10-Q 1 f10q_63003-0096.txt FORM 10-Q 6-30-03 FSF FINANCIAL CORP. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ______________ FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTS OF 1934 For the quarterly period ended June 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-24648 FSF FINANCIAL CORP. (Exact name of registrant as specified in its charter) Minnesota 41-1783064 (State or other jurisdiction of incorporation (IRS employer or organization) identification no.) 201 Main Street South, Hutchinson, Minnesota 55350-2573 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (320) 234-4500 Former name, former address and former fiscal year, if changed since last report. Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X APPLICABLE ONLY TO CORPORATE ISSUERS: Indicated the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date August 8, 2003. ------------- Class Outstanding ----- ----------- $.10 par value common stock 2,340,737 shares FSF FINANCIAL CORP. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2003 INDEX Page Number ------ PART I - CONSOLIDATED FINANCIAL INFORMATION Item 1. Financial Statements 1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 Item 4. Controls and Procedures 18 PART II - OTHER INFORMATION Item 1. Legal Proceedings 19 Item 2. Changes in Securities and Use of Proceeds 19 Item 3. Defaults Upon Senior Securities 19 Item 4. Submission of Matters to a Vote of Security Holders 19 Item 5. Other Information 19 Item 6. Exhibits and Reports on Form 8-K 19 SIGNATURES 20 FSF FINANCIAL CORP. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

See Notes to Unaudited Consolidated Financial Statements 1 FSF FINANCIAL CORP. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

See Notes to Unaudited Consolidated Financial Statements 2 FSF FINANCIAL CORP. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Unaudited Consolidated Financial Statements 3 FSF FINANCIAL CORP. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

See Notes to Unaudited Consolidated Financial Statements 4 FSF FINANCIAL CORP. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2003 NOTE 1- PRINCIPLES OF CONSOLIDATION The unaudited consolidated financial statements as of and for the three and nine months ended June 30, 2003 include the accounts of FSF Financial Corp. (the "Corporation") and its wholly owned subsidiaries, Insurance Planners of Hutchinson, Inc. (the "Agency") and First Federal fsb (the "Bank"), with its wholly owned subsidiaries, Firstate Services and Homeowners Mortgage Corporation ("HMC"). All significant inter-company accounts and transactions have been eliminated in consolidation. NOTE 2- BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include information or footnotes necessary for a complete presentation of consolidated financial condition, results of operations and cash flows in conformity with United States Generally Accepted Accounting Principles ("GAAP"). However, all adjustments consisting of normal recurring accruals, which in the opinion of management are necessary for fair presentation of the consolidated financial statements, have been included. The results of operations for the three and nine month periods ended June 30, 2003 are not necessarily indicative of the results which may be expected for the entire fiscal year or any other future period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation's Annual Report of Form 10-K for the year ended September 30, 2002. NOTE 3- BUSINESS SEGMENTS The Corporation is a holding company whose affiliated companies provide financial services. The Agency is a property and casualty insurance agency. The Bank is a community financial institution attracting deposits from the general public and using such deposits, together with borrowings and other funds, to make mortgage, construction, consumer, commercial and agricultural loans. Firstate Services is an investment services company. HMC, a mortgage banking entity, has become an integral part of the Bank's lending and fee income function. At June 30, 2003, the Bank operated 13 retail-banking offices in Minnesota. The Bank is subject to significant competition from other financial institutions and is also subject to regulation by certain federal agencies, therefore undergoing periodic examinations by those regulatory authorities. The Corporation's operating segments are business units that offer different products and services that are marketed through different channels. Firstate Services, the Agency and FSF Financial Corp., did not meet the quantitative thresholds for determining reportable segments and therefore are included in the "other" category. Management has identified the Bank and HMC's banking activity as aggregated components of a reportable business segment.

NOTE 4- EARNINGS PER SHARE The earnings per share amounts are computed using the weighted average number of shares outstanding during the periods presented. The weighted average number of shares outstanding for basic and diluted earnings per share computation for the quarter ended June 30, 2002 were 2,182,167 and 2,322,339, respectively. For the same period in 2003, the numbers of shares outstanding for basic and diluted earnings per share computation were 2,264,577 and 2,400,251, respectively. For the nine months ended June 30, 2002, the weighted average number or shares outstanding for basic and diluted earnings per share computation were 2,172,290 and 2,291,896, respectively. For the same period in 2003, the numbers of shares outstanding for basic and diluted earnings per share were 2,241,262 and 2,370,045, respectively. The difference between the basic and diluted earnings per share denominator is the effect of stock based compensation plans. 6 NOTE 5- STOCK OPTION ACCOUNTING The Corporation accounts for stock options under the intrinsic value method of recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation- Transition and Disclosure, is effective for the interim period beginning after December 15, 2002 and requires pro-forma net income and earnings per share disclosures on a quarterly basis. The following table illustrates the effect on net income and earnings per share as if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

On November 19, 2002, the Corporation awarded 1,250 stock options from the 1994 stock option plan and 20,687 stock options from the 1998 stock option plan. The awards may be exercised over a ten-year period at an exercise price of $23.00, the fair value of the Corporation's stock on the date of the option grant. In addition, 62,621 options were exercised at various prices in the current fiscal year. NOTE 6- EFFECT OF NEW FINANCIAL ACCOUNTING STANDARDS Goodwill Accounting Changes The Corporation adopted Statement of Financial Accounting Standards (SFAS) Statement No. 142, Goodwill and Other Intangible Assets, on October 1, 2002. Statement 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Thus, amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of the Statement. Pursuant to SFAS No. 147, which amended SFAS No. 72 Accounting for Certain Acquisitions of Banking and Thrift Institutions, the unidentifiable intangible goodwill recognized (i.e. the unamortized excess of the fair value of liabilities assumed over the fair value of assets acquired) was reclassified as goodwill as of the date that SFAS 142 was applied. Note that as of such date, the carrying amount of core deposit intangible (for which individual accounting records have been kept) is recorded separately and continues to be amortized. Reclassified goodwill is now accounted for in accordance with SFAS 142, thus effectively, amortization ceased as of October 1, 2002. 7 Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. In the event of impairment, an impairment loss would be recognized in an amount equal to that excess. SFAS No. 142 requires a two step impairment test to identify potential goodwill impairment and measure the amount of the goodwill impairment loss to be recognized. The two step impairment test is summarized as follows: 1. Compare the fair value of the reporting unit with its carrying amount including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired and no second step is required. 2. To measure the amount of impairment loss, compare the implied fair value of the reporting unit goodwill with the carrying amount of the goodwill. The impairment loss shall equal the excess of carrying value over fair value. Goodwill was tested for impairment on May 1, 2003 and its fair value exceeded the carrying value. Amortization of goodwill for the three and nine months ended June 30, 2002 was $72,000 and $166,000, respectively. On a pro-forma basis, net income without goodwill amortization for the same periods would have been $1.4 million and $4.4 million, while basic earnings per share would have been $0.62 and $1.92, respectively. NOTE 7- COMPREHENSIVE INCOME Comprehensive income consists of net income and other gains and losses affecting shareholder's equity that, under generally accepted accounting principles in the United States of America, is excluded from net income. For the Corporation, the difference between net income and comprehensive income consists of the change, for the periods reported, in unrealized gains and losses on securities available for sale, net of tax. At September 30, 2002, the Bank had a total of $33.1 million of securities that were classified as held-to-maturity. During the quarter ended December 31, 2002, the Bank transferred all of the securities to available-for-sale in accordance with SFAS 115 and SFAS 130. In order to remain within the held-to-maturity classification, the Bank must have the ability and intent to hold the securities to maturity. Although the Bank still has the ability to hold the securities to maturity, the intent to hold the securities to maturity no longer exists. Based upon a review of interest rates, potential liquidity needs, interest rate risk characteristics of the securities and other factors, management has determined that it would be in the best interest of the Bank to transfer the securities. This will provide greater flexibility in dealing with changing economic circumstances. The following table provides information regarding the impact of the transfer on comprehensive income.

8 FSF FINANCIAL CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words "believes", "anticipates", "contemplates", "expects" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, risks associated with the effect of integrating newly acquired businesses, the ability to control costs and expenses and general economic conditions. GENERAL The Corporation's total assets at June 30, 2003 and September 30, 2002 totaled $543.4 million and $532.2 million, respectively. This increase of $11.2 million was primarily the result of an increase in cash and cash equivalents, offset in part by a reduction in the outstanding loan balances. Cash and cash equivalents increased $39.2 million from $14.6 million at September 30, 2002 to $53.8 million at June 30, 2003, mainly due to principal repayments on investments and loans plus new deposits. The Corporation utilizes this excess liquidity to fund loan originations. During the quarter ended December 31, 2002, the Corporation transferred all its held-to-maturity debt securities and mortgage-backed and related securities to the available-for-sale category. The net carrying amount of these securities at the time of transfer was $31.0 million and the unrealized gain, net of income taxes, was $561,000 (see Note 7 to financial statements). During this fiscal year, $7.0 million of available-for-sale securities were purchased. Loans held for sale increased $4.1 million to $33.3 million at June 30, 2003 from $29.2 million at September 30, 2002. As of June 30, 2003, the Bank and HMC had forward commitments to sell all of their loans held for sale in the secondary market. Payment for these loans usually occurs within fourteen days of funding. Loans receivable decreased $19.9 million to $362.8 million at June 30, 2003 from $382.7 million at September 30, 2002. The balance of land and commercial real estate loans decreased by $17.1 million, consumer loans increased by $919,000, one-to-four family loans decreased $11.6 million and commercial business loans decreased $6.6 million. The decrease in loans was the result of prepayments and refinancing activity due to the lower interest rate environment. Construction loans increased from $239.2 million at September 30, 2002 to $260.2 million at June 30, 2003. During that period, the Bank also sold $3.8 million of agricultural loans to Farmer Mac, an agency of the federal government. These loans were sold, with servicing retained, in order to allow the Bank to expand their agricultural lending base without increasing the overall percentage of agricultural loans. 9 The following table sets forth information on loans originated and purchased for the periods indicated:

The following table sets forth the composition of the Bank's loan portfolio in dollars and in percentages of total loans at the dates indicated:

10 In originating loans, the Bank recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the collateral for the loan. The Bank's management evaluates the need to establish reserves against losses on loans and other assets each quarter based on estimated losses on specific loans and on any real estate held for sale or investment when a finding is made that a loss is estimable and probable. Such an evaluation includes a review of all loans for which full collectibility may not be reasonably assured and considers, among other matters, the estimated market value of the underlying collateral of problem loans, prior loss experience, economic conditions and overall portfolio quality. While management recognizes and charges against the allowance for loan losses accounts that are determined to be uncollectible, experience indicates that at any point in time, inherent losses may exist in the loan portfolio which are not specifically identifiable. Therefore, based upon management's best estimate, an amount may be charged to earnings to maintain the allowance for loan losses at a level sufficient to recognize inherent credit risk. Loans are evaluated for impairment in accordance with SFAS 114, including all loans that are in a troubled debt restructuring involving a modification of terms, are measured at the present value of expected future cash flows discounted at the loan's initial effective interest rate. The fair value of the collateral of an impaired collateral dependent loan or an observable market price, if one exists, may be used as an alternative to discounting. If the measure of the impaired loan is less than the recorded investment in the loan, impairment is recognized through a charge to earnings and a reduction to the loan balance or an increase in the allowance for loan losses. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Bank believes it has established its existing allowance for loan losses in accordance with GAAP. The allowance for loan losses is evaluated based on a detailed review of the loan portfolio, historic loan losses, current economic conditions and other factors. From period to period, the outstanding balance in various loan categories will increase and decrease thereby increasing or decreasing the amount of the allowance attributable to particular categories. Management believes that the resulting level of the allowance for loan losses reflects an adequate reserve against inherent losses in the loan portfolio. However, there can be no assurance that banking regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase its allowance for loan losses or that a deteriorating real estate market or other unforeseen economic changes may cause an increase in allowance for loan losses. This is likely to negatively affect the Bank's financial condition and earnings. The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated:

11 The residential construction loans are comprised of 24 loans. The outstanding balance of the loans ranges from $45,000 to $354,000. The loan-to-value ratios of the loans range between 53% and 97%. Each of the loans has been evaluated for impairment and is carried at the lower of fair value or cost. There are 5 permanent loans secured by one-to-four family residential units that range from $14,000 to $134,000. Commercial and agricultural loans are comprised of 8 loans. The outstanding values of these loans range from $1,000 to $90,000. Each of the loans has been evaluated for impairment and is carried at the lower of fair value or cost. The consumer loan total is made up of 22 loans that range from $1,000 to $97,000. The foreclosed real estate consists of 6 construction loans with balances between $130,000 and $301,000, all of which are carried at the lower of fair value or cost. Deposits, after interest credited, increased $12.2 million from $381.9 million at September 30, 2002 to $394.1 million at June 30, 2003. Overall cost of funds on deposits during the period decreased 56 basis points (100 basis points equals 1%) as a result of the Bank's attempt to maintain deposit rates consistent with competitors in the market place. Demand deposits increased $5.0 million or 7.9% from September 30, 2002 to June 30, 2003. Savings account balances decreased 1.0% during the same period, while certificates of deposit increased $8.0 million. The Bank utilized the increase in deposits to increase liquidity and to reduce Federal Home Loan Bank ("FHLB") borrowings. The Corporation completed the repurchase of 36,448 shares of common stock which, when netted against 62,621 shares issued in connection with the exercise of stock options, decreased the number of treasury shares to 2,171,590 at June 30, 2003. Treasury shares are used for general corporate purposes, including the issuance of shares in connection with the exercise of stock options. Total stockholders' equity increased $4.5 million since September 30, 2002 due to net income, the change in accumulated comprehensive income and amortization of ESOP shares. Total stockholder's equity was reduced by the amount of dividends paid during the nine months of the fiscal year. Accumulated other comprehensive income increased as a result of changes in the net unrealized gains on the available-for-sale securities due to fluctuations in interest rates (see Note 7 to financial statements). Because of interest rate volatility, the Corporation's accumulated other comprehensive income could materially fluctuate. Book value per share increased from $20.79 at September 30, 2002 to $22.14 at June 30, 2003. 12 COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2003 AND 2002 The following table sets forth information with respect to the Corporation's average balance sheet, interest and dividends earned and paid and related yields and rates (dollars in thousands):

Net Income The Corporation recorded net income of $1.6 million for the three months ended June 30, 2003, as compared to net income of $1.4 million for the three months ended June 30, 2002. This increase in net income was $200,000 or 14.0%. The increase in net income for third quarter 2003 was primarily the result of increases in net interest income and non-interest income, partially offset by increases in non-interest expense. Net interest income increased $41,000 in the third quarter of fiscal 2003, an increase of 1.0% over third quarter 2002. The increase in net interest income was primarily attributable to a 65 basis point decline in the average cost of funds. The mix of the Bank's deposits helped to stabilize its cost of funds in this lower interest rate environment. Non-interest income was 60.8% of non-interest expense for the quarter. 13 Total Interest Income Total interest income decreased by $499,000 to $8.2 million for the quarter ended June 30, 2003 from the comparable 2002 period. The average yield on loans decreased to 7.43% for the quarter ended June 30, 2003 from 8.03% for the quarter ended June 30, 2002. During the same period, the average yield on mortgage-backed securities decreased 111 basis points. The average balance of investment securities increased to $76.9 million for the quarter ended June 30, 2003 from $47.3 million for the quarter ended June 30, 2002, primarily as a result of loan repayments and deposit growth invested. The average yield on investment securities decreased from 2.86% for the three months ended June 30, 2002 to 2.05% for the same period in 2003. Total Interest Expense Total interest expense decreased to $3.5 million for the three months ended June 30, 2003 from $4.1 million for the same period in 2002. The average balance of interest-bearing deposits increased from $361.6 million for the three months ended June 30, 2002 to $394.9 million for the three months ended June 30, 2003. The average cost of deposits decreased 68 basis points from 3.00% for the quarter ended June 30, 2002 to 2.32% for the same period in 2003, as the rates offered by the Bank on deposits decreased. No assurance can be made that deposits can be maintained in the future without further increasing the cost of funds if interest rates increase. The average balance of borrowings decreased $5.0 million to $93.0 million for the three months ended June 30, 2003 from $98.0 million for the three months ended June 30, 2002. The cost of borrowings decreased by 23 basis points to 5.40% for the quarter ended June 30, 2003 from 5.63% for the same period in 2002. Borrowings decreased as the Bank utilized repayments of loans and an increase in deposits to meet liquidity needs. Net Interest Income Net interest income remained at $4.6 million for the quarters ended June 30, 2002 and June 30, 2003, respectively. Average interest-earning assets increased $33.0 million from $482.1 million for the quarter ended June 30, 2002 to $515.1 million for the quarter ended June 30, 2003, while the average yield on interest-earning assets decreased from 7.20% for 2002 to 6.35% for 2003. Average interest-bearing liabilities increased by $28.3 million to $487.9 million for the quarter ended June 30, 2003 from $459.6 million for the quarter ended June 30, 2002, while the cost of interest-bearing liabilities decreased from 3.56% in 2002 to 2.91% in 2003. Provision for Loan Losses The Corporation's provision for loan losses was $305,000 for the quarter ended June 30, 2003, compared to $203,000 for the same period in 2002. The increase in the provision for loan losses was primarily attributable to an increase in the Bank's charge-offs for residential construction loans. The allowance for loan losses is established through a provision for loan losses charged to expense. While the Corporation maintains its allowance for losses at a level which it considers to be adequate, there can be no assurance that further additions will not be made to the loss allowances or that such losses will not exceed the estimated amounts. Non-interest Income Total non-interest income increased from $2.1 million for the quarter ended June 30, 2002 to $2.8 million for the quarter ended June 30, 2003. Gain on sale of loans, increased $382,000 over the same period in 2002, primarily due to an increase in the number of residential construction loans that were modified and sold in the secondary market. Other service charges and fees increased from $344,000 for the three months ended June 30, 2002 to $461,000 for the same period ended June 30, 2003, primarily due to declining interest rates that helped boost the purchase and refinance markets. Service charges on deposit accounts increased $219,000 due to an increase in fees charged. Non-interest Expense Total non-interest expense increased $479,000 or 11.2% over the periods compared. Compensation and benefits increased $365,000, as a result of higher indirect administrative costs related to the increased levels of construction lending activities and increased Employee Stock Ownership Plan (ESOP) expense. Repayment of the ESOP loan was accelerated by one year and thereby increased the related expense. Occupancy and equipment expense increased $75,000 while professional fees increased $29,000 over the periods compared due to expenses incurred in connection with the use of consultants and the increased cost of outside auditors. Data processing increased $13,000 to $254,000 for the period ended June 30, 2003, due to the delivery of additional data processing related services to our customer base. 14 Income Tax Expense Income taxes increased to $894,000 for the quarter ended June 30, 2003 from $893,000 for the same period in 2002. COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002

Net Income The Corporation recorded an increase in net income of $611,000 or 14.1% to $4.9 million for the nine months ended June 30, 2003, compared to net income of $4.3 million for the comparable 2002 period. The increase in net income for nine months ended June 30, 2003 was primarily the result of increases in net interest income and non-interest income partially offset by increases in non-interest expense. Net interest income increased $1.4 million in the third quarter of fiscal 2003, an increase of 10.4% over third quarter 2002. The increase in net interest income was primarily attributable to a 75 basis point decline in the average cost of funds. The mix of the Bank's deposits helped to stabilize its cost of funds in this lower interest rate environment. Non-interest income was 58.8% of non-interest expense for the period. 15 Total Interest Income Total interest income decreased by $544,000 to $25.7 million for the nine months ended June 30, 2003, from the comparable 2002 period. The average yield on loans decreased to 7.59% for the nine months ended June 30, 2003 from 8.19% for the nine months ended June 30, 2002. During the same period, the average yield on mortgage-backed securities decreased 67 basis points. The average balance of investment securities increased to $61.9 million for the nine months ended June 30, 2003 from $50.6 million for the nine months ended June 30, 2002. The average yield on investment securities decreased from 2.72% for the nine months ended June 30, 2002 to 2.19% for the same period in 2003. Total Interest Expense Total interest expense decreased to $11.3 million for the nine months ended June 30, 2003 from $13.2 million for the same period in 2002. The average balance of interest-bearing deposits increased from $358.2 million for the nine months ended June 30, 2002 to $395.4 million for the nine months ended June 30, 2003. The average cost of deposits decreased 76 basis points from 3.28% for the nine months ended June 30, 2002 to 2.52% for the same period in 2003, as the rates offered by the Bank on deposits decreased. No assurance can be made that deposits can be maintained in the future without further increasing the cost of funds if interest rates increase. The average balance of borrowings decreased $7.9 million to $93.9 million for the nine months ended June 30, 2003 from $101.8 million for the nine months ended June 30, 2002. The cost of borrowings decreased by 31 basis points to 5.42% for the nine months ended June 30, 2003 from 5.73% for the same period in 2002. Borrowings decreased as the Bank utilized repayments of loans and an increase in deposits to meet liquidity needs. Net Interest Income Net interest income increased from $13.0 million for the nine months ended June 30, 2002 to $14.4 million for the same period ended June 30, 2003. Average interest-earning assets increased $33.1 million from $481.9 million for the nine months ended June 30, 2002 to $515.0 million for the nine months ended June 30, 2003, while the average yield on interest-earning assets decreased from 7.25% for 2002 to 6.65% for 2003. Average interest-bearing liabilities increased by $29.2 million to $489.3 million for the nine months ended June 30, 2003 from $460.1 million for the nine months ended June 30, 2002, while the cost of interest-bearing liabilities decreased from 3.83% in 2002 to 3.08% in 2003. Provision for Loan Losses The Corporation's provision for loan losses was $786,000 for the nine months ended June 30, 2003, compared to $628,000 for the same period in 2002. The increase in the provision for loan losses was primarily attributable to an increase in the Bank's charge-offs for residential construction loans. The allowance for loan losses is established through a provision for loan losses charged to expense. While the Corporation maintains its allowance for losses at a level which it considers to be adequate, there can be no assurance that further additions will not be made to the loss allowances or that such losses will not exceed the estimated amounts. 16 The following table sets forth information with respect to the Bank's allowance for loan losses at the dates indicated:

Non-interest Income Total non-interest income increased from $6.5 million for the nine months ended June 30, 2002 to $8.0 million for the nine months ended June 30, 2003. Other service charges and fees increased from $1.0 million for the nine months ended June 30, 2002 to $1.3 million for the same period ended June 30, 2003, primarily due to declining interest rates that helped boost the purchase and refinance markets. Gain on sale of loans, net increased $604,000 over the same period in 2002, due to the declining interest rate environment, resulting in an increased refinance market. Service charges on deposit accounts increased $576,000 due to an increase in fees charged. Non-interest Expense Total non-interest expense increased $1.8 million or 15.6% over the periods compared. Compensation and benefits increased $1.5 million, as a result of higher indirect administrative costs related to the increased levels of construction lending activities and increased Employee Stock Ownership Plan (ESOP) expense. Repayment of the ESOP loan was accelerated by one year and thereby increased the related expense. Occupancy and equipment expense increased $160,000 while professional fees increased $112,000 over the periods compared due to expenses incurred in connection with the use of consultants and the increased cost of outside auditors. Data processing increased $79,000 to $744,000 for the nine months ended June 30, 2003, due to the delivery of additional data processing related services to our customer base. Income Tax Expense Income taxes increased by $232,000 to $3.0 million for the nine months ended June 30, 2003 from $2.8 million for the same period in 2002, which was primarily due to an increase of $843,000 in pre-tax income. A state income tax refund of approximately $119,000 impacted the nominal tax rate for the comparative periods. The refund was the result of an apportionment formula related to the multi-state residential construction lending. 17 LIQUIDITY AND CAPITAL RESOURCES The Corporation's primary sources of funds are deposits, borrowings, principal and interest payments on loans, investments and mortgage-backed securities, sales of mortgage loans and funds provided by operations. While scheduled payments on loans, mortgage-backed securities and short-term investments are relatively predictable sources of funds, deposit flows and early loan repayments are greatly influenced by general interest rates, economic conditions and competition. The amount of certificate accounts that are scheduled to mature during the twelve months ending June 30, 2004 is approximately $166.7 million. To the extent that these deposits do not remain upon maturity, the Bank believes that it can replace these funds with new deposits, excess liquidity and FHLB advances or outside borrowings. It has been the Bank's experience that substantial portions of such maturing deposits remain at the Bank. At June 30, 2003, the Bank had outstanding loan commitments of $5.3 million. Funds required to meet these commitments are derived primarily from current excess liquidity, loan sales, advances, deposit inflows or loan and security repayments. OTS regulations require the Bank to maintain core capital of 4.0% of assets, of which 2.0% must be tangible equity capital, excluding goodwill. The Bank is also required to maintain risk-based capital equal to 8.0% of total risk-based assets. The Bank's regulatory capital exceeded its tangible equity, tier 1 (risk-based), tier 1 (core) and risk-based capital requirements by 6.2%, 7.6%, 3.7% and 4.1%, respectively. Management believes that under current regulations, the Bank will continue to meet its minimum capital requirements in the foreseeable future. Events beyond the control of the Bank, such as increased interest rates or a downturn in the economy in areas in which the Bank operates, could adversely affect future earnings and, as a result, the ability of the Bank to meet its future minimum capital requirements. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes from the information regarding market risk disclosed under the heading "Asset and Liability Management" in the Corporation's Annual Report for the year ended September 30, 2002. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Based on their -------------------------------------------------- evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the Registrant's principal executive officer and principal financial officer have concluded that the Registrant's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. (b) Changes in internal controls. There were no significant changes in ---------------------------- the Registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 18 ITEM 1. LEGAL PROCEEDINGS Neither the Corporation nor any of its subsidiaries were engaged in any legal proceedings of a material nature at June 30, 2003. From time to time, the Corporation is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in loans. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of this report. 3.1 Articles of Incorporation of FSF Financial Corp. * 3.2 Bylaws of FSF Financial Corp. * 4.0 Stock Certificate of FSF Financial Corp. * 10.1 Form of Employment Agreement with Donald A. Glas, George B. Loban and Richard H. Burgart * 10.2 First Federal fsb Management Stock Plan ** 10.3 FSF Financial Corp. 1996 Stock Option Plan ** 10.4 FSF Financial Corp. 1998 Stock Compensation Plan *** 31.0 Section 302 Certifications 32.0 Certification Pursuant to 18 U.S.C. 1350 Pursuant to the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K (i) The Company furnished a current report on Form 8-K on April 22, 2003 pursuant to items 7 and 9 to report operating results for the quarter ended March 31, 2003. (ii) A report on Form 8-K was filed on May 9, 2003 pursuant to items 4 and 7 to announce the resignation of the Company's independent auditors and the appointment of the Company's new independent auditors. ___________ * Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement initially filed with the Commission on June 1, 1994. Registration No. 33-79570. ** Incorporated herein by reference into this document from the Registrant's Proxy Statement for the Annual Meeting of Stockholders held on January 17, 1996 and filed with the Commission on December 13, 1995. *** Incorporated herein by reference into this document from the Registrant's Proxy Statement for the Annual Meeting of Stockholders held on January 20, 1998 and filed with the Commission on December 10, 1997. 19 FSF FINANCIAL CORP. AND SUBSIDIARIES SIGNATURES Pursuant to the requirements 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. FSF FINANCIAL CORP. Date: August 8, 2003 By: /s/ Donald A. Glas -------------- ----------------------------- Donald A. Glas Chief Executive Officer Date: August 8, 2003 By: /s/ Richard H. Burgart -------------- ----------------------------- Richard H. Burgart Chief Financial Officer 20

FSF FINANCIAL CORP 10-Q