**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C.  20549**

 

**FORM 10-K**

 
| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|
|       |                                                                                      |
|       | **For the Fiscal Year Ended December 31, 2002**                                           |

 

**OR**

 
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                       |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                |
|   | **For the  transition period  from                    to                    .** |

 

**Commission File Number 0-23063**

 

**FIRST SECURITYFED FINANCIAL, INC.**

(Exact Name of Registrant as Specified in its Charter)

 

| **Delaware**                                                                      |   | **36-4177515**                          |
|-----------------------------------------------------------------------------------|--------|-----------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization)                    |   | (I.R.S. Employer Identification Number) |
|                                                                              |   |                                    |
| **936 North Western Avenue, Chicago, Illinois**                                   |   | **60622**                               |
| (Address of Principal Executive Offices)                                          |   | Zip Code                                |
|                                                                              |   |                                    |
| Registrant’s telephone number, including area code:  **(773) 772-4500** |
|                                                                              |   |                                    |
| Securities Registered Pursuant to Section 12(b) of the Act:                       |
| **None**                                                                          |
|                                                                              |   |                                    |
| Securities Registered Pursuant to Section 12(g) of the Act:                       |
| **Common Stock, par value $.01 per share**                                        |
| (Title of Class)                                                                  |

 

Indicateby check mark whether the Registrant (1) filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding twelve months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such requirementsfor the past 90 days.

YES ý   NO  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§ 229.405 of this chapter) is not contained herein, and willnot be contained, to the best of Registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined byRule 12b-2 of the act).

YES o NO ý

 

Theaggregate market value of the voting stock held by non-affiliates of theRegistrant, computed by reference to the closing price of such stock on June30, 2002 was $62.8 million. (The exclusion from such amount of the market valueof the shares owned by any person shall not be deemed an admission by theRegistrant that such person is an affiliate of the Registrant.)

 

Asof March 14, 2003, the Registrant had 3,952,754 shares of Common Stock issuedand outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

PARTII of Form 10-K - Annual Report to Stockholders for the fiscal year endedDecember 31, 2002.

PARTIII of Form 10-K - Proxy Statement for 2003 Annual Meeting of Stockholders.

 

 

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FORWARD-LOOKINGSTATEMENTS

 

FirstSecurityFed Financial, Inc. (“First SecurityFed” or the “Company”), and itswholly owned subsidiary, First Security Federal First Savings Bank (“FirstSecurity” or the “Bank”), may from time to time make written or oral“forward-looking statements,” including statements contained in its filingswith the Securities and Exchange Commission (“SEC”).  Theseforward-looking statements may be included in this Annual Report on Form 10-Kand the exhibits attached to it, in First SecurityFed’s reports to shareholdersand in other communications, which are made in good faith by us pursuant to the“safe harbor” provisions of the Private Securities Litigation Reform Act of1995.

 

Theseforward-looking statements include statements about our beliefs, plans, objectives,goals, expectations, anticipations, estimates and intentions, that are subjectto significant risks and uncertainties, and are subject to change based onvarious factors, some of which are beyond our control.  The words “may”,“could”, “should”, “would”, “believe”, “anticipate”, “estimate”, “expect”,“intend”, “plan” and similar expressions are intended to identifyforward-looking statements. The following factors, among others, could causeour financial performance to differ materially from the plans, objectives,expectations, estimates and intentions expressed in the forward-lookingstatements:

 

•                                          the strength of the United States economy ingeneral and the strength of the local economies in which we conduct operations;

 

•                                          the effects of, and changes in, trade, monetaryand fiscal policies and laws, including interest rate policies of the FederalReserve Board;

 

•                                          inflation, interest rate, market and monetaryfluctuations;

 

•                                          the timely development of and acceptance of ournew products and services and the perceived overall value of these products andservices by users, including the features, pricing and quality compared tocompetitors’ products and services;

 

•                                          the willingness of users to substitute ourproducts and services for products and services of our competitors;

 

•                                          our success in gaining regulatory approval of ourproducts and services, when required;

 

•                                          the impact of changes in financial services’ lawsand regulations (including laws concerning taxes, banking, securities andinsurance);

 

•                                          the impact of technological changes;

 

•                                          acquisitions;

 

•                                          changes in consumer spending and saving habits;and

 

•                                          our success at managing the risks involved in theforegoing.

 

Thelist of important factors stated above is not exclusive.  We do notundertake to update any forward-looking statement, whether written or oral,that may be made from time to time by or on behalf of First SecurityFed orFirst Security.

 

i

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**PART I**

 

**Item 1 . Business**

 

**General**

 

FirstSecurityFed is a Delaware corporation that was formed in 1997 by the Bank forthe purpose of becoming a savings and loan holding company.  The Companyowns all of the outstanding capital stock of the Bank.

 

Asa community-oriented financial institution, First Security seeks to serve thefinancial needs of communities in its ethnically diverse market area.  Wehave achieved a significant penetration in our market area by engaging insubstantial community service activities and targeting marketing initiatives focusedon groups within our market area.

 

Ourbusiness involves attracting deposits from the general public and using suchdeposits, together with other funds, to originate primarily one- to four-familyresidential mortgage loans and, to a lesser extent, multi-family and commercialreal estate, construction, consumer and other loans in our market area. We alsoinvest in mortgage-backed and other securities and other permissibleinvestments.

 

TheBank offers a variety of accounts having a range of interest rates andterms.  Our deposits include passbook and NOW accounts, money marketaccounts and certificate accounts with terms of three months to fiveyears.  We solicit deposits only in our primary market area and do notaccept brokered deposits.

 

**Market Area**

 

Ourmain office is located in Chicago, Illinois and our branch offices are locatedin Chicago, Illinois, Philadelphia, Pennsylvania and Palatine, Illinois.

 

OurWestern Avenue office is located on the near northwest side of Chicago in the“Ukrainian Village” community, a middle-income community where the Bank hasfocused its operations since 1964.  This community is locatedapproximately two and one half miles to the northwest of downtown Chicago andapproximately three miles west of Lake Michigan.  The majority of thecommunity’s many businesses are small and local companies.  Residenceswithin the community consist primarily of two- to four-family flats and singlefamily homes although there are also mid-size apartment buildings.  Realestate values within this community have risen sharply over the last ten yearsas “gentrification” has begun to occur as a result of the community’s proximityto downtown Chicago.

 

OurMilwaukee Avenue office was opened in 1993 and is located in the “Norwood Park”neighborhood of Chicago.  This community is a stable middle income areawhich also has many residents of Eastern European descent.  Residenceswithin the community consist primarily of single family homes as well as twoand three flats and small apartment buildings.  This area is locatedapproximately eight miles northwest of downtown Chicago.

 

OurPhiladelphia branch was acquired in 1994 through a purchase from the ResolutionTrust Corporation.  The branch is located in a moderate incomeneighborhood of Philadelphia known as “Rhawnhurst.”  The community is hometo many persons of Eastern European heritage, including new immigrants. Residences within the community consist primarily of single family row housesand, to a lesser extent, small apartment buildings.

 

Our northwest suburban Chicago branch was openedin 1977 in Rolling Meadows, Illinois, and in December 2002 relocated to a newfacility in nearby Palatine, Illinois.  Over the last 20 years, thenorthwest suburban area of Chicago has experienced significant population andcommercial growth.  However, as a result of competition, the branch’sdeposit and loan growth has been modest. In December 2002, the Bank completed the remodeling of a building inPalatine, Illinois for its relocated northwest suburban office.  The remodeled office is located in veryclose proximity to the Bank’s Rolling Meadows branch, but is a larger facilitylocated on one acre of land enabling the Bank to offer drive-up lanes, 24-hourATM service and a night depository.  Thenew branch was opened to service the public in January 2003 and the RollingMeadows facility was closed at that time.

 

1

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**Lending Activities**

 

***General.***  Our principal lending activity isoriginating for our portfolio fixed and, to a much lesser extent, adjustablerate (“ARM”) mortgage loans secured by one- to four-family residences locatedprimarily in our market area.  First Security also originates multi-familyand commercial real estate, construction, home equity, consumer and other loansin its market area. At December 31, 2002, our net loans receivable totaled$301.6 million.  See “- Originations of Loans.”

 

Thefollowing table sets forth the composition of the Bank’s loan portfolio indollar amounts and in percentages as of the dates indicated.

 
|                          |   | **December 31,**           |    |
|-------------------------------|--------|----------------------------|---------|
|                          |   | **2002**                   |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                          |   | **Amount**                 |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                          |   | **(Dollars in thousands)** |    |
| Real Estate Loans:            |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family           |   | $                          | 188,449 |   | 59.46 | % | $ | 207,067 |   | 68.60 | % | $ | 212,863 |   | 75.32 | % | $ | 200,201 |   | 80.58 | % | $ | 182,452 |   | 82.23 | %  |
| Construction                  |   | 32,486                     |    | 10.25 |   | 23,371 |   | 7.74 |   | 11,745 |   | 4.16 |   | 3,800 |   | 1.53 |   | — |   | — |   |
| Multi-family                  |   | 33,464                     |    | 10.56 |   | 28,659 |   | 9.50 |   | 19,272 |   | 6.82 |   | 13,389 |   | 5.39 |   | 11,313 |   | 5.10 |   |
| Commercial                    |   | 31,182                     |    | 9.84 |   | 24,546 |   | 8.13 |   | 20,845 |   | 7.38 |   | 15,304 |   | 6.16 |   | 11,535 |   | 5.20 |   |
| Mixed use (1)                 |   | 21,026                     |    | 6.63 |   | 7,931 |   | 2.63 |   | 8,972 |   | 3.17 |   | 9,084 |   | 3.65 |   | 9,898 |   | 4.46 |   |
| Total real estate loans       |   | 306,607                    |    | 96.74 |   | 291,574 |   | 96.60 |   | 273,697 |   | 96.85 |   | 241,778 |   | 97.31 |   | 215,198 |   | 96.99 |   |
|                          |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer loans:               |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Share loans                   |   | 1,135                      |    | 0.36 |   | 1,004 |   | 0.33 |   | 1,368 |   | 0.48 |   | 1,164 |   | 0.47 |   | 1,091 |   | 0.49 |   |
| Automobile                    |   | —                     |    | — |   | — |   | — |   | — |   | — |   | 3 |   | 0.01 |   | 14 |   | 0.01 |   |
| Home equity                   |   | 8,704                      |    | 2.75 |   | 8,847 |   | 2.93 |   | 7,147 |   | 2.53 |   | 5,103 |   | 2.05 |   | 5,158 |   | 2.32 |   |
| Home improvement              |   | —                     |    | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 10 |   | 0.01 |   |
| Other                         |   | 482                        |    | 0.15 |   | 398 |   | 0.14 |   | 383 |   | 0.14 |   | 402 |   | 0.16 |   | 398 |   | 0.18 |   |
| Total consumer loans          |   | 10,321                     |    | 3.26 |   | 10,249 |   | 3.40 |   | 8,898 |   | 3.15 |   | 6,672 |   | 2.69 |   | 6,671 |   | 3.01 |   |
| Total loans                   |   | 316,928                    |    | 100.00 | % | 301,823 |   | 100.00 | % | 282,595 |   | 100.00 | % | 248,450 |   | 100.00 | % | 221,869 |   | 100.00 | % |
| Less:                         |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction loans in process |   | 10,227                     |    |   |   | 9,576 |   |   |   | 2,777 |   |   |   | 3,467 |   |   |   | — |   |   |   |
| Deferred fees and discounts   |   | 2,122                      |    |   |   | 1,991 |   |   |   | 1,803 |   |   |   | 1,500 |   |   |   | 1,489 |   |   |   |
| Allowance for losses          |   | 2,937                      |    |   |   | 2,806 |   |   |   | 2,561 |   |   |   | 2,315 |   |   |   | 2,069 |   |   |   |
| Total loans receivable, net   |   | $                          | 301,642 |   |   |   | $ | 287,450 |   |   |   | $ | 275,454 |   |   |   | $ | 241,168 |   |   |   | $ | 218,311 |   |   |   |

 

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(1)Mixed use refers to real estate on which the borrower both resides and conductsa business.

 

2

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Thefollowing table shows the composition of the Bank’s loan portfolio by fixed-and adjustable-rate at the dates indicated.

 
|                          |   | **December 31,**           |    |
|-------------------------------|--------|----------------------------|---------|
|                          |   | **2002**                   |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                          |   | **Amount**                 |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                          |   | **(Dollars in Thousands)** |    |
| Fixed-Rate Loans:             |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate:                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family           |   | $                          | 183,393 |   | 57.86 | % | $ | 202,753 |   | 67.18 | % | $ | 204,971 |   | 72.53 | % | $ | 193,552 |   | 77.90 | % | $ | 175,246 |   | 78.99 | % |
| Multi-family                  |   | 33,464                     |    | 10.56 |   | 28,659 |   | 9.50 |   | 19,272 |   | 6.82 |   | 13,389 |   | 5.39 |   | 11,313 |   | 5.10 |   |
| Commercial                    |   | 22,910                     |    | 7.23 |   | 16,615 |   | 5.50 |   | 15,740 |   | 5.57 |   | 12,668 |   | 5.10 |   | 8,625 |   | 3.89 |   |
| Mixed use(1)                  |   | 11,463                     |    | 3.62 |   | 7,931 |   | 2.63 |   | 8,972 |   | 3.17 |   | 9,084 |   | 3.66 |   | 9,444 |   | 4.26 |   |
| Total real estate loans       |   | 251,230                    |    | 79.27 |   | 255,958 |   | 84.81 |   | 248,955 |   | 88.09 |   | 228,693 |   | 92.05 |   | 204,628 |   | 92.24 |   |
| Consumer                      |   | 1,617                      |    | 0.51 |   | 1,402 |   | 0.46 |   | 1,751 |   | 0.62 |   | 1,569 |   | 0.63 |   | 1,513 |   | 0.68 |   |
| Loans secured by leases       |   | —                     |    | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Total fixed-rate loans        |   | 252,847                    |    | 79.78 |   | 257,360 |   | 85.27 |   | 250,706 |   | 88.71 |   | 230,262 |   | 92.68 |   | 206,141 |   | 92.92 |   |
| Adjustable-Rate Loans         |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate:                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One-to-four-family            |   | 5,056                      |    | 1.60 |   | 4,314 |   | 1.43 |   | 7,892 |   | 2.79 |   | 6,649 |   | 2.68 |   | 7,206 |   | 3.25 |   |
| Multi-family                  |   | —                     |    | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Commercial                    |   | 17,835                     |    | 5.62 |   | 7,931 |   | 2.63 |   | 5,105 |   | 1.81 |   | 2,636 |   | 1.06 |   | 2,910 |   | 1.31 |   |
| Mixed use (1)                 |   | —                     |    | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 454 |   | 0.20 |   |
| Construction                  |   | 32,486                     |    | 10.25 |   | 23,371 |   | 7.74 |   | 11,745 |   | 4.16 |   | 3,800 |   | 1.53 |   | — |   | — |   |
| Home Equity                   |   | 8,704                      |    | 2.75 |   | 8,847 |   | 2.93 |   | 7,147 |   | 2.53 |   | 5,103 |   | 2.05 |   | 5,158 |   | 2.32 |   |
| Total adjustable-rate loans   |   | 64,081                     |    | 20.22 |   | 44,463 |   | 14.73 |   | 31,889 |   | 11.29 |   | 18,188 |   | 7.32 |   | 15,728 |   | 7.08 |   |
| Total loans                   |   | 316,928                    |    | 100.00 | % | 301,823 |   | 100.00 | % | 282,595 |   | 100.00 | % | 248,450 |   | 100.00 | % | 221,869 |   | 100.00 | % |
| Less:                         |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Construction loans in process |   | 10,227                     |    |   |   | 9,576 |   |   |   | 2,777 |   |   |   | 3,467 |   |   |   | — |   |   |   |
| Deferred fees and discounts   |   | 2,122                      |    |   |   | 1,991 |   |   |   | 1,803 |   |   |   | 1,500 |   |   |   | 1,489 |   |   |   |
| Allowance for losses          |   | 2,937                      |    |   |   | 2,806 |   |   |   | 2,561 |   |   |   | 2,315 |   |   |   | 2,069 |   |   |   |
| Total loans receivable, net   |   | $                          | 301,642 |   |   |   | $ | 287,450 |   |   |   | $ | 275,454 |   |   |   | $ | 241,168 |   |   |   | $ | 218,311 |   |   |   |

 

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(1)Mixed use refers to real estate on which the borrower both resides and conductsa business.

 

The following schedule illustrates the interest rate sensitivity of theBank’s loan portfolio at December 31, 2002.  Mortgages that haveadjustable or renegotiable interest rates are shown as maturing in the periodduring which the final payment is due.  The schedule does not reflect theeffects of possible prepayments or enforcement of due-on-sale clauses.

 
| **Due During  Years Ending  December 31,** |   | **One- to four-family********Residential** |    | **Multi-family,  Construction and  Commercial Real  Estate** |   | **Consumer**                |   | **Total**  |   |
|--------------------------------------------|--------|--------------------------------------------|---------|--------------------------------------------------------------|--------|-----------------------------|--------|------------|--------|
| **Amount**                                 |   | **Weighted  Average  Rate**                |    | **Amount**                                                   |   | **Weighted  Average  Rate** |   | **Amount** |   | **Weighted  Average  Rate** |   | **Amount** |   | **Weighted  Average  Rate** |   |
| **(Dollars in Thousands)**                 |   |
| 2003                                       |   | $                                          | 1,788   |                                                         | 8.29   | %                           | $      | 40,819     |   | 6.76 | % | $ | 557 |   | 8.61 | % | $ | 43,164 |   | 6.80 | % |
| 2004 to 2005                               |   | 6,439                                      |    | 7.77                                                         |   | 23,754                      |   | 8.20       |   | 3,992 |   | 8.19 |   | 34,185 |   | 7.72 |   |
| 2006 and 2007                              |   | 10,180                                     |    | 6.94                                                         |   | 42,306                      |   | 7.58       |   | 5,772 |   | 8.11 |   | 58,258 |   | 7.19 |   |
| 2008 to 2012                               |   | 13,491                                     |    | 7.15                                                         |   | 4,989                       |   | 8.22       |   | — |   | — |   | 18,480 |   | 7.43 |   |
| 2013 to 2022                               |   | 55,362                                     |    | 6.84                                                         |   | 3,250                       |   | 8.26       |   | — |   | — |   | 58,612 |   | 6.91 |   |
| 2023 and following                         |   | 101,189                                    |    | 7.32                                                         |   | 3,040                       |   | 7.55       |   | — |   | — |   | 104,229 |   | 7.33 |   |
| Total                                      |   | $                                          | 188,449 |                                                         | 7.17   |                        | $      | 118,158    |   | 7.46 |   | $ | 10,321 |   | 8.14 |   | $ | 316,928 |   | 7.20 |   |

 

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Thetotal amount of loans due after December 31, 2003 that have predeterminedinterest rates is $257.3 million, while the total amount of loans due aftersuch date that have floating or adjustable interest rates is $16.5 million.

 

Underfederal law, the aggregate amount of loans that we are permitted to make to anyone borrower is generally limited to 15% of unimpaired capital and surplus (25%if the security for such loan has a “readily ascertainable” value or 30%for certain residential development loans).  At December 31, 2002, basedon the above, the Bank’s regulatory loans-to-one borrower limit wasapproximately $9.9 million.  On the same date, the Bank had no borrowerswith outstanding balances in excess of this amount.   As of December31, 2002, the largest dollar amount outstanding or committed to be lent to oneborrower, or group of related borrowers, was $2.3 million, secured by twocommercial buildings in the metropolitan Chicago area.  At December 31,2002, this loan was performing in accordance with its terms.  As of thesame date, there were 38 other lending relationships with carrying values inexcess of $1.0 million.

 

Allof the Bank’s lending is subject to its written underwriting standards and toloan origination procedures.  Decisions on loan applications are made onthe basis of detailed applications and property valuations (consistent with theBank’s appraisal policy). The loan applications are designed primarily todetermine the borrower’s ability to repay, and the more significant items onthe application are verified through use of credit reports, financialstatements, tax returns or confirmations. ** **All mortgage loans currently originated by First Security areapproved by the loan committee, currently comprised of Directors Babyk, Gawrykand Nadzikewycz and Vice President Korb, and ratified by the full Board ofDirectors.

 

TheBank requires title insurance or other evidence of title on its mortgage loans,as well as fire and extended coverage casualty insurance in amounts at leastequal to the principal amount of the loan or the value of improvements on theproperty, depending on the type of loan.  The Bank also requires floodinsurance to protect the property securing its interest when the property islocated in a flood plain.

 

***One- to Four-Family Residential Real EstateLending.***  Thecornerstone of our lending program is the origination of loans secured bymortgages on owner-occupied one- to four-family residences. Historically, theBank focused its residential lending activities on fixed-rate loans with termsup to 30 years.  In the 1980s, in order to reduce the average term torepricing of its assets, the Bank began to offer 15-year and 10-year fixed-rateloans as well as ARMs (although, as a result of customer preference, the ARMloan volume has been limited).  Substantially all of our one- tofour-family residential mortgage originations are secured by properties locatedin our market area.  All mortgage loans currently originated by the Bankare retained and serviced by it.

 

Wecurrently offer fixed-rate one-to-four family mortgage loans with maturitiesfrom 10 to 30 years.  We also offer fixed-rate balloon products with a30-year amortization schedule that are due in five years and which, undercertain circumstances, may be extended for an additional term of up to fiveyears, as applicable.  As of December 31, 2002, we had $8.6 million offixed rate loans with original terms of 10 years or less (most of which werethree- or five-year balloon loans), $68.9 million of fixed-rate loans withoriginal terms of 10-15 years and $105.9 million of fixed rate loans withoriginal terms of more than 15 years.  See “– Originations of Loans.”

 

Wealso originate fixed-rate home equity loans with terms of up to ten years.These loans are written so that the total balance does not exceed the lesser of$50,000 or 80% of the appraised value of the security property when combinedwith the balance of the first mortgage lien.  At December 31, 2002, we had$2.3 million of home equity loans, all of which are classified in the tabulardata as one- to four-family residential loans.

 

TheBank also offers ARM loans, which carry interest rates that adjust at a margin(generally 250 basis points) over the yield on the One-Year and the Three-YearAverage Monthly U.S. Treasury Constant Maturity Indexes (“CMT”).  Such loans may carry terms to maturity of up to 30 years. The ARM loans currentlyoffered by the Bank provide for a cap on annual interest rate changes of 200basis points and a lifetime cap generally of 600 basis points over the initialrate.  Initial interest rates offered on our ARM loans may beapproximately 100-150 basis points below the fully indexed rate, althoughborrowers are qualified at the fully indexed rate.   As a result, therisk of default on these loans may increase as interest rates increase. AtDecember 31, 2002, one- to four-family ARMs totaled $5.1 million or 1.60% ofthe Bank’s total loan portfolio.

 

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Wegenerally lend up to 95% of the lesser of the sales price or appraised value ofthe security property on owner occupied one- to four-family loans, provided,however, that private mortgage insurance is obtained in an amount sufficient toreduce our exposure to not more than 80% of the sales price or appraised value,as applicable.   The loan-to-value ratio on non-owner occupied, one-to four-family loans is generally 80% of the lesser of the sales price orappraised value of the security property.   Non-owner occupied one-to four-family loans may pose a greater risk to the Bank than traditional owneroccupied one- to four-family loans.  In underwriting one- to four-familyresidential real estate loans, we currently evaluate the borrower’s ability tomake principal, interest and escrow payments, the borrower’s credit history,the value of the property that will secure the loan and debt to income ratios.

 

Residentialloans do not currently include prepayment penalties, are non-assumable and donot produce negative amortization.  Our underwriting practices do notcomply in every way with those required by most purchasers in the secondarymarket.  For instance, the Bank, on occasion, will lend to borrowers thathave income/debt service ratios below that required by many secondary marketpurchasers.  In that event, we require that the borrower have otherattributes that justify approving a loan, such as a favorable repayment recordwith the Bank on previous lending relationships, favorable cash flow, a lowloan to value ratio or other assets that can be used as additionalcollateral.  We have found that non-compliance with secondary marketstandards at the time of origination does not in and of itself cause creditproblems, since the Bank has engaged in this type of lending for many years andour overall delinquency experience on these loans has been satisfactory todate.  In addition, these loans, once seasoned, generally are saleable onthe secondary market.  Furthermore, we have found that these policies andprocedures help us maintain and improve our customer relations and the Bank’sreputation in the communities we serve.

 

Whilewe seek to originate most of our one- to four-family residential loans inamounts that are less than or equal to the applicable Federal Home LoanMortgage Corporation maximum, we do make one- to four-family residential loansin amounts in excess of such maximum.  Our delinquency experience on suchloans has been similar to our experience on our other residential loans.

 

Ourresidential mortgage loans customarily include due-on-sale clauses giving usthe right to declare the loan immediately due and payable in the event that,among other things, the borrower sells or otherwise disposes of the propertysubject to the mortgage and the loan is not repaid.

 

***Multi-family and Commercial Real EstateLending.***  In order to increase the yield of its loan portfolio and to complementresidential lending opportunities, the Bank originates permanent multi-familyand commercial real estate loans secured by properties in its primary marketarea. ** **As a result of thestrong economy in our Chicago market area, increased customer demand and anincreased emphasis on this lending on our part, we have been able to increaseour holdings of these types of loans over the last several years.  AtDecember 31, 2002, we had multi-family loans totaling $33.5 million, or 10.56%of our total loan portfolio, and $52.2 million in commercial and mixed use realestate loans, representing 16.47% of the total loan portfolio.

 

Ourmulti-family loan portfolio consists primarily of loans secured by 24 or fewerunits.  Our commercial real estate loans are secured primarily byretail stores, small office buildings, store/apartment complexes, taverns andstore front offices.

 

Ourmulti-family real estate loans generally carry a maximum term of five years andhave fixed rates; most of these loans are five-year balloons with a 25-year ormore amortization schedule.  These loans are generally made in amounts ofup to 80% of the lesser of the appraised value or the purchase price of theproperty.  Most of our commercial real estate loans are five-year balloonloans with fixed rates of interest. Included in our commercial real estateloans are lines of credit with outstanding balances of $17.8 million secured bycommercial real estate with floating interest rates tied to the prime rate ofinterest.  Commercial real estate loans are generally made in amounts upto 75% of the lesser of the appraised value or the purchase price of theproperty.

 

Appraisalson properties securing multi-family and commercial real estate loans in excessof $250,000 are performed by an independent appraiser designated by us at thetime the loan is made.  All appraisals on multi-family and commercial realestate loans are reviewed by the loan committee.  In addition, ourunderwriting procedures require verification of the borrower’s credit history,income and financial statements, banking relationships, references and incomeprojections for the property.  We obtain personal guarantees on theseloans.

 

5

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AtDecember 31, 2002, our largest commercial real estate or multi-family orconstruction loan outstanding totaled $2.2 million and was secured by a 24 unitapartment building located in Chicago, Illinois.  The loan was performingin accordance with its terms as of that date.

 

Multi-familyand commercial real estate loans may present a higher level of risk than loanssecured by one- to four-family residences.  This greater risk is due toseveral factors, including the concentration of principal in a limited numberof loans and borrowers, the effects of general economic conditions on incomeproducing properties and the increased difficulty of evaluating and monitoringthese types of loans.

 

***Construction Lending.*** We originate construction loans tobuilders, developers and individuals to finance development of one- tofour-family, multi-family and, to a lesser extent, small commercialproperties.  Most of these loans do not have prearranged takeout financingat the time of commitment and most of the underlying projects do not havetenants or buyers at the time of commitment.

 

Wesignificantly increased our construction lending activities over the lastseveral years primarily as a result of customer demand and the lower interestrate environment during the past year.  These loans generally carryinterest rates that float with the prime rate of interest and have maturitiesof one year or less.

 

TheBank requires independent appraisals with a loan to value ratio not in excessof 80%.   Disbursements are made in increments as constructionprogresses, and inspections warrant. Land loans do not exceed 60% of theappraised value or actual cost.

 

Asof December 31, 2002, the Bank had committed $32.5 million to borrowers forconstruction loans.  As of this same date, $22.3 million of the committedfunds have been disbursed.

 

***Consumer Lending.***  Management believes that offering consumerloan products helps to expand the Bank’s customer base and to create strongerties to its existing customer base. In addition, because consumer loansgenerally have shorter terms to maturity and carry higher rates of interest thando residential mortgage loans, they can be valuable asset/liability managementtools.  We originate a variety of different types of consumer loans,including home equity lines of credit, and deposit account loans for householdand personal purposes.  Due to the tax advantages to the borrower of homeequity lines of credit, we have focused our recent consumer lending activitiesprimarily on home equity lines of credit.  At December 31, 2002 consumerloans totaled $10.3 million or 3.26% of total loans outstanding.

 

Consumerloan terms vary according to the type and value of collateral, length ofcontract and creditworthiness of the borrower.  Other than the home equitylines of credit, the Bank’s consumer loans are made at fixed interest rates,with terms of up to five years.

 

Ourhome equity lines of credit are written so that the total commitment amount,when combined with the balance of the first mortgage lien, may not exceed 80%of the appraised value of the property.  These loans are written withfixed terms of up to five years and carry interest rates that float with theprime rate of interest.  At December 31, 2002, our home equity lines ofcredit totaled $8.7 million outstanding, or 2.75% of our total loan portfolio.

 

Theunderwriting standards we employ for consumer loans include a determination ofthe applicant’s payment history on other debts and ability to meet existingobligations and payments on the proposed loan.  Although creditworthinessof the applicant is of primary consideration, the underwriting process alsoincludes a comparison of the value of the security, if any, in relation to theproposed loan amount. Consumer loans may entail greater credit risk than doresidential mortgage loans, particularly in the case of consumer loans whichare unsecured.  In addition, consumer loan collections are dependent onthe borrower’s continuing financial stability, and thus are more likely to beaffected by adverse personal circumstances.  Furthermore, the applicationof various federal and state laws, including bankruptcy and insolvency laws,may limit the amount which can be recovered on such loans.

 

**Originations of Loans**

 

Realestate loans are originated by our staff through walk-ins and referrals fromexisting customers or real estate agents.

 

6

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Ourability to originate loans is dependent upon customer demand for loans in ourmarket and to a lesser extent, customer service and marketing efforts. Demand is affected by both the local economy and the interest rateenvironment.  As a result of the strong real estate market in our primarymarket areas and our emphasis on customer service and community outreach, theBank has experienced significant loan growth in recent years.   See“Market Area.”  However, as a result of consumer demand, most recentoriginations have carried fixed rather than adjustable rates.  Undercurrent policy, all loans we originate are retained in our portfolio. See “One-to Four- Family Residential Lending” and “Management’s Discussion and Analysisof Financial Condition and Results of Operations - Asset/Liability Management”in the Annual Report attached as Exhibit 13 hereto.

 

Asa reflection of our emphasis on customer service, we have not sold loans in thepast, but may do so in the future to manage interest rate risk. Servicingof such loans would be retained by us.

 

Thefollowing table shows the loan origination, purchase and repayment activitiesof the Bank for the periods indicated.

 

|                              |   | **Year Ended December 31,** |   |
|-----------------------------------|--------|-----------------------------|--------|
|                              |   | **2002**                    |   | **2001** |   | **2000** |   |
|                              |   | **(In Thousands)**          |   |
| Originations by type:             |   |                        |   |   |   |   |   |
| Adjustable rate:                  |   |                        |   |   |   |   |   |
| Real estate - one- to four-family |   | $                           | 4,271  |   | $ | 18,288 |   | $ | 3,030 |   |
| – multi-family               |   | —                      |   | 5,001 |   | — |   |
| – commercial                 |   | 21,756                      |   | 1,250 |   | — |   |
| Total adjustable rate             |   | 26,027                      |   | 24,539 |   | 3,030 |   |
| Fixed rate:                       |   |                        |   |   |   |   |   |
| Real estate - one- to four-family |   | 58,010                      |   | 72,718 |   | 57,544 |   |
| – multi-family               |   | 14,428                      |   | 13,460 |   | 10,230 |   |
| – commercial                 |   | 17,468                      |   | 10,600 |   | 12,911 |   |
| Non-real estate - consumer        |   | 3,479                       |   | 5,721 |   | 1,538 |   |
| Total fixed-rate                  |   | 93,385                      |   | 102,499 |   | 82,223 |   |
| Total loans originated            |   | 119,412                     |   | 127,038 |   | 85,253 |   |
| Principal repayments              |   | (104,958                    | )      | (114,615 | ) | (50,420 | ) |
| Decrease in other items, net      |   | (262                        | )      | (427 | ) | (547 | ) |
| Net increase                      |   | $                           | 14,192 |   | $ | 11,996 |   | $ | 34,286 |   |

 

**Delinquencies and Non-Performing Assets**

 

***Delinquency Procedures.* **When a borrower fails to make a required payment on a loan, we attempt tocure the delinquency by contacting the borrower.  Generally, our personnelwork with the delinquent borrower on a case by case basis to solve thedelinquency.  Generally, a late notice is sent on all delinquent loansfollowed by a phone call after the thirtieth day of delinquency. Additional written and verbal contacts may be made with the borrowerbetween 30 and 60 days after the due date.  If the loan iscontractually delinquent for 90 days, we may institute appropriate action toforeclose on the property.  Generally, after 120 days, foreclosureprocedures are initiated.  If foreclosed, the property is sold at public saleand may be purchased by the Bank.

 

Realestate we acquire as a result of foreclosure or by deed in lieu of foreclosureis classified as real estate owned until it is sold.  When property isacquired by foreclosure or deed in lieu of foreclosure, it is recorded at the lowerof cost or fair value less estimated selling costs.  After acquisition,all costs incurred in maintaining the property are expensed.  Costsrelating to the development and improvement of the property, however, arecapitalized.

 

Thefollowing table sets forth the Bank’s loan delinquencies by type, by amount andby percentage of type at December 31, 2002.

 

7

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|                |   | **Loans Delinquent For:**  |   | **Total Loans Delinquent** |   |
|---------------------|--------|----------------------------|--------|----------------------------|--------|
|                |   | **60-89 Days**             |   | **90 Days and Over**       |   | **60 Days or More** |   |
|                |   | **Number**                 |   | **Amount**                 |   | **Percent of  Loan  Category** |   | **Number** |   | **Amount** |   | **Percent of  Loan  Category** |   | **Number** |   | **Amount** |   | **Percent of  Loan  Category** |   |
|                |   | **(Dollars in Thousands)** |   |
| Real Estate:        |   |                       |   |                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family |   | 9                          |   | $                          | 588    |   | 0.31 | % | 12 |   | $ | 1,746 |   | 0.93 | % | 21 |   | $ | 2,334 |   | 1.24 | % |
|                |   |                       |   |                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial          |   | 2                          |   | 735                        |   | 2.35 |   | 2 |   | 220 |   | 0.71 |   | 4 |   | 955 |   | 3.06 |   |
|                |   |                       |   |                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mixed Use           |   | —                     |   | —                     |   | — |   | 1 |   | 77 |   | 0.37 |   | 1 |   | 77 |   | 0.37 |   |
|                |   |                       |   |                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer            |   | 2                          |   | 1                          |   | — |   | 13 |   | 15 |   | 0.15 |   | 15 |   | 16 |   | 0.16 |   |
|                |   |                       |   |                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total               |   | 13                         |   | $                          | 1,324  |   | 0.42 | % | 28 |   | $ | 2,058 |   | 0.65 | % | 41 |   | $ | 3,382 |   | 1.07 | % |

 

***Classification of Assets*.** Federal regulations require that each savings institution classify its ownassets on a regular basis.  In addition, in connection with examinationsof savings institutions, Office of Thrift Supervision (“OTS”) and FederalDeposit Insurance Corporation (“FDIC”) examiners have authority to identifyproblem assets and, if appropriate, require them to be classified.  Thereare three classifications for problem assets:  Substandard, Doubtful andLoss.  Substandard assets have one or more defined weaknesses and arecharacterized by the distinct possibility that we will sustain some loss if thedeficiencies are not corrected.  Doubtful assets have the weaknesses ofSubstandard assets, with the additional characteristics that the weaknessesmake collection or liquidation in full on the basis of currently existingfacts, conditions and values questionable, and there is a high possibility ofloss.  An asset classified Loss is considered uncollectible and of suchlittle value that continuance as an asset on the balance sheet of theinstitution is not warranted.  Assets classified as Substandard orDoubtful require the institution to establish prudent general allowances forloan losses.  If an asset or portion thereof is classified as a Loss, theinstitution charges off such amount against the loan loss allowance.  Ifan institution does not agree with an examiner’s classification of an asset, itmay appeal this determination to the District Director of the OTS.

 

Onthe basis of management’s review of its assets, at December 31, 2002, it hadclassified a total of $2.1 million of its loan and other assets as follows:

 

|        |   | **At  December 31,  2002** |   |
|-------------|--------|----------------------------|--------|
|        |   | **(In Thousands)**         |   |
| Substandard |   | $                          | 1,819  |   |
| Doubtful    |   | 239                        |   |
| Loss        |   | —                     |   |
| Total       |   | 2,058                      |   |
|             |        |                            |        |  |

 

Ourclassified assets consist of the non-performing loans referred to below.

 

***Non-Performing Assets.***  The table below sets forth the amounts andcategories of non-performing assets in our loan portfolio.  Accruedinterest on loans delinquent 90 days or more is credited to an interest reserveaccount which

 

8

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offsetsthe amount of capitalized interest in loans receivable.  See Note 3 of theNotes to Consolidated Financial Statements in the Annual Report attached asExhibit 13 hereto. Foreclosed assets include assets acquired in settlement ofloans.

 
|                                       |   | **December 31,**           |   |
|--------------------------------------------|--------|----------------------------|--------|
|                                       |   | **2002**                   |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                       |   | **(Dollars in Thousands)** |   |
| Non-accruing loans:                        |   |                       |   |   |   |   |   |   |   |   |   |
| One- to four-family                        |   | $                          | 876    |   | $ | 433 |   | $ | 680 |   | $ | — |   | $ | 9 |   |
| Commercial real estate                     |   | 219                        |   | 206 |   | 110 |   | — |   | — |   |
| Mixed Use                                  |   | —                     |   | — |   | 235 |   | — |   | — |   |
| Total                                      |   | 1,095                      |   | 639 |   | 1,025 |   | — |   | 9 |   |
| Accruing loans delinquent 90 days or more: |   |                       |   |   |   |   |   |   |   |   |   |
| One- to four-family                        |   | 876                        |   | 845 |   | 208 |   | 934 |   | 459 |   |
| Multi-family                               |   | —                     |   | — |   | — |   | 25 |   | 224 |   |
| Commercial real estate                     |   | —                     |   | 259 |   | 237 |   | 360 |   | 313 |   |
| Mixed Use                                  |   | 77                         |   | 81 |   | 82 |   | — |   | — |   |
| Consumer                                   |   | 10                         |   | 7 |   | 9 |   | 8 |   | 7 |   |
| Total                                      |   | 963                        |   | 1,192 |   | 536 |   | 1,327 |   | 1,003 |   |
| Foreclosed assets:                         |   |                       |   |   |   |   |   |   |   |   |   |
| One- to four-family                        |   | —                     |   | — |   | — |   | 66 |   | — |   |
| Commercial real estate                     |   | —                     |   | — |   | — |   | — |   | — |   |
| Total                                      |   | —                     |   | — |   | — |   | 66 |   | — |   |
| Non-performing leases                      |   | —                     |   | — |   | — |   | — |   | — |   |
| Total non-performing assets                |   | $                          | 2,058  |   | $ | 1,831 |   | $ | 1,561 |   | $ | 1,393 |   | $ | 1,012 |   |
| Total as a percentage of total assets      |   | 0.44                       | %      | 0.33 | % | 0.39 | % | 0.37 | % | 0.30 | % |

 

Forthe years ended December 31, 2002 and December 31, 2001, the gross interestincome (less additions to the interest reserve) that would have been recordedhad the non-accruing loans (and accruing loans delinquent 90 days or more) beencurrent in accordance with their original terms amounted to $231,000 and$168,000, respectively.  No interest income was recognized on non-accruingloans for the years ended December 31, 2002 and December 31, 2001,respectively.

 

***Other Loans of Concern.***  In addition to the non-performing assetsset forth in the table above, as of December 31, 2002, there were no otherloans with respect to which known information about the possible creditproblems of the borrowers or the cash flows of the security properties havecaused management to have concerns as to the ability of the borrowers to complywith present loan repayment terms and that may result in the future inclusionof such items in the non-performing asset categories.

 

Managementconsiders its non-performing and “of concern” assets in establishing itsallowance for loan losses.

 

9

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Thefollowing table sets forth an analysis of our allowance for loan losses.

 
|                                                                                                    |   | **Year Ended December 31,** |   |
|---------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                                    |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                                                    |   | **(Dollars in Thousands)**  |   |
| Balance at beginning of period                                                                          |   | $                           | 2,806  |   | $ | 2,561 |   | $ | 2,315 |   | $ | 2,069 |   | $ | 1,828 |   |
| Charge-offs:                                                                                            |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                                                                                     |   | —                      |   | — |   | — |   | — |   | — |   |
| Multi-family                                                                                            |   | —                      |   | — |   | — |   | — |   | — |   |
| Commercial real estate                                                                                  |   | —                      |   | 42 |   | — |   | — |   | — |   |
| Construction or development                                                                             |   | —                      |   | — |   | — |   | — |   | — |   |
| Consumer                                                                                                |   | 4                           |   | — |   | — |   | — |   | 5 |   |
| Leases                                                                                                  |   | —                      |   | — |   | — |   | — |   | — |   |
|                                                                                                    |   | 4                           |   | 42 |   | — |   | — |   | 5 |   |
| Recoveries:                                                                                             |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                                                                                     |   | —                      |   | — |   | — |   | — |   | — |   |
| Multi-family                                                                                            |   | —                      |   | — |   | — |   | — |   | — |   |
| Commercial real estate                                                                                  |   | —                      |   | — |   | — |   | — |   | — |   |
| Construction or development                                                                             |   | —                      |   | 143 |   | — |   | — |   | — |   |
| Consumer                                                                                                |   | 8                           |   | — |   | — |   | — |   | — |   |
| Leases                                                                                                  |   | —                      |   | — |   | — |   | — |   | — |   |
|                                                                                                    |   | 8                           |   | 143 |   | — |   | — |   | — |   |
| Net (charge-offs) recoveries                                                                            |   | 4                           |   | 101 |   | — |   | — |   | (5 | ) |
| Additions charged to operations                                                                         |   | 127                         |   | 144 |   | 246 |   | 246 |   | 246 |   |
| Balance at end of period                                                                                |   | $                           | 2,937  |   | $ | 2,806 |   | $ | 2,561 |   | $ | 2,315 |   | $ | 2,069 |   |
| Ratio of net charge-offs (recoveries) during the  period to average loans outstanding during the period |   | —                      | %      | (0.04 | )% | — | % | — | % | — | % |
| Ratio of net charge-offs (recoveries) during the  period to average non-performing assets               |   | (0.19                       | )%     | (6.96 | )% | — | % | — | % | 0.38 | % |

 

10

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Thedistribution of our allowance for losses on loans at the dates indicated issummarized as follows:

 
|                                  |   | **December 31,**                     |   |
|---------------------------------------|--------|--------------------------------------|--------|
|                                  |   | **2002**                             |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                  |   | **Amount of  Loan  Loss  Allowance** |   | **Loan  Amounts by  Category** |   | **Percent  of Loans  in Each  Category  of Total  Loans** |   | **Amount of  Loan  Loss  Allowance** |   | **Loan  Amounts by  Category** |   | **Percent  of Loans  in Each  Category  of Total  Loans** |   | **Amount of  Loan  Loss  Allowance** |   | **Loan  Amounts by  Category** |   | **Percent  of Loans in  Each  Category of  Total  Loans** |   | **Amount of  Loan  Loss  Allowance** |   | **Loan  Amounts by  Category** |   | **Percent  of Loans  in Each********Category  of Total  Loans** |   | **Amount of  Loan  Loss  Allowance** |   | **Loan  Amounts by  Category** |   | **Percent  of Loans in  Each  Category of  Total********Loans** |   |
|                                  |   | **(Dollars in Thousands)**           |   |
| One-to four-family                    |   | $                                    | 730    |   | $ | 188,449 |   | 61.44 | % | $ | 839 |   | $ | 207,067 |   | 70.85 | % | $ | 872 |   | $ | 212,863 |   | 76.07 | % | $ | 823 |   | $ | 200,201 |   | 81.71 | % | $ | 736 |   | $ | 182,452 |   | 82.23 | % |
| Multi-family                          |   | 330                                  |   | 33,464 |   | 10.91 |   | 172 |   | 28,659 |   | 9.81 |   | 116 |   | 19,272 |   | 6.89 |   | 80 |   | 13,389 |   | 5.47 |   | 83 |   | 11,313 |   | 5.10 |   |
| Commercial and mixed use real  estate |   | 565                                  |   | 52,208 |   | 17.02 |   | 490 |   | 32,477 |   | 11.11 |   | 473 |   | 29,817 |   | 10.66 |   | 607 |   | 24,388 |   | 9.95 |   | 483 |   | 21,433 |   | 9.66 |   |
| Construction                          |   | 765                                  |   | 22,259 |   | 7.26 |   | 710 |   | 13,795 |   | 4.72 |   | 448 |   | 8,968 |   | 3.20 |   | 33 |   | 333 |   | 0.14 |   | — |   | — |   | — |   |
| Consumer                              |   | 80                                   |   | 10,321 |   | 3.37 |   | 76 |   | 10,249 |   | 3.51 |   | 35 |   | 8,904 |   | 3.18 |   | 107 |   | 6,680 |   | 2.73 |   | 112 |   | 6,680 |   | 3.01 |   |
| Loans secured by leases               |   | —                               |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Unallocated                           |   | 467                                  |   | — |   | — |   | 519 |   | — |   | — |   | 617 |   | — |   | — |   | 665 |   | — |   | — |   | 655 |   | — |   | — |   |
| Total                                 |   | $                                    | 2,937  |   | $ | 306,701 |   | 100.00 | % | $ | 2,806 |   | $ | 292,247 |   | 100 | % | $ | 2,561 |   | $ | 279,824 |   | 100.00 | % | $ | 2,315 |   | $ | 244,991 |   | 100.00 | % | $ | 2,069 |   | $ | 221,878 |   | 100.00 | % |

 

11

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Theallowance for loan losses is established through a provision for loan lossescharged to earnings based on management’s evaluation of the risk inherent inits entire loan portfolio.  This evaluation, which includes a review ofall loans of which full collectibility may not be reasonably assured, considersthe market value of the underlying collateral, growth and composition of theloan portfolio, delinquency trends, adverse situations that may affect theborrower’s ability to repay, prevailing economic conditions and other factorsthat warrant recognition in providing for an adequate allowance for loanlosses.  In determining the general reserves under these policies,historical charge-offs and recoveries, changes in the mix and levels of thevarious types of loans, collateral values in the current loan portfolio andcurrent economic conditions are considered.

 

Whilemanagement believes that it uses the best information available to determinethe allowance for loan losses, unforeseen economic and market conditions couldresult in adjustments to the allowance for loan losses, and net earnings couldbe significantly affected, if circumstances differ substantially from theassumptions used in making the final determination.

 

**Securities Activities**

 

***General.***  Generally, the investment policy of theCompany is to invest funds among categories of investments based upon ourasset/liability management policies, investment quality, loan and depositvolume, liquidity needs and performance objectives. ** **In accordance with our asset/liability managementpolicy, we have recently focused a significant part of our investmentactivities on instruments with terms to repricing or maturity of five years orless and municipal securities that are exempt from federal taxes.

 

Oursecurities are classified into two categories: held-to-maturity andavailable-for-sale.  Securities that we have the positive intent andability to hold to maturity are classified as held-to-maturity and reported atamortized cost.  All other securities not classified as held-to-maturityare classified as available-for-sale.  At December 31, 2002, we had $42.6million of securities classified as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gainsand losses included, on an after-tax basis, in a separate component ofshareholders’ equity.

 

***Mortgage-Backed and Related Securities.*** In order to supplement our lending activities and achieve our asset/liabilitymanagement goals, we invest in mortgage-backed and related securities.  Asof December 31, 2002, all of the mortgage-backed and related securities weowned were issued, insured or guaranteed either directly or indirectly by afederal agency or are rated “AAA” by a nationally recognized credit ratingagency.  It should be noted, however, that, while a (direct or indirect)federal guarantee or a high credit rating may indicate a high degree ofprotection against default, they do not indicate that the securities will beprotected from declines in value based on changes in interest rates orprepayment speeds.

 

Consistentwith our asset/liability management strategy, at December 31, 2002, $12.8million, or 51.82% of our mortgage-backed and related securities wereclassified available-for-sale.  In addition, on the same date, $4.3million or 17.55% of our mortgage-backed and related securities carriedadjustable rates.  For additionalinformation regarding our mortgage-backed securities portfolio, see Note 2 ofthe Notes to Consolidated Financial Statements in the Annual Report attached asExhibit 13 hereto.

 

12

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Thefollowing table sets forth the composition of our mortgage-backed securities atthe dates indicated.

 
|                                             |   | **December 31,**           |   |
|--------------------------------------------------|--------|----------------------------|--------|
|                                             |   | **2002**                   |   | **2001** |   | **2000** |   |
|                                             |   | **Carrying  Value**        |   | **%  of********Total** |   | **Carrying  Value** |   | **%  of********Total** |   | **Carrying  Value** |   | **%  of********Total** |   |
|                                             |   | **(Dollars in Thousands)** |   |
| Mortgage-backed securities  held-to-maturity:    |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Government National Mortgage  Association        |   | $                          | 8,043  |   | 32.62 | % | $ | 13,285 |   | 55.64 | % | $ | 2,902 |   | 22.28 | % |
| Federal National Mortgage  Association           |   | 1,001                      |   | 4.06 |   | 1,716 |   | 7.19 |   | 624 |   | 4.79 |   |
| Federal Home Loan Mortgage  Association          |   | 2,836                      |   | 11.50 |   | 2,708 |   | 11.34 |   | 1,278 |   | 9.81 |   |
| Collateralized Mortgage  Obligations             |   | —                     |   | — |   | 171 |   | 0.72 |   | 620 |   | 4.76 |   |
|                                             |   | 11,880                     |   | 48.18 |   | 17,880 |   | 74.89 |   | 5,424 |   | 41.64 |   |
| Mortgage-backed securities  available-for- sale: |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Government National Mortgage  Association        |   | 856                        |   | 3.47 |   | 794 |   | 3.32 |   | 1,151 |   | 8.84 |   |
| Federal National Mortgage  Association           |   | 9,004                      |   | 36.51 |   | 2,264 |   | 9.48 |   | 2,690 |   | 20.65 |   |
| Federal Home Loan Mortgage  Association          |   | 2,920                      |   | 11.84 |   | 2,938 |   | 12.31 |   | 3,761 |   | 28.87 |   |
|                                             |   | 12,780                     |   | 51.82 |   | 5,996 |   | 25.11 |   | 7,602 |   | 58.36 |   |
| Total mortgage-backed  securities                |   | $                          | 24,660 |   | 100.00 | % | $ | 23,876 |   | 100.00 | % | $ | 13,026 |   | 100.00 | % |

 

Thefollowing table sets forth the contractual maturities of our mortgage-backedsecurities at December 31, 2002.

 
|                                     |   | **Due in**            |   | **December 31, 2002**   |   |
|------------------------------------------|--------|-----------------------|--------|-------------------------|--------|
|                                     |   | **6 Months or  Less** |   | **6 Months to  1 Year** |   | **1 to 3  Years** |   | **3 to 5  Years** |   | **5 to 10  Years** |   | **10 to 20  Years** |   | **Over 20  Years** |   | **Amortized  Cost** |   | **Carrying  Value** |   |
|                                     |   | **(In Thousands)**    |   |
| Federal Home Loan Mortgage Corporation   |   | $                     | 2      |                    | $      | 28 |   | $ | 10 |   | $ | 56 |   | $ | 157 |   | $ | 4,470 |   | $ | 1,091 |   | $ | 5,814 |   | $ | 5,756 |   |
| Federal National Mortgage Association    |   | 20                    |   | —                  |   | 14 |   | 3 |   | 15 |   | 4,066 |   | 5,820 |   | 9,938 |   | 10,005 |   |
| Government National Mortgage Association |   | —                |   | —                  |   | 55 |   | 39 |   | — |   | 804 |   | 7,991 |   | 8,889 |   | 8,899 |   |
|                                     |   |                  |   |                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                    |   | $                     | 22     |                    | $      | 28 |   | $ | 79 |   | $ | 98 |   | $ | 172 |   | $ | 9,340 |   | $ | 14,902 |   | $ | 24,641 |   | $ | 24,660 |   |

 

13

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Themarket values of a portion of our mortgage-backed securities held-to-maturityhave been from time to time lower than their carrying values. However, forfinancial reporting purposes, such declines in value are considered to betemporary in nature, since they have been due to changes in interest ratesrather than credit concerns.  See Note 2 of the Notes to ConsolidatedFinancial Statements in the Annual Report attached as Exhibit 13 hereto.

 

Thefollowing table shows our mortgage-backed securities purchase, sale andrepayment activities for the periods indicated.

 

|                                |   | **Year Ended December 31,** |   |
|-------------------------------------|--------|-----------------------------|--------|
|                                |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                |   | **(In Thousands)**          |   |
| Purchases:                          |   |                        |   |   |   |   |   |
| Adjustable-rate                     |   | $                           | — |   | $ | — |   | $ | — |   |
| Fixed-rate                          |   | 9,417                       |   | 15,879 |   | — |   |
| Collateralized Mortgage Obligations |   | —                      |   | — |   | — |   |
| Total purchases                     |   | 9,417                       |   | 15,879 |   | — |   |
| Principal repayments                |   | (9,176                      | )      | (5,675 | ) | (4,046 | ) |
| Discount/premium net change         |   | 500                         |   | 462 |   | (53 | ) |
| Fair value net change               |   | 43                          |   | 184 |   | 138 |   |
| Net increase (decrease)             |   | $                           | 784    |   | $ | 10,850 |   | $ | (3,961 | ) |

 

Ourholdings of mortgage-backed securities are approximately 5.31% of our totalassets.  Since pass-through mortgage-backed securities generally carry ayield approximately 50 to 100 basis points below that of the corresponding typeof residential loan (due to the implied federal agency guarantee fee and theretention of a servicing spread by the loan servicer), in the event that theproportion of our assets consisting of mortgage-backed securities increases,our asset yields could be somewhat adversely affected. We will evaluatemortgage-backed securities purchases in the future based on our asset/liabilityobjectives, market conditions and alternative investment opportunities.

 

***Other Securities.***  In order to complement our lending andmortgage-backed securities activities, and to increase our holdings of shortand intermediate term assets, we invest in liquid investments and inhigh-quality investments, such as U.S. Treasury and agencyobligations.   At December 31, 2002 and December 31, 2001, ourother securities portfolio totaled $87.1 million and $90.1 million,respectively.  At December 31, 2002, we did not own any other securitiesof a single issuer in an amount exceeding 10% of our shareholders equity, otherthan federal agency obligations.  See Note 2 of the Notes to ConsolidatedFinancial Statements in the Annual Report attached as Exhibit 13 hereto foradditional information regarding our other securities portfolio.

 

14

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Thefollowing table sets forth the composition of our other securities and otherearning assets at the dates indicated.

 
|                                 |   | **December 31,**           |   |
|--------------------------------------|--------|----------------------------|--------|
|                                 |   | **2002**                   |   | **2001** |   | **2000** |   |
|                                 |   | **Carrying  Value**        |   | **%  of********Total** |   | **Carrying  Value** |   | **%  of********Total** |   | **Carrying  Value** |   | **%  of********Total** |   |
|                                 |   | **(Dollars in Thousands)** |   |
| Securities held-to-maturity:         |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| US government agencies               |   | $                          | 28,474 |   | 32.69 | % | $ | 46,223 |   | 51.31 | % | $ | 57,164 |   | 58.83 | % |
| Municipal bonds                      |   | 28,772                     |   | 33.04 |   | 28,113 |   | 31.21 |   | 15,718 |   | 16.17 |   |
|                                 |   |                       |   |   |   |   |   |   |   |   |   |   |   |
|                                 |   | 57,246                     |   | 65.73 |   | 74,336 |   | 82.52 |   | 72,882 |   | 75.00 |   |
|                                 |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Securities available-for sale:       |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| US Treasury                          |   | 361                        |   | 0.42 | % | 348 |   | 0.39 | % | 352 |   | 0.36 | % |
| US government agencies               |   | 14,982                     |   | 17.20 |   | 3,078 |   | 3.41 |   | 10,833 |   | 11.15 |   |
| Mutual funds                         |   | 3,294                      |   | 3.78 |   | 3,182 |   | 3.53 |   | 3,128 |   | 3.22 |   |
| Municipal bonds                      |   | 11,064                     |   | 12.70 |   | 8,737 |   | 9.70 |   | 9,365 |   | 9.64 |   |
| Corporate notes                      |   | —                     |   | — |   | 260 |   | 0.29 |   | 232 |   | 0.24 |   |
| Other equity                         |   | 147                        |   | 0.17 |   | 140 |   | 0.16 |   | 382 |   | 0.39 |   |
|                                 |   | 29,848                     |   | 34.27 |   | 15,745 |   | 17.48 |   | 24,292 |   | 25.00 |   |
| Total securities                     |   | $                          | 87,094 |   | 100.00 | % | $ | 90,081 |   | 100.00 | % | 97,174 |   | 100.00 | % |
|                                 |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Other earning assets:                |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning deposits with banks |   | $                          | 5,631  |   | 21.62 | % | $ | 1,423 |   | 9.81 | % | 1,353 |   | 28.89 | % |
| FHLB stock                           |   | 14,788                     |   | 56.77 |   | 12,162 |   | 83.80 |   | 3,330 |   | 71.11 |   |
| Federal funds sold                   |   | 5,629                      |   | 21.61 |   | 928 |   | 6.39 |   | — |   | — |   |
|                                 |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Total                                |   | $                          | 26,048 |   | 100.00 | % | $ | 14,513 |   | 100.00 | % | 4,683 |   | 100.00 | % |
|                                      |        |                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thecomposition and remaining maturities of our other securities portfolio,excluding mutual funds, other equity securities and Federal Home Loan Bank(“FHLB”) stock, is indicated in the following table.

 
|                       |   | **December 31, 2002**      |   |
|----------------------------|--------|----------------------------|--------|
|                       |   | **Less Than 1 Year**       |   | **1 to 5  Years** |   | **5 to 10  Years** |   | **Over 10  years** |   | **Total Securities** |   |
|                       |   | **Amortized  Cost**        |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Fair  Value** |   |
|                       |   | **(Dollars in Thousands)** |   |
| US Treasury                |   | $                          | — |   | $ | — |   | $ | — |   | $ | 258 |   | $ | 258 |   | $ | 361 |   |
| Federal agency obligations |   | —                     |   | 5,502 |   | 27,405 |   | 10,320 |   | 43,227 |   | 44,516 |   |
| Municipal bonds            |   | —                     |   | 1,963 |   | 6,887 |   | 30,307 |   | 39,157 |   | 41,622 |   |
|                       |   |                       |   |   |   |   |   |   |   |   |   |   |   |
| Total securities           |   | $                          | — |   | $ | 7,465 |   | $ | 34,292 |   | $ | 40,885 |   | $ | 82,642 | (1)  | $ | 86,499 |   |
| Weighted average yield     |   | —                     | %      | 4.650 | % | 5.563 | % | 5.333 | % | 5.372 | % |   |   |

 

----

(1)    Includes $43.2 million of callable securities.

 

SeeNote 2 of Notes to the Consolidated Financial Statements in the AnnualReport attached as Exhibit 13 hereto for

 

15

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adiscussion of our securities portfolio.

 

**Sources of Funds**

 

***General.***  The Bank’s primary sources of funds aredeposits, payments (including prepayments) of loan principal, interest earnedon loans and securities, repayments of securities, borrowings and fundsprovided from operations.

 

***Deposits.***  We offer deposit accounts having a wide rangeof interest rates and terms.  The Bank’s deposits consist of passbooksavings, NOW, money market and various certificate accounts.  We relyprimarily on competitive pricing, customer service and community outreach toattract and retain these deposits.  The Bank’s customers may access theiraccounts through any of our five offices and five automated teller machines(“ATMs”).    In addition, our customers may access theiraccounts through several nationwide ATM networks.  The Bank only solicitsdeposits in its market area and does not currently use brokers to obtaindeposits.

 

Wemanage the pricing of our deposits in keeping with our asset/liabilitymanagement, profitability and growth objectives.   The variety ofdeposit accounts offered by the Bank has allowed us to be competitive inobtaining funds and to respond with flexibility to changes in consumerdemand.  As some customers have become more interest rate conscious,however the Bank has become more susceptible to short-term fluctuations in itscertificate of deposit flows.

 

Managementbelieves that the “core” portion of our regular passbook savings, NOW and moneymarket accounts, which amounted to $131.6 million or 45.29% of total depositsat December 31, 2002, can have a lower cost and be more resistant to interestrate changes (and competing non-depository financial products) than certificateaccounts.  We utilize customer service, community outreach and marketinginitiatives in an effort to build and maintain the volume of such deposits. However, there can be no assurance as to whether we will be able to maintain orincrease our core deposits in the future.

 

Thetable below sets forth the Bank’s deposit flows for the periods indicated.

 

|                        |   | **Year Ended December 31,** |    |
|-----------------------------|--------|-----------------------------|---------|
|                        |   | **2002**                    |    | **2001** |   | **2000** |   |
|                        |   | **(Dollars In Thousands)**  |    |
| Opening balance             |   | $                           | 268,857 |   | $ | 252,662 |   | $ | 238,123 |   |
| Deposits                    |   | 457,133                     |    | 439,561 |   | 426,788 |   |
| Withdrawals                 |   | (443,392                    | )       | (434,362 | ) | (423,146 | ) |
| Interest credited           |   | 8,014                       |    | 10,996 |   | 10,897 |   |
| Ending balance              |   | 290,612                     |    | 268,857 |   | 252,662 |   |
| Net increase (decrease)     |   | 21,755                      |    | 16,195 |   | 14,539 |   |
| Percent increase (decrease) |   | 8.09                        | %       | 6.41 | % | 6.11 | % |
|                             |        |                             |         |  |  |  |  |  |  |  |

 

16

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Thefollowing table sets forth the dollar amount of savings deposits in the Bank asof the dates indicated.

 
|                        |   | **December 31,**           |    |
|-----------------------------|--------|----------------------------|---------|
|                        |   | **2002**                   |    | **2001** |   | **2000** |   |
|                        |   | **Amount**                 |    | **Percent********of  Total** |   | **Amount** |   | **Percent********of  Total** |   | **Amount** |   | **Percent********of  Total** |   |
|                        |   | **(Dollars in Thousands)** |    |
|                        |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Passbook Accounts 2.00%     |   | $                          | 100,371 |   | 34.5 | % | $ | 83,963 |   | 31.2 | % | $ | 77,232 |   | 30.5 | % |
| NOW Accounts 0.85%          |   | 25,233                     |    | 8.7 |   | 23,946 |   | 8.9 |   | 20,456 |   | 8.1 |   |
| Money Market Accounts 1.60% |   | 5,978                      |    | 2.1 |   | 4,720 |   | 1.8 |   | 4,215 |   | 1.7 |   |
| Total Non-Certificates      |   | 131,582                    |    | 45.3 |   | 112,629 |   | 41.9 |   | 101,903 |   | 40.3 |   |
| Certificates :              |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| 0.00 - 3.99%                |   | 127,023                    |    | 43.7 |   | 73,044 |   | 27.2 |   | — |   | — |   |
| 4.00 - 5.99%                |   | 22,570                     |    | 7.8 |   | 70,067 |   | 26.0 |   | 97,125 |   | 38.5 |   |
| 6.00 - 7.99%                |   | 9,395                      |    | 3.2 |   | 13,075 |   | 4.9 |   | 53,585 |   | 21.2 |   |
| 8.00 - 9.00%                |   | 42                         |    | — |   | 42 |   | — |   | 49 |   | — |   |
| Total Certificates          |   | 159,030                    |    | 54.7 |   | 156,228 |   | 58.1 |   | 150,759 |   | 59.7 |   |
| Total Deposits              |   | $                          | 290,612 |   | 100.0 | % | 268,857 |   | 100.0 | % | 252,662 |   | 100.0 | % |
|                             |        |                            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table shows rate and maturity information for our certificates ofdeposit as of December 31, 2002.

 
|         |   | **Less Than  1 Year**      |    | **1 to 2  Years** |   | **2 to 3  Years** |   | **3 to 4  Years** |   | **4 to 5  Years** |   | **Total** |   |
|--------------|--------|----------------------------|---------|-------------------|--------|-------------------|--------|-------------------|--------|-------------------|--------|-----------|--------|
|         |   | **(Dollars in Thousands)** |    |
| 2.00 - 2.99% |   | $                          | 91,107  |              | $      | 2,427             |   | 21                |   | $                 | — |      | $      | — |   | $ | 93,555 |   |
| 3.00 - 3.99% |   | 29,509                     |    | 3,216             |   | 707               |   | 36                |   | —            |   | 33,468    |   |
| 4.00 - 4.99% |   | 2,332                      |    | 600               |   | —            |   | 781               |   | 8,127             |   | 11,840    |   |
| 5.00 - 5.99% |   | 4,116                      |    | 440               |   | 575               |   | 406               |   | 5,193             |   | 10,730    |   |
| 6.00 - 6.99% |   | 1,044                      |    | 3,702             |   | 4,621             |   | 28                |   | —            |   | 9,395     |   |
| 7.00 - 7.99% |   | —                     |    | —            |   | —            |   | —            |   | —            |   | —    |   |
| 8.00 - 8.99% |   | —                     |    | 42                |   | —            |   | —            |   | —            |   | 42        |   |
|         |   | $                          | 128,108 |              | $      | 10,427            |   | $                 | 5,924  |              | $      | 1,251     |   | $ | 13,320 |   | $ | 159,030 |   |
|              |        |                            |         |                   |        |                   |        |                   |        |                   |        |           |        |  |  |  |  |  |  |

 

Thefollowing table indicates the amount of our certificates of deposit and otherdeposits by time remaining until maturity as of December 31, 2002.

 
|                                            |   | **Maturity**          |   |
|-------------------------------------------------|--------|-----------------------|--------|
|                                            |   | **3 Months  or Less** |   | **Over  3 to 6  Months** |   | **Over  6 to 12 Months** |   | **Over  12  Months** |   | **Total** |   |
|                                            |   | **(In Thousands)**    |   |
| Certificates of deposit less than $100,000 |   | $                     | 27,858 |   | $ | 27,471 |   | $ | 28,252 |   | $ | 21,099 |   | $ | 104,680 |   |
| Certificates of deposit $100,000 or more   |   | 13,524                |   | 18,504 |   | 12,499 |   | 9,823 |   | 54,350 |   |
| Total certificates of deposit                   |   | $                     | 41,382 |   | $ | 45,975 |   | $ | 40,751 |   | $ | 30,922 |   | $ | 159,030 |   |

 

Foradditional information regarding the composition of our deposits, seeNote 6 of the Notes to the Consolidated Financial Statements in the AnnualReport attached as Exhibit 13 hereto.

 

***Borrowings.***  Our other available sources of fundsinclude advances from the FHLB of Chicago and other

 

17

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borrowings. Our FHLB advances to date have primarily consisted of subsidized borrowings tofund special housing programs. As a member of the FHLB of Chicago, the Bank isrequired to own capital stock in the FHLB of Chicago and is authorized to applyfor advances from the FHLB of Chicago.  Each FHLB credit program has itsown interest rate, which may be fixed or variable, and range of maturities. The FHLB of Chicago may prescribe the acceptable uses for these advances, aswell as limitations on the size of the advances and repaymentprovisions.   At December 31, 2002, the weighted average term tomaturity of our FHLB advances was 56.7 months.  See Note 7 of the Notes toConsolidated Financial Statements in the Annual Report attached as Exhibit 13hereto.

 

Thefollowing table sets forth the maximum month-end balance and average balance ofFHLB advances for the periods indicated. 

 
|                                                             |   | **Year Ended December 31,** |   |
|------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                             |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                             |   | **(Dollars In Thousands)**  |   |
| Maximum Balance:                                                 |   |                        |   |   |   |   |   |   |   |   |   |
| FHLB Advances                                                    |   | $                           | 94,682 |   | $ | 83,600 |   | $ | 65,850 |   | $ | 46,300 |   | $ | 29,000 |   |
| Average Balance:                                                 |   |                        |   |   |   |   |   |   |   |   |   |
| FHLB Advances                                                    |   | $                           | 86,904 |   | $ | 68,003 |   | $ | 56,597 |   | $ | 34,607 |   | $ | 21,667 |   |
| Weighted average interest rate of FHLB advances during  the year |   | 5.33                        | %      | 5.47 | % | 6.03 | % | 5.41 | % | 5.10 | % |

 

**Subsidiary Activities**

 

Asa federally chartered savings bank, First Security is permitted by OTSregulations to invest up to 2% of its assets in the stock of, or loans to,service corporation subsidiaries, and may invest an additional 1% of its assetsin service corporations where such additional funds are used for inner-city orcommunity development purposes.  In addition to investments in servicecorporations, federal institutions are permitted to invest an unlimited amountin operating subsidiaries engaged solely in activities which a federal savingsassociation may engage in directly.

 

AtDecember 31, 2002, First Security had one wholly owned service corporation,Western Security Service Corporation (“Western” or the “Subsidiary”). Western,an Illinois corporation, was incorporated in November 1977 for the purpose ofoffering customers and members of the general public credit, life, mortgage anddisability insurance.  First Security’s investment in Western was $80,429as of December 31, 2002.  Western recognized net income of $26,913 duringthe year ended December 31, 2002 and $24,919 during the year ended December 31,2001.

 

**Competition**

 

Weface strong competition both in originating real estate loans and in attractingdeposits.  Competition in originating loans comes primarily from creditunions, mortgage bankers, commercial banks and other savings institutions,which also make loans secured by real estate located in our market area. First Security competes for loans principally on the basis of the interestrates and loan fees it charges, the types of loans it originates, communityoutreach and the quality of services it provides to borrowers.

 

Competitionfor deposits is principally from credit unions, commercial banks, mutual funds,securities firms and other savings institutions located in the samecommunities.  The ability of the Bank to attract and retain depositsdepends on its ability to provide an investment opportunity that satisfies therequirements of investors as to rate of return, liquidity, risk, convenientlocations and other factors.  We compete for these deposits by offeringcompetitive rates, convenient business hours, community outreach and a customeroriented staff.

 

18

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**Regulations - General**

 

FirstSecurity is a federally chartered savings bank, the deposits of which arefederally insured and backed by the full faith and credit of the United StatesGovernment.  Accordingly, First Security is subject to broad federalregulation and oversight extending to all its operations.  First Securityis a member of the FHLB of Chicago and is subject to certain limited regulationby the Board of Governors of the Federal Reserve System (“Federal ReserveBoard”).  As the savings and loan holding company of First Security, theCompany also is subject to federal regulation and oversight.  The purposeof the regulation of the Company and other holding companies is to protectsubsidiary savings associations.  First Security is a member of theSavings Association Insurance Fund (“SAIF”) and the deposits of First Securityare insured by the Federal Deposit Insurance Corporation ("FDIC"). As a result, the FDIC has certain regulatory and examination authority overFirst Security.

 

Certainof these regulatory requirements and restrictions are discussed below orelsewhere in this document.

 

**Federal Regulation of Savings Associations**

 

TheOTS has extensive authority over the operations of savings associations. As part of this authority, First Security is required to file periodic reportswith the OTS and is subject to periodic examinations by the OTS and theFDIC.   When these examinations are conducted by the OTS and theFDIC, the examiners may require First Security to provide for higher general orspecific loan loss reserves.  All savings associations are subject to asemi-annual assessment, based upon the savings association’s total assets, tofund the operations of the OTS.

 

TheOTS also has extensive enforcement authority over all savings institutions andtheir holding companies, including First Security and the Company.  Thisenforcement authority includes, among other things, the ability to assess civilmoney penalties, to issue cease-and-desist or removal orders and to initiateinjunctive actions.  In general, these enforcement actions may beinitiated for violations of laws and regulations and unsafe or unsoundpractices.  Other actions or inactions may provide the basis forenforcement action, including misleading or untimely reports filed with theOTS.  Except under certain circumstances, public disclosure of finalenforcement actions by the OTS is required.

 

Inaddition, the investment, lending and branching authority of First Security isprescribed by federal laws and it is prohibited from engaging in any activitiesnot permitted by such laws.  For instance, no savings institution mayinvest in non-investment grade corporate debt securities.  In addition,the permissible level of investment by federal associations in loans secured bynon-residential real property may not exceed 400% of total capital, except withapproval of the OTS.  Federal savings associations are also generally authorizedto branch nationwide.  First Security is in compliance with the notedrestrictions.

 

FirstSecurity’s general permissible lending limit for loans-to-one-borrower is equalto the greater of $500,000 or 15% of unimpaired capital and surplus (except forloans fully secured by certain readily marketable collateral, in which casethis limit is increased to 25% of unimpaired capital and surplus).  AtDecember 31, 2002, First Security’s lending limit under this restriction wasapproximately $9.9 million. First Security is in compliance with theloans-to-one-borrower limitation.

 

TheOTS, as well as the other federal banking agencies, has adopted guidelinesestablishing safety and soundness standards on such matters as loanunderwriting and documentation, asset quality, internal controls and auditsystems, interest rate risk exposure and compensation and other employeebenefits.  Any institution that fails to comply with these standards mustsubmit a compliance plan.

 

**Insurance of Accounts and Regulation by the FDIC**

 

FirstSecurity is a member of the SAIF, which is administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and such insurance isbacked by the full faith and credit of the United States Government.  Asthe insurer, the FDIC imposes deposit insurance premiums and is authorized toconduct examinations of and to require reporting by FDIC-insuredinstitutions.  It also may prohibit any FDIC-insured institution fromengaging in any activity the FDIC determines by regulation or order to pose aserious risk to the FDIC.  The FDIC also has the authority to initiateenforcement actions against savings associations, after giving the OTS anopportunity to take such action, and may terminate the deposit insurance if itdetermines that the institution has engaged in unsafe or unsound practices oris in an unsafe or unsound condition.

 

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TheFDIC’s deposit insurance premiums are assessed through a risk-based systemunder which all insured depository institutions are placed into one of ninecategories and assessed insurance premiums based upon their level of capitaland supervisory evaluation.  Under the system, institutions classified aswell capitalized (*i.e.*, a corecapital ratio of at least 5%, a ratio of Tier 1 or core capital torisk-weighted assets (“Tier 1 risk-based capital”) of at least 6% and arisk-based capital ratio of at least 10%) and considered healthy pay the lowestpremium while institutions that are less than adequately capitalized (*i.e.*, core or Tier 1 risk-basedcapital ratios of less than 4% or a risk-based capital ratio of less than 8%)and considered of substantial supervisory concern pay the highestpremium.  Risk classification of all insured institutions will be made bythe FDIC for each semi-annual assessment period.  Based on the Bank’s most recent semi-annual assessment, as ofDecember 31, 2002, the Bank is classified as well capitalized and healthy.

 

TheFDIC is authorized to increase assessment rates, on a semiannual basis, if itdetermines that the reserve ratio of the SAIF will be less than the designatedreserve ratio of 1.25% of SAIF-insured deposits.  In setting theseincreased assessments, the FDIC must seek to restore the reserve ratio to thatdesignated reserve level, or such higher reserve ratio as established by theFDIC.  The FDIC may also impose special assessments on SAIF members torepay amounts borrowed from the United States Treasury or for any other reasondeemed necessary by the FDIC.

 

Effective January 1, 1997, the premium schedule for Bank Insurance Fund(“BIF”) and SAIF insured institutions ranged from 0 to 27 basis points. In addition, all BIF and SAIF insured institutions are required to pay afinancing corporation assessment in order to fund the interest on bonds issuedto resolve the thrift failures in the 1980s.   Prior to January 1,2000, SAIF members paid approximately 6 basis points for each $100 of domesticdeposits.  The assessment was reduced to 2.12 basis points as ofJanuary 1, 2000, when BIF insured institutions began to fully participate inthe assessment.  As of January 1, 2003, the assessment stood at 1.68 basispoints.  These assessments, which may be revised based upon the level ofBIF and SAIF deposits, will continue until the bonds mature in the year 2017.

 

**Regulatory Capital Requirements**

 

Federally insured savings associations, such as First Security, arerequired to maintain a minimum level of regulatory capital. The OTS hasestablished capital standards that require the Bank to maintain minimum amountsand ratios of total and Tier I capital to risk-weighted assets and of Tier Icapital to qualifying total assets (leverage ratio). These capital requirementsmust be generally as stringent as the comparable capital requirements fornational banks. The OTS is also authorized to impose capital requirements inexcess of these standards on individual associations on a case-by-case basis.

 

The capital regulations require a leverage ratio of 4% of adjustedtotal assets (as defined by regulation). Tier I capital, used to calculate theleverage ratio, generally includes common stockholders’ equity and retainedincome and certain noncumulative perpetual preferred stock and related income.In addition, all intangible assets, other than a limited amount of purchasedmortgage servicing rights, must be deducted from Tier I capital for calculatingcompliance with the requirement. At December 31, 2002, First Security had$85,100 of intangible assets recorded as assets on its financial statements, asa result of its acquisition of assets and assumption of liabilities from theResolution Trust Corporation in 1994.

 

The OTS regulations establish special capitalization requirements forsavings associations that own subsidiaries. In determining compliance with thecapital requirements, all subsidiaries engaged solely in activities permissiblefor national banks or engaged in certain other activities solely as agent forits customers are “includable” subsidiaries that are consolidated for capital purposesin proportion to the association’s level of ownership. For excludablesubsidiaries the debt and equity investments in such subsidiaries are deductedfrom assets and capital.   At December 31, 2002, First SecurityFedhad no deductions for non-includable subsidiaries.

 

AtDecember 31, 2002, First Security had Tier I capital of $65.9 million or 14.4%of adjusted total assets, which is approximately $47.6 million above theminimum requirement of 4% of adjusted total assets in effect on the date.

 

Thecapital standards also require Tier I capital equal to at least 4% ofrisk-weighted assets.

 

AtDecember 31, 2002, First Security had Tier I capital equal to $65.9 million or25.5% of risk-weighted assets,

 

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whichis $55.6 million above the minimum Tier I risk-based capital ratio of 4% ineffect on that date.

 

TheOTS risk-based requirement requires savings associations to have total capitalof at least 8% of risk-weighted assets.  Total capital consists of corecapital, as defined above, and supplementary capital.  Supplementarycapital consists of certain permanent and maturing capital instruments that donot qualify as core capital and general valuation loan and lease lossallowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only tothe extent of core capital.  The OTS is also authorized to require asavings association to maintain an additional amount of total capital to accountfor concentration of credit risk and the risk of non-traditionalactivities.  At December 31, 2002, First Security had $2.9 million ofgeneral loss reserves all, of which qualifies as supplementary capital, whichwas less than 1.25% of risk-weighted assets.

 

Certainexclusions from capital and assets are required to be made for the purpose ofcalculating total capital.  Such exclusions consist of equity investments(as defined by regulation) and that portion of land loans and nonresidentialconstruction loans in excess of an 80% loan-to-value ratio and reciprocalholdings of qualifying capital instruments.  First Security had no suchexclusions from capital and assets at December 31, 2002.

 

Indetermining the amount of risk-weighted assets, all assets, including certainoff-balance sheet items, will be multiplied by a risk weight, ranging from 0%to 100%, based on the risk inherent in the type of asset.  For example,the OTS has assigned a risk weight of 50% for prudently underwritten permanentone- to four-family first lien mortgage loans not more than 90 days delinquentand having a loan to value ratio of not more than 80% at origination unlessinsured to such ratio by an insurer approved by the FNMA or FHLMC.

 

OnDecember 31, 2002, First Security had total risk-based capital of approximately$68.9 million (including $65.9 million in core capital and $2.9 million inqualifying supplementary capital) and risk-weighted assets of $258.0 million;or total capital equal to 26.7% of risk-weighted assets.  This amount was$48.3 million above the 8% requirement in effect on that date.

 

TheOTS and the FDIC are authorized and, under certain circumstances, required totake certain actions against savings associations that fail to meet theircapital requirements.  The OTS is generally required to take action torestrict the activities of an “undercapitalized association” (generally definedto be one with less than either a 4% core capital ratio, a 4% Tier 1risked-based capital ratio or an 8% risk-based capital ratio).  Any suchassociation must submit a capital restoration plan and, until such plan isapproved by the OTS, may not increase its assets, acquire another institution,establish a branch or engage in any new activities, and generally may not makecapital distributions.  The OTS is authorized to impose the additionalrestrictions that are applicable to significantly undercapitalizedassociations.

 

Asa condition to the approval of the capital restoration plan, any companycontrolling an undercapitalized association must agree that it will enter intoa limited capital maintenance guarantee with respect to the institution’sachievement of its capital requirements.

 

Anysavings association that fails to comply with its capital plan or is“significantly undercapitalized” (*i.e.*,Tier 1 risk-based or core capital ratios of less than 3% or a risk-basedcapital ratio of less than 6%) must be made subject to one or more ofadditional specified actions and operating restrictions that may cover allaspects of its operations and include a forced merger or acquisition of theassociation.  An association that becomes “critically undercapitalized” (*i.e.*, a tangible capital ratio of 2% orless) is subject to further mandatory restrictions on its activities inaddition to those applicable to significantly undercapitalizedassociations.  In addition, the OTS must appoint a receiver (orconservator with the concurrence of the FDIC) for a savings association, withcertain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized association is also subject to the general enforcementauthority of the OTS and the FDIC, including the appointment of a conservatoror a receiver.

 

TheOTS is also generally authorized to reclassify an association into a lowercapital category and impose the restrictions applicable to such category if theinstitution is engaged in unsafe or unsound practices or is in an unsafe orunsound condition.

 

Theimposition by the OTS or the FDIC of any of these measures on the associationmay have substantial adverse effects on its operations and profitability.

 

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**Limitations on Dividends and Other Capital Distributions**

 

OTSregulations impose various restrictions on savings associations with respect totheir ability to make distributions of capital, which include dividends, stockredemptions or repurchases, cash-out mergers and other transactions charged tothe capital account.  OTS regulations also prohibit a savings associationfrom declaring or paying any dividends or from repurchasing any of its stockif, as a result, the regulatory capital of the association would be reducedbelow the amount required to be maintained for the liquidation accountestablished in connection with its mutual to stock conversion.

 

Generally,savings associations, such as First Security, that before and after theproposed distribution remain well-capitalized, may make capital distributionsduring any calendar year equal to 100% of net income for the year-to-date plusretained net income for the two preceding years.  However, an associationdeemed to be in need of more than normal supervision by the OTS may have itsdividend authority restricted by the OTS.  First Security may pay dividendsin accordance with this general authority.

 

Savingsassociations proposing to make any capital distribution need not submit writtennotice to the OTS prior to such distribution unless they are not a subsidiaryof a holding company or would not remain well capitalized following thedistribution 30 days prior to such distribution.  Savings associationsthat do not, or would not meet their current minimum capital requirementsfollowing a proposed capital distribution, however, must obtain OTS approvalprior to making such distribution.  The OTS may object to the distributionduring that 30-day period based on safety and soundness concerns.  See “-Regulatory Capital Requirements.”

 

**Liquidity**

 

Priorto the passage of the Financial Regulatory Relief and Economic Efficiency Actof 2000, all savings associations, including First Security, were required tomaintain an average daily balance of liquid assets equal to a certainpercentage of the average daily balance of its liquidity base during thepreceding calendar quarter or a percentage of the amount of its liquidity baseat the end of the preceding quarter.  For a discussion of what FirstSecurity includes in liquid assets, see “Management’s Discussion and Analysisof Financial Condition and Results of Operations - Liquidity and CapitalResources” in the Annual Report attached as Exhibit 13 hereto. This liquidasset ratio requirement would vary from time to time (between 4% and 10%)depending upon economic conditions and savings flows of all savingsassociations.  At the time the rule was in effect, the minimum liquidasset ratio was 4%.

 

**Qualified Thrift Lender Test**

 

Allsavings associations, including First Security, are required to meet aqualified thrift lender (“QTL”) test to avoid certain restrictions on theiroperations.  This test requires a savings association to have at least 65%of its portfolio assets (as defined by regulation) in qualified thriftinvestments on a monthly average for nine out of every 12 months on a rollingbasis.  As an alternative, the savings association may maintain 60% of itsassets in those assets specified in Section 7701(a)(19) of the Internal RevenueCode.  Under either test, such assets primarily consist of residentialhousing related loans and investments.  At December 31, 2002, First Securitymet the test and has always met the test since its effectiveness.

 

Anysavings association that fails to meet the QTL test must convert to a nationalbank charter, unless it requalifies as a QTL and thereafter remains aQTL.  If such an association has not yet requalified or converted to anational bank, its new investments and activities are limited to thosepermissible for both a savings association and a national bank, and it islimited to national bank branching rights in its home state.  In addition,the association is immediately ineligible to receive any new FHLB borrowingsand is subject to national bank limits for payment of dividends.  If suchassociation has not requalified or converted to a national bank within threeyears after the failure, it must divest of all investments and cease allactivities not permissible for a national bank.  If any association thatfails the QTL test is controlled by a holding company, then within one yearafter the failure, the holding company must register as a bank holding companyand become subject to all restrictions on bank holding companies.  See “-Holding Company Regulation.”

 

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**Community Reinvestment Act**

 

Underthe Community Reinvestment Act (“CRA”), every FDIC insured institution has acontinuing and affirmative obligation consistent with safe and sound bankingpractices to help meet the credit needs of its entire community, including lowand moderate income neighborhoods.  The CRA does not establish specificlending requirements or programs for financial institutions nor does it limitan institution’s discretion to develop the types of products and services thatit believes are best suited to its particular community, consistent with theCRA.  The CRA requires the OTS, in connection with the examination ofFirst Security, to assess the institution’s record of meeting the credit needsof its community and to take such record into account in its evaluation ofcertain applications, such as a merger or the establishment of a branch, byFirst Security.  An unsatisfactory rating may be used as the basis for thedenial of an application by the OTS.

 

Thefederal banking agencies, including the OTS, have recently revised the CRAregulations and the methodology for determining an institution’s compliancewith the CRA.  Due to the heightened attention being given to the CRA inthe past few years, First Security may be required to devote additional fundsfor investment and lending in its local community.  First Security wasexamined for CRA compliance in July 2001 and received a rating of satisfactory.

 

**Transactions with Affiliates**

 

Generally,transactions between a savings bank or its subsidiaries and its affiliates arerequired to be on terms as favorable to the bank as transactions withnon-affiliates.  In addition, certain of these transactions, such as loansto an affiliate, are restricted to a percentage of the bank’s capital. Affiliates of First Security include the Company and any company that is undercommon control with First Security.  In addition, a savings bank may notlend to any affiliate engaged in activities not permissible for a bank holdingcompany or acquire the securities of most affiliates.  The OTS has thediscretion to treat subsidiaries of savings banks as affiliates on a case bycase basis.

 

Certaintransactions with directors, officers or controlling persons are also subjectto conflict of interest regulations enforced by the OTS.  These conflictof interest regulations and other statutes also impose restrictions on loans tosuch persons and their related interests.  Among other things, such loansmust be made on terms substantially the same as for loans to unaffiliatedindividuals.

 

**Holding Company Regulation**

 

TheCompany is a unitary savings and loan holding company subject to regulatoryoversight by the OTS.  As such, the Company is required to register andfile reports with the OTS and is subject to regulation and examination by theOTS.  In addition, the OTS has enforcement authority over the Company andits non-savings association subsidiaries, such as Western.  This authority permits the OTS to restrictor prohibit activities that are determined to be a serious risk to thesubsidiary savings association.

 

Asa unitary savings and loan holding company, the Company generally is notsubject to activity restrictions.  If the Company acquires control ofanother savings association as a separate subsidiary, it would become amultiple savings and loan holding company, and the activities of the Companyand any of its subsidiaries (other than First Security or any otherSAIF-insured savings association) would become subject to such restrictionsunless such other associations each qualify as a QTL and were acquired in asupervisory acquisition.

 

IfFirst Security fails the QTL test, the Company must obtain the approval of theOTS prior to continuing after such failure, directly or through its othersubsidiaries, any business activity other than those approved for multiplesavings and loan holding companies or their subsidiaries.  In addition,within one year of such failure the Company must register as, and will becomesubject to, the restrictions applicable to bank holding companies.  Theactivities authorized for a bank holding company are more limited than are theactivities authorized for a unitary or multiple savings and loan holdingcompany.  See “- Qualified Thrift Lender Test.”

 

TheCompany must obtain approval from the OTS before acquiring control of any otherSAIF-insured association.  Such acquisitions are generally prohibited ifthey result in a multiple savings and loan holding company controlling savingsassociations in more than one state.  However, such interstateacquisitions are permitted based on specific

 

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stateauthorization or in a supervisory acquisition of a failing savings association.

 

**Federal Securities Law**

 

Thecommon stock of the Company is registered with the SEC under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”).  The Company issubject to the information, proxy solicitation, insider trading restrictionsand other requirements of the SEC under the Exchange Act.

 

FirstSecurityFed common stock held by persons who are deemed to be affiliates(generally officers, directors and principal stockholders) of the Companypursuant to the SEC’s rules and regulations may not be resold withoutregistration or unless sold in accordance with certain resalerestrictions.  If the Company meets specified current public informationrequirements, each affiliate of the Company is able to sell in the publicmarket, without registration, a limited number of shares in any three-monthperiod, subject to restrictions on the manner of sale and a reportingrequirement.

 

**Sarbanes-Oxley Act of 2002**

 

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Actof 2002, which contains important new requirements for public companies in thearea of financial disclosure and corporate governance.  Among the requirements of the Sarbanes-OxleyAct of 2002 are written certifications by our Chief Executive Officer and ChiefFinancial Officer of our quarterly and annual reports filed with the SEC, aswell as disclosures regarding our internal controls and procedures.  In response to the Sarbanes-Oxley Act of2002, the Company has reviewed its practices, policies and procedures to ensureour ability to comply with the requirements of the Act.  Some of the regulations mandated by theSarbanes-Oxley Act of 2002 have not yet been promulgated by the SEC and, as newregulations are finalized, we will continue to assess their impact on ourbusiness.

 

**Federal Reserve System**

 

TheFederal Reserve Board requires all depository institutions to maintainnon-interest bearing reserves at specified levels against their transactionaccounts (primarily checking, NOW and Super NOW checking accounts).  AtDecember 31, 2002, First Security was in compliance with these reserverequirements.  The balances maintained to meet the reserve requirements imposedby the Federal Reserve Board may be used to satisfy liquidity requirements thatmay be imposed by the OTS.  See “-Liquidity.”

 

Savingsassociations are authorized to borrow from the Federal Reserve Bank “discountwindow,” but Federal Reserve Board regulations require associations to exhaustother reasonable alternative sources of funds, including FHLB borrowings,before borrowing from the Federal Reserve Bank.

 

**Federal Home Loan Bank System**

 

FirstSecurity is a member of the FHLB of Chicago, which is one of 12 regional FHLBs,that administers the home financing credit function of savingsassociations.  Each FHLB serves as a reserve or central bank for itsmembers within its assigned region.  It is funded primarily from proceedsderived from the sale of consolidated obligations of the FHLB System.  Itmakes loans to members (*i.e.*,advances) in accordance with policies and procedures, established by the boardof directors of the FHLB, that are subject to the oversight of the FederalHousing Finance Board.  All advances from the FHLB are required to befully secured by sufficient collateral as determined by the FHLB.  Inaddition, all long-term advances are required to provide funds for residentialhome financing.

 

Asa member, First Security is required to purchase and maintain stock in the FHLBof Chicago.  At December 31, 2002, First Security had $14.8 millionin FHLB stock, which was in compliance with this requirement.  In pastyears, First Security has received substantial dividends on its FHLB stock.Over the past five calendar years such dividends have averaged 6.58% and were5.62% for calendar year 2002.  As a result of its holdings, the Bank couldborrow up to $296 million from the FHLB.

 

Forthe year ended December 31, 2002, dividends paid by the FHLB of Chicago toFirst Security totaled $705,000, which constitutes a $294,000 increase from theamount of dividends received in calendar year 2001.

 

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**Federal and State Taxation**

 

Savingsassociations such as First Security that meet certain conditions prescribed bythe Internal Revenue Code of 1986, as amended (the “Code”), were previouslypermitted to establish reserves for bad debts and to make annual additionsthereto that may, within specified formula limits, be taken as a deduction incomputing taxable income for federal income tax purposes.  The amount ofthe bad debt reserve deduction is computed under the experience method. Under the experience method, the bad debt reserve deduction is an amount determinedunder a formula based generally upon the bad debts actually sustained by thesavings association over a period of years.

 

Inaddition to the regular income tax, corporations, including savingsassociations such as First Security, generally are subject to a minimumtax.  An alternative minimum tax is imposed at a minimum tax rate of 20%on alternative minimum taxable income, which is the sum of a corporation’sregular taxable income (with certain adjustments) and tax preference items,less any available exemption.  The alternative minimum tax is imposed tothe extent it exceeds the corporation’s regular income tax and net operatinglosses can offset no more than 90% of alternative minimum taxable income.

 

Aportion of the Bank’s reserves for losses on loans may not, without adverse taxconsequences, be utilized for the payment of cash dividends or otherdistributions to a shareholder (including distributions on redemption,dissolution or liquidation) or for any other purpose (except to absorb bad debtlosses).  As of December 31, 2002, First Security’s excess for taxpurposes totaled approximately $2.0 million.

 

FirstSecurity files its federal, state and local income tax returns on a calendaryear basis using the accrual method of accounting.

 

FirstSecurity has not been audited by the IRS with respect to consolidated federalincome tax returns in the past five years. With respect to years examined bythe IRS, either all deficiencies have been satisfied or sufficient reserveshave been established to satisfy asserted deficiencies.   In theopinion of management, any examination of still open returns (including returnsof subsidiary and predecessors of, or entities merged into, First Security)would not result in a deficiency that could have a material adverse effect onthe financial condition of First Security and its consolidated subsidiary.

 

***Illinois Taxation.***  For Illinois income tax purposes, the Bankis taxed at an effective rate equal to 7.18% of Illinois taxableincome.   For these purposes, “Illinois Taxable Income” generallymeans federal taxable income, subject to certain adjustments (including theaddition of interest income on state and municipal obligations and theexclusion of interest income on United States Treasury obligations).

 

***Delaware Taxation.***  As a Delaware holding company, the Companyis exempted from Delaware corporate income tax but is required to file anannual report with and pay an annual fee to the State of Delaware.  TheCompany is also subject to an annual franchise tax imposed by the State ofDelaware.

 

**Employees**

 

AtDecember 31, 2002, the Company, including its subsidiaries, had a total of 95employees, including 24 part-time employees.  Our employees are notrepresented by any collective bargaining group.   Managementconsiders its employee relations to be good.

 

**Executive and Other Officers of the Company Who Are NotDirectors**

 

Thebusiness experience of each officer who is not also a director is set forthbelow.  Each of the following officersserves until his or her successor is duly elected.

 

**Executive Officers**

 

HarryKucewicz.  Mr. Kucewicz, age 46, is currently serving as the Treasurer andChief Financial Officer of both the Company and the Bank.  He beganworking at the Bank in 1978 as the Controller.  He was elected Treasurer and

 

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ChiefFinancial Officer in 1990.  Mr. Kucewicz is responsible for all of theCompany’s and Bank’s financial and accounting functions.

 

PaulT. Bandriwsky.  Mr. Bandriwsky, age 47, is currently Vice President andChief Operating Officer of both the Company and the Bank.   He beganworking at the Bank in 2000 and was appointed to his present capacity at thattime.  Mr. Bandriwsky has over 20 years of experience in bankingmanagement, lending and real estate.  He is responsible for the day-to-dayoperations of the Bank’s retail banking branches, human resources andmarketing/advertising.

 

##### **Other Officers**

 

MaryH. Korb.  Ms. Korb, age 55, is currently Vice President of the Company andVice President - Lending of the Bank.  Ms. Korb supervises all aspects ofthe Bank’s lending operations, including lending compliance.  Ms. Korb hasbeen with the Bank since 1970, and has served in her present capacity sinceMarch 1991.

 

IreneS. Subota.  Ms. Subota, age 56, currently serves as Vice President of theCompany and as Vice President - Savings of the Bank.  Ms. Subota is incharge of all aspects of the Bank’s savings function, includingcompliance.  Ms. Subota has been employed by the Bank since 1973, and hasserved in her current position since 1992.

 

AdrianHawryliw.  Mr. Hawryliw, age 66, has served as Philadelphia Branch Managerof the Bank since 1994 when the Philadelphia, Pennsylvania branch was acquiredfrom the Resolution Trust Corporation, and is currently a Vice President of theBank and of the Company.  Mr. Hawryliw is responsible for supervisingoperations of the Philadelphia, Pennsylvania branch, including businessdevelopment, retail deposits, real estate lending, accounting andmarketing.  He has over 34 years of banking experience in the Philadelphiaarea, holding various positions including Chief Financial Officer and VicePresident/Investments for other area institutions.

 

PeterIlnyckyj.  Mr. Ilnyckyj, age 34 iscurrently serving as the Vice President of Investor Relations of both theCompany and the Bank.  Mr. Ilnyckyjbegan working at the Bank in 1987 and was elected Vice President in 2002.  Mr. Ilnyckyj has also functioned as theAccounting Department Manager since 1994 and oversees the daily accountingduties and OTS Regulatory Reporting.

 

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**Item 2.    Properties**

 

Thefollowing table sets forth information concerning the main office and eachbranch office of the Bank at December 31, 2002.  At December 31, 2002, theBank’s premises had an aggregate net book value of approximately $3.6 million.

 
| **Location**                                            |   | **Year  Acquired/  Established** |   | **Owned or  Leased** |   | **Net Book Value at  December 31, 2002** |   | **Deposits** |   |
|---------------------------------------------------------|--------|----------------------------------|--------|----------------------|--------|------------------------------------------|--------|--------------|--------|
|                                                    |   | **(In Thousands)**               |   |
| *Main Office:*                                          |   |                             |   |                 |   |                                     |   |         |   |
| 936 North Western Avenue  Chicago, Illinois 60622-4695  |   | 1964                             |   | Owned                |   | $                                        | 819    |         | $      | 172,098 |   |
| *Branch Offices:*                                       |   |                             |   |                 |   |                                     |   |         |   |
| 2166 Plum Grove Road  Rolling Meadows, Illinois 60008   |   | 1977                             |   | Leased               | (1)    | —                                   |   | 14,741       |   |
| 820 N. Western Avenue  Chicago, Illinois 60622          |   | 1983                             |   | Owned                |   | 180                                      |   | 2,982        |   |
| 5670 N. Milwaukee Avenue  Chicago, Illinois 60646       |   | 1993                             |   | Owned                |   | 945                                      |   | 20,917       |   |
| 7918 Bustleton Avenue  Philadelphia, Pennsylvania 19152 |   | 1994                             |   | Owned                |   | 511                                      |   | 79,874       |   |
| 2251 Plum Grove Road  Palatine, Illinois 60067          |   | 2002                             |   | Owned                | (2)    | 1,160                                    |   | —       |   |
|                                                         |        |                                  |        |                      |        |                                          |        |              |        |  |  |

 

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(1)                      The lease expires in July 2003.

(2)                      This branchwas opened to service the public in January 2003.  The deposits attributable to the Rolling Meadows branch weremoved to this branch.

 

Webelieve that our current facilities are adequate to meet our present andforeseeable future needs.  However, in the future, we may consider theaddition of one or more new branches within the Chicago or Philadelphia areaswhether through purchase, acquisition or otherwise.

 

TheBank’s depositor and borrower customer files are maintained by an independentdata processing company.  The net book value of the data processing andcomputer equipment utilized by the Bank at December 31, 2002 was approximately$228,800.

 

**Item 3.    LegalProceedings**

 

Fromtime to time, First Security is involved as plaintiff or defendant in variouslegal proceedings arising in the normal course of its business.  While theultimate outcome of these various legal proceedings cannot be predicted withcertainty, it is the opinion of management that the resolution of these legalactions should not have a material effect on the Company’s and the Bank’sfinancial position or results of operations.

 

**Item 4.    Submission ofMatters to a Vote of Security Holders**

 

Nomatter was submitted to a vote of security holders, through the solicitation ofproxies or otherwise, during the quarter ended December 31, 2002.

 

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**PART II**

 

**Item 5.    Market forRegistrant’s Common Equity and Related Stockholder Matters**

 

Theinformation set forth under the caption “Shareholders Information” in theattached 2002 Annual Report to Stockholders is incorporated herein byreference.

 

**Item 6.    SelectedFinancial Data**

 

Theinformation set forth under the caption “Selected Consolidated FinancialInformation” in the attached 2002 Annual Report to Stockholders is incorporatedherein by reference.

 

**Item 7.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

Theinformation set forth under the caption “Management’s Discussion and Analysis”in the attached 2002 Annual Report to Stockholders is incorporated herein byreference.

 

**Item 7A.  Quantitativeand Qualitative Disclosures About Market Risk**

 

Theinformation set forth under the caption “Quantitative and QualitativeDisclosures About Market Risk” in the attached 2002 Annual Report toStockholders is incorporated herein by reference.

 

**Item 8.    FinancialStatements and Supplementary Data**

 

Theinformation set forth under the caption “Consolidated Financial Statements” inthe attached 2002 Annual Report to Stockholders is incorporated herein byreference.

 

**Item 9.    Changes inand Disagreements With Accountants on Accounting and Financial Disclosure**

 

Therehas been no Current Report on Form 8-K filed within 24 months prior to the dateof the most recent financial statements reporting a change of accountantsand/or reporting disagreements on any matter of accounting principle orfinancial statement disclosure.

 

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**PART III**

 

**Item 10.  Directorsand Executive Officers of the Registrant**

 

**Directors**

 

Theinformation concerning Directors of the Corporation is incorporated herein byreference from the definitive Proxy Statement for the Annual Meeting ofStockholders to be held in April 2003.

 

**Executive Officers**

 

Informationregarding the business experience of the executive officers of the Corporationand the Bank who are not also directors contained in Part I of this Form 10-Kis incorporated herein by reference.

 

**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Theinformation set forth under the caption “Section 16(a) Beneficial OwnershipReporting Compliance” in our definitive Proxy Statement for the Annual Meetingof Stockholders to be held in April 2003 is incorporated herein by reference.

 

**Item 11.  ExecutiveCompensation**

 

Information concerning executive compensation is incorporated herein byreference from the definitive Proxy Statement for the Annual Meeting ofStockholders to be held in April 2003.

 

**Item 12.  SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

 

Information concerning security ownership of certain beneficial ownersand management and information concerning equity compensation plans isincorporated herein by reference from the definitive Proxy Statement for theAnnual Meeting of Stockholders to be held in April 2003.

 

**Item 13.  CertainRelationships and Related Transactions**

 

Information concerning certain relationships and related transactionsis incorporated herein by reference from the definitive Proxy Statement for theAnnual Meeting of Stockholders to be held in April 2003 a copy of which will befiled not later than 120 days after the close of the fiscal year.

 

29

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**PART IV**

 

**Item 14.  Controls andProcedures**

 

Management, including the Chief Executive Officer and Chief FinancialOfficer, have conducted an evaluation of the effectiveness of disclosurecontrols and procedures pursuant to Exchange Act Rule 13a-14. Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the disclosure controls and procedures are effective in ensuring that allmaterial information required to be filed in this annual report has been madeknown to them in a timely fashion. There have been no significant changes ininternal controls, or in factors that could significantly affect internalcontrols, subsequent to the date the Chief Executive Officer and ChiefFinancial Officer completed their evaluation.

 

**Item 15. Exhibits,Financial Statement Schedules and Reports on Form 8-K**

 

**(a)(1)  Financial Statements:**

 

Thefollowing financial statements are included in this Form 10-K:

 
| 1.     | Five-Year  Summary of Selected Consolidated Financial Data.                                                         |
|--------|---------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                |
| 2.     | Report  of Independent Auditors.                                                                                    |
|   |                                                                                                                |
| 3.     | Consolidated  Balance Sheets at December 31, 2002 and 2001.                                                         |
|   |                                                                                                                |
| 4.     | Consolidated  Statements of Income for the fiscal years ended December 31, 2002, 2001 and  2000.                    |
|   |                                                                                                                |
| 5.     | Consolidated  Statements of Comprehensive Income for the fiscal years ended December 31,  2002, 2001 and 2000.      |
|   |                                                                                                                |
| 6.     | Consolidated  Statements of Shareholders’ Equity for the fiscal years ended December 31,  2002, 2001 and 2000. |
|   |                                                                                                                |
| 7.     | Consolidated  Statements of Cash Flows for the fiscal years ended December 31, 2002, 2001  and 2000.                |
|   |                                                                                                                |
| 8.     | Notes  to Consolidated Financial Statements.                                                                        |

 

**(a)(2) Financial Statement Schedules:**

 

Allfinancial statement schedules have been omitted as the required information isinapplicable or has been included in the Notes to Consolidated FinancialStatements.

 

**(a)(3) Exhibits:**

 

SeeExhibit Index.

 

**(b)  Reports on Form 8-K**:

 

There were no current reports on Form 8-K filed by the Corporation during the quarterended December 31, 2002.

 

30

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**SIGNATURES**

 

Pursuantto the requirements of Section 15(d) of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|   | FIRST  SECURITYFED FINANCIAL, INC.               |
|--------|--------------------------------------------------|
|   |                                             |
|   | By:                                              | /s/  Julian E. Kulas |   |
|   | Its:  President and Chief Executive officer |
|   | Date: March 31, 2003                             |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 

 
| /s/  Julian E. Kulas                             |                                        | /s/  Steve Babyk           |   |   |
|--------------------------------------------------|---------------------------------------------|----------------------------|--------|--------|
| Julian  E. Kulas                                 | Steve  Babyk                                |                       |
| President,  Chief Executive Officer and Director | Director                                    |                       |
| *(Principal Executive Officer)*                  |                                        |                       |
| Date:   March 31, 2003                 | Date:   March 31, 2003            |                       |
|                                             |                                        |                       |
|                                             |                                        |                       |
| /s/  Lila Maria Bodnar                           |                                        | /s/  Myron Dobrowolsky     |   |   |
| Lila  Maria Bodnar                               | Myron  Dobrowolsky                          |                       |
| Recording  Secretary and Director                | Director                                    |                       |
| Date:   March 31, 2003                 | Date:   March 31, 2003            |                       |
|                                             |                                        |                       |
|                                             |                                        |                       |
| /s/  Terry Gawryk                                |                                        | /s/  George Kawka          |   |   |
| Terry  Gawryk                                    | George  Kawka                               |                       |
| Secretary  and Director                          | Director                                    |                       |
| Date:   March 31, 2003                 | Date:   March 31, 2003            |                       |
|                                             |                                        |                       |
|                                             |                                        |                       |
| /s/  Paul Nadzikewycz                            |                                        | /s/  Jaroslav H. Sydorenko |   |   |
| Paul  Nadzikewycz                                | Jaroslav  H. Sydorenko                      |                       |
| Chairman  of the Board                           | Director                                    |                       |
| Date:   March 31, 2003                 | Date:   March 31, 2003            |                       |
|                                             |                                        |                       |
|                                             |                                        |                       |
| /s/  Chrysta Wereszczak                          |                                        | /s/  Harry Kucewicz        |   |   |
| Chrysta  Wereszczak                              | Harry  Kucewicz                             |                       |
| Director                                         | Principal  Financial and Accounting Officer |                       |
| Date:   March 31, 2003                 | Date:   March 31, 2003            |                       |

 

31

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**CERTIFICATIONS**

 

I,Julian E. Kulas, certify that:

 

1.  I have reviewed this annual report on Form10-K of First SecurityFed Financial, Inc.;

 

2.  Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.  The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) forthe registrant and have:

 

a)  designed such disclosure controlsand procedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b)  evaluated the effectiveness ofthe registrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c)  presented in this annualreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a)  all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

b)  any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officersand I have indicated in this annual report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  March 31, 2003 |
|-----------------------|
|                  |
|                  | /s/  Julian E. Kulas |   |
|                  | Julian  E. Kulas, |
|                  | Principal  Executive Officer |

 

32

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**CERTIFICATIONS**

 

I,Harry Kucewicz, certify that:

 

1.  I have reviewed this annual report on Form10-K of First SecurityFed Financial, Inc.;

 

2.  Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.  The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) forthe registrant and have:

 

a)  designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this annualreport is being prepared;

 

b)  evaluated the effectiveness ofthe registrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c)  presented in this annual reportour conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a)  all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

b)  any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officersand I have indicated in this annual report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  March 31, 2003 |
|-----------------------|
|                  |
|                  | /s/  Harry Kucewicz |   |
|                  | Harry  Kucewicz, |
|                  | Principal  Financial Officer |

 

33

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**EXHIBIT INDEX**

 
| **Regulation  S-K  Exhibit  Number** |   | **Document**                                                                            |   | **Reference to  Prior Filing  or Exhibit  Number  Attached  Hereto** |
|--------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|
| 3(a)                                 |   | Certificate  of Incorporation                                                           |   | *                                                                    |
| 3(b)                                 |   | By-Laws                                                                                 |   | **                                                                   |
| 4                                    |   | Instruments  defining the right of security holders, including debentures               |   | *                                                                    |
| 10                                   |   | Executive  Compensation Plans and Arrangements                                          |   |                                                                 |
|                                 |   | (a)  Employment Agreement between Julian E. Kulas  and the Bank.                   |   | 10(a)                                                                |
|                                 |   | (b)  Change-In-Control Severance Agreement  between Harry I. Kucewicz and the Bank |   | 10(b)                                                                |
|                                 |   | (c)  Change-In-Control Severance Agreement  between Paul Bandriwsky and the Bank   |   | 10(c)                                                                |
|                                 |   | (d)  1998 Stock Option and Incentive Plan                                          |   | ***                                                                  |
|                                 |   | (e)  1998 Recognition and Retention Plan                                           |   | ***                                                                  |
| 13                                   |   | Annual  Report to Security Holders                                                      |   | 13                                                                   |
| 21                                   |   | Subsidiaries  of Registrant                                                             |   | 21                                                                   |
| 23                                   |   | Consent  of Independent Auditor                                                         |   | 23                                                                   |
| 99                                   |   | Additional  Exhibits                                                                    |   |                                                                 |
|                                 |   | (a)  Statement pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002          |   | 99(a)                                                                |

 

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*              Filed as an Exhibit to theCompany’s Form S-1 Registration Statement filed on July 21, 1997 (File No.333-31739) pursuant to Section 5 of the Securities Act of 1933.  All ofsuch previously filed documents are hereby incorporated herein by reference inaccordance with Item 601 of Regulation S-K.

 

**           Filed as an Exhibit to the Company’sForm 10-Q Quarterly report filed on November 15,1999 (File No. 000-23063)pursuant to Section 12 of the Securities Exchange Act of 1934. All of suchpreviously filed documents are hereby incorporated by reference in accordancewith Item 601 of Regulation S-K.

 

***         Filed as an Exhibit to the Company’sDefinitive Proxy Statement on Schedule 14A on March 24, 1998 (File No.0-23063).  All of such previously filed documents are hereby incorporatedherein by reference in accordance with Item 601 of Regulation S-K.

 

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