NASB Financial, Inc. (the "Company") was formed in 1998 as a unitary thrift holding company of North American Savings Bank, F.S.B. ("North American" or the "Bank"). The Bank is a federally chartered stock savings bank, with its headquarters in the Kansas City area. The Bank began operating in 1927, and became a member of the Federal Home Loan Bank of Des Moines ("FHLB") in 1940. Its customer deposit accounts are insured by the Deposit Insurance Fund ("DIF"), a division of the Federal Deposit Insurance Corporation ("FDIC"). The Bank converted to a stock form of ownership in September 1985.
The Bank's primary market area includes the counties of Jackson, Cass, Clay, Buchanan, Andrew, Platte, and Ray in Missouri, and Johnson and Wyandotte counties in Kansas. The Bank currently has eight customer deposit offices in Missouri including one each in Grandview, Lee's Summit, Independence, Harrisonville, Excelsior Springs, and St. Joseph, and two in Kansas City. North American also operates loan production offices in Lee's Summit and Springfield in Missouri, Overland Park and Leawood in Kansas. The economy of the Kansas City area is diversified with major employers in agribusiness, greeting cards, automobile production, transportation, telecommunications, and government.
The Bank's principal business is to attract deposits from the general public and to originate real estate loans, other loans and short-term investments. The Bank obtains funds mainly from deposits received from the general public, sales of loans and loan participations, advances from the FHLB, and principal repayments on loans and mortgage-backed securities ("MBS"). The Bank's primary sources of income include interest on loans, interest on MBS, customer service fees, and mortgage banking fees. Its primary expenses are interest payments on customer deposit accounts and borrowings and normal operating costs.
WEIGHTED AVERAGE YIELDS AND RATES The following table presents the balances of interest-earning assets and interest-costing liabilities with weighted average yields and rates. Average balances and weighted average yields include all accrual and non-accrual loans. Dollar amounts are expressed in thousands.
Fiscal 2006 ---------------------- Average Yield/ Balance Rate ---------------------- Interest-earning assets: Loans $ 1,336,590 7.02% Mortgage-backed securities 112,201 3.71% Investments 23,417 3.84% Bank deposits 7,929 3.01% ---------------------- Total earning assets 1,480,137 6.70% Non-earning assets 57,259 --------- ----------- Total $ 1,537,396 ===========
Interest-costing liabilities: Customer checking and savings deposit accounts $ 184,180 1.07% Customer and brokered certificates of deposit 683,167 4.10% FHLB advances 481,422 4.53% Other borrowings 24,231 3.24% ---------------------- Total costing liabilities 1,373,000 3.83% Non-costing liabilities 12,468 --------- Stockholders' equity 151,928 ----------- Total $1,537,396 =========== Net earning balance $ 107,137 =========== Earning yield less costing rate 2.87% =========
Fiscal 2005 ---------------------- Average Yield/ Balance Rate ---------------------- Interest-earning assets: Loans $ 1,218,854 6.34% Mortgage-backed securities 151,686 3.73% Investments 21,406 2.63% Bank deposits 10,357 2.81% ---------------------- Total earning assets 1,402,303 5.97% Non-earning assets 50,065 --------- ----------- Total $ 1,452,368 ===========
Interest-costing liabilities: Customer checking and savings deposit accounts $ 199,411 0.78% Customer and brokered certificates of deposit 534,218 2.91% FHLB advances 430,581 2.73% Other borrowings 135,569 2.70% ---------------------- Total costing liabilities 1,299,779 2.50% Non-costing liabilities 10,426 --------- Stockholders' equity 142,163 ----------- Total $1,452,368 =========== Net earning balance $ 102,524 =========== Earning yield less costing rate 3.47% =========
Fiscal 2004 ---------------------- Average Yield/ Balance Rate ---------------------- Interest-earning assets: Loans $ 1,058,919 6.30% Mortgage-backed securities 149,209 3.90% Investments 19,217 2.40% Bank deposits 16,282 0.71% ---------------------- Total earning assets 1,243,627 5.88% Non-earning assets 46,966 --------- ----------- Total $ 1,290,593 ===========
Interest-costing liabilities: Customer checking and savings deposit accounts $ 208,935 0.70% Customer and brokered certificates of deposit 464,152 2.44% FHLB advances 345,596 1.60% Other borrowings 133,954 1.31% ---------------------- Total costing liabilities 1,152,637 1.74% Non-costing liabilities 6,723 --------- Stockholders' equity 131,233 ----------- Total $1,290,593 =========== Net earning balance $ 90,990 =========== Earning yield less costing rate 4.14% =========
RATIOS The following table sets forth, for the periods indicated, the Company's return on assets (net income divided by average total assets), return on equity (net income divided by average equity), and equity-to-assets ratio (average equity divided by average total assets), and dividend payout ratio (total cash dividends paid divided by net income).
Year ended September 30, --------------------------------------- 2006 2005 2004 2003 2002 --------------------------------------- Return on average assets 1.35% 1.77% 2.04% 2.30% 2.04% Return on average equity 13.60% 17.94% 18.88% 20.24% 19.40% Equity to asset ratio 10.27% 9.57% 10.21% 11.51% 11.19% Dividend payout ratio 45.59% 54.82% 48.74% 23.23% 24.41%
The following table sets forth the amount of cash dividends per share paid on the Company's common stock during the months indicated.
Calendar year ----------------------------------------------- 2006 2005 2004 2003 2002 ----------------------------------------------- February $ 0.225 0.225 0.20 0.17 0.15 May 0.225 0.225 0.20 0.17 0.15 August 0.225 0.225 0.20 0.17 0.15 November 0.225 0.45 1.00 0.85 0.15
ASSET ACTIVITIES
LENDING ACTIVITIES The Bank, has traditionally concentrated its lending activities on mortgage loans secured by residential and business property and, to a lesser extent, development lending. The residential mortgage loans originated have predominantly long-term fixed and adjustable rates. The Bank also has a portfolio of mortgage loans that are secured by multifamily, construction, development, and commercial real estate properties. The remaining part of North American's loan portfolio consists of non-mortgage commercial loans and installment loans. The following table presents the Bank's total loans receivable, held for investment plus held for sale, for the periods indicated. The related discounts, premiums, deferred fees and loans-in-process accounts are excluded. Dollar amounts are expressed in thousands.
The following table sets forth information at September 30, 2006, regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans, which have no stated schedule of repayment and no stated maturity, are reported as due in one year or less. Scheduled repayments are reported in the maturity category in which the payment is due. Dollar amounts are expressed in thousands. Through After 2007 2011 2011 Total ------------------------------------------ Mortgage Loans: Permanent: - at fixed rate $ 2,222 11,338 241,126 254,686 - at adjustable rates 3,236 11,681 655,439 670,356 Construction and development: - at fixed rates 16,272 247 -- 16,519 - at adjustable rates 377,590 111,925 -- 489,515 ----------------------------------------- Total mortgage loans 399,320 135,191 896,565 1,431,076 Commercial loans 1,951 350 58,391 60,692 Installment loans to Individuals 864 3,894 12,521 17,279 ------------------------------------------ Total loans receivable $402,135 139,435 967,477 1,509,047 ==========================================
RESIDENTIAL REAL ESTATE LOANS The Bank offers a range of residential loan programs. At September 30, 2006, 29% of total loans receivable were permanent loans on residential properties. Also, the Bank is authorized to originate loans guaranteed by the Veterans Administration ("VA") and loans insured by the Federal Housing Administration ("FHA"). Included in residential loans as of September 30, 2006, are $1.9 million or less than 1% of the Bank's total loans that were insured by the FHA or VA.
The Bank's residential loans come from several sources. The loans that the Bank originates are generally a result of direct solicitations of real estate brokers, builders, developers, or potential borrowers via the internet. North American periodically purchases real estate loans from other savings institutions or mortgage bankers. Loan originations and purchases must be approved by various levels of management and, depending on the loan amount, are subject to review by the Board of Directors.
At the time a potential borrower applies for a single family residential mortgage loan, it is designated as either a portfolio loan, which is held for investment and carried at amortized cost, or a loan held-for-sale in the secondary market and carried at the lower of cost or fair value. All the loans on single family property that the Bank holds for sale conform to secondary market underwriting criteria established by the Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA"). All loans originated, whether held for sale or held for investment, conform to internal underwriting guidelines, which consider, among other things, a property's value and the borrower's ability to repay the loan.
CONSTRUCTION AND DEVELOPMENT LOANS Construction and land development loans are made primarily to builders/developers, who construct properties for resale. As of September 30, 2006, 34% of the Bank's total loans receivable were construction and development loans. The Bank originates both fixed and variable rate construction loans, and most are due and payable within one year. In some cases, extensions are permitted if payments are current and construction has progressed satisfactorily.
The Bank's requirements for a construction loan are similar to those of a mortgage on an existing residence. In addition, the borrower must submit accurate plans, specifications, and cost projections of the property to be constructed. North American's staff performs periodic inspections of each property during construction to ensure adequate progress is achieved before scheduled loan disbursements are made.
COMMERCIAL REAL ESTATE LOANS The Bank purchases and originates several different types of commercial real estate loans. As of September 30, 2006, commercial real estate loans on business properties were $482.0 million or 32% of the Bank's total loan portfolio. Permanent multifamily mortgage loans on properties of 5 to 36 dwelling units have a 50% risk-weight for risk-based capital requirements if they have an initial loan-to-value ratio of not more than 80% and if their annual average occupancy rate exceeds 80%. All other performing commercial real estate loans have 100% risk-weights.
INSTALLMENT LOANS As of September 30, 2006, consumer installment loans and lease financing to individuals represented approximately 1% of loans receivable. These loans consist primarily of loans on savings accounts and consumer lines of credit that are secured by a customer's equity in their primary residence.
SALES OF MORTGAGE LOANS The Bank is an active seller of loans in the national secondary mortgage market. A portion of loans originated are sold to various investors with the rights to service the loans (servicing released). Another portion are originated for sale with loan servicing rights kept by the Bank (servicing retained), or with servicing rights sold to a third party servicer. At the time of each loan commitment, management decides if the loan will be held in portfolio or sold and, if sold, which investor is appropriate. During fiscal 2006, the Bank sold $939,000 in loans with servicing released.
The Bank records loans held for sale at the lower of cost or estimated fair value, and any adjustments made to record them at estimated fair value are made through the income statement. As of September 30, 2006, the Bank had loans held for sale with a carrying value of $50.5 million.
CLASSIFIED ASSETS, DELINQUENCIES, AND ALLOWANCE FOR LOSS Classified Assets. In accordance with the asset classification system outlined by the Office of Thrift Supervision ("OTS"), North American's problem assets are classified as either "substandard," "doubtful," or "loss."
An asset is considered substandard if it is inadequately protected by the borrower's ability to repay, or the value of collateral. Substandard assets include those characterized by a possibility that the institution will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have the same weaknesses of those classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as loss are considered uncollectible and of such little value that their existence without establishing a specific loss allowance is not warranted.
When the Bank classifies a problem asset, it establishes a specific loss allowance needed to reduce its book value to the present value of the expected future cash flows discounted at the loan's initial effective interest rate, or as a practical expedient, to the loan's observable market price or the fair value of the collateral, if the loan is dependent on collateral. In addition, Allowances for Loan and Lease Losses ("ALLL") are established by management. ALLL represent allowances that recognize inherent risks associated with distinct and homogenous loans pools. When the Bank classifies all or part of problem assets as loss, it establishes a specific loss allowance equal to 100% of the loss classification. The OTS reviews North American's asset classification during each examination and can require changes to asset classifications, specific loss allowances, ALLL, and loan loss provision.
Each month, management reviews the problem loans in its portfolio to determine whether changes to the asset classifications or allowances are needed. The following table summarizes the Bank's classified assets as reported to the OTS, plus any classified assets of the holding company. Dollar amounts are expressed in thousands.
As of September 30, ----------------------------------------- 2006 2005 2004 2003 2002 ----------------------------------------- Asset Classification Substandard $ 12,361 13,346 17,462 15,932 14,822 Doubtful -- -- -- -- -- Loss 434 595 1,861 2,325 1,395 ----------------------------------------- Total Classified 12,795 13,941 19,323 18,257 16,217 Allowance for loan/REO losses (8,266) (7,731) (9,315) (9,348) (6,854) ----------------------------------------- Net classified assets $ 4,529 6,210 10,008 8,909 9,363 ========================================= Net classified to total classified assets 35% 45% 52% 49% 58% =========================================
When a loan becomes 90 days past due, the Bank stops accruing interest and establishes a reserve for the interest accrued-to-date. The following table summarizes non-performing assets, troubled debt restructurings, and real estate acquired through foreclosure or in- substance foreclosure. Dollar amounts are expressed in thousands.
September 30, --------------------------------------------- 2006 2005 2004 2003 2002 --------------------------------------------- Total Assets $1,524,796 1,556,344 1,361,888 1,107,359 978,222 =============================================
Non-accrual loans $ 6,396 5,643 15,748 6,924 6,361 Troubled debt restructurings 3,477 74 2,844 3,565 3,337 Net real estate and other assets acquired through foreclosure 5,231 7,760 4,014 4,561 4,938 --------------------------------------------- Total $ 15,104 13,477 22,606 15,050 14,636 ============================================= Percent of total assets 0.99% 0.87% 1.66% 1.36% 1.50% =============================================
Delinquencies. The following table summarizes delinquent loan information.
As of September 30, 2006 ---------------------------------------------------------------------- Number of Percent of Loans delinquent for Loans Amount Total Loans ---------------------------------------------------------------------- 30 to 89 days 68 $ 6,593 0.4% 90 or more days 63 6,396 0.4% ----------- ----------------------------- Total 131 $ 12,989 0.8% =========== =============================
As of September 30, 2005 ---------------------------------------------------------------------- Number of Percent of Loans delinquent for Loans Amount Total Loans ---------------------------------------------------------------------- 30 to 89 days 73 $ 4,936 0.3% 90 or more days 86 5,643 0.4% ----------- ----------------------------- Total 159 $ 10,579 0.7% =========== =============================
The effect of non-performing loans on interest income for fiscal year 2006 is presented below. Dollar amounts are expressed in thousands.
Principal amount of non-performing loans as of September 30, 2006 $ 6,396 ======== Gross amount of interest income that would have been recorded during fiscal 2006 if these loans had been performing $ 487 Actual amount included in interest income for fiscal 2006 232 -------- Interest income not recognized on non-performing loans $ 255 ========
Allowance for loss. Management records a provision for estimated loan losses in an amount sufficient to cover current net charge-offs and probable losses based on an analysis of risks inherent in the loan portfolio. Management continually monitors the performance of the loan portfolio and establishes specific loss allowances when warranted. Specifically, when it appears that a property and borrower are no longer capable of full repayment, management establishes a specific loss allowance to reduce the loan's book value to fair value based on the anticipated results of collections. In addition, management establishes Allowance for Loan and Lease Losses ("ALLL") through charges to the provision for loan loss based on an assessment of the portfolio's credit risk, other than specifically identified problem loans. Management attempts to maintain ALLL proportionate to the level of risk in the Bank's performing loan portfolio.
Management records an Allowance for Loan and Lease Losses sufficient to cover current net charge-offs and an estimate of probable losses based on an analysis of risks that management believes to be inherent in the loan portfolio. The ALLL recognizes the inherent risks associated with lending activities but, unlike a specific allowance, has not been allocated to particular problem assets but to a homogenous pool of loans. Management analyzes the adequacy of the allowance on a monthly basis and believes that the Bank's specific loss allowances and ALLL are adequate. While management uses information currently available to determine these allowances, they can fluctuate based on changes in economic conditions and changes in the information available to management. Also, regulatory agencies review the Bank's allowances for loan loss as part of their examination, and they may require the Bank to recognize additional loss provisions based on the information available at the time of their examinations.
Management estimates the required level of ALLL using a formula based on various subjective and objective factors. ALLL is established and maintained in the form of a provision on loss charged to earnings. Based on its analysis, management may determine that ALLL is above appropriate levels. If so, a negative loss provision would be recorded to reduce the ALLL. This could occur due to significant asset recoveries or significant reductions in the level of classified assets. Each quarter management assesses the risk of the assets in the loan portfolio using historical loss data and current economic conditions in order to determine impairment of the various loan portfolios and adjusts the level of ALLL. At any given time, the ALLL should be sufficient to absorb at least all estimated credit losses on outstanding balances over the next twelve months.
When considering the adequacy of ALLL, management's evaluation of the asset portfolio has two primary components: foreclosure probability and loss severity. Foreclosure probability is the likelihood of loans not repaying in accordance with their original terms, which would result in the foreclosure and subsequent liquidation of the property. Loss severity is any potential loss resulting from the loan's foreclosure and subsequent liquidation. Management calculates estimated foreclosure frequency and loss severity ratios for each homogenous loan pool based upon objective factors such as historical data and loan characteristics, plus an estimate of certain subjective factors including future market trends and economic conditions. These ratios are applied to the balances of the homogeneous loan pools to determine the adequacy of the ALLL each month.
In addition to analyzing homogenous pools of loans for impairment, management reviews individual loans for impairment each month. A loan becomes impaired when management believes it will be unable to collect all principal and interest due according to the contractual terms of the loan. If a loan is impaired, the Bank records a specific allowance equal to the excess of the loan's carrying value over the present value of the estimated future cash flows discounted at the loan's effective rate based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Loans on residential properties with greater than four units and loans on construction/development and commercial properties are evaluated for impairment on a loan by loan basis.
The following table sets forth the activity in the allowance for loan losses. Dollar amounts are expressed in thousands.
September 30, ----------------------------------------- 2006 2005 2004 2003 2002 ----------------------------------------- Balance at beginning of year $ 7,536 8,221 7,986 5,865 5,835 Total provisions 745 522 465 538 557 Recoveries (charge-offs)on: Residential properties (2) 53 51 87 (108) Business properties (280) (1,237) (273) (92) (291) Construction and development (2) -- -- 320 (3) Commercial loans -- -- -- -- -- Installment loans (6) (23) (8) (41) (125) ----------------------------------------- Total net recoveries (charge-offs) (290) (1,207) (230) 274 (527) Acquired in merger -- -- -- 1,309 -- ----------------------------------------- Balance at end of year $ 7,991 7,536 8,221 7,986 5,865 =========================================
The following table sets forth the allocation of the allowance for loan losses. Dollar amounts are expressed in thousands.
REAL ESTATE ACQUIRED THROUGH FORECLOSURE The Bank's staff attempts to contact borrowers who fail to make scheduled payments, generally after a payment is more than 15 days past due. In most cases, delinquencies are cured promptly. If a delinquency exceeds 90 days, North American will implement measures to remedy the default, such as accepting a voluntary deed for the property in lieu of foreclosure or commencing a foreclosure action. If a foreclosure occurs, the property is classified as real estate owned ("REO") until the property is sold. North American sometimes finances the sale of foreclosed real estate ("loan to facilitate"). Loans to facilitate may involve a reduced down payment, a reduced rate, or a longer term than the Bank's typical underwriting standards.
If a loan has a specific loss reserve at the time it is foreclosed, the specific reserve is netted against the loan balance in recording the foreclosed loan as REO. Management records a provision for losses on REO when, subsequent to foreclosure, the estimated net realizable value of a repossessed asset declines below its book value. The following table sets forth activity in the allowance for loss on REO. Dollar amounts are expressed in thousands.
September 30, --------------------------------------- 2006 2005 2004 2003 2002 --------------------------------------- Beginning allowance for loss $ 195 1,093 1,019 646 1,220 Provisions (1,026) (899) (237) 1,984 (236) Net recoveries (charge-offs) 1,106 1 311 (1,611) (318) --------------------------------------- Allowance for loss at year-end $ 275 195 1,093 1,019 646 =======================================
SECURITIES AND MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE Management classifies debt securities as available for sale if the Bank does not have the intention and ability to hold until maturity. Assets available for sale are carried at estimated fair value, with all fair value adjustments recorded as accumulated other comprehensive income or loss.
MORTGAGE-BACKED SECURITIES HELD TO MATURITY The Bank's MBS portfolio consists primarily of securities issued by the FHLMC, FNMA, and GNMA. As of September 30, 2006 the Bank had $250,000 in fixed rate and $75,000 in balloon and adjustable rate mortgage-backed securities ("MBS") issued by these agencies.
INVESTMENT SECURITIES As of September 30, 2005, the Bank held no investment security from a single issuer for which the market value exceeded 10% of the Bank's stockholders' equity.
SOURCE OF FUNDS In addition to customer deposits, the Bank obtains funds from loan and MBS repayments, sales of loans held-for-sale and securities available-for-sale, investment maturities, FHLB advances, and other borrowings. Loan repayments, as well as the availability of customer deposits, are influenced significantly by the level of market interest rates. Borrowings may be used to compensate for insufficient customer deposits or to support expanded loan and investment activities.
CUSTOMER DEPOSIT AND BROKERED DEPOSIT ACCOUNTS The following table sets forth the composition of various types of customer deposit accounts. Dollar amounts are expressed in thousands.
The following table presents the deposit activities at the Bank. Dollar amounts are expressed in thousands.
For the years ended September 30, ------------------------------------------------- 2006 2005 2004 2003 2002 ------------------------------------------------- Deposit receipts $1,477,500 1,302,290 1,199,330 1,178,584 873,622 Withdrawals 1,457,221 1,199,596 1,183,083 1,171,160 930,237 ------------------------------------------------- Deposit receipts and purchases in excess of (less than) withdrawals 20,279 102,694 16,247 7,424 (56,615) Deposits sold -- -- -- -- -- Deposits acquired in merger -- -- -- 82,750 -- Interest credited 28,069 16,260 12,805 15,077 20,015 ------------------------------------------------- Net increase (decrease) $ 48,348 118,954 29,052 105,251 (36,600) ================================================= Balance at end of year $ 851,042 802,694 683,740 654,688 549,437 =================================================
Customers who wish to withdraw certificates of deposit prior to maturity are subject to a penalty for early withdrawal.
The following table presents contractual maturities of certificate accounts of $100,000 or more at September 30, 2006. Dollar amounts are expressed in thousands.
Maturing in three months or less $ 15,952 Maturing in three to six months 23,651 Maturing in six to twelve months 31,531 Maturing in over twelve months 30,304 -------- $ 101,438 ========
FHLB ADVANCES AND OTHER BORROWINGS FHLB advances are an important source of borrowing for North American. The FHLB functions as a central reserve bank providing credit for thrifts and other member institutions. As a member of the FHLB, North American is required to own stock in the FHLB of Des Moines and can apply for advances, collateralized by the stock and certain types of mortgages, provided that certain standards related to credit-worthiness are met.
The Bank has historically relied on customer deposits and loan repayments as its primary sources of funds. Advances are sometimes used as a funding supplement when management determines that it can profitably invest the advances over their term. During fiscal 2006, the Bank borrowed an additional $371.0 million in advances, repaid $337.3 million, and as of September 30, 2006, had a balance of $499.4 million (36% of total liabilities) of advances from the FHLB.
The following table presents, for the periods indicated, certain information as to the Bank's advances from the FHLB and other borrowings. Dollar amounts are expressed in thousands.
As of September 30, -------------------------------------------------- 2006 2005 2004 2003 2002 -------------------------------------------------- FHLB advances $ 499,357 465,907 367,341 308,088 295,192 Other borrowings -- 122,000 159,100 -- -- -------------------------------------------------- Total $ 499,357 587,907 526,441 308,088 295,192 ================================================== Weighted average rate 5.21% 3.67% 1.91% 1.62% 3.73% ==================================================
OTHER ACTIVITIES
SERVICE CORPORATION ACTIVITIES The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") substantially limits the types of service corporation activities permissible by the Bank. North American's service corporation, Nor-Am, was incorporated in 1972. Nor-Am sells tax- deferred annuities and mutual funds through the Bank's branch offices and credit life and disability insurance to loan customers.
OTHER INFORMATION EMPLOYEES As of September 30, 2006, the Bank and its subsidiaries had 362 employees. Management considers its relations with the employees to be excellent.
The Bank currently maintains a comprehensive employee benefit program including a qualified pension plan, hospitalization and major medical insurance, paid vacations, paid sick leave, long-term disability insurance, life insurance, and reduced loan fees for employees who qualify. The Bank's employees are not represented by any collective bargaining group.
COMPETITION The Bank, like other savings institutions, is operating in a changing environment. Non-depository financial service companies such as securities dealers, insurance agencies, and mutual funds have become competitors for retail savings and investments. In addition to offering competitive interest rates, a savings institution can attract customer deposits by offering a variety of services and convenient office locations and business hours. Mortgage banking/brokerage firms compete for the residential mortgage business. The primary factors in competing for loans are interest rates and rate adjustment provisions, loan maturity, loan fees, and the quality of service to borrowers and brokers.
REGULATION GENERAL Federal savings institutions are members of the FHLB System and their deposits are insured by the DIF, a division of the Federal Deposit Insurance Corporation ("FDIC"). They are subject to extensive regulation by the OTS as the chartering authority and now, since the passage of the FIRREA, the FDIC. DIF insured institutions are limited in the transactions in which they may engage by statute and regulation, which in certain instances may require an institution to conform with regulatory standards or to receive prior approval from regulators. Institutions must also file periodic reports with these government agencies regarding their activities and their financial condition. The OTS and FDIC make periodic examinations of the Bank to test compliance with the various regulatory requirements. If it is deemed appropriate, the FDIC can require a re-valuation of the Bank's assets based on examinations and they can require the Bank to establish specific allowances for loss that reflect any such re- valuation. This supervision and regulation is intended primarily for the protection of depositors. Savings institutions are also subject to certain reserve requirements under Federal Reserve Board regulations.
The enforcement provisions of the Federal Deposit Insurance Act ("FDI Act") are applicable to savings institutions and savings and loan holding companies. While the OTS is primarily responsible for enforcing those provisions, the FDIC also has authority to impose enforcement action on savings institutions in certain situations. The jurisdiction of the FDI Act's enforcement powers cover all "insured- related parties" including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Regulators have broad flexibility to impose enforcement action on an institution that fails to comply with its regulatory requirements, particularly with respect to the capital requirements. Possible enforcement action ranges from requiring a capital plan, restricting operations, or terminating deposit insurance. The FDIC can recommend to the director of the OTS (the "Director") enforcement action, and if action is not taken by the Director, the FDIC has the authority to compel such action under certain circumstances.
FEDERAL HOME LOAN BANKING SYSTEM The Bank is a member of the FHLB System, which consists of 12 regional Federal Home Loan Banks each subject to OTS supervision and regulation. The FHLBs provide a central credit facility for member institutions. The Bank, as a member of the FHLB of Des Moines, is required to hold shares of capital stock of the FHLB in an amount equal to at least 1% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 1/20 of its advances from the FHLB of Des Moines, whichever is greater. The Bank complies with this requirement and holds stock in the FHLB of Des Moines at September 30, 2006, of $24.0 million. FHLB advances must be secured by specified types of collateral. Also, standards of community investment and community service must be met by members that apply for FHLB advances.
LIQUIDITY Effective July 18, 2001, the OTS adopted a rule that removed the regulation to maintain a specific average daily balance of liquid assets, but retained a provision that requires institutions to maintain sufficient liquidity to ensure their safe and sound operation. North American maintains a level of liquid assets adequate to meet the requirements of normal banking activities, including the repayment of maturing debt and potential deposit withdrawals. The Bank's primary sources of liquidity are the sale and repayment of loans, retention of existing or newly acquired retail deposits, and FHLB advances. Management continues to use FHLB advances as a primary source of short-term funding. FHLB advances are secured by a blanket pledge agreement of the loan and securities portfolio, as collateral, supported by quarterly reporting of eligible collateral to FHLB. Available FHLB borrowings are limited based upon a percentage of the Bank's assets and eligible collateral, as adjusted by appropriate eligibility and maintenance levels. Management continually monitors the balance of eligible collateral relative to the amount of advances outstanding. At September 30, 2006, the Bank had available advances at FHLB of $613.1 million, and outstanding advances of $499.4 million. The Bank has established relationships with various brokers, and, as a secondary source of liquidity, the Bank may purchase brokered deposit accounts. At September 30, 2006, the Bank has $128.2 million in brokered deposits, and it could purchase up to an additional$145.2 million in brokered deposits and remain "well capitalized" as defined by the OTS.
INSURANCE ON CUSTOMER DEPOSIT ACCOUNTS Deposit insurance reform legislation was signed into law on February 8, 2006. A key provision of this legislation was the merger of the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) into a single fund, the Deposit Insurance Fund (DIF). The merger of the funds was effective March 31, 2006. The DIF insures the Bank's customer deposit accounts to a maximum of $100,000 for each insured owner, with the exception of self-directed retirement accounts, which are insured to a maximum of $250,000. Deposit premiums are determined using a Risk-Related Premium Schedule ("RRPS"), a matrix which places each insured institution into one of three capital groups and one of three supervisory subgroups. The capital groups are an objective measure of risk based on regulatory capital calculations and include well capitalized, adequately capitalized, and undercapitalized. The supervisory subgroups (A, B, and C) are more subjective and are determined by the FDIC based on recent regulatory examinations. Member institutions are eligible for reclassification every six months.
Annual deposit insurance premiums range from 0 to 27 basis points of insured deposits based on where an institution fits on the RRPS. North American is considered to be "well capitalized" and has been placed in the most favorable capital subgroup. In addition to deposit insurance premiums institutions assessed a premium, which is used to service the interest on the Financing Corporation ("FICO") debt.
The FDIC has authority to conduct examinations of, require reporting of, and initiate enforcement actions against a thrift. Regardless of an institution's capital level, 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.
REGULATORY CAPITAL REQUIREMENTS Regulations require that thrifts maintain minimum levels of regulatory capital, which are at least as stringent as those imposed on national banks by the Office of the Comptroller of the Currency ("OCC").
Leverage Limit. The leverage limit requires that a thrift maintain "core capital" of at least 4% of its adjusted tangible assets. "Core capital" includes (i) common stockholders' equity, including retained earnings; non-cumulative preferred stock and related earnings; and minority interest in the equity accounts of consolidated subsidiaries, minus (ii) those intangibles (including goodwill) and investments in and loans to subsidiaries not permitted in computing capital for national banks, plus (iii) certain purchased mortgage servicing rights and certain qualifying supervisory goodwill. At September 30, 2006, intangible assets of $3.0 million and servicing rights and deferred tax assets totaling an additional $2.4 million were deducted from the Bank's regulatory capital. At September 30, 2006, the Bank's core capital ratio was 8.9%.
Tangible Capital Requirement. The tangible capital requirement mandates that a thrift maintain tangible capital of at least 1.5% of tangible assets. For the purposes of this requirement, adjusted total assets are generally calculated on the same basis as for the leverage ratio requirement. Tangible capital is defined in the same manner as core capital, except that all goodwill and certain other intangible assets must be deducted. As of September 30, 2006, North American's regulatory tangible capital was 8.9% of tangible assets.
Risk-Based Capital Requirement. The OTS's standards require that institutions maintain risk-based capital equal to at least 8% of risk- weighted assets. Total risk-based capital includes core capital plus supplementary capital. In determining risk-weighted assets, all assets including certain off-balance-sheet items are multiplied by a risk weight factor from 0% to 100%, based on risk categories assigned by the OTS. The RRPS categorizes bank risk-based capital ratio over 10% as well capitalized, 8% to 10% as adequately capitalized, and under 8% as undercapitalized. As of September 30, 2006, the Bank's current risk-based regulatory capital was 10.9% of risk-weighted assets.
OTS ASSESSMENTS The OTS has a sliding scale assessment formula to provide funding for its operations. Troubled savings associations are charged a "premium assessment" at a rate of 50% higher than non-troubled savings associations at the same level of assets. Non-troubled institutions are charged "general assessments." The changes in assessment fees reflect the increased supervisory attention that troubled institutions require from the OTS, which in turn increases the cost of regulation and examinations.
EQUITY RISK INVESTMENTS OTS regulations limit the aggregate amount that an insured institution may invest in real estate, service corporations, equity securities, and nonresidential construction loans and loans with loan- to-value ratios greater than 80%. Under the regulations, savings associations which meet their minimum regulatory capital requirements and have tangible capital of less than 6% of total liabilities may make aggregate equity risk investments equal to the greater of 3% of assets or two and one-half times their tangible capital. Savings associations that meet their minimum regulatory capital requirements and have tangible capital equal to or greater than 6% of total liabilities may make aggregate equity risk investments of up to three times their tangible capital.
LOANS TO ONE BORROWER FIRREA prohibits an institution from investing in any one real estate project in an amount in excess of the applicable loans-to-one- borrower limit, which is an amount equal to 15% of unimpaired capital on an unsecured basis and an additional amount equal to 10% of unimpaired capital and surplus if the loan is secured by certain readily marketable collateral. Renewals that exceed the loans-to-one- borrower limit are permissible if the original borrower remains liable for the debt and no additional funds are disbursed. The Bank recently received regulatory approval from the OTS under 12 CFR 560.93 which increased it's loans-to-one-borrower limit to $30 million for loans secured by certain residential housing units. Such loans must, in the aggregate, not exceed 150% of the Bank's unimpaired capital and surplus.
INVESTMENT IN SUBSIDIARIES Investments in and extensions of credit to subsidiaries not engaged in activities permissible for national banks must generally be deducted from capital. As of September 30, 2006, the Bank did not have any investments in or advances to subsidiaries engaged in activities not permissible for national banks.
FEDERAL RESERVE SYSTEM Regulations require that institutions maintain reserves of 3% against transaction accounts up to a specified level and an initial reserve of 10% against that portion of total transaction accounts in excess of such amount. In addition, an initial reserve of 3% must be maintained on non-personal time deposits, which include borrowings with maturities of less than four years. Such reserves are non- interest bearing. These percentages are subject to change by the Federal Reserve Board. As of September 30, 2006, North American met its reserve requirements.
Savings institutions have authority to borrow from the Federal Reserve Bank's "discount window," but only after exhausting all FHLB sources of borrowing.
TAXATION
The Company is subject to the general applicable corporate tax provisions of the Internal Revenue Code ("Code") and the Bank is subject to certain additional provisions of the Code which apply to savings institutions and other types of financial institutions.
BAD DEBT RESERVES Prior to October 1, 1996, the Bank was allowed a special bad debt deduction for additions to tax bad debt reserves established for the purpose of absorbing losses. This deduction was either based on an institution's actual loss experience (the "experience method") or, subject to certain tests relating to the composition of assets, based on a percentage of taxable income ("percentage method"). Under the percentage method, qualifying institutions generally deducted 8% of their taxable income.
As a result of changes in the Federal tax code, the Bank's bad debt deduction was based on actual experience beginning with the fiscal year ended September 30, 1997, as the percentage method for additions to the tax bad debt reserve was eliminated. Under the new tax rules, thrift institutions were required to recapture their accumulated tax bad debt reserve, except for the portion that was established prior to 1988, the "base-year". The recapture was completed over a six-year phase-in period that began with the fiscal year ended September 30, 1999. A deferred tax liability is required to the extent the tax bad debt reserve exceeds the 1988 base year amount. As of September 30, 2006, North American had approximately $3.7 million established as a tax bad debt reserve in the base-year. Distributing the Bank's capital in the form of purchasing treasury stock forced North American to recapture its after base-year bad debt reserve prior to the phase-in period. Management believes that accelerating the recapture was more than offset by the opportunity to buy treasury stock at lower average market prices.
MINIMUM TAX For taxable years beginning after December 31, 1986, the alternative minimum tax rate is 20%. The alternative minimum tax generally applies to a base of regular taxable income plus certain tax preferences and is payable to the extent such preferences exceed an exemption amount.
STATE TAXATION The Bank is subject to a special financial institution state tax based on approximately 7% of net income. This tax is in lieu of all other taxes on thrift institutions except taxes on real estate, tangible personal property owned by the Bank, contributions paid to the State unemployment insurance fund, and sales/use taxes.
