923 $ 195,456
========= ========= ========= ========= ========= ========= =========
LESS:
Unearned discounts, premiums
and deferred loan fees, net ............ (7,361) 39 (7,322)
Unrealized loss on securities
available for sale ..................... -- -- (35) (35)
Allowance for loan losses ................ (814) -- (814)
--------- --------- ---------
Loans receivable, net .................... $ 184,358 $ 2,927 $ 187,285
========= ========= =========
- --------------------------------------------------------------------------------
(1) Consists primarily of home equity loans secured by one-to-four-family
properties.
9
The following table sets forth at December 31, 1997, the dollar amount of all
loans and mortgage-backed securities due after December 31, 1998, and whether
such loans have fixed or adjustable interest rates.
At December 31, 1997
----------------------------------
Fixed Adjustable
Rates Rates Total
-------- -------- --------
(In Thousands)
Due after December 31, 1998:
Mortgage loans:
One-to-four family ................... $108,059 $ 15,251 $123,310
Multi-family ......................... 1,174 -- 1,174
Commercial real estate ............... 1,764 -- 1,764
Other loans .......................... 3,344 -- 3,344
-------- -------- --------
Total loans receivable (1) .............. 114,341 15,251 129,592
Mortgage-backed securities .............. -- -- --
-------- -------- --------
Total loans receivable
and mortgage-backed securities ....... 114,341 15,251 129,592
- --------------------------------------------------------------------------------
(1) Includes portfolio loans receivable, loans held for sale, and discounted
loans receivable.
10
One-to-Four Family Residential Loans. At December 31, 1997, approximately
92.20% of Argo Savings' loan portfolio were comprised of one-to-four family
residential mortgage loans. Permanent conventional residential mortgage loans
are made for up to 95.0% of the appraised value of the property when the loan is
secured by real estate improved by not more than four family units.
The loan-to-value ratio, maturity and other provisions of the loans made by
Argo Savings have generally reflected a policy of making available to the public
the maximum loan permissible consistent with applicable regulations, market
conditions, and the lending practices and underwriting standards established by
Argo Savings. Mortgage loans made by Argo Savings are generally long-term loans,
amortized on a monthly basis, with principal and interest due each month. The
initial contractual loan payment period for a residential loan is typically
thirty (30) years. Borrowers may refinance or prepay loans at their option. Most
of Argo Savings' one-to-four family fixed-rate residential loan originations are
sold in the secondary market. See "-- Loan Origination, Purchases and Sales."
All conventional loans with a loan-to-value ratio in excess of 80.0% are
required to have private mortgage insurance covering that portion of the loan in
excess of 80.0% of appraised value.
Multi-Family Residential Real Estate Lending and Commercial Real Estate
Lending. Argo Savings also originates loans for the acquisition of existing
multi-family residences or refinancing of such properties, such as five to
twelve unit apartment buildings located in the greater Chicago metropolitan
area. At December 31, 1997, Argo Savings had loans secured by multi-family
properties in the amount of $1.3 million, or .65% of the total loan portfolio.
Loans originated on multi-family dwellings are generally 5-year fixed-rate
balloon mortgages amortized over thirty (30) years. An origination fee is
generally charged on such loans. Multi-family residential real estate lending
entails additional risk as compared with one-to-four family residential property
lending. Multi-family real estate loans typically involve large loan balances to
a single borrower or groups of affiliated borrowers. The payment experience on
such loans is typically dependent on the successful operation of the real estate
project. Argo Savings evaluates all aspects of multi-family real estate loan
transactions in order to mitigate risk to the greatest extent possible. To
minimize these risks, Argo Savings generally limits its multi-family lending to
properties used solely for residential purposes. Argo Savings seeks to ensure
that the property securing the loan will generate cash flow to adequately cover
operating expenses and debt service payments. To this end, multi-family real
estate loans generally are made at a loan-to-value ratio no greater than 75.0%
and Argo Savings generally imposes a conservative debt coverage ratio (the ratio
of net cash from operations before payment of debt service to debt service).
Argo Savings requires title insurance to insure the priority of its lien on
all of its mortgage loans, as well as requires fire and casualty insurance on
all its properties securing loans provided by the Savings Bank.
Commercial Real Estate Lending. The commercial real estate loan portfolio
originated or purchased is primarily secured by office buildings and
income-producing commercial properties and amounted to $2.0 million or 1.0% of
the total loan portfolio at December 31, 1997. Argo Savings does not originate
or purchase out of area commercial real estate loans.
11
Argo Savings will continue on a limited basis to originate loans secured by
commercial real estate in its primary market area. In underwriting these loans,
consideration is given to the property's operating history, future operating
projections, current and projected occupancy, position in the local and regional
market, location and physical condition. The underwriting analysis also includes
credit checks and a review of the financial condition of the borrower. An
appraisal report is prepared in accordance with OTS regulation by an outside
appraiser qualified by federal and state law to substantiate property values for
every multi-family and commercial real estate loan. These appraisal reports are
reviewed by Argo Savings prior to the closing of the loan to assure compliance
with OTS appraisal standards and policies and the adequacy of the value of the
security property. Argo Savings also typically obtains full personal loan
guarantees from the borrowers. Argo Savings validates such personal loan
guarantees through an investigation of the borrower's personal finances.
Commercial real estate lending entails significant additional risks as
compared with one-to-four family residential property lending. Commercial real
estate loans typically involve larger loan balances to a single borrower or
groups of affiliated borrowers. The payment experience on such loans is
typically dependent on the successful operation of the real estate project.
These risks can be significantly impacted by supply and demand conditions in the
market for office and retail space, and as such may be subject to a greater
extent to adverse conditions in the economy generally.
Consumer and Other Loans. Federal regulations also permit thrift
institutions to make secured and unsecured consumer loans for up to 35.0% of the
Savings Bank's assets. Additionally, a federal association has lending authority
above the 35.0% maximum category for certain consumer loans, such as property
improvement loans, mobile home loans, savings account secured loans and other
secured and unsecured personal loans.
Argo Savings generates various types of secured consumer loans, primarily
home equity loans and mobile home loans. The home equity loans are made for
terms of up to ten (10) years, while mobile home loans have terms of up to
fifteen (15) years. At December 31, 1997, Argo Savings' consumer loan portfolio
totaled $11.8 million, or 6.1%, of Argo Savings' total loan portfolio.
Management considers consumer loans to involve more credit risk than
secured single family residential mortgage loans and, therefore, consumer loans
generally yield a higher return to Argo Savings and generally provide Argo
Savings with a shorter maturity than single-family residential mortgage loans.
Discounted Loans Receivable. Through activities conducted by its
subsidiary, Argo Mortgage Corporation, Argo Savings has acquired mortgage loans
at a deep discount for which the borrowers are either not current as to
principal and interest payments or there is doubt to the borrower's ability to
pay, in full, the contractual principal and interest outstanding. The purchased
discounted loans are primarily comprised of one-to-four family residential
loans. During the year ended December 31, 1997, Argo Savings sold approximately
$20.7 million in
12
discounted loans receivable and purchased $8.9 million, decreasing its
investment in discounted loans receivable from $47.7 million at December 31,
1996, to $30.6 million at December 31, 1997. The investment in discounted loans
receivable has resulted in $5.2 million and $3.7 million of interest income, and
$279,000 and $1.8 million of gains on the sale of these assets, for the years
ended December 31, 1997, and 1996, respectively.
Loan Solicitation and Processing. Loan originations are derived primarily
from referrals, existing customers, advertisements and the mortgage broker
network established through Margo. Both Margo personnel as well as employees of
Argo Savings accept loan applications. Upon receipt of a loan application,
credit reports are ordered to verify specific information relating to a loan
applicant's employment, income, assets and credit standing, and independent
verification of all credit, income and liability information provided by the
applicant is completed. In the case of a real estate loan originated by Argo
Savings, or by Margo for Argo Savings, an independent appraiser approved by the
Savings Bank's Board of Directors undertakes an appraisal of the real estate
intended to secure the proposed loan. For loans originated by Margo for third
parties, an independent appraiser approved by the third party is used.
The loan documentation and processing activities utilized by Argo Savings /
Margo in connection with the origination of real estate loans conforms to
standards imposed by the FNMA and Federal Home Loan Mortgage Corporation
("FHLMC"), as well as third party investor guidelines. Loan documentation and
processing activities utilized by Argo Savings / Margo conforms to both FNMA and
FHLMC requirements, as well as standards promulgated by the Federal Housing
Authority ("FHA"), the Department of Housing and Urban Development ("HUD") and
the Veterans Administration ("VA"). Additionally, written policies and
procedures governing the origination of mortgage and other loans conforming to
regulatory guidelines promulgated by the OTS are in place and utilized by Argo
Savings.
Upon completion of loan application processing activities, files are
presented to Argo Savings' loan underwriters if the loan is originated on behalf
of Argo Savings, or to third party investors if the loan is originated for
immediate sale. In the case of Argo Savings, certain senior officers have
lending authority and may approve loans of up to $350,000 after completion of
the underwriting process. Loans in excess of $350,000, as well as multi-family
and commercial real estate loans, are subject to approval by the Board of
Directors or a Committee of the Board of Argo Savings.
Both Argo Savings and Margo promptly notify loan applicants in writing of
the final determination of the loan request. If approved, the terms and
conditions of the loan decision including the amount of the loan, interest rate,
amortization term, brief description of the real estate securing the mortgage as
well as all conditions to final closing of the transaction are provided in
writing to the loan applicant. If denied, disclosure of the reasons relating to
denial is made pursuant to the requirements of applicable federal and state law.
13
Statistics regarding all loan applications, both denied and approved, are
retained by Argo Savings and Margo, and reported annually under the Home
Mortgage Disclosure Act. Quality control procedures verifying data obtained
through loan processing activities are in place at Argo Savings and Margo.
Loan Originations, Purchases, and Sales. Argo Savings purchases loans when
its savings inflows exceed the Savings Bank's ability to originate loans or when
Argo Savings determines to restructure its loan portfolio. During 1997, the
growth in loan originations generated by Margo has allowed the Savings Bank to
decrease its loan purchasing activities. The Savings Bank purchasing activities
are primarily directed at seasoned high yield fixed mortgage loans with low loan
to values. Argo Savings originated and purchased a total of approximately $115.2
million of portfolio loans receivable and loans held for sale, and purchased
$8.9 million of discounted loans receivable, during the year ended December 31,
1997.
Currently, most fixed rate, long-term mortgage loans originated are sold in
the secondary mortgage market. These sales have been made to the FNMA, FHLMC,
and other investors. Originated loans sold on a non-recourse basis amounted to
$23.7 million in 1997, $3.5 million in 1996 and $568,300 in 1995.
The success of these secondary mortgage market activities is dependent upon
Argo Savings' ability to originate loans at yields, which are competitive with
other loans in the secondary market. The proceeds from the sale of such loans
are reinvested in adjustable rate mortgage loans.
In an effort to make the yields on its loan portfolio and investments more
responsive to its cost of money, Argo Savings has implemented a number of
policies. Those measures include the origination of long-term, fixed-rate
mortgage loans where such loans can be sold in the secondary market, the
granting of adjustable rate mortgage loans and the origination of consumer,
commercial real estate, and multi-family loans with shorter maturities.
14
Set forth below is a table showing Argo Savings' loan originations and loan and
mortgage backed securities purchases, sales and principal repayments for the
periods indicated:
Year Ended
December 31,
------------------------------------------------------------------
1993 1994 1995 1996 1997
------------------------------------------------------------------
(In Thousands)
Mortgage loans (gross):
At beginning of period ...................................... $ 67,267 $ 83,312 $ 115,254 $ 147,490 $ 183,336
--------- --------- --------- --------- ---------
Mortgage loans originated:
One-to-four family .......................................... 29,496 11,646 10,292 12,904 56,318
Multi-family ................................................ -- 179 -- 455 333
Commercial real estate ...................................... -- 1,100 890 1,440 --
--------- --------- --------- --------- ---------
Total mortgage loans originated ........................... 29,496 12,925 11,182 14,799 56,651
One-to-four family mortgage loans purchased ................. 155,050 134,444 95,275 99,920 48,379
--------- --------- --------- --------- ---------
Total mortgage loans originated and purchased ............ 184,546 147,369 106,457 114,719 105,030
Transfer of mortgage loans:
to/from foreclosed real estate ............................. (868) (256) (2,871) (4,422) (4,955)
to mortgage-backed securities .............................. (7,679) -- -- -- --
Principal repayments ......................................... (27,150) (19,541) (21,885) (27,386) (33,510)
Mortgage loans sold .......................................... (132,804) (95,630) (49,465) (46,293) (69,177)
--------- --------- --------- --------- ---------
At the end of period ....................................... $ 83,312 $ 115,254 $ 147,490 $ 183,336 $ 180,724
========= ========= ========= ========= =========
Other loans:
At beginning of period ...................................... 9,121 8,790 4,864 6,325 8,394
Other loans originated ...................................... 11,860 12,385 15,504 20,914 18,137
Principal repayments ........................................ (12,191) (12,395) (14,043) (18,845) (14,722)
Other loans sold ............................................ -- (3,916) -- -- --
--------- --------- --------- --------- ---------
At end of period ........................................... $ 8,790 $ 4,864 $ 6,325 $ 8,394 $ 11,809
========= ========= ========= ========= =========
Mortgage-backed securities available for sale (gross):
At beginning of period ...................................... 15,384 8,494 6,597 5,661 4,927
Mortgage-backed securities purchased ........................ -- -- -- -- --
Mortgage-backed securities sold ............................. (10,226) -- -- -- (1,149)
Mortgage-backed securities transferred ...................... 7,679 -- -- -- --
Principal repayments ........................................ (4,343) (1,897) (936) (734) (855)
--------- --------- --------- --------- ---------
At end of period ........................................... $ 8,494 $ 6,597 $ 5,661 $ 4,927 $ 2,923
========= ========= ========= ========= =========
Mortgage-backed securities held for sale:
At beginning of period ..................................... 3,075 -- -- -- --
Securities transferred ..................................... -- -- -- -- --
Principal repayments ....................................... -- -- -- -- --
Securities sold .............................................. (3,075) -- -- -- --
--------- --------- --------- --------- ---------
At end of period ........................................... $ -- $ -- $ -- $ -- $ --
========= ========= ========= ========= =========
15
Loan Origination and Other Fees. In addition to interest earned on loans
and commitments for making loans, Argo Savings earns fees in connection with
originating loans. Origination fees are a percentage of the principal amount of
the mortgage loan charged to the borrower for the granting of the loan. Loan
fees are accounted for by deferring all loan origination fees and certain direct
costs associated with originations. Net deferred fees or costs are amortized as
yield adjustments over the custodial life of the related loans using the
interest method, adjusted for estimated prepayment based on the Savings Bank's
historical prepayment experience. At December 31, 1997, Argo Savings had
$681,000 in net deferred loan costs that will be recognized in future periods.
Loan origination and commitment fee income vary with the volume and type of
loans and commitments made and purchased and with competitive conditions in
mortgage markets, which in turn tend to vary in response to the demand and
availability of money.
Argo Savings also receives other fees and charges relating to existing
loans, which include late charges, and fees collected in connection with a
change in borrower or other loan modifications.
Problem Assets and Asset Classification. Loans are reviewed on a regular
basis and an allowance for loan losses is established when, in the opinion of
management, the net realizable value of the property collateralizing the loan is
less than the outstanding principal, and interest and the collectibility of the
loan's principal and interest becomes doubtful. Argo Savings' procedures provide
that when a loan becomes delinquent fifteen (15) days or more, the borrower is
contacted. Typically, Argo Savings' will initiate foreclosure action against a
borrower when principal and interest become ninety (90) days or more past due.
Argo Savings' policy is to stop accruing interest for any loan in excess of
ninety (90) days delinquent separate from management's analysis as to the future
collectibility of the interest. It is the opinion of management that this policy
is an appropriately conservative approach.
Real estate acquired by Argo Savings as a result of foreclosure is carried
at the lower of cost or fair value, net of estimated selling costs.
The following table sets forth information with respect to the Company's
non-performing assets as of the dates indicated. All non-performing loan totals
exclude discounted loans receivable.
At December 31,
---------------------------------------------------------------------
1993 1994 1995 1996 1997
---------------------------------------------------------------------
(Dollars in Thousands)
Loans 90 days or more delinquent ........................ $ 1,097 $ 2,324 $ 1,987 $ 3,942 $ 5,525
======== ======== ======== ======== =========
Loans 90 days or more delinquent as
a percentage of portfolio loans and loans
held for sale, net of discount ........................ 1.19% 1.98% 1.54% 3.12% 3.57%
======== ======== ======== ======== =========
Foreclosed real estate, net of related reserves ........ $ 554 $ 359 $ 2,234 $ 3,913 $ 4,251
======== ======== ======== ======== =========
Total loans 90 days or more delinquent and
foreclosed real estate to total assets ................ 1.31% 1.72% 2.26% 3.43% 4.14%
======== ======== ======== ======== =========
16
At December 31, 1997, the Company had $5.5 million of portfolio loans
receivable and loans held for sale and $6.2 million of discounted loans
receivable ninety (90) days or more delinquent. Discounted loans, which are
often purchased with the intent to foreclose and sell the underlying property,
are excluded from non-performing loans. In general, loans greater than ninety
(90) days delinquent are first liens on loans secured by one-to-four family
residences. The Company's policy is to cease accruing interest on loans over
ninety (90) days delinquent. Therefore, there were no loans ninety (90) days
delinquent and accruing interest.
At December 31, 1997, the Company had $4.3 million of foreclosed real
estate, which consisted of one hundred thirteen (113) properties. The largest
single balance was $283,000 secured by a single family residence in New York.
The increase is primarily the result of the Company's investment in discounted
loans. These loans were acquired with the intention of ultimate foreclosure and
sale.
OTS regulations require that each insured institution shall classify its
owned assets on a regular basis. Additionally, in connection with examinations
of insured institutions, OTS examiners have authority to identify problem assets
and, if appropriate, require assets to be classified. There are three
classifications for problem assets: Substandard, Doubtful and Loss. Substandard
assets must have one or more defined weaknesses and are characterized by the
distinct possibility that the insured institution will sustain some loss if
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable and there is a high possibility of loss. An
asset classified Loss is considered uncollectible and of such little value that
continuation as an asset of the institution is not warranted. The OTS recently
discontinued classifying assets as "special mention" if such assets possessed
weakness but did not expose the institution to sufficient risk to warrant
classification in the Substandard category. Argo Savings, however, currently
continues to designate assets as special mention.
At December 31, 1997, Argo Savings had $5.5 million of loans and $4.3
million of foreclosed real estate classified as Substandard or Doubtful,
respectively. Excluded from this total is the $6.2 million of discounted loans
ninety (90) days or more past due. Management does not consider these loans
non-performing and thus excludes them from all non-performing loan analysis and
from all general valuation allowance analysis. If an asset or portion thereof is
classified Loss, the insured institution must either establish specific
allowances for loan losses in the amount of 100 percent of the portion of the
asset classified Loss, or charge off such amount. At December 31, 1997, Argo
Savings had no assets classified as Loss. General loss allowances established to
cover possible losses related to assets classified Substandard or Doubtful may
be included in determining an institution's regulatory capital, while specific
valuation allowances for loan losses do not qualify as regulatory capital. A
savings institution's determination as to the classification of its assets and
the amount of its valuation allowances is subject to review by the OTS, which
can order the establishment of additional general or specific loss allowances.
If an institution does not agree with an examiner's classification of an asset,
it may appeal the determination. The OTS, in conjunction with the other federal
banking agencies, has adopted an interagency policy statement on the allowance
for loan and lease losses. The policy statement provides guidance to financial
institutions on both the responsibilities of management for the assessment and
establishment of adequate allowances and guidance for banking agency examiners
to use in determining the adequacy of general valuation allowances. Generally,
the policy statement requires that institutions have effective systems and
controls to identify, monitor and address asset quality problems, have analyzed
all significant factors that affect the collectibility of the loan portfolio in
a reasonable manner; and have established acceptable allowance evaluation
processes that meet the objectives set forth in the policy statement.
17
Analysis of Allowance for Loan Losses. The allowance for loan losses is
maintained at a level determined to be adequate by management to absorb future
charge-offs of loans deemed uncollectible. During the year ended December 31,
1997, the Savings Bank experienced an increase in the percentage of loans ninety
(90) days or more delinquent from 3.12% of portfolio loans receivable and loans
held for sale to 3.57% of portfolio loans receivable and loans held for sale at
December 31, 1997. Management believes that the allowances for loan losses are
currently adequate. Currently, management is unaware of any identifiable
charge-offs. In addition to the allowance for loan losses, the Savings Bank
maintains an allowance for losses on foreclosed real estate. The balance at
December 31, 1997, represents specific reserves currently in place on foreclosed
real estate. As of December 31, 1997, all of the allowance for loan losses
pertains to a general allowance. Argo Savings had no specific reserves
established at December 31, 1997, other than the reserves against foreclosed
real estate. The allowance is increased by provisions charged to operating
expense and by recoveries on loans previously charged off.
Determination of an appropriate level of allowance for loan losses
necessarily involves a high degree of judgment. Primary considerations in this
evaluation are prior loan loss experience, the character and mix of the loan
portfolio, adverse situations which may affect a borrower's ability to repay,
size of the loan portfolio, business and economic conditions and management's
estimate of potential losses. While management uses all available information,
including the monitoring of the economic conditions in the geographic regions in
which the loan portfolio is located, future additions to the allowance may be
necessary based on estimates that are susceptible to significant revision as a
result of changes in economic conditions and other factors. Additionally,
various regulatory agencies, as an integral part of their examination process,
periodically review Argo Savings' allowance for loan losses. Such agencies may
require Argo Savings to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
18
The following table sets forth information with respect to the Argo Savings'
allowance for loan losses by loan category for the periods and at the dates
indicated.
December 31
-------------------------------------------------------------------
1993 1994 1995 1996 1997
-------------------------------------------------------------------
(Dollars in thousands)
Balance at beginning of period:
One-to-four family ..................................... $ 138 $ 313 $ 315 $ 330 $ 412
Multi-family ........................................... 14 14 14 14 14
Commercial loans ....................................... 216 216 216 216 216
Other loans ............................................ 13 70 68 27 23
----- ----- ----- ----- -----
Total ................................................. 381 613 613 587 665
----- ----- ----- ----- -----
Provision for loan losses
One-to-four family .................................... 175 48 96 248 210
Multi-family .......................................... -- -- -- -- --
Commercial loans ...................................... -- -- -- -- --
Other loans ........................................... 70 -- (41) -- --
----- ----- ----- ----- -----
Total ................................................ 245 48 55 248 210
----- ----- ----- ----- -----
Transfer to allowance for losses on foreclosed
real estate ........................................... -- (43) (45) (77) (50)
----- ----- ----- ----- -----
Charge-offs
One-to-four family .................................... -- (5) (36) (89) (11)
Multi-family .......................................... -- -- -- -- --
Commercial loans ...................................... -- -- -- -- --
Other loans ........................................... (13) -- -- (4) --
----- ----- ----- ----- -----
Total ................................................ (13) (5) (36) (93) (11)
----- ----- ----- ----- -----
Balance at end of period
One-to-four family ..................................... 313 315 330 412 561
Multi-family ........................................... 14 14 14 14 14
Commercial loans ....................................... 216 216 216 216 216
Other loans ............................................ 70 68 27 23 23
----- ----- ----- ----- -----
Total ................................................. $ 613 $ 613 $ 587 $ 665 $ 814
===== ===== ===== ===== =====
Ratio of net charge-offs during the period to
loans receivable, excluding discounted loans ........... .01% .04% .04% --% .01%
===== ===== ===== ===== =====
Ratio of allowance for loan losses to net
loans receivable, excluding discounted loans ........... .68% .52% .45% .53% .53%
===== ===== ===== ===== =====
19
Mortgage-Backed Securities
The Savings Bank has an investment in mortgage-backed securities and has,
at times, utilized such investments as an alternative to mortgage lending. All
of the mortgaged-backed securities are insured or guaranteed by the Government
National Mortgage Association ("GNMA"), FNMA or FHLMC. At December 31, 1997,
gross mortgaged-backed securities, totaled $2.9 million or 1.24% of total
assets.
Purchased Mortgage Servicing Rights
Purchase Mortgage Servicing Rights ("PMSRs") represent the right to receive
a fee for the collection and administration of the mortgage payments on the
loans being serviced for others. The servicing of mortgages primarily consists
of the collection of monthly principal and interest payments, collection and
disbursement of escrow funds for taxes and insurance, providing various customer
services and account maintenance, reporting, foreclosure processing, and
investor notification. For performing these administrative tasks, the servicer
retains a monthly servicing fee generally calculated as a percentage of the
outstanding loan balance, and holds the escrowed payments for taxes and
insurance in non-interest-bearing custodial accounts. The servicing fee is
intended to cover anticipated operating expenses incurred in servicing the loans
and to provide for an adequate profit margin. Argo Bancorp uses an independent
servicing company to perform the administrative activities discussed above under
a subservicing agreement. Argo Bancorp's primary administrative task associated
with PMSRs is to review monthly analyses of all servicing and accounting reports
prepared by the subservicer and to perform regular on-site inspections and
reviews of the subservicer's operations.
Prior to completing any acquisition of servicing rights, Argo Bancorp
analyzes a wide range of parameters with respect to each portfolio under
consideration. This review includes the projected revenues and expenses,
geographic distribution, interest rate distribution, loan-to-value ratios,
outstanding balances, delinquency history and other statistics. Due diligence is
either performed by Argo Savings' employees or a designated independent
contractor on a representative sample of the mortgages involved. The purchase
price is based on the present value of the expected future stream of cash flows,
computed by using a discount rate that management considers to appropriately
reflect the risk associated with the investment, and using a loan prepayment
assumption that management considers to be conservative relative to the
characteristics of the serviced loans. Management does not purchase PMSRs with
recourse servicing, thus Argo Bancorp is not subject to the risk of and costs
(including foreclosure costs) associated with borrower default on the underlying
loans.
Mortgage servicing activities carry interest rate risk since the total
amount of servicing fees earned, as well as the amortization of the investment
in the servicing rights, fluctuate based on loan prepayments which generally
result from changes in market interest rates and the effect of these changes on
the average life of the underlying residential mortgage loans. Prepayment of the
mortgage loans may be influenced by a variety of economic, geographic, social,
and other factors and, most importantly, the difference between interest rates
on the mortgage loans underlying the PMSRs and prevailing mortgage rates
available for comparable mortgages.
20
The value of PMSRs decreases in a decreasing interest rate environment and
increases in an increasing interest rate environment due to the actual or
anticipated fluctuation in the prepayment speeds of the underlying mortgage
loans. The value of the PMSRs reacts inversely with the other interest-earning
assets of Argo Savings. The value of mortgage loans, comprising the majority of
Argo Savings' assets, decreases in a rising interest rate environment and
increases in a declining interest rate environment. Thus, the PMSRs act as a
natural hedge against the mortgage loans in Argo Savings' portfolio in a
changing interest rate environment.
A portion of Argo Bancorp and Argo Savings' business consists of servicing
loans for others. Mortgage loans serviced for others are an off-balance sheet
item and, therefore, the principal balance of the serviced loans is not included
on Argo Bancorp's Consolidated Statements of Financial Condition. The cost of
acquiring the right to service the mortgage loans is carried as a capitalized
asset. The cost of the acquisition of PMSRs represents the right to receive a
future cash flow. The cost of acquiring servicing rights purchased is amortized
in proportion to and over the period of estimated servicing income based on
management's estimate of remaining loan lives. Other loan servicing costs are
netted against servicing income as incurred.
Argo Savings has invested $5.9 million for an equity interest in three
divisions of a single limited partnership whose business activity is to purchase
current mortgage servicing rights. There are several equity investors in each
division. The purchase of the servicing rights is then leveraged, allowing the
partnership to purchase rights equal to two times the equity investment by its
partners. The cost of the borrowings, as well as the service fee income and
expense and related amortization, is recorded at the limited partnership level.
Each quarter, financial statements are issued to the investors and the pro-rata
share of the income for each investor is calculated. At the end of five years,
or at such time as the investors may agree, the servicing rights will be sold
and the proceeds divided pro-rata among the investors. As with a direct
investment in PMSRs, the collateral behind the equity investment is the
servicing rights. All limited partnership purchases of servicing rights must be
approved by all equity investors and undergo the same stringent guidelines
outlined previously for direct purchases of servicing. The task of finding and
acquiring the servicing rights controlled by the partnership as well as all
associated administrative duties, is assigned to Dovenmuehle Mortgage, Inc.
("DMI"), the general partner of the limited partnership. DMI also services the
PMSRs in the partnership. Each division is audited annually by an independent
auditor and an independent third party valuation is performed annually. The
results of both reviews are sent directly to each investor.
The return on the Savings Bank's PMSRs investment for the year ended
December 31, 1997, was approximately 6.6%. This investment constitutes 48.5% of
Argo Savings' capital at December 31, 1997. Another benefit derived from the
PMSRs is the interest free custodial accounts comprised of the borrowers' taxes
and insurance escrows and, for a short time period, the float on their principal
and interest payments. The custodial balances are maintained in interest free
accounts and are not affected by changes in interest rates. The custodial
balances relating to the servicing owned at December 31, 1997, were $6.4
million.
21
Investment Activities
The Savings Bank must maintain minimum levels of investments that qualify
as liquid assets under OTS regulations. Liquidity may increase or decrease
depending upon the availability of funds and comparative yields on investments
in relation to the return on loans. Historically, the Savings Bank has
maintained liquid assets at levels above the minimum requirements imposed by the
OTS regulations and at levels believed adequate to meet the requirements of
normal operations, including potential deposit outflows. Cash flow projections
are regularly reviewed and updated to assure that adequate liquidity is
maintained. At December 31, 1997, the Savings Bank's liquidity ratio (liquid
assets as a percentage of deposits and borrowings payable in one year or less)
was 6.51%. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Sources of Funds and Liquidity and Capital Resources"
in the 1997 Annual Report incorporated by reference herein.
Federally chartered savings institutions have the authority to invest in
various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certain certificates of deposit of
insured banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their assets in commercial paper,
investment grade corporate debt securities and mutual funds whose assets conform
to the investments that a federally chartered savings institution is otherwise
authorized to make directly.
Generally, the investment policy of the Savings Bank is to invest funds
among various categories of investments and maturities based upon the Savings
Bank's asset/liability management policies, investment quality and
marketability, liquidity needs and performance objectives. It is the Savings
Bank's general policy to invest in certificates of deposit, overnight funds, and
securities, which are U.S. Government securities and federal agency obligations,
and other issues that are rated investment grade. At December 31, 1997, Argo
Bancorp had $5,027,000 of investment securities available for sale with an
aggregate market value of $4,974,000.
22
The following table sets forth the carrying value of Argo Bancorp's consolidated
investment securities and securities held for sale, and short-term investments,
at the dates indicated.
At December 31,
-----------------------------------------------------------------------
1995 1996 1997
------------------- -------------------- --------------------
Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
------ ------ ------ ------ ------ ------
(In thousands)
Interest-earning deposits:
FHLB daily investment ................................ 2,537 2,537 356 356 1,322 1,322
Other Investments ................................... 1,300 1,300 402 402 1,144 1,144
------ ------ ------ ------ ------ ------
Total interest-earning deposits ................... $3,837 $3,837 $ 758 $ 758 $2,466 $2,466
====== ====== ====== ====== ====== ======
Investment Securities:
FHLB-Chicago stock
(investment required by law) ....................... 2,669 2,669 3,428 3,428 3,271 3,271
------ ------ ------ ------ ------ ------
Investment securities available for sale:
U.S. Government obligations and
agencies ........................................ 603 603 -- -- -- --
Municipal and state Governments
and agencies ...................................... 619 619 602 602 380 380
Marketable equity securities ......................... 639 639 282 282 1,667 1,667
Mortgage-backed securities ........................... 5,712 5,712 4,904 4,904 2,927 2,927
------ ------ ------ ------ ------ ------
Total investment securities available for sale ....... $7,573 $7,573 $5,788 $5,788 $4,974 $4,974
====== ====== ====== ====== ====== ======
23
The table below sets forth certain information regarding the amortized cost,
weighted average yields and maturities of securities available for sale at
December 31, 1997.
Weighted
Amortized Average
Maturing Cost Yield
- -------- --------- --------
Within one year ..................................... $ 234 8.81%
After one year through five years .................. 565 6.15
Due after five through ten years .................... 50 9.50
Due after ten years ................................. 2,483 6.99
Marketable equity securities ........................ 1,695 --
Federal Home Loan Bank of Chicago stock
(investment required by law) ...................... 3,271 --
------ ----
Total ............................................... $8,298 --%
====== ====
24
Sources of Funds and Borrowings
General. Deposits are the major source of Argo Savings' funds for lending
and other investment purposes. In addition to deposits, Argo Savings derives
funds from loan principal repayments, proceeds from sales of loans, borrowings,
and the custodial balances on loans serviced for others. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used to compensate for reductions in the availability of other
sources of funds. They may also be used on a longer term basis for general
business purposes.
Deposits. Argo Savings offers a number of deposit accounts, including
tiered passbook, NOW accounts, money market accounts and certificate accounts
currently ranging in maturity from seven days to ten years. Deposit accounts
vary as to terms, with the principal differences being the minimum balance
required, the period the funds must remain on deposit and the interest rate.
Argo Savings in the past has utilized brokered deposits, and will continue to
use this source of funds as needed in the future. Argo Savings had $6.5 million
in brokered deposits at December 31, 1997. Argo Savings has traditionally priced
its deposit products at or near market rates in its primary market.
25
Deposit Flow. The following table sets forth the change in dollar amount of
savings accounts offered by Argo Savings between the dates indicated.
Amount at Percent Amount at Percent Amount at Percent
Dec. 31, of Total Increase Dec. 31, of Total Increase Dec. 31, of Total Increase
1995 Deposits (Decrease) 1996 Deposits (Decrease) 1997 Deposits (Decrease)
-------- ----- -------- -------- ----- -------- -------- ----- --------
(Dollars in thousands)
Passbook accounts ......... $ 18,516 15.0% $ (2,680) $ 18,349 12.2% $ (167) $ 17,607 10.2 (742)
NOW accounts .............. 12,830 10.4 (951) 12,426 8.3 (404) 13,225 7.7 799
Money market accounts ..... 4,483 3.6 400 4,957 3.3 474 6,223 3.6 1,266
-------- ----- -------- -------- ----- -------- -------- ----- --------
Total ..................... 35,829 29.0 (3,231) 35,732 23.8 (97) 37,055 21.5 1,323
-------- ----- -------- -------- ----- -------- -------- ----- --------
Certificate accounts:
3.99% or less ............ 18 -- (5,993) 52 -- 34 10 -- (42)
4.00% to 4.99% ........... 5,457 4.4 (11,733) 769 0.5 (4,688) 874 .5 105
5.00% to 5.99 ............ 36,937 30.0 13,828 71,169 47.2 34,232 62,935 36.5 (8,234)
6.00% to 6.99 ............ 30,560 24.7 17,785 39,194 26.0 8,634 69,962 40.5 30,768
7.00% to 7.99 ............ 14,550 11.8 12,298 3,612 2.4 (10,938) 1,513 .9 (2,099)
8.00% to 8.99 ............ 133 .1 (167) 99 .1 (34) 120 .1 21
9.00% to 9.99 ............ -- -- -- -- -- -- -- -- --
----- -------- -------- ----- -------- -------- ----- --------
Total ................... 87,655 71.0 26,018 114,895 76.2 27,240 135,414 78.5 20,519
-------- ----- -------- -------- ----- -------- -------- ----- --------
Total deposits ............ $123,484 100.0% $ 22,787 $150,627 100.0% $ 27,143 $172,469 100.0% $ 21,842
======== ===== ======== ======== ===== ======== ======== ===== ========
Weighted Average Rate...... 5.13% 5.13% 5.18%
===== ===== =====
- --------------------------------------------------------------------------------
(1) See Note 9 in the 1997 Annual Report to the Stockholders, incorporated by
reference herein for a weighted average percentage by deposit type.
26
Certificate Accounts. The following table presents the amount of
certificate accounts outstanding at December 31, 1997, and the periods to
maturity or repricing.
Weighted
Average
Amount Rate
------ ----
(Dollars in thousands)
Within one year (1) ....................... $116,154 5.85%
One to three years ........................ 13,313 5.98
Thereafter ................................ 5,947 6.36
-------- ----
Total ..................................... $135,414 5.85%
======== ====
(1) Includes a $13.0 million certificate that reprices annually and matures in
one (1) year.
At December 31, 1997, Argo Savings had outstanding $42.7 million of
certificate of deposit accounts in amounts of $100,000 or more maturing or
repricing as follows:
Amount
------
(In thousands)
Three months or less ....................................... $ 3,216
Over three through six months .............................. 1,102
Over six through 12 months ................................. 20,354
Over 12 months ............................................. 17,978
-------
Total ...................................................... $42,650
=======
Certificate Accounts Classified by Rates. The following table sets forth
the certificate accounts of Argo Savings classified by rates as of the dates
indicated.
At December 31,
-----------------------------------
(In thousands)
Rate 1995 1996 1997
- ---- ---- ---- ----
3.99% or less............................ $ 18 $ 52 $ 10
4.00% to 4.99%........................... 5,457 769 874
5.00% to 5.99:........................... 36,937 71,169 62,935
6.00% to 6.99%........................... 30,560 39,194 69,962
7.00% to 7.99%........................... 14,550 3,612 1,513
8.00% to 8.99%........................... 133 99 120
------- -------- --------
Total.................................... $87,655 $114,895 $135,414
======= ======== ========
27
Deposit Activity. The following table sets forth the savings deposit
activities of Argo Bancorp for the periods indicated.
Year Ended
December 31
-------------------------------
1995 1996 1997
------- ------- -------
(In thousands)
Deposits in excess of (withdrawals) ........ $17,177 $18,123 $13,352
Interest credited .......................... 5,610 9,020 8,490
------- ------- -------
Net increase (decrease) in
savings deposits ......................... $22,787 $27,143 $21,842
======= ======= =======
Substantially all of Argo Savings' depositors are residents of Illinois and
Indiana.
Borrowings. Argo Bancorp's other borrowings at December 31, 1997 consist
of three (3) notes payable. The first note payable for $5,279,000 is drawn on a
$6.0 million open line with a third party financial institution and is
collateralized by Argo Savings' stock. The interest rate on this note adjusts
monthly at prime. Also included is On-Line's note payable of $830,000, which is
an open line of credit totaling $1.0 million with a third party financial
institution. This note also adjusts monthly at prime. The third note payable is
an ESOP note payable, which has a balance of $57,000 and the interest on this
note is 8.0%. The 18,253 shares of common stock of Argo Bancorp held by the ESOP
are pledged as collateral for the ESOP note. Also included in other borrowings
is the $329,000 margin account loan from a third party securities broder. The
rate of interest on this loan adjusts daily at prime less .50%. The margin
account loan was secured at December 31, 1997 by securities held by the broker
having a market value of $1.1 million.
Included in other borrowings for the year ended December 31, 1997, is $3.8
million in capital lease obligations for premises and equipment arising from the
acquisition of On-Line.
Savings deposits are the primary source of funds of Argo Savings' lending
and investment activities and for its general business purposes. Argo Savings
can also borrow funds from the FHLB of Chicago to supplement its supply of
lendable funds and to meet deposit withdrawal requirements. The FHLB has served
as Argo Savings' primary borrowing source. Advances from the FHLB are secured by
Argo Savings' stock in the FHLB and a portion of Argo Savings' portfolio of
first mortgage loans. The rates on these advances vary from time to time in
response to general economic conditions. At December 31, 1997, Argo Savings had
$17.8 million of fixed rate advances from the FHLB with interest rates ranging
from 5.48% to 8.43%. At December 31, 1997, Argo Savings had overnight advances
outstanding of $6.0 million at a weighted interest rate of 6.24%. The FHLB
functions as a central reserve bank providing credit for savings and loan
associations and certain other member financial institutions. As a member, Argo
Savings is required to own capital stock in the FHLB and is authorized to apply
for advances on the security of such stock and certain of its home mortgages and
other assets (principally, securities that are obligations of, or guaranteed by,
the United States Government or its agencies) provided certain standards related
to creditworthiness have been met. Advances are made pursuant to several
different programs. Each credit program has its own interest rate and the amount
of advances is based either on a fixed percentage of an association's net worth
or on the FHLB's assessment of an association's creditworthiness.
28
The following table sets forth contain information regarding borrowings by
Argo Bancorp on a consolidated basis at the end of and during the periods
indicated. The borrowings at and during the periods consisted of FHLB advances,
and promissory notes. The weighted average was computed on a monthly average
basis.
At December 31,
---------------------
1995 1996 1997
---- ---- ----
Weighted average interest rate at end of year paid on:
FHLB advances ......................................... 5.85% 5.80% 6.22%
Other borrowings ...................................... 8.91 8.48 8.63
During the Year
At December 31,
-------------------------------
1995 1996 1997
---- ---- ----
(Dollars in thousands)
Maximum amount of borrowings
outstanding at any month end:
FHLB advances .......................... $38,416 $45,257 $49,587
Other borrowings ....................... 8,120 8,760 11,541
During the Year
At December 31,
--------------------------------------
1995 1996 1997
---- ---- ----
(Dollars in thousands)
Average borrowings outstanding with respect to:
FHLB advances ................................ $ 32,852 $ 34,608 30,191
Other borrowings ............................. 5,916 7,669 10,621
---------- ---------- ----------
TOTAL ..................................... $ 38,768 $ 42,277 $ 40,812
========== ========== ==========
Weighted average interest rate during the year
paid on:
FHLB advances ................................ 6.06% 5.69% 5.98%
Other borrowings ............................. 7.86 8.60 8.43
---------- ---------- ----------
TOTAL WEIGHTED AVERAGE .................... 6.34% 6.20% 6.50%
========== ========== ==========
29
Subsidiaries
Argo Savings has two wholly-owned subsidiaries, Argo Mortgage Corp. and
Dolton-Riverdale Savings Service Corp. Argo Mortgage Corp. engages in mortgage
brokerage activities that focus on the purchase and sale of deeply discounted
mortgage loans into the secondary market. Dolton-Riverdale Savings Service Corp.
sells insurance annuities to the customer base of Argo Savings. Argo Savings
also has a majority interest in a limited liability corporation, Margo Financial
Services, LLC ("Margo"). The primary activity of Margo is the origination of
mortgage loans for portfolio and sale into the secondary market. At December 31,
1997, Argo Savings' had an equity investment in Argo Mortgage, Dolton-Riverdale
Savings Service Corp., and Margo of $34.6 million, $160,000 and $49,000,
respectively.
Competition
Argo Savings faces strong competition in attracting deposits and in
originating real estate loans. Its most direct competition for deposits has
historically come from other savings institutions, credit unions, and savings
banks and from commercial banks located in its primary market area. Particularly
in times of high interest rates, Argo Savings also faces additional significant
competition for investor funds from short-term money market securities and other
corporate and government securities. Argo Savings' competition for real estate
loans comes principally from other thrift institutions, commercial banks and
mortgage banking companies. Competition may also increase as a result of the
lifting of restrictions on the interstate operations of financial institutions.
Argo Savings competes for loans principally through the interest rates and
loan fees it charges and the efficiency and quality of the services it provides
borrowers, real estate brokers and home builders. It competes for deposits by
offering depositors a wide variety of savings accounts, checking accounts, and
convenient office locations.
Argo Savings is a community oriented savings institution and competes with
many financial institutions in its primary market area, most of which have
assets which are significantly larger than the assets of Argo Savings.
Management considers the Savings Bank's reputation for financial strength and
customer service as its major competitive advantage in attracting and retaining
customers in its market area. The Savings Bank also believes it benefits from
its community bank orientation as well as it has a relatively high core deposit
base.
Personnel
As of December 31, 1997, the Savings Bank including its subsidiaries, had
forty-one (41) full-time employees and fourteen (14) part-time employees.
On-Line had eighty-one (81) full-time employees and one (1) part-time employees.
A collective bargaining unit does not represent the employees. The Company
believes its relationship with its employees and auditors is good.
30
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file
certain reports, and otherwise comply, with the rules and regulations of the OTS
under the Home Owners' Loan Act, as amended (the "HOLA"). Additionally, the
activities of savings institutions, such as the Savings Bank, are governed by
the HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Savings Bank is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. Argo Savings is a member of the FHLB System and its deposit
accounts are insured up to applicable limits by the Savings Association
Insurance Fund ("SAIF") managed by the FDIC. The Savings Bank must file reports
with the OTS and the FDIC concerning its activities and financial condition, in
addition to obtaining regulatory approvals prior to entering into certain
transactions such as mergers with, or acquisitions of, other savings
institutions. The OTS and/or the FDIC conduct periodic examinations to test the
Savings Bank's compliance with various regulatory requirements. This regulation
and supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such regulatory
requirements and policies, whether by the OTS, the FDIC or the Congress could
have a material adverse impact on the Company, the Savings Bank and their
operations. Certain of the regulatory requirements applicable to the Savings
Bank and to the Company are referred to below or elsewhere herein. The
description of statutory provisions and regulations applicable to savings
institutions and their holding companies set forth in this Form 10-KSB does not
purport to be a complete description of such statutes and regulations and their
effects on the Savings Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As a unitary savings and loan holding company,
the Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that Argo Savings continues
to be a qualified thrift lender ("QTL"). Upon any non-supervisory acquisition by
the Company of another savings institution or savings bank that meets the QTL
test and is deemed to be a savings institution by the OTS, the Company would
become a multiple savings and loan holding company (if the acquired institution
is held as a separate subsidiary) and would be subject to extensive limitations
on the types of business activities in which it could engage. The HOLA limits
the activities of a multiple savings and loan holding company and its
non-insured institution subsidiaries primarily to activities permissible for
bank holding companies under Section 4(c)(8) of the Bank Holding Company Act
("BHC Act"), subject to the prior approval of the OTS, and activities authorized
by OTS regulation. Recently proposed legislation could restrict the activities
of unitary savings and loan holding companies.
31
The Company's acquisition of On-Line in 1995 was in compliance with
existing laws and did not impact the unitary savings and loan holding company
status.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5.0%
of the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5.0% of a nonsubsidiary company engaged in activities
other than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Savings Bank must notify the OTS
thirty (30) days before declaring any dividend to the Company. In addition, the
financial impact of a holding company on its subsidiary institution is a matter
that is evaluated by the OTS and the agency has authority to order cessation of
activities or divestiture of subsidiaries deemed to pose a threat to the safety
and soundness of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3.0% leverage (core) capital ratio and an 8.0% risk-based capital
ratio. In addition, the prompt corrective action standards discussed below also
establish, in effect, a minimum 2.0% tangible capital standard, a 4.0% leverage
(core) capital ratio (3.0% for institutions receiving the highest rating on the
CAMEL financial institution rating system) and, together with the risk-based
capital standard itself, a 4.0% Tier I risk-based capital standard. Core capital
is defined as common stockholder's equity (including retained earnings), certain
noncumulative perpetual preferred stock and related surplus and minority
interests in equity accounts of consolidated subsidiaries, less intangibles
other than certain purchased mortgage servicing rights and credit card
relationships. The OTS regulations also require that, in meeting the leverage
ratio, tangible and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities as
principal that are not permissible for a national bank.
32
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4.0% and 8.0%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weighting
ranging from 0.0% to 100.0%, as assigned by the OTS capital regulation based on
the risks OTS believes are inherent in the type of asset. The components of Tier
I (core) capital are equivalent to those discussed earlier. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100.0% of
core capital.
The OTS regulatory capital requirements also incorporate an interest rate
risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities, and off-balance sheet contracts) that would result
from a hypothetical 200 basis point increase or decrease in market interest
rates divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2.0% must deduct
an amount equal to one-half of the difference between the institution's measured
interest rate risk and 2.0% multiplied by the estimated economic value of the
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12.0% is not subject to the interest rate risk component, unless
the OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At December 31, 1997, the
Savings Bank met each of its capital requirements, and it is anticipated that
Argo Savings will not be subject to the interest rate risk component.
The following table presents the Savings Bank's capital position at
December 31, 1997:
Capital
---------------------------------------------------
Actual Required Excess Actual Required
Capital Capital Amount Percent Percent
------- ------- ------ ------- -------
(Dollars in thousands)
Tangible................... $13,035 $ 3,296 $ 9,739 5.93% 1.5%
Core (Leverage)............ 13,035 6,592 6,443 5.93 3.0
Risk-based:
Tier I (core)............ 13,035 -- -- 10.45 4.0
Total.................... 13,849 9,981 3,868 11.10 8.0
33
A reconciliation between regulatory capital and GAAP capital at December
31, 1997, in the accompanying consolidated financial statements is presented
below:
Total
Tangible Core Risk-based
Capital Capital Capital
------- ------- -------
(In thousands)
GAAP capital originally reported to regulatory
authorities and on accompanying consolidated
financial statements .......................... $ 13,731 $ 13,731 $ 13,731
Regulatory capital adjustments:
Adjustment for net unrealized gains (losses) in
available for sale securities ............... (16) (16) (16)
General valuation allowances .................. -- -- 814
Purchase mortgage servicing rights ............ (531) (531) (531)
Goodwill ...................................... $ (149) $ (149) $ (149)
-------- -------- --------
Regulatory Capital ............................ $ 13,035 $ 13,035 $ 13,849
======== ======== ========
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations, the OTS is required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6.0%, its ratio of core capital to total assets is at least
5.0% and it is not subject to any order or directive by the OTS to meet a
specific capital level. A savings institution generally is considered
"adequately capitalized" if its ratio of total capital to risk-weighted assets
is at least 8.0%, its ratio of Tier I (core) capital to risk-weighted assets is
at least 4.0% and its ratio of core capital to total assets is at least 4.0%
(3.0% if the institution receives the highest CAMEL rating). A savings
institution that has a ratio of total capital to risk weighted assets of less of
than 8.0%, a ratio of Tier I (core) capital to risk-weighted assets of less than
4.0% or a ratio of core capital to total assets of less than 4.0% (3.0% or less
for institutions with the highest examination rating) is considered to be
"undercapitalized." A savings institution that has a total risk-based capital
ratio less than 6.0%, a Tier I risk-based capital ratio of less than 3.0% or a
leverage ratio that is less than 3.0% is considered to be "significantly
undercapitalized". A savings institution that has a tangible capital to assets
ratio equal to or less than 2.0% is deemed to be "critically undercapitalized."
Subject to a narrow exception, the banking regulator is required to appoint a
receiver or conservator for an institution that is "critically
undercapitalized." The regulation also provides that a capital restoration plan
must be filed with the OTS within forty-five (45) days of the date a savings
institution receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. Additionally, numerous
mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS may also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors. The Savings Bank is
considered well capitalized under prompt corrective action regulations.
34
Insurance of Deposit Accounts. Deposits of the Bank are presently insured
by the SAIF. On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed
a special one-time assessment on SAIF member institutions, including the Savings
Bank, to recapitalize the SAIF. The SAIF was undercapitalized due primarily to a
statutory requirement that SAIF members make payments on bonds issued in the
late 1980's by the Financing Corporation ("FICO") to recapitalize the
predecessor to the SAIF. As required by the Funds Act, the FDIC imposed a
special assessment of 65.7 basis points on SAIF assessable deposits held as of
March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The
Savings Bank recognized the SAIF Special Assessment as an expense in the quarter
ended September 30, 1996, and was generally tax deductible. The SAIF Special
Assessment recorded by the Savings Bank amounted to $789,000 on a pre-tax basis
and $489,000 on an after-tax basis.
The Funds Act also spreads the obligation for payment of the FICO bonds
across all SAIF and Bank Insurance Fund ("BIF") members. The BIF is the fund
which primarily insures commercial bank deposits. Beginning January 1, 1997, BIF
deposits were assessed for a FICO payment of approximately 1.3 basis points,
while SAIF deposits pay approximately 6.4 basis points. Full pro rata sharing of
the FICO payments between BIF and SAIF members will occur on the earlier of
January 1, 2000, or the date the BIF and SAIF are merged. The Funds Act
specifies that the BIF and SAIF will be merged on January 1, 1999, provided no
savings associations remain as of that time.
As a result of the Funds Act, the FDIC voted to effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to
that of BIF members. SAIF members will also continue to make the FICO payments
described above. Management cannot predict the level of FDIC insurance
assessments on an on-going basis, whether the savings association charter will
be eliminated or whether the BIF and SAIF will eventually be merged.
The Savings Bank's assessment rate for fiscal 1997 was approximately 6.0
basis points and the premium paid for this period was $102,000. A significant
increase in SAIF insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Savings Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Savings Bank does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. The Funds Act provides that the BIF and
SAIF will merge on January 1, 1999, if there are no more savings association as
of that date. Various proposals to eliminate the federal thrift charter, create
a uniform financial institutions charter and abolish the OTS have been
introduced in Congress. Some bills would require federal savings institutions to
convert to a national bank or some type of state charter by a specified date or
they would automatically become national banks. Under some bills converted
federal
35
thrifts would generally be required to conform their activities to those
permitted for the charter selected and divestiture of nonconforming assets would
be required over a two (2) year period, subject to two possible one year
extensions. State chartered thrifts would become subject to the same federal
regulation as applies to state commercial banks. A more recent bill passed by
the House Banking Committee would allow savings institutions to continue to
exercise activities conducted when they convert to a bank regardless of whether
a National Bank could engage in the activity. Holding companies for savings
institutions would become subject to the same regulation as holding companies
that control commercial banks, with some limited grandfathered provision for
unitary including savings and loan holding company activities. The
grandfathering would be lost under certain circumstances such as a change in
control of the Company. Argo Savings is unable to predict whether such
legislation would be enacted or the extent to which the legislation would
restrict or disrupt its operations.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the limits on loans to one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a single
or related group of borrowers in excess of 15.0% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10.0% of unimpaired capital
and surplus, if such loan is secured by readily-marketable collateral, which is
defined to include certain financial instruments and bullion. At December 31,
1997, the Savings Bank's largest aggregate outstanding balance of loans to one
borrower consisted of loans totaling $1.7 million, which does not exceed the
Savings Bank's loan to one borrower limit. All loans to this borrower were
current.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings and loan association either must qualify as a "domestic
building and loan association" as defined in the Internal Revenue Code or be
required to maintain at least 65.0% of its "portfolio assets" (total assets less
(i) specified liquid assets up to 20.0% of total assets; (ii) intangibles,
including goodwill; and (iii) the value of property used to conduct business in
certain "qualified thrift investments" (primarily residential mortgages and
related investments, including certain mortgage-backed securities) in at least
nine (9) months out of each twelve (12) month period.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
December 31, 1997, the Savings Bank maintained 99.0% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test. Recent
legislation has expanded the extend to which education loans, credit card loans,
and small business loans may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier I Association") and has not been advised by the OTS that it
is in need of more than normal supervision may, after prior notice but without
obtaining approval of the OTS, make
36
capital distributions during a calendar year equal to the greater of (i) 100.0%
of its net earnings to date during the calendar year plus the amount that would
reduce by one-half its "surplus capital ratio" (the excess capital over its
fully phased-in capital requirements) at the beginning of the calendar year, or
(ii) 75.0% of its net income for the previous four quarters. Any additional
capital distributions require prior regulatory approval. In the event the
Savings Bank's capital fell below its regulatory requirements or the OTS
notified it that it was in need of more than normal supervision, the Savings
Bank's ability to make capital distributions could be restricted. In addition,
the OTS could prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice. In December 1994,
the OTS proposed amendments to its capital distribution regulation that would
generally authorize the payment of capital distributions without OTS approval
provided the payment does not make the institution undercapitalized within the
meaning of the prompt corrective action regulation. However, institutions in a
holding company structure would still have a prior notice requirement. At
December 31, 1997, the Savings Bank was a Tier I Association.
Liquidity. The Savings Bank is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than a
specified percentage of its net withdrawable deposit accounts plus short-term
borrowings. This liquidity requirement is currently 4.0%, but may be changed
from time to time by the OTS to any amount within the range of 4.0% to 10.0%
depending upon economic conditions and the savings flows of member institutions.
Penalties may be imposed for failure to meet these liquidity requirements. The
Savings Bank's liquidity ratio for December 31, 1997, was 6.51%, respectively,
which exceeded the then applicable requirements. The Savings Bank has never been
subject to monetary penalties for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the
OTS to fund the agency's operations. The general assessment, paid on a
semi-annual basis, is computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Savings Bank's latest
quarterly Thrift Financial Report. The assessments paid by the Savings Bank for
the fiscal year ended December 31, 1997, totaled $68,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Savings Bank's authority to engage
in transactions with related parties or "affiliates" (e.g., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and 23B
of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of
covered transactions with any individual affiliate to 10.0% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to 20.0% of the savings institution's capital and
surplus. Certain transactions with affiliates are required to be secured by
collateral in an amount and of a type described in Section 23A, and the purchase
of low quality assets from
37
affiliates is generally prohibited. Section 23B generally provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. Additionally, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The Savings Bank's authority to extend credit to executive officers,
directors and 10.0% shareholders ("insiders"), as well as entities controlled by
such persons, is governed by Sections 22(g) and 22(h) of the FRA and Regulation
O thereunder. Among other things, such loans are required to be made on terms
substantially the same as those offered to unaffiliated individuals and to not
involve more than the normal risk of repayment. Recent legislation created an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. Regulation O also places individual
and aggregate limits on the amount of loans the Savings Bank may make to
insiders based, in part, on the Savings Bank's capital position and requires
certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all "institution-affiliated parties," including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order, to removal of officers and/or
directors, to placement of an institution into receivership, conservatorship or
termination of deposit insurance. Civil penalties cover a wide range of
violations and amount to $25,000 per day, or even $1.0 million per day in
especially severe cases. Under the FDI Act, the FDIC has the authority to
recommend to the Director of the OTS enforcement action to be taken with respect
to a particular savings institution. If action is not taken by the Director, the
FDIC has authority to take such action under certain circumstances. Federal law
also establishes criminal penalties for certain violations.
38
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; asset quality; earnings; and
compensation, fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
Guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard, as required by the FDI
Act. The final rule establishes deadlines for the submission and review of such
safety and soundness compliance plans when such plans are required.
Federal Home Loan Bank System
The Savings Bank is a member of the FHLB System, which consists of seven
(7) regional FHLBS. The FHLB provides a central credit facility primarily for
member institutions. The Savings Bank, as a member of the FHLB-Chicago, is
required to acquire and hold shares of capital stock in that FHLB in an amount
at least equal to 1.0% of the aggregate principal amount of its unpaid
residential mortgage loans and similar obligations at the beginning of each
year, or 1/20th of its advances (borrowings) from the FHLB-Chicago, whichever is
greater. The Savings Bank was in compliance with this requirement, with an
investment in FHLB-Chicago stock at December 31, 1997, of $3.3 million. FHLB
advances must be secured by specified types of collateral and may be obtained
primarily for the purpose of providing funds for residential housing finance.
The FHLBs are required to provide funds to cover certain obligations on
bonds issued to fund the resolution of insolvent thrifts and to contribute funds
for affordable housing programs. These requirements could reduce the amount of
dividends that the FHLBs pay to their members and could also result in the FHLB
imposing a higher rate of interest on advances to their members. Dividends from
the FHLB-Chicago to the Savings Bank amounted to $226,000 and $188,000 for the
year ended December 31, 1997, and 1996, respectively. If dividends were reduced,
or interest on future advances increased, the Savings Bank's net interest income
might also be reduced.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally required for most of 1997, that reserves be maintained
against aggregate transaction accounts as follows: for accounts aggregating
$49.3 million or less (subject to adjustment by the Federal Reserve Board), the
reserve requirement is 3.0%; for accounts greater than $49.3 million, the
reserve requirement is $1.48 million plus 10.0% (subject to adjustment by the
Federal Reserve Board between 8.0% and 14.0%) against that portion of total
transaction accounts in excess of $49.3 million. The first $4.4 million of
otherwise reservable balances (subject to adjustments by the
39
Federal Reserve Board) were exempted from the reserve requirements. The Savings
Bank is in compliance with the foregoing requirements. For 1998, the Federal
Reserve Bank has decreased from $49.3 million to $47.8 million the amount of
transaction accounts subject to the 3.0% reserve requirement and to increase the
amount of exempt reservable balances from $4.4 million to $4.7 million. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The following is a discussion of material tax matters and does not
purport to be a comprehensive description of the tax rules applicable to Argo
Savings or Argo Bancorp. The Companies have not been audited by the IRS during
the last ten (10) years. For federal income tax purposes Argo Bancorp and its
subsidiaries (except Margo) file consolidated income tax returns and report
their income on a calendar year basis using the accrual method of accounting and
subject to federal income taxation in the same manner as other corporations with
some exceptions, including particularly the tax reserve for bad debts, discussed
below. Margo Financial Services, LLC files a separate partnership income tax
return.
Recent Tax Legislation Regarding Tax Bad Debt Reserves
Prior to the enactment, on August 20, 1996, of the Small Business Job
Protection Act of 1996 (the "Small Business Act'), for federal income tax
purposes, thrift institutions such as Argo Savings, which met certain
definitional tests primarily relating to their assets and the nature of their
business, were permitted to establish tax reserves for bad debts and to make
annual additions thereto, which additions could, within specific limitations, be
deducted in arriving at their taxable income. Argo Savings' deduction with
respect to "qualifying loans", which are generally loans secured by certain
interests in real property, could be computed using an amount based on a six (6)
year moving average of Argo Savings' actual loss experience (the "Experience
Method"), or a percentage equal to 8.0% of Argo Savings' taxable income (the
"PTI Method"), computed without regard to this deduction and with additional
modifications and reduced by the amounts of any permitted addition to the
non-qualifying reserve.
Under the Small Business Act, the PTI Method was repealed and Argo Savings
will be required to use the Experience Method of computing additions to its bad
debt reserve for taxable years beginning after December 31, 1995. In addition,
Argo Savings will be required to recapture (i.e., take into taxable income) over
a six (6) year period, beginning with the Savings Bank's taxable year beginning
January 1, 1996, the excess of the balance of its bad debt reserves (other than
the supplemental reserve) as of December 31, 1995, over the greater of (s) its
"base year reserve," i.e., the balance of such reserves as of December 31, 1987,
or (b) an amount that would have been the balance of such reserves as of
December 31, 1995, had Argo Savings always computed the additions to its
reserves using the Experience Method. However, under the Small Business Act such
recapture requirements will be suspended for each of the two (2) successive
taxable years beginning January 1, 1996, in which the Savings Bank originates a
minimum amount of certain residential loans during such years that is not
40
less than the average of the principal amounts of such loans made by Argo
Savings during its six (6) taxable years preceding January 1, 1996.
Distributions. To the extent that Argo Savings makes "nondividend
distributions" to shareholders, such distributions will be considered to result
in distributions from Argo Savings base year reserve to the extent thereof and
then from its supplemental reserve for losses on loans, and an amount based on
the amount distributed will be included in the Savings Bank's taxable income.
Nondividend distributions include distributions in excess of Argo Savings'
current and accumulated earnings and profits, distributions in redemption of
stock and distributions in partial or complete liquidation. However, dividends
paid out of the Savings Bank's current or accumulated earnings and profits, as
calculated for federal income tax purposes, will not constitute nondividend
distributions and, therefore, will not be included in Argo Savings' income.
The amount of additional taxable income created from a nondividend
distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Thus, in certain instances,
approximately one and one-half times the nondividend distribution would be
includable in gross income for federal income tax purposes, assuming a 34.0%
federal corporate income tax rate.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended (the "Code") imposes a tax ("AMT") on alternative minimum taxable income
("AMTI") at a rate of 20.0%. Only 90.0% of AMTI can be offset by net operating
loss carryovers of which Argo Savings currently has about $267,000. AMTI is also
adjusted by determining the tax treatment of certain items in a manner that
negates the deferral of income resulting from the regular tax treatment of those
items. Thus, Argo Savings' AMTI is increased by an amount equal to 75.0% of the
amount by which the Savings Bank's adjusted current earnings exceeds its AMTI
(determined without regard to this adjustment and prior to reduction for net
operating losses). AMT cannot be reduced by tax credits, other than foreign tax
credits. Accordingly, the Bank's low income housing tax credits may not be used
to reduce AMT. The AMT has limited the utilization of these tax credits in 1997
and 1996. In addition, for taxable years beginning after December 31, 1986, and
before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI
(with certain modifications) over $2.0 million is imposed on corporations,
including Argo Savings, whether or not an AMT is paid. Under pending legislative
proposals, the environmental tax would be extended to taxable years beginning
before January 1, 2007. Argo Savings does not expect to be subject to the AMT,
but may be subject to the environmental tax liability.
Elimination of Dividends; Dividends Received Deduction. Argo Bancorp may
exclude from its income 100.0% of dividends received from Argo Savings as a
member of the same affiliated group of corporations. A 70.0% dividends received
deduction generally applies with respect to dividends received from domestic
corporations that are not members of such affiliated group, except that an 80.0%
dividends received deduction applies if Argo Bancorp and Argo Savings own more
than 20.0% of the stock of the corporation paying a dividend. Under pending
legislative proposals, the 70.0% dividends received deduction would be reduced
to 50.0% with respect to dividends paid after enactment of such legislation.
41
State and Local Taxation
State of Illinois. Argo Bancorp and Argo Savings filed an Illinois income
tax return. For Illinois income tax purposes, Argo Bancorp and Argo Savings are
taxed at an effective rate equal to 7.3% of Illinois Taxable Income. For these
purposes, "Illinois Taxable Income" generally means federal taxable income,
subject to certain adjustments (including the addition of interest income on
state and municipal obligations and the exclusion of interest income on United
States Treasury obligations). The exclusion of income on United States Treasury
obligations has the effect of reducing the Illinois taxable income of the
Savings Bank.
As a Delaware holding company, Argo Bancorp has registered as a foreign
corporation authorized to transact business in Illinois. As such, it files an
Illinois Foreign Corporation Annual Report and pays an annual franchise tax to
the State of Illinois.
State of Delaware. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but files
an annual report with and pays an annual franchise tax to the State of Delaware.
Recent and Proposed Changes in Accounting Rules
The Financial Accounting Standards Board ("FASB") recently adopted or
issued proposals and guidelines which may have a significant impact on the
accounting practices of commercial enterprises in general and financial
institutions in particular.
42
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains,
and losses) in a full set of general purpose financial statements. SFAS No. 130
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from net worth
and additional paid-in capital in the equity section of a statement of financial
position. SFAS No. 130 is effective for fiscal years beginning after December
15, 1997. Reclassification of financial statements for earlier periods provided
for comparative purposes are required. Management of the Company does not expect
that adoption of SFAS No. 130 will have a material effect on the consolidated
financial statements of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires
disclosure for each segment that are similar to those required under current
standards with the addition of quarterly disclosure requirements and a finer
partitioning of geographic disclosures. It requires limited segment data on a
quarterly basis. It also requires geographic data by country, as opposed to
broader geographic regions as permitted under current standards. SFAS No. 131 is
effective for fiscal year beginning after December 15, 1997, with earlier
application permitted.
Item 2. Description of Property
The Company is located and conducts its business at its home office in
Summit, Illinois, located at 7600 W. 63rd Street, Summit, and four (4) branch
offices located in Bridgeview, the near West Side of Chicago, Dolton, and
Gurnee, Illinois. The Savings Bank conducts its business through its home
office. On-Line is located and conducts its business at its office in Oak Brook,
Illinois located at 900 Commerce Drive. The Company believes that the Argo
Savings' and On-Line's current facilities are adequate to meet the present and
immediately foreseeable needs of the Company. See Note 5 to the Notes to
Consolidated Financial Statements for the net book value of the property of the
Company.
43
Item 3. Legal Proceedings
Neither the Company nor its subsidiaries are involved in any pending legal
proceedings, other than routine legal matters occurring in the ordinary course
of business, which in the aggregate involve amounts which are believed by
management to be immaterial to the consolidated financial condition or results
of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of the fiscal year ended December 31, 1997, no
matters were submitted to a vote of security holders through a solicitation of
proxies or otherwise.
44
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Information relating to the market for Registrant's common equity and
related stockholder matters appears under "Shareholder Information" in the 1997
Annual Report to Stockholders on pages 51 through 54 is incorporated herein by
reference.
Item 6. Management's Discussion and Analysis or Plan of Operations
The above-captioned information appears under the caption "Management's
Discussion and Analysis of Financial Condition" of the 1997 Annual Report to
Stockholders on pages 3 through 16 and is incorporated herein by reference.
Item 7. Financial Statements
The Consolidated Financial Statements of Argo Bancorp, Inc. and its
subsidiaries as of December 31, 1997, and 1996, together with the report thereon
by KPMG Peat Marwick LLP appears in the Registrant's 1997 Annual Report to
Stockholders, on pages 17 through 50 incorporated herein by reference.
Item 8. Change in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III.
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Information regarding the directors of the Holding Company is omitted from
this Report as the Holding Company intends to file a definitive proxy statement
for the Annual Meeting of Stockholders scheduled to be held on May 20, 1998, and
the information to be included therein under the heading "Information with
respect to the Nominees, Continuing Directors and Certain Executive Officers"
and "Beneficial Ownership Reporting Compliance with Section 16(a)" is
incorporated herein by reference.
45
Item 10. Executive Compensation
The information relating to executive compensation is omitted from this
Report as the Holding Company intends to file a definitive proxy statement for
the Annual Meeting of Stockholders scheduled to be held on May 20, 1998, and the
information to be included therein under headings "Director's Compensation" and
"Executive Compensation" is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The information relating to security ownership of certain beneficial owners
and management is omitted from this Report as the Holding Company intends to
file a definitive proxy statement for the Annual Meeting of Stockholders
scheduled to be held on May 20, 1998, and the information to be included therein
under the headings "Security Ownership of Certain Beneficial Owners" and
"Information with Respect to the Nominees, Continuing Directors and Certain
Executive Officers" is incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions
The information relating to certain relationships and related transactions
is omitted from this Report as the Company intends to file a definitive proxy
statement for the Annual Meeting of Stockholders scheduled to be held on May 20,
1998, and the information to be included therein under the heading "Indebtedness
of Management and Transactions with Certain Related Persons" is incorporated
herein by reference.
Item 13. Exhibits, Financial Statement Schedules, and Reports on Form 10-K
(a)(1) Financial Statements
The following consolidated financial statements of the Registrant and its
subsidiaries, together with the report thereon of KPMG Peat Marwick LLP
dated March 24, 1998, appearing in the 1997 Annual Report of Stockholders
are incorporated herein by reference.
Consolidated Statements of Financial Condition as of December 31, 1997, and
1996.
Consolidated Statements of Operations for the years ended December 31,
1997, 1996, and 1995.
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996, and 1995.
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1996, and 1995.
Notes to Consolidated Financial Statements.
46
The remaining information appearing in the Annual Report is not deemed to
be filed as a part of this report, except as expressly provided herein.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or are not
applicable or the required information is shown in the consolidated
financial statements or notes thereto.
(a)(3) Exhibits
The following exhibits are either filed as part of this report or are
incorporated herein by reference:
Exhibit No. 2. Acquisition
(a) On-Line Stock Purchase Agreement dated as of October 31, 1995, between
Argo Bancorp, Inc., I.S.C. Incorporation, Savings and Loan Service
Bureau of Indiana, Inc., O and H Services, Inc., Superior Savings
Bank, and OLF Acquisition Corp. *
Exhibit No. 3. Certificate of Incorporation and By-Laws.
(a) Certificate of Incorporation of Argo Bancorp, Inc.**
(b) By-Laws of Argo Bancorp, Inc.**
Exhibit No. 4.
(a) Stockholder Agreement dated as of December 31, 1996, between Argo
Bancorp, Inc., The Deltec Corporation Limited, and John G. Yedinak.
***
(b) Stock Certificate of Argo Bancorp, Inc.**
Exhibit No. 10. Material Contracts.
(a) Argo Federal Savings Bank, FSB Employee Stock Ownership Plan and
Trust.**
(b) Argo Federal Savings Bank, FSB Amended and Restated Management
Recognition Plan and Trust.****
(c) Argo Bancorp, Inc. 1990 Incentive Stock Option Plan.**
(d) Argo Bancorp, Inc. 1990 Stock Option Plan for Outside Directors.**
(e) 1996 Argo Bancorp, Inc. Management Recognition and Retention Plan.
*****
(f) Amended and Restated Employment Agreement between Argo Bancorp, Inc.
and John G. Yedinak.
(g) Amended and Restated Employment Agreement between Argo Federal Savings
Bank, FSB and John G. Yedinak.
(h) Amended and Restated Employment Agreement between Argo Bancorp, Inc.
and Frances M. Pitts.
(i) Amended and Restated Employment Agreement between Argo Federal Savings
47
Bank, FSB and Frances M. Pitts.
(j) Employment Agreement between Argo Bancorp, Inc. and Lawrence H. Chlum
(filed herewith).
(k) Employment Agreement between Argo Federal Savings Bank, FSB and George
L. Koehm (filed herewith)
Exhibit No. 11.
Computation of earnings per share (filed herewith).
Exhibit No. 13.
Portion of the 1997 Annual Report to Stockholders are incorporated herein
by reference. Portions of the Annual Report to Stockholders have been
incorporated by reference into the Form 10-KSB. (filed herewith).
Exhibit No. 21.
Subsidiary information is incorporated herein by reference to "Part I -
Subsidiaries."
Exhibit No. 23.
Consent of KPMG Peat Marwick LLP (filed herewith).
Exhibit No. 27.
(a) Financial Data Schedule (filed herewith)
(b)(1) Reports on Form 8-K
The Registrant filed a Report on Form 8-K on January 8, 1997, announcing
the sale of 111,563 shares of Argo Bancorp stock to The Deltec Banking
Corporation Limited in a negotiated private offering.
- --------------------------------------------------------------------------------
* Incorporate herein by reference into this document from the Form 10-K
for the fiscal year ended December 31, 1995.
** Incorporated herein by reference into this document from the Exhibits
to Form S-1, Registration Statement, and filed on January 28, 1992,
any amendments thereto, Registration No. 33-45222.
*** Incorporate herein by reference into this document from the Form 8-K
dated January 8, 1997.
**** Incorporated herein by reference into this document from the Proxy
Statement for the 1995 Annual Meeting of Stockholders filed on March
29, 1996.
***** Incorporate herein by reference into this document from the Form S-8
filed on September 30, 1996, (Registration No. 333-13047).
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARGO BANCORP, INC.
--------------------------------------------
(Registrant)
Date: March , 1998 By: /s/ John G. Yedinak
--------------------- ------------------------------------------
John G. Yedinak, Chairman of the
Board, President, Chief Executive
Officer, and Director
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.
Date: March , 1998 By: /s/ John G. Yedinak
--------------------- ------------------------------------------
John G. Yedinak, Chairman of the
Board, President, Chief Executive
Officer, and Director
Date: March , 1998 By: /s/ Sergio Martinucci
--------------------- ------------------------------------------
Sergio Martinucci, Vice President
and Director
Date: March , 1998 By: /s/ Arthur Byrnes
--------------------- ------------------------------------------
Arthur Byrnes, Director
Date: March , 1998 By: /s/ Donald G. Wittmer
--------------------- ------------------------------------------
Donald G. Wittmer, Director
Date: March , 1998 By: /s/ Frances M. Pitts
--------------------- ------------------------------------------
Frances M. Pitts, Secretary and
Director