UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File Number 0-18082
GREAT SOUTHERN BANCORP, INC.
(417) 887-4400
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
SECURITIES
PART I
ITEM 1. BUSINESS.
Great Southern Bancorp, Inc.
Great Southern Bancorp, Inc. ("Bancorp" or "Company") is a financial holding company which, as of December 31, 2005, owned directly all of the stock of Great Southern Bank ("Great Southern" or the "Bank") and other non-banking subsidiaries. Bancorp was incorporated under the laws of the State of Delaware in July 1989 as a unitary savings and loan holding company. After receiving the approval of the Federal Reserve Bank of St. Louis (the "Federal Reserve Board" or "FRB"), the Company became a one-bank holding company on June 30, 1998, upon the conversion of Great Southern to a Missouri-chartered trust company. In 2004, Bancorp was re-incorporated under the laws of the State of Maryland and is no longer incorporated under the laws of the State of Delaware.
As a Maryland corporation, the Company is authorized to engage in any activity that is permitted by the Maryland General Corporation Law and is not prohibited by law or regulatory policy. The Company currently conducts its business as a financial holding company. Through the financial holding company structure, it is possible to expand the size and scope of the financial services offered by the Company beyond those offered by the Bank. The financial holding company structure provides the Company with greater flexibility than the Bank has to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions or mergers of other financial institutions as well as other companies. At December 31, 2005, Bancorp's consolidated assets were $2.08 billion, consolidated net loans were $1.51 billion, consolidated deposits were $1.55 billion and consolidated stockholders' equity was $153 million. The assets of the Company consist primarily of the stock of Great Southern, available-for-sale securities, minority interests in a local trust company and a merchant banking company and cash.
Through the Bank and subsidiaries of the Bank, the Company offers insurance, travel, investment and related services, which are discussed further below. The activities of the Company are funded by retained earnings and through dividends from Great Southern. Activities of the Company may also be funded through borrowings from third parties, sales of additional securities or through income generated by other activities of the Company. The Company expects to finance its future activities in a similar manner.
The executive offices of the Company are located at 1451 East Battlefield, Springfield, Missouri 65804, and its telephone number at that address is (417) 887-4400.
Great Southern Bank
Great Southern was formed as a Missouri-chartered mutual savings and loan association in 1923, and, in 1989, was converted to a Missouri-chartered stock savings and loan association. In 1994, Great Southern changed to a federal savings bank charter and then, on June 30, 1998, changed to a Missouri-chartered trust company (the equivalent of a commercial bank charter). Headquartered in Springfield, Missouri, Great Southern offers a broad range of banking services through its 35 branches located in southwestern and central Missouri. At December 31, 2005, the Bank had total assets of $2.08 billion, net loans of $1.51 billion, deposits of $1.55 billion and stockholders' equity of $168 million, or 8.1% of total assets. Its deposits are insured by the Savings Association Insurance Fund ("SAIF") to the maximum levels permitted by the Federal Deposit Insurance Corporation ("FDIC").
Great Southern is principally engaged in the business of originating residential and commercial real estate loans, construction loans, other commercial and consumer loans and funding these loans through attracting deposits from the general public, originating brokered deposits and borrowings from the Federal Home Loan Bank of Des Moines (the "FHLBank") and others.
For many years, Great Southern has followed a strategy of emphasizing quality loan origination through residential, commercial and consumer lending activities in its local market area. The goal of this strategy has been to maintain its position as one of the leading providers of financial services in its market area, while simultaneously diversifying assets and reducing interest rate risk by originating and holding adjustable-rate loans in its portfolio and selling fixed-rate single-family mortgage loans in the secondary market. The Bank continues to place primary emphasis on residential mortgage and other real estate lending while also expanding and increasing its originations of commercial business and consumer loans.
The corporate office of the Bank is located at 1451 East Battlefield, Springfield, Missouri 65804 and its telephone number at that address is (417) 887-4400.
Forward-Looking Statements
When used in this Form 10-K and in future filings by the Company with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or shareholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result" "are expected to," "will continue," "is anticipated," "estimate," "project, "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among other things, the changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses, the Company's ability to access cost-effective funding, demand for loans and deposits in the Company's market area and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The Company does not undertake-and specifically declines any obligation- to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Internet Website
Bancorp maintains a website at www.greatsouthernbank.com. The information contained on that website is not included as part of, or incorporated by reference into, this Annual Report on Form 10-K. Bancorp currently makes available on or through its website Bancorp's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K or amendments to these reports. These materials are also available free of charge (other than a user's regular internet access charges) on the Securities and Exchange Commission's website at www.sec.gov.
Primary Market Area
Great Southern's primary market area encompasses 14 counties in southwestern and central Missouri. The Bank's branches and ATMs support deposit and lending activities throughout the region, serving such diversified markets as Springfield, Joplin, the resort areas of Branson and Lake of the Ozarks, and various smaller communities in the Bank's market area. Management believes that the Bank's share of the deposit and lending markets in its market area is approximately 10% and that the Bank's affiliates have an even smaller percent, with the exception of the travel agency which has a larger percent of its respective business in its market area.
Great Southern's largest concentration of loans and deposits is in the Greater Springfield area. With a population of approximately 390,000, the Greater Springfield area is the third largest metropolitan area in Missouri. Employment in this area is diversified, including small and medium-sized manufacturing concerns, service industries, especially in the resort and leisure activities sectors, agriculture, the federal government, and a major state university. Springfield is also a regional health care center. The unemployment rate in this area is, and has consistently been, below the national average.
The second largest concentration of loans is in the Branson area. The region is a vacation and entertainment center, attracting tourists to its theme parks, resorts, country music and novelty shows and other recreational facilities. As a result of the rapid growth of the Branson area in the early 1990's, property values increased at unusually high rates. This growth also provided for increased loan demand and a more volatile lending market than had previously been present in that area. Due to overbuilding of commercial properties during the mid-1990's, property values experienced downward pressure in the late 1990's. In recent years, commercial real estate values have stabilized. Reduced demand for residential properties in the 1990's similarly created downward pressure on one- to four-family and multi-family, primary and vacation residences in this area. In recent years, residential real estate demand and values have shown improvements. Branson is currently experiencing significant growth again as a result of a large retail, hotel, convention center project which is under construction in Branson's historic downtown. This project is expected to create hundreds of new jobs in the area.
A significant portion of the Bank's loans are secured by properties in the two county region that includes the Branson area. Approximately $194 million, or 10.9%, of the total loan portfolio at December 31, 2005, was secured by commercial real estate, commercial construction, other residential properties, one- to four-family residential properties, and one- to four-family construction properties, and consumer loans in the Branson area. Residential mortgages account for approximately $69 million of this total. Included in the Branson concentration totals are approximately $4.1 million of non-performing loans.
To expand and diversify the Bank's loan portfolio, the Bank opened a loan production office in Kansas City, Missouri, and a loan production office in Rogers, Arkansas, in 2003. In February 2005, Great Southern opened a loan production office in St. Louis, Missouri. Great Southern historically served commercial lending needs in the St. Louis, Kansas City and Northwest Arkansas regions from its Springfield office. The Bank's familiarity with these three growth markets, coupled with potential strong loan demand, led to physical expansion in these regions that allows Great Southern to more conveniently serve and expand relationships with existing customers and attract new business. Managed by seasoned commercial lenders who have personal experience and knowledge in their respective markets, the offices offer all Great Southern commercial lending services, including fixed and variable rate commercial real estate loans for new and existing customers. Underwriting of all loan production in these regions is performed in Springfield, so credit decisions are consistent across all markets.
In 2005, the Kansas City office experienced growth with $104.8 million in commercial loan originations. As of December 31, 2005, the Kansas City office had $196.0 million in outstanding loan balances, which includes loans previously originated and serviced by the Springfield office.
The Northwest Arkansas office primarily serves the Northwest Arkansas corridor, which includes the cities of Fayetteville, Rogers, Springdale and Bentonville. The Northwest Arkansas corridor was recently named as one of the strongest regional economies in the nation, according to a recent Milken Institute Report. Loan originations in 2005 for the Northwest Arkansas office were $88.9 million. As of December 31, 2005, the Arkansas office had outstanding loan balances of $118.3 million, which included loans previously originated and serviced by the Springfield office.
In 2005, the St. Louis office experienced growth with $137.3 million in commercial loan originations, which included both funded and unfunded portions of construction loans and other short term loans. As of December 31, 2005, the St. Louis office had $71.2 million in outstanding loan balances, which included loans previously originated and serviced by the Springfield office.
In March 2006, Great Southern opened a loan production office in Columbia, Missouri, which will serve the Columbia, Jefferson City and Lake of the Ozarks markets. Similar to the other loan production offices, the Columbia office is managed by a seasoned commercial lender who has personal experience and knowledge in these markets
Recent Acquisitions
In August 2005, Great Southern completed the acquisition of three branches in Camdenton, Climax Springs and Greenview, Missouri, from Peoples Bank of the Ozarks. The acquisition represented approximately $35 million in deposits and $13 million in loans, bringing the Bank's number of retail branches at that time to 34 in southwest and central Missouri and strengthening its presence in central Missouri with six branches. The Bank paid a $1 million premium to purchase the deposits and approximately $900,000 for the acquisition of the real estate and fixed assets of the three branches.
In August 2005, Great Southern acquired Canterbury Travel and Tiger Travel Associates in Columbia, Missouri. Canterbury Travel and Tiger Travel Associates is the official travel agency of University of Missouri Athletics and an appointed agency of the State of Missouri. It offers corporate and leisure travel services to the Columbia market.
In January 2006, Great Southern acquired Classic Cruise and Travel in Lee's Summitt, Missouri. The agency serves both leisure and corporate travel needs in the Lee's Summit market.
Lending Activities
General
From its beginnings in 1923 through the early 1980s, Great Southern primarily made long-term, fixed-rate residential real estate loans that it retained in its loan portfolio. Beginning in the early 1980s, Great Southern increased its efforts to originate short-term and adjustable-rate loans. Beginning in the mid-1980s, Great Southern increased its efforts to originate commercial real estate and other residential loans, primarily with adjustable rates or shorter-term fixed rates. In addition, some competitor banking organizations have merged with larger institutions and changed their business practices or moved operations away from the local area, and others have consolidated operations from the local area to larger cities. This has provided Great Southern expanded opportunity in these areas as well as in the origination of commercial business and consumer loans, primarily the indirect automobile area. In addition to origination of these loans, the Bank has expanded and enlarged its relationships with smaller banks to purchase participations (at par, generally with no servicing costs) in loans the smaller banks originate but are unable to retain in their portfolios due to capital limitations. The Bank uses the same underwriting guidelines in evaluating these participations as it does in its direct loan originations. At December 31, 2005, the balance of participation loans purchased was $75.4 million, or 4.3% of the total loan portfolio. None of these participation loans were non-performing at December 31, 2005.
One of the principal historical lending activities of Great Southern is the origination of fixed and adjustable-rate conventional residential real estate loans to enable borrowers to purchase or refinance owner-occupied homes. Great Southern originates a variety of conventional, residential real estate mortgage loans, principally in compliance with Freddie Mac and Fannie Mae standards for resale in the secondary market. Great Southern promptly sells most of the fixed-rate residential mortgage loans that it originates. Depending on market conditions, the ongoing servicing of these loans is at times retained by Great Southern and at other times released to the purchaser of the loan. Great Southern retains substantially all of the adjustable-rate mortgage loans in its portfolio.
Another principal lending activity of Great Southern is the origination of commercial real estate and construction loans. Since the early 1990s, this area of lending has been an increasing percentage of the loan portfolio and accounted for approximately 53% of the portfolio at December 31, 2005.
In addition, Great Southern in recent years has increased its emphasis on the origination of other commercial loans, home equity loans, consumer loans and student loans, and is also an issuer of letters of credit. See "-- Other Commercial Lending," "- Classified Assets," and "Loan Delinquencies and Defaults" below. Letters of credit are contingent obligations and are not included in the Bank's loan portfolio.
Great Southern has a policy of obtaining collateral for substantially all real estate loans. The percentage of collateral value Great Southern will loan on real estate and other property varies based on factors including, but not limited to, the type of property and its location and the borrower's credit history. As a general rule, Great Southern will loan up to 80% of the appraised value on one- to four-family residential property and will loan up to an additional 15% with private mortgage insurance for the loan amount above the 80% level. For commercial real estate and other residential real property loans, Great Southern generally loans up to a maximum of 85% of the appraised value. The origination of loans secured by other property is considered and determined on an individual basis by management with the assistance of any industry guides and other information which may be available.
Loan applications are approved at various levels of authority, depending on the type, amount and loan-to-value ratio of the loan. Loan commitments of more than $750,000 (or loans exceeding the Freddie Mac loan limit in the case of fixed-rate one- to four-family residential loans for resale) must be approved by Great Southern's loan committee. The loan committee is comprised of the Chairman of the Bank, as chairman of the committee, and other senior officers of the Bank involved in lending activities.
Although Great Southern is permitted under applicable regulations to originate or purchase loans and loan participations secured by real estate located in any part of the United States, the Bank has concentrated its lending efforts in Missouri and Northern Arkansas, with the largest concentration of its lending activity being in southwestern and central Missouri. In addition, the Bank has made some loans, secured primarily by commercial real estate, in other states, primarily Oklahoma, Kansas and other Midwestern states.
Loan Portfolio Composition
The following table sets forth information concerning the composition of the Bank's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowance for loan losses) as of the dates indicated. The table is based on information prepared in accordance with generally accepted accounting principles and is qualified by reference to the Company's consolidated financial statements and the notes thereto contained in Item 8 of this report.
The following table shows the fixed- and adjustable-rate composition of the Bank's loan portfolio at the dates indicated. The table is based on information prepared in accordance with generally accepted accounting principles.
The following table presents the contractual maturities of loans at December 31, 2005. The table is based on information prepared in accordance with generally accepted accounting principles.
As of December 31, 2005, loans due after December 31, 2006 with fixed interest rates totaled $259.3 million and loans due after December 31, 2006 with adjustable rates totaled $703.1 million.
Environmental Issues
Loans secured by real property, whether commercial, residential or other, may have a material, negative effect on the financial position and results of operations of the lender if the collateral is environmentally contaminated. The result can be, but is not necessarily limited to, liability for the cost of cleaning up the contamination imposed on the lender by certain federal and state laws, a reduction in the borrower's ability to pay because of the liability imposed upon it for any clean up costs, a reduction in the value of the collateral because of the presence of contamination or a subordination of security interests in the collateral to a super priority lien securing the clean up costs by certain state laws.
Management of the Bank is aware of the risk that the Bank may be negatively affected by environmentally contaminated collateral and attempts to control such risk through commercially reasonable methods, consistent with guidelines arising from applicable government or regulatory rules and regulations, and to a more limited extent publications of the lending industry. Management currently is unaware (without, in many circumstances, specific inquiry or investigation of existing collateral, some of which was accepted as collateral before risk controlling measures were implemented) of any environmental contamination of real property securing loans in the Bank's portfolio that would subject the Bank to any material risk. No assurance can be made, however, that the Bank will not be adversely affected by environmental contamination.
Residential Real Estate Lending
At December 31, 2005 and 2004, loans secured by residential real estate, excluding that which is under construction, totaled $279 million and $289 million, respectively, and represented approximately 15.7% and 19.6%, respectively, of the Bank's total loan portfolio. Compared to historical levels, market rates for fixed rate mortgages were low during the years ended December 31, 2002 through 2004. This caused a higher than normal level of refinancing of adjustable-rate loans into fixed-rate loans primarily during 2002 and 2003, most of which were sold in the secondary market, and accounted for the decline in the Bank's one- to four-family residential real estate loan portfolio prior to 2004. As rates began to move up in 2004 and 2005, fewer loans were refinanced and paid off early. In addition, more borrowers opted for adjustable-rate loans which the Bank generally retains in its portfolio.
The Bank currently is originating one- to four-family adjustable-rate residential mortgage loans primarily with one-year adjustment periods. Rate adjustments on loans originated prior to July 2001 are based upon changes in prevailing rates for one-year U.S. Treasury securities. Rate adjustments on loans originated since July 2001 are based upon changes in the average of interbank offered rates for twelve months U.S. Dollar-denominated deposits in the London Market or changes in prevailing rates for one-year U.S. Treasury securities. Rate adjustments are generally limited to 2% maximum annual adjustments as well as a maximum aggregate adjustment over the life of the loan. Accordingly, the interest rates on these loans typically may not be as rate sensitive as is the Bank's cost of funds. Generally, the Bank's adjustable-rate mortgage loans are not convertible into fixed-rate loans, do not permit negative amortization of principal and carry no prepayment penalty. The Bank also currently is originating other residential (multi-family) mortgage loans with interest rates that are generally either adjustable with changes to the prime rate of interest or fixed for short periods of time (three to five years).
The Bank's portfolio of adjustable-rate mortgage loans also includes a number of loans with different adjustment periods, without limitations on periodic rate increases and rate increases over the life of the loans, or which are tied to other short-term market indices. These loans were originated prior to the industry standardization of adjustable-rate loans. Since the adjustable-rate mortgage loans currently held in the Bank's portfolio have not been subject to an interest rate environment which causes them to adjust to the maximum, these loans entail unquantifiable risks resulting from potential increased payment obligations on the borrower as a result of upward repricing. Further, the adjustable-rate mortgages offered by Great Southern, as well as by many other financial institutions, sometimes provide for initial rates of interest below the rates which would prevail were the index used for pricing applied initially. Compared to fixed-rate mortgage loans, these loans are subject to increased risk of delinquency or default as the higher, fully-indexed rate of interest subsequently comes into effect in replacement of the lower initial rate. The Bank has not experienced a significant increase in delinquencies in adjustable-rate mortgage loans due to a relatively low interest rate environment in recent years.
In underwriting one- to four-family residential real estate loans, Great Southern evaluates the borrower's ability to make monthly payments and the value of the property securing the loan. It is the policy of Great Southern that generally all loans in excess of 80% of the appraised value of the property be insured by a private mortgage insurance company approved by Great Southern for the amount of the loan in excess of 80% of the appraised value. In addition, Great Southern requires borrowers to obtain title and fire and casualty insurance in an amount not less than the amount of the loan. Real estate loans originated by the Bank generally contain a "due on sale" clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the property securing the loan. The Bank may enforce these due on sale clauses to the extent permitted by law.
Commercial Real Estate and Construction Lending
Commercial real estate lending has traditionally been a part of Great Southern's business activities. Great Southern does commercial real estate lending in order to increase the yield on, and the proportion of interest rate sensitive loans in, its portfolio. Great Southern expects to continue to maintain or increase the current percentage of commercial real estate and commercial construction loans in its total loan portfolio by originating loans secured by commercial real estate, subject to commercial real estate and other market conditions and to applicable regulatory restrictions. See "Government Supervision and Regulation" below.
At December 31, 2005 and 2004, loans secured by commercial real estate (excluding that which is under construction) totaled $553 million and $527 million, respectively, or approximately 31.2% and 35.6%, respectively, of the Bank's total loan portfolio. In addition, at December 31, 2005 and 2004, construction loans secured by projects under construction and the land on which the projects are located aggregated $702 million and $431 million, respectively, or 39.6% and 29.0%, respectively, of the Bank's total loan portfolio. The majority of the Bank's commercial real estate loans have been originated with adjustable rates of interest, most of which are tied to the Bank's prime rate. Substantially all of these loans were originated with loan commitments which did not exceed 80% of the appraised value of the properties securing the loans.
The Bank's construction loans generally have terms of one year or less. The construction loan agreements for one- to four-family projects generally provide that principal payments are required as individual condominium units or single-family houses are built and sold to a third party. This insures the remaining loan balance, as a proportion to the value of the remaining security, does not increase. Loan proceeds are disbursed in increments as construction progresses. Generally, the amount of each disbursement is based on the construction cost estimate of an independent architect, engineer or qualified fee inspector who inspects the project in connection with each disbursement request. Normally, Great Southern's commercial real estate and other residential construction loans are made either as the initial stage of a combination loan (i.e., with a commitment from the Bank to provide permanent financing upon completion of the project) or with a commitment from a third party to provide permanent financing.
The Bank's commercial real estate and construction loan portfolio consists of loans with diverse collateral types. The following table sets forth loans that are secured by certain types of collateral at December 31, 2005. These collateral types represent the five highest percentage concentrations of commercial real estate and construction loan types to the total loan portfolio.
The Bank's commercial real estate and construction loans generally involve larger principal balances than do its residential loans. In general, state banking laws restrict loans to a single borrower and related entities to no more than 25% of a bank's unimpaired capital and unimpaired surplus, plus an additional 10% if the loan is collateralized by certain readily marketable collateral. (Real estate is not included in the definition of "readily marketable collateral.") As computed on the basis of the Bank's unimpaired capital and surplus at December 31, 2005, this limit was approximately $48.7 million. See "Government Supervision and Regulation." At December 31, 2005, the Bank was in compliance with the loans-to-one borrower limit. At December 31, 2005, the Bank's largest relationship totaled $29.2 million. All loans included in this relationship were current at December 31, 2005.
Commercial real estate and construction lending generally affords the Bank an opportunity to receive interest at rates higher than those obtainable from residential lending and to receive higher origination and other loan fees. In addition, commercial real estate and construction loans are generally made with adjustable rates of interest or, if made on a fixed-rate basis, for relatively short terms. Nevertheless, commercial real estate lending entails significant additional risks as compared with residential mortgage lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by commercial properties is typically dependent on the successful operation of the related real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy generally.
Construction loans also involve additional risks attributable to the fact that loan funds are advanced upon the security of the project under construction, which is of uncertain value prior to the completion of construction. Moreover, because of the uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages, and other unpredictable contingencies, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, and the related loan-to-value ratios. See also the discussion under the headings "- Classified Assets" and "- Loan Delinquencies and Defaults" below.
Other Commercial Lending
At December 31, 2005 and 2004, respectively, Great Southern had $102 million and $104 million in other commercial loans outstanding, or 5.7% and 7.0%, respectively, of the Bank's total loan portfolio. Great Southern's other commercial lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment.
Great Southern expects to continue to originate loans in this category subject to market conditions and applicable regulatory restrictions. See "Government Supervision and Regulation" below.
Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, other commercial loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. Commercial loans are generally secured by business assets, such as accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of other commercial loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
The Bank's management recognizes the generally increased risks associated with other commercial lending. Great Southern's commercial lending policy emphasizes complete credit file documentation and analysis of the borrower's character, capacity to repay the loan, the adequacy of the borrower's capital and collateral as well as an evaluation of the industry conditions affecting the borrower. Review of the borrower's past, present and future cash flows is also an important aspect of Great Southern's credit analysis. In addition, the Bank generally obtains personal guarantees from the borrowers on these types of loans. The majority of Great Southern's commercial loans have been to borrowers in southwestern and central Missouri. Great Southern intends to continue its commercial lending in this geographic area.
As part of its commercial lending activities, Great Southern issues letters of credit and receives fees averaging approximately 1% of the amount of the letter of credit per year. At December 31, 2005, Great Southern had 134 letters of credit outstanding in the aggregate amount of $23.5 million. Approximately 76% of the aggregate amount of these letters of credit were secured, including one $5.8 million letter of credit, secured by real estate, which was issued to enhance the issuance of housing revenue refunding bonds.
Consumer Lending
Great Southern management views consumer lending as an important component of its business strategy. Specifically, consumer loans generally have short terms to maturity, thus reducing Great Southern's exposure to changes in interest rates, and carry higher rates of interest than do residential mortgage loans. In addition, Great Southern believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base.
Great Southern offers a variety of secured consumer loans, including automobile loans, home equity loans and loans secured by savings deposits. In addition, Great Southern also offers home improvement loans, guaranteed student loans and unsecured consumer loans. Consumer loans totaled $138 million and $131 million at December 31, 2005 and 2004, respectively, or 7.8% and 8.8%, respectively, of the Bank's total loan portfolio.
The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Beginning in 1998, the Bank implemented indirect lending relationships, primarily with automobile dealerships. Through these dealer relationships, the dealer completes the application with the consumer and then submits it to the Bank for credit approval. At December 31, 2005, the Bank had $69.8 million of indirect auto, boat, modular home and recreational vehicle loans in its portfolio. While the Bank's initial concentrated effort has been on automobiles, the program is available for use with most tangible products where financing of the product is provided through the seller.
Student loans are underwritten in compliance with the regulations of the U.S. Department of Education for the Federal Family Education Loan Programs ("FFELP"). The FFELP loans are administered and guaranteed by the Missouri Coordinating Board for Higher Education as long as the Bank complies with the regulations. The Bank has contracted with the Missouri Higher Education Loan Authority (the "MOHELA") to originate and service these loans and to purchase these loans during the grace period immediately prior to the loans beginning their repayment period. This repayment period is generally at the time the student graduates or does not maintain the required hours of enrollment.
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial strength, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state consumer bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans. These loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of these loans such as the Bank, and a borrower may be able to assert against the assignee claims and defenses which it has against the seller of the underlying collateral.
Originations, Purchases, Sales and Servicing of Loans
The Bank originates loans through internal loan production personnel located in the Bank's main and branch offices, as well as loan production offices. Walk-in customers and referrals from real estate brokers and builders are also important sources of loan originations.
Management does not expect the high level of residential mortgage originations experienced during the past several years to continue. However, as long as the lower interest rate environment continues, there is a higher level of financing and refinancing expected than would exist in a higher rate environment. Management does expect that commercial real estate and construction originations will continue to be strong in 2006.
Great Southern may also purchase whole loans and participation interests in loans (generally without recourse, except in cases of breach of representation, warranty or covenant) from other banks, thrift institutions and life insurance companies (originators). The purchase transaction is governed by a participation agreement entered into by the originator and participant (Great Southern) containing guidelines as to ownership, control and servicing rights, among others. The originator may retain all rights with respect to enforcement, collection and administration of the loan. This may limit Great Southern's ability to control its credit risk when it purchases participations in these loans. For instance, the terms of participation agreements vary; however, generally Great Southern may not have direct access to the borrower, and the institution administering the loan may have some discretion in the administration of performing loans and the collection of non-performing loans.
A number of banks, both locally and regionally, do not have the capital to handle large commercial credits or are seeking diversification of risk in their portfolios. In order to take advantage of this situation, beginning in 1998, Great Southern increased the number and amount of participations purchased in commercial real estate and commercial construction loans. Great Southern subjects these loans to its normal underwriting standards used for originated loans and rejects any credits that do not meet those guidelines. The originating bank retains the servicing of these loans. The Bank purchased $73.1 million of these loans in the fiscal year ended December 31, 2005 and $33.1 million in the fiscal year ended December 31, 2004. Of the total $75.4 million of purchased participation loans outstanding at December 31, 2005, $18.1 million was purchased from one institution, secured by properties located in Missouri, Kansas and Nebraska. None of these loans were non-performing at December 31, 2005.
There have been no whole loan purchases by the Bank in the last five years. At December 31, 2005 and 2004, approximately $287,000, or .02%, and $382,000, or .03%, respectively, of the Bank's total loan portfolio consisted of purchased whole loans.
Great Southern sells non-residential loan participations generally without recourse to private investors, such as other banks, thrift institutions and life insurance companies (participants). The sales transaction is governed by a participation agreement entered into by the originator (Great Southern) and participant containing guidelines as to ownership, control and servicing rights, among others. Great Southern retains servicing rights for these participations sold. These participations are sold with a provision for repurchase upon breach of representation, warranty or covenant.
Great Southern also sells whole residential real estate loans without recourse to Freddie Mac as well as private investors, such as other banks, thrift institutions, mortgage companies and life insurance companies Whole real estate loans are sold with a provision for repurchase upon breach of representation, warranty or covenant. These loans are generally sold for cash in amounts equal to the unpaid principal amount of the loans determined using present value yields to the buyer. The sale amounts generally produce gains to the Bank and allow a margin for servicing income on loans when the servicing is retained by the Bank. However, residential real estate loans sold in recent years have primarily been with Great Southern releasing control of the servicing of the loans.
The Bank sold one- to four-family whole real estate loans and loan participations in aggregate amounts of $49.2 million, $60.4 million and $144.8 million during fiscal 2005, 2004 and 2003, respectively. Sales of whole real estate loans and participations in real estate loans can be beneficial to the Bank since these sales generally generate income at the time of sale, produce future servicing income on loans where servicing is retained, provide funds for additional lending and other investments, and increase liquidity. The volume of loans sold in 2004 and 2005 decreased from prior years as interest rates increased in 2004 and 2005, reducing the volume of refinancing activity. In addition in 2004 and 2005, the level of fixed-rate one- to four-family loans (which the Bank generally sells) decreased as more borrowers elected adjustable-rate mortgages (which the Bank generally retains in its portfolio).
Great Southern also sells guaranteed student loans to the MOHELA. These loans are sold for cash in amounts equal to the unpaid principal amount of the loans and a premium based on average borrower indebtedness. Great Southern does not underwrite these loans. Students work with their respective colleges' or universities' financial aid offices to secure these loans directly from MOHELA, with all underwriting performed by MOHELA and the financial aid offices. Periodically, MOHELA sells loans to financial institutions such as Great Southern for a short time. Great Southern then holds the loans for a short period and sells the loans back to MOHELA. This is all done without recourse unless the Bank engaged in some action that would constitute gross misconduct.
The Bank sold guaranteed student loans in aggregate amounts of $3.9 million, $8.0 million and $9.0 million during fiscal 2005, 2004 and 2003, respectively. Sales of guaranteed student loans generally can be beneficial to the Bank since these sales remove the burdensome servicing requirements of these types of loans once the borrower begins repayment.
Gains, losses and transfer fees on sales of loans and loan participations are recognized at the time of the sale. When real estate loans and loan participations sold have an average contractual interest rate that differs from the agreed upon yield to the purchaser (less the agreed upon servicing fee), resulting gains or losses are recognized in an amount equal to the present value of the differential over the estimated remaining life of the loans. Any resulting discount or premium is accreted or amortized over the same estimated life using a method approximating the level yield interest method. When real estate loans and loan participations are sold with servicing released, as the Bank primarily does, an additional fee is received for the servicing rights. Net gains and transfer fees on sales of loans for fiscal 2005, 2004 and 2003 were $983,000, $992,000 and $2.2 million, respectively. Of these amounts, $72,000, $140,000 and $157,000, respectively, were gains from the sale of guaranteed student loans and $911,000, $852,000 and $2.0 million, respectively, were gains from the sale of fixed-rate residential loans.
Although most loans currently sold by the Bank are sold with servicing released, the Bank had the servicing rights for approximately $43.9 million and $48.4 million at December 31, 2005 and 2004, respectively, of loans owned by others. The servicing of these loans generated net servicing fees to the Bank for the years ended December 31, 2005 and 2004, of $64,000 and $91,000, respectively.
In addition to interest earned on loans and loan origination fees, the Bank receives fees for loan commitments, letters of credit, prepayments, modifications, late payments, transfers of loans due to changes of property ownership and other miscellaneous services. The fees vary from time to time, generally depending on the supply of funds and other competitive conditions in the market. Fees from prepayments, commitments, letters of credit and late payments totaled $1.7 million, $1.0 million and $923,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Loan origination fees, net of related costs, are accounted for in accordance with Statement of Financial Accounting Standards No. 91 "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases." Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized in interest income using the level-yield method over the contractual life of the loan. For further discussion of this matter see Note 1 of the Notes to Consolidated Financial Statements.
Loan Delinquencies and Defaults
When a borrower fails to make a required payment on a loan, the Bank attempts to cause the delinquency to be cured by contacting the borrower. In the case of loans secured by residential real estate, a late notice is sent 15 days after the due date. If the delinquency is not cured by the 30th day, a delinquent notice is sent to the borrower. Additional written contacts are made with the borrower 45 and 60 days after the due date. If the delinquency continues for a period of 65 days, the Bank usually institutes appropriate action to foreclose on the collateral. The actual time it takes to foreclose on the collateral varies depending on the particular circumstances and the applicable governing law. If foreclosed, the property is sold at public auction and may be purchased by the Bank. Delinquent consumer loans are handled in a generally similar manner, except that initial contacts are made when the payment is five days past due and appropriate action may be taken to collect any loan payment that is delinquent for more than 15 days. The Bank's procedures for repossession and sale of consumer collateral are subject to various requirements under the applicable consumer protection laws as well as other applicable laws and the determination by the Bank that it would be beneficial from a cost basis.
Delinquent commercial business loans and loans secured by commercial real estate are initially handled by the loan officer in charge of the loan, who is responsible for contacting the borrower. The President and Senior Lending Officer also work with the commercial loan officers to see that necessary steps are taken to collect delinquent loans. In addition, the Bank has a Problem Loan Committee which meets at least quarterly and reviews all classified assets, as well as other loans which management feels may present possible collection problems. If an acceptable workout of a delinquent commercial loan cannot be agreed upon, the Bank may initiate foreclosure proceedings on any collateral securing the loan. However, in all cases, whether a commercial or other loan, the prevailing circumstances may be such that management may determine it is in the best interest of the Bank not to foreclose on the collateral.
The following table sets forth our loans delinquent 30 - 89 days by type, number, amount and percentage of type at December 31, 2005.
Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful" or "loss" assets. The regulations require insured institutions to classify their own assets and to establish prudent general allowances for losses from assets classified "substandard" or "doubtful." For the portion of assets classified as "loss," an institution is required to either establish specific allowances of 100% of the amount classified or charge such amount off its books. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess a potential weakness, are required to be designated "special mention" by management. In addition, a bank's regulators may require the establishment of a general allowance for losses based on assets classified as "substandard" and "doubtful" or based on the general quality of the asset portfolio of the bank. Following are the total classified assets per the Bank's internal asset classification list. There were no significant off- balance sheet items classified at December 31, 2005.
Non-Performing Assets
The table below sets forth the amounts and categories of gross non-performing assets (classified loans which are not performing under regulatory guidelines and all foreclosed assets, including assets acquired in settlement of loans) in the Bank's loan portfolio as of the dates indicated. Loans generally are placed on non-accrual status when the loan becomes 90 days delinquent or when the collection of principal, interest, or both, otherwise becomes doubtful. For all years presented, the Bank has not had any troubled debt restructurings, which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates.
Gross impaired loans totaled $16.2 million at December 31, 2005 and $4.5 million at December 31, 2004. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.
For the year ended December 31, 2005, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $834,000. The amount that was included in interest income on these loans was $415,000 for the year ended December 31, 2005.
The level of non-performing assets is primarily attributable to the Bank's commercial real estate, commercial and residential construction, commercial business and one- to four-family residential lending activities. Commercial activities generally involve significantly greater credit risks than single-family residential lending. The level of non-performing assets increased at a rate greater than that of the Bank's commercial lending portfolio in the years ended December 31, 2005 and 2002, and at a rate less than that of the Bank's commercial lending portfolio in the years ended December 31, 2004, 2003 and 2001. For a discussion of significant non-performing assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Allowances for Losses on Loans and Foreclosed Assets
Great Southern maintains an allowance for loan losses to absorb losses known and inherent in the loan portfolio based upon ongoing, monthly assessments of the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include a formula allowance, specific allowances for identified problem loans and portfolio segments and economic conditions that may lead to a concern about the loan portfolio or segments of the loan portfolio.
The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and non-performing loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience and on significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. Loan loss factors for portfolio segments are representative of the credit risks associated with loans in those segments. The greater the credit risks associated with a particular segment, the greater the loss factor.
The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas. Other conditions that management considers in determining the appropriateness of the allowance include, but are not limited to, changes to our underwriting standards (if any), credit quality trends (including changes in non-performing loans expected to result from existing conditions), trends in collateral values, loan volumes and concentrations, and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of those loans.
Senior management reviews theses conditions monthly in discussions with our senior credit officers. To the extent that any of these conditions are evidenced by a specifically identifiable problem loan or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance applicable to such loan or portfolio segment. Where any of these conditions are not evidenced by a specifically identifiable problem loan or portfolio segment as of the evaluation date, management's evaluation of the loss related to these conditions is reflected in the unallocated allowance associated with our portfolios of mortgage, consumer, commercial and construction loans. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem loans or portfolio segments.
The amounts actually observed in respect to these losses can vary significantly from the estimated amounts. Our methodology permits adjustments to any loss factor used in the computation of the formula allowances in the event that, in management's judgment, significant factors which affect the collectibility of the portfolio, as of the evaluation date, are not reflected in the current loss factors. By assessing the estimated losses inherent in our loan portfolio on a monthly basis, we can adjust specific and inherent loss estimates based upon more current information.
On a quarterly basis, senior management presents a formal assessment of the adequacy of the allowance for loan losses to Great Southern's board of directors for the board's approval of the allowance. Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates including the amount and timing of future cash flows expected to be received on impaired loans or changes in the market value of collateral securing loans that may be susceptible to significant change. In the opinion of management, the allowance when taken as a whole is adequate to absorb reasonable estimated loan losses inherent in Great Southern's loan portfolio.
Allowances for estimated losses on foreclosed assets (real estate and other assets acquired through foreclosure) are charged to expense, when in the opinion of management, any significant and permanent decline in the market value of the underlying asset reduces the market value to less than the carrying value of the asset. Senior management assesses the market value of each foreclosed asset individually.
The Bank has maintained a strong lending presence in the Branson area during recent years, primarily due to the substantial growth in the area. While management believes the loans it has funded have been originated pursuant to sound underwriting standards, and individually have no unusual credit risk, the heavy reliance on tourism in Branson causes some concern as to the credit risk associated with the Branson area as a whole. Due to this concern and the overall growth of the loan portfolio, and due more specifically to the growth of the commercial business, consumer and commercial real estate loan portfolios, and the related inherent risks, management provided increased levels of loan loss allowances over the past few years.
At December 31, 2005 and 2004, Great Southern had an allowance for losses on loans of $24.5 million and $23.5 million, respectively, of which $5.7 million and $5.0 million, respectively, had been allocated as an allowance for specific loans, including $2.2 million and $496,000, respectively, allocated for impaired loans. The allowance is discussed further in Note 4 of the Notes to Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The allocation of the allowance for losses on loans at the dates indicated is summarized as follows. The table is based on information prepared in accordance with generally accepted accounting principles.
The following table sets forth an analysis of the Bank's allowance for losses on loans showing the details of the allowance by types of loans and the allowance balance by loan type. The table is based on information prepared in accordance with generally accepted accounting principles.
Investment Activities
Excluding those issued by the United States Government, or its agencies, there were no investment securities in excess of 10% of the Bank's retained earnings at December 31, 2005 and 2004, respectively.
As of December 31, 2005 and 2004, the Bank held approximately $1.5 million and $1.5 million, respectively, in principal amount of investment securities which the Bank intends to hold until maturity. As of such dates, these securities had fair values of approximately $1.6 million and $1.6 million, respectively. In addition, as of December 31, 2005 and 2004, the Company held approximately $369.3 million and $355.1 million, respectively, in principal amount of investment securities which the Company classified as available-for-sale. See Notes 1 and 2 of the Notes to Consolidated Financial Statements.
The amortized cost and approximate fair values of, and gross unrealized gains and losses on, investment securities at the dates indicated are summarized as follows. The table is based on information prepared in accordance with generally accepted accounting principles.
The following tables present the contractual maturities and weighted average tax-equivalent yields of available-for-sale securities at December 31, 2005. The tables are based on information prepared in accordance with generally accepted accounting principles.
The following table presents the contractual maturities and weighted average tax-equivalent yields of held-to-maturity securities at December 31, 2005. The table is based on information prepared in accordance with generally accepted accounting principles.
The following table shows our investments' gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2005, 2004 and 2003, respectively:
Sources of Funds
General. Deposit accounts have traditionally been the principal source of the Bank's funds for use in lending and for other general business purposes. In addition to deposits, the Bank obtains funds through advances from the Federal Home Loan Bank of Des Moines, Iowa ("FHLBank") and other borrowings, loan repayments, loan sales, and cash flows generated from operations. Scheduled loan payments are a relatively stable source of funds, while deposit inflows and outflows and the related costs of such funds have varied widely. Borrowings such as FHLBank advances may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels and may be used on a longer-term basis to support expanded lending activities. The availability of funds from loan sales is influenced by general interest rates as well as the volume of originations.
Deposits. The Bank attracts both short-term and long-term deposits from the general public by offering a wide variety of accounts and rates and also purchases brokered deposits. In recent years, the Bank has been required by market conditions to rely increasingly on short-term accounts and other deposit alternatives that are more responsive to market interest rates. The Bank offers regular savings accounts, checking accounts, various money market accounts, fixed-interest rate certificates with varying maturities, certificates of deposit in minimum amounts of $100,000 ("Jumbo" accounts), brokered certificates and individual retirement accounts.
The following table sets forth the dollar amount of deposits, by interest rate range, in the various types of deposit programs offered by the Bank at the dates indicated. Interest rates on time deposits reflect the rate paid to the certificate holder and do not reflect the effects of the Company's interest rate swaps. The table is based on information prepared in accordance with generally accepted accounting principles.
A table showing maturity information for the Bank's time deposits as of December 31, 2005, is presented in Note 6 of the Notes to Consolidated Financial Statements.
The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and has allowed it to respond with flexibility to changes in consumer demand. The Bank has become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience, management believes that its certificate accounts are relatively stable sources of deposits, while its checking accounts have proven to be more volatile. However, the ability of the Bank to attract and maintain deposits, and the rates paid on these deposits, has been and will continue to be significantly affected by money market conditions.
The following table sets forth the time remaining until maturity of the Bank's time deposits as of December 31, 2005. The table is based on information prepared in accordance with generally accepted accounting principles.
Brokered deposits. Brokered deposits are marketed through national brokerage firms to their customers in $1,000 increments. The Bank maintains only one account for the total deposit amount while the records of detailed owners are maintained by the Depository Trust Company under the name of CEDE & Co. The deposits are transferable just like a stock or bond investment and the customer can open the account with only a phone call, just like buying a stock or bond. This provides a large deposit for the Bank at a lower operating cost since the Bank only has one account to maintain versus several accounts with multiple interest and maturity checks. At December 31, 2005 and 2004, the Bank had approximately $584.4 million and $456.8 million in brokered deposits, respectively.
Unlike non-brokered deposits where the deposit amount can be withdrawn with a penalty for any reason, including increasing interest rates, a brokered deposit can only be withdrawn in the event of the death, or court declared mental incompetence, of the depositor. This allows the Bank to better manage the maturity of its deposits. Currently, the rates offered by the Bank for brokered deposits are comparable to that offered for retail certificates of deposit of similar size and maturity.
The Company uses interest rate swaps to manage its interest rate risks from recorded financial liabilities. During fiscal 2005 and 2004, the Company entered into interest rate swap agreements with the objective of economically hedging against the effects of changes in the fair value of its liabilities for fixed rate brokered certificates of deposit caused by changes in market interest rates. These interest rate swaps allow the Company to create funding of varying maturities at a variable rate that approximates three-month LIBOR.
Borrowings. Great Southern's other sources of funds include advances from the FHLBank and a Qualified Loan Review ("QLR") arrangement with the FRB and other borrowings.
As a member of the FHLBank, the Bank is required to own capital stock in the FHLBank and is authorized to apply for advances from the FHLBank. Each FHLBank credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLBank may prescribe the acceptable uses for these advances, as well as other risks on availability, limitations on the size of the advances and repayment provisions. At December 31, 2005, the Bank's FHLBank advances outstanding were $203.4 million.
The FRB has a QLR program where the Bank can borrow on a temporary basis using commercial loans pledged to the FRB. Under the QLR program, the Bank can borrow any amount up to a calculated collateral value of the commercial loans pledged, for virtually any reason that creates a temporary cash need. Examples of this could be: (1) the need to fund for late outgoing wires or cash letter settlements, (2) the need to disburse one or several loans but the permanent source of funds will not be available for a few days; (3) a temporary spike in interest rates on other funding sources that are being used; or (4) the need to purchase a security for collateral pledging purposes a few days prior to the funds becoming available on an existing security that is maturing. The Bank had commercial loans pledged to the FRB at December 31, 2005 that would have allowed approximately $84.4 million to be borrowed under the above arrangement. At December 31, 2005, the amount outstanding was zero.
Great Southern Capital Trust I ("GSBCP"), a Delaware business trust, issued 1,725,000 unsecured 9.00% Cumulative Trust Preferred Securities at the liquidation value of $10 per security in an underwritten public offering and simultaneously therewith GSBCP issued 53,400 9.00% Common Securities, at liquidation value of $10 per security, to the Company. The gross proceeds of the sale of the trust preferred and trust common securities were used to purchase $17,784,000 in 9.00% Junior Subordinated Debentures from the Company. The Company's proceeds from the issuance of the subordinated debentures to GSBCP, net of underwriting fees and offering expenses, were $16.3 million. The subordinated debentures mature in 2031 and are redeemable at the Company's option beginning in June 2006.
The Company entered into an interest rate swap agreement to effectively convert the subordinated debentures, which are fixed rate debt, into variable rates of interest. The variable rate is three-month LIBOR plus 202 basis points, adjusting quarterly. The initial rate was 6.25% and the rate at December 31, 2005 and 2004, was 6.04% and 4.58%, respectively.
The following table sets forth the maximum month-end balances, average daily balances and weighted average interest rates of FHLBank advances during the periods indicated. The table is based on information prepared in accordance with generally accepted accounting principles.
The following table sets forth certain information as to the Company's FHLBank advances at the dates indicated. The table is based on information prepared in accordance with generally accepted accounting principles.
The following tables set forth the maximum month-end balances, average daily balances and weighted average interest rates of other borrowings during the periods indicated. Other borrowings includes primarily overnight borrowings and securities sold under reverse repurchase agreements. The tables are based on information prepared in accordance with generally accepted accounting principles.
The following tables set forth year-end balances and weighted average interest rates of the Company's other borrowings at the dates indicated. The tables are based on information prepared in accordance with generally accepted accounting principles.
The following table sets forth the maximum month-end balances, average daily balances and weighted average interest rates of subordinated debentures issued to capital trust during the periods indicated. The table is based on information prepared in accordance with generally accepted accounting principles.
The following table sets forth certain information as to the Company's subordinated debentures issued to capital trust at the dates indicated. The table is based on information prepared in accordance with generally accepted accounting principles.
Subsidiaries
Great Southern. As a Missouri-chartered trust company, Great Southern may invest up to 3%, which was equal to $62.4 million at December 31, 2005, of its assets in service corporations. At December 31, 2005, the Bank's total investment in Great Southern Real Estate Development Corporation ("Real Estate Development") was $2.4 million. Real Estate Development was incorporated and organized in 2003 under the laws of the State of Missouri. At December 31, 2005, the Bank's total investment in Great Southern Financial Corporation ("GSFC") was $3.0 million. GSFC is incorporated under the laws of the State of Missouri, and does business as Great Southern Insurance and Great Southern Travel. At December 31, 2005, the Bank's total investment in Great Southern Community Development Corporation ("Community Development") was $1.1 million. Community Development was incorporated and organized in 2004 under the laws of the State of Missouri. At December 31, 2005, the Bank's total investment in GS, L.L.C. ("GSLLC") was $1.1 million. GSLLC was incorporated and organized in 2005 under the laws of the State of Missouri. These subsidiaries are primarily engaged in the activities described below.
Great Southern Real Estate Development Corporation. Generally, the purpose of Real Estate Development is to hold real estate assets which have been obtained through foreclosure by the Bank and which require ongoing operation of a business or completion of construction. In 2005 and 2004, Real Estate Development did not hold any significant real estate assets. Real Estate Development had net income of $-0- and $51,000 in the years ended December 31, 2005 and 2004, respectively.
General Insurance Agency. Great Southern Insurance, a division of GSFC, was organized in 1974. It acts as a general property, casualty and life insurance agency for a number of clients, including the Bank. Great Southern Insurance had net income of $162,000 and $124,000 in the years ended December 31, 2005 and 2004, respectively. In addition, Great Southern Insurance had gross revenues of $1.5 million and $1.4 million in the years ended December 31, 2005 and 2004, respectively.
Travel Agency. Great Southern Travel, a division of GSFC, was organized in 1976. At December 31, 2005, it was the largest travel agency based in southwestern Missouri and was estimated to be in the top 5% (based on gross revenue) of travel agencies nationwide. Great Southern Travel operates from eleven full-time locations, including a facility at the Springfield-Branson Regional Airport, and additional corporate on-site locations. It engages in personal, commercial and group travel services. Great Southern Travel had net income of $383,000 and $197,000 in the years ended December 31, 2005 and 2004, respectively. In addition, Great Southern Travel had gross revenues of $5.1 million and $4.2 million in the years ended December 31, 2005 and 2004, respectively.
GSB One, L.L.C. At December 31, 2005, the Bank's total investment in GSB One, L.L.C. ("GSB One") and GSB Two, L.L.C. ("GSB Two") was $640 million. The capital contribution was made by transferring participations in loans to GSB Two. GSB One is a Missouri limited liability company that was incorporated in March of 1998. Currently the only activity of this company is the ownership of GSB Two.
GSB Two, L.L.C. This is a Missouri limited liability company that was incorporated in March of 1998. GSB Two is a real estate investment trust ("REIT"). It holds participations in real estate mortgages from the Bank. The Bank continues to service the loans in return for a management and servicing fee from GSB Two. GSB Two had net income of $34.1 million and $25.1 million in the years ended December 31, 2005 and 2004, respectively.
Great Southern Community Development Corporation. Generally, the purpose of Community Development is to invest in community development projects that have a public benefit, and are lawful under Missouri statute. These include such activities as investing in real estate and investing in other community development corporations. Community Development had a net loss of $11,000 in the year ended December 31, 2005.
GS, L.L.C. GS, L.L.C. was organized in 2005. GSLLC is a limited liability corporation that invests in multiple limited liability corporations (as a limited partner) for the purpose of acquiring state and federal historic tax credits which are utilized by Great Southern. GSLLC had a net loss of $432,000 in the year ended December 31, 2005, which primarily resulted from the cost to acquire tax credits. This loss was offset by the tax credits utilized by Great Southern.
Competition
Great Southern faces strong competition both in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from other commercial banks, savings institutions and mortgage bankers making loans secured by real estate located in the Bank's market area. Commercial banks and finance companies provide vigorous competition in commercial and consumer lending. The Bank competes for real estate and other loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers. The other lines of business of the Bank, including loan servicing and loan sales, as well as the Bank and Company subsidiaries, face significant competition in their markets.
The Bank faces substantial competition in attracting deposits from other commercial banks, savings institutions, money market and mutual funds, credit unions and other investment vehicles. The Bank attracts a significant amount of deposits through its branch offices primarily from the communities in which those branch offices are located; therefore, competition for those deposits is principally from other commercial banks and savings institutions located in the same communities. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, and convenient branch and ATM locations with inter-branch deposit and withdrawal privileges at each branch location.
Employees
At December 31, 2005, the Bank and its affiliates had a total of 681 employees, including 137 part-time employees. None of the Bank's employees are represented by any collective bargaining agreement. Management considers its employee relations to be good.
Government Supervision and Regulation
On June 30, 1998, the Bank converted from a federal savings bank to a Missouri-chartered trust company, with the approval of the Missouri Division of Finance ("MDF") and the FRB. The Bank is regulated as a bank under state and federal law. By converting, the Bank was able to expand its consumer and commercial lending authority.
Bancorp and its subsidiaries are subject to supervision and examination by applicable federal and state banking agencies. The earnings of the Bank's subsidiaries, and therefore the earnings of Bancorp, are affected by general economic conditions, management policies and the legislative and governmental actions of various regulatory authorities, including the FRB, the Federal Deposit Insurance Corporation ("FDIC") and the MDF. In addition, there are numerous governmental requirements and regulations that affect the activities of the Company and its subsidiaries. The following is a brief summary of certain aspects of the regulation of the Company and Great Southern and does not purport to fully discuss such regulation.
Bank Holding Company Regulation
The Company is a bank holding company that has elected to be treated as a financial holding company by the FRB. Financial holding companies are subject to comprehensive regulation by the FRB under the Bank Holding Company Act, and the regulations of the FRB. As a financial holding company, the Company is required to file reports with the FRB and such additional information as the FRB may require, and is subject to regular examinations by the FRB. The FRB also has extensive enforcement authority over financial holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
Under FRB policy, a bank holding company must serve as a source of strength for its subsidiary banks. Under this policy the FRB may require, and has required in the past, that a bank holding company contribute additional capital to an undercapitalized subsidiary bank.
Under the Bank Holding Company Act, a financial holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank or financial holding company; or (iii) merging or consolidating with another bank or financial holding company.
The Bank Holding Company Act also prohibits a financial holding company generally from engaging directly or indirectly in activities other than those involving banking, activities closely related to banking that are permitted for a bank holding company, securities, insurance or merchant banking.
Interstate Banking and Branching
Federal law allows the FRB to approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The FRB may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. Federal law also prohibits the FRB from approving an application if the applicant (and its depository institution affiliates)
Additionally, the federal banking agencies are generally authorized to approve interstate bank merger transactions without regard to whether such transactions are prohibited by the law of any state. Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration amounts described above.
Federal law also authorizes the Office of the Comptroller of the Currency ("OCC") and the FDIC to approve interstate branching de novo by national and state banks, respectively, only in states which specifically allow for such branching. As required by federal law, the OCC, FDIC and FRB have prescribed regulations which prohibit any out-of-state bank from using the interstate branching authority primarily for the purpose of deposit production, including guidelines to ensure that interstate branches operated by an out-of-state bank in a host state reasonably help to meet the credit needs of the communities which they serve.
Certain Transactions with Affiliates and Other Persons
Transactions involving the Bank and its affiliates are subject to sections 23A and 23B of the Federal Reserve Act, and regulations thereunder, which impose certain quantitative limits and collateral requirements on such transactions, and require all such transactions to be on terms at least as favorable to the Bank as are available in transactions with non-affiliates.
All loans by Great Southern to its directors and executive officers are subject to FRB regulations restricting loans and other transactions with affiliated persons of Great Southern. Transactions involving such persons must be on terms and conditions comparable to those for similar transactions with non-affiliates. A bank may have a policy allowing favorable rate loans to employees as long as it is an employee benefit available to bank employees. The Bank has such a policy in place that allows for loans to all employees.
Dividends
The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB's view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the holding company's capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, a bank holding company may be prohibited from paying any dividends if the holding company's bank subsidiary is not adequately capitalized.
Bank holding companies are required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company's consolidated net worth. The FRB may disapprove such
The Federal banking agencies have adopted various capital-related regulations. Under those regulations, a bank will be well capitalized if it has: (i) a total risk- based capital ratio of 10% or greater; (ii) a Tier I risk-based ratio of 6% or greater; (iii) a leverage ratio of 5% or greater; and (iv) is not subject to a regulatory requirement to maintain any specific capital measure. A bank will be adequately capitalized if it is not "well capitalized" and: (i) has a total risk-based capital ratio of 8% or greater; (ii) has a Tier I risk-based ratio of 4% or greater; and (iii) has a leverage ratio of 4% or greater. As of December 31, 2005, the Bank was "well capitalized."
Federal banking agencies take into consideration concentrations of credit risk and risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. This evaluation will generally be made as part of the institution's regular safety and soundness examination. Under their regulations, the federal banking agencies consider interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of a bank's capital adequacy. The banking agencies have issued guidance on evaluating interest rate risk.
The FRB has established capital regulations for bank holding companies that generally parallel the capital regulations for banks. As of December 31, 2005, the Company was "well capitalized."
Insurance of Accounts and Regulation by the FDIC
The FDIC currently maintains two separate deposit insurance funds: the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund (the "SAIF"). Great Southern's depositors are insured by the SAIF up to $100,000 per insured account (as defined by law and regulation). This insurance is backed by the full faith and credit of the United States Government.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by SAIF-insured associations. It also may prohibit any FDIC- insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the SAIF. The FDIC also has the authority to take enforcement actions against banks and savings associations.
Great Southern pays annual assessments for SAIF insurance. Under current FDIC regulations, the annual SAIF assessment rate is based, in part, on the degree of risk to the deposit insurance fund that, in the opinion of the FDIC, is presented by a particular depository institution compared to other depository institutions. The FDIC uses a matrix having as variables the level of capitalization of a particular institution and the level of supervision that its operations require; and the rates determined in this fashion range from 0.00% of deposits for the least risky to 0.27% for the most risky. There is no cap on the amount the FDIC may increase the SAIF assessment rate. The Bank currently has a risk based assessment rate of 0.00%. Under the Federal Deposit Insurance Reform Act of 2005, the BIF and the SAIF will be merged and the FDIC is authorized to revise the current risk-based assessment system in regulations, subject to public notice and comment. Under the new regulations, premium costs could increase, which would negatively impact the earnings of Great Southern.
The FDIC also collects assessments against BIF and SAIF assessable deposits to service the debt on bonds issued during the 1980's to resolve the thrift bailout. For the quarter ended December 31, 2005, the assessment rate for both BIF and SAIF insured institutions was 1.34 basis points per $100 of assessable deposits.
The Federal banking regulators are required to take prompt corrective action if an institution fails to satisfy the requirements to qualify as adequately capitalized. All institutions, regardless of their capital levels, will be restricted from making any capital distribution or paying any management fees that would cause the institution to fail to satisfy the requirements to qualify as adequately capitalized. An institution that is not at least adequately capitalized will be: (i) subject to increased monitoring by the appropriate Federal banking regulator; (ii) required to submit an acceptable capital restoration plan (including certain guarantees by any company controlling the institution) within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of business. Additional restrictions, including appointment of a receiver or conservator, can apply, depending on the institution's capital level. The FDIC has jurisdiction over the Bank for purposes of prompt corrective action.
Federal Reserve System
The FRB requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At December 31, 2005, the Bank was in compliance with these reserve requirements.
Banks are authorized to borrow from the FRB "discount window," but FRB regulations only allow this borrowing for short periods of time and generally require banks to exhaust other reasonable alternative sources of funds where practical, including FHLBank advances, before borrowing from the FRB. See "Sources of Funds Borrowings" above.
Federal Home Loan Bank System
The Bank is a member of the FHLBank of Des Moines, which is one of 12 regional FHLBanks.
As a member, Great Southern is required to purchase and maintain stock in the FHLBank of Des Moines in an amount equal to the greater of 1% of its outstanding home loans or 5% of its outstanding FHLBank advances. At December 31, 2005, Great Southern had $11.9 million in FHLBank stock, which was in compliance with this requirement. In past years, the Bank has received dividends on its FHLBank stock. Over the past five years, such dividends have averaged 3.10% and were 2.83% for year the ended December 31, 2005.
Legislative and Regulatory Proposals
Any changes in the extensive regulatory scheme to which the Company or the Bank is and will be subject, whether by any of the Federal banking agencies or Congress, could have a material effect on the Company or the Bank, and the Company and the Bank cannot predict what, if any, future actions may be taken by legislative or regulatory authorities or what impact such actions may have.
Federal and State Taxation
The following discussion contains a summary of certain federal and state income tax provisions applicable to the Company and the Bank. It is not a comprehensive description of the federal income tax laws that may affect the Company and the Bank. The following discussion is based upon current provisions of the Internal Revenue Code of 1986 (the "Code") and Treasury and judicial interpretations thereof.
The Company and its subsidiaries file a consolidated federal income tax return using the accrual method of accounting, with the exception of GSB Two which files a separate return as a REIT. All corporations joining in the consolidated federal income tax return are jointly and severally liable for taxes due and payable by the consolidated group. The following discussion primarily focuses upon the taxation of the Bank, since the federal income tax law contains certain special provisions with respect to banks.
Financial institutions, such as the Bank, are subject, with certain exceptions, to the provisions of the Code generally applicable to corporations.
Bad Debt Deduction
As of December 31, 2005 and 2004, retained earnings includes approximately $17,500,000 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions for tax purposes only for tax years prior to 1988. If the Bank were to liquidate, the entire amount would have to be recaptured and would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $6,475,000 at December 31, 2005 and 2004.
The Bank is required to follow the specific charge-off method which only allows a bad debt deduction equal to actual charge-offs, net of recoveries, experienced during the fiscal year of the deduction. In a year where recoveries exceed charge-offs, the Bank would be required to include the net recoveries in taxable income.
Interest Deduction
In the case of a financial institution, such as the Bank, no deduction is allowed for the pro rata portion of its interest expense which is allocable to tax-exempt interest on obligations acquired after August 7, 1986. A limited class of tax-exempt obligations acquired after August 7, 1986 will not be subject to this complete disallowance rule. For tax-exempt obligations acquired after December 31, 1982 and before August 8, 1986 and for obligations acquired after August 7, 1986 that are not subject to the complete disallowance rule, 80% of interest incurred to purchase or carry such obligations will be deductible. No portion of the interest expense allocable to tax-exempt obligations acquired by a financial institution before January 1, 1983, which is otherwise deductible, will be disallowed. The interest expense disallowance rules cited above have not significantly impacted the Bank.
Alternative Minimum Tax
Corporations generally are subject to a 20% corporate alternative minimum tax ("AMT"). A corporation must pay the AMT to the extent it exceeds that corporation's regular federal income tax liability The AMT is imposed on "alternative minimum taxable income," defined as taxable income with certain adjustments and tax preference items, less any available exemption. Such adjustments and items include, but are not limited to, (i) net interest received on certain tax-exempt bonds issued after August 7, 1986; and (ii) 75% of the difference between adjusted current earnings and alternative minimum taxable income, as otherwise determined with certain adjustments. Net operating loss carryovers may be utilized, subject to adjustment, to offset up to 90% of the alternative minimum taxable income, as otherwise determined. A portion of the AMT paid, if any, may be credited against future regular federal income tax liability.
Missouri Taxation
Missouri-based banks, such as the Bank, are subject to a franchise tax which is imposed on the larger of (i) the bank's taxable income at the rate of 7% of the taxable income (determined without regard for any net operating losses) - income-based calculation; or (ii) the bank's assets at a rate of .033% of total assets less deposits and the investment in greater than 50% owned subsidiaries - asset-based calculation. Missouri-based banks are entitled to a credit against the income-based franchise tax for all other state or local taxes on banks, except taxes on real estate, unemployment taxes, bank tax, and taxes on tangible personal property owned by the Bank and held for lease or rental to others.
The Company and all subsidiaries are subject to an income tax that is imposed on the corporation's taxable income at the rate of 6.25%. The return is filed on a consolidated basis by all members of the consolidated group including the Bank, but excluding GSB Two. As a REIT, GSB Two files a separate Missouri income tax return.
Maryland Taxation
As a Maryland corporation, the Company is required to file an annual report with and pay an annual fee to the State of Maryland.
Examinations
The Company and its consolidated subsidiaries have not been audited recently by the Internal Revenue Service or the State of Missouri with respect to income or franchise tax returns, and as such, tax years through December 31, 2001, have been closed without audit.
ITEM 1A. RISK FACTORS
An investment in the common stock of Great Southern is speculative in nature and is subject to certain risks inherent in the business of Great Southern and the Bank. The material risks and uncertainties that management believes affect Great Southern and the Bank are described below. You should carefully consider the risks described below, as well as the other information included or incorporated by reference in this Annual Report on Form 10-K, before making an investment in Great Southern's common stock. The risks described below are not the only ones we face in our business. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations. If any of the following risks occur, our business, financial condition or operating results could be materially harmed. In such an event, our common stock could decline in price.
References to "we," "us," and "our" in this "Risk Factors" section refer to Great Southern and its subsidiaries, including the Bank, unless otherwise specified or unless the context otherwise requires.
Since our business is concentrated in the Southwest Missouri area, including the Springfield metropolitan area and Branson, a downturn in the Springfield and Branson economies may adversely affect our business.
Our lending and deposit gathering activities have been historically concentrated primarily in the Springfield and Branson, Missouri areas. Our success depends on the general economic condition of Springfield and Branson and their surrounding areas. Although we believe the economy in these areas has been favorable, we do not know whether these conditions will continue. Our greatest concentration of loans and deposits is in the Greater Springfield area. With a population of approximately 390,000, the Greater Springfield area is the third largest metropolitan area in Missouri.
The next largest concentration of loans is in the Branson area. The region is a vacation and entertainment center, attracting tourists to its theme parks, resorts, country music and novelty shows and other recreational facilities. As a result of the rapid growth of the Branson area in the early 1990's, property values increased at unusually high rates. This growth also provided for increased loan demand and a more volatile lending market than had previously been present in that area. Due to overbuilding of commercial properties during the mid-1990's, property values experienced downward pressure in the late 1990's. In recent years, commercial real estate values have stabilized. Reduced demand for residential properties in the 1990's similarly created downward pressure on one- to four-family and multi-family, primary and vacation residences in this area. In recent years, residential real estate demand and values have shown improvements. Branson is currently experiencing significant growth again as a result of a large retail, hotel, convention center project which is under construction in Branson's historic downtown. This project is expected to create hundreds of new jobs in the area. At December 31, 2005, approximately 11% of our loan portfolio consisted of loans in the two county region that includes the Branson area.
Adverse changes in the regional and general economic conditions could reduce our growth rate, impair our ability to collect loans, increase loan delinquencies, increase problem assets and foreclosure, increase claims and lawsuits, decrease the demand for the Bank's products and services, and decrease the value of collateral for loans, especially real estate, thereby having a material adverse effect on our financial condition and results of operations.
Our loan portfolio possesses increased risk due to our relatively high concentration of commercial and residential construction, commercial real estate and multi-family loans.
Our commercial and residential construction, commercial real estate and multi-family loans accounted for approximately 76.8% of our total loan portfolio as of December 31, 2005. Generally, we consider these types of loans to involve a higher degree of risk compared to first mortgage loans on one- to four-family, owner-occupied residential properties. At December 31, 2005, we had $129.5 million of loans secured by residential subdivisions, $125.5 million of loans secured by healthcare facilities, $115.0 million of loans secured by motels and $97.3 million of loans secured by retail facilities, which are particularly sensitive to certain risks including the following:
large loan balances owed by a single borrower;payments that are dependent on the successful operation of the project; andloans that are more directly impacted by adverse conditions in the real estate market or the economy generally.
The risks associated with construction lending include the borrower's inability to complete the construction process on time and within budget, the sale of the project within projected absorption periods, the economic risks associated with real estate collateral, and the potential of a rising interest rate environment. These loans may include financing the development and/or construction of residential subdivisions. This activity may involve financing land purchase, infrastructure development (i.e. roads, utilities, etc.), as well as construction of residences or multi-family dwellings for subsequent sale by the developer/builder. Because the sale of developed properties is critical to the success of developer business, loan repayment may be especially subject to the volatility of real estate market values. Management has established underwriting and monitoring criteria to help minimize the inherent risks of commercial real estate construction lending. However, there is no guaranty that these controls and procedures will avoid all losses on this type of lending.
Commercial and multi-family real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on the successful operation of the property securing the loan or the business conducted on the property securing the loan. These loans may therefore be more adversely affected by conditions in the real estate markets or in the economy generally. For example, if the cash flow from the borrower's project is reduced due to leases not being obtained or renewed, the borrower's ability to repay the loan may be impaired. In addition, many commercial and multi-family real estate loans are not fully amortized over the loan period, but have balloon payments due at maturity. A borrower's ability to make a balloon payment typically will depend on being able to either refinance the loan or completing a timely sale of the underlying property.
We plan to continue our emphasis on commercial real estate and construction lending. Because of the increased risks related to these types of loans, we may determine it necessary to increase the level of our provision for loan losses. Increased provisions for loan losses would adversely impact our operating results. See "Item 1. Business-The Company-Lending Activities-Commercial Real Estate and Construction Lending," "-Other Commercial Lending," "-Residential Real Estate Lending" and "-Allowance for Losses on Loans and Foreclosed Assets" in this Annual Report on Form 10-K.
Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.
Lending money is a substantial part of our business. However, every loan we make carries a certain risk of non-payment. This risk is affected by, among other things:
cash flow of the borrower and/or the project being financed;in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral;the credit history of a particular borrower;changes in economic and industry conditions; andthe duration of the loan.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within the loan portfolio. We make various assumptions and judgments about the collectibility of our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances for growing portfolios is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. Excessive loan losses and significant additions to our allowance for loan losses could have a material adverse impact on our financial condition and results of operations.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on our financial condition and results of operations.
Our operations depend upon our continued ability to access brokered deposits and Federal Home Loan Bank advances.
Due to the high level of competition for deposits in our market, we utilize a sizable amount of certificates of deposit obtained through deposit brokers and advances from the Federal Home Loan Bank of Des Moines to help fund our asset base. Brokered deposits are marketed through national brokerage firms that solicit funds from their customers for deposit in banks, including our bank. Brokered deposits and Federal Home Loan Bank advances may generally be more sensitive to changes in interest rates and volatility in the capital markets than retail deposits attracted through our branch network, and our reliance on these sources of funds increases the sensitivity of our portfolio to these external factors. At December 31, 2005, we had $584.4 million in brokered deposits and $203.4 million in Federal Home Loan Bank advances.
Bank regulators can restrict our access to these sources of funds in certain circumstances. For example, if the Bank's regulatory capital ratios declined below the "well capitalized" status, banking regulators would require the Bank to obtain their approval prior to obtaining or renewing brokered deposits. The regulators might not approve our purchases of deposits in amounts that we desire or at all. Similarly, Federal Home Loan Bank advances are only available to borrowers that meet certain conditions. If the Bank were to cease meeting these conditions, our access to Federal Home Loan Bank advances could be significantly reduced or eliminated.
We rely on these sources of funds because we believe that generating funds through brokered deposits and Federal Home Loan Bank advances in many instances decreases our cost of funds, relative to the cost of generating and retaining retail deposits through our branch network. If our access to brokered deposits or Federal Home Loan Bank advances were reduced or eliminated for whatever reason, the resulting decrease in our net interest income or limitation on our ability to fund additional loans would adversely affect our business, financial condition and results of operations.
Certain Federal Home Loan Banks, including Des Moines, have experienced lower earnings from time to time and paid out lower dividends to its members. Future problems at the Federal Home Loan Banks may impact the collateral necessary to secure borrowings and limit the borrowings extended to its member banks, as well as require additional capital contributions by its member banks. Should this occur, Great Southern's short term liquidity needs could be negatively impacted. Should Great Southern be restricted from using Federal Home Loan Bank advances due to weakness in the system or with the Federal Home Loan Bank of Des Moines, Great Southern may be forced to find alternative funding sources. Such alternative funding sources may include the utilization of existing lines of credit with third party banks along with seeking other lines of credit, borrowing under repurchase agreement lines, increasing deposit rates to attract additional funds, accessing additional brokered deposits, or selling certain investment securities categorized as available-for-sale in order to maintain adequate levels of liquidity. At December 31, 2005, the Bank owned $11.9 million of Federal Home Loan Bank of Des Moines stock, which paid a dividend approximating 2.80% for the fourth quarter of 2005. The Federal Home Loan Bank of Des Moines may eliminate or reduce dividend payments at any time in the future in order for it to maintain or restore its retained earnings.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. To date, we have grown our business successfully by focusing on our geographic market and emphasizing the high level of service and responsiveness desired by our customers. We compete for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, consumer finance companies, insurance companies and brokerage firms. Many of our competitors offer products and services which we do not offer, and many have substantially greater resources, name recognition and market presence that benefit them in attracting business. In addition, larger competitors (including certain national banks that have a significant presence in Great Southern's market area) may be able to price loans and deposits more aggressively than we do, and smaller and newer competitors may also be more aggressive in terms of pricing loan and deposit products than us in order to obtain a larger share of the market. As we have grown, we have become increasingly dependent on outside funding sources, including funds borrowed from the Federal Home Loan Bank and brokered deposits, where we face nationwide competition. Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies, federally insured state-chartered banks and national banks and federal savings banks. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services.
We also experience competition from a variety of institutions outside of the Company's market area. Some of these institutions conduct business primarily over the Internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer.
Our business may be adversely affected by the highly regulated environment in which we operate, including the various capital adequacy guidelines we are required to meet.
We are subject to extensive federal and state legislation, regulation, examination and supervision. Recently enacted, proposed and future legislation and regulations have had, will continue to have, or may have a material adverse effect on our business and operations. Our success depends on our continued ability to maintain compliance with these regulations. Some of these regulations may increase our costs and thus place other financial institutions in stronger, more favorable competitive positions. We cannot predict what restrictions may be imposed upon us with future legislation. See "Item 1.-The Company -Government Supervision and Regulation" in this Annual Report on Form 10-K.
Great Southern and the Bank are required to meet certain regulatory capital adequacy guidelines and other regulatory requirements imposed by the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Missouri Division of Finance. If Great Southern or the Bank fails to meet these minimum capital guidelines and other regulatory requirements, our financial condition and results of operations could be materially and adversely affected and could compromise the status of Great Southern as a financial holding company. See "Item 1 -The Company -Government Supervision and Regulation" in this Annual Report on Form 10-K for detailed capital guidelines for bank holding companies and banks.
We may be adversely affected by interest rate changes.
Our earnings are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our loan and mortgage-backed securities portfolios. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
We generally seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period. As such, Great Southern has adopted asset and liability management strategies to attempt to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments and funding sources, including interest rate swaps, so that it may reasonably maintain its net interest income and net interest margin. However, interest rate fluctuations, the level and shape of the interest rate yield curve, loan prepayments, loan production and deposit flows are constantly changing and influence the ability to maintain a neutral position. Accordingly, we may not be successful in maintaining a neutral position and, as a result, our net interest margin may be adversely impacted.
Our exposure to operational risks may adversely affect the Company.
Similar to other financial institutions, the Company is exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, the risk that sensitive customer or Company data is compromised, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors. If any of these risks occur, it could result in material adverse consequences for the Company.
We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients.
As a service to our clients, we currently offer an Internet PC banking product. Use of this service involves the transmission of confidential information over public networks. We cannot be sure that advances in computer capabilities, new discoveries in the field of cryptography or other developments will not result in a compromise or breach in the commercially available encryption and authentication technology that we use to protect our clients' transaction data. If we were to experience such a breach or compromise, we could suffer losses and our operations could be adversely affected.
Our accounting policies and methods impact how we report our financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.
Great Southern's accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. The Company's management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management's judgment of the most appropriate manner to report its financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in the Company reporting materially different amounts than would have been reported under a different alternative. Note 1 "Summary of Significant Accounting Policies" in the "Notes to Consolidated Financial Statements" describes the Company's significant accounting policies. These accounting policies are critical to presenting the Company's financial condition and results of operations. They may require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions.
Changes in accounting standards could materially impact our consolidated financial statements.
The accounting standard setters, including the Financial Accounting Standards Board, Securities and Exchange Commission and other regulatory bodies, from time to time may change the financial accounting and reporting standards that govern the preparation of the Company's consolidated financial statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings.
Our internal controls may be ineffective.
We regularly review and update our internal controls, disclosure controls and procedures and corporate governance policies and procedures. As a result, we may incur increased costs to maintain and improve our controls and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls or procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations or financial condition.
Our stock price can be volatile.
Our stock price can fluctuate widely in response to a variety of factors. Factors include actual or anticipated variations in our quarterly operating results, recommendations by securities analysts, operating and stock price performance of other companies, news reports, results of litigation and other factors, including those described in this "Risk Factors" section. General market fluctuations, industry factors and general economic conditions and events, such as economic slowdowns or recessions, interest rate changes and credit loss trends could also cause Great Southern's common stock price to decrease regardless of the Company's operating results. Our common stock also has a low average daily trading volume relative to many other stocks, which may limit a person's ability to quickly accumulate or divest themselves of large blocks of our stock. This can lead to significant price swings even when a relatively small number of shares are being traded.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES.
The following table sets forth certain information concerning the main corporate office and each branch office of the Company at December 31, 2005. The aggregate net book value of the Company's premises and equipment was $27.3 million at December 31, 2005 and $23.4 million at December 31, 2004. See also Note 5 and Note 13 of the Notes to Consolidated Financial Statements. Substantially all buildings owned are free of encumbrances or mortgages. In the opinion of management, the facilities are adequate and suitable for the needs of the Company.
_________________
In addition, the travel division has offices in many of the above locations as well as several small offices in other locations including some of its larger corporate customer's headquarters.
The Bank maintains depositor and borrower customer files on an on-line basis, utilizing a telecommunications network, portions of which are leased. The book value of all data processing and computer equipment utilized by the Bank at December 31, 2005 was $439,000 compared to $234,000 at December 31, 2004. Management has a disaster recovery plan in place with respect to the data processing system as well as the Bank's operations as a whole.
The Bank maintains a network of Automated Teller Machines ("ATMs"). The Bank utilizes an external service for operation of the ATMs that also allows access to the various national ATM networks. A total of 165 ATMs are located at various branches and primarily convenience stores located throughout southwest and central Missouri. The book value of all ATMs utilized by the Bank at December 31, 2005 was $436,000 compared to $536,000 at December 31, 2004. The Bank will evaluate and relocate existing ATMs as needed, but has no plans in the near future to materially increase its investment in the ATM network.
ITEM 3. LEGAL PROCEEDINGS.
In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some for which the relief or damages sought are substantial. After reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the results of operations or stockholders' equity. We are not able to predict at this time whether the outcome or such actions may or may not have a material adverse effect on the results of operations in a particular future period as the timing and amount of any resolution of such actions and its relationship to the future results of operations are not known.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
Pursuant to General Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K, the following list is included as an unnumbered item in Part I of this Form 10-K in lieu of being included in the Registrant's Definitive Proxy Statement.
The following information as to the business experience during the past five years is supplied with respect to executive officers of the Company and its subsidiaries who are not directors of the Company and its subsidiaries. There are no arrangements or understandings between the persons named and any other person pursuant to which such officers were selected. The executive officers are elected annually and serve at the discretion of their respective Boards of Directors.
Steven G. Mitchem. Mr. Mitchem, age 54, is Senior Vice President and Chief Lending Officer of the Bank. He joined the Bank in 1990 and is responsible for all lending activities of the Bank. Prior to joining the Bank, Mr. Mitchem was a Senior Bank Examiner for the Federal Deposit Insurance Corporation.
Rex A. Copeland. Mr. Copeland, age 41, is Treasurer of the Company and Senior Vice President and Chief Financial Officer of the Bank. He joined the Bank in 2000 and is responsible for the financial functions of the Company, including the internal and external financial reporting of the Company and its subsidiaries. Mr. Copeland is a Certified Public Accountant. Prior to joining the Bank, Mr. Copeland served other financial services companies in the areas of corporate accounting, internal audit and independent public accounting.
Douglas W. Marrs. Mr. Marrs, age 48, is Vice President - Operations of the Bank. He joined the Bank in 1996 and is responsible for all operations functions of the Bank. Prior to joining the Bank, Mr. Marrs was a bank officer in the areas of operations and data processing at a competing $1 billion bank.
Larry A. Larimore. Mr. Larimore, age 65, is Secretary of the Company and Secretary, Vice President - Compliance Officer of the Bank. He joined the Bank in 1998 and is responsible for Compliance and Internal Audit for the Company and Bank. Prior to joining the Bank, Mr. Larimore was a bank officer in the areas of lending, compliance and internal audit at a competing area bank.
PART II
Responses incorporated by reference into the items under Part II of this Form 10-K are done so pursuant to Rule 12b-23 and General Instruction G(2) for Form 10-K.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information. The Company's Common Stock is listed on The NASDAQ Stock Market under the symbol "GSBC."
As of December 31, 2005 there were 13,722,801 total shares outstanding and approximately 2,400 shareholders of record.
High/Low Stock Price (adjusted for 2004 2-for-1 stock split in the form of a stock dividend)
The last sale price of the Company's Common Stock on December 31, 2005 was $27.61.
Dividend Declarations (adjusted for 2004 2-for-1 stock split in the form of a stock dividend)
The Company's ability to pay dividends is substantially dependent on the dividend payments it receives from the Bank. For a description of the regulatory restrictions on the ability of the Bank to pay dividends to the Company, and the ability of the Company to pay dividends to its stockholders, see "Item 1. Business - Government Supervision and Regulation - Dividends."
Issuer Purchases of Equity Securities
On December 26, 2000, the Company's Board of Directors authorized management to repurchase up to 400,000 shares of the Company's outstanding common stock, under a program of open market purchases or privately negotiated transactions. The plan does not have an expiration date. Information on the shares purchased during the fourth quarter of 2005 is as follows.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial information and other financial data of the Company. The selected balance sheet and statement of income data, insofar as they relate to the years ended December 31, 2005, 2004, 2003, 2002 and 2001, are derived from our consolidated financial statements, which have been audited by BKD, LLP. The amounts for 2004, 2003, 2002 and 2001 are restated amounts, as described in the discussion following the table under "Restatement of Previously Issued Consolidated Financial Statements." See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8, "Financial Statements and Supplementary Information." Results for past periods are not necessarily indicative of results that may be expected for any future period. All share and per share amounts have been adjusted for the two-for-one stock split in the form of a stock dividend declared in May 2004.
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RESTATEMENT OF PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS
On January 23, 2006, the Company announced that it is restating certain of its historical financial statements for the quarters ended March 31, 2005, June 30, 2005, and September 30, 2005, and years ended December 31, 2004, 2003, 2002, and 2001. The restatement of this financial information relates to the correction of prior accounting errors relating to certain interest rate swaps associated with brokered certificates of deposit (CDs).
The Company has entered into interest rate swap agreements to hedge the interest rate risk inherent in certain of its CDs. From the inception of the hedging program in 2000, the Company has applied a method of fair value hedge accounting under Statement of Financial Accounting Standards (SFAS) 133 to account for the CD swap transactions that allowed the Company to assume the effectiveness of such transactions (the so-called "short-cut" method). The Company concluded, that the CD swap transactions did not qualify for this method in prior periods because the method to pay the related CD broker placement fee was determined, in retrospect, to have caused the swap to not have a fair value of zero at inception (which is required under SFAS 133 to qualify for the "short-cut" method). Although the impact of applying the alternative "long-haul" method of documentation using SFAS 133 and the results under the "short-cut" method are believed to result in no significant difference in the hedge effectiveness of the majority of these swaps, and management believes these interest rate swaps have been effective as economic hedges, hedge accounting under SFAS 133 is not allowed for the affected periods because the proper hedge documentation was not in place at the inception of the hedge.
The Company is charged a fee in connection with its acquisition of brokered CDs. This fee is not paid separately by the Company to the CD broker, but rather is built in as part of the overall rate on the interest rate swap. In connection with the restatement, the Company has determined that this broker fee should be accounted for separately as a prepaid fee at the origination of the brokered CD and amortized into interest expense over the maturity period of the brokered CD. If the Company calls the brokered CD (at par) prior to maturity, the remaining unamortized broker fee is expensed at that time. The remaining unamortized prepaid broker fees related to these brokered CDs at December 31, 2005 and 2004, were $6.5 million and $6.4 million, respectively.
As a result, the financial statements for all affected periods through December 31, 2005, reflect a cumulative charge of approximately $3.4 million (net of income taxes) to account for the interest rate swaps referred to above as if hedge accounting was never applicable to them. In addition, the fiscal year 2005 financial statements include a charge of approximately $5.1 million (net of income taxes), to reflect the same treatment.
Fair value hedge accounting allows a company to record the change in fair value of the hedged item (in this case, brokered CDs) as an adjustment to income by offsetting the fair value adjustment on the related interest rate swap. Eliminating the application of fair value hedge accounting reverses the fair value adjustments that were made to the brokered CDs. Therefore, while the interest rate swap is recorded on the balance sheet at its fair value, the related hedged items, the brokered CDs, are required to be carried at par. Additionally, the net cash settlement payments received during each of the above periods for these interest rate swaps were reclassified from interest expense on brokered CDs to noninterest income.
The effects of the change in accounting for certain interest rate swaps on the consolidated balance sheet as of, and income statement for the year ended, December 31, 2005, are as follows (dollars in thousands):
The effects of the restatement on the consolidated balance sheets as of, and income statements for the years ended, December 31, 2004, 2003, 2002 and 2001, are as follows (dollars in thousands):
The effects of the restatement on the consolidated balance sheets as of, and income statements for the three months ended September 30, 2005, June 30, 2005, March 31, 2005, December 31, 2004, September 30, 2004, June 30, 2004 and March 31, 2004, are as follows: (dollars in thousands)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Forward-looking Statements
When used in this Annual Report and in future filings by the Company with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or shareholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among other things, changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, the credit risks of lending activities, including changes in the level and direction of loan delinquencies and charge-offs and changes in estimates of the adequacy of the allowance for loan losses, the Company's ability to access cost-effective funding, demand for loans and deposits in the Company's market area and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to advise readers that the factors listed above could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The Company does not undertake-and specifically declines any obligation-to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining an allowance level believed by management to be sufficient to absorb estimated loan losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss once loans default, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods.
Additional discussion of the allowance for loan losses is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005, under the section titled "Item 1. Business - Allowances for Losses on Loans and Foreclosed Assets." Judgments and assumptions used by management in the past have resulted in an overall allowance for loan losses that has been sufficient to absorb estimated loan losses.
Stock Split
All share and per share amounts have been adjusted for the two-for-one stock split in the form of a stock dividend declared in May 2004.
The profitability of the Company and, more specifically, the profitability of its primary subsidiary, Great Southern Bank (the "Bank"), depends primarily on its net interest income. Net interest income is the difference between the interest income it earns on its loans and investment portfolio, and the interest it pays on interest-bearing liabilities, which consists mainly of interest paid on deposits and borrowings. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on these balances. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
In 2005, Great Southern was able to generate significant loan growth and thereby generate additional interest income. As loan demand is affected by a variety of factors, including general economic conditions, we cannot be assured that our loan growth will continue at its current pace. If economic conditions remain strong in future periods, we believe that we are well positioned to capture loan market share in our Southwest Missouri market as well as our loan production markets of St. Louis, Kansas City and Northwest Arkansas. In addition, we may consider other markets in which to establish loan production offices. We expect that the majority of our loan portfolio growth will continue to be in the commercial real estate and residential and commercial construction categories. In the year ended December 31, 2005, commercial real estate loan balances (including industrial revenue bonds on commercial real estate projects) increased $26 million and construction loan balances increased $159 million.
A portion of this loan growth was funded by attracting deposit accounts from our retail branch network, correspondent banking and corporate services customers. The Company then utilized these funding sources to meet loan demand from existing and new customers. In the year ended December 31, 2005, total deposit balances increased $252 million. Of this total increase, brokered certificate balances increased $128 million, customer checking accounts increased $83 million, and retail certificates increased $42 million. As the generation of increased net interest income is critical to the growth of Great Southern's earnings, the continued ability to attract deposits or to fund loan growth through other funding sources is very important to our success. Although there is a high level of competition for deposits in our markets, we were successful in attracting deposits in 2005. While it is our goal to continue to aggressively gain deposit market share in our branch footprint, we cannot be assured of this in future periods.
Our ability to fund growth in future periods may also be dependent on our ability to continue to access brokered deposits and FHLBank advances. In times when our loan demand has outpaced our generation of new deposits, we have utilized brokered deposits and FHLBank advances to fund these loans. In the year ended December 31, 2005, the outstanding balance of FHLBank advances decreased $28 million due to deposit growth and increases in brokered certificates. FHLBank advances have been attractive to us because we can create variable rate funding which more closely matches the variable rate nature of much of our loan portfolio. While we do not currently anticipate that our ability to access these funding sources will be reduced or eliminated in future periods, if this should happen, the limitation on our ability to fund additional loans would adversely affect our business, financial condition and results of operations.
Our net interest income may be affected positively or negatively by market interest rate changes. A large portion of our loan portfolio is tied to the "prime" rate and adjusts immediately when this rate adjusts. We also have a large portion of our liabilities that will reprice with changes to the federal funds rate or the three-month LIBOR rate. We monitor our sensitivity to interest rate changes on an ongoing basis (see "Item 7A. Quantitative and Qualitative Disclosures About Market Risk").
The Company's profitability is also affected by the level of its non-interest income and operating expenses. Non-interest income consists primarily of the effects of the Company's interest rate swaps, gains on sales of loans and available-for-sale investments, service charges and ATM fees, commissions earned by non-bank affiliates and other general operating income. Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, postage, insurance, advertising, office expenses and other general operating expenses.
In 2005, non-interest income decreased primarily due to the restated effects of the Company's interest rate swaps and the realized impairment of one available-for-sale investment. In 2005, the fair value of the Company's interest rate swaps decreased significantly as a result of increasing market interest rates throughout the year. In addition, the net settlements received on these interest rate swaps decreased in 2005 compared to 2004 as the Company's variable interest payments increased due to rising LIBOR rates. This was partially offset by increases in service charges and overdraft fees and increases in commission revenues earned by the Company's travel, insurance and investment divisions. Fees from service charges and overdrafts will likely increase moderately in 2006 compared to 2005 as we expect that retail checking accounts will grow slowly in 2006. We expect to continue to add checking balances; however, much of this growth is expected to come from additional corporate and correspondent banking relationships which typically do not generate as much fee income as smaller individual checking accounts. The level of commission revenue is likely to remain at or slightly above 2005 levels in 2006, assuming no substantial shocks occur in the financial markets or the travel industry.
In 2005, operating expenses increased primarily in the categories of salaries and benefits and occupancy expense. We anticipate that increases will occur again in 2006, at a bit more moderate level, with regard to employee costs and occupancy expenses as we continue to add new branches in Southwest Missouri and the Kansas City market area to serve new and existing customers and support growth in lending and operational areas. In 2006, we expect to add one to three new branch locations. In addition, in 2006, we opened a loan production office in Columbia, Missouri to serve new and existing customers in the central part of the state. We anticipate that lending opportunities will continue to increase in our existing loan production offices in St. Louis, Kansas City and Northwest Arkansas and we will increase staffing as needed in these offices to meet demand for commercial and residential loans.
The operations of the Bank, and banking institutions in general, are significantly influenced by general economic conditions and related monetary and fiscal policies of regulatory agencies. Deposit flows and the cost of deposits and borrowings are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing real estate and other types of loans, which in turn are affected by the interest rates at which such financing may be offered and other factors affecting loan demand and the availability of funds.
Ongoing changes in the level and shape of the interest rate yield curve pose challenges for interest rate risk management. Beginning in 2001, market interest rates were in a downward trend, settling at historically low levels from late 2003 through early 2004. During this period, Great Southern was able to effectively manage its interest rate risk and maintain its net interest margin at fairly stable levels.
In the second half of 2004 and throughout 2005, the Board of Governors of the FRB increased short-term interest rates through steady increases to the Federal Funds rate. Other short-term rates, such as LIBOR and short-term U. S. Treasury rates, began to increase in conjunction with these increases by the FRB. By the end of 2005, the FRB had raised the Federal Funds rates by 3.25% and other short-term rates rose by corresponding amounts. However, there was not a parallel shift in the yield curve; intermediate and long-term interest rates did not increase at a corresponding pace. In some cases, these rates actually declined. This caused the shape of the interest rate yield curve to become much flatter, which creates different issues for interest rate risk management. In addition during this period, Great Southern's net interest margin was affected by certain characteristics of some of its loans, deposit mix, loan and deposit pricing by competitors, and timing of interest rate increases by the FRB as compared to interest rate increases in the financial markets.
The effect of these factors began to be seen in the fourth quarter of 2004 in the form of net interest margin compression. This margin compression continued and increased during the first half of 2005, before stabilizing in the second half of 2005.
Generally, the flattening interest rate yield curve has hurt Great Southern's ability to reinvest proceeds from loan and investment repayments at higher rates. The Company's cost of funds has increased faster than its yield on loans and investments in part because of aggressive pricing of deposits by competitors in local markets. Great Southern has increased rates on checking, money market and retail certificate accounts in order to remain competitive, while not leading the market. Great Southern's deposit mix has also led to more rapidly increasing interest rates. The Company has significant balances in high-dollar money market and premium NOW accounts, the owners of which are very rate sensitive and compare these products to other bank and non-bank products available by competing financial services companies. In addition, nearly all of Great Southern's brokered certificates of deposit are subject to interest rate swaps which create variable rate funding based on three-month LIBOR. As the market anticipates rate increases by the FRB, LIBOR rates tend to increase ahead of the FRB Federal Funds rate increases. The rate earned on the portion of the Company's loan portfolio which is tied to the "prime rate of interest" only increases when the FRB actually increases the Federal Funds rate.
Margin compression has also occurred in the Company's investment securities portfolio. The Company added securities in 2003 and 2004 to pledge as collateral to secure public funds deposits and customer reverse repurchase agreements. The interest rates paid to these customers has increased consistent with short-term market interest rate increases, while the overall yield on the investment portfolio has not increased significantly from December 31, 2004 to December 31, 2005. In the first half of 2004, the Company earned a greater spread on these securities due to the very low rate environment and the then-steeper interest rate yield curve. As borrowing costs have increased, the spread earned on these securities has decreased. The Company has also repositioned some of its investment portfolio over time to shorten the time frame its securities will reprice, resulting in lower interest rate yields currently.
At December 31, 2005, the Company also had a portfolio of prime based loans totaling approximately $960 million with rates that change immediately with changes to the prime rate of interest. Of this total, $581 million represented loans which had interest rate floors. These floors were at varying rates, with $496 million of loans having floor rates between 7.0% and 8.5%. During 2003 and 2004, the Company's loan portfolio had loans with rate floors that were much lower. However, since market interest rates were also much lower at that time, these loan rate floors went into effect and established a loan rate which was higher than the contractual rate would have otherwise been. This led to a loan portfolio yield which was approximately 139 basis points higher than the "prime rate of interest" at December 31, 2003. As interest rates rose in the second half of 2004 and throughout 2005, these interest rate floors were exceeded and the loans reverted back to their normal contractual interest rate terms. At December 31, 2004, the loan portfolio yield was approximately 55 basis points higher than the "prime rate of interest," resulting in lower interest rate margins. At December 31, 2005, the loan portfolio yield versus the "prime rate of interest" was down to a difference of 8 basis points.
Effect of Federal Laws and Regulations
Federal legislation and regulation significantly affect the banking operations of the Company and the Bank, and have increased competition among commercial banks, savings institutions, mortgage banking enterprises and other financial institutions. In particular, the capital requirements and operations of regulated depository institutions such as the Company and the Bank have been and will be subject to changes in applicable statutes and regulations from time to time, which changes could, under certain circumstances, adversely affect the Company or the Bank.
Recent Accounting Pronouncements
The Emerging Issues Task Force (EITF) of FASB previously issued EITF Issue 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. EITF Issue 03-1 provides guidance on the meaning of the phrase other-than-temporary impairment and its application to several types of investments, including debt securities classified as held-to-maturity and available-for-sale under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. EITF Issue 03-1 attempted to better define whether impairment losses should be recognized on available-for-sale securities prior to sale of the securities. It provided guidance for evaluating whether and when unrealized losses should be deemed "other-than-temporary," requiring immediate recognition of those losses through earnings. In addition, EITF 03-1 requires financial statement disclosure for impaired securities on which an impairment loss has not been recognized, including the amount of unrealized loss and the term of that impairment. Certain portions of EITF 03-1 were delayed in order for the FASB Staff to provide implementation guidance and clarify several issues that were raised by interested parties during the public comment period. FASB ultimately directed the FASB Staff to issue a Staff Position (FSP) in order to complete and codify the guidance on this topic.
In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, to provide guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. This FSP amends FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The guidance nullifies certain requirements of EITF Issue 03-1 and supersedes EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. The guidance in this FSP will apply to reporting periods beginning after December 15, 2005, with earlier application permitted. The Company does not believe the adoption of this standard will have a material impact on the financial condition or the results of operation of the Company.
In December 2004, the FASB issued a revision to FASB Statement No. 123, Accounting for Stock Based Compensation (SFAS 123). FASB Statement No. 123(R), Share Based Payment (SFAS 123(R)), supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and its related implementation guidance. SFAS 123(R) established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, including transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of the equity instruments. The impact to the Company of SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions - in this case primarily stock options. The Company currently accounts for its stock-based compensation using the intrinsic method as defined in APB 25 and, accordingly, has not recognized expense for stock option plans in the Consolidated Financial Statements (seeNote 1 of the Notes to Consolidated Financial Statements for additional information regarding the Company's accounting for stock-based compensation). The SEC delayed the required implementation date of SFAS 123(R) for public entities. Implementation of SFAS 123(R) is now required for the Company beginning in the interim period ending March 31, 2006. The Company is currently evaluating the requirements of this pronouncement to determine the impact on its financial statements. As a result of SFAS 123(R), the Company may adopt different models than are currently utilized to calculate the expense effect associated with the Company's stock options. Note 1 of the Notes to Consolidated Financial Statements illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of SFAS 123.
In a related matter to SFAS 123(R), the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107, Share-Based Payments (SAB 107), to give public companies guidance in applying the provisions of SFAS 123(R). Among other things, SAB 107 provides interpretive guidance related to the interaction between SFAS 123(R) and certain SEC rules and regulations, as well as provides the SEC's views regarding the valuation of share-based payment arrangements for public companies.
In May 2005, the FASB issued FASB Statement No. 154, Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement that does not include specific transition provisions. Generally, this Statement requires retrospective application to prior periods' financial statements of changes in accounting principle. The provisions of this Statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe the adoption of this standard will have a material impact on the financial condition or the results of operation of the Company.
In July 2005, the FASB issued an exposure draft - Accounting for Uncertain Tax Positions, an Interpretation of SFAS No. 109 - Accounting for Income Taxes. This exposure draft addresses accounting for tax uncertainties that arise when a position that an entity takes on its tax return may be different from the position that the taxing authority may take, and provides guidance about the accounting for tax benefits associated with uncertain tax positions, classification of a liability recognized for those positions, and interim reporting considerations. The final version of this interpretation has not yet been issued. The Company is evaluating the requirements of the exposure draft to determine the impact, if any, on the financial condition or the results of operation of the Company.
In January 2006, the FASB issued an exposure draft - The Fair Value Option for Financial Assets and Financial Liabilities--Including an amendment of FASB Statement No. 115. This exposure draft would provide companies with the option to report selected financial assets and liabilities at fair value. Under the option, any changes in fair value would be included in earnings. The proposed Standard seeks to reduce both complexity in accounting and volatility in earnings caused by differences in the existing accounting rules. Current accounting principles use different measurement attributes for different assets and liabilities, which can lead to earnings volatility. The proposed standard helps to mitigate this type of accounting-induced volatility by enabling companies to achieve a more consistent accounting for changes in the fair value of related assets and liabilities without having to apply complex hedge accounting provisions. Under this proposal, entities would be able to measure at fair value financial assets and liabilities selected on a contract-by-contract basis. They would be required to display those values separately from those measured under different attributes on the face of the balance sheet. Furthermore, the proposal would require companies to provide additional information that would help investors and other users of financial statements to more easily understand the effect on earnings. The Company is evaluating the exposure draft to determine the impact, if adopted, on certain of its financial assets and liabilities.
Comparison of Financial Condition at December 31, 2005 and December 31, 2004
During the year ended December 31, 2005, the Company increased total assets by $230 million to $2.08 billion. Net loans increased by $178 million. The main loan areas experiencing increases were commercial construction, commercial real estate, industrial revenue bonds and consumer. The Company's strategy continues to be focused on growing the loan portfolio, while maintaining credit risk and interest rate risk at appropriate levels. For many years, the Company has developed a niche in commercial real estate and construction lending in Southwest Missouri. Great Southern's strategy is to continue to build on this competency in Southwest Missouri and in other geographic areas through the Company's loan production offices. In addition, loan growth should continue as we strengthen existing relationships with loan customers who are expanding their operations in other areas. Available-for-sale investment securities increased by $14 million, which was primarily an increase in U.S. Government agency securities and an increase in tax-exempt securities issued by states and municipalities. The Company expects to continue to add available-for-sale securities as its overall assets increase. While there is no specifically stated goal, the available-for-sale securities portfolio has recently been approximately 15% to 20% of total assets. As market interest rates increased in 2005 and are generally expected to increase in 2006, the Company has focused on adding securities to the portfolio which should provide an adequate yield while holding their value reasonably well in a rising rate environment. Cash and cash equivalents increased $25 million, primarily due to larger cash letter settlements between the Company and other banks at December 31, 2005.
Total liabilities increased $218 million from $1.71 billion at December 31, 2004 to $1.93 billion at December 31, 2005. Deposits increased $252 million, FHLBank advances decreased $28 million and short-term borrowings decreased $18 million. The decrease in short-term borrowings was the result of decreases in overnight borrowings and securities sold under repurchase agreements. The reduction in FHLBank advances, from $231 million at December 31, 2004, to $203 million at December 31, 2005, resulted from the increase in deposits. Retail certificates of deposit increased $42 million, to $376 million. Total brokered deposits were $584 million at December 31, 2005, up from $457 million at December 31, 2004. Non-interest-bearing checking balances increased $31 million. Checking and savings account balances totaled $589 million at December 31, 2005, up from $507 million at December 31, 2004. The Company increased its relationships with retail customers and as a correspondent bank for several local financial institutions, which led to a portion of the increase in checking account balances. At December 31, 2005, the Company had approximately 40 correspondent banking customers, primarily banks, thrifts, and credit unions in Southwest Missouri, with account balances totaling approximately $119 million.
Stockholders' equity increased $12.0 million from $140.8 million at December 31, 2004 to $152.8 million at December 31, 2005. Net income for fiscal year 2005 was $22.7 million, partially offset by a decrease of $3.2 million in accumulated other comprehensive income, dividends declared of $7.1 million and net repurchases of the Company's common stock of $423,000. In 2005, the Company repurchased 37,279 shares of common stock at an average price of $29.50 per share and issued 61,572 shares of stock at an average price of $10.86 per share to cover stock option exercises.
In 2005, the Company was not aggressively buying back shares of its stock, choosing instead to utilize its capital to support growth in the loan portfolio. Management intends to continue to buy stock back from time to time as long as management believes that repurchasing the stock contributes to the overall growth of shareholder value. The timing of repurchases, number of shares of stock that will be repurchased and the price that will be paid is the result of many factors, several of which are outside the control of the Company. The primary factors, however, are the number of shares available in the market from sellers at any given time, the price of the stock within the market as determined by the market, and the projected impact on the Company's earnings per share.
Results of Operations and Comparison for the Years Ended December 31, 2005 and 2004
Including the effects of the Company's accounting change for interest rate swaps, net income decreased $3.7 million, or 14.1%, during the year ended December 31, 2005, compared to the year ended December 31, 2004. This decrease was primarily due to a decrease in non-interest income of $11.8 million, or 35.3%, and an increase in non-interest expense of $4.9 million, or 12.6%, partially offset by an increase in net interest income of $8.6 million, or 17.2%, a decrease in provision for income taxes of $3.6 million, or 28.5%, and a decrease in provision for loan losses of $775,000, or 16.1%.
Excluding the effects of the Company's accounting change for interest rate swaps, net income increased $857,000, or 3.2%, during the year ended December 31, 2005, compared to the year ended December 31, 2004. This increase was primarily due to an increase in net interest income of $2.4 million, or 4.0%, an increase in non-interest income of $1.5 million, or 3.7%, a decrease in provision for income taxes of $1.1 million, or 8.8%, and a decrease in provision for loan losses of $775,000, or 16.1%, partially offset by an increase in non-interest expense of $4.9 million, or 12.6%. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Total Interest Income
Total interest income increased $27.4 million, or 31.5%, during the year ended December 31, 2005 compared to the year ended December 31, 2004. The increase was due to a $24.0 million, or 32.3%, increase in interest income on loans and a $3.5 million, or 26.9%, increase in interest income on investments and other interest-earning assets. Interest income for both loans and investment securities and other interest-earning assets increased due to both higher average balances and higher average rates of interest.
Interest Income - Loans
During the year ended December 31, 2005 compared to December 31, 2004, interest income on loans increased due to higher average balances and higher average interest rates. Interest income increased $12.3 million as the result of higher average loan balances from $1.26 billion during the year ended December 31, 2004 to $1.46 billion during the year ended December 31, 2005. The higher average balance resulted principally from the Bank's increased commercial and residential construction lending, commercial real estate lending, residential real estate lending, commercial business lending and consumer lending. In previous years, the Bank's one- to four-family residential loan portfolio had decreased due to the origination of a greater dollar amount of fixed-rate, rather than adjustable-rate, loans. The Bank generally sells these fixed-rate loans in the secondary market. In 2005, the Bank's one- to four-family residential portfolio increased as more borrowers selected adjustable rate loans, which the Bank retains. In addition, loan refinancing slowed dramatically in 2005 compared to the previous few years.
Interest income on loans increased $11.7 million as the result of higher average interest rates. The average yield on loans increased from 5.87% during the year ended December 31, 2004, to 6.73% during the year ended December 31, 2005. Loan rates were generally low in 2004, as a result of decreases in market rates of interest, primarily the "prime rate" of interest from 2001 through the first half of 2004. In 2005, market interest rates increased substantially, with the "prime rate" of interest increasing 2.00% during the year. A large portion of the Bank's loan portfolio adjusts with changes to the "prime rate" of interest.
Interest Income - Investments and Other Interest-earning Deposits
Interest income on investments and other interest-earning assets increased mainly as a result of higher average balances during the year ended December 31, 2005, when compared to the year ended December 31, 2004. Interest income increased $2.6 million as a result of an increase in average balances from $343 million during the year ended December 31, 2004, to $410 million during the year ended December 31, 2005. This increase was primarily in available-for-sale securities, where additional securities were acquired for liquidity and pledging to deposit accounts under repurchase agreements. In addition, interest income increased by $832,000 as a result of an increase in average interest rates from 3.76% during the year ended December 31, 2004, to 3.99% during the year ended December 31, 2005. In 2004 and 2005, as principal balances on higher rate fixed-rate mortgage-backed securities were paid down, the Company replaced a large portion of these securities with variable-rate mortgage-backed securities (primarily hybrid ARMs) which had a lower yield relative to the fixed-rate securities. As market interest rates increased in 2005 and are generally expected to increase in 2006, the Company has focused on adding securities to the portfolio which should provide an adequate yield while holding their value reasonably well in a rising rate environment. In addition, the Company also increased its portfolio of tax-exempt securities issued by states and municipalities by approximately $26 million during 2004 and $11 million in 2005. These securities generally have coupon yields that are comparable to the variable-rate mortgage-backed securities that the Company purchased; however, the tax-equivalent yield is higher.
Total Interest Expense
Including the effects of the Company's accounting change for interest rate swaps, total interest expense increased $18.9 million, or 50.7%, during the year ended December 31, 2005, when compared with the year ended December 31, 2004, primarily due to an increase in interest expense on deposits of $13.3 million, or 46.0%, an increase in interest expense on FHLBank advances of $1.8 million, or 29.3%, an increase in interest expense on short-term borrowings of $3.4 million, or 214%, and an increase in interest expense on subordinated debentures issued to capital trust of $376,000, or 61.6%.
Excluding the effects of the Company's accounting change for interest rate swaps, economically, total interest expense increased $25.0 million, or 94.5%, during the year ended December 31, 2005, when compared with the year ended December 31, 2004, primarily due to an increase in interest expense on deposits of $19.5 million, or 107%, an increase in interest expense on FHLBank advances of $1.8 million, or 29.3%, an increase in interest expense on short-term borrowings of $3.4 million, or 214%, and an increase in interest expense on subordinated debentures issued to capital trust of $376,000, or 61.6%. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Interest Expense - Deposits
Including the effects of the Company's accounting change for interest rate swaps, interest on demand deposits increased $3.4 million due to an increase in average rates from 1.24% during the year ended December 31, 2004, to 2.12% during the year ended December 31, 2005. The average interest rates increased due to higher overall market rates of interest in 2005. Market rates of interest on checking and money market accounts began to increase in the latter half of 2004 and throughout 2005 as the FRB raised short-term interest rates. The Company's interest-bearing checking balances have grown through increased relationships with correspondent, corporate and retail customers. Average interest-bearing demand balances were $382 million, $382 million and $276 million in 2005, 2004 and 2003, respectively. Average non-interest bearing demand balances were $170 million, $138 million and $105 million in 2005, 2004 and 2003, respectively.
Interest expense on deposits increased $3.0 million as a result of an increase in average rates of interest on time deposits from 3.44% during the year ended December 31, 2004, to 3.84% during the year ended December 31, 2005, and increased $7.0 million due to an increase in average balances of time deposits from $704 million during the year ended December 31, 2004, to $891 million during the year ended December 31, 2005. The average interest rates increased due to higher overall market rates of interest throughout 2005. As certificates of deposit matured in 2005, they were generally replaced with certificates bearing a higher rate of interest. Market rates of interest on new certificates began to increase in the latter half of 2004 and throughout 2005 as the Federal Reserve Board started raising short-term interest rates. In 2004 and 2005, the Company increased its balances of brokered certificates of deposit to fund a portion of its loan growth.
The effects of the Company's accounting change for interest rate swaps did not impact interest on demand deposits.
Excluding the effects of the Company's accounting change for interest rate swaps, economically, interest expense on deposits increased $11.8 million as a result of an increase in average rates of interest on time deposits from 1.91% during the year ended December 31, 2004, to 3.32% during the year ended December 31, 2005, and increased $4.3 million due to an increase in average balances of time deposits from $704 million during the year ended December 31, 2004, to $891 million during the year ended December 31, 2005. The average interest rates increased due to higher overall market rates of interest throughout 2005. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Interest Expense - FHLBank Advances, Short-term Borrowings and Subordinated Debentures Issued to Capital Trust
Interest expense on FHLBank advances increased $2.3 million due to an increase in average interest rates from 2.77% during the year ended December 31, 2004, to 3.86% during the year ended December 31, 2005. Partially offsetting this increase, average balances on FHLBank advances decreased from $220 million in the year ended December 31, 2004, to $204 million in the year ended December 31, 2005, resulting in decreased interest expense of $472,000.
Interest expense on short-term borrowings increased $1.1 million due to an increase in average balances from $103 million during the year ended December 31, 2004, to $158 million during the year ended December 31, 2005. In addition, average rates on short-term borrowings increased from 1.53% in the year ended December 31, 2004, to 3.15% in the year ended December 31, 2005, resulting in increased interest expense of $2.3 million. The increase in balances of short-term borrowings was primarily due to increases in securities sold under repurchase agreements. A number of Great Southern's corporate customers have expressed a desire to earn interest on their excess cash balances. Rather than move these balances to brokerages or other investment sources, the customers have chosen to place these funds with Great Southern in the form of repurchase agreements. The average interest rates increased due to higher overall market rates of interest in 2005. Market rates of interest on short-term borrowings have increased since the middle of 2004 as the Federal Reserve Board began raising short-term interest rates.
Interest expense on subordinated debentures issued to capital trust increased due to increases in average rates from 3.24% in the year ended December 31, 2004, to 5.39% in the year ended December 31, 2005. The average rate on these subordinated debentures increased significantly in 2005 as these liabilities are subject to an interest rate swap that requires the Company to pay a variable rate of interest that is indexed to LIBOR. Average LIBOR rates are expected to remain higher in 2006 than in 2005.
Net Interest Income
Including the effects of the Company's accounting change for interest rate swaps, the Company's overall interest rate spread decreased 8 basis points, or 2.8%, from 2.81% during the year ended December 31, 2004, to 2.73% during the year ended December 31, 2005. The decrease was due to a 78 basis point increase in the weighted average rate paid on interest-bearing liabilities, partially offset by a 70 basis point increase in the weighted average yield on interest-earning assets. The Company's overall net interest margin increased three basis points, or 1.0%, from 3.10% during the year ended December 31, 2004, to 3.13% during the year ended December 31, 2005. In comparing the two years, the yield on loans increased 86 basis points while the yield on investment securities and other interest-earning assets increased 23 basis points. The rate paid on deposits increased 65 basis points, the rate paid on FHLBank advances increased 109 basis points, the rate paid on short-term borrowings increased 162 basis points, and the rate paid on subordinated debentures issued to capital trust increased 215 basis points. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
The prime rate of interest averaged 4.34% during the year ended December 31, 2004, compared to an average of 6.19% during the year ended December 31, 2005. During the first half of 2004, the prime rate of interest was 4.00%. The prime rate began to increase in the second half of 2004 and throughout 2005 as the Federal Reserve Board began to raise short-term interest rates, and stood at 7.25% at December 31, 2005. Over half of the Bank's loans were tied to prime at December 31, 2005.
Interest rates paid on deposits, FHLBank advances and other borrowings increased dramatically in 2005 compared to 2004. Interest costs on these liabilities increased in the latter half of 2004 and all of 2005 as a result of rising short-term market interest rates, primarily increases by the Federal Reserve Board. These interest costs are likely to continue to increase in early 2006 to the extent the Federal Reserve Board continues to increase short-term interest rates. The Company continues to utilize interest rate swaps and FHLBank advances that reprice frequently to manage overall interest rate risk. See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" for additional information on the Company's interest rate swaps.
Excluding the effects of the Company's accounting change for interest rate swaps, economically, the Company's overall interest rate spread decreased 56 basis points, or 15.7%, from 3.57% during the year ended December 31, 2004, to 3.01% during the year ended December 31, 2005. The decrease was due to a 127 basis point increase in the weighted average rate paid on interest-bearing liabilities, partially offset by a 71 basis point increase in the weighted average yield on interest-earning assets. The Company's overall net interest margin decreased 40 basis points, or 10.6%, from 3.77% during the year ended December 31, 2004, to 3.37% during the year ended December 31, 2005. In comparing the two years, the yield on loans increased 86 basis points while the yield on investment securities and other interest-earning assets increased 23 basis points. The rate paid on deposits increased 128 basis points, the rate paid on FHLBank advances increased 109 basis points, the rate paid on short-term borrowings increased 162 basis points, and the rate paid on subordinated debentures issued to capital trust increased 215 basis points. See "Item 6 - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest swaps.
Provision for Loan Losses and Allowance for Loan Losses
The provision for loan losses was $4.0 million and $4.8 million during the years ended December 31, 2005 and December 31, 2004, respectively. The allowance for loan losses increased $1.1 million, or 4.5%, at December 31, 2005 compared to December 31, 2004.
Management records a provision for loan losses in an amount it believes sufficient to result in an allowance for loan losses that will cover current net charge-offs as well as risks believed to be inherent in the loan portfolio of the Bank. The amount of provision charged against current income is based on several factors, including, but not limited to, past loss experience, current portfolio mix, actual and potential losses identified in the loan portfolio, economic conditions, regular reviews by internal staff and regulatory examinations.
Weak economic conditions, higher inflation or interest rates, or other factors may lead to increased losses in the portfolio. Management has established various controls in an attempt to limit future losses, such as a watch list of possible problem loans, documented loan administration policies and a loan review staff to review the quality and anticipated collectibility of the portfolio. Management determines which loans are potentially uncollectible, or represent a greater risk of loss and makes additional provisions to expense, if necessary, to maintain the allowance at a satisfactory level.
The Bank's allowance for loan losses as a percentage of total loans was 1.59% and 1.73% at December 31, 2005 and 2004, respectively. Management considers the allowance for loan losses adequate to cover losses inherent in the Company's loan portfolio at this time, based on current economic conditions. If economic conditions deteriorate significantly, it is possible that additional assets would be classified as non-performing, and accordingly, an additional provision for losses would be required, thereby adversely affecting future results of operations and financial condition.
Non-performing Assets
As a result of continued growth in the loan portfolio, changes in economic and market conditions that occur from time to time, and other factors specific to a borrower's circumstances, the level of non-performing assets will fluctuate. Non-performing assets at December 31, 2005, were $16.8 million, up $10.3 million from December 31, 2004. Non-performing assets as a percentage of total assets were .81% at December 31, 2005. Compared to December 31, 2004, nonperforming loans increased $11.7 million to $16.2 million while foreclosed assets decreased $1.4 million to $595,000. Commercial real estate and business loans comprised $14.7 million, or 91%, of the total $16.2 million of non-performing loans at December 31, 2005. Commercial real estate and business loans historically comprise the majority of non-performing loans.
Non-performing Loans. Non-performing loans increased primarily as a result of the addition of eight unrelated loan relationships to the non-performing category since December 31, 2004. The first relationship totals $1.5 million and is secured primarily by a completed office building and five houses under construction in the Branson, Missouri, area. These loans are part of a larger relationship which, at December 31, 2005, totaled $7.7 million. The remainder of this relationship was included in the Potential Problem Loans category at December 31, 2005. The second relationship totals $640,000 and is secured primarily by several single-family houses that are completed or under construction in Northwest Arkansas. This relationship was reduced from $1.9 million at December 31, 2004, when it was included in Potential Problem Loans, through the sale of some of the houses that have been completed. Subsequent to December 31, 2005, the loans paid down another $535,000 to 105,000. The third relationship totals $744,000 and is secured primarily by a mobile home park in the Kansas City, Missouri, metropolitan area. The fourth relationship totals $993,000 and is secured primarily by the receivables, inventory, equipment and other business assets of a home building materials company in Springfield, Missouri. The fifth relationship totals $3.7 million and is secured primarily by a nursing home in Missouri. This nursing home has experienced cash flow problems recently. This relationship is part of a total $5.3 million relationship. The remainder of this relationship is included in Potential Problem Loans at December 31, 2005. The sixth relationship totals $2.0 million and is secured by commercial real estate of an automobile dealership and additional commercial and residential real estate collateral in Missouri. During the quarter ended September 30, 2005, the loan relationship balance was reduced $675,000, to $2.0 million, through a charge-off against the allowance for loan losses. Subsequent to December 31, 2005, the borrower has sold the automobile dealership. This sale reduced the relationship balance by approximately $1.0 million. The seventh relationship totals $1.5 million and is secured by commercial real estate and equipment of two restaurants - one in Springfield and one in central Missouri. The restaurant in Springfield has been closed and the building and land are currently offered for sale. The eighth relationship totals $649,000 and is secured by a motel near Branson, Missouri and additional commercial real estate collateral. At December 31, 2005, the significant relationships described above accounted for $11.7 million of the non-performing loan total.
Foreclosed Assets. Of the total $595,000 of foreclosed assets at December 31, 2005, foreclosed real estate totaled $78,000 and repossessed automobiles, boats and other personal property totaled $517,000. During the latter portion of 2005, the Company sold almost all of its foreclosed real estate assets in separate transactions to unrelated buyers. At December 31, 2005, there were no foreclosed assets in excess of $50,000 individually.
Potential Problem Loans. Potential problem loans decreased $5.2 million during the year ended December 31, 2005 from $23.6 million at December 31, 2004 to $18.4 million at December 31, 2005. Potential problem loans are loans which management has identified through routine internal review procedures as having possible credit problems which may cause the borrowers difficulty in complying with current repayment terms. These loans are not reflected in the non-performing assets. During the year ended December 31, 2005, potential problem loans decreased primarily due to the transfer to the non-performing loan category portions of three unrelated loan relationships and the removal of one relationship from potential problem loan status due to loan balance reductions and improvements to the credit relationship. At December 31, 2005, four large unrelated relationships make up the majority of the potential problem loan category. The first relationship totals $6.2 million (with an additional $1.5 million included in Non-performing Loans) and is secured primarily by vacant land, developed and undeveloped residential subdivisions, and single-family houses used as rental property in the Branson, Missouri, area. This relationship was described as a $7.5 million relationship in the September 2005 Quarterly Report on Form 10-Q in the category Potential Problem Loans. During the three months ended December 31, 2005, $660,000 was moved from potential problem loans to non-performing loans and the relationship was reduced $650,000 through payments by the borrower. The second relationship totals $3.2 million and is secured primarily by a motel in the State of Illinois and additional real estate collateral. The motel began operations in early 2005 and is currently offered for sale. The third relationship totals $1.6 million in potential problem loans (with an additional $3.7 million included in non-performing loans) and is secured primarily by a nursing home in the Springfield, Missouri area. The fourth relationship totals $3.1 million and is secured primarily by a townhome development in the Kansas City, Missouri area. The project has experienced cash flow problems recently due to vacancies in some of the units. Several of the tenants were military personnel who have been redeployed to other locations. The project is currently offered for sale. At December 31, 2005, the significant relationships described above accounted for $14.2 million of the potential problem loan total.
Non-interest Income
Including the effects of the Company's restatement for interest rate swaps, total non-interest income decreased $11.8 million, or 35.3%, in the year ended December 31, 2005 when compared to the year ended December 31, 2004. The decrease was primarily due to: (i) a negative change in the fair value of the Company's interest rate swaps of $7.7 million, from a positive $1.1 million to a negative $6.6 million, as a result of changes in related market interest rates; (ii) a decrease in the amount of interest rate swap net settlements received from counter-parties of $5.5 million; and (iii) an increase in the net realized loss on sales and impairments of available-for-sale securities in 2005 of $276,000. During 2005, the Company determined that the impairment of one security with an original cost of $3.5 million had become other than temporary. Consequently, the Company recorded a $734,000 charge to income. Additionally in 2004, the Company realized a gain of $396,000 on the sale of land that had been previously purchased for a branch location. After completion of the branch, most of the remaining land was sold.
The changes described above were partially offset by: (i) an increase in service charges and ATM/point of sale fees of $583,000, or 4.6%; (ii) an increase in commissions revenue in the Company's investment, travel and insurance divisions of $933,000, or 12.0%; (iii) an increase in late charges and prepayment penalties on loans of $559,000, or 64.1%; and (iv) smaller increases and decreases in loan and commitment fees, loan servicing income, and merchant card fees. The increase in service charges and fees resulted from a larger number of accounts and a higher level of insufficient funds transactions by customers. The increase in ATM/point of sale fees was related to increases in overall usage by customers, primarily in point of sale usage. Increases in commission revenues occurred in the travel and investments divisions. In the latter half of 2003, the Company acquired two travel agencies in the Springfield, Missouri market and, in mid-2005, we acquired a travel agency in Columbia, Missouri. The operations of these agencies, along with organic growth in our existing travel operations, have led to increased revenue in both the leisure and corporate travel areas. In late 2003, we began to implement some strategic sales initiatives in our investment division and throughout our branch network. Increased sales of a variety of investment products were realized during 2005 as a result of these initiatives. While loan prepayments occur from time to time, in 2005, a few unrelated borrowers elected to pay off some or all of their loans prior to the contractual maturity, with the Company receiving large prepayment penalties on those loans that allowed for penalties as part of the borrowing agreements. The Company includes prepayment penalties in many of its loans; however, there is no way to estimate the level or timing of prepayment penalties that may be realized in future periods.
Excluding the effects of the Company's restatement for interest rate swaps, economically, total non-interest income increased $1.5 million, or 6.3%, in the year ended December 31, 2005 when compared to the year ended December 31, 2004. The increases and decreases are the same as those stated above except that the interest rate swap net settlements would have been included in interest expense and the change in fair value of the interest rate swaps would have been recorded as an increase or decrease to the related brokered certificates of deposit. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Non-Interest Expense
Total non-interest expense increased $4.9 million, or 12.6%, in the year ended December 31, 2005, when compared to the year ended December 31, 2004. The increase was primarily due to an increase of $3.3 million, or 15.2%, in salaries and employee benefits. During 2005, Great Southern completed its acquisition of three bank branches and a travel company. Non-interest expenses increased over $500,000 in 2005 related to the ongoing operations of these branches and the travel office. In addition, the Company's increase in salary and benefits expense in 2005 compared to 2004 related to the continued growth of the Company. During 2005, Great Southern opened two new banking centers, replaced an existing banking center, expanded the loan production offices in Overland Park, Kansas, and Rogers, Arkansas, opened a new loan production office in St. Louis, and added lending and lending support personnel in the Springfield market. Consistent with many other employers, the cost of health insurance premiums and other benefits for the Company continues to rise and added $781,000 in expense in 2005 compared to 2004. Net occupancy and equipment expense increased $342,000, or 4.7%, primarily due to increases in rent and depreciation on new offices and equipment and various maintenance projects on buildings and equipment. Additionally, there were smaller increases and decreases in other non-interest expense areas, such as postage, advertising, insurance, legal and professional fees, and bank charges and fees related to additional correspondent and customer relationships.
Provision for Income Taxes
Provision for income taxes as a percentage of pre-tax income decreased from 32.4% for the year ended December 31, 2004, to 28.6% for the year ended December 31, 2005. The decrease was primarily due to higher balances and rates of tax-exempt investment securities and loans, federal tax credits and deductions for stock options exercised by certain employees. For future periods, the Company expects the effective tax rate to be in the range of 30-33% of pre-tax net income.
Average Balances, Interest Rates and Yields
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. Average balances of loans receivable include the average balances of non-accrual loans for each period. Interest income on loans includes interest received on non-accrual loans on a cash basis. Interest income on loans includes the amortization of net loan fees which were deferred in accordance with accounting standards. Fees included in interest income were $2.0 million, $1.4 million and $1.2 million for 2005, 2004 and 2003, respectively. Tax-exempt income was not calculated on a tax equivalent basis. The table does not reflect any effect of income taxes.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the periods shown. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in rate (i.e., changes in rate multiplied by old volume) and (ii) changes in volume (i.e., changes in volume multiplied by old rate). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to volume and rate. Tax-exempt income was not calculated on a tax equivalent basis.
Results of Operations and Comparison for the Years Ended December 31, 2004 and 2003
Including the effects of the Company's restatement for interest rate swaps, net income increased $6.1 million, or 30.1%, during the year ended December 31, 2004, compared to the year ended December 31, 2003. This increase was primarily due to an increase in net interest income of $5.4 million, or 12.1%, and an increase in non-interest income of $7.1 million, or 26.9%, partially offset by an increase in non-interest expense of $3.5 million, or 9.8%, and an increase in provision for income taxes of $2.8 million, or 28.6%.
Excluding the effects of the Company's restatement for interest rate swaps, net income increased $3.8 million, or 16.4%, during the year ended December 31, 2004, compared to the year ended December 31, 2003. This increase was primarily due to an increase in net interest income of $7.6 million, or 14.3%, and an increase in non-interest income of $1.3 million, or 5.9%, partially offset by an increase in non-interest expense of $3.5 million, or 9.8%, and an increase in provision for income taxes of $1.6 million, or 13.8%. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Total interest income increased $10.9 million, or 14.3%, during the year ended December 31, 2004 compared to the year ended December 31, 2003. The increase was due to a $7.4 million, or 11.1%, increase in interest income on loans and a $3.5 million, or 36.6%, increase in interest income on investments and other interest-earning assets. Interest income for both loans and investment securities and other interest-earning assets increased due to higher average balances, while interest income for loans was negatively impacted by slightly lower average rates of interest.
During the year ended December 31, 2004 compared to December 31, 2003, interest income on loans increased due to higher average balances, partially offset by lower average interest rates. Interest income increased $9.2 million as the result of higher average loan balances from $1.11 billion during the year ended December 31, 2003 to $1.26 billion during the year ended December 31, 2004. The higher average balance resulted principally from the Bank's increased commercial real estate and construction lending, multi-family real estate lending and consumer lending. Through 2003, the Bank's one- to four-family residential loan portfolio had decreased since December 31, 2000, due to the origination of a greater dollar amount of fixed-rate rather than adjustable-rate loans. The Bank generally sells these fixed-rate loans in the secondary market. In 2004, the Bank's one- to four-family residential portfolio increased as more borrowers selected adjustable rate loans, which the Bank retains. In addition, loan refinancing slowed dramatically in 2004.
Interest income on loans decreased $1.8 million as the result of lower average interest rates. The average yield on loans decreased from 6.03% during the year ended December 31, 2003, to 5.87% during the year ended December 31, 2004. Loan rates were generally low in both 2003 and 2004, as a result of decreases in market rates of interest, primarily the "prime rate" of interest throughout 2001 through the first half of 2004. A large portion of the Bank's loan portfolio adjusts with changes to the "prime rate" of interest. In addition, as fixed rate commercial and consumer loans paid off during 2001 through 2003, they would have generally been replaced with fixed or variable rate loans that carried a lower rate of interest.
Interest income on investments and other interest-earning assets increased mainly as a result of higher average balances during the year ended December 31, 2004, when compared to the year ended December 31, 2003. Interest income increased $3.3 million as a result of an increase in average balances from $255 million during the year ended December 31, 2003, to $343 million during the year ended December 31, 2004. This increase was primarily in available-for-sale securities, where additional securities were acquired for liquidity and pledging to deposit accounts under repurchase agreements. In addition, interest income increased $141,000 due to a slight increase in average interest rates from 3.71% during the year ended December 31, 2003, to 3.76% during the year ended December 31, 2004. In 2004, as principal balances on higher rate fixed-rate mortgage-backed securities were paid down, the Company replaced a large portion of these securities with variable-rate mortgage-backed securities (primarily hybrid ARMs) which had a lower yield relative to the fixed-rate securities. The Company increased its portfolio of tax-exempt securities issued by states and municipalities by approximately $26 million during 2004. These securities generally have coupon yields that are comparable to the variable-rate mortgage-backed securities that the Company purchased; however, the tax-equivalent yield is higher.
Including the effects of the Company's restatement for interest rate swaps, total interest expense increased $5.5 million, or 17.3%, during the year ended December 31, 2004, when compared with the year ended December 31, 2003, primarily due to an increase in interest expense on deposits of $3.8 million, or 15.1%, an increase in interest expense on FHLBank advances of $691,000, or 12.8%, an increase in interest expense on short-term borrowings of $992,000, or 169%, and an increase in interest expense on subordinated debentures issued to capital trust of $16,000, or 2.7%.
Excluding the effects of the Company's restatement for interest rate swaps, economically, total interest expense increased $3.3 million, or 14.3%, during the year ended December 31, 2004, when compared with the year ended December 31, 2003, primarily due to an increase in interest expense on deposits of $1.6 million, or 9.7%, an increase in interest expense on FHLBank advances of $691,000, or 12.8%, an increase in interest expense on short-term borrowings of $992,000, or 169%, and an increase in interest expense on subordinated debentures issued to capital trust of $16,000, or 2.7%. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Including the effects of the Company's restatement for interest rate swaps, interest on demand deposits increased $1.4 million due to an increase in average balances from $276 million during the year ended December 31, 2003, to $382 million during the year ended December 31, 2004, and increased $317,000 due to an increase in average rates from 1.10% during the year ended December 31, 2003, to 1.24% during the year ended December 31, 2004. The average interest rates increased due to higher overall market rates of interest in the second half of 2004. Market rates of interest on checking and money market accounts began to increase in the latter half of 2004 as the Federal Reserve Board started raising short-term interest rates. The Company continued to increase its checking balances in 2004 through increased relationships with correspondent, corporate and retail customers. Average interest-bearing demand balances were $382 million, $276 million and $188 million in 2004, 2003 and 2002, respectively.
Interest expense on deposits increased $1.4 million as a result of an increase in average rates of interest on time deposits from 3.27% during the year ended December 31, 2003, to 3.44% during the year ended December 31, 2004, and increased $740,000 due to an increase in average balances of time deposits from $677 million during the year ended December 31, 2003, to $704 million during the year ended December 31, 2004. The average interest rates on the Company's retail certificates of deposit decreased due to lower overall market rates of interest in the first half of 2004. As retail certificates of deposit matured in early 2004, they were generally replaced with certificates bearing a slightly lower rate of interest. Market rates of interest on new certificates began to increase in the latter half of 2004 as the Federal Reserve Board started raising short-term interest rates. In 2004, the Company increased its balances of brokered certificates of deposit to fund loan growth. These brokered certificates generally had higher rates of interest because they had maturity dates further into the future compared to retail certificates. The restatement that disallowed the effects of the Company's interest rate swaps to be recorded in interest expense caused the increase in average rates of interest in 2004 compared to 2003.
The effects of the Company's restatement for interest rate swaps did not impact interest on demand deposits.
Excluding the effects of the Company's restatement for interest rate swaps, economically, interest expense on deposits decreased $617,000 as a result of a decrease in average rates of interest on time deposits from 2.00% during the year ended December 31, 2003, to 1.91% during the year ended December 31, 2004, partially offset by an increase of $527,000 due to an increase in average balances of time deposits from $677 million during the year ended December 31, 2003, to $704 million during the year ended December 31, 2004. The average interest rates decreased due to lower overall market rates of interest in the first half of 2004. As certificates of deposit matured in early 2004, they were generally replaced with certificates bearing a slightly lower rate of interest. Market rates of interest on new certificates began to increase in the latter half of 2004 as the Federal Reserve Board started raising short-term interest rates. In 2004, the Company increased its balances of brokered certificates of deposit to fund loan growth. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
Interest expense on FHLBank advances increased $851,000 due to an increase in average balances from $189 million during the year ended December 31, 2003, to $220 million during the year ended December 31, 2004. Partially offsetting this increase, average rates on FHLBank advances decreased from 2.85% in the year ended December 31, 2003, to 2.77% in the year ended December 31, 2004, resulting in decreased interest expense of $160,000. The increase in FHLBank advances was used to fund growth in the Company's interest-earning assets.
Interest expense on short-term borrowings increased $743,000 due to an increase in average balances from $51 million during the year ended December 31, 2003, to $103 million during the year ended December 31, 2004. In addition, average rates on short-term borrowings increased from 1.14% in the year ended December 31, 2003, to 1.53% in the year ended December 31, 2004, resulting in increased interest expense of $249,000. The increase in balances of short-term borrowings was primarily due to increases in securities sold under repurchase agreements. A number of Great Southern's corporate customers have expressed a desire to earn interest on their excess cash balances. Rather than move these balances to brokerages or other investment sources, the customers have chosen to place these funds with Great Southern in the form of repurchase agreements. The average interest rates increased due to higher overall market rates of interest in the second half of 2004. Market rates of interest on short-term borrowings began to increase in the second half of 2004 as the Federal Reserve Board started raising short-term interest rates.
Interest expense on subordinated debentures issued to capital trust increased slightly due to increases in average rates from 3.17% in the year ended December 31, 2003, to 3.24% in the year ended December 31, 2004. The average rate on these subordinated debentures is likely to increase significantly in 2005 as these liabilities are subject to an interest rate swap that requires the Company to pay a variable rate of interest that is indexed to LIBOR. LIBOR rates are expected to be higher in 2005 than in 2004.
Including the effects of the Company's restatement for interest rate swaps, the Company's overall interest rate spread decreased 17 basis points, or 5.7%, from 2.98% during the year ended December 31, 2003, to 2.81% during the year ended December 31, 2004. The decrease was due to a 18 basis point decrease in the weighted average yield received on interest-earning assets, partially offset by a 1 basis point decrease in the weighted average rate paid on interest-bearing liabilities. The Company's overall net interest margin decreased 17 basis points, or 5.2%, from 3.27% during the year ended December 31, 2003, to 3.10% during the year ended December 31, 2004. In comparing the two years, the yield on loans decreased 16 basis points while the yield on investment securities and other interest-earning assets increased 5 basis points. The rate paid on deposits increased 3 basis points, the rate paid on FHLBank advances decreased 8 basis points, the rate paid on short-term borrowings increased 39 basis points, and the rate paid on subordinated debentures issued to capital trust increased 7 basis points.
The prime rate of interest averaged 4.12% during the year ended December 31, 2003, compared to an average of 4.34% during the year ended December 31, 2004. During the first half of 2004, the prime rate of interest was 4.00%. The prime rate began to increase in the second half of 2004 as the Federal Reserve Board began to raise short-term interest rates, and stands at 5.25% at December 31, 2004. Over half of the Bank's loans were tied to prime at December 31, 2004, which should result in increased loan yields in 2005.
Interest rates paid on deposits, FHLBank advances and other borrowings were relatively unchanged in 2004 compared to 2003. However, interest costs on these liabilities began to increase in the latter half of 2004 as a result of rising short-term market interest rates, primarily increases by the Federal Reserve Board. These interest costs are likely to continue to increase in 2005. The Company continues to utilize interest rate swaps and FHLBank advances that reprice frequently to manage overall interest rate risk. See "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" for additional information on the Company's interest rate swaps.
Excluding the effects of the Company's restatement for interest rate swaps, economically, the Company's overall interest rate spread decreased 11 basis points, or 3.0%, from 3.68% during the year ended December 31, 2003, to 3.57% during the year ended December 31, 2004. The decrease was due to a 17 basis point decrease in the weighted average yield received on interest-earning assets, partially offset by a 6 basis point decrease in the weighted average rate paid on interest-bearing liabilities. The Company's overall net interest margin decreased 12 basis points, or 3.1%, from 3.89% during the year ended December 31, 2003, to 3.77% during the year ended December 31, 2004. In comparing the two years, the yield on loans decreased 14 basis points while the yield on investment securities and other interest-earning assets decreased 15 basis points. The rate paid on deposits decreased 6 basis points, the rate paid on FHLBank advances decreased 8 basis points, the rate paid on short-term borrowings increased 39 basis points, and the rate paid on subordinated debentures issued to capital trust increased 7 basis points. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
The provision for loan losses remained unchanged at $4.8 million during the years ended December 31, 2004 and December 31, 2003, respectively. The allowance for loan losses increased $2.6 million, or 12.7%, at December 31, 2004 compared to December 31, 2003.
The Bank's allowance for loan losses as a percentage of total loans was 1.73% and 1.78% at December 31, 2004 and 2003, respectively. Management considers the allowance for loan losses adequate to cover losses inherent in the Company's loan portfolio at this time, based on current economic conditions. If economic conditions deteriorate significantly, it is possible that additional assets would be classified as non-performing, and accordingly, an additional provision for losses would be required, thereby adversely affecting future results of operations and financial condition.
Non-performing assets decreased $9.9 million, or 60.3%, from $16.4 million at December 31, 2003, to $6.5 million at December 31, 2004. Non-performing loans decreased $2.9 million, or 39.4%, from $7.4 million at December 31, 2003, to $4.5 million at December 31, 2004, and foreclosed assets decreased $7.0 million, or 77.5%, from $9.0 million at December 31, 2003, to $2.0 million at December 31, 2004. As a result of continued growth in the loan portfolio, changes in economic and market conditions that occur from time to time, and other factors specific to a borrower's circumstances, the level of non-performing assets will fluctuate. At December 31, 2004, non-performing assets were at relatively low levels.
Non-performing Loans. Non-performing loans decreased primarily as a result of the repayment of the remaining balance of the largest non-performing relationship, as well as principal payments on other non-performing relationships. In addition, the transfer of one $504,000 relationship to foreclosed assets in the first quarter of 2004 was subsequently transferred to fixed assets and was opened as a branch in December 2004. Commercial loans comprise $2.9 million, or 66%, of the total $4.5 million non-performing loans at December 31, 2004. Two unrelated credit relationships, totaling $621,000 and $506,000, respectively, account for a large portion of the non-performing loan total at December 31, 2004. The $621,000 relationship is secured by a commercial retail shopping center in Stone County near Branson, Missouri. This loan balance was reduced from $942,000 at December 31, 2003, by payments received from the sale of unrelated properties owned by the borrower. The $506,000 relationship is secured primarily by a dinner theater in Branson, Missouri, as well as additional real estate collateral and business assets. Mortgage loans comprise $968,000, or 22%, of the total $4.5 million non-performing loans at December 31, 2004.
Foreclosed Assets. Of the total $2.0 million of foreclosed assets at December 31, 2004, foreclosed real estate totaled $1.4 million and repossessed automobiles totaled $604,000. Of the total real estate assets, one relationship accounted for $511,000. This relationship had a remaining balance of $511,000 as of December 31, 2004, and involves a motel, restaurant, golf course and condominium units in the Branson, Missouri area. This foreclosed asset was sold in 2005.
In February 2004, the Company completed the sale of a $6.0 million foreclosed asset described under "Results of Operations and Comparison for the Years Ended December 31, 2003 and 2002 - Non-performing Assets - Foreclosed Assets." The Company received cash proceeds of $6.0 million less expenses of approximately $40,000. This transaction accounted for the majority of the decrease in foreclosed assets from December 31, 2003 to December 31, 2004.
Potential Problem Loans. Potential problem loans (including industrial revenue bonds) increased $16.7 million during the year ended December 31, 2004 from $6.9 million at December 31, 2003 to $23.6 million at December 31, 2004. Potential problem loans are loans which management has identified through routine internal review procedures as having possible credit problems that may cause the borrowers difficulty in complying with current repayment terms. These loans are not reflected in the non-performing assets. During the year ended December 31, 2004, potential problem loans experienced increases primarily due to the addition of four large unrelated relationships to the potential problem loan category. The first relationship totals $8.8 million and is secured primarily by an office building, vacant land, developed and undeveloped residential subdivisions, and single-family houses used as rental property in the Branson, Missouri, area. The second relationship totals $3.8 million and is secured primarily by a motel under construction in the state of Illinois. The third relationship totals $1.9 million and is secured primarily by several single-family houses under construction in Northwest Arkansas. The fourth relationship totals $1.7 million and is secured primarily by several single-family houses used as rental property in Springfield, Missouri. In addition, during the year ended December 31, 2004, one relationship that included both industrial revenue bonds and loans was added to potential problem assets. This relationship totals $5.7 million and is secured primarily by two nursing homes in Missouri. One of the nursing homes has experienced cash flow problems recently. The borrower maintains reserve funds to cover debt service shortfalls and required payments are current at December 31, 2004. These increases were partially offset by the removal of three unrelated relationships from potential problem loan status. The first relationship totaled $2.3 million and was secured primarily by commercial real estate, equipment and inventory in Springfield, Missouri. The second relationship totaled $1.3 million and was secured primarily by a motel in Springfield, Missouri. The third relationship totaled $1.3 million and was secured primarily by a motel in Branson, Missouri. At December 31, 2004, the significant relationships described above accounted for $21.9 million of the potential problem loan total.
Including the effects of the Company's restatement for interest rate swaps, total non-interest income increased $7.1 million, or 26.9%, in the year ended December 31, 2004 when compared to the year ended December 31, 2003. The increase was primarily due to: (i) a positive change in the fair value of the Company's interest rate swaps of $4.2 million, from a negative $3.1 million to a positive $1.1 million, as a result of changes in related market interest rates; (ii) an increase in the amount of interest rate swap net settlements received from counter-parties of $1.5 million; (iii) an increase in service charges and ATM fees of $1.5 million, or 13.5%; (iv) an increase in commissions revenue in the Company's investment, travel and insurance divisions of $1.9 million, or 33.0%; and (v) smaller increases and decreases in loan and commitment fees, late and prepayment charges on loans, loan servicing income, and merchant card fees. The increase in service charge fees resulted from a larger number of accounts, higher levels of insufficient funds transactions by customers, and slight increases in fees for insufficient funds checks. The increase in ATM fees was related to a change during 2003 by the Company to process its transactions in-house and increases in overall usage by customers and non-customers. Increases in commission revenues occurred in the travel and investments divisions. In the latter half of 2003, the Company acquired two travel agencies in the Springfield, Missouri market. These two additions, along with organic growth in our existing travel operations, have led to increased revenue in both the leisure and corporate travel areas. In late 2003, we began to implement some strategic sales initiatives in our investment division and throughout our branch network. Increased sales of a variety of investment products were realized during 2004 as a result of these initiatives.
Additionally in 2004, the Company realized a gain of $396,000 on the sale of land that had been previously purchased for a branch location. After completion of the branch, most of the remaining land was sold.
The increases described above were partially offset by: (i) a decrease in net realized gains on sales of fixed-rate residential and student loans of $1.2 million, or 54.6%; and (ii) a net realized loss on sales of available-for-sale securities in 2004 of $373,000 versus a net realized gain of $795,000 in 2003. During 2004, the Bank sold fewer residential loans than in 2003. During 2003, lower interest rates were conducive to the generation of fixed-rate mortgages, which the Bank typically sells, rather than adjustable-rate mortgages, which the Bank typically retains in its portfolio. In addition, unusually high levels of refinancing activity occurred in 2003. The decrease in gain on sale of securities was primarily due to the sale in 2003 of the Company's holdings of the trust preferred securities of another publicly traded company, with no such similar sale in 2004, and sales of other debt securities for net gains. In 2004, the Company sold approximately $62 million of available-for-sale securities at a loss to reposition some of its portfolio in anticipation of rising interest rates. The Company primarily sold low yielding agency callable securities and fixed rate mortgage-backed securities and purchased variable rate mortgage-backed securities and municipal securities, which should provide higher yields in future periods.
Excluding the effects of the Company's restatement for interest rate swaps, economically, total non-interest income increased $1.3 million, or 5.9%, in the year ended December 31, 2004 when compared to the year ended December 31, 2003. The increase was primarily due to: (i) an increase in service charges and ATM fees of $1.5 million, or 13.5%; (ii) an increase in commissions revenue in the Company's investment, travel and insurance divisions of $1.9 million, or 33.0%; and (iii) smaller increases and decreases in loan and commitment fees, late and prepayment charges on loans, loan servicing income, and merchant card fees, as discussed above. See "Item 6. - Selected Consolidated Financial Data - Restatement of Previously Issued Consolidated Financial Statements" for a reconciliation of the current and previously reported financial statements due to the Company's accounting change for certain interest rate swaps.
These increases were partially offset by: (i) a decrease in net realized gains on sales of fixed-rate residential and student loans of $1.2 million, or 54.6%; and (ii) a net realized loss on sales of available-for-sale securities in 2004 of $373,000 versus a net realized gain of $795,000 in 2003, as described above.
Total non-interest expense increased $3.5 million, or 9.8%, in the year ended December 31, 2004, when compared to the year ended December 31, 2003. The increase was primarily due to: (i) an increase of $3.3 million, or 17.4%, in salaries and employee benefits primarily due to the hiring of additional experienced personnel to fill commercial lending, loan administration, and branch supervisory positions, increased incentives paid to investment and travel personnel due to increased commission revenue generated, the opening during 2003 of two loan production offices and the hiring of additional personnel in these offices in 2004, increased costs for health insurance and pension benefits, and normal merit increases for existing employees; (ii) an increase in net occupancy and equipment expense of $912,000, or 14.4%, primarily due to increases in rent and depreciation on new offices and equipment and various maintenance projects on buildings and equipment, including required upgrades to the Company's ATMs; and (iii) smaller increases and decreases in other non-interest expense areas, such as postage, advertising, insurance, legal and professional fees, and bank charges and fees related to additional correspondent relationships.
The increases described above were partially offset by a decrease in expense on foreclosed assets of $1.5 million in the year ended December 31, 2004, when compared to the year ended December 31, 2003. In 2003, the Company experienced a $450,000 loss on the disposition of one foreclosed asset, a $670,000 write-down of the carrying value of another unrelated foreclosed asset, and other expenses of maintaining various foreclosed assets.
Provision for income taxes as a percentage of pre-tax income decreased slightly from 32.7% for the year ended December 31, 2003, to 32.4% for the year ended December 31, 2004. The decrease was primarily due to higher balances of tax-exempt investment securities and loans.
Liquidity and Capital Resources
Liquidity is a measure of the Company's ability to generate sufficient cash to meet present and future financial obligations in a timely manner through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. These obligations include the credit needs of customers, funding deposit withdrawals and the day-to-day operations of the Company. Liquid assets include cash, interest-bearing deposits with financial institutions and certain investment securities and loans. As a result of the Company's management of the ability to generate liquidity primarily through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs. At December 31, 2005 the Company had commitments of approximately $412 million to fund loan originations, issued lines of credit, outstanding letters of credit and unadvanced loans.
The following table summarizes the Company's fixed and determinable contractual obligations by payment date as of December 31, 2005. Additional information regarding these contractual obligations is discussed further in Notes 6, 7, 8, 10 and 13 of the Notes to Consolidated Financial Statements.
Management continuously reviews the capital position of the Company and the Bank to ensure compliance with minimum regulatory requirements, as well as to explore ways to increase capital either by retained earnings or other means.
The Company's stockholders' equity was $152.8 million, or 7.3% of total assets of $2.08 billion at December 31, 2005, compared to equity of $140.8 million, or 7.6% of total assets of $1.85 billion at December 31, 2004.
Banks are required to maintain minimum risk-based capital ratios. These ratios compare capital, as defined by the risk-based regulations, to assets adjusted for their relative risk as defined by the regulations. Guidelines require banks to have a minimum Tier 1 risk-based capital ratio, as defined, of 4.00%, a minimum total risked-based capital ratio of 8.00%, and a minimum 4.00% Tier 1 leverage ratio. On December 31, 2005, the Bank's Tier 1 risk-based capital ratio was 10.05%, total risk-based capital ratio was 11.30% and the Tier 1 leverage ratio was 8.27%. As of December 31, 2005, the Bank was "well capitalized" as defined by the Federal banking agencies' capital-related regulations. The FRB has established capital regulations for bank holding companies that generally parallel the capital regulations for banks. On December 31, 2005, the Company's Tier 1 risk-based capital ratio was 10.17%, total risk-based capital ratio was 11.42% and the Tier 1 leverage ratio was 8.35%. As of December 31, 2005, the Company was "well capitalized" under the capital ratios described above.
At December 31, 2005, the held-to-maturity investment portfolio included no gross unrealized losses.
The Company's primary sources of funds are certificates of deposit, FHLBank advances, other borrowings, loan repayments, proceeds from sales of loans and available-for-sale securities and funds provided from operations. The Company utilizes particular sources of funds based on the comparative costs and availability at the time. The Company has from time to time chosen not to pay rates on deposits as high as the rates paid by certain of its competitors and, when believed to be appropriate, supplements deposits with less expensive alternative sources of funds.
Statements of Cash Flows. During the years ended December 31, 2005, 2004 and 2003, the Company had positive cash flows from operating activities and positive cash flows from financing activities. The Company experienced negative cash flows from investing activities during each of these same time periods.
Cash flows from operating activities for the periods covered by the Statements of Cash Flows have been primarily related to changes in accrued and deferred assets, credits and other liabilities, the provision for loan losses, depreciation, and the amortization of deferred loan origination fees and discounts (premiums) on loans and investments, all of which are non-cash or non-operating adjustments to operating cash flows. Net income adjusted for non-cash and non-operating items and the origination and sale of loans held-for-sale were the primary sources of cash flows from operating activities. Operating activities provided cash flows of $35.4 million, $31.6 million and $33.9 million during the years ended December 31, 2005, 2004 and 2003, respectively.
During the years ended December 31, 2005, 2004 and 2003, investing activities used cash of $173.0 million, $293.7 million and $142.7 million, primarily due to the net increase of loans and the net purchases of investment securities in each period.
Changes in cash flows from financing activities during the periods covered by the Statements of Cash Flows are due to changes in deposits after interest credited, changes in FHLBank advances and changes in short-term borrowings, as well as the purchases of Company stock and dividend payments to stockholders. Financing activities provided cash flows of $162.1 million, $280.5 million and $127.8 million for the years ended December 31, 2005, 2004 and 2003, respectively. Financing activities in the future are expected to primarily include changes in deposits, changes in FHLBank advances, changes in short-term borrowings, purchases of Company stock and dividend payments to stockholders.
Dividends. During the year ended December 31, 2005, the Company declared dividends of $0.52 per share (31.9% of net income) and paid dividends of $0.50 per share (30.7% of net income), compared to dividends declared of $0.44 per share (23.3% of net income) and paid of $0.42 per share (22.2% of net income) during the year ended December 31, 2004. The Board of Directors meets regularly to consider the level and the timing of dividend payments. Dividends declared but unpaid at December 31, 2005, were paid to shareholders on January 17, 2006.
Common Stock Repurchases. The Company has been in various buy-back programs since May 1990. During the year ended December 31, 2005, the Company repurchased 37,279 shares of its common stock at an average price of $29.50 per share and reissued 61,572 shares of Company stock at an average price of $10.86 per share to cover stock option exercises. During the year ended December 31, 2004, the Company repurchased 28,642 shares of its common stock at an average price of $38.97 per share and reissued 25,596 shares of Company stock at an average price of $16.78 per share to cover stock option exercises. The share and price information for 2004 in the immediately preceding sentence has not been adjusted for the two-for-one stock split in the form of a 100% stock dividend paid on May 17, 2004.
Management intends to continue its stock buy-back programs from time to time as long as repurchasing the stock contributes to the overall growth of shareholder value. The number of shares of stock that will be repurchased and the price that will be paid is the result of many factors, several of which are outside of the control of the Company. The primary factors, however, are the number of shares available in the market from sellers at any given time and the price of the stock within the market as determined by the market.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Asset and Liability Management and Market Risk
A principal operating objective of the Company is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. The Company has sought to reduce its exposure to adverse changes in interest rates by attempting to achieve a closer match between the periods in which its interest-bearing liabilities and interest-earning assets can be expected to reprice through the origination of adjustable-rate mortgages and loans with shorter terms to maturity and the purchase of other shorter term interest-earning assets. Since the Company uses laddered brokered deposits and FHLBank advances to fund a portion of its loan growth, the Company's assets tend to reprice more quickly than its liabilities.
Our Risk When Interest Rates Change
The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is Great Southern's most significant market risk.
How We Measure the Risk To Us Associated with Interest Rate Changes
In an attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor Great Southern's interest rate risk. In monitoring interest rate risk we regularly analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to actual or potential changes in market interest rates.
The ability to maximize net interest income is largely dependent upon the achievement of a positive interest rate spread that can be sustained despite fluctuations in prevailing interest rates. Interest rate sensitivity is a measure of the difference between amounts of interest-earning assets and interest-bearing liabilities which either reprice or mature within a given period of time. The difference, or the interest rate repricing "gap," provides an indication of the extent to which an institution's interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities repricing during the same period, and is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets during the same period. Generally, during a period of rising interest rates, a negative gap within shorter repricing periods would adversely affect net interest income, while a positive gap within shorter repricing periods would result in an increase in net interest income. During a period of falling interest rates, the opposite would be true. As of December 31, 2005, Great Southern's internal interest rate risk models indicate a one-year interest rate sensitivity gap that is slightly negative.
Interest rate risk exposure estimates (the sensitivity gap) are not exact measures of an institution's actual interest rate risk. They are only indicators of interest rate risk exposure produced in a simplified modeling environment designed to allow management to gauge the Bank's sensitivity to changes in interest rates. They do not necessarily indicate the impact of general interest rate movements on the Bank's net interest income because the repricing of certain categories of assets and liabilities is subject to competitive and other factors beyond the Bank's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and in different amounts and cause a change, which potentially could be material, in the Bank's interest rate risk.
In order to minimize the potential for adverse effects of material and prolonged increases and decreases in interest rates on Great Southern's results of operations, Great Southern has adopted asset and liability management policies to better match the maturities and repricing terms of Great Southern's interest-earning assets and interest-bearing liabilities. Management recommends and the Board of Directors sets the asset and liability policies of Great Southern which are implemented by the asset and liability committee. The asset and liability committee is chaired by the Chief Financial Officer and is comprised of members of Great Southern's senior management. The purpose of the asset and liability committee is to communicate, coordinate and control asset/liability management consistent with Great Southern's business plan and board-approved policies. The asset and liability committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The asset and liability committee meets on a monthly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital positions and anticipated changes in the volume and mix of assets and liabilities. At each meeting, the asset and liability committee recommends appropriate strategy changes based on this review. The Chief Financial Officer or his designee is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Board of Directors at their monthly meetings.
In order to manage its assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, Great Southern has focused its strategies on originating adjustable rate loans, and managing its deposits and borrowings to establish stable relationships with both retail customers and wholesale funding sources.
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, we may determine to increase our interest rate risk position somewhat in order to maintain or increase our net interest margin.
The asset and liability committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and market value of portfolio equity, which is defined as the net present value of an institution's existing assets, liabilities and off-balance sheet instruments, and evaluating such impacts against the maximum potential changes in net interest income and market value of portfolio equity that are authorized by the Board of Directors of Great Southern.
The Company uses interest rate swap derivatives to manage its interest rate risks from recorded financial liabilities. Interest rate swaps are carried at fair value, estimated using quoted dealer prices, and are recognized in the statement of financial condition in the prepaid expenses and other assets or accounts payable and accrued expenses caption. The Company uses interest rate swaps to help manage its interest rate risks from recorded financial liabilities. These instruments are utilized when they can be demonstrated to effectively hedge a designated liability and the liability exposes the Company to interest rate risk. For those interest rate swaps which meet the requirements for hedge accounting treatment, amounts to be paid or received under interest rate swaps are accounted for on the accrual basis and recognized as interest income or expense of the related liability. For those interest rate swaps which do not meet the requirements for hedge accounting treatment, amounts to be paid or received under interest rate swaps are accounted for on the accrual basis and recognized as noninterest income. Gains and losses on early termination of these instruments are deferred and amortized as an adjustment to the yield on the related liability over the shorter of the remaining contract life or the maturity of the related asset or liability. If the related liability is sold or otherwise liquidated, the instrument is marked to market, with the resultant gains and losses recognized in noninterest income.
The Company has entered into interest rate swap agreements with the objective of economically hedging against the effects of changes in the fair value of its liabilities for fixed rate brokered certificates of deposit and subordinated debentures issued to capital trust caused by changes in market interest rates. The swap agreements generally provide for the Company to pay a variable rate of interest based on a spread to the one-month or three-month London Interbank Offering Rate (LIBOR) and to receive a fixed rate of interest equal to that of the hedged instrument. Under the swap agreements the Company is to pay or receive interest monthly, quarterly, semiannually or at maturity.
At December 31, 2005, the notional amount of interest rate swaps outstanding was approximately $521.0 million. Of this amount, $177.3 million consisted of swaps in a net settlement receivable position and $343.7 million consisted of swaps in a net settlement payable position. At December 31, 2004, the notional amount of interest rate swaps outstanding was approximately $450.4 million, all consisting of swaps in a receivable position. The maturities of interest rate swaps outstanding at December 31, 2005 and 2004, in terms of notional amounts and their average pay and receive rates is discussed further in Note 14 of the Notes to Consolidated Financial Statements.
The following tables illustrate the expected maturities and repricing, respectively, of the Bank's financial instruments at December 31, 2005. These schedules do not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. The tables are based on information prepared in accordance with generally accepted accounting principles.
Maturities
Repricing
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
Audit Committee, Board of Directors and StockholdersGreat Southern Bancorp, Inc.Springfield, Missouri
We have audited the accompanying consolidated statements of financial condition of Great Southern Bancorp, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Great Southern Bancorp, Inc. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Notes 1 and 14, in 2005 the Company changed its method of accounting for certain of its interest rate swaps by retroactively restating its prior years' financial statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Great Southern Bancorp, Inc.'s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 16, 2006, expressed an unqualified opinion on management's assessment and an adverse opinion on the effectiveness of the Company's internal control over financial reporting.
/s/ BKD, LLP
Springfield, MissouriFebruary 16, 2006
Great Southern Bancorp, Inc.Consolidated Statements of Financial ConditionDecember 31, 2005 and 2004(In Thousands, Except Per Share Data)
Assets
See Notes to Consolidated Financial Statements
Liabilities and Stockholders' Equity
Great Southern Bancorp, Inc.Consolidated Statements of IncomeYears Ended December 31, 2005, 2004 and 2003(In Thousands, Except Per Share Data)
Great Southern Bancorp, Inc.Consolidated Statements of Stockholders' EquityYears Ended December 31, 2005, 2004 and 2003(In Thousands, Except Per Share Data)
Great Southern Bancorp, Inc.Consolidated Statements of Cash FlowsYears Ended December 31, 2005, 2004 and 2003(In Thousands)
Great Southern Bancorp, Inc.Notes to Consolidated Financial StatementsDecember 31, 2005, 2004 and 2003
The fair value of each option granted is estimated on the date of the grant using the Black Scholes pricing model with the following assumptions:
The Company and the Bank are subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. At December 31, 2005 and 2004, the Company and the Bank exceeded their minimum capital requirements. The entities may not pay dividends which would reduce capital below the minimum requirements shown above.
Note 21: Litigation Matters
Note 22: Summary of Unaudited Quarterly Operating Results
Following is a summary of unaudited quarterly operating results for the years 2005, 2004 and 2003:
Note 23: Condensed Parent Company Statements
The condensed balance sheets at December 31, 2005 and 2004, and statements of income and cash flows for the years ended December 31, 2005, 2004 and 2003, for the parent company, Great Southern Bancorp, Inc., are as follows:
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
ITEM 9A. CONTROLS AND PROCEDURES.
We maintain a system of disclosure controls and procedures (as defined in Section 13(a) - 15(e) of the Securities Exchange Act (the "Exchange Act")) that is designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate. An evaluation of our disclosure controls and procedures was carried out as of December 31, 2005, under the supervision and with the participation of our principal executive officer, principal financial officer and several other members of our senior management. Our principal executive officer and principal financial officer concluded that, as of December 31, 2005, our disclosure controls and procedures were not effective because of a material weakness in internal control over financial reporting (described below in Management's Report on Internal Control Over Financial Reporting) relating to our accounting for certain of our interest rate swaps under SFAS No. 133.
We do not expect that our disclosure controls and procedures and internal control over financial reporting will prevent all errors and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended December 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The annual report of management on the effectiveness of internal control over financial reporting and the attestation report thereon issued by our independent registered public accounting firm are set forth below under "Management's Report on Internal Control Over Financial Reporting" and "Report of the Independent Registered Public Accounting Firm."
The management of Great Southern Bancorp, Inc. (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2005, the Company's internal control over financial reporting was not effective due to the existence of the material weakness described below:
We had ineffective policies and procedures relating to the accounting for certain derivative financial instruments under SFAS No. 133, "Accounting For Derivative Instruments and Hedging Activities." Specifically, our policies and procedures did not provide for sufficient testing and verification of the criteria for the "short-cut" method to ensure proper application of the provisions of SFAS No. 133 at inception for certain derivative financial instruments related to brokered certificates of deposit. This material weakness has resulted in the restatement of our financial statements for the first three quarters of 2005, and the years ended December 31, 2004, 2003, 2002 and 2001.
Management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2005 has been audited by BKD, LLP, an independent registered public accounting firm. Their attestation report on management's assessment and on the effectiveness of the Company's internal control over financial reporting as of December 31, 2005 is set forth below.
We have reevaluated our conclusion regarding the assessment and the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, and advise the reader not to rely on our management's conclusion set forth in "Item 9A. Controls and Procedures - Management's Report on Internal Controls Over Financial Reporting," in our Annual Report on Form 10-K for the year ended December 31, 2004, that our internal control over financial reporting was effective due to the material weakness related to certain derivative financial instruments described above.
Management's revised assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, has been audited by BKD, LLP, an independent registered public accounting firm. Their restated attestation report on management's assessment and on the effectiveness of the Company's internal control over financial reporting as of December 31, 2004 is set forth below.
Report of Independent Registered Public Accounting Firm
We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that Great Southern Bancorp, Inc. did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of the material weakness related to the misapplication of hedge accounting principles related to the Company's interest rate swaps, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Audit Committee, Board of Directors and StockholdersGreat Southern Bancorp, Inc.Page 2
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management's assessment. The Company misapplied hedge accounting to certain of its interest rate swaps. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2005 consolidated financial statements, and this report does not affect our report dated February 16, 2006, on those consolidated financial statements.
In our opinion, management's assessment that Great Southern Bancorp, Inc. did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Great Southern Bancorp, Inc. has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/BKD, LLP
We have audited management's revised assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that Great Southern Bancorp, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, because of the effect of the material weakness related to the misapplication of hedge accounting related to the Company's interest rate swaps, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management's assessment. The Company misapplied hedge accounting principles to certain of its interest rate swaps. As a result of the material weakness, the Company's consolidated financial statements, for the years ended December 31, 2004, and for each of the quarters in 2004 have been restated. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2004 consolidated financial statements, and this report does not affect our report dated February 4, 2005, on those consolidated financial statements, except as to the restatement discussed in Note 1 to the 2005 consolidated financial statements, which is as of February 16, 2006.
As stated in the 5th paragraph of Management's Report on Internal Control Over Financial Reporting, management's assessment of the effectiveness of the Company's internal control over financial reporting has been revised.
In our opinion, management's revised assessment that Great Southern Bancorp, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Great Southern Bancorp, Inc. has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Springfield, MissouriFebruary 14, 2005, except as to the 5th paragraph of Management's Report on Internal Control Over Financial Reporting (Revised), which is as of February 16, 2006
ITEM 9B. OTHER INFORMATION.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Directors and Executive Officers. The information concerning our directors and executive officers required by this item is incorporated herein by reference from our definitive proxy statement for our 2006 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
Section 16(a) Beneficial Ownership Reporting Compliance. The information concerning compliance with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934 by our directors, officers and ten percent stockholders required by this item is incorporated herein by reference from our definitive proxy statement for our 2006 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
Code of Ethics. We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions, and to all of our other employees and our directors. A copy of our code of ethics was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2003.
ITEM 11. EXECUTIVE COMPENSATION.
The information concerning compensation required by this item is incorporated herein by reference from our definitive proxy statement for our 2006 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information concerning security ownership of certain beneficial owners and management required by this item is incorporated herein by reference from our definitive proxy statement for our 2006 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
The following table sets forth information as of December 31, 2005 with respect to compensation plans under which shares of our common stock may be issued:
(1) Under the Company's 2003 Stock Option and Incentive Plan, all remaining shares could be issued to plan participants as restricted stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information concerning certain relationships and related transactions required by this item is incorporated herein by reference from our definitive proxy statement for our 2006 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information concerning principal accountant fees and services is incorporated herein by reference from our definitive proxy statement for our 2006 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the end of our fiscal year.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
The Registrant's 1997 Stock Option and Incentive Plan previously filed with the Commission (File no. 000-18082) as Annex A to the Registrant's Definitive Proxy Statement on Schedule 14A filed on September 18, 1997, for the fiscal, is incorporated herein by reference as Exhibit 10.2.
The Registrant's 2003 Stock Option and Incentive Plan previously filed with the Commission (File No. 000-18082) as Annex A to the Registrant's Definitive Proxy Statement on Schedule 14A filed on April 14, 2003, is incorporated herein by reference as Exhibit 10.3.
The employment agreement dated September 18, 2002 between the Registrant and William V. Turner previously filed with the Commission (File no. 000-18082) as Exhibit 10.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, is incorporated herein by reference as Exhibit 10.4.
The employment agreement dated September 18, 2002 between the Registrant and Joseph W. Turner previously filed with the Commission (File no. 000-18082) as Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, is incorporated herein by reference as Exhibit 10.5.
The form of incentive stock option agreement under the Registrant's 2003 Stock Option and Incentive Plan previously filed with the Commission as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File no. 000-18082) filed on February 24, 2005 is incorporated herein by reference as Exhibit 10.6.
The form of non-qualified stock option agreement under the Registrant's 2003 Stock Option and Incentive Plan previously filed with the Commission as Exhibit 10.2 to the Registrant's Current Report on Form 8-K (File no. 000-18082) filed on February 24, 2005 is incorporated herein by reference as Exhibit 10.7.
A description of the salary and bonus arrangements for the Registrant's named executive officers for 2005 is attached as Exhibit 10.8.
A description of the current fee arrangements for the Registrant's directors is attached as Exhibit 10.9.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
We, the undersigned officers and directors of Great Southern Bancorp, Inc., hereby severally and individually constitute and appoint Joseph W. Turner and Rex A. Copeland, and each of them, the true and lawful attorneys and agents of each of us to execute in the name, place and stead of each of us (individually and in any capacity stated below) any and all amendments to this Annual Report on Form 10-K and all instruments necessary or advisable in connection therewith and to file the same with the Securities and Exchange Commission, each of said attorneys and agents to have the power to act with or without the others and to have full power and authority to do and perform in the name and on behalf of each of the undersigned every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as any of the undersigned might or could do in person, and we hereby ratify and confirm our signatures as they may be signed by our said attorneys and agents or each of them to any and all such amendments and instruments.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
INDEX TO EXHIBITS