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Fidelity Federal Bancorp – ‘10KT405/A’ for 12/31/99

On:  Friday, 3/2/01, at 5:34pm ET   ·   For:  12/31/99   ·   Accession #:  926274-1-130   ·   File #:  0-22880

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 3/02/01  Fidelity Federal Bancorp          10KT405/A  12/31/99    2:228K                                   Bembenek Consulting/FA

Amendment to Annual-Transition Report — [x] Reg. S-K Item 405   —   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10KT405/A   Amendment to Annual-Transition Report -- [x] Reg.     79    402K 
                          S-K Item 405                                           
 2: EX-21       Subsidiaries of the Registrant                         1      4K 


10KT405/A   —   Amendment to Annual-Transition Report — [x] Reg. S-K Item 405
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
3Item 1. Business
10Item 2. Properties
"Item 3. Legal Proceedings
"Item 4. Submission of Matters to A Vote of Security Holders
11Item 5
13Item 6. Selected Financial Data
14Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
"Item 7A. Quantitative and Qualitative Disclosures About Market Risk
"Management's Discussion and Analysis of Results of Operations and Financial Condition
25Year 2000
28Non-Performing Loans
30Allowance for Loan Losses
41Item 8. Financial Statements and Supplementary Data
76Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures
"Item 10
"Item 10. Directors and Executive Officers of the Registrant
"Item 11. Executive Compensation
"Item 12. Security Ownership of Certain Beneficial Owners and Management
"Item 13. Certain Relationships and Related Transactions
77Item 14
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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------------- FORM 10-K/A [ ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (fee required) For the fiscal year ended: _____________ or [X] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (no fee required) For the Transition period from July 1, 1999 to December 31, 1999. --------------------------------- Commission File No. 0-22880 Fidelity Federal Bancorp ------------------------------------------------------ (Exact name of registrant as specified in its charter) Indiana 35-1894432 ------------------------------------------------------------------------------ (State of other jurisdiction (I.R.S. Employer of Incorporation or Identification No.) Organization) 700 S. Green River Road, Suite 2000, PO Box 5584, Evansville, Indiana 47715 --------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's Telephone number, including area code (812) 469-2100 -------------- Securities registered pursuant to Section 12 (b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock, $1 Stated Value ----------------------------- (Title of Class) DOCUMENTS INCORPORATED BY REFERENCE Exhibit index is on page 79 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of Registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the Registrant (for purposes of such calculation, includes persons who are not directors, executive officers, or holders of more than 10% of the registrant's common stock) based on the average bid and asked prices of such stock at February 29, 2000 was approximately $6,892,772. Indicated below is the number of shares outstanding of each of the registrant's classes of common stock as of February 29, 2000. Common Stock - 3,147,662 shares
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FIDELITY FEDERAL BANCORP Index PART I Page ---- ITEM 1 - Business 3 ITEM 2 - Properties 10 ITEM 3 - Legal Proceedings 10 ITEM 4 - Submission of Matters to a Vote of Security Holders 10 PART II ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters 11 ITEM 6 - Selected Financial Data 13 ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 14 ITEM 7 A Quantitative and Qualitative Disclosures About Market Risk 14 ITEM 8 - Financial Statements and Supplementary Data Report of Independent Auditors 41 Consolidated Balance Sheet 42 Consolidated Statement of Income 43 Consolidated Statement of Stockholders' Equity 45 Consolidated Statement of Cash Flows 46 Notes to Consolidated Financial Statements 48 ITEM 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 76 PART III ITEM 10 - Directors and Executive Officers of the Registrant 76 ITEM 11 - Executive Compensation 76 ITEM 12 - Security Ownership of Certain Beneficial Owners and Management 76 ITEM 13 - Certain Relationships and Related Transactions 76 PART IV ITEM 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K 77 SIGNATURES 78 2
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PART I ITEM 1. BUSINESS Special Note Regarding Forward-Looking Statements Certain matters discussed in this Annual Report on Form 10-K are "forward-looking statements" intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as Fidelity Federal Bancorp ("Fidelity") "believes", "anticipates", "expects", "estimates" or words of similar import. Similarly, statements that describe Fidelity's future plans, objectives or goals are also forward-looking statements. Such forward-looking statements are subject to certain risks and uncertainties which are described in close proximity to such statements and which could cause actual results to differ materially from those anticipated as of the date of this report. Shareholders, potential investors and other readers are urged to consider these factors in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included herein are only made as of the date of this report and Fidelity undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Overview Fidelity Federal Bancorp, incorporated in 1993 under the laws of the State of Indiana, is a registered savings and loan holding company with its principal office in Evansville, Indiana. Fidelity's savings bank subsidiary, United Fidelity Bank, fsb ("United"), was organized in 1914 and is a federally-chartered stock savings bank located in Evansville, Indiana. Fidelity, through its savings bank subsidiary, is engaged in the business of obtaining funds in the form of savings deposits and other borrowings and investing such funds in consumer, commercial, and mortgage loans, and in investment and money market securities. In December, 1999, Fidelity's Board of Directors voted to change Fidelity's fiscal year end from June 30 to December 31. Accordingly, the following discussion analyzes the results of operations for the six months ended December 31, 1999 compared to the twelve months ended June 30, 1999 and the financial position as of December 31, 1999 to the financial position as of June 30, 1999. Fluctuations in the results of operations are significant in part because there are two quarters less in the period ended December 31, 1999 compared to fiscal 1999. All references to percentage changes in income or expense items for the period ended December 31, 1999 have been annualized. Fidelity has engaged in the business of owning, renting and managing affordable housing projects through its wholly-owned subsidiaries, Village Management Corporation and Village Housing Corporation (collectively, the "Affordable Housing Group"). Fidelity has been engaged in affordable housing activities since September, 1992 through United, and since April, 1994, through Village Capital Corporation ("VCC"). The December 31, 1999 audited financial statements include condensed financial information about both of Fidelity's business segments. Another subsidiary of United, Village Insurance Corporation, receives fee income for credit life and accident health insurance sales to United's loan customers. A second subsidiary of Fidelity, Village Affordable Housing Corporation, was formed in fiscal 1998. This company was formed to hold an interest in a housing partnership that was initially financed by United, which was subsequently charged off and transferred to Village Housing Corporation. A third subsidiary of Fidelity, Village Securities Corporation, is currently inactive. Fidelity had consolidated total assets of $171.5 million and total shareholders' equity of $5.4 million as of December 31, 1999. 3
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Fidelity's subsidiaries at December 31, 1999, are listed below: [Enlarge/Download Table] Subsidiary Principal Office Year Organized Assets (in thousands) 1. United Fidelity Bank, fsb Evansville, IN 1914 $168,746 Subsidiaries of United Fidelity Bank, fsb: Village Capital Corporation Evansville, IN 1994 777 Village Insurance Corporation Evansville, IN 1980 88 Village Management Corporation Evansville, IN 1992 259 Village Housing Corporation Evansville, IN 1992 2,572 2. Village Affordable Housing Corporation Evansville, IN 1998 36 3. Village Securities Corporation Evansville, IN 1994 85 Fidelity's home office is located at 700 S. Green River Road, Suite 2000, Evansville, Indiana, 47715 and its telephone number is (812) 469-2100. Competition Fidelity and United face strong direct competition for deposits, loans and other financial-related services. United competes in Indiana, Kentucky and Illinois with other thrifts, commercial banks, credit unions, stockbrokers, finance companies and insurance companies. Some of these competitors are local, while others are statewide or national. United competes for deposits principally by offering depositors a variety of deposit programs, convenient office locations, hours and other services, and for loan originations primarily through competitive interest rates and fees, the efficiency and quality of service provided and the variety of loan products offered. Some of the non-bank financial institutions and financial services organizations with which United competes are not subject to the same degree of regulation as that imposed on federal savings banks, thrifts, or thrift-holding companies. As a result, such competitors may have advantages over United in providing certain services. As of February 29, 2000, approximately 4 banks, 3 thrifts, and 11 credit unions operated in the Evansville, Indiana metropolitan area, which is United's principal deposit market area. Currently one of the local banks has reached an agreement to acquire another local thrift, subject to regulatory and shareholder approval. Completion of this transaction would make United the largest thrift in this market. Many competitors are substantially larger or have significantly greater capital resources than United. Due to recently enacted legislation to allow unlimited interstate branching, Fidelity and United may experience heightened competition from existing competitors and other major financial institutions seeking to expand their regional banking presence in Indiana. Fidelity has discontinued development activities pertaining to the affordable housing industry and multifamily development in part because of increased levels of competition, and significant losses taken in the most recent three years. SUPERVISION AND REGULATION In addition to the general provisions discussed below, Fidelity and United are also subject to the provisions of the Supervisory Agreement entered into with the OTS in February 1999, which also impacts the operations of Fidelity and United. See the "Other Restrictions" footnote in Fidelity's Notes to Consolidated Financial Statements. Regulation of Fidelity Fidelity is a savings and loan holding company within the meaning of the Home Owners' Loan Act of 1933 ("HOLA"), as amended. Fidelity is registered with the Office of Thrift Supervision ("OTS") and is subject to OTS regulations, examinations, supervision and reporting requirements. As a subsidiary of a savings and loan holding company, United is subject to certain restrictions in its dealings with Fidelity and with other companies affiliated with Fidelity. The HOLA generally prohibits a savings and loan holding company, without prior approval of the Director of the OTS, from (i) acquiring control of, or controlling the assets of, any other savings association or savings and loan holding company; or (ii) acquiring or retaining more than 5% of the voting shares of a savings association or savings and loan holding company which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may 4
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acquire control of any savings association, other than a subsidiary association, or any other savings and loan holding company. Fidelity operates as a unitary savings and loan holding company. There are generally no restrictions on the activities of a unitary savings and loan holding company. However, if the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness, or stability of its subsidiary savings association, the Director of the OTS may impose such restrictions as deemed necessary to address such risk and limit (i) payment of dividends by the savings association, (ii) transactions between the savings association and its affiliates, and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the above rules as to permissible business activities of unitary savings and loan holding companies, if the savings association subsidiary of such a holding company fails to meet the Qualified Thrift Lender Test ("QTL test"), as discussed below, then such unitary holding company would become subject to the activities restrictions applicable to multiple savings and loan holding companies. Additional restrictions on the savings association's ability to obtain advances from the FHLB also apply. If Fidelity were to acquire control of another savings association, other than through merger or other business combinations with United, Fidelity would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority of the regulatory agencies to approve emergency thrift acquisitions and where each subsidiary savings association meets the QTL test, the activities of Fidelity and any of its subsidiaries (other than United or other subsidiary savings associations) would thereafter be subject to further restrictions. The HOLA provides that, among other things, no multiple savings and loan holding company or subsidiary thereof which is not a savings association shall commence or continue for a limited period of time after becoming a multiple savings and loan holding company or subsidiary thereof, any business activity other than (i) furnishing or performing management services for a subsidiary savings association, (ii) conducting an insurance agency or escrow business, (iii) holding, managing or liquidating assets owned by or acquired from a subsidiary savings association, (iv) holding or managing properties used or occupied by a subsidiary savings association, (v) acting as trustee under deeds of trust, (vi) those activities previously directly authorized by regulation as of March 5, 1987, to be engaged in by multiple savings and loan holding companies, or (vii) those activities authorized by regulation of the Board of Governors of the Federal Reserve System as permissible for bank holding companies, unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies. Those activities described in (vii) above must also be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company. The Director of the OTS may also approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings associations in more than one state, if the multiple savings and loan holding company involved controls a savings association which operated a home or branch office in the state of the association to be acquired as of March 5, 1987, or if the laws of the state in which the association to be acquired is located specifically permit associations to be acquired by state-chartered associations or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings associations). The Director of the OTS may also approve an acquisition resulting in a multiple savings and loan holding company controlling savings associations in more than one state in the case of certain emergency thrift acquisitions. Indiana law permits federal and state savings association holding companies with their home offices located outside of Indiana to acquire savings associations whose home offices are located in Indiana and savings and loan holding companies with their principal place of business in Indiana ("Indiana Savings and Loan Holding Companies") upon receipt of approval by the Indiana Department of Financial Institutions. Moreover, Indiana Savings and Loan Holding Companies may acquire savings associations with their home offices located outside of Indiana and savings association holding companies with their principal place of business located outside of Indiana upon receipt of approval by the Indiana Department of Financial Institutions. Subject to certain exceptions, commonly controlled banks and savings associations must reimburse the Federal Deposit Insurance Corporation ("FDIC") for any losses suffered in connection with a failed bank or savings association affiliate. Institutions are commonly controlled if one is owned by another or if both are owned by the same holding company. Such claims by the FDIC under this provision are subordinate to claims of depositors, secured creditors, and holders of subordinated debt, other than affiliates. Savings Bank Regulation General. As a federally chartered, SAIF-insured savings association, United is subject to extensive regulation by the OTS and the FDIC. The OTS periodically examines the books and records of United and, in conjunction with the FDIC in certain situations, has examination and enforcement powers. This supervision and regulation are intended primarily for the protection of depositors and federal deposit insurance funds. 5
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In addition, its activities and operations are subject to a number of additional detailed, complex and sometimes overlapping federal and state laws and regulations. These include state usury and consumer credit laws, state laws relating to fiduciaries, the Federal Truth-In-Lending Act and Regulation Z, the Federal Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Community Reinvestment Act, anti-redlining legislation and antitrust laws. The earnings of financial institutions are also affected by general economic conditions and prevailing interest rates, both domestic and foreign and by the monetary and fiscal policies of the United States Government and its various agencies, particularly the Federal Reserve. Additional legislation and administrative actions affecting the banking industry is often considered by Congress, state legislatures and various regulatory agencies. It cannot be predicted with certainty whether such legislation or administrative action will be enacted or the extent to which the banking industry in general or Fidelity and United in particular would be affected. Financial Modernization Legislation: The Gramm Leach Bliley Act. On November 12, 1999, the President signed the Gramm-Leach-Bliley Act into law. Effective as of March 11, 2000, the Gramm-Leach-Bliley Act: - allows bank holding companies meeting management, capital and CRA standards to engage in a substantially broader range of nonbanking activities than was previously permissible, including insurance underwriting and agency, and underwriting and making merchant banking investments in commercial and financial companies; - allows insurers and other financial services companies to acquire banks and thrifts; - removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies and; - establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. In order for a bank holding company to engage in the broader range of activities that are permitted by the Gramm-Leach-Bliley Act, (1) all of its depository institutions must be well capitalized and well managed and (2) it must file a declaration with the Federal Reserve Broad that it elects to be a "financial holding company". In addition, to commence any new activity permitted by the Gramm-Leach-Bliley Act, each insured depository institution of the financial holding company must have received at least a "satisfactory" rating in its most recent examination under the Community Reinvestment Act. The Gramm-Leach-Bliley Act also modified laws related to financial privacy and community reinvestment. The new financial privacy provisions generally prohibit financial institutions, including United, from disclosing nonpublic personal financial information to third parties unless customer have the opportunity to "opt out" of the disclosure. Regulations governing the privacy requirements of the Act have been proposed. Until the final rules have been issued, it is difficult to determine the impact of the regulations on the activities of United. Qualified Thrift Lender Requirement. In order for United to exercise the powers granted to federally-chartered savings associations and maintain full access to FHLB advances, it must be a "qualified thrift lender" ("QTL"). A savings association is a QTL if its qualified thrift investments equal or exceed 65% of the savings association's portfolio assets on a monthly basis in 9 out of every 12 months. Qualified thrift investments generally consist of (i) various housing related loans and investments (such as residential construction and mortgage loans, home improvement loans, manufactured housing loans, home equity loans and mortgage-backed securities), (ii) certain obligations of the FSLIC, the FDIC, the FSLIC Resolution Fund and the Resolution Trust Corporation (for limited periods), and (iii) shares of stock issued by any Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Association. At December 31, 1999, the qualified thrift investment percentage test for United was 86.75%. Liquidity. Under applicable federal regulations, savings associations are required to maintain an average daily balance of liquid assets (including cash, certain time deposits, certain banker's acceptances, certain corporate debt securities and highly rated commercial paper, securities of certain mutual funds and specified United States government, state or federal agency obligations) of not less than 4% of the average daily balance of the savings association's net withdrawable deposits plus short-term borrowing during the preceding calendar month. Under HOLA, this liquidity requirement may be changed from time to time by the Director of the OTS to any amount within the range of 4% to 10%, depending upon economic conditions and the deposit flows of member associations. At December 31, 1999, United was in compliance with these liquidity requirements. Loans-to-One-Borrower Limitations. HOLA generally requires savings associations to comply with the loans-to-one-borrower limitations applicable to national banks. In general, national banks may make loans to one borrower in amounts up to 15% 6
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of the bank's unimpaired capital and surplus, plus an additional 10% of capital and surplus for loans secured by readily marketable collateral. At December 31, 1999, United's loan-to-one-borrower limitation was approximately $3 million and no loans to a single borrower exceeded that amount, except as provided herein. Under certain conditions, a savings association may make loans to one borrower for residential housing developments in amounts up to 30% of the bank's unimpaired capital and surplus provided that all loans made in reliance upon the increased lending limit do not, in the aggregate, exceed 150% of the bank's unimpaired capital and surplus. At December 31, 1999, United had made 6.1 million in such loans under this higher lending limit. Commercial Real Property Loans. HOLA limits the aggregate amount of commercial real estate loans that a federal savings association may make to an amount not in excess of 400% of the savings association's capital. Limitation on Capital Distributions. The OTS regulations impose limitations on capital distributions by savings associations. Under the rule, a savings association is classified as a tier 1 institution, a tier 2 institution, or a tier 3 institution, depending on its level of regulatory capital both before and after giving effect to a proposed capital distribution. A tier 1 institution may generally make capital distributions in any calendar year up to 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (i.e., the percentage by which the association's capital-to-assets ratio exceeds the ratio of its capital requirements to its assets) at the beginning of the calendar year. No regulatory approval of the capital distribution is required, but prior notice must be given to the OTS. Restrictions exist on the ability of tier 2 and tier 3 institutions to make capital distributions. Also, the OTS may prohibit any capital distribution otherwise permitted if such distribution would constitute an unsafe or unsound practice, such as a proposed distribution by an institution whose capital is decreasing because of substantial losses or by an institution that is in need of more than normal supervision. Insurance of Deposits. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of banks and thrifts and safeguards the safety and soundness of the banking and thrift industries. The FDIC administers two separate insurance funds, the Bank Insurance Fund (the "BIF") for commercial banks and state savings banks and the SAIF for savings associations such as United. The FDIC is required to maintain designated levels of reserves in each fund. The FDIC is authorized to establish separate annual assessment rates for deposit insurance for members of the BIF and members of the SAIF. The FDIC may increase assessment rates for either fund if necessary to restore the fund's ratio of reserves to insured deposits to the target level within a reasonable time and may decrease these rates if the target level has been met. The FDIC has established a risk-based assessment system for both SAIF and BIF members. Under this system, assessments vary depending on the risk the institution poses to its deposit insurance fund. An institution's risk level is determined based on its capital level and the FDIC's level of supervisory concern about the institution. Annual deposit insurance premiums range between $0.00 and $0.27 per $100 of deposits are in effect, based on the assessment determined in accordance with the risk-assessment system discussed above. With respect to the funding of the obligations issued by the federally-chartered corporation ("FICO") which provided some of the financing to resolve the thrift crisis in the 1980's, BIF institutions pay approximately 20% of the rate paid by SAIF institutions on their deposits. After December 31, 1999, both BIF and SAIF institutions will be assessed at the same rate for FICO payments. Community Reinvestment Act. Ratings of depository institutions under the Community Reinvestment Act of 1977 ("CRA") must be disclosed. The disclosure includes both a four-tier descriptive rating using terms such as "outstanding," "satisfactory," "needs to improve," or "substantial non-compliance" and a written evaluation of each institution's performance. United received a satisfactory rating from the OTS in its most recent CRA examination. Also, the Federal Housing Finance Board has adopted regulations establishing standards of community investment and service for members of the FHLB System to meet to be eligible for long-term advances. These regulations take into account a savings association's CRA record and the member's record of lending to first-time home buyers. Brokered Deposits. Pursuant to the FDIC regulations, well-capitalized institutions are subject to no brokered deposits limitations, while adequately capitalized institutions are able to accept, renew or rollover brokered deposit only (i) with a waiver from the FDIC, and (ii) subject to certain restrictions on payment of rates. Undercapitalized institutions are not permitted to accept brokered deposits and may not solicit deposits by offering an effective yield that significantly exceeds the prevailing effective yields on insured deposits of comparable maturity in the institution's normal market area or in which such deposits are being solicited. Enforcement. The OTS has primary enforcement responsibility over savings associations and has the authority to bring enforcement action against 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. Civil penalties cover a wide range of violations and actions and range up to $25,000 per day unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. In addition, regulators are provided with far greater 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 the 7
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imposition of a capital directive to receivership, conservatorship or the termination of deposit insurance. The FDIC has the authority to recommend to the Director of OTS that 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. Standards for Safety and Soundness. The federal banking agencies have prescribed for all insured depository institutions safety and soundness standards in the form of guidelines, relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset quality and growth, earnings, and compensation, fees and benefits. If an insured depository institution fails to meet any of the standards described above, it will be required to submit to the appropriate federal banking agency a plan specifying the steps that will be taken to cure the deficiency. If an institution fails to submit an acceptable plan or fails to implement the plan, the appropriate federal banking agency will issue an order requiring the institution to take immediate steps to correct a safety and soundness deficiency. Real Estate Lending Standards. OTS regulations require savings associations to establish and maintain written internal real estate lending policies. Each association's lending policies must be consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its operations. The policies must establish loan portfolio diversification standards; establish prudent underwriting standards, including loan-to-value limits that are clear and measurable; establish loan administration procedures for the association's real estate portfolio; and establish documentation, approval, and reporting requirements to monitor compliance with the association's real estate lending policies. The association's written real estate lending policies must be reviewed and approved by the association's Board of Directors at least annually. Further, each association is expected to monitor conditions in its real estate market to ensure that its lending policies continue to be appropriate for current market conditions. Prompt Corrective Regulatory Action. The Federal Deposit Insurance Act ("FDI Act") establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the banking regulators are required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. Under the OTS prompt corrective action regulation, generally, a savings association that has a total risk-based capital of less than 8.0% or a tier 1 risk-based capital ratio or leverage ratio of less than 4.0% is considered to be undercapitalized. A savings association that has a total risk-based capital of less than 6.0%, a tier 1 risk-based capital ratio of less than 3%, or a leverage ratio that is less than 3.0% is considered to be "significantly undercapitalized" and a savings association that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Generally, a capital restoration plan must be filed with the OTS within 45 days of the date an association receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the associations, including, but not limited to, restrictions on growth, investment activities, capital distributions, and affiliate transactions. The OTS could 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. Capital Requirements. The Director of the OTS has adopted capital standards under which savings associations must maintain (i) "core capital" in an amount not less than 3% of total adjusted assets for a savings association with a composite rating of 1, and not less than 4% for all other savings associations, (ii) "tangible capital" in an amount not less than 1.5% of total adjusted assets, and (iii) a level of risk-based capital equal to 8.0% of risk-weighted assets. Under OTS regulations "core capital" includes common stockholders' equity, noncumulative perpetual preferred stock and related surplus, and minority interests in the equity accounts of consolidated subsidiaries, less nonqualifying intangible assets. In determining compliance with the capital standards, a savings association must deduct from capital its entire investment in and loans to any subsidiary engaged in activities not permissible for a national bank, other than subsidiaries (i) engaged in such non-permissible activities solely as agent for their customers; (ii) engaged in mortgage banking activities; or (iii) that are themselves savings associations or companies, the only investment of which is another savings association, acquired prior to May 1, 1989. In determining total risk-weighted assets for purposes of the risk-based requirement, (i) each off-balance sheet asset must be converted to its on-balance sheet credit equivalent by multiplying the face amount of each such item by a credit conversion factor ranging from 0% to 100% (depending upon the nature of the asset), (ii) the credit equivalent amount of each off-balance sheet asset and the book value of each on-balance sheet asset must be multiplied by a risk factor ranging from 0% to 100% (again depending upon the nature of the asset), and (iii) the resulting amounts are added together and constitute total risk-weighted assets. Total capital, for purposes of the risk-based requirement, equals the sum of core capital plus supplementary capital (which, as defined, includes, among other items, perpetual preferred stock not counted as core capital, limited life preferred stock, subordinated debt and general loan and lease loss allowances up to 1.25% of risk-weighted assets, less certain deductions). The amount of supplementary capital that may be counted towards satisfaction of the total capital requirement may not exceed 100% of core capital. 8
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Capital requirements higher than the generally applicable minimum requirement may be established for a particular savings association if the OTS determines that the association's capital was or may become inadequate in view of its particular circumstances. Individual minimum capital requirements may be appropriate where the savings association is receiving special supervisory attention, has a high degree of exposure to interest rate risk, or poses other safety or soundness concerns. In determining compliance with the risk-based capital requirements, a savings association must determine its interest rate risk and, if such risk exceeds a certain level, it must deduct an interest rate risk component in calculating its total capital for purposes of determining whether it meets its risk-based capital requirements. An association's interest rate risk (IRR) is measured by the decline in the net portfolio value (NPV) resulting from a 200 basis point increase or decrease in market interest rates, divided by the estimated economic value of its assets. If an association's measured IRR exposure exceeds 2%, it must then deduct an IRR component from total capital for determining its risk-based capital requirement. The IRR component is an amount equal to one-half the difference between its measured interest rate risk and 2%, multiplied by the estimated economic value of its total assets. The Savings Bank's Subsidiaries. The OTS regulations permit federal savings associations to invest in the capital stock, obligations or specified types of securities of subsidiaries (referred to as "service corporations") and to make loans to such subsidiaries and joint ventures in which such subsidiaries are participants in an aggregate amount not exceeding 3% of an association's assets, provided any investment over 2% is used for specified community or inner-city development purposes. In addition, federal regulations permit associations to make specified types of loans to such subsidiaries in an aggregate amount not exceeding 50% of the association's regulatory capital if certain requirements and conditions are met. The FDIC may, after consultation with the OTS, prohibit specific activities if it determines such activities pose a serious threat to SAIF. Assessments. Savings associations are required by OTS regulation to pay assessments to the OTS to fund the operations of the OTS. The general assessment is computed upon the savings association's total assets, including consolidated subsidiaries, as reported in the Saving Bank's latest quarterly Thrift Financial Report. United's total assessment for the six months ended December 31, 1999 was $35,000. Acquisitions and Branching The Bank Holding Company Act specifically authorizes a bank holding company, upon receipt of appropriate regulatory approvals, to acquire control of any savings association or holding company thereof wherever located. Similarly, a savings and loan holding company may acquire control of a bank. Moreover, federal savings associations may acquire or be acquired by any insured depository institution. Regulations promulgated by the Federal Reserve Board restrict the branching authority of savings associations acquired by bank holding companies. Savings associations acquired by bank holding companies may be converted to banks if they continue to pay SAIF premiums, but as such they become subject to branching and activity restrictions applicable to banks. The OTS has adopted regulations which permit nationwide branching to the extent permitted by federal statute. Federal statutes permit federal savings associations to branch outside of their home state if the association meets the domestic building and loan test in ss.7701(a)(19) of the Internal Revenue Code or the asset composition test of ss.7701(c) of the Internal Revenue Code. Branching that would result in the formation of a multiple savings and loan holding company controlling savings associations in more than one state is permitted if the law of the state in which the savings association to be acquired is located specifically authorizes acquisitions of its state-chartered associations by state-chartered associations or their holding companies in the state where the acquiring association or holding company is located. Moreover, Indiana banks and savings associations are permitted to acquire other Indiana banks and savings associations and to establish branches throughout Indiana. Transactions with Affiliates Pursuant to HOLA, transactions engaged in by a savings association or one of its subsidiaries with affiliates of the savings association generally are subject to the affiliate transaction restrictions contained in Sections 23A and 23B of the Federal Reserve Act in the same manner and to the same extent as such restrictions now apply to transactions engaged in by a member bank or one of its subsidiaries with affiliates of the member bank. Section 23A of the Federal Reserve Act imposes both quantitative and qualitative restrictions on transactions engaged in by a member bank or one of its subsidiaries with an affiliate, while Section 23B of the Federal Reserve Act requires, among other things, that all transactions with affiliates be on terms substantially the same, and at least as favorable to the member bank or its subsidiary, as the terms that would apply to or would be offered in a comparable transaction with an unaffiliated party. Section 22(h) of the Federal Reserve Act imposes restrictions on loans to executive officers, directors, and principal shareholders. Further, the Federal Reserve Board pursuant to Section 22(h) requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons. United was in compliance with these rules at December 31, 1999. 9
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Federal Home Loan Bank System United is a member of the Federal Home Loan Bank of Indianapolis. The Federal Home Loan Bank System consists of 12 regional Federal Home Loan Banks ("FHLBs"), each subject to supervision and regulation by the Federal Housing Finance Board (the "FHFB"). The FHLBs provide a central credit facility for member savings associations. As a member of the FHLB of Indianapolis, United is required to own shares of capital stock in the FHLB in an amount at least equal to 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 (borrowings) from the FHLB, whichever is greater. As of December 31, 1999, United was in compliance with this requirement. Personnel As of December 31, 1999 Fidelity had 90 full-time equivalent employees. The employees are not represented by any collective bargaining unit. Fidelity believes its relations with its employees are good. Fidelity maintains group life, hospital, surgical, dental, major medical, and long-term disability programs for full-time employees. Fidelity also participates in a defined benefit pension plan covering all eligible employees, as well as a defined contribution 401(k) plan. ITEM 2. PROPERTIES The following table sets forth the location of Fidelity's savings bank offices, all of which are owned by United, as well as certain additional information relating to these offices as of December 31, 1999. ------------------------------------------------------------------------ Office Location Year Facility Opened Net Book Value ------------------------------------------------------------------------ Home Office 1974 $993,000 18 NW Fourth Street Evansville, IN 47708 ------------------------------------------------------------------------ Eastside Branch 1997 1,901,000 700 S. Green River Rd Evansville, IN 47715 ------------------------------------------------------------------------ Northside Branch 1976 92,000 4441 First Avenue Evansville, IN 47710 ------------------------------------------------------------------------ Westside Branch 1979 91,000 4801 W. Lloyd Expressway Evansville, IN 47712 ------------------------------------------------------------------------ Fidelity and the other non-bank subsidiaries use the premises of United's Home Office and 2nd floor of the Eastside Branch for their office and equipment needs and pay rent for such use. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Registrant's business, to which the Registrant or its subsidiaries is a party or of which any of their property is the subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On December 22, 1999, at 8:30 AM, at Fidelity's subsidiary downtown offices at 18 N.W. Fourth Street, Evansville, Indiana, the Annual meeting of Shareholders was held in order to vote on two matters. Matter 1 was to elect one director to the Board of Directors to serve for the ensuing term of three years and until his successor is duly elected and qualified. The vote tabulation for the election of Jack Cunningham was 1,854,904 for and 227,152 shares against. The following directors terms continued after the meeting; Curt J. Angermeier, William Baugh, Bruce Cordingley (until his subsequent resignation from the Board on December 27, 1999), Jack Cunningham, M. Brian Davis, Donald R. Neel and Barry A. Schnakenburg. 10
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Matter 2 was the ratification of the appointment of the auditor of Fidelity. The vote tabulation for Olive LLP was 1,866,085 for, 212,798 shares against, and 3,166 shares abstained. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS Fidelity Federal Bancorp's common stock is traded on the NASDAQ National Market System under the symbol FFED. The following table sets forth, for the periods indicated, the high and low bid prices per share as reported by NASDAQ. The bid prices represent prices between dealers, do not include retail mark-up, mark-down, or commissions and may not represent actual transactions. [Enlarge/Download Table] Six Months Ended Year Ended December 31, 1999 June 30, 1999 --------------------------------------------------------------- Common Stock Bid Prices Common Stock Bid Prices --------------------------------------------------------------- High Low High Low -------------------------------------------------------------------------------------- First quarter $3 1/16 $2 5/8 $ 6 1/2 $3 1/2 Second quarter 2 7/8 1 1/4 5 3 1/4 Third quarter N/A N/A 4 2 1/2 Fourth quarter N/A N/A 3 7/8 2 3/4 Fidelity declared no dividends during the six months ended December 31, 1999 and fiscal 1999 compared to $.35 per share for 1998. Fidelity's principal source of income and funds is dividends from its savings bank subsidiary (United) which currently is subject to dividend restrictions. Unlike United, Fidelity is not subject to any regulatory restriction on future dividends. Fidelity's dividend policy is to pay cash or distribute stock dividends when the Board of Directors deems it to be appropriate, taking into account Fidelity's financial condition and results of operations, economic and market conditions, industry standards, and other factors, including regulatory capital requirements of its savings bank subsidiary. United will not pay any dividends in the immediate future without regulatory approval. Refer to the "Other Restrictions" footnote in Fidelity's consolidated financial statements for further details. United is uncertain when it will pay dividends in the future and the amount of such dividends, if any. Fidelity anticipates that it will not pay any dividends in the foreseeable future. There were 499 stockholders of record as of February 29, 2000. 11
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES CORPORATE INFORMATION [Enlarge/Download Table] Toll-Free Shareholder Inquiries: 1-800-280-8280 Common Stock Information If you have inquiries or questions regarding your NASDAQ Fidelity Federal Bancorp Shareholder account, call Ticker Symbol: FFED shareholder relations at 1-800-280-8280 or 812-469-2100, Ext. 2226. Market Makers as of March 29, 2000 Stock Transfers, Dividend Payments and Natcity Investments, Inc. Dividend Reinvestment Fleet Trading, a Division of Fleet Securities Fidelity Federal Bancorp Spear, Leeds & Kellogg Attn: Shareholder Relations 700 S. Green River Road, Suite 2000 Products and Services PO Box 5584 For specific information on products and Evansville, IN 47716-5584 Services offered by Fidelity's banking subsidiary, United Fidelity Bank, fsb, call 1-800-280-8280 or Fidelity Federal Bancorp offers its common stock (812) 424-0921. For specific information on any shareholders a no-cost way in which to reinvest of the Village Housing affordable housing developments, cash dividends. For additional information about this contact Village Management Corporation plan, contact us at the above address or phone number. (812) 469-2100, Ext. 2250 Financial Information Corporate Headquarters If you are seeking financial information, contact: Fidelity Federal Bancorp 700 S. Green River Road, Suite 2000 Mark A. Isaac, Vice President and Controller PO Box 5584 Fidelity Federal Bancorp Evansville, IN 47716-5584 18 NW Fourth Street 1-800-280-8280 PO Box 1347 812-469-2100 Evansville, IN 47706-1347 812-429-0550, Ext. 3319 Internet All other requests, including requests for the Annual Information on Fidelity Federal Bancorp is available Reort,Form 10-K, and Form 10-Q, should be on the Internet at: http://www.ufb-ffed.com directed to: Shareholder Relations Fidelity Federal Bancorp 700 S. Green River Road, Suite 2000 PO Box 5584 Evansville, IN 47716-5584 812-469-2100, Ext. 2226 12
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ITEM 6. SELECTED FINANCIAL DATA FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Selected Statistical Information (Dollars in Thousands, Except Share and Per Share Data) [Enlarge/Download Table] As of and for the six months ended As of and for the years ended --------------------------------------------------------------------------------------------------------------------------------- December 31, June 30, June 30, June 30, June 30, 1999 1999 1998 1997 1996 --------------------------------------------------------------------------------------------------------------------------------- Selected Financial Data Total assets $ 171,457 $ 172,253 $ 197,046 $ 240,819 $ 262,216 Interest-bearing deposits 22,911 14,668 6,266 1,765 4,107 Investment securities available for sale 24,305 27,325 9,854 13,790 17,459 Loans, net 96,919 110,436 156,683 203,183 216,162 Deposits 135,016 128,596 148,939 181,787 181,702 Short-term borrowings 89 128 2,531 5,191 5,693 Long-term debt 23,504 29,149 29,488 38,089 57,292 Stockholders' equity 5,427 7,814 7,515 12,936 14,295 Interest income $ 6,019 $ 14,094 $ 17,192 $ 20,282 $ 21,529 Interest expense 4,268 9,730 11,586 13,831 15,525 ---------------------------------------------------------------------- Net interest income 1,751 4,364 5,606 6,451 6,004 Provision for loan losses 1,345 (138) 4,543 975 455 ---------------------------------------------------------------------- Net interest income after provision for loan losses 406 4,502 1,063 5,476 5,549 Non-interest income 1,001 2,663 3,025 3,856 8,180 Non-interest expense 5,148 6,878 16,076 9,474 8,608 ---------------------------------------------------------------------- Income (loss) before income tax (3,741) 287 (11,988) (142) 5,121 Income tax expense (benefit) (1,671) (338) (5,194) (255) 1,886 ---------------------------------------------------------------------- Net income (loss) $ (2,070) $ 625 $ (6,794) $ 113 $ 3,235 ====================================================================== Selected Financial Ratios Return on average assets (2.41)% .33% (3.12)% .04% 1.18% Return on stockholders' equity (51.37) 7.58 (50.68) .83 23.75 Net interest margin 2.24 2.48 2.79 2.72 2.29 Net interest spread 2.05 2.24 2.62 2.57 2.11 Tangible equity to assets at year end 6.78 8.49 6.31 6.93 7.08 Allowance for loan losses to loans 2.04 3.09 1.91 .87 .49 Allowance for loan losses to non-performing loans 179.96 69.57 532.11 624.91 275.06 Dividend payout ratio N/A N/A N/A 1,500.00 67.52 Per Share Data Diluted net income (loss) $ (0.66) $ .20 $ (2.30) $ .04 $ 1.17 Basic net income (loss) (0.66) .20 (2.30) .05 1.32 Cash dividends declared .35 .60 .79 Book value at period end 1.72 2.48 2.40 5.20 5.73 Closing market price (bid) at period end 1.25 2.88 6.50 8.75 11.25 Number of average common and common equivalent shares outstanding 3,147,662 3,143,179 2,956,157 2,655,181 2,776,147 13
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition General Fidelity Federal Bancorp (Fidelity), incorporated in 1993 under the laws of the State of Indiana, is a registered savings and loan holding company with its principal office in Evansville, Indiana. Fidelity's savings bank subsidiary, United Fidelity Bank, fsb (United), was organized in 1914 and is a federally-chartered stock savings bank located in Evansville, Indiana. Fidelity, through its savings bank subsidiary, is engaged in the business of obtaining funds in the form of savings deposits and other borrowings and investing such funds in consumer, commercial, and mortgage loans, and in investment and money market securities. Fidelity has engaged in the business of owning, developing, building, renting and managing affordable housing projects through its wholly-owned subsidiaries, Village Management Corporation and Village Housing Corporation (collectively, the Affordable Housing Group). The Affordable Housing Group has structured and participated in multi-family housing developments which have been granted tax credits pursuant to Section 42 of the Internal Revenue Code of 1986 (Section 42), as amended (Code) and tax-exempt bonds. Village Housing Corporation, as general partner to the limited partnerships which own the developments, receives a percentage interest in the profits, losses and tax credits during the life of the project and receives a percentage of the annual cash flow and residual (sale or refinancing) proceeds during operation and at disposition or refinancing of the developments, respectively. Village Community Development Corporation, (a subsidiary merged into Village Housing Corporation during fiscal 1999) as contractor and developer, received construction and development fees as the projects were completed. As the developments progressed, development fee income was earned contractually on each project. These fees were not recognized as income until the limited partner's equity investment had been received or the syndication firm providing the equity had given a firm commitment to provide the funds. As part of Village Management's duties as project manager, it monitors compliance with the requirements of the Code to prevent recapture of all or a portion of the tax credits or forfeiture of the tax-exempt status of the bonds which would occur if certain tenant eligibility and rent restriction requirements were violated. Village Management Corporation, as manager of the completed project, receives a fee based on a percentage of rental payments received from the project's tenants. Fidelity has been engaged in affordable housing activities since September, 1992, through United, and since April, 1994, through Village Capital Corporation (VCC). Since June 30, 1994, VCC has earned fees by providing real estate mortgage banking services to unaffiliated borrowers. In December, 1999, Fidelity's Board of Directors voted to change Fidelity's fiscal year end from June 30 to December 31. Accordingly, the following discussion analyzes the results of operations for the six months ended December 31, 1999 compared to the twelve months ended June 30, 1999 (fiscal 1999) and the financial position as of December 31, 1999 to the financial position as of June 30, 1999. Fluctuations in the results of operations are significant in part because there are two quarters less in the period ended December 31, 1999 compared to fiscal 1999. All references to percentage changes in income or expense items have been annualized. In 1992, the Board of Directors developed and began implementation of a new business plan for United to improve the financial performance of the organization. The key elements of this business plan included: (i) the formation of a holding company to provide financial flexibility and to develop and engage in non-banking business; (ii) the formation of an affordable housing group to engage in real estate development, management and financing of affordable housing projects; and (iii) the growth of assets through the origination and acquisition of loans. After the implementation of the business plan, the holding company as well as the affordable housing group, consisting of three non-bank subsidiaries of United, was formed. In 1995 and 1996, revenue generated from affordable housing activities increased dramatically and significant asset growth was achieved, also resulting in higher revenues. To conserve capital, Fidelity slowed its growth rate in fiscal 1996 and positioned Fidelity to reduce debt, increase core deposits, sell loans, and use the proceeds to fund new loan production. During 1996, Fidelity encountered increasing competition in the affordable housing group arena. As a result, Fidelity re-evaluated its business plan in fiscal 1997 and closed its Indianapolis, Indiana real estate development office. In 1998, Fidelity's Affordable Housing Group discontinued the development of real estate but continued to actively manage existing Company affordable housing projects. As a result of this, fee income from real estate development and real estate investment banking fees declined significantly. There were no real estate development fees recorded in the six months ending December 31, 1999, fiscal 1999 or 1998. Village Housing Corporation and Village Management Corporation continue to be fully operational at Fidelity's headquarters in Evansville. 14
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Fidelity's results in 1998 included an increase in the provision for loan losses of $3.6 million, a letter of credit valuation provision of $6.8 million, and an additional write-down of its investments in affordable housing projects of $1.5 million. The majority of these charges relate to Fidelity's involvement in the Section 42 tax-credit real estate development program. The additional provision for loan loss and letter of credit valuation provision that was recorded in fiscal 1998 was recorded as a result of Fidelity's position that it was probable that the losses would occur and that the losses could be reasonably estimated. Statement of Financial Accounting Standards No. 5 "Accounting for Contingencies" (SFAS No. 5) requires that both of these conditions must be met before an estimated loss from a loss contingency is recorded. Prior to the third quarter of fiscal 1998, Fidelity had determined that the possibility of loss was "reasonably possible", but could not support that losses were "probable". During the third quarter of fiscal 1998, Fidelity came to the realization that it was probable that assets had been impaired (loans and equity investments) and liabilities had been incurred (the letter of credit reserves). Fidelity came to this realization because an adequate amount of time had passed since the inception of the projects to support Fidelity's realization that the poor performance of several of these projects was likely to continue. This performance was below that which was originally projected for the majority of the projects. Competing projects in several of the communities in which the projects were in operation caused Fidelity to reduce its estimates of future profitability. These projects are not designed to initially have positive cash flow, but the expectation is that they will have positive cash flow after the projects have been active for a certain amount of time. Prior to the third quarter of 1998, Fidelity determined that the reason for the projects not generating positive cash flows was principally due to the recent start-up of the projects. Fidelity was able to support that future improvements in monthly rents, monthly occupancies, expense control, and in some cases financing, would occur. This precluded Fidelity from determining that losses were "probable". The average amount of time that Fidelity's seventeen projects (those projects for which Fidelity's subsidiaries had equity investments) had been fully operational, as of March 31, 1998, was 36 months. While Fidelity has not participated in the development of any new projects that it manages, the performance of a majority of the projects that Fidelity is managing is below that which was originally projected when the projects were formed. This has resulted in lower than expected cash flows, which are needed to support debt repayment. Cash flows of the projects have been affected by a number of items, including lower than expected occupancy and/or rent levels, higher-than-expected expenses and, in certain situations, additional construction costs or delays which resulted in longer start-up periods for the projects. The areas in which many of the projects are located have seen increased competition in affordable housing, which has affected the project's ability to perform at the levels originally projected. Each of the projects are beyond the start-up or construction phase and have been in operation for a sufficient period of time to enable management to conclude that additional provisions and reserves were required. Fidelity's current plans are to not originate, participate or invest in any new or additional Section 42 projects. Fidelity believes that the properties' cash flows will not improve significantly unless a change in the properties' financing or debt structure occurs. It is currently pursuing plans to restructure its Section 42 projects and has been successful on two Section 42 projects during the six months ended December 31, 1999. The availability of such refinancing depends upon numerous factors, including, among other things, interest rates, third-party appraisals and the occupancy levels in the Section 42 projects. During the six months ended December 31, 1999 and fiscal 1999, one of Fidelity's primary goals was to seek refinancing opportunities with other potential financing sources. While this is typically a lengthy process, Fidelity has been successful on reducing its overall level of classified assets. Fidelity's classified assets and letters of credit have decreased $18.5 million to $22.2 million at December 31, 1999 from $40.7 million at June 30, 1999. Fidelity has a number of other credits in process for refinancing to potentially further reduce the classified assets during calendar 2000. However activities are temporarily on hold until interest rates are lower, which will result in a higher level of principal that can be refinanced. The workout effort is anticipated to be a significant portion of the Fidelity and United business plan during calendar 2000. See "Allowance for Loan Losses" and "Classified Assets" for a more detailed discussion. The December 31, 1999 audited financial statements include condensed financial information about both of Fidelity's business segments. The following table details average balances, interest income/expense and average rates/yield for Fidelity's earning assets and interest bearing liabilities for the six months ended December 31, 1999, and years ended June 30, 1999, and 1998. The average rates for the six months ended December 31, 1999 were adjusted to reflect annualized percentages. 15
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Fidelity Federal Bancorp and Subsidiaries Management's Discussion and Analysis of Results of Operations and Financial Condition Average Balance Sheet and Net Interest Analysis (Dollars In Thousands on Fully Taxable Equivalent Basis) [Enlarge/Download Table] December 1999 June 1999 June 1998 Average Average Average Average Average Average Year Ended: Balances Interest Rates Balances Interest Rates Balances Interest Rates ---------------------------------------------------------------------------------------------------------------------------------- Assets Federal funds sold and other short-term money market investments $17,069 $ 454 5.28% $ 18,962 $ 964 5.08% $ 5,533 $ 330 5.96% Investment securities available for sale Taxable 25,857 849 6.51 15,455 955 6.18 10,806 650 6.01 Tax exempt (1) 444 36 8.33 Loans held for sale Federal Home Loan Bank Stock 3,920 158 8.00 3,920 314 8.01 3,920 316 8.06 Loans (2) (3) Commercial loans 5,512 276 9.93 8,055 791 9.82 11,683 1,124 9.62 Multi-family loans 24,525 1,026 8.30 33,918 2,999 8.84 25,573 2,672 10.45 Real estate mortgages 51,414 1,944 7.50 63,980 4,956 7.75 114,335 9,213 8.06 Consumer loans 27,004 1,312 9.64 31,840 3,115 9.78 28,939 2,863 9.89 ----------------------- ------------------------ ----------------------- Total loans 108,455 4,558 8.33 137,793 11,861 8.61 180,530 15,872 8.75 ----------------------- ------------------------ ----------------------- Total earning assets 155,301 6,019 7.69 176,130 14,094 8.00 201,233 17,204 8.55 ---------- ----------- ----------- Allowance for loan losses (2,868) (3,414) (2,538) Cash and due from banks 4,193 2,680 3,018 Premises and equipment 5,747 5,749 6,214 Other assets 8,346 10,426 9,799 ------------- ------------- ------------ Total assets $170,719 $191,571 $217,726 ============= ============= ============ Liabilities Interest-bearing deposits Interest-bearing checking $ 19,107 $ 327 3.39% $ 20,436 $ 716 3.50% $ 22,211 $ 942 4.24% Money market accounts 2,545 26 2.03 2,733 61 2.23 3,027 82 2.71 Savings accounts 4,657 53 2.26 5,082 118 2.32 4,813 136 2.83 Certificates of deposit 96,476 2,745 5.64 112,539 6,572 5.84 128,142 7,625 5.95 ----------------------- ------------------------ ----------------------- Total interest-bearing Deposits 122,785 3,151 5.09 140,790 7,467 5.30 158,193 8,785 5.55 Federal funds purchased 116 7 6.03 Other borrowings 16,505 760 9.13 15,167 1,384 9.13 17,673 1,523 8.62 Federal Home Loan Bank Advances 10,844 357 6.53 13,103 879 6.71 19,253 1,271 6.60 ----------------------- ------------------------ ----------------------- Total interest-bearing liabilities 150,134 4,268 5.64 169,060 9,730 5.76 195,235 11,586 5.93 ---------- ----------- ----------- Non-interest bearing demand Deposits 6,097 5,724 5,229 Advances by borrowers for Taxes and insurance 463 457 596 Other liabilities 6,033 8,079 3,260 ------------- ------------- ------------ Total liabilities 162,727 183,320 204,320 Stockholders' Equity 7,992 8,251 13,406 ------------- ------------- ------------ Total liabilities and Stockholders' equity $170,719 $191,571 $217,726 ============= ============= ============ Recap: (3) Interest income 6,019 7.69% 14,094 8.00% 17,204 8.55% Interest expense 4,268 5.45 9,730 5.52 11,586 5.76 ---------------------- --------------------- --------------------- Net interest income/margin $1,751 2.24% $ 4,364 2.48% $ 5,618 2.79% ====================== ===================== ===================== Interest rate spread (4) 2.05% 2.24% 2.62% Average interest-bearing assets to average interest-bearing liabilities 103.44% 104.18% 103.07% -------------------------------- (1) Tax-exempt securities have been adjusted to a fully tax equipment basis using a marginal tax rate of 34%. (2) Nonaccrual loans have been included in the average balances. (3) Loan income includes interest and fees on loans. (4) Interest rate spread is calculated by subtracting combined weighted average interest rate cost from combined weighted average interest rate earned for the period indicated. 16
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Results of Operations Net Interest Income Net interest income, Fidelity's largest component of income, represents the difference between interest and fees earned on loans, investments and other interest-earning assets, and interest paid on interest-bearing liabilities. It also measures how effectively management has balanced and allocated Fidelity's interest rate-sensitive assets and liabilities. Due to a significant decrease in earning assets, net interest income decreased to $1.8 million for the six months ended December 31, 1999. On an annualized basis this represents a $3.6 million or 18.2% decrease compared to fiscal 1999 net interest income of $4.4 million. The reduction in net interest income during the six months was primarily due to the continued reduction in average earning assets of $20.8 million, which was partially offset by a decrease in average interest-bearing liabilities of $18.9 million. Fidelity's reduction in average earning assets and average interest-bearing liabilities has occurred in fixed rate 1-4 family mortgage loans, multifamily loans and certificates of deposit, primarily agent-acquired deposits. Average real estate mortgage loans have decreased $12.6 million, resulting in a decrease of $1.1 million on an annualized basis in interest income. Average multifamily loans also decreased $9.4 million due to continued workout efforts, which has a negative impact on interest income, resulting in a decrease of $964,000 on an annualized basis. Certificates of deposit and borrowings partially offset this reduction in assets with a decrease of $16.1 million in certificates and $921,000 in borrowings. This resulted in decreased interest expense, on an annualized basis of $1.2 million and $49,000, respectively. Interest income on an annualized basis for the six months ended December 31, 1999 was $11.9 million compared to $14.1 million for the year ended June 30, 1999, a decrease of $2.2 million or about 15.6%. Interest expense on an annualized basis for the year ended December 31, 1999 was $8.5 million compared to $9.7 million for the year ended June 30, 1999, a decrease of $1.2 million or 12.4%. The reduction in average earning assets was attributable to loan payoffs, multifamily loan workout activities for refinancing, and payoffs on conventional real estate mortgage loans. The decrease in commercial and multifamily loans is expected to continue during the time that United operates under the Supervisory Agreement. Please refer to the footnote. "Other Restrictions" in the Notes to Consolidated Financial Statements for further details. The average balance of agent-acquired certificates of deposit, which had an average rate of 6.02% in 1999, was reduced from $33.5 million in fiscal 1999 to $18.1 million for the six months ended December 31, 1999 with an average rate of 5.88%. The net interest margin decreased during the six month period to 2.24% from 2.48% in fiscal 1999. The average yield on interest-earning assets and average rate paid on interest-bearing liabilities of 7.69% and 5.64% declined from last year's average rates of 8.00% and 5.76%. This is expected to be a continuing trend during the term of the Supervisory Agreement between United and the OTS, as certain lending activities are restricted. The reduction in net interest income in the period ended June 30, 1999 compared to June 30, 1998 was primarily due to the continued reduction in average earning assets of $25.1 million, which was partially offset by a decrease in average interest-bearing liabilities of $26.2 million. Fidelity's reduction in average earning assets and average interest-bearing liabilities in fiscal 1999 compared to fiscal 1998 has occurred in fixed rate 1-4 family mortgage loans and certificates of deposit, primarily agent-acquired deposits. Average real estate mortgage loans have decreased $50.4 million, resulting in a decrease of $4.3 million in interest income. Certificates of deposit and borrowings partially offset this reduction in assets with a decrease of $15.6 million in certificates and $8.7 million in borrowings. This resulted in decreased interest expense of $1.1 million and $.5 million, respectively. Interest income for the year ended June 30, 1999 was $14.1 million compared to $17.2 million for the year ended June 30, 1998, a decrease of $3.1 million or about 18.0%. Interest expense for the year ended June 30, 1999 was $9.7 million compared to $11.6 million for the year ended June 30, 1998, a decrease of $1.9 million or 16.4%. The reduction in average earning assets was attributable to payoffs and the sale of several conventional real estate mortgage loans. The average balance of agent-acquired certificates of deposit, which had an average rate of 6.26% in 1998, was reduced from $42.4 million in 1998 to $33.5 million in 1999 with an average rate of 6.02%. 17
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The net interest margin decreased in 1999 to 2.48% from 2.79% in 1998. The average yield on interest-earning assets and average rate paid on interest-bearing liabilities of 8.00% and 5.76% declined from last year's average rates of 8.55% and 5.93%. The decrease in the net interest margin, as previously mentioned, is the result of loan payoffs on fixed rate 1-4 family loans and the sale of new loan production on the secondary market. Commercial loans and higher yielding multi- family loans continue to decrease due to refinancing and payoffs. As such, earnings variability is possible in future periods. Quarterly Results of Operations Fidelity's earnings have experienced some variability from quarter to quarter due to the uncertainty of the timing when certain classified assets, and letters of credit are refinanced, paid off or require additional or reduced provisions or valuation reserves. [Enlarge/Download Table] September 30 December 31 March 31 June 30 Total ----------------------------------------------------------------------------------------------------------------------- (In Thousands) December 31, 1999 Interest income $2,990 $3,029 $6,019 Interest expense 2,085 2,183 4,268 ---------------------------------------------------------------------------------- Net interest income 905 846 1,751 Provision for loan losses 75 1,270 1,345 Non-interest income 488 513 1,001 Non-interest expense 1,302 3,846 5,148 ---------------------------------------------------------------------------------- Income (loss) before income tax 16 (3,757) (3,741) Income tax benefit (88) (1,583) (1,671) ---------------------------------------------------------------------------------- Net income $ 104 $ (2,174) $ (2,070) ================================================================================== Net income per share Diluted net income $.03 $(.69) $(.66) Basic net income .03 (.69) (.66) Cash dividends* June 30, 1999 Interest income $3,883 $3,709 $3,363 $3,139 $14,094 Interest expense 2,618 2,556 2,364 2,192 9,730 ---------------------------------------------------------------------------------- Net interest income 1,265 1,153 999 947 4,364 Provision for loan losses 75 75 (404) 116 (138) Non-interest income 895 738 571 459 2,663 Non-interest expense 1,841 1,788 1,874 1,375 6,878 ---------------------------------------------------------------------------------- Income (loss) before income tax 244 28 100 (85) 287 Income tax benefit (92) (73) (35) (138) (338) ---------------------------------------------------------------------------------- Net income $ 336 $ 101 $ 135 $ 53 $ 625 ================================================================================== Net income per share Diluted net income $.11 $.03 $.04 $.02 $.20 Basic net income .11 .03 .04 .02 .20 Cash dividends* *No cash dividends were paid in the six months ended December 31, 1999 or for fiscal 1999. 18
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Rate/Volume Analysis The following table sets forth an analysis of volume and rate changes in interest income and interest expense of Fidelity's average earning assets and average interest-bearing liabilities. The table distinguishes between the changes related to average outstanding balances of assets and liabilities (changes in volume holding the initial interest rate constant) and the changes related to average interest rates (changes in average rate holding the initial outstanding balance constant). The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. The column labeled, "Change in fiscal year," represents the change in net interest income due to Fidelity changing the fiscal year from June 30 to December 31. [Enlarge/Download Table] December 31, 1999 June 30, 1999 Compared to June 30, 1999 Compared to June 30, 1998 Increase (Decrease) Due To Increase (Decrease) Due To Change in ------------------------------- Volume Rate Fiscal Year Total Volume Rate Total --------------------------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Interest income on average earning assets Loans $(2,525) $(294) $(4,484) ($7,303) $(3,758) $(254) ($4,012) Investment securities 643 86 (835) (106) 243 25 268 Federal Home Loan Bank stock (1) (155) (156) (2) (2) Federal funds sold and other short-term money market investments (96) 33 (447) (510) 801 (167) 634 ------------------------------------------------------------------------------- Total interest income (1,978) (176) (5,921) (8,075) (2,714) (398) (3,112) ------------------------------------------------------------------------------- Interest expense on average interest- bearing liabilities Interest bearing accounts (47) (21) (322) (390) (75) (151) (226) Money market deposit accounts (4) (5) (26) (35) (8) (13) (21) Savings accounts (10) (3) (52) (65) 8 (26) (18) Certificates of deposit (937) (189) (2,700) (3,826) (928) (125) (1,053) Federal funds purchased (7) (7) Other borrowings 122 2 (748) (624) (216) 77 (139) Federal Home Loan Bank advances (152) (19) (351) (522) (406) 14 (392) ------------------------------------------------------------------------------- Total interest expense (1,028) (235) (4,199) (5,462) (1,632) (224) (1,856) ------------------------------------------------------------------------------- Changes in net interest income $ (950) $ 59 $ (1,722) $ (2,613) $(1,082) $(174) $(1,256) =============================================================================== 19
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Provision for Loan Losses and Letter of Credit Reserves Fidelity makes provisions for possible loan losses in amounts estimated to be sufficient to maintain the allowance for loan losses at a level considered necessary by management to absorb losses in the loan portfolios. The provision for loan losses for the six months ending December 31, 1999 was $1.3 million compared to a credit of $138,000 in the prior year, an increase of $1.5 million. During fiscal year ended June 30, 1999, as a result of a reduction in classified and criticized assets and an overall improvement in the operating results of Fidelity's affordable housing portfolio, Fidelity reduced its provision for loan losses and reserve for letters of credit and recognized income of $607,000. The operating results in the affordable housing portfolio deteriorated during the six month period ending December 31, 1999, as discussed below, resulting in significant additional provisions for loan losses of $1.3 million. Additionally, a large hotel loan's operating results deteriorated to the extent that management established a provision of approximately $470,000. The ratio of allowance for loan losses to non performing loans was 180.0% at December 31, 1999 compared to 69.6% at June 30, 1999. The decrease in non-performing loans is due to one large multi-family loan to an unaffiliated borrower that paid off in October 1999. A specific reserve of $510,000 had been previously established for this loan. During fiscal 1998 changes in loan and letter of credit concentrations and terms did not affect the amount of the allowance for loan losses and letter of credit valuation reserve for each period. The primary factor that led Fidelity to determine that additional reserves were required, in 1998, was that enough time had passed since start-up of the projects to more accurately project the future performance of the projects. This changed Fidelity's evaluation of the quality of the applicable projects and its assessment of the quality of those credits which it held in its portfolio. The method used beginning in the third quarter of fiscal 1998 to determine the amount of required reserves for affordable housing industry permanent and general partner loans, equity investments and letters of credit used past monthly cash flows as a determinant as to how much debt service the projects could support. Specifically, the method determined the amount of debt service for fiscal 1998, 1999, and the six months ended December 31, 1999 as follows: 1. Cash flows from the projects were scheduled from internal project records. These were used to project annualized cash flows that were based on periods of time that were considered to be best reflective of future performance of that project. Certain items affecting cash flows during only certain months of the year, such as the payment of real estate taxes, were subtracted from the calculated annualized amounts so that monthly cash flows would be reflective of actual monthly operation. 2. A projected loan amount that could be supported by current cash flows was calculated using the computed cash flows for the most appropriate period (converted to a monthly cash flow amount), the current rate, and a 25-year amortization period. This amount was added to the computed residual value of the project at the end of a 15-year amortization period to reflect the total value of the project in fiscal 1998 and 1999. In the period ended December 31, 1999, the project loan amounts that could be supported by cash flows were adjusted to provide for a 1.15:1 debt service coverage ratio, due to the continued aging of the loan portfolio, and historical volatility of the cash flows. This adjustment, along with recent deterioration in cash flows in a segment of the affordable housing loan portfolio, significantly reduced the total value of certain projects, and thus increased the required reserves for those projects. 3. This information was used to determine proper classifications, and ultimately reserves, for the loan, letter of credit, general partner loan and equity investment amounts. A "potential tax credit market adjustment" was computed in fiscal 1998 and 1999 by taking the difference between the price paid by investors for tax credits at the project's inception and an amount that was determined to be better reflective of the true value of the credits. This market adjustment was used to determine what portion of the loans, letters of credit, general partner loans and equity investments would be classified as doubtful, which included a 50 percent reserve, and loss, which included a 100 percent reserve or charge-off of the related asset or reserve for the letter of credit. This market adjustment was not used to compute the appropriate level of reserves at December 31, 1999. The elimination of the market value adjustment with respect to determining the overall reserve level, resulted in a significant increase in the reserves required. 20
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The assignment was based on the possibility of limited partner participation in operating deficits of the partnerships due to the market value appreciation of the tax credits held by the limited partners in the respective partnerships. Since this participation has not occurred, management classified the potential adjustment as loss, despite continued appreciation of the remaining tax credits. 4. The analyses were updated quarterly for current operating information of the actual projects. Except for the market value adjustment and the increased debt service coverage requirement noted above for the December 31, 1999 review, the assumptions used to compute reserves were not changed for any of the quarters in fiscal 1999; only the data used to compute classifications was changed. The period of cash flows used was changed in certain instances if it was determined that a change better reflected future projected results. For the period ended December 31, 1999, calendar 1999 data was used. Prior to the quarter ended March 31, 1998, affordable housing industry loans and letters of credit were classified in the categories of pass, special mention, substandard, doubtful and loss. Percentages were applied to the balances classified in the respective categories that represented Fidelity's best estimate of loss for those classifications. Specific reserves are assigned to certain credits. The reserves are determined by management's evaluation of those credits. The results of internal loan reviews, OTS evaluations and recent events assist Fidelity in making that evaluation. The independent support for the allowance for loan losses and letter of credit valuation reserve includes documentation that supports the amount of recorded reserves for these credits. During the six months ended an additional provision for letter of credit losses of $1.1 million was recognized due to a deterioration in the affordable housing portfolio. General reserves for loans and letters of credit not specifically reserved are also determined. Fidelity computes general reserves for the commercial, commercial mortgage, residential mortgage, consumer and credit card loan portfolios by utilizing historical information and information currently available about the loans within those portfolios that provides information as to the likelihood of loss. The potential effect of current economic conditions is also considered with respect to establishing general reserve amounts. As a result of recent loss levels in consumer loans originated prior to 1999, the provision for consumer loan losses was increased to a level approximating 1.5% of consumer loans outstanding. 21
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Non-Interest Income Non-interest income decreased by $1.7 million or $661,000 on an annualized basis for the six months ending December 31, 1999, compared to a decrease of $362,000 or 12.0% for the year ended June 30, 1999. The percent change for December 31, 1999 has been annualized. The following table summarizes non-interest income for the following time periods: [Enlarge/Download Table] Change From Prior Year Increase (Decrease) ------------------------------------------- Amount December 31, 1999 June 30, 1999 ------------------------------------------------------------------------------------------ Six months ended Year ended Year ended December 31, June 30, June 30, Annualized 1999 1999 1998 Amount Percent Amount Percent --------------------------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Fee income from real estate Development and management $ 88 $ 196 $ 191 $ (108) (10.2)% $ 5 2.6% Service charges on deposit Accounts 201 437 436 (236) (8.0) 1 .2 Gain on sale of Real estate loans 110 343 186 (233) (35.9) 157 84.4 Investment securities 79 0.0 (79) (100.0) Letter of credit fees 291 582 657 (291) 0.0 (75) (11.4) Servicing fees on loans sold 55 91 93 (36) 20.9 (2) (2.2) Release fees on multifamily loans 20 82 74 (62) (51.2) 8 10.8 Real estate investment Banking fees 13 78 139 (65) (66.7) (61) (43.9) Agent fee income 4 333 650 (329) (97.6) (317) (48.8) Title fee income 18 72 10 (54) (50.0) 62 620.0 Other 201 449 510 (248) (10.5) (61) (12.0) ------------------------------------------------------------------------------------------ Total non-interest income $1,001 $2,663 $3,025 $(1,662) (24.8)% $(362) (12.0)% ========================================================================================== Fidelity's level of activity in Section 42 real estate activities has continued to decrease. Fidelity has recorded no Section 42 real estate development fees over the past three years. Fee income from management activities for fiscal 1999 was approximately the same as 1998 even though there was a reduction during the year in fee percentage from 5% to 4% collected on partnerships for which Village Housing Corporation is the general partner. Management fee income for the six months ended December 31, 1999, annualized decreased $20,000 from fiscal 1999 due to lower occupancy levels and a reduction in rent charged at certain properties in an effort to increase occupancy levels. Service charges on deposit accounts remained approximately the same in fiscal 1999 and 1998 despite a reduction in the deposits. There is a slight decrease in the six months ended December 31, 1999, annualized of $402,000 compared to the prior fiscal years due to the continuing decrease in deposits. Net gains on the sale of single-family loans during fiscal 1999 increased $157,000 over the same period in 1998, resulting from increased loan originations during the year. Loan originations during the six months ending December 31, 1999 have decreased due to the higher level of mortgage interest rates compared to prior years. As a result, annualized net gains of $220,000 were down $123,000 compared to fiscal 1999. No securities were sold in the six months ending December 31, 1999 or fiscal 1999; gains of $79,000 were recorded in 1998. Letter of credit fees annualized in the short year and fiscal 1999 were $582,000 compared to $657,000 in fiscal year 1998. Outstanding letters of credit at December 31, 1999 and June 30, 1999 were $44.6 million and $45.0 million respectively, compared to $55.5 million at June 30, 1998. Real estate investment banking fees continue to decrease from prior years and are estimated to be minimal in the foreseeable future. Title fee income decreased $36,000 on an annualized basis compared to fiscal 1999, but increased $26,000 over fiscal 1998. The decrease is primarily due to a decrease in loan volume compared to last year. 22
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Fidelity Federal Bancorp and Subsidiaries Management's Discussion and Analysis of Results of Operations and Financial Condition United has participated in an arrangement in which automobile loans are originated on behalf of another organization for the last three fiscal years. Agent fee income, which represents earned fees from these transactions, decreased $317,000 for the year ended June 30, 1999 compared to fiscal 1999. In January 1999, the head of United's consumer loan division and key members of the consumer loan division staff left United to accept employment with a competitor. As such, United's revenue from consumer loans has been sharply reduced. During the fourth quarter of fiscal 1999, United hired a manager and staff to resume this lending activity. United commenced certain types of consumer lending, such as home equity lending as of June 30, 1999. United fully resumed indirect lending during the first quarter of the fiscal period ended December 31, 1999. Agent fees annualized for the six months ended December 31, 1999 were only $8,000 compared to prior periods. United is currently retaining the majority of these originations in the consumer loan portfolio. United has been adding new consumer loans to the portfolio during the past six months, which adds to consumer loan interest income, but not fee income. Non-Interest Expense Non-interest expense on an annualized basis increased $3.4 million or 49.7% for the year ended December 31, 1999, compared to fiscal 1999 after decreasing by $9.2 million or 57.2% in fiscal 1999 from 1998. The following table summarizes non-interest expense for the six months ending December 31, 1999, and years ended June 30, 1999 and 1998: [Enlarge/Download Table] Change From Prior Year Increase (Decrease) ------------------------------------------------ December 1999 June 1999 --------------------------------------------------------------------------------------- Year Ended Six Months Ended Year Ended Year Ended December June June Annualized 1999 1999 1998 Amount Percent Amount Percent ----------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Salaries and employee benefits $1,747 $3,414 $ 3,341 $ (1,667) (2.3)% $ 73 2.2% Letter of credit valuation provision 1,069 (715) 6,778 1,784 (399.0)% (7,493) (110.5)% Write down of affordable housing partnership investments 331 545 1,478 (214) (47.5) (933) (63.1) Legal and professional 379 379 304 (0) 100.0 75 24.7 Occupancy expense 192 394 444 (202) (2.5) (50) (11.3) Equipment expense 166 299 354 (133) 11.0 (55) (15.5) Data processing expense 247 407 456 (160) 21.4 (49) (10.7) Affordable housing group activity expenses 769 (769) (100.0) Advertising 78 202 199 (124) (22.8) 3 1.5 Deposit insurance 156 244 140 (88) 27.9 104 74.3 SAIF assessment Correspondent bank charges 79 154 160 (75) 2.6 (6) (3.8) Printing and supplies 57 104 130 (47) 9.6 (26) (20.0) Loss on investment 25 246 87 (221) (25.2) 159 182.8 Telephone 48 74 74 (26) 29.7 0 0.0 Postage 42 95 79 (53) (11.6) 16 20.3 Travel and lodging 30 44 68 (14) 36.4 (24) (35.3) Other operating expense 502 992 1,215 (490) 5.0 (223) (18.4) --------------------------------------------------------------------------------------- Total non-interest expense $5,148 $6,878 $16,076 $(1,730) 49.7% $(9,198) (57.2)% ======================================================================================= 23
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The increase in total non-interest expense annualized for the six months ending December 31, 1999, as compared to fiscal 1999, relates primarily to expenses associated with Fidelity's Section 42 tax credit real estate development program. Due to a deterioration in cashflows and occupancy during the six months ending December 31, 1999, additional letter of credit provisions of $1.1 million were recognized. Volatility in cashflows, occupancy and other performance measurements can create large variances in reserves that are necessary based on quarterly loan and letters of credit reviews of the partnerships. Writedowns on affordable housing partnerships were $331,000 for the six months ended December 31, 1999 or $662,000 annualized. This is a $117,000 increase over fiscal 1999 primarily due to the same issues mentioned above. The letter of credit provision was $6.8 million in fiscal 1998. Due to refinancings and reductions of classified letters of credit, a portion of $6.8 million in reserves were reversed in fiscal 1999. Although the majority of the letters of credit reserve relates to the Section 42 program, a portion of this reserve relates to letters of credit that are not related to the Section 42 program. Included in the 1998 expense of $769,000 were abandoned projects expense of $213,000 and write-offs of partnership management, investment banking, real estate development and letter of credit fees totaling $384,000. Abandoned projects expense consists of costs that were incurred at sites that will not be fully developed. Salaries and employee benefits on an annualized basis increased $80,000 over fiscal 1999 due primarily to open positions in the consumer lending area during fiscal 1999 that were filled in the six month period ending December 31, 1999. In addition, severance expense of $50,000 associated with the elimination of duplicative positions within Fidelity was recognized. For both the six months and fiscal 1999 legal and professional fees were $379,000 for each time period compared to $304,000 for fiscal 1998. Legal and professional fees are higher primarily due to additional costs incurred for workout activities with respect to various classified assets, and other legal actions commenced by Fidelity, including actions connected with Fidelity's efforts to divest of its Section 42 tax-credit property loans and investments. An additional $103,000 in legal fees associated with the Lincolnshire transaction that was terminated in November 1999 were also incurred during the six month period. Legal fees of $21,000 associated with the Pedcor transaction were also expensed during the six months ending December 31, 1999. Occupancy expense for the six months ending December 31, 1999 was approximately the same as fiscal 1999 on an annualized basis. Equipment expense increased $33,000 on an annualized basis over fiscal 1999 primarily due to higher cost repairs on equipment than last year. Data processing expense was $247,000 for the six month period compared to $407,000 in fiscal 1999. Year 2000 expense and improved data communications between the branches accounts for the increase during the six months ending December 31, 1999 over fiscal 1999 on an annualized basis. Data processing expense for fiscal 1999 decreased $49,000 from fiscal 1998 due to a smaller number of transactions with the data processor resulting from the reduction in Fidelity's asset size. Deposit insurance increased $68,000 on an annualized basis due to the change in United's risk classification compared to the prior year. Fidelity recorded its percentage share of losses, as accounted for under the equity method of accounting, for its investments in various IRS Section 42 developments of $50,000 annualized compared to $246,000 and $87,000 in the prior years. These writedowns are partially offset by tax credits received and recorded as reductions of income tax expense. Other operating expense on an annualized basis increased slightly over fiscal 1999 by $12,000. Management continues to monitor expenses closely. Income Tax Benefit The income tax benefit was $1.7 million or $3.4 million annualized for the six months ending December 31, 1999 compared to $338,000 and $5.2 million for fiscal 1999 and 1998, respectively. This represents a $3.0 million increase in income tax benefits primarily resulting in a decrease in taxable income. Income tax benefit decreased $4.9 million for the year ended June 30, 1999 compared to the same period in 1998, primarily due to an increase in taxable income. Included in the tax benefit of $1.7 million for the six months ending December 31, 1999 are tax credits of $193,000. These credits are received from Fidelity's investment in Section 42 affordable housing projects and comprise a portion of the return on these investments. Fidelity also receives the tax benefit of its percentage of the operating losses for those projects. Some of the benefits associated with these tax credits are partially offset by reductions of the investment in the Section 42 projects, which are included in the above table under the caption "Loss on Investment". The effective tax rate for the six months ended December 31, 1999 was 44.7% compared to 117.8% and 43.3% for fiscal 1999 and 1998, respectively. 24
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The change in the deferred tax asset balance from June 30, 1997 to June 30, 1998 was $3,368,000 and was due primarily to the loss incurred in fiscal 1998. At June 30, 1998, a portion of the net operating loss was carried forward and a portion was carried back to generate refunds from prior tax years. The portion that was carried back "freed up" credits utilized in prior years. These credits are now being carried forward. The remainder of the change in the deferred tax balance is primarily due to writedowns of assets that are not deductible for tax purposes for fiscal 1998. A consideration of a valuation allowance for the deferred tax asset was made at December 31, 1999 and June 30, 1999 and 1998 after projecting the reversal of the deferred items. These analyses were based on projected operating income in future years, action plans developed and partially implemented included in a newly developed business plan, cost reductions, planned sale of a portion of United's limited partnership interests and the completion of Fidelity's transaction with Pedcor Holdings LLC ("Pedcor"). Please refer to the last footnote in the Notes to Consolidated Financial Statements for further details regarding the Pedcor transaction. These analyses showed that it was more likely than not that all carryforwards would be utilized within the carryforward periods (federal and state) and therefore no valuation allowance was recorded. The analyses assume that Fidelity will execute approximately 50% of the initiatives included within its current business plan, sell approximately 50% of its limited partnerships interests (reducing tax credits granted annually) and then achieve 5 to 10% growth in annual earnings thereafter. The level of earnings contemplated by these analyses, if achieved, will still constitute, for the majority of the carry forward periods, earnings levels that are below other thrift holding companies included within Fidelity's peer group. The analyses to consider the need for a valuation allowance for the deferred tax asset are subject to certain risks and uncertainties that could impact the final determination regarding the amount of the valuation allowance. These risks include the failure of the Company to complete the transaction with Pedcor, the failure to implement the newly developed business plan including cost reductions, or the planned sale of United's limited partnership interests. Year 2000 For the past several years, Fidelity has been taking corrective measures to ensure that, on January 1, 2000, its computer systems and equipment that use embedded computer chips would be able to distinguish between "1900" and "2000." Fidelity also undertook corrective measures to avoid any business disruptions on February 29, 2000 as a result of the millennium's first leap year. Due to these efforts, Fidelity has not experienced any material system errors or failures as a result of Year 2000 issues. Prior to December 31, 1999, Fidelity assigned certain individuals to act as a single point of coordination and information about all Year 2000 events, whether internal or external, that could impact normal business processes. In addition, Fidelity will continue its business as usual practices to monitor its computer systems and infrastructure, as well as the Year 2000 efforts of third parties with which the Corporation does business. Although Fidelity does not anticipate that any future Year 2000 issues will result in a material impact on Fidelity, there can be no assurance that this will be the case. Fidelity has incurred cumulative Year 2000 costs of approximately $250,000 through December 31, 1999. A significant amount of these costs was not incremental to Fidelity but instead constituted a reallocation of existing internal systems technology resources and, accordingly, was funded from normal operations. Remaining costs are expected to be immaterial and similarly funded. Forward-looking statements contained in the foregoing "Year 2000" section should be read in conjunction with the cautionary statements included in the introductory paragraphs under "Management's Discussion and Analysis of Results of Operations and Financial Condition". Financial Condition Total assets at December 31, 1999 decreased $796,000 to $171.5 million from $172.2 million in fiscal 1999. Average assets for the six months ended December 31, 1999 decreased 10.9% from fiscal 1999 to $170.7 million. Average interest-bearing liabilities decreased $18.9 million as Fidelity used loan payoff proceeds to reduce borrowings and agent-acquired certificates of deposit, which represent a higher-cost source of funds for Fidelity. The decrease in total assets is primarily the result of loan payoffs, refinancing and payments received on commercial, multifamily and fixed 1-4 family mortgage loans. Fidelity has continued to sell current production of fixed 1-4 family mortgages to investors in the secondary market, therefore the mortgage loan portfolio continues to decline. 25
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Loans The following table shows the composition of Fidelity's loan portfolio as of December 31, 1999 and June 30: [Enlarge/Download Table] December June June June June 1999 1999 1998 1997 1996 ----------------------------------------------------------------------------------------------------------- (In Thousands) Real estate mortgage loans First mortgage loans Conventional $ 48,845 $ 49,733 $ 71,343 $ 94,293 $ 106,344 Construction 1,867 6,732 16,110 32,577 36,938 Commercial 8,576 14,140 20,753 26,668 18,267 Multi-family loans 3,629 7,597 5,742 9,602 15,420 First mortgage real estate loans purchased 1,899 2,061 2,704 3,184 7,612 ------------------------------------------------------------------- 64,816 80,263 116,652 166,324 184,581 Commercial loans, other than secured by real estate 4,154 6,076 11,568 12,522 9,393 Consumer and home equity loans 29,970 27,618 31,512 26,118 23,247 ------------------------------------------------------------------- Total loans 98,940 113,957 159,732 204,964 217,221 Allowance for loan losses (2,021) (3,521) (3,049) (1,781) (1,059) ------------------------------------------------------------------- Net loans $ 96,919 $ 110,436 $ 156,683 $ 203,183 $ 216,162 =================================================================== Total assets $ 171,457 $ 172,253 $ 197,046 $ 240,819 $ 262,216 =================================================================== Total loans to total assets 57.7% 66.2% 81.1% 85.4% 82.8% =================================================================== Fidelity began selling current production of 1-4 family loans in 1997, recording the gain or loss and using the proceeds to fund new products. With this strategy in place, conventional real estate mortgage loans decreased $45.4 million from June 30, 1997 to December 31, 1999. Construction loans decreased by $4.9 million at December 31, 1999 from June 30, 1999. Construction loans at December 31, 1999 include only $1.5 million of multi-family loans, compared to $5.9 million at June 30, 1999. Multi-family loans decreased $4.0 million from the prior fiscal year due to Fidelity's efforts on reducing classified assets and charge offs of $2.6 million. Fidelity continues to pursue refinancing opportunities for available outlets for the remaining classified multifamily loans, commercial loans and letters of credit. Commercial real estate loans and commercial loans have continued to decrease since 1997 due to payoffs, paydowns and an overall decline in originations. One additional factor playing a role in this decrease is the Supervisory Agreement that United is currently under which restricts new commercial lending. Refer to the "Other Restrictions" footnote for additional information. The focus of United's commercial lending department has been to develop action plans to minimize potential losses relating to its classified commercial credits and its letter of credit exposure. Multi-family loans overall, including construction, have decreased since 1995 as Fidelity has sold participations in the loans or received payoffs because of the availability of more favorable financing alternatives. In several cases where multi-family loan borrowers required more favorable financing alternatives, Fidelity has issued a standby letter of credit and continued to assume the credit risk associated with the financing. Consumer and home equity loans increased $2.4 million from June 30, 1999 to $30 million at December 31, 1999. United has reestablished its presence in the indirect auto lending market during the past six months. Recent staff replacements to the consumer loan department in late fiscal 1999 have contributed to the increase in the consumer and home equity loan portfolios. 26
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Fidelity's loan portfolio contains no loans to foreign governments, foreign enterprises, foreign operations of domestic companies or highly leveraged transactions, nor any concentration to borrowers engaged in the same or similar industries that exceed ten percent of total loans. Loan Maturities The following table sets forth the remaining maturities for certain loan categories as of December 31, 1999: [Download Table] Within One One to Five After Five Year Years Years Total --------------------------------------------------------------------------- (In Thousands) Real estate mortgage loans $ 3,029 $12,655 $49,132 $64,816 Consumer and home equity loans 12,628 16,360 982 29,970 Commercial loans 1,208 2,946 4,154 ------------------------------------------ Total $16,865 $31,961 $50,114 $98,940 ========================================== Predetermined interest rates $ 8,685 $24,963 $26,503 $60,151 Floating interest rates 8,180 6,998 23,611 38,789 ------------------------------------------ $16,865 $31,961 $50,114 $98,940 ========================================== (This space intentionally left blank) 27
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Non-Performing Loans Fidelity discontinues the accrual of interest income on loans when, in the opinion of management, there is reasonable doubt as to the timely collectibility of interest or principal. When a loan reaches a ninety day or more past due status, the asset is generally repossessed or sold, if applicable, or the foreclosure process is initiated and the loan is re-classified to other real estate owned to be sold. A loan could be placed in a nonaccrual status sooner than ninety days, if management knows the customer has abandoned the collateral and has no intention of repaying the loan. At this point, management discontinues the accrual of interest and Fidelity would initiate the repossession or foreclosure process. Typically, when a loan reaches nonaccrual status, the accrued interest is reversed from income, unless strong evidence exists that the value of the collateral would support the collection of interest in a foreclosure situation. Nonaccrual loans are returned to an accrual status when, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the timely payment of principal and interest. Income received on nonaccrual loans was $18,000 for the six months ended December 31, 1999, $157,000 in fiscal 1999 and $10,000 in 1998. Additional interest income of approximately $13,000, $214,000, and $33,000 for the six months ended December 31, 1999, fiscal 1999, and 1998, respectively, would have been recorded had income on nonaccruing and restructured loans been considered collectible and accounted for on an accrual basis. The following table provides information on Fidelity's non-performing loans as of December 31, 1999 and June 30: [Enlarge/Download Table] December 31, June 30, June 30, June 30, June 30, 1999 1999 1998 1997 1996 -------------------------------------------------------------------------------------------------------------- (Dollars In Thousands) Non-accrual loans Real estate mortgage $ 253 $ 76 $ 461 $ 256 $ 342 Multi-family 229 4,112 Total non-accrued loans 482 4,188 461 256 342 Restructured Real estate mortgage Consumer 75 77 Commercial 118 Total restructured loans 193 77 90 days or more past due and accruing Consumer 135 164 86 29 43 Commercial 313 632 26 -------------------------------------------------------------- Total 90 days or more past due and accruing 448 796 112 29 43 -------------------------------------------------------------- Total non-performing loans $1,123 $5,061 $ 573 $ 285 $ 385 ============================================================== Ratio of non-performing loans to total loans 1.14% 4.44% .36% .14% .18% ============================================================== Non-performing loans were 1.14% of total loans at December 31, 1999, as compared to 4.44% of total loans at June 30, 1999 and consisted primarily of commercial and multi-family loans. The decrease in non-performing loans is due to one large multi-family loan to an unaffiliated borrower which was paid off in October 1999. Multi-family affordable housing loans, for which specific reserves have been computed, are currently performing with respect to debt service and are, therefore, not included in the above "non-performing loans" totals. The ability of the multi-family loans to remain performing is in part due to general partner or other advances made by Fidelity to support cash flow deficits incurred by the affordable housing projects. During the six month period ended December 31, 1999, $541,000 was accrued by Village Housing Corporation for delinquent real estate and property taxes, deferred maintenance and delinquent debt service payments. The $541,000 was recorded due to the probability of not being reimbursed for these necessary expenditures by the partnerships in the foreseeable future. There is no assurance that general partner advances will not be necessary in the future to support further cash flow deficits, or that Fidelity will not have to extend funds in order to protect its collateral position with respect to the loans. The majority of recorded general partner advances were charged off in fiscal 1998. 28
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Analysis of Allowance for Loan Losses and Letter of Credit Valuation Allowance Fidelity establishes its provision for loan losses and evaluates the adequacy of the allowance for loan losses based on management's evaluation of the performance of its loan and letter of credit portfolio. Such evaluation, which includes a review of all loans and letters of credit for which full collectibility may not be reasonably assured, considers among other matters, the present value of capitalized cash flows, the estimated fair value of the underlying collateral, economic conditions, historical loss experience, the composition of the portfolios and other factors that warrant recognition in providing for an adequate loan loss allowance and letter of credit valuation allowance. This evaluation is performed on a monthly basis and is designed to ensure that all relevant matters affecting collectibility will consistently be identified in a detailed review and that the outcome of the review will be considered in a disciplined manner by management in determining the necessary allowances and related provisions. The amounts actually reported in each period will vary with the outcome of this detailed review. Classified Assets and Letters of Credit (In Thousands) [Download Table] December 31, June 30, 1999 1999 ---------------------------------------------------------------------------- Classified assets $8,991 $19,680 Classified letters of credit 13,218 20,977 ------------------------ Total classified assets/letters of credit $22,209 $40,657 ======================== Classified and criticized assets of Fidelity totaled $22.2 million at December 31, 1999 compared to $40.7 million at June 30, 1999 a decrease of 45.4%. Classified assets and letters of credit were 167.8% and 246.4% of Fidelity's capital and reserves at December 31, 1999 and June 30, 1999, respectively. Impaired loans are those that management believes will not perform under the original loan terms. At December 31, 1999, Fidelity had impaired loans totaling $7.4 million compared to $16.5 million at June 30, 1999, a decrease of 55.1%. The 55.1% decrease in impaired loans recognizes Fidelity's ongoing efforts and dedication in reducing classified loans. Fidelity recognizes there is still a substantial risk in the remaining classified assets. The allowance for losses on such impaired loans totaled $1.1 million and $1.8 million and is included in Fidelity's allowance for loan losses at December 31, 1999 and June 30, 1999, respectively. In addition, using the same guidelines for impaired loans, impaired letters of credit at December 31, 1999 total $13.2 million versus $21.0 million at June 30, 1999, a decrease of 37.1%. The valuation allowance on such impaired letters of credit totaled $5.8 million and $5.2 million and is included in Fidelity's letters of credit valuation allowance at December 31, 1999 and June 30, 1999, respectively. Impaired loans do not include large groups of homogeneous loans that are collectively evaluated for impairment, such as, residential mortgage and consumer installment loans. 29
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The following table sets forth loan charge-offs and recoveries by the type of loan and an analysis of the allowance for loan losses at December 31, 1999 and the fiscal years ended June 30: [Enlarge/Download Table] December 31, June 30, June 30, June 30, June 30, 1999 1999 1998 1997 1996 ---------------------------------------------------------------------------------------------------------- (In Thousands) Allowance for loan losses balance at July 1 $ 3,521 $ 3,049 $ 1,781 $ 1,059 $ 713 ------------------------------------------------------------------------ Loan charge offs Real estate mortgage 15 100 12 Multi-family 2,631 3,089 Commercial 11 14 25 Consumer 235 324 195 142 128 ------------------------------------------------------------------------ Total loan charge offs 2,877 338 3,299 267 140 ------------------------------------------------------------------------ Loan recoveries Real estate mortgage 15 3 17 Multi-family 3 Commercial 3 3 Consumer 26 35 24 11 14 ------------------------------------------------------------------------ Total loan recoveries 32 53 24 14 31 ------------------------------------------------------------------------ Net charge offs 2,845 285 3,275 253 109 Reclassifications 895 Provision for loan losses 1,345 (138) 4,543 975 455 ------------------------------------------------------------------------ Allowance for loan losses at end of period $ 2,021 $ 3,521 $ 3,049 $ 1,781 $ 1,059 ======================================================================== Ratio of net charge offs to average loans outstanding during period 5.20% .21% 1.81% .12% .05% ======================================================================== Ratio of provision for loan losses to average loans outstanding during period 2.46% (.10)% 2.52% .46% .20% ======================================================================== Ratio of allowance for loan losses to total loans outstanding at year end 2.04% 3.09% 1.91% .87% .49% ======================================================================== Average amount of loans outstanding for the period $ 108,455 $ 137,794 $ 180,530 $ 213,793 $ 226,874 ======================================================================== Amount of loans outstanding at end of period $ 98,940 $ 113,957 $ 159,732 $ 204,964 $ 217,221 ======================================================================== 30
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The allowance for loan losses was $2.0 million at December 31, 1999 compared to $3.5 million at June 30, 1999. Net loan charge-offs were $2.8 million or 5.20% of average loans for the six months ended December 31, 1999 compared to $285,000 or .21% of average loans for the year ended June 30, 1999. During the six months ended December 31, 1999, Fidelity reevaluated some of the loans that it had previously established reserves for in fiscal 1998 and charged off $2.8 million in loans. In addition, it was determined a $3.2 million loan originated for the financing of a hotel was not meeting its cash flow projections, and thus was classified. This substandard classification resulted in an approximate $470,000 increase in the allowance for loan losses. Based on recent loss experience in United's consumer loan portfolio originated prior to 1999, United increased the allowance for loan losses to $496 at December 31, 1999, or approximately 1.5% of consumer loans outstanding. During the six months ended December 31, 1999 an additional provision for letter of credit losses of $1.1 million was recognized due to deterioration in the affordable housing portfolio. A letter of credit was funded during the first quarter of fiscal 1999 and was classified as a non-accrual loan upon conversion. This loan was previously classified as a substandard letter of credit with a specific reserve of $895,000. The loan was paid in full during the second quarter of fiscal 1999 and Fidelity reclassified the $895,000 specific reserve to the general allowance for loan losses. As discussed previously, Fidelity increased the provision for loan losses during fiscal 1998 primarily in connection with loans made to certain Section 42 tax-credit real estate development projects that Fidelity was currently managing. Fidelity has loans and letters of credit securing third-party loans to these projects and also has other loans and letters of credit outstanding that are related to other multi-family developments, most of which are outside Fidelity's geographic market. Fidelity also recorded a letter of credit valuation allowance and related provision of $6.8 million in fiscal 1998, the balance of which is $5.8 million at December 31, 1999. The decrease is primarily due to the transfer of $895,000 from the letter of credit valuation allowance to the allowance for loan losses. Multi-family letters of credit, an off-balance sheet item, carry the same risk characteristics as conventional loans and totaled $44.5 million at December 31, 1999. The valuation allowance for letters of credit, as a percentage of total outstanding letters of credit, were 13.0% at December 31, 1999 as compared to 11.5% at June 30, 1999. Classified loans and letters of credit to total loans and letters of credit were 16.5% at December 31, 1999 and 24.2% at June 30, 1999. Management is not currently aware of any additional letters of credit that are expected to be called or funded. Management considers the allowance for loan losses and letter of credit valuation reserve adequate to meet losses inherent in the loan portfolio as of December 31, 1999. 31
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Allocation of Allowance for Loan Losses The allocation for loan losses and the percentage of loans within each category to total loans at December 31, 1999 and at June 30, are as follows: [Enlarge/Download Table] Allocation of Amount ---------------------------------------------------------------------------- December 31, June 30, June 30, June 30, June 30, 1999 1999 1998 1997 1996 --------------------------------------------------------------------------------------------------------- (In Thousands) Real Estate Mortgage Conventional $ 103 $ 99 $ 173 $ 153 $ 155 Multi-family 482 2,177 1,868 994 420 Home equity and consumer 496 182 275 168 214 Commercial 940 1,063 733 466 270 ---------------------------------------------------------------------------- Total $2,021 $3,521 $3,049 $1,781 $1,059 ============================================================================ Percentage of Loans to Total Loans ---------------------------------------------------------------------------- December 31, June 30, June 30, June 30, June 30, 1999 1999 1998 1997 1996 --------------------------------------------------------------------------------------------------------- Real Estate Mortgage Conventional 51.3% 46.2% 48.7% 53.9% 63.2% Multi-family 3.7 11.5 11.4 14.3 13.4 Home equity and consumer 30.3 24.2 19.7 12.7 10.7 Commercial 14.7 18.1 20.2 19.1 12.7 ---------------------------------------------------------------------------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ============================================================================ 32
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Association with Section 42 As noted previously, Fidelity has various investments in seventeen real estate development projects located throughout Indiana, Illinois and Kentucky. Management considers the projects and properties to be in good condition. Fidelity has various Section 42 loans, general partner loans, equity investments and letters of credit associated with these projects. The following table summarizes Fidelity's association with these projects: [Enlarge/Download Table] Balances ------------------------------------------------------------------------------- Conventional Bank General Financing Partner Loans* Additional Equity Letters of Notes Investments Credit ------------------------------------------------------------------------------- Balance at June 30, 1998 $5,325 $606 - $1,686 $19,423 Increases 61 13 284 - - Paydowns, payoffs, or loss on investment (563) (369) - (262) - Payoffs of loans secured by letters of credit - - - - (2,757) Charge-offs - - - (545) - ------------------------------------------------------------------------------- Balance at June 30, 1999 4,823 250 284 879 16,666 Increases - - - 58 1 Paydowns, payoffs, or loss on investment (1,401) (152) (77) - - Charge-offs (994) (85) (151) (235) (450) ------------------------------------------------------------------------------- Balance at December 31, 1999 $2,428 $13 $56 $702 $16,217 =============================================================================== Specific reserves included in allowance for loan losses ------------------------------------------------------------------------------- Specific Valuation Conventional Bank General Allowance Reserves Allowance Financing Partner Loans Additional For Equity For Letters of Notes Investments Credit ------------------------------------------------------------------------------- Balance at June 30, 1998 $878 $56 - 75 $5,300 Provision-year ended June 30, 1999 (205) 69 44 470 (532) Charge-offs - - - (545) - ------------------------------------------------------------------------------- Balance at June 30, 1999 673 125 44 - 4,768 Provision-six months ended December 31, 1999 651 (40) 111 253 606 Funding on outstanding letter of credit - - - - (450) Charge-offs (994) (85) (151) (235) - ------------------------------------------------------------------------------- Balance at December 31, 1999 330 - 4 18 4,924 =============================================================================== *Per the partnership agreement, each partnership could request up to a specified amount of additional money to cover shortfalls at the partnerships, therefore no original amount is specified. Investment Securities United's investment policy is annually reviewed by its Board of Directors. Any significant changes to the policy must be approved by the Board. The Board has an asset/liability management committee, which is responsible for keeping the investment policy current. 33
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Fidelity Federal Bancorp and Subsidiaries Management's Discussion and Analysis of Results of Operations and Financial Condition At December 31, 1999, the investment portfolio represented 14.2% of Fidelity's assets, compared to 15.9% at June 30, 1999, and is managed in a manner designed to meet the Board's investment policy objectives. During fiscal 1999 due to continued reductions in the loan portfolio, the excess liquidity was reinvested in lower risk investment securities. The primary objectives, in order of priority, are to further the safety and soundness of Fidelity, to provide the liquidity necessary to meet day to day, cyclical, and long-term changes in the mix of Fidelity's assets and liabilities and to provide for diversification of risk and management of interest rate and economic risk. At December 31, 1999, the entire investment portfolio was classified as available for sale. The net unrealized loss at December 31, 1999, which is included as a component of stockholders' equity, was $775,000 and was comprised of gross losses of $1,284,000 and a tax benefit of $509,000. The increase in unrealized loss was caused by market interest rate changes during the period. Although the entire portfolio is available for sale, management has not identified specific investments for sale in future periods. The following table sets forth the components of United's available-for-sale investment portfolio as of December 31, 1999 and June 30, 1999 and 1998: [Enlarge/Download Table] December 31, June 30, June 30, 1999 1999 1998 ------------------------------------------------------------------------------------- (In Thousands) Investment securities available for sale U. S. Treasury $1,001 Federal agency securities 2,985 Federal Home Loan Mortgage Corporation mortgage-backed securities $ 1,043 $ 1,202 1,779 Federal National Mortgage Association mortgage-backed securities 1,377 1,510 1,945 Government National Mortgage Association mortgage-backed securities 21,885 24,613 2,144 --------------------------------------- Total securities available for sale $24,305 $27,325 $9,854 ======================================= United's investment securities portfolio decreased by $3.0 million to $24.3 million at December 31, 1999, compared to $27.3 million at June 30, 1999. The current year's decrease is the result of maturities and paydowns received during the year. In fiscal 1999, United purchased $25.4 million of GNMA securities. As mentioned above, this was the result of excess liquidity generated from the reduction in the loan portfolio. United holds various types of securities, including mortgage-backed securities. Inherent in mortgage-backed securities is prepayment risk. Prepayment rates generally can be expected to increase during periods of lower interest rates as some of the underlying mortgages are refinanced at lower rates. Conversely, the average lives of these securities generally are extended as interest rates increase. 34
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The following table sets forth the contractual maturities of investment and mortgage-backed securities as of December 31, 1999, and the weighted average yields of such securities. The contractual maturities of mortgage-backed securities are not typically indicative of the actual holding period for such investments, as pre-payments on the underlying mortgage loans will reduce the average life of the investment, based on prevailing market interest rates. [Enlarge/Download Table] ------------------------------------------------------------------------------------------- After One But After Five But Within Within Five Years Ten Years Over Ten Years Total -------------------------------------------------------------------------------------------------------------------------- Amount Yield Amount Yield Amount Yield Amount Yield -------------------------------------------------------------------------------------------------------------------------- Federal Home Loan Mortgage Corporation $408 7.06% $ $ 635 5.81% $ 1,043 6.29% Federal National Mortgage Association 424 7.00 953 6.01 1,377 6.31 Government National Mortgage Association 1 7.00 3,920 6.98% 17,964 6.91 21,885 6.92 ------------- ------------ ------------ ------------- Total $833 7.03% $3,920 6.98% $19,552 6.83% $24,305 6.86% ============= ============ ============ ============= Percent of total 3% 16% 81% 100% ============= ============ ============ ============= Funding Sources Deposits Fidelity attracts both short-term and long-term deposits from the retail market by offering a wide assortment of accounts with different terms and different interest rates. These deposit alternatives include checking accounts, regular savings accounts, money market deposit accounts, fixed rate certificates with varying maturities, variable interest rate certificates, negotiable rate jumbo certificates ($100,000 or more), and variable rate IRA certificates. Average deposits decreased by $17.6 million for the year ended December 31, 1999. The decrease came primarily in the area of agent-acquired certificates and core certificates of deposit, for which the average balance decreased $15.3 million and $743,000, respectively. The average balance of NOW, money market , and savings accounts decreased by $1.3 million, $188,000 and $425,000, respectively, from fiscal 1999, while the average balance of demand accounts increased $373,000 over fiscal 1999. According to the provisions of the Supervisory Agreement, Fidelity is unable to use agent-acquired certificates as a funding source. Agent-acquired certificates of deposit were acquired at rates higher than the current local market for retail deposits, but generally below rates charged for FHLB advances. 35
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition The following table sets forth the average balances of and the average rate paid on deposits by deposit category for the years ended December 31, 1999 and June 30, 1999, and 1998. [Enlarge/Download Table] December 31, June 30, June 30, 1999 1999 1998 --------------------------------------------------------------------------- Average Deposits Amount Rate Amount Rate Amount Rate --------------------------------------------------------------------------------------------------------------------- (In Thousands) Demand $ 6,097 $ 5,724 $ 5,229 NOW accounts 19,107 3.39% 20,436 3.50% 22,211 4.24% Money market accounts 2,545 2.03 2,733 2.23 3,027 2.71 Savings accounts 4,657 2.26 5,082 2.32 4,813 2.83 Certificates of deposit 78,329 5.60 79,072 5.76 85,699 5.80 Agent-acquired certificates of deposit 18,147 5.88 33,467 6.02 42,443 6.26 ----------- ----------- ----------- Totals $128,882 4.85% $146,514 5.10% $163,422 5.38% =========== =========== =========== The following table summarizes certificates of deposit in amounts of $100,000 or more by maturity as of the following dates: December 31, June 30, June 30, 1999 1999 1998 ----------------------------------------------------------------------------- (In Thousands) Three months or less $ 5,656 $ 4,218 $ 2,716 Three to six months 7,727 1,364 4,008 Six to twelve months 2,766 7,760 4,227 Over twelve months 6,825 3,763 11,471 ------------------------------------------- Totals $22,974 $17,105 $22,422 =========================================== Borrowings Fidelity's long-term debt decreased $5.6 million from fiscal 1999 primarily due to a decrease in Federal Home Loan Bank advances of $3.5 million and the payoff of $2.2 million on notes payable secured by specific multifamily loans. The payoff of the specific multifamily loans securing these notes was the result of Fidelity locating refinancing for the mortgages securing these notes and represented a continued commitment of Fidelity's loan workout efforts. With the current dividend restrictions in the Supervisory Agreement, a $2.0 million loan was obtained in fiscal 1999 to meet anticipated cash requirements of the parent company. Alternate funding sources for United were provided by loan sales and loan payoffs, as well as through retail deposits for United. 36
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Short-term borrowings totaled only $89,000 at December 31, 1999, which represented a decrease of $39,000 since June 30, 1999. The Treasury Tax and Loan Note Option was the only short-term borrowing utilized for the six months ended December 31, 1999. During fiscal 1999, the guaranteed investment contracts matured. Capital Resources Fidelity's stockholders' equity decreased $2.4 million to $5.4 million at December 31, 1999, compared to $7.8 million at June 30, 1999. The change in stockholders' equity was accounted for by a net loss of $2.1 million and an increase in the in the net unrealized loss on securities available for sale of $317,000. Total capital for United consists of Tier I capital plus the allowance for loan losses. Minimum capital levels are 4% for the leverage ratio, which is, defined as Tier I capital as a percentage of total assets less goodwill and other identifiable intangible assets; 4% for Tier I to risk-weighted assets; and 8% for total capital to risk-weighted assets. United's capital ratios have exceeded each of these levels. The leverage ratio was 6.8% for the year ended December 31, 1999 and 8.5% for June 30, 1999, tier I capital to risk-weighted assets was 9.1% and 10.5% and total capital to risk-weighted assets was 14.3% and 15.4% at December 31, 1999 and June 30, 1999. Book value per share, excluding unrealized losses on investment securities, decreased to $1.97 at December 31, 1999, compared to $2.63 six months earlier. Including, unrealized losses, book value per share was $ 1.72 and $2.48, respectively. The capital category assigned to an entity can also be affected by qualitative judgements made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. At December 31, 1999 and June 30, 1999, the Bank is categorized as well capitalized and met all capital adequacy requirements at those dates; however, per the Supervisory Agreement, the OTS felt additional capital was necessary based on asset quality concerns. United has evaluated and pursued alternatives to increasing its total capital for the purpose of improving its capital ratios during the six months ended December 31, 1999 and fiscal 1999. Management is progressing on a proposed stock issuance with Pedcor that will increase Fidelity's capital. See the last footnote in the Notes to Consolidated Financial Statements for further details regarding the Pedcor transaction. At December 31, 1999 United has improved its capital ratios over fiscal 1998 by reducing the asset size and mix of assets. As noted above, risk-based capital decreased to 14.3% at December 31, 1999 compared to 15.4% at June 30, 1999 and 10.8% at June 30, 1998. 37
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Liquidity Fidelity's principal source of income and funds is dividends from United and is not subject to any regulatory restrictions on the payment of dividends to its stockholders. However, United is restricted from paying any dividends to Fidelity without prior approval of the OTS. Fidelity in late fiscal 1999, obtained additional financing of $2.0 million to cover operating costs, debt reduction for three affordable housing developments, and servicing of debt at the holding company level. Absent potential sources of liquidity available to the holding company including the potential issuance of additional stock, potential execution of additional debt financing, and dividends from United (with OTS approval), the holding company may deplete its available cash during calendar 2000. Management is progressing on a proposed stock issuance to Pedcor and believes it will be completed before available cash is depleted, although it cannot provide any assurance due to required regulatory and shareholder approvals that must be obtained. United is required by federal regulations to maintain specified levels of "liquid" assets consisting of cash and other eligible investments. Currently, liquid assets must equal at least four percent of net withdrawable savings plus borrowings payable upon demand or due within one year or less. As of December 31, 1999 and June 30, 1999, United's liquidity ratios were 31.4% and 16.99%. United's significant increase in liquidity was the result of United's cash contingency plan for Y2K. United will reduce the liquidity to a more reasonable level during the first quarter of 2000. Management believes that this level of liquidity is sufficient to meet any anticipated requirements for United's operations. The primary sources of funds for operations are principal and interest payments on loans, deposits from customers, and sales and maturities of investment securities. In addition, United is authorized to borrow money from the FHLB and other sources as needed. United decreased its borrowings from the FHLB from $12.5 million at June 30, 1999, to $9.0 million at December 31, 1999. Fidelity has also decreased its utilization of agency-acquired certificates of deposit as total loans have decreased and the need for these types of funds has also decreased. Supervisory Agreement As noted previously and discussed in the footnotes under "Other Restrictions", United is currently operating under restrictions imposed by the Supervisory Agreement entered into with the OTS. The restrictions regarding certain activities in the Supervisory Agreement have had a significant impact on United's net interest margin, net interest income, and net income as a result of United's inability to participate in new commercial lending. Management has expended significant time and effort ensuring that United has operated and will continue to operate in compliance with the Supervisory Agreement. While the Supervisory Agreement remains in place, it is likely that total loans outstanding will continue to decline, and management efforts will be concentrated on compliance, rather than business development. This will likely have a further negative impact on the financial condition and the operating results of United and Fidelity. Accounting Pronouncements The Financial Accounting Standards Board has issued Statement No. 133, Accounting for Derivative Instruments and Hedge Activities, which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. The provisions of this statement were to become effective for fiscal years beginning after June 15, 1999. The effective date of the statement has been delayed by Statement No. 137 to fiscal years beginning after June 15, 2000. Fidelity does not expect the statement to have a material impact on Fidelity's financial condition or results of operations and plans on adopting it on January 1, 2001. 38
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Asset/Liability Management Fidelity is subject to interest rate risk to the degree that its interest-bearing liabilities, primarily deposits with short and medium term maturities, mature or reprice at different rates than its interest-earning assets. Although having liabilities that mature or reprice less frequently than average assets will be beneficial in times of rising interest rates, such an asset/liability structure will result in lower net income during periods of declining interest rates, unless offset by other factors. The OTS utilizes a model, the "Office of Thrift Supervision Net Portfolio Value" ("NPV") model, which uses a net market value methodology to measure the interest rate risk exposure of savings associations. Under this model, an institution's "normal" level of interest rate risk in the event of an assumed change in interest rates is a decrease in the institution's NPV in an amount not exceeding 2% of the present value of its assets. Savings associations with over $300 million in assets or less than a 12% risk-based capital ratio are required to file OTS Schedule CMR. Data from Schedule CMR is used by the OTS to calculate changes in NPV (and the related "normal" level of interest rate risk) based upon certain interest rate changes (discussed below). Associations which do not meet either of the filing requirements are not required to file OTS Schedule CMR, but may do so voluntarily. United is not required to file a CMR since it exceeds the risk-based capital requirement and its assets are less than $300 million, but does so on a voluntary basis. Under the regulation, associations, which must file are required to take a deduction (the interest rate risk capital component) from their total capital available to calculate their risk based capital requirement if their interest rate exposure is greater than "normal". The amount of that deduction is one-half of the difference between (a) the institution's actual calculated exposure to a 200 basis point interest rate increase or decrease (whichever results in the greater pro forma decrease in NPV) and (b) its "normal" level of exposure which is 2% of the present value of its assets. Presented below, at December 31, 1999 and June 30, 1999, is an analysis performed by the OTS of United's interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts in the yield curve, in 100 basis point increments, up and down 300 basis points. At December 31, 1999 and June 30, 1999, 2% of the present value of United's assets was approximately $3.4 million for December 31, 1999 and June 30, 1999. Because the interest rate risk of a 200 basis point increase in market rates (which was greater than the interest rate risk of a 200 basis point decrease) was $2.9 million at December 31, 1999 and $1.8 million` at June 30, 1999, United would not have been required to make a deduction from its total capital available to calculate its risk based capital requirement. The increase in interest rate risk from December 31, 1999 to June 30, 1999 is due to interest rate changes and a change in United's balance sheet mix. Interest Rate Risk as of December 31, 1999 NPV as Percent of Present Net Portfolio Value Value of Assets ---------------------------------------------------------------- Change Dollar Dollar Percentage in Rates Amount Change Change NPV Ratio Change --------------------------------------------------------------------------- + 300 bp $10,879 $(4,685) (30)% 6.75% - 242 bp + 200 bp 12,622 (2,942) (19) 7.69 - 148 bp + 100 bp 14,256 (1,308) (8) 8.53 - 64 bp 0 bp 15,564 9.17 - 100 bp 16,148 585 4 9.41 24 bp - 200 bp 16,023 459 3 9.27 10 bp - 300 bp 16,010 446 3 9.19 2 bp 39
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Management's Discussion and Analysis of Results of Operations and Financial Condition Interest Rate Risk as of June 30, 1999 NPV as Percent of Present Net Portfolio Value Value of Assets ---------------------------------------------------------------- Change Dollar Dollar Percentage in Rates Amount Change Change NPV Ratio Change --------------------------------------------------------------------------- + 300 bp $11,390 $(3,126) (22)% 7.09% - 151 bp + 200 bp 12,763 (1,753) (12) 7.81 - 80 bp + 100 bp 13,916 (600) (4) 8.37 - 24 bp 0 bp 14,516 8.61 - 100 bp 14,145 (371) (3) 8.31 - 30 bp - 200 bp 13,203 (1,312) (9) 7.70 - 91 bp - 300 bp 12,292 (2,224) (15) 7.10 - 150 bp As with any method of measuring interest rate risk, certain shortcomings are inherent in the methods of analysis presented above. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features, which restrict changes in interest rates on a short-term basis and over the life of the assets. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could likely deviate significantly from those assumptions used in calculating the table. 40
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA [OLIVE LETTERHEAD] Independent Auditor's Report Stockholders and Board of Directors Fidelity Federal Bancorp Evansville, Indiana We have audited the accompanying consolidated balance sheet of Fidelity Federal Bancorp and subsidiaries as of December 31, 1999 and June 30, 1999 and the related consolidated statements of income, changes in stockholders' equity and cash flows for the six month period ended December 31, 1999 and for the years ended June 30, 1999 and 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements described above present fairly, in all material respects, the consolidated financial position of Fidelity Federal Bancorp and subsidiaries as of December 31, 1999 and June 30, 1999, and the results of their operations and their cash flows for the six month period ended December 31, 1999 and for the years ended June 30, 1999 and 1998 in conformity with generally accepted accounting principles. /s/ OLIVE LLP Evansville, Indiana March 27, 2000 41
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Consolidated Balance Sheet (In Thousands, Except Share Data) [Enlarge/Download Table] December 31, June 30, 1999 1999 ------------------------------------------------------------------------------------------------------------ Assets Cash and due from banks $ 8,003 $ 1,599 Interest-bearing demand deposits 22,911 14,668 --------------------------------------- Cash and cash equivalents 30,914 16,267 Investment securities available for sale 24,305 27,325 Loans, net of allowance for loan losses of $2,021 and $3,521 96,919 110,436 Premises and equipment 5,727 5,692 Federal Home Loan Bank of Indianapolis stock 3,920 3,920 Deferred income tax receivable 5,372 3,490 Interest receivable and other assets 4,300 5,123 --------------------------------------- Total assets $171,457 $172,253 ======================================= Liabilities Deposits Non-interest bearing $ 6,593 $ 6,224 Interest bearing 128,423 122,372 --------------------------------------- Total deposits 135,016 128,596 Short-term borrowings 89 128 Long-term debt 23,504 29,149 Advances by borrowers for taxes and insurance 409 392 Valuation allowance for letters of credit 5,787 5,168 Other liabilities 1,225 1,006 --------------------------------------- Total liabilities 166,030 164,439 --------------------------------------- Stockholders' Equity Preferred stock, no par or stated value Authorized and unissued--5,000,000 shares Common stock, $1 stated value Authorized--5,000,000 shares Issued and outstanding--3,147,662 shares 3,147 3,147 Additional paid-in capital 10,869 10,869 Stock warrants 11 11 Retained earnings (7,825) (5,755) Accumulated other comprehensive loss (775) (458) --------------------------------------- Total stockholders' equity 5,427 7,814 --------------------------------------- Total liabilities and stockholders' equity $171,457 $172,253 ======================================= See notes to consolidated financial statements. 42
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Consolidated Statement of Income (In Thousands, Except Share Data) [Enlarge/Download Table] Six Month Period Ended Year Ended June 30, December 31, ----------------------------- 1999 1999 1998 ---------------------------------------------------------------------------------------------------------------- Interest Income Loans receivable $4,558 $11,861 $15,872 Investment securities Taxable 849 955 650 Tax exempt 24 Federal funds sold 25 75 Deposits with financial institutions 454 939 255 Other dividend income 158 314 316 ----------------------------------------------- Total interest income 6,019 14,094 17,192 ----------------------------------------------- Interest Expense Deposits 3,151 7,467 8,785 Short-term borrowings 1 26 170 Long-term debt 1,116 2,237 2,631 ----------------------------------------------- Total interest expense 4,268 9,730 11,586 ----------------------------------------------- Net Interest Income 1,751 4,364 5,606 Provision for loan losses 1,345 (138) 4,543 ----------------------------------------------- Net Interest Income After Provision for Loan Losses 406 4,502 1,063 ----------------------------------------------- Other Income Fee income--management fees 88 196 191 Service charges on deposit accounts 201 437 436 Net realized gains on sales of securities available for sale 79 Net gains on loan sales 110 343 186 Letter of credit fees 291 582 657 Real estate investment banking fees 13 78 139 Agent fee income 4 333 650 Title fee income 18 72 10 Servicing fees on loans sold 55 91 93 Release fees on multifamily loans 20 82 74 Other income 201 449 510 ----------------------------------------------- Total non-interest income 1,001 2,663 3,025 ----------------------------------------------- 43
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Consolidated Statement of Income (In Thousands, Except Share Data) (Continued) [Enlarge/Download Table] Six Month Period Ended Year Ended June 30, December 31, ------------------------------- 1999 1999 1998 ----------------------------------------------------------------------------------------------------------- Other Expenses Salaries and employee benefits $1,747 $ 3,414 $ 3,341 Net occupancy expenses 192 394 444 Equipment expenses 166 299 354 Data processing fees 247 407 456 Deposit insurance expense 156 244 140 Legal and professional fees 379 379 304 Advertising 78 202 199 Letter of credit valuation provision 1,069 (715) 6,778 Valuation allowance--affordable housing investments 331 545 1,478 Affordable housing group activities 769 Other expense 783 1,709 1,813 ------------------------------------------------- Total non-interest expense 5,148 6,878 16,076 ------------------------------------------------- Income (Loss) Before Income Tax (3,741) 287 (11,988) Income tax benefit (1,671) (338) (5,194) ------------------------------------------------- Net Income (Loss) $(2,070) $ 625 $ (6,794) ================================================= Basic Earnings (Loss) Per Share $(.66) $.20 $(2.30) Diluted Earnings (Loss) Per Share (.66) .20 (2.30) See notes to consolidated financial statements. 44
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Consolidated Statement of Changes in Stockholders' Equity (In Thousands, Except Share Data) [Enlarge/Download Table] Accumulated Common Stock Comprehensive Other --------------------- Paid-in Stock Income Retained Comprehensive Shares Amount Capital Warrants (Loss) Earnings Loss Total ------------------------------------------------------------------------------------- Balances, July 1, 1997 2,487,385 $2,487 $ 8,708 $264 $ 1,508 $ (31) $12,936 Comprehensive loss Net loss $(6,794) (6,794) (6,794) Other comprehensive loss, net of tax Unrealized loss on securities, net of reclassification adjustment (11) (11) (11) ------------- Comprehensive loss $(6,805) ============= Cash dividends ($.35 per share) (1,094) (1,094) Exercise of stock warrants 641,323 641 2,104 (253) 2,492 Purchase of stock (1,500) (1) (13) (14) ---------------------------------------- -------------------------------- Balances, June 30, 1998 3,127,208 3,127 10,799 11 (6,380) (42) 7,515 Comprehensive income Net income $625 625 625 Other comprehensive loss, net of tax Unrealized loss on securities (416) (416) (416) ------------- Comprehensive income $209 ============= Sale of stock 20,458 20 70 90 Purchase of stock (4) ---------------------------------------- -------------------------------- Balances, June 30, 1999 3,147,662 3,147 10,869 11 (5,755) (458) 7,814 Comprehensive loss Net loss Other comprehensive loss, net of tax $(2,070) (2,070) (2,070) Unrealized loss on securities (317) (317) (317) ------------- Comprehensive loss $(2,387) ============= ---------------------------------------- -------------------------------- Balances, December 31, 1999 3,147,662 $3,147 $10,869 $ 11 $(7,825) $(775) $ 5,427 ======================================== ================================ See notes to consolidated financial statements. 45
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Consolidated Statement of Cash Flows (In Thousands) [Enlarge/Download Table] Six Month Period Ended Year Ended June 30, December 31, ---------------------------- 1999 1999 1998 -------------------------------------------------------------------------------------------------------------- Operating Activities Net income (loss) $ (2,070) $ 625 $ (6,794) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities Provision for loan losses 1,345 (138) 4,543 Investment securities gains (79) Letter of credit valuation provision 1,069 (715) 6,778 Funding on outstanding letter of credit (450) Gain on sale of premises and equipment (21) Gain on sale of mortgage servicing rights (134) Depreciation 196 402 449 Investment securities amortization (accretion), net 31 39 (16) Valuation allowance for premises and equipment 100 Valuation allowance--affordable housing investments 331 545 1,478 Loans originated for sale (4,527) (25,474) (9,755) Proceeds from sale of loans 4,542 25,342 9,468 Amortization of net loan origination fees and points (14) (61) (26) Deferred income tax benefit (1,673) (6) (3,389) Changes in Interest payable and other liabilities 219 66 (682) Interest receivable and other assets 594 3,642 (1,361) ---------------------------------------------- Net cash provided (used) by operating activities (407) 4,246 580 ---------------------------------------------- Investing Activities Purchases of securities available for sale (25,388) (1,906) Proceeds from maturities of securities available for sale 2,463 7,189 2,476 Proceeds from sales of securities available for sale 3,451 Proceeds from sale of mortgage servicing rights 687 Net change in loans 12,069 45,683 42,270 Purchase of premises and equipment (231) (267) (111) Proceeds from sales of premises and equipment 40 56 ---------------------------------------------- Net cash provided by investing activities 14,301 27,257 46,923 ---------------------------------------------- Financing Activities Net change in Noninterest-bearing, interest-bearing demand and savings deposits (2,022) (1,430) 910 Certificates of deposit 8,442 (18,913) (33,758) Short-term borrowings (39) (2,403) (2,660) Proceeds of long-term debt 5,000 Repayment of long-term debt (5,645) (5,339) (8,601) Net change in advances by borrowers for taxes and insurance 17 (34) (248) Purchase of stock (14) Sale of stock 90 Cash dividends (156) (1,186) Proceeds from exercise of stock warrants 2,492 ---------------------------------------------- Net cash provided (used) by financing activities 753 (23,185) (43,065) ---------------------------------------------- 46
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Consolidated Statement of Cash Flows (In Thousands) (Continued) [Enlarge/Download Table] Six Month Period Ended Year Ended June 30, December 31, ---------------------------- 1999 1999 1998 --------------------------------------------------------------------------------------------------- Net Change in Cash and Cash Equivalents $14,647 $ 8,318 $ 4,438 Cash and Cash Equivalents, Beginning of Year 16,267 7,949 3,511 -------------------------------------------- Cash and Cash Equivalents, End of Year $30,914 $16,267 $ 7,949 ============================================ Additional Cash Flows Information Interest paid $ 4,211 $ 9,879 $11,900 Income tax paid (refunded) (3,013) 625 See notes to consolidated financial statements. 47
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Nature of Operations and Summary of Significant Accounting Policies The accounting and reporting policies of Fidelity Federal Bancorp (Fidelity) and its wholly-owned subsidiaries conform to generally accepted accounting principles and reporting practices followed by the thrift industry. The more significant of the policies are described below. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fidelity is a registered thrift holding company whose principal activity is the ownership and management of United Fidelity Bank, fsb (United). United operates under a national thrift charter and provides full banking services. As a federally chartered thrift, United is subject to regulation by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation. United generates mortgage, consumer and commercial loans and receives deposits from customers located primarily in Vanderburgh County, Indiana and surrounding counties. Fidelity's loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Two of United's wholly-owned subsidiaries, Village Management Corporation and Village Housing Corporation (collectively, the Affordable Housing Group), are in the business of owning, renting and managing affordable housing projects. United's other wholly-owned subsidiaries are Village Capital Corporation, which primarily receives consulting fees for packaging various multi-family deals to be financed and completed, and Village Insurance Corporation, which offers an array of insurance products. Fidelity's other subsidiary is Village Affordable Housing Corporation, which is dormant. The Affordable Housing Group has discontinued the development of real estate, but continues actively managing affordable housing projects. Consolidation--The consolidated financial statements include the accounts of Fidelity and its subsidiaries after elimination of all material intercompany transactions. Securities available for sale are carried at fair value, with unrealized gains and losses reported separately in accumulated other comprehensive income, net of tax. Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses of securities are recorded on the specific-identification method. Loans held for sale are carried at the lower of aggregate cost or market value. Market is determined using the aggregate method. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income, based on the difference between estimated sales proceeds and aggregate cost. 48
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Loans are carried at the principal amount outstanding. Interest income is accrued on the principal balances of loans. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed when considered uncollectible. Interest income is subsequently recognized only to the extent cash payments are received. Certain loan fees and related direct costs are being deferred and amortized over the lives of the loans as an adjustment of yield on the loans. Allowance for loan losses and letter of credit valuation allowance are maintained to absorb losses based on management's continuing review and evaluation of the loan and letter of credit portfolios and its judgment as to the impact of economic conditions on the portfolios. The evaluation by management includes consideration of past loss experience, changes in the composition of the portfolios, the current condition and amount of loans and letters of credit outstanding and the probability of collecting all amounts due. Impaired loans are measured by the present value of expected future cash flows, or the fair value of the collateral of the loan, if collateral dependent. The determination of the adequacy of the allowance for loan losses and the letter of credit valuation allowance is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of December 31, 1999, the allowance for loan losses and the letter of credit valuation allowance is adequate based on information currently available. A worsening or protracted economic decline in the area within which Fidelity operates could affect the possibility of additional losses due to credit and market risks and could create the need for additional loss reserves. Premises and equipment are carried at cost, net of accumulated depreciation. Depreciation is computed using the straight-line method based principally on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations. Federal Home Loan Bank (FHLB) stock is a required investment for institutions that are members of the FHLB system. The required investment in the common stock is based on a predetermined formula. Income tax in the consolidated statement of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes. Fidelity files consolidated income tax returns with its subsidiaries. Fee income on real estate development and management in the consolidated statement of income is attributable to activities of the Affordable Housing Group. The fees are recognized when earned under the applicable agreements and when collectibility is assured. Fee income related to insurance services is recognized when earned and collected. Mortgage servicing rights on originated loans are capitalized by allocating the total cost of the mortgage loans between the mortgage servicing rights and the loans based on their relative fair values. Capitalized servicing rights, which includes purchased servicing rights, are amortized in proportion to and over the period of estimated servicing revenues. 49
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Stock options are granted for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. Fidelity accounts for and will continue to account for stock option grants in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognized no compensation expense for the stock option grants. Earnings per share have been computed based upon the weighted average common shares outstanding during the year. >> Restriction on Cash and Due From Banks United is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 1999 was $378. >> Investment Securities Available for Sale [Enlarge/Download Table] Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------------------- December 31, 1999 Mortgage-backed securities $25,589 $(1,284) $24,305 ======================================================= June 30, 1999 Mortgage-backed securities $28,083 $(758) $27,325 ======================================================= Securities with a carrying value of $23,650 and $27,322 were pledged at December 31, 1999 and June 30, 1999 to secure certain deposits and for other purposes as permitted or required by law. Proceeds from sales of investment securities available for sale during the year ended June 30, 1998 were approximately $3,451. Gross gains of approximately $79 were realized on those sales. There were no sales of investment securities available for sale during the six months ended December 31, 1999 and the year ended June 30, 1999. 50
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Loans and Allowance [Enlarge/Download Table] December 31, June 30, 1999 1999 ----------------------------------------------------------------------------------------- Real estate mortgage loans First mortgage loans Conventional $ 48,845 $ 49,733 Construction 1,867 6,732 Commercial 8,576 14,140 Multi-family 3,629 7,597 First mortgage real estate loans purchased 1,899 2,061 Commercial loans--other than secured by real estate 4,154 6,076 Consumer and home equity loans 29,970 27,618 -------------------------- Total loans 98,940 113,957 Allowance for loan losses (2,021) (3,521) -------------------------- Total loans, net of the allowance for loan losses $ 96,919 $ 110,436 ========================== Multi-family first mortgage loans are loans made to affordable housing developments. An additional $1,529 and $5,937 in multi-family loans is included in construction loans at December 31 and June 30, 1999. [Enlarge/Download Table] Six Month Period Ended Year Ended June 30 December 31, ------------------------ Allowance for Loan Losses 1999 1999 1998 ----------------------------------------------------------------------------------------------- Balances, beginning of period $3,521 $3,049 $1,781 Provision for losses 1,345 (138) 4,543 Transfer from letter of credit valuation reserve 895 Recoveries on loans 32 53 24 Loans charged off (2,877) (338) (3,299) --------------------------------------- Balances, end of period $2,021 $3,521 $3,049 ======================================= 51
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Information on impaired loans is summarized below: [Enlarge/Download Table] December 31, June 30, 1999 1999 ------------------------------------------------------------------------------------- Impaired loans with an allowance $ 7,351 $16,533 ============================= Allowance for impaired loans (included in allowance for loan losses) $ 1,055 $ 1,842 ============================= December 31, June 30, 1999 1999 ------------------------------------------------------------------------------------- Average balance of impaired loans $13,548 $13,868 Interest income recognized on impaired loans 663 1,396 Cash-basis interest included above 614 1,396 52
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Letter of Credit Valuation Allowance In the year ended June 30, 1998, Fidelity recorded specific reserves related to letters of credit issued by Fidelity and United of approximately $6,800 primarily related to the permanent financing for certain affordable housing projects. Multifamily letters of credit, an off-balance sheet item, carry the same risk characteristics as conventional loans and totaled $44,463 and $45,000 at December 31 and June 30, 1999, respectively. [Download Table] June 30, December 31, ----------------------- 1999 1999 1998 ------------------------------------- Letter of credit valuation allowance Balances, beginning of year $5,168 $6,778 Provision 1,069 (715) $6,778 Transfer to allowance for loan losses (895) Funding on outstanding letter of credit (450) ------------------------------------- Balances, end of year $5,787 $5,168 $6,778 ===================================== During the six months ended December 31, 1999, Fidelity disbursed $450 to holders of a bond obligation of a limited partnership in which Fidelity is a general partner. This was done in an effort to place the partnership's debt service coverage ratio at a level that would support full repayment of the obligation. Fidelity funded one letter of credit totaling $4,200 during the year ended June 30, 1999. The valuation allowance for this letter of credit, totaling $895 was transferred to the allowance for loan losses. >> Premises and Equipment [Download Table] December 31, June 30, 1999 1999 ------------------------------------------------------------------------------- Land $1,620 $1,620 Building and land improvements 5,369 5,337 Furniture, fixtures and equipment 2,455 2,256 -------------------------------------- Total cost 9,444 9,213 Accumulated depreciation (3,717) (3,521) -------------------------------------- Net $5,727 $5,692 ====================================== 53
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Other Assets and Investments in Limited Partnerships Included in other assets at December 31, 1999 and June 30, 1999 are investments of $1,302 and $1,652 in limited partnerships which are organized to build, own and operate apartment complexes. The investments at December 31, 1999 are as follows: Percentage and Type of Amount of Number of Partnership Interest Investment Partnerships ----------------------------------------------------------- 1%--General $ 23 17 1%--General and 47%--Limited 319 1 1%--General and 39%--Limited 360 1 10%--Limited 362 1 10%--Limited 147 1 99%--Limited 91 2 Fidelity records income on the equity method in the income and losses of the limited partnerships, which resulted in losses of $25, $246 and $87 during the period ended December 31, 1999 and years ended June 30, 1999 and 1998. In addition to recording its equity in the losses of these projects, Fidelity has recorded the benefit of low-income housing tax credits of $193, $460 and $508 for the period ended December 31, 1999 and years ended June 30, 1999 and 1998. Combined condensed financial statements (unaudited) for the limited partnerships as of December 31, 1999 and June 30, 1999 and for the six months ended December 31, 1999 and years ended June 30, 1999 and 1998 are as follows: December June 30, 31, 1999 1999 -------------------------------------------------------------------------- Combined condensed balance sheet (unaudited) Assets Cash $ 322 $ 487 Land and property 54,531 53,424 Other assets 1,733 1,516 ------------------------- Total assets $56,586 $55,427 ========================= Liabilities Notes payable $40,015 $38,157 Other liabilities 2,575 2,732 ------------------------- Total liabilities 42,590 40,889 Partners' equity 13,996 14,538 ------------------------- Total liabilities and partners' equity $56,586 $55,427 ========================= 54
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) [Enlarge/Download Table] Six Months Ended Year Ended June 30, December 31, ----------------------- 1999 1999 1998 ---------------------------------------------------------------------------------------------- Combined condensed statement of operations (unaudited) Total revenue $ 3,481 $ 5,734 $ 5,259 Total expenses 4,539 7,161 6,784 ------------------------------------ Net loss $(1,058) $(1,427) $(1,525) ==================================== Approximately $2,459 and $3,042 of the notes payable are due to Fidelity from these partnerships at December 31, 1999 and June 30, 1999. Of the remaining balance, specific reserves of $334 and $1,700 are included in the allowance for loan losses at December 31 and June 30, 1999. Fidelity wrote down the investments in limited partnerships by $331 and $1,478 during the six months ended December 31, 1999 and years ended June 30, 1999 and 1998, based on the performance of the underlying real estate operations. Included in other assets is interest receivable as follows: December 31, June 30, 1999 1999 -------------------------------------------------------------------------------- Interest receivable on loans $570 $707 Interest receivable on investment securities and other 170 180 ----------------------- Total interest receivable $740 $887 ======================= >> Deposits December 31, June 30, 1999 1999 ------------------------------------------------------------------------------- Non-interest bearing transaction accounts $ 6,593 $ 6,223 Interest-bearing transaction accounts 17,766 18,829 Money market deposit accounts 2,072 2,715 Savings accounts 4,559 5,245 Certificates of $100 or more 22,974 17,105 Other certificates and time deposits 81,052 78,479 ----------------------- Total deposits $135,016 $128,596 ======================= 55
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Certificates maturing in years ending December 31: 2000 $ 56,583 2001 39,988 2002 5,896 2003 1,372 2004 185 Thereafter 2 ----------- $104,026 =========== >> Short-Term Borrowings December 31, June 30, 1999 1999 --------------------------------------------------------------- Treasury tax and loan note option $89 $128 =========================== >> Long-Term Debt [Enlarge/Download Table] December 31, June 30, 1999 1999 ----------------------------------------------------------------------------------------------------- Note payable, 6.78%, adjusted annually, payable $15 per month, including interest, due April 2009, secured by specific multi-family mortgages $ 2,182 Note payable, 8.48% adjusted annually, payable $8 per month, including interest, due September 2010, secured by specific multi-family mortgages $ 985 990 Note payable, 8.48% adjusted annually, payable $12 per month, including interest, due September 2010, secured by specific multi-family mortgages 1,510 1,517 Note payable, 9.50%, interest paid quarterly, due June 2001, secured by United stock 2,000 2,000 Junior subordinated notes, 9.125%, interest paid semi-annually, due April 2001, unsecured 1,476 1,476 Junior subordinated notes, 9.25%, interest paid semi-annually, due January 2002, unsecured 1,494 1,494 Senior subordinated notes, 10.00%, interest paid semi-annually, due June 2005, unsecured 7,000 7,000 Federal Home Loan Bank advances, due at various dates through 2003 (weighted average rates of 6.59% and 6.50% at December 31 and June 30, 1999) 9,039 12,490 -------------------------- Total long-term debt $23,504 $29,149 ========================== 56
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) The terms of a security agreement with the FHLB require United to pledge as collateral qualifying first mortgage loans in an amount equal to at least 125% of these advances and all stock in the FHLB or eligible securities with a market value in an amount equal to at least 110% of these advances. In addition to first mortgage loans pledged of $11,299, Fidelity had $23,522 of investment securities pledged at December 31, 1999. Certain advances are subject to restrictions or penalties in the event of prepayment. All long-term debt, except for Federal Home Loan Bank advances, is debt of the parent company and totals $14,465. The scheduled principal reduction of borrowings at December 31, 1999, is as follows: 2000, $1,162; 2001, $7,074; 2002, $5,858; 2003, $34; 2004, $36; and thereafter, $9,340. >> Loan Servicing Loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of mortgage loans serviced for others totaled $40,693, $38,646 and $19,481 at December 31, 1999 and June 30, 1999 and 1998. The aggregate fair value of capitalized mortgage servicing rights at December 31, 1999 and June 30, 1999 approximated $509 and $483. Comparable market prices were used to estimate fair value. June 30, December 31, ------------------- 1999 1999 1998 --------------------------------- Mortgage servicing rights Balances, beginning of year $409 $226 $721 Servicing rights capitalized 45 250 127 Amortization of servicing rights (24) (67) (69) Sale of servicing rights (553) --------------------------------- Balances, end of year $430 $409 $226 ================================= 57
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Income Tax [Enlarge/Download Table] Six Month Period Ended Year Ended June 30, December 31, ----------------------- 1999 1999 1998 ------------------------------------------------------------------------------------------------ Income tax benefit Currently payable Federal $(330) $(1,803) State $ 2 (2) (2) Deferred Federal (1,356) (39) (2,382) State (317) 33 (1,007) ------------------------------------- Total income tax benefit $(1,671) $(338) $(5,194) ===================================== Reconciliation of federal statutory to actual tax benefit Federal statutory income tax at 34% $(1,272) $ 98 $(4,076) Effect of state income taxes (208) 21 (666) Affordable housing tax credits and other (191) (457) (452) ------------------------------------- Actual tax benefit $(1,671) $(338) $(5,194) ===================================== 58
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) A cumulative deferred tax asset is included in other assets. The components of the asset are as follows: [Enlarge/Download Table] December 31, June 30, 1999 1999 --------------------------------------------------------------------------------------------------------- Assets Differences in accounting for certain accrued liabilities $ 12 $ 16 Allowance for loan losses 2,391 1,252 Letter of credit allowance for loss 926 916 Loan fees 32 68 Unrealized gain/loss on available-for-sale securities 509 300 Alternative minimum tax credit 147 147 Low income housing credit carryforward 1,337 1,145 State net operating loss carryforward 805 703 Federal net operating loss carryforward 761 382 Other 39 6 --------------------------------------- Total assets 6,959 4,935 --------------------------------------- Liabilities Depreciation (40) (40) State income tax (273) (239) Differences in basis of FHLB stock (66) (66) Basis differential on certain partnership interests (1,038) (938) Differences in accounting for mortgage servicing rights (170) (162) --------------------------------------- Total liabilities (1,587) (1,445) --------------------------------------- $5,372 $3,490 ======================================= At December 31, 1999, Fidelity has federal net operating loss carryforwards for tax purposes totaling $2,239. These loss carryforwards expire in varying amounts through the year 2019. Fidelity has state net operating loss carryforwards for tax purposes of $9,470. These loss carryforwards expire in varying amounts through the year 2014. Fidelity has affordable housing credit carryforwards of $1,337. These carryforwards expire in varying amounts through the year 2019. In addition, Fidelity has an alternative minimum tax credit carryforward of $147. Retained earnings include approximately $1,870 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses, including redemption of bank stock or excess dividends, or loss of "bank" status, would create income for tax purposes only, which income would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $635. The Company has recorded a deferred tax asset of $1,566 for the expected benefit to be realized from the federal and state net operating loss carryovers discussed above. Realization depends upon the ability of the Company to generate sufficient taxable income before the expiration of the carryover periods. The amount that management considers to be realizable is reevaluated at each financial statement date. That estimate could be reduced in the near term if management lowers its estimate of future taxable income during the carryover period. 59
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Commitments and Contingent Liabilities In the normal course of business, there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. Fidelity's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. Fidelity uses the same credit policies in making such commitments as it does for instruments that are included on the consolidated balance sheet. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Fidelity evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Fidelity upon extension of credit, is based on management's credit evaluation. Collateral held varies, but may include residential real estate, income-producing commercial properties, or other assets of the borrower. At December 31 and June 30, 1999, commitments to extend credit, which represent financial instruments whose contract amount represents credit risk, were $8,098 and $5,372. Fidelity has issued standby letters of credit on affordable housing developments in which one of Fidelity's subsidiaries has a partnership interest. The letters of credit secure tax exempt bond issues and other permanent financing of limited partnerships in which one of Fidelity's subsidiaries owns a one percent general partner interest. The amount outstanding on these letters of credit at December 31 and June 30, 1999 was $16,240 and $16,666. Fidelity has also issued standby letters of credit on affordable housing developments in which the borrowers are not affiliated with Fidelity. The letters of credit secure tax-exempt bond issues and other permanent financing of limited partnerships. The amount outstanding on the letters of credit at December 31 and June 30, 1999 was $28,223. Fidelity also has standby letters of credit to guarantee the performance of a customer to a third party. The amount outstanding on the standby letters of credit at December 31 and June 30, 1999 was $115 and $160. Fidelity, in its role as general partner on various affordable housing developments through its subsidiaries, is committed to advance certain amounts to limited partnerships. These commitments potentially include short-term loans to the limited partners or an increase in the general partner's equity investment. Fidelity has entered into change in control agreements with five of its employees which provide for the continuation of a multiple of the employee's existing salary and certain benefits for a two-year period of time under certain conditions following a change in control. The agreements become effective if there is a change in control that is accompanied by a significant change in job responsibilities and/or compensation. Fidelity and its subsidiaries are also subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of Fidelity. 60
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Dividend and Capital Restrictions Fidelity's dividend policy is to pay cash or distribute stock dividends when its Board of Directors deems it to be appropriate, taking into account Fidelity's financial condition and results of operations, economic and market conditions, industry standards, and other factors, including regulatory capital requirements of its savings bank subsidiary. Fidelity is not subject to any regulatory restrictions on payments to its stockholders. Fidelity's primary source of income is dividends from United. United has entered into a Supervisory Agreement (Agreement) with the OTS. One of the provisions of the Agreement restricts the payments of dividends from United to Fidelity without prior written OTS approval. The OTS, in 1999, permitted the payment of dividends to assist Fidelity in meeting interest payments on its outstanding debt; however, there can be no assurance that this approval will be granted going forward. Fidelity is uncertain when it will pay dividends in the future and the amount of such dividends, if any. >> Regulatory Capital United is subject to various regulatory capital requirements administered by the federal banking agencies and is assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations: total risk adjusted capital, Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures of the entity. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations. At December 31 and June 30, 1999, United is categorized as well capitalized and met all subject capital adequacy requirements at those dates. There are no specific targets for capital levels included or agreed to within the Supervisory Agreement ("Agreement") between United and the OTS, only a requirement that United include capital targets within a strategic plan. The original strategic plan developed by United established capital targets of 8.25% for tangible, leverage and core capital and 16% for risk-based capital. The Agreement did set a target level to reduce its classified assets to 50% of core capital plus the allowance for loan losses and the letter of credit valuation reserves by December 31, 1999. At December 31, 1999, United's tangible, leverage and core capital was 6.8% and risk-based capital was 14.3%. United's classified assets to core capital plus the allowance for loan losses and letter of credit valuation reserves was 85.8% at December 31, 1999. 61
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) United's actual and required capital amounts and ratios are as follows: [Enlarge/Download Table] Required for To Be Well Actual Adequate Capital* Capitalized* ------------------------------------------------------------------ Amount Ratio Amount Ratio Amount Ratio ------------------------------------------------------------------ As of December 31, 1999 Total risk-based capital* (to risk- weighted assets) $17,603 14.3% $ 9,839 8.0% $12,298 10.0% Tier 1 capital* (to risk-weighted assets) 11,167 9.1 4,919 4.0 7,379 6.0 Core capital* (to adjusted total assets) 11,167 6.8 6,593 4.0 8,241 5.0 As of June 30, 1999 Total risk-based capital* (to risk- weighted assets) 20,591 15.4 10,718 8.0 13,398 10.0 Tier 1 capital* (to risk-weighted assets) 14,033 10.5 5,359 4.0 8,039 6.0 Core capital* (to adjusted total assets) 14,033 8.5 6,615 4.0 8,269 5.0 *As defined by regulatory agencies 62
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Other Restrictions United entered into a Supervisory Agreement with the OTS on February 3, 1999 which is in effect until terminated, modified or suspended by the OTS. Under the terms of the Agreement, United must develop and submit to the OTS for approval a strategic plan which includes, at a minimum, capital targets; specific strategies; the completion of quarterly projections for a three-year period; concentration limits for all assets; a plan for reducing United's concentrations of high risk assets; review of infrastructure, staffing and expertise with respect to each area of United's operations; and capital planning. The strategic plan was submitted and approved by the OTS. In addition, United must, among other things, take other specified actions within specified time frames. These actions include, among others; the development of and adherence to a written plan for the reduction of classified and criticized assets to specified levels; maintenance of sufficient allowances for loan and lease losses; quarterly reporting to the OTS relating to classified assets and workout plans; restriction of its growth in total assets to an amount not in excess of an amount equal to the net interest credited on deposit liabilities without prior OTS approval; limiting growth of its consumer loan portfolio to an amount not in excess of 25 percent of its total assets; development of a written plan to divest all real estate held for development; adoption of policies and procedures designed to avoid potential conflicts of interest; development of policies and procedures to increase liquidity; adoption of a policy with respect to its mortgage brokerage activity, which would address its operation and methods for risk management; development of a policy to administer the general partnerships held by Village Housing Corporation; and maintenance of a fully staffed and functioning internal audit and independent loan review processes. United is also prohibited from taking certain actions without prior approval, including but not limited to: investing in, purchasing, or committing to make or purchase any additional commercial loans or commercial real estate loans; requesting permission from the OTS to engage in additional commercial loan activity until United has hired an experienced loan staff and credit analyst; refinancing or extending classified or criticized commercial loans without the prior approval of the OTS; engaging in "sub prime" consumer lending activities; making capital distributions, including dividends to Fidelity; making any additional equity investments; developing any real estate without specific approval of the OTS; acquiring any additional real estate for future development; selling any asset to an affiliated party without prior written approval of the OTS; engaging in any new activities not included in the to-be developed strategic plan; and, refinancing or extending any non-classified or criticized commercial loan if additional funds are extended. United is also required to obtain OTS approval prior to adding or replacing any director or senior executive officer. United is also prohibited, without prior OTS approval, from entering into any contract with any executive officer or director which would require a "golden parachute" payment and from increasing the executive benefit package in an amount in excess of the annual cost of living. United is also required to develop a plan to reduce employee turnover, build an experienced staff, and provide for management succession. Management of United has begun taking, or refraining from taking, as applicable, some of the actions requested by the OTS. United was in compliance with all of the provisions of the Agreement at December 31, 1999, except for the targeted capital levels it set forth in its strategic plan and the targeted reduction in classified asset levels set forth in the Agreement. 63
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Stockholders' Equity In connection with Fidelity's first debt and equity rights offering completed April 30, 1994, Fidelity reserved 415,500 shares of its common stock for issuance upon exercise of 1,500 outstanding warrants. Each warrant represents the right to purchase 277 shares of common stock. The warrants were valued at $100 per warrant, carrying an exercise price of $6.22 per share, and expire on April 30, 2004. At December 31, 1999, a total of 397,218 of the shares originally reserved had been issued and 18,282 remained reserved and unissued. In connection with Fidelity's second debt and equity offering completed on January 31, 1995, Fidelity reserved 346,500 shares of its common stock for issuance upon exercise of 1,500 outstanding warrants. Each warrant represents the right to purchase 231 shares of common stock. The warrants were valued at $100 per warrant, carrying an exercise price of $8.93 per share, and expire on January 31, 2005. At December 31, 1999, a total of 337,029 of the shares originally reserved had been issued and 9,471 remained reserved and unissued. On September 22, 1997, Fidelity filed Schedule 13E4 with the Securities and Exchange Commission for a warrant tender offer to holders of its 1994 and 1995 warrants. The offer and withdrawal rights expired on October 31, 1997. Fidelity decreased the exercise price, upon the terms and subject to the conditions set forth in the Letter of Transmittal, to $3.70 for the 1994 warrants and $4.04 for the 1995 warrants. The proceeds from the exercise of the warrants under this offer totaled $2,500. >> Benefit Plans Fidelity is a participant in the Financial Institutions Retirement Fund (FIRF). This defined-benefit plan is a multi-employer plan; separate actuarial valuations are not made with respect to each participating employer. According to FIRF administrators, the market value of the fund's assets exceeded the value of vested benefits in the aggregate as of June 30, 1999, the date of the latest actuarial valuation. The plan provides pension benefits for substantially all of Fidelity's employees. No expense was recorded for Fidelity during the six months ended December 31, 1999 and the years ended June 30, 1999 and 1998. Fidelity has a retirement savings 401(k) plan in which substantially all employees may participate. Fidelity matches employees' contributions at the rate of 25% up to 6% of the participant's salary. Fidelity's expense for the plan was $8, $17 and $19 for the six months ended December 31, 1999 and the years ended June 30, 1999 and 1998. 64
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Related Party Transactions Fidelity has entered into transactions with certain directors, executive officers, significant stockholders and limited partnerships in which Fidelity is an investor and their affiliates and associates. Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans, as defined, to such related parties were as follows: Balances, July 1, 1999 $5,909 Loans charged off (1,569) New loans, including renewals 162 Payments, etc., including renewals (1,510) -------- Balances, December 31, 1999 $2,992 ======== Total internally classified related party loans included in the total related party loans at December 31 and June 30, 1999 were $2,943 and $6,200. General reserves for these classified related party loans totaled $427 and are included in the allowance for loan losses. >> Stock Option Plans Under Fidelity's stock option plans, Fidelity grants stock option awards which vest and become exercisable at various dates. During the six months ended December 31, 1999 and years ended June 30, 1999 and 1998, Fidelity authorized the grant of options for up to 3,000, 12,500 and 71,531 shares of its common stock. The exercise price of each option, which has a ten year life, was greater than the market price of Fidelity's stock on the date of grant; therefore, no compensation expense was recognized. Although Fidelity has elected to follow APB No. 25, SFAS No. 123 requires proforma disclosures of net income and earnings per share as if Fidelity had accounted for its employee stock options under that Statement. The fair value of each option grant was estimated on the grant date using an option-pricing model with the following assumptions: [Enlarge/Download Table] Six Months Ended Year Ended Year Ended December 31, June 30, June 30, 1999 1999 1998 ---------------------------------------------------------------------------------------------- Risk-free interest rates 6.0% 5.2% 7.0% Dividend yields 0.0 0.0 2.50 Volatility factors of expected market price of common stock 28.9 26.9 27.4 Weighted-average expected life of the options 10 years 10 years 9 years 65
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Under SFAS No. 123, compensation cost is recognized in the amount of the estimated fair value of the options and amortized to expense over the options' vesting period. The pro forma effect on net income and earnings per share of this statement is as follows: Six Months Year Year Ended Ended Ended December 31, June 30, June 30, 1999 1999 1998 ------------------------------------------------------------------------------- Net income (loss) As reported $(2,070) $625 $(6,794) Pro forma $(2,076) $611 $(6,851) Basic earnings (loss) per share As reported $(.66) $.20 $(2.30) Pro forma $(.66) $.20 $(2.32) Diluted earnings (loss) per share As reported $(.66) $.20 $(2.32) Pro forma $(.66) $.20 $(2.34) The following is a summary of the status of the Fidelity's stock option plans and changes in the plans as of and for the six months ended December 31, 1999 and the years ended June 30, 1999 and 1998. Directors' Plan In August 1993, the Board of Directors of Fidelity adopted a non-qualified stock option plan (Directors' Plan) which provides for the grant of non-qualified stock options to individuals who are directors of Fidelity, or any of its subsidiaries. The Directors' Plan provides for the grant of non-qualified stock options to acquire shares of common stock of Fidelity for the price of not less than $2 above the average of the high and low bid quotations, as reported by NASDAQ, for the common stock of Fidelity for the five trading days immediately preceding the date the option is granted. A total of 233,779 shares have been reserved for issuance under the Directors' Plan. 66
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) At December 31, 1999, there were 115,486 options available for grant. A summary of the stock options activity for the Directors' Plan is as follows: December 31, June 30, 1999 1999 1998 ----------------------------------------------------------------------------- Shares under option Outstanding at beginning of year 118,293 118,293 86,762 Granted 31,531 Outstanding at end of year 118,293 118,293 118,293 Exercisable at end of year 118,293 118,293 118,293 Weighted option price per share Exercisable $ 7.92 $ 7.92 $ 7.92 Granted 11.81 Weighted-average fair value of options $1.38 granted during the year (per option) 1995 Key Employees' Stock Option Plan The 1995 Key Employees' Stock Option Plan (1995 Plan) provides for the granting of either incentive stock options (ISOs) pursuant to Section 422A of the Internal Revenue Code of 1986, as amended (Code), or stock options which do not qualify as incentive stock options (ISOs), or any combination thereof. Options may be granted to key employees and officers of Fidelity and its subsidiaries. The option price per share for ISOs will not be less than the fair market value of a share on the date the option is granted. The option price per share for ISOs granted to an employee owning 10 percent or more of the common stock of Fidelity will be not less than 110 percent of the fair market value of a share on the date the option is granted. The option price per share for ISOs will be determined by the compensation committee, but may not be less than 100 percent of the fair market value on the date of grant. A total of 236,500 shares have been reserved for issuance under the 1995 Plan. 67
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) At December 31, 1999, there were 189,670 options available for grant. A summary of the stock options activity for the 1995 Plan is as follows: December 31, June 30, 1999 1999 1998 ----------------------------------------------------------------------------- Shares under option Outstanding at beginning of year 77,278 64,220 80,443 Granted 3,000 23,058 40,000 Forfeited/expired (10,000) (56,223) Outstanding at end of year 80,278 77,278 64,220 Exercisable at end of year 47,620 47,020 36,176 Weighted option price per share Exercisable $ 10.16 $ 10.26 10.68 Granted 3.01 3.22 10.81 Weighted-average fair value of options granted during the year (per option) $1.64 $1.43 $1.53 >> Earnings Per Share Earnings per share were computed as follows: [Enlarge/Download Table] Six Month Period Ended Year Ended June 30 December 31, --------------------------------------------------------------- 1999 1999 1998 ------------------------------------------------------------------------------------------------- Weighted Per- Weighted Per- Weighted Per- Average Share Average Share Average Share Income Shares Amount Income Shares Amount Loss Shares Amount --------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $(2,070) $625 $(6,794) ---------- -------- ---------- Basic Earnings (Loss) Per Share Income available to common stockholders (2,070) 3,147,662 $(.66) 625 3,143,179 $.20 (6,794) 2,956,157 $(2.30) ------------------------------------------------------------------------------------------------- Diluted Earnings (Loss) Per Share Income available to common stockholders and assumed conversions $(2,070) 3,147,662 $(.66) $625 3,143,179 $.20 $(6,794) 2,956,157 $(2.30) ================================================================================================= 68
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Options to purchase 165,913, 152,694 and 55,714 shares of common stock at an average price of $8.56 for the six months ended December 31, 1999, $8.33 for the year ended June 30, 1999, and $11.81 and $10.81 for the year ended June 30, 1998 were outstanding at December 31, 1999 and June 30, 1999 and 1998 but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. For the six months and years ended December 31, and June 30, 1999 and 1998, the effect of outstanding options and warrants were anti-dilutive. >> Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Cash and Cash Equivalents--The fair value of cash and cash equivalents approximates carrying value. Interest-bearing Time Deposits--The fair value of interest-bearing time deposits approximates carrying value. Investment Securities--Fair values are based on quoted market prices. Loans--For both short-term loans and variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans, including one-to-four family residential, are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Interest Receivable/Payable--The fair values of interest receivable/payable approximate carrying values. FHLB Stock--The fair value is estimated to be the carrying value, which is par. All transactions in the capital stock of the FHLB of Indianapolis are executed at par. Deposits--The fair values of non-interest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits. Short-Term Borrowings--The fair value of these borrowings is estimated using rates currently available to Fidelity for debt with similar terms and remaining maturities. These instruments adjust on a periodic basis and the carrying amount represents the fair value. 69
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Long-Term Debt--The fair value of these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt. Long-term debt consists of adjustable instruments tied to a variable market interest rate. Off-Balance-Sheet Commitments--Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature. The fair value of the loan commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The carrying amounts of the commitments to purchase and originate mortgage loans and to sell mortgage loans, which are immaterial, are reasonable estimates of the fair value of these financial instruments. The carrying amount of the standby letters of credit, which consist of a letter of credit valuation allowance of $5,787, is a reasonable estimate of the fair value of those off-balance sheet items. The estimated fair values of Fidelity's financial instruments are as follows: [Enlarge/Download Table] December 31, June 30, 1999 1999 -------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ---------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 30,914 $ 30,914 $ 16,267 $ 16,267 Investment securities available for sale 24,305 24,305 27,325 27,325 Loans, net 96,919 96,194 110,436 110,594 Interest receivable 740 740 887 887 FHLB stock 3,920 3,920 3,920 3,920 Liabilities Deposits 135,016 135,077 128,596 128,856 Short-term borrowings 89 89 128 128 Long-term debt 23,504 23,515 29,149 28,896 Interest payable 329 329 272 272 Standby letters of credit 5,787 5,787 5,168 5,168 70
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Condensed Financial Information (Parent Company Only) Presented below is condensed financial information as to financial position, results of operations and cash flows of Fidelity: Condensed Balance Sheet December 31, June 30, 1999 1999 ------------------------------------------------------------------------------ Assets Cash and cash equivalents $ 444 $ 2,220 Investment in common stock of subsidiaries 12,541 14,848 Loans 2,161 3,808 Subordinated debentures and other loan receivables from subsidiaries 4,875 4,875 Income tax receivable 1,723 1,744 Other assets 471 585 ------------------------- Total assets $22,215 $28,080 ========================= Liabilities Long-term debt $14,948 $17,144 Letter of credit valuation allowance 1,670 2,855 Other liabilities 170 267 ------------------------- Total liabilities 16,788 20,266 Stockholders' Equity 5,427 7,814 ------------------------- Total liabilities and stockholders' equity $22,215 $28,080 ========================= 71
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Condensed Statement of Income [Enlarge/Download Table] Six Month Period Ended Year Ended June 30, December 31, ---------------------- 1999 1999 1998 -------------------------------------------------------------------------------------------- Income Dividends from subsidiaries $ 150 $ 875 Interest income $ 485 1,010 1,089 Other income 2 8 10 -------------------------------------- Total income 487 1,168 1,974 -------------------------------------- Expense Interest expense 777 1,400 1,402 Provision for loan losses 284 424 1,092 Letter of credit valuation provision (735) (434) 3,289 Other expenses 293 461 555 -------------------------------------- Total expense 619 1,851 6,338 -------------------------------------- Loss Before Income Tax and Equity in Undistributed (Distributions in Excess of) Income of Subsidiaries (132) (683) (4,364) Income Tax Benefit (52) (330) (2,075) -------------------------------------- Loss Before Equity in Undistributed (Distributions in Excess of) Income of Subsidiaries (80) (353) (2,289) Equity in Undistributed (Distributions in Excess of) Income of Subsidiaries (1,990) 978 (4,505) -------------------------------------- Net Income (Loss) $(2,070) $ 625 $(6,794) ====================================== 72
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Condensed Statement of Cash Flows [Enlarge/Download Table] Six Month Period Year Ended June 30, Ended December 31, ------------------------ 1999 1999 1998 ------------------------------------------------------------------------------------------------------ Operating Activities Net income (loss) $(2,070) $ 625 $(6,794) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities Depreciation and amortization 8 24 40 Provision for loan losses 284 424 1,092 Letter of credit valuation provision (735) (434) 3,289 Funding on outstanding letter of credit (450) Undistributed net income of subsidiaries 1,990 (978) 4,505 (Increase) decrease in other assets 127 371 (1,611) (Increase) decrease in other liabilities (97) 123 (1,045) ------------------------------------------ Net cash provided (used) by operating activities (943) 155 (524) ------------------------------------------ Investing Activities Decrease in interest-bearing deposits in other banks 6 Capital contributions to subsidiaries (1,094) (1,400) Advance on note to subsidiary (250) Principal payments received on notes from subsidiaries 1,188 Net change in loans 1,363 (160) 1,084 ------------------------------------------ Net cash provided (used) by investing activities 1,363 (60) (566) ------------------------------------------ Financing Activities Repayment of long-term debt (2,196) (51) (52) Proceeds from issuance of long-term debt 2,000 Proceeds from exercise of stock warrants 2,492 Cash dividends (156) (1,186) Purchase of treasury stock (14) Sale of common stock 90 ------------------------------------------ Net cash provided (used) by financing activities (2,196) 1,883 1,240 ------------------------------------------ Change in Cash and Cash Equivalents (1,776) 1,978 150 Cash and Cash Equivalents, Beginning of Year 2,220 242 92 ------------------------------------------ Cash and Cash Equivalents, End of Year $ 444 $2,220 $ 242 ========================================== 73
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Business Segment Information Fidelity operates principally in two industries, banking and real estate development and management. Through United Fidelity, Fidelity offers traditional banking products, such as checking, savings and certificates of deposit, as well as mortgage, commercial and consumer loans. Through the Affordable Housing Group, Fidelity is or was involved in various aspects of developing, building, renting and managing affordable housing units. Banking revenue consists primarily of interest and fee income, while real estate development and management fee income consists primarily of real estate management, investment banking, development and other fees. All revenue is earned in the United States. Operating profit is total revenue less operating expenses. In computing operating profit, income taxes have been deducted. Identified assets are principally those used in each segment and are all held in the United States. Real estate development and management activities conducted by Fidelity are not asset intensive. 74
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) Presented below is condensed financial information relating to Fidelity's business segments: [Enlarge/Download Table] December 31, 1999 --------------------------------------------------------------------------------- Real Estate Development Banking & Management Eliminations Total ----------------------------------------------------------------------------------------------------------------- Interest income $ 6,019 $ 3 $ (3) $ 6,019 Other income 854 167 (20) 1,001 Interest expense 4,268 3 (3) 4,268 Other expense 4,731 437 (20) 5,148 Provision for loan losses 1,345 1,345 Loss before tax (3,471) (270) (3,741) Income tax benefit (1,283) (388) (1,671) Total assets 172,044 3,089 (3,676) 171,457 Capital expenditures 231 231 Depreciation and amortization 192 4 196 June 30, 1999 ------------------------------------------------------------------------------ Real Estate Development Banking & Management Eliminations Total -------------------------------------------------------------------------------------------------------------- Interest income $ 14,175 $ 197 $ (278) $ 14,094 Other income 2,368 335 (40) 2,663 Interest expense 9,730 278 (278) 9,730 Other expense 5,916 1,002 (40) 6,878 Provision for loan losses (454) 316 (138) Income (loss) before tax 1,351 (1,064) 287 Income tax expense (benefit) 112 (450) (338) Total assets 172,864 2,975 (3,586) 172,253 Capital expenditures 263 4 267 Depreciation and amortization 390 12 402 June 30, 1998 ------------------------------------------------------------------------------ Real Estate Development Banking & Management Eliminations Total -------------------------------------------------------------------------------------------------------------- Interest income $ 17,332 $ 444 $ (584) $ 17,192 Other income 2,695 330 3,025 Interest expense 11,586 584 (584) 11,586 Other expense 13,660 2,416 16,076 Provision for loan losses 2,152 2,391 4,543 Loss before tax (7,371) (4,617) (11,988) Income tax benefit (3,268) (1,926) (5,194) Total assets 200,082 9,720 (12,756) 197,046 Capital expenditures 103 8 111 Depreciation and amortization 430 19 449 Eliminations in the above tables include, for total assets, the elimination of the Bank's investment in its affordable housing subsidiaries. 75
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FIDELITY FEDERAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Thousands, Except Share Data) >> Capital Infusion On July 16, 1999, Fidelity signed a letter of intent with Lincolnshire Management, Inc. (Lincolnshire). This proposed transaction was terminated in November 1999. On January 21, 2000 as amended and restated on March 15, 2000, Fidelity signed a definitive stock purchase agreement to sell 1,460,000 shares of its common stock to Pedcor Investments, a limited liability company (Pedcor). One of the principals of Pedcor was a director of the Company until his resignation in December 1999. The consideration to be paid by Pedcor includes $3,000 in cash, a five-year guarantee to United in an aggregate amount up to $1,500 against any negative cash flow from operations of certain specified development properties in the Bank's portfolio and an agreement to provide management and certain accounting services for the specified properties for ten years at no fee to the Bank or Company. Consummation of the agreement is subject to receipt of all regulatory and shareholder approvals. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES No response to this item is required. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT This information called for by this item is incorporated by reference to the definitive proxy statement of Fidelity to be filed with the Securities Exchange Commission not later than 120 days after December 31, 1999 and to be delivered to stockholders in connection with the annual meeting of the stockholders to be held in 2000. ITEM 11. EXECUTIVE COMPENSATION This information called for by this item is incorporated by reference to the definitive proxy statement of Fidelity to be filed with the Securities Exchange Commission not later than 120 days after December 31, 1999 and to be delivered to stockholders in connection with the annual meeting of the stockholders to be held in 2000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information called for by this item is incorporated by reference to the definitive proxy statement of Fidelity to be filed with the Securities Exchange Commission not later than 120 days after December 31, 1999 and to be delivered to stockholders in connection with the annual meeting of the stockholders to be held in 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information called for by this item is incorporated by reference to the definitive proxy statement of Fidelity to be filed with the Securities Exchange Commission not later than 120 days after December 31, 1999 and to be delivered to stockholders in connection with the annual meeting of the stockholders to be held in 2000. 76
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PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements are included in Item 8: Page Number in 10-K Independent Auditor's Report on Consolidated Financial Statements 41 Consolidated Balance Sheet December 31, 1999 and June 30, 1999 42 Consolidated Statement of Income- For the six months ended December 31, 1999, and years ended June 30, 1999 and 1998 43 and 44 Consolidated Statement of Changes in Stockholders' Equity - For the six months ended December 31, 1999, and years ended June 30, 1999 and 1998 45 Consolidated Statement of Cash Flows - For the six months ended December 31, 1999, and years ended June 30, 1999 and 1998 46 and 47 Notes to consolidated Financial Statements 48 through 76 (2) See response to Item 14 (a) (1). All other financial statement schedules have been omitted because they are not applicable, or the required information is shown in the consolidated financial statements or notes thereto. (3) List of Exhibits Exhibit Number Description -------------- ----------- 3(a) Articles of Incorporation of Fidelity, filed as exhibit 3(a) to Fidelity's 1995 Annual Report on Form 10-K, are incorporated herein by reference. 3(b) By-Laws of Fidelity, filed as exhibit 3(b) to Fidelity's 1994 Annual Report on Form 10-K, are incorporated herein by reference. 10(a) The 1993 Director's Stock Option Plan, filed as exhibit 10(d) to Fidelity's 1995 Annual Report on Form 10-K, is incorporated herein by reference. (b) The 1995 Key Employee's Stock Option Plan, filed as exhibit 10(c) to Fidelity's 1996 Annual Report on Form 10-K, is incorporated herein by reference. (c) Severance Agreement between Fidelity and M. Brian Davis, filed as exhibit 10(c) to Fidelity's 1998 Annual Report on Form 10-K, is incorporated herein by reference. (d) Severance Agreement between Fidelity and Donald R. Neel, filed as exhibit 10(d) to Fidelity's 1998 Annual Report on Form 10-K, is incorporated herein by reference. 11 Statement regarding computation of per share earnings 21 Subsidiaries of Fidelity Federal Bancorp. 27 Financial Data Schedule. (b) A Form 8-K was filed on November 23, 1999. Fidelity released that negotiations with Mortgage Finance Acquisition Partners, L.P., an affiliate of Lincolnshire Equity Fund II, had terminated. (c) See the list of exhibits in Item 14 (a) (3). (d) No other financial statement schedules are required to be submitted. 77
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SIGNATURES Pursuant to the requirements of Section 13 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 on the 30th day of March, 2000. FIDELITY FEDERAL BANCORP Registrant By /S/ M. BRIAN DAVIS ------------------------------------------ M. Brian Davis President and Chief Executive Officer (Principal Executive Officer) By /S/ DONALD R. NEEL ------------------------------------------ Donald R. Neel, Executive Vice President, Treasurer and Chief Financial Officer (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on September 27, 1999, by the following persons on behalf of the registrant and in the capacities indicated. By /S/ JACK CUNNINGHAM ------------------------------------------- Jack Cunningham, Chairman By /S/ M. BRIAN DAVIS ------------------------------------------- M. Brian Davis President, Chief Executive Officer and Director By:/S/ CURT J. ANGERMEIER ------------------------------------------- Curt J. Angermeier, Director By /S/ WILLIAM R. BAUGH ------------------------------------------- William R. Baugh, Director By /S/ DONALD R. NEEL ------------------------------------------- Donald R. Neel, Director By /S/ BARRY A. SCHNAKENBURG ------------------------------------------- Barry A. Schnakenburg, Director 78
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INDEX TO EXHIBITS ----------------- Page Exhibit Number Exhibit ------------------------------------------------------------------------------ 67 11 Statement regarding computation of per share earnings. See (Earnings per Share) of this document. 80 21 Subsidiaries of Fidelity Federal Bancorp. 81 27 Financial Data Schedule. 79

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For Period End:12/31/9917710KT405,  10KT405/A
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