<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934
For the fiscal year ended DECEMBER 31, 1996
Commission File No.: 0-28162
LENOX BANCORP, INC.
(exact name of registrant as specified in its charter)
OHIO 31-1445959
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
5255 BEECH STREET, ST. BERNARD, OHIO 45217
(Address of principal executive offices)
Registrant's telephone number, including area code: (513) 242-6900
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of class)
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 mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of the voting stock held by non-affiliates of
the registrant, I.E., persons other than directors and executive officers of the
registrant is $5,785,486 and is based upon the last sales price as quoted in the
National Daily Quotation Service "Pink Sheet" for March 24, 1997.
As of March 24, 1997, the Registrant had 425,677 shares outstanding
(excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER
31, 1996 ARE INCORPORATED BY REFERENCE INTO PART II OF THIS FORM 10-K.
PORTIONS OF THE PROXY STATEMENT FOR THE 1997 ANNUAL MEETING OF
STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III OF THIS FORM 10-K.
<PAGE> 2
INDEX
PART I PAGE
----
Item 1. Business ........................................... 1
Additional Item. Executive Officers of the Registrant....... 34
Item 2. Properties.......................................... 34
Item 3. Legal Proceedings................................... 35
Item 4. Submission of Matters to a Vote of Security Holders. 35
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................. 35
Item 6. Selected Financial Data............................. 35
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 35
Item 8. Financial Statements and Supplementary Data......... 35
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.............. 35
PART III
Item 10. Directors and Executive Officers of the Registrant.. 36
Item 11. Executive Compensation.............................. 36
Item 12. Security Ownership of Certain Beneficial Owners
and Management...................................... 36
Item 13. Certain Relationships and Related Transactions...... 36
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K......................................... 37
SIGNATURES................................................... 39
<PAGE> 3
PART I
ITEM 1. BUSINESS.
- -----------------
GENERAL
Lenox Bancorp, Inc. (also referred to as the "Company") was incorporated
under Ohio law on July 24, 1995. On July 17, 1996, the Registrant acquired Lenox
Savings Bank (the "Bank" or "Lenox") as a part of the Bank's conversion from a
mutual to a stock Ohio chartered savings bank. The Registrant is a savings and
loan holding company and is subject to regulation by the Office of Thrift
Supervision (the "OTS"), the Federal Deposit Insurance Corporation (the "FDIC")
and the Securities and Exchange Commission (the "SEC"). Currently, the
Registrant does not transact any material business other than through the Bank.
The Registrant retained 50% of the net conversion proceeds amounting to $1.89
million which was used to purchase investment securities and fund loan demand.
At December 31, 1996, the Company had total assets of $47.1 million and
stockholders' equity of $7.3 million (15.4% of total assets).
The Bank was originally chartered in 1887 as an Ohio building and loan
company for the primary purpose of serving the financial needs of the employees
of Procter & Gamble. The Bank later converted to an Ohio savings and loan
company and in November 1993, converted to an Ohio savings bank under its
current name. The Bank conducts its business from one office located in St.
Bernard, Ohio.
The Bank is primarily engaged in attracting deposits from the general
public in its primary market area and investing such deposits and other
available funds in mortgage loans secured by one- to four-family residences. At
December 31, 1996, the Bank had invested $34.8 million, or 92.8%, of its total
loan portfolio in one- to four-family mortgage loans. The Bank also invests in
consumer loans. Due to the close ties that have existed between the Bank and
Procter & Gamble, the Bank has a high concentration of borrowers and depositors
who are Procter & Gamble employees. The Bank has hired a mortgage loan
originator to help it attract borrowers and has also begun to market its
products and services more aggressively throughout its primary market area. In
times of low mortgage demand, the Bank has sought to invest available funds in
short-term investment securities including U.S. Government and Agency
securities.
MARKET AREA AND COMPETITION
The Bank primarily originates one- to four-family residential mortgage
loans within its primary market area. The Bank's deposit gathering and lending
markets are concentrated in Hamilton County, Ohio, however, the Bank also offers
loans in Warren, Butler and Clermont counties, Ohio and Boone, Campbell and
Kenton counties, Kentucky. The Bank's high concentration of lending to and
deposit gathering from Procter & Gamble employees has resulted in the Bank
directly competing with institutions throughout the Cincinnati area, and most
recently directly with a Cincinnati commercial bank that has opened branch
offices at Procter & Gamble facilities.
The Cincinnati area, which includes Hamilton County, has a stable economic
base supported by a variety of industries and employment sectors. Cincinnati is
the second largest metropolitan area in the state of Ohio. Although Cincinnati's
economy was founded on manufacturing, which remained the dominant employment
sector throughout much of the twentieth century, manufacturing industries now
trail services and wholesale and retail trade in terms of employment. Following
the national trend, service
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industries were the fastest growing employment sector through the 1980s and are
now the largest employment sector in the Cincinnati metropolitan area, led by
health, business, and legal services. The second largest employment sector is
the wholesale and retail trade sector. Although less prominent, manufacturing
remains a large employment sector, providing employment in such industries as
transportation equipment, food products, industrial machinery and chemicals.
Cincinnati is the chosen headquarters for many Fortune 500 companies,
including Procter & Gamble, E.W. Scripps, Federated Department Stores and
Cincinnati Milacron. Many other companies among the Fortune 500 have also
established operations in Cincinnati, including Ford Motor Corp. and General
Electric. Overall, Cincinnati's popularity among large employers has served to
increase the size and stability of the Cincinnati economy.
The Cincinnati area's increasingly diverse economic mix provides the
metropolitan area with a strong degree of economic stability, which has served
to lessen the impact the national recession has had on the Cincinnati area.
Employment increases in the service and wholesale/retail trade industries,
coupled with less dependence on manufacturing employment has further insulated
the economy from recessionary trends. Hamilton County, the location of
Cincinnati, has benefitted the most from this economic diversification as
evidenced by its lower rate of unemployment relative to Ohio and U.S. averages.
The Bank faces significant competition both in making loans and in
attracting deposits. The Bank's competitors are the financial institutions
operating in its primary market area, many of which are significantly larger and
have greater financial resources than the Bank. The Bank's competition for loans
comes principally from commercial banks, savings and loan associations, mortgage
banking companies, credit unions and insurance companies. Its most direct
competition for deposits has historically come from savings and loan
associations and commercial banks. The Cincinnati area is the home to many
commercial banks and savings institutions. As of December 31, 1996, the Bank
estimates that it represented less than 1% of the total assets and market share
for loans and deposits, among financial institutions serving the Cincinnati
area. In addition, the Bank faces increasing competition for deposits from
non-bank institutions such as brokerage firms and insurance companies in such
areas as short-term money market funds, corporate and government securities
funds, mutual funds and annuities. Competition may also increase as a result of
the lifting of restrictions on the interstate operations of financial
institutions.
2
<PAGE> 5
LENDING ACTIVITIES
GENERAL. Historically, the principal lending activity of the Bank has been
the origination of long-term fixed-rate and adjustable rate one- to four-family
mortgage loans. To a lesser extent, the Bank originates consumer loans. At
December 31, 1996, the Bank had invested $34.8 million, or 92.8% of its total
loan portfolio in one- to four-family mortgage loans. The Bank has hired a
mortgage loan originator to help it attract borrowers and has also begun to
market its products and services more aggressively throughout its primary market
area. As of December 31, 1996, the Bank exceeded all regulatory capital
requirements.
LOAN PORTFOLIO COMPOSITION. The Bank's loan portfolio consists primarily
of one- to four-family loans. The types of loans that the Bank may originate are
subject to federal and state law and regulations. Interest rates charged by the
Bank on loans are affected by the demand for such loans and the supply of money
available for lending purposes and the rates offered by competitors. These
factors are, in turn, affected by, among other things, economic conditions,
monetary policies of the federal government, including the Federal Reserve Board
and legislative tax policies.
3
<PAGE> 6
The following table sets forth the composition of the Bank's loan
portfolio in dollar amounts and in percentages of the respective portfolios at
the dates indicated.
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------- ------------------- ---------------- ----------------- -----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- --------- ------- ------- -------- ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REAL ESTATE LOANS:
One- to four-family(1).... $35,124 93.68% $30,633 91.76% $29,265 92.60% $26,112 92.58% $26,466 91.91%
Construction(2)........... 120 0.32 53 .16 -- -- 107 .38 291 1.01
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate loans. 35,244 94.00 30,686 91.92 29,265 92.60 26,219 92.96 26,757 92.92
OTHER LOANS:
Consumer loans(3)......... 2,399 6.39 2,817 8.44 2,465 7.80 2,213 7.85 2,450 8.51
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans............. 37,643 100.39 33,503 100.36 31,730 100.40 28,432 100.81 29,207 101.43
------- ------- ------- ------- -------
LESS:
Deferred loan fees. 42 0.11 43 .13 59 .19 80 .29 166 .58
Loans in process... 48 0.13 16 .05 -- -- 82 .29 188 .65
Allowance for loan losses. 58 0.15 60 .18 66 .21 66 .23 57 .20
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total reductions.......... 148 0.39 119 .36 125 .40 228 .81 411 1.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
TOTAL LOANS RECEIVABLE, NET $37,495 100.00% $33,384 100.00% $31,605 100.00% $28,204 100.00% $28,796 100.00%
======= ====== ======= ====== ======= ====== ======= ====== ======= ======
- ----------------------------
(1) Includes second mortgage loans and home equity lines of credit on
residential one- to four-family properties.
(2) Construction loans are originated for the construction of residential one-
to four-family homes. The Bank approves the borrowers for the end loan financing
on all construction loans it originates.
(3) Includes loans secured by automobiles, boats, common stock, savings accounts and unsecured loans.
</TABLE>
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<PAGE> 7
LOAN MATURITY. The following table shows the maturity of the Bank's loans
at December 31, 1996. The table does not include principal repayments. Principal
repayments totaled $7.3 million, $6.5 million and $7.4 million for the years
ended December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, all
loans held by the Bank were classified as held to maturity. The table does not
include the effect of future loan prepayment activity. While the Bank cannot
project future loan prepayment activity, the Bank anticipates that in periods of
stable interest rates, prepayment activity would be lower than prepayment
activity experienced in periods of declining interest rates. In general, the
Bank originates adjustable and fixed-rate one- to four-family loans with
maturities from 15 to 30 years, one- to four-family loans with balloon features
which mature from 5 to 7 years and consumer loans with maturities of up to 5
years.
<TABLE>
<CAPTION>
At December 31, 1996
-------------------------------------
One- to
Four- Total Loans
Family(1) Consumer(2) Receivable
---------- ----------- ------------
(In thousands)
<S> <C> <C> <C>
Amounts due:
One year or less..................... $ 63 $ 163 $ 226
After one year:
More than one year to three years... 319 1,156 1,475
More than three years to five years. 1,845 989 2,834
More than five years to ten years... 2,920 -- 2,920
More than 10 years to twenty years.. 9,188 -- 9,188
More than twenty years.............. 20,909 91 21,000
------ ----- ------
Total due after December 31, 1997. 35,181 2,236 37,417
------ ----- ------
Total amount due.................. 35,244 2,399 37,643
------ ----- ------
Less:
Undisbursed loan funds.............. 48
Deferred loan fees, net............. 42
Allowance for loan losses........... 58
--------
Total loans, net............... $37,495
=======
- -----------------------------
(1) Includes second mortgage loans on residential one- to four-family
properties and construction loans originated to fund the construction of
residential one- to four-family mortgage loans.
(2) Includes loans secured by automobiles, boats, common stock, savings accounts
and unsecured loans.
</TABLE>
5
<PAGE> 8
The following table sets forth at December 31, 1996, the dollar amount of
gross loans receivable, contractually due after December 31, 1997, and whether
such loans have fixed interest rates or adjustable interest rates.
<TABLE>
<CAPTION>
Due After December 31, 1997
--------------------------------------------
Fixed Adjustable Total
------------- -------------- -------------
(In thousands)
<S> <C> <C> <C>
One- to four-family...... $18,025 $17,156 $35,181
Consumer................. 2,145 91 2,236
------- ------- -------
Total loans............ $20,170 $17,247 $37,417
======= ======= =======
</TABLE>
LOAN ORIGINATIONS. The following table sets forth the Bank's loan
originations, purchases, sales and principal repayment information for the
periods indicated:
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------
1996 1995 1994
--------- ---------- --------
(In thousands)
<S> <C> <C> <C>
Gross loans:
Loans receivable, beginning of period....... $33,444 $31,671 $28,270
Loans originated:
One- to four-family(1)................... 9,278 6,201 8,524
Consumer(2).............................. 1,311 2,096 2,149
Loans purchased............................. 884 -- --
Principal repayments........................ (7,365) (6,524) (7,375)
Other changes, net.......................... 1 -- 103
------- -------- -------
Increase (decrease) in loans receivable.. 4,109 1,773 3,401
Loans receivable, end of period............. $37,553 $33,444 $31,671
======= ======= =======
- ---------------------
(1) Includes second mortgage loans and construction loans on residential one- to four- family properties.
(2) Includes loans secured by automobiles, boats, common stock, savings accounts and unsecured loans.
</TABLE>
6
<PAGE> 9
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The Bank offers both fixed-rate and
adjustable-rate mortgage loans secured by one- to four-family residences,
primarily owner-occupied, located in the Bank's primary market area, with
maturities up to thirty years. Substantially all of such loans are secured by
property located in Hamilton County, Ohio.
At December 31, 1996, the Bank's total loans, net outstanding were $37.5
million, of which $34.8 million or 92.8% of the Bank's total loan portfolio were
one- to four-family residential mortgage loans. Of the one- to four-family
residential mortgage loans outstanding at that date, 50.4% were fixed-rate
loans, and 49.6% were ARM loans. Currently, the interest rate for the Bank's ARM
loans are tied to the one and three year Constant Maturity Index ("CMI").
However, in the past, the Bank's index was based upon the monthly national
median cost of funds as reported by the OTS, which lags behind CMI and the one
year U.S. Treasury index and which results in those loans repricing at interest
rates that may be higher or lower than the prevailing market rates.
Approximately $7.2 million of the Bank's ARM loans, or 41.7% of the Bank's total
ARM loans, are based on that index, which adversely affects the Bank's results
of operations in an increasing rate environment because loans may be repricing
at a rate that is slower than the Bank's cost of funds. In addition,
approximately $2.5 million of the loans tied to the lagging market index bear
margins as little as 50 basis points above the lagging market index. The Bank
does not intend to offer one- to four-family ARM loans based on a lagging index
in the future and has standardized the margin it uses, which is currently at
least 2.75%. The Bank currently offers a number of adjustable-rate mortgage loan
programs with interest rates which adjust either annually or every 3-year
period. Such interest rate adjustments are limited to a 2% annual adjustment cap
and a 5% and 6% life-of-the-loan cap for the Bank's 15 year ARMs and 30 year
ARMs, respectively. The Bank also offers mortgage loans with balloon features.
In general, these loans may be refinanced on the balloon date if the customer
completes a new loan application and meets all of the underwriting criteria
required of new customers. The Bank currently has no mortgage loans that are
subject to negative amortization. Finally, the Bank offers a limited amount of
construction loans for the construction of one- to four-family homes that will
serve as the primary residence of the borrower. These loans are only made,
however, when the Bank will provide the end loan financing.
The origination of adjustable-rate residential mortgage loans, as opposed
to fixed-rate residential mortgage loans, helps reduce the Bank's exposure to
increases in interest rates. However, adjustable-rate loans generally pose
credit risks not inherent in fixed-rate loans, primarily because as interest
rates rise, the underlying payments of the borrower rise, thereby increasing the
potential for default. At the same time, the marketability of the underlying
property may be adversely affected. Periodic and lifetime caps on
adjustable-rate mortgage loans help to reduce these risks but also limit the
interest rate sensitivity of such loans.
The Bank's policy is to originate one- to four-family residential mortgage
loans in amounts up to 80% of the lower of the appraised value or the selling
price of the property securing the loan and up to 95% of the appraised value or
selling price if private mortgage insurance is obtained. Mortgage loans
originated by the Bank generally include due-on-sale clauses which provide the
Bank with the contractual right to deem the loan immediately due and payable in
the event the borrower transfers ownership of the property without the Bank's
consent. Due-on-sale clauses are an important means of adjusting the rates on
the Bank's fixed-rate mortgage loan portfolio and the Bank has generally
exercised its rights under these clauses.
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<PAGE> 10
The Bank also offers second mortgage loans based upon a lagging market
index, the monthly national median cost of funds as reported by the OTS. The
second mortgage loans are originated as fixed rate loans for the first five
years and thereafter adjust on an annual basis. At December 31, 1996, the Bank
had second mortgage loans totalling $723,000.
CONSUMER LENDING. The Bank's portfolio of consumer loans consists of a
combination of automobile, boat and common stock and savings secured loans. The
Bank also offers unsecured loans up to $5,000 for a maximum three year term. As
of December 31, 1996, consumer loans amounted to $2.4 million or 6.39% of the
Bank's total loan portfolio. Consumer loans are generally originated in the
Bank's primary market area and generally have maturities of one to five years.
The consumer loans secured by common stock are originated with terms up to five
years and the loan amounts are limited to 80% of the value of the common stock
securing the loan. The Bank reviews the loans secured by common stock on a
monthly basis and requires that borrowers pledge additional collateral in the
event fluctuations in the market value of the pledged common stock results in
the value of the collateral dropping below the required loan to value ratio of
80%.
Consumer loans are shorter term and generally contain higher interest
rates than residential mortgage loans. Management believes the consumer loan
market has been helpful in improving its spread between average loan yield and
costs of funds and at the same time improved the matching of its rate sensitive
assets and liabilities.
The underwriting standards employed by the Bank for consumer loans include
a determination of the applicant's credit history and an assessment of the
applicant's ability to meet existing obligations and payments on the proposed
loan. The stability of the applicant's monthly income may be determined by
verification of gross monthly income from primary employment, and additionally
from any verifiable secondary income. Creditworthiness of the applicant is of
primary consideration; however, the underwriting process also includes a
comparison of the value of the collateral in relation to the proposed loan
amount.
Consumer loans entail greater risks than one- to four-family residential
mortgage loans, particularly consumer loans that are secured by rapidly
depreciable assets such as automobiles or that are unsecured. In such cases,
repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance, since there is a greater
likelihood of damage, loss or depreciation of the underlying collateral.
Further, consumer loan collections are dependent on the borrower's continuing
financial stability, and therefore are more likely to be adversely affected by
job loss, divorce, illness or personal bankruptcy. Finally, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans in
the event of a default. At December 31, 1996, the Bank had 8 consumer loans
totalling $14,000 that were 90 days or more delinquent.
LOAN APPROVAL PROCEDURES AND AUTHORITY. The Board of Directors authorizes
the lending activity of the Bank, establishes the lending policies of the Bank
and reviews properties offered as security. Consumer loans conforming to the
Bank's loan policy may be approved by the President, the Chief Operating Officer
or the lending operations supervisor. All other loans in amounts up to $200,000
may be approved by two of the Bank's executive officers. Loans over $200,000
must be approved by the Board of Directors.
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<PAGE> 11
For all loans originated by the Bank, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered and certain
other information is verified by an independent credit agency. If necessary,
additional financial information may be required. An appraisal of real estate
intended to secure a proposed loan generally is required to be performed by an
appraiser designated and approved by the Bank. For proposed mortgage loans, the
Board annually approves independent appraisers used by the Bank and approves the
Bank's appraisal policy. The Bank's policy is to obtain title and hazard
insurance on all mortgage loans.
DELINQUENCIES AND CLASSIFIED ASSETS. Management and the Board of Directors
perform a monthly review of all delinquent loans. The procedures taken by the
Bank with respect to delinquencies vary depending on the nature of the loan and
period of delinquency. The Bank generally requires that delinquent mortgage
loans be reviewed and that a written late charge notice be mailed no later than
the 15th day of delinquency. The Bank's policies provide that telephone contact
will be attempted to ascertain the reasons for delinquency and the prospects of
repayment. When contact is made with the borrower at any time prior to
foreclosure, the Bank will attempt to obtain full payment or work out a
repayment schedule with the borrower to avoid foreclosure. It is the Bank's
policy to place all loans that are delinquent by three or more payments on
non-accrual status, resulting in the Bank no longer accruing interest on such
loans and reversing any interest previously accrued but not collected. A
non-accrual loan may be restored to accrual status when delinquent principal and
interest payments are brought current and future monthly principal and interest
payments are expected to be collected. Property acquired by the Bank as a result
of foreclosure on a mortgage loan is classified as "real estate owned" and is
recorded at the lower of the unpaid principal balance or fair value less costs
to sell at the date of acquisition and thereafter. Upon foreclosure, the Bank
generally would require an appraisal of the property and, thereafter, appraisals
of the property on an annual basis and external inspections on at least a
quarterly basis.
The Bank's Classification of Assets Policy requires that the Bank utilize
an internal asset classification system as a means of reporting problem and
potential problem assets. The Bank currently classifies problem and potential
problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset is
considered Substandard if it is inadequately protected by the current net worth
and paying capacity of the obligor or of the collateral pledged, if any.
Substandard assets include those characterized by the distinct possibility that
the insured institution will sustain "some loss" if the deficiencies are not
corrected. Assets classified as Doubtful have all of the weaknesses inherent in
those classified Substandard with the added characteristic that the weaknesses
present make collection or liquidation in full, on the basis of currently
existing facts, conditions and values, highly questionable and improbable.
Assets classified as Loss are those considered uncollectible and of such little
value that their continuance as assets without the establishment of a specific
loss reserve is not warranted. Assets which do not currently expose the insured
institution to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are required to be designated
"Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, it is required to establish a general
valuation allowance for loan losses in an amount deemed prudent by management.
General valuation allowances, which is a regulatory term, represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution classifies
one or more assets, or portions thereof, as Loss, it is required either to
establish a specific allowance for losses equal to 100% of the amount of the
asset so classified or to charge off such amount.
9
<PAGE> 12
The FDIC, in conjunction with the other federal banking agencies, recently
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financial institutions, there has
been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of the examination of
institutions by the FDIC. While the Bank believes that it has established an
adequate allowance for loan losses, there can be no assurance that regulators,
in reviewing the Bank's loan portfolio, will not request the Bank to materially
increase at that time its allowance for loan losses, thereby negatively
affecting the Bank's financial condition and earnings at that time. Although
management believes that adequate specific and general loan loss allowances have
been established, actual losses are dependent upon future events and, as such,
further additions to the level of specific and general loan loss allowances may
become necessary.
The President of the Bank reviews the Bank's loans on a monthly basis and
classifies loans on a quarterly basis and reports the results of her review to
the Board of Directors. The Bank classifies loans in accordance with the
management guidelines described above. At December 31, 1996, the Bank had no
real estate owned as a result of foreclosure ("REO"). At December 31, 1996, the
Bank had $137,000 of assets classified as Special Mention, $77,000 of assets
classified as Substandard, and $6,000 classified as Doubtful or Loss.
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<PAGE> 13
The following table sets forth delinquencies in the Bank's loan portfolio
as of the dates indicated:
<TABLE>
<CAPTION>
At December 31, 1996 At December 31, 1995
------------------------------------- --------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
------------------ ----------------- ------------------ ------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
-------- -------- -------- -------- -------- --------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family............... 2 $90 3 $95 4 $116 2 $66
Consumer.......................... 6 25 8 14 10 20 11 23
- --- -- --- -- --- -- --
Total....................... 8 $115 11 $109 14 $136 13 $89
= ==== == ==== == === == ===
Delinquent loans to total gross loans 0.31% 0.29% .41% .27%
</TABLE>
<TABLE>
<CAPTION>
At December 31, 1994
--------------------------------------
60-89 Days 90 Days or More
------------------ ------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
One- to four-family..................... 5 $161 2 $88
Consumer................................ 3 15 3 5
- ---- - ---
Total............................. 8 $176 5 $93
= ==== = ===
Delinquent loans to total gross loans... .56% .29%
</TABLE>
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<PAGE> 14
NON-ACCRUAL AND PAST-DUE LOANS. The following table sets forth information
regarding loans contractually past due 90 days or more. At such date, there were
no accruing loans past due 90 days or more. If all non-accrual loans had been
performing in accordance with their original term and had been outstanding from
the earlier of the beginning of the period or origination, the Bank would have
recorded interest income of $3,303, $3,146, $7,470, $5,008 and $3,119 for the
years ended December 31, 1996, 1995, 1994, 1993 and 1992. The Bank had no
troubled debt restructurings within the meaning of SFAS No. 15 at any of the
dates indicated.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------
1996 1995 1994 1993 1992
------- ------- -------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual one- to four-family loans
delinquent 90 days or more........ $95 $66 $88 $109 $148
Non-accrual consumer loans
delinquent 90 days or more........ 14 23 5 1 --
---- -- --- ---- ----
Total non-performing loans............ 109 89 93 110 148
Total investment in REO............... -- -- -- -- --
---- --- --- ---- ----
Total non-performing assets........ $109 $89 $93 $110 $148
==== === === ==== ====
Non-performing loans to total loans... .29% .27% .29% .39% .51%
Non-performing assets to total assets. .23 .21 .23 .26 .35
</TABLE>
12
<PAGE> 15
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance for
loan losses is maintained at an amount management considers adequate to cover
estimated losses in loans receivable which are deemed probable and estimable
based on information available to management at such time. While management
believes the Bank's allowance for loan losses is sufficient to cover losses
inherent in its loan portfolio at this time, no assurances can be given that the
Bank's level of allowance for loan losses will be sufficient to cover future
loan losses incurred by the Bank or that future adjustments to the allowance for
loan losses will not be necessary if economic and other conditions differ
substantially from the economic and other conditions used by management to
determine the current level of the allowance for loan losses. The allowance is
based upon a number of factors, including asset classifications, economic
trends, industry experience and trends, industry and geographic concentrations,
estimated collateral values, management's assessment of the credit risk inherent
in the portfolio, historical loan loss experience, and the Bank's underwriting
policies. As of December 31, 1996, the Bank's allowance for loan losses was .15%
of total loans as compared to .18% as of December 31, 1995. The Bank had
$109,000 of nonperforming loans at December 31, 1996 and $89,000 at December 31,
1995. The Bank will continue to monitor and modify its allowances for loan
losses as conditions dictate. Various regulatory agencies, as an integral part
of their examination process, periodically review the Bank's valuation
allowance. These agencies may require the Bank to establish additional valuation
allowances, based on their judgments of the information available at the time of
the examination.
At December 31, 1996, the Bank had no REO. For a description of how the
Bank would treat REO, see the Financial Statements and Notes thereto appearing
elsewhere in this Form 10-K.
13
<PAGE> 16
The following table sets forth activity in the Bank's allowance for loan
losses for the periods set forth in the table.
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Allowance for loan losses:
Balance at beginning of period.... $60 $66 $66 $57 $60
Provision (credit) for loan losses -- (2) -- 6 4
Charge-offs:
Consumer....................... 4 5 1 -- 10
-- -- -- --- --
Total charge-offs............ 4 5 1 -- 10
Recoveries:
Consumer....................... 2 1 1 3 3
--- -- -- --- ---
Total recoveries............. 2 1 1 3 3
--- -- --- --- ---
Net charge-offs................... 2 4 -- (3) 7
--- -- ---- ---
Balance at end of period.......... $58 $60 $66 $66 $57
=== === === === ===
Ratio of net loan charge-offs
during the period to average
loans outstanding during period. .01% .01% --% (.01)% .02%
Ratio of allowance for loan losses
to gross loans at end of period. .15 .18 .21 .23 .20
Ratio of allowance for loan losses
to non-performing loans
at end of period................ 53.21 66.67 71.17 59.86 38.39
</TABLE>
14
<PAGE> 17
The following tables set forth the Bank's allocation of allowance for loan
losses by loan category, the percent of the allocated allowance to the total
allowance and the percent of each specific loan category to total loans. The
portion of the allowance for loan losses allocated to each loan category does
not represent the total available for future losses which may occur within the
loan category since the total allowance for loan losses is a valuation reserve
applicable to the entire loan portfolio.
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------------------------------------------------------------------------------------
1996 1995 1994
---------------------------------- ---------------------------------- ----------------------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF PERCENT OF PERCENT OF
ALLOWANCE LOANS IN ALLOWANCE LOANS IN ALLOWANCE LOANS IN EACH
TO TOTAL EACH CATEGORY TO TOTAL EACH CATEGORY TO TOTAL CATEGORY
AMOUNT ALLOWANCE TO TOTAL LOANS AMOUNT ALLOWANCE TO TOTAL LOANS AMOUNT ALLOWANCE TO TOTAL LOANS
--------- --------- -------------- ------ --------- -------------- -------- --------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family... $20 34.48% 93.63% $20 33.33% 91.59% $20 30.30% 92.23%
Consumer.............. 38 65.52 6.37 40 66.67 8.41 46 69.70 7.77
--- ------ ------ -- ----- ----- --- ------ ----
Total allowance for
loan losses..... $58 100.00% 100.00% $60 100.00% 100.00% $66 100.00% 100.00%
=== ====== ====== === ====== ====== === ====== ======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------------------
1993 1992
---------------------------------- -----------------------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
ALLOWANCE LOANS IN EACH ALLOWANCE LOANS IN EACH
TO TOTAL CATEGORY TO TO TOTAL CATEGORY
AMOUNT ALLOWANCE TOTAL LOANS AMOUNT ALLOWANCE TO TOTAL LOANS
--------- --------- ------------ -------- --------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
One- to four-family..... $20 30.30% 92.22% $20 35.09% 91.61%
Consumer................ 46 69.70 7.78 37 64.91 8.39
--- ------ ---- --- ------ ----
Total allowance for
loan losses.......... $66 100.00% 100.00% $57 100.00% 100.00%
=== ====== ====== === ====== ======
</TABLE>
15
<PAGE> 18
INVESTMENT ACTIVITIES
Federal and state regulations require the Bank to maintain a prudent
amount of liquid assets to protect the safety and soundness of the Bank.
Therefore, the investment policy of the Bank as established by the Board of
Directors attempts to provide and maintain liquidity, generate a favorable
return on investments without incurring undue interest rate and credit risk and
complement the Bank's lending activities. The Bank's policies generally limit
investments to government and federal agency-backed securities and other
non-government guaranteed securities, including corporate debt obligations, that
are investment grade. The Bank's policies provide the authority to invest in
U.S. Treasury and U.S. Government guaranteed securities, securities backed by
federal agencies such as Federal National Mortgage Association ("FNMA"), Federal
Home Loan Mortgage Corporation ("FHLMC") and the Federal Farm Credit Bureau,
mortgage-backed securities which are backed by federal agency securities,
obligations of state and political subdivisions with at least an "A" rating,
certificates of deposit purchased through the FHLB and securities issued by
mutual funds which invest in securities consistent with the Bank's allocable
investments. The Bank's policies provide that the Chief Financial Officer is
authorized to execute all transactions within specified limits which are
reviewed by the Board of Directors on a monthly basis and are currently $1.0
million. From time to time the Board of Directors may authorize the Chief
Financial Officer to exceed the policy limitations.
At December 31, 1996, the Bank had a total of $8.67 million in
certificates of deposit, other interest earning deposits, corporate notes,
federal funds and other investment and mortgage-backed securities. At December
31, 1996, all investment and mortgage-backed securities were classified as
available for sale. Included in this total, at December 31, 1996, the Bank had
$6.2 million in U.S. Government and agencies securities and $1.1 million in
mortgage-backed securities. Investments in mortgage-backed securities involve a
risk that actual prepayments will exceed prepayments estimated over the life of
the security which may result in a loss of any premium paid for such instruments
thereby reducing the net yield on such securities. In addition, if interest
rates increase, the market value of such securities may be adversely affected
which, in turn, would adversely affect stockholders' equity to the extent such
securities are held for sale. The Bank may invest in mortgage-backed securities
in the future.
16
<PAGE> 19
The following table sets forth certain information regarding the carrying
and market values of the Bank's federal funds sold and other short-term
investments and investment securities at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
----------------------------------------------------
1996 1995 1994
----------------- ---------------- ----------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
-------- ------- -------- ------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Certificates of deposit(1)...... $162 $162 $ 151 $ 151 $ 488 $ 488
Other interest-earning deposits. 357 357 164 164 195 195
Investment securities:
Corporate notes............... -- -- 455 456 1,159 1,150
Federal funds................. 364 364 97 97 204 204
FHLB stock.................... 436 436 407 407 381 381
U. S. government obligations.. 6,193 6,089 5,567 5,625 2,997 2,926
Mutual Funds.................. 14 14 1 1 1,000 1,000
FHLMC preferred stock......... -- -- -- -- -- --
Mortgage-backed securities.... 1,148 1,148 1,024 1,082 787 799
------ ------ ------ ------ ------ ------
Total....................... $8,674 $8,570 $7,866 $7,983 $7,211 $7,143
====== ====== ====== ====== ====== ======
- ----------------------------
(1) Includes certificates of deposit with original maturities of greater than 90 days.
</TABLE>
17
<PAGE> 20
The table below sets forth certain information regarding the carrying
value, weighted average yields and contractual maturities of the Bank's
certificates of deposit, other interest-bearing deposits and investment
securities as of December 31, 1996.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996
--------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS MORE THAN TEN YEARS TOTAL
----------------- ----------------- ----------------- ------------------- --------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
------- -------- ------- -------- ------- -------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Certificates of Deposit(1)...... $ -- --% $162 5.98% $ -- --% $ -- --% $162 5.98%
Other interest-bearing deposit.. 357 6.15 -- -- -- -- -- -- 357 6.15
Investment securities:
U.S. government obligations.. -- -- -- -- 2,956 7.14 3,133 7.51 6,089 7.33
Federal funds................ 364 5.50 -- -- -- -- -- -- 364 5.50
Mutual funds................. 14 4.92 -- -- -- -- -- -- 14 4.92
Corporate notes.............. -- -- -- -- -- -- -- -- -- --
FHLB stock................... -- -- -- -- -- -- 436 7.04 436 7.04
Mortgage-backed securities... -- -- 20 9.75 -- -- 1,128 7.89 1,148 7.92
---- --- ------ ------ ------
Total...................... $735 5.80 $182 6.39 $2,956 7.14 $4,697 7.56 $8,570 7.24
==== ==== ====== ====== ======
- -----------------------------
(1) Includes certificates of deposit with original maturities of greater than 90 days.
</TABLE>
18
<PAGE> 21
SOURCE OF FUNDS
GENERAL. Deposits, loan repayments and prepayments, and cash flows
generated from operations are the primary source of the Bank's funds for use in
lending, investing and for other general purposes.
The Bank also relies upon advances from the FHLB.
DEPOSITS. The Bank offers a variety of deposit accounts with a range of
interest rates and terms. For the year ended December 31, 1996, certificates of
deposit constituted 66.90% of total average deposits.
The Bank's current deposit products include savings, NOW accounts, money
market and certificate of deposit accounts ranging in term from thirty days to
five years. Included in the Bank's certificate of deposit accounts are
certificates of deposit with balances in excess of $100,000 (jumbo
certificates), and Individual Retirement Accounts ("IRAs").
Deposits are obtained primarily from residents of Hamilton County, Ohio.
The Bank seeks to attract deposit accounts by offering a variety of products,
competitive rates, and service hours. Although a substantial amount of the
Bank's depositors are past and present Procter & Gamble employees, the Bank has
sought to attract new depositors through traditional methods of advertising,
including print media advertising. The Bank does not generally advertise outside
of its market area or utilize the services of deposit brokers. Management
believes that an insignificant number of deposit accounts are held by
non-residents of the Bank's primary market area.
The Bank sets interest rates on its deposits on a weekly basis, based upon
a number of factors, including: the previous week's deposit flow; a current
survey of a selected group of competitors' rates for similar products; external
data which may influence interest rates; investment opportunities and loan
demand; and scheduled maturities.
The following table presents the deposit activity of the Bank for the
periods indicated.
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------
1996 1995 1994
-------- ---------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
Balance beginning of period $33,669 $35,526 $38,120
Net increase (decrease)
before interest credited (2,745) (3,506) (4,171)
Interest credited.......... 1,627 1,649 1,577
------ ------ -------
Balance end of period $32,551 $33,669 $35,526
======= ======= =======
</TABLE>
19
<PAGE> 22
At December 31 , 1996, the Bank had $3.6 million in certificate accounts
in amounts of $100,000 or more maturing as follows:
<TABLE>
<CAPTION>
WEIGHTED
MATURITY PERIOD AMOUNT AVERAGE RATE
--------------- -------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Three months or less................... $100 5.60%
Over three through nine months......... 234 5.40
Over six through 12 months............. 202 5.84
Over 12 months......................... 3,032 6.32
-----
Total............................ $3,568 6.21
======
</TABLE>
The following table sets forth the distribution of the Bank's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------
1996 1995 1994
--------------------------- --------------------------- ----------------------------
PERCENT PERCENT PERCENT
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
------- --------- -------- ------- -------- -------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Statement savings
accounts........ $6,047 17.67% 2.58% $ 5,805 16.94% 2.68% $ 6,406 17.75% 2.64%
NOW and Money
Market accounts 5,281 15.43 2.46 5,155 15.05 2.47 6,091 16.87 2.64
Total certificate
accounts....... 22,896 66.90 5.75 23,299 68.01 5.87 23,603 65.38 5.28
------- ------ ------- ------ ------- ------
Total average
deposits.......... $34,224 100.00% 4.68 $34,259 100.00% 4.81% $36,100 100.00% 4.37%
======= ====== ======= ====== ======= ======
</TABLE>
20
<PAGE> 23
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1996.
<TABLE>
<CAPTION>
PERIOD TO MATURITY FROM DECEMBER 31, 1996 AT DECEMBER 31,
---------------------------------------------------- -----------------------------
TWO TO FOUR TO
LESS THAN ONE TO THREE THREE TO FIVE
ONE YEAR TWO YEARS YEARS FOUR YEARS YEARS 1996 1995 1994
---------- ---------- ------- ---------- ------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts(1):
0 to 4.00%............... $ -- $ -- $ -- $ -- $ --$ -- $ -- $ 1,506
4.01 to 5.00%............ 370 -- -- 42 -- 412 797 6,229
5.01 to 6.00%............ 9,665 3,392 1,021 698 1,346 16,122 12,972 9,377
6.01 to 7.00%............ 1,181 571 2,347 1,088 -- 5,187 7,944 3,942
7.01 to 8.00%............ -- -- -- 149 -- 149 753 1,166
8.01 to 9.00%............ -- -- -- -- -- -- -- 1,231
Over 9.01%............... -- -- -- -- -- -- -- 259
------- ------ ------ ------ ------ ------ ------- ------
Total.................. $11,216 $3,963 $3,368 $1,977 $1,346 $21,870 $22,466 $23,710
======= ====== ====== ====== ====== ======= ======= =======
- -------------------------
(1) Certificates of deposit include IRA accounts of $9,430, $9,899 and $10,666 as of
December 31, 1996, 1995 and 1994, respectively.
</TABLE>
21
<PAGE> 24
BORROWINGS
At December 31, 1996, the Bank had $7.0 million in outstanding advances
from the FHLB and had no other borrowings. The FHLB advances are used by the
Bank to fund assets, including loan originations. The majority of FHLB advances
bear fixed rates and have terms of one year or less. The maximum amount that the
FHLB will advance to member institutions, including the Bank, fluctuates from
time to time in accordance with current regulations. The Bank may obtain
additional advances from the FHLB as part of its operating strategy.
The following table sets forth certain information regarding the Bank's
borrowed funds at or for the periods ended on the dates indicated:
<TABLE>
<CAPTION>
AT OR FOR THE YEAR
ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
--------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
FHLB advances:
Average balance outstanding....................... $5,924 $3,199 $ 398
Maximum amount outstanding at any
month-end during the period.................... 7,007 5,806 417
Balance outstanding at end of period.............. 7,007 5,327 402
Weighted average interest rate during the period.. 5.77% 6.16% 5.78%
Weighted average interest rate at end of period... 5.73% 6.09% 5.99%
</TABLE>
PERSONNEL
As of December 31, 1996, the Bank had 10 full-time employees and one
part-time employee. The employees are not represented by a collective bargaining
unit, and the Bank considers its relationship with its employees to be good.
22
<PAGE> 25
REGULATION AND SUPERVISION
GENERAL
The Bank is an Ohio chartered savings bank, a member of the FHLB system,
and its deposit accounts are insured up to applicable limits by the FDIC through
the SAIF. The Bank is subject to extensive regulation, examination and
supervision by the FDIC and the Superintendent of the Ohio Division of Commerce,
Division of Financial Institutions (the "Superintendent"). The Bank must file
reports with the Superintendent and the FDIC concerning its activities and
financial condition, in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with, or acquisitions of,
other financial institutions. There are periodic examinations by the
Superintendent and the FDIC to test the Bank's compliance with various
regulatory requirements. This regulation and supervision establishes a
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the Superintendent, the FDIC or the
Congress, could have a material adverse impact on the Company, the Bank and
their operations. The Company, as a savings and loan holding company, is also
required to file certain reports with, and otherwise comply with the rules and
regulations of the OTS and of the Securities and Exchange Commission (the "SEC")
under the federal securities laws. Certain of the regulatory requirements
applicable to the Bank and to the Company are referred to below or elsewhere
herein.
As an insured depository institution, the Bank is subject to the Community
Reinvestment Act ("CRA") and to various statutes and implementing regulations
promulgated by the Board of Governors of the Federal Reserve System (the "FRB")
including, without limitation, regulations relating to equal credit opportunity,
reserves, electronic fund transfers, truth in lending, availability of funds,
and truth in savings. As lenders whose loans are secured by real property and as
owners of real property, financial institutions, including the Bank, may be
subject to potential liability under various statutes and regulations applicable
to property owners generally, including statutes and regulations relating to the
environmental condition of real property. The Bank is also subject to the usury
laws of Ohio and other states in which it makes loans. In Ohio, there is a
maximum interest rate applicable to mortgage loans secured by the borrower's
residence which is no greater than eight percent in excess of the discount rate
on ninety-day commercial paper in effect at the Federal Reserve Bank in the
Fourth Federal Reserve District. There are also limitations on interest rates
for other loans, such as consumer loans, and limitations on the amounts of fees
which may be charged in connection with such loans.
The FDIC has extensive enforcement authority over insured Ohio-chartered
savings banks, including the Bank. This enforcement authority includes, among
other things, the ability to assess civil money penalties, to issue cease and
desist or removal orders and to initiate injunctive actions. In general, these
enforcement actions may be initiated in response to violations of laws and
regulations and unsafe or unsound practices.
23
<PAGE> 26
The FDIC has authority to appoint a conservator or receiver for an insured
savings bank under certain circumstances. The grounds for appointment of a
conservator or receiver for a state savings bank on the basis of an
institution's financial condition include: (i) insolvency, in that the assets of
the savings bank are less than its liabilities to depositors and others; (ii)
substantial dissipation of assets or earnings through violations of law or
unsafe or unsound practices; (iii) existence of an unsafe or unsound condition
to transact business; (iv) likelihood that the savings bank will be unable to
meet the demands of its depositors or to pay its obligations in the normal
course of business; and (v) insufficient capital, or the incurring or likely
incurring of losses that will deplete substantially all the institution's
capital with no reasonable prospect of replenishment of capital without federal
assistance.
DIVISION REGULATION
The Superintendent is responsible for the regulation and supervision of
Ohio savings banks in accordance with the laws of the State of Ohio. Ohio law
prescribes the permissible investments and activities of Ohio savings banks,
including the types of lending that such banks may engage in and the investments
in real estate, subsidiaries and corporate or government securities that such
banks may make. The ability of Ohio savings banks to engage in these
state-authorized investments generally is subject to various limitations under
FDIC regulations and oversight by the FDIC.
Any mergers involving, or acquisitions of control of, Ohio savings banks
are subject to the prior approval of the Superintendent. The Superintendent may
initiate certain supervisory measures or formal enforcement actions against Ohio
savings banks. Ultimately, if the grounds provided by law exist, the
Superintendent may place an Ohio savings bank in conservatorship or
receivership.
The Superintendent conducts regular examinations of the Bank approximately
once a year. The Superintendent imposes assessments on Ohio savings banks based
on the savings bank's asset size to cover the cost of supervision and
examination.
In addition to being governed by the laws of Ohio specifically governing
savings banks, the Bank is also governed by Ohio corporate law, to the extent
such law does not conflict with the laws specifically governing savings banks.
Since the enactment of the Federal Deposit Insurance Corporation
Improvement Act of 1991, all state-chartered financial institutions, including
savings banks and their subsidiaries have generally been limited to activities
and equity investments of the type and in the amount authorized for national
banks, notwithstanding state law. The FDIC is authorized to permit such
institutions to engage in state authorized activities or investments that do not
meet this standard (other than non-subsidiary equity investments) for
institutions that meet all applicable capital requirements if it is determined
that such activities or investments do not pose a significant risk to the SAIF.
All non-subsidiary equity investments were required to be divested by December
19, 1996, pursuant to an FDIC-approved divestiture plan. The FDIC restrictions
on state-chartered institutions have not affected the operations of the Bank.
FDIC REGULATIONS
CAPITAL REQUIREMENTS. The FDIC has adopted risk-based capital guidelines
to which the Bank is subject. The guidelines establish a systematic analytical
framework that makes regulatory capital requirements more sensitive to
differences in risk profiles among banking organizations. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet items
to four risk-
24
<PAGE> 27
weighted categories ranging from 0% to 100%, with higher levels of capital being
required for the categories perceived as representing greater risk.
These guidelines divide a savings bank's capital into two tiers. The first
tier ("Tier I") includes common equity, retained earnings, certain
non-cumulative perpetual preferred stock (excluding auction rate issues) and
minority interests in equity accounts of consolidated subsidiaries, less
goodwill and other intangible assets (except mortgage servicing rights and
purchased credit card relationships subject to certain limitations).
Supplementary ("Tier II") capital includes, among other items, cumulative
perpetual and long-term limited-life preferred stock, mandatory convertible
securities, certain hybrid capital instruments, term subordinated debt and the
allowance for loan and lease losses, subject to certain limitations, less
required deductions. Savings banks are required to maintain a total risk-based
capital ratio of 8%, of which at least 4% must be Tier I capital. The FDIC may,
however, set higher capital requirements on individual institutions when
particular circumstances warrant. Savings banks experiencing or anticipating
significant growth are expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
In addition, the FDIC has established regulations prescribing a minimum
Tier I leverage ratio (Tier I capital to adjusted total assets as specified in
the regulations). These regulations provide for a minimum Tier I leverage ratio
of 3% for banks that meet certain specified criteria, including that they have
the highest examination rating and are not experiencing or anticipating
significant growth. All other banks are required to maintain a Tier I leverage
ratio of 3% plus an additional cushion of at least 100 to 200 basis points.
The following is a summary of the Bank's regulatory capital at December
31, 1996:
<TABLE>
<CAPTION>
<S> <C>
GAAP Capital to Total Assets.............. 15.4%
Total Capital to Risk-Weighted Assets..... 11.7%
Tier I Leverage Ratio..................... 24.1%
</TABLE>
In August 1995, the FDIC, along with the other federal banking agencies,
adopted a regulation providing that the agencies will take account of the
exposure of a bank's capital and economic value to changes in interest rate risk
in assessing a bank's capital adequacy. According to the agencies, applicable
considerations include the quality of the bank's interest rate risk management
process, the overall financial condition of the bank and the level of other
risks at the bank for which capital is needed. Institutions with significant
interest rate risk may be required to hold additional capital. The agencies
recently issued a joint policy statement providing guidance on interest rate
risk management, including a discussion of the critical factors affecting the
agencies' evaluation of interest rate risk in connection with capital adequacy.
The agencies have determined not to proceed with a previously issued proposal to
develop a supervisory framework for measuring interest rate risk and an explicit
capital component for interest rate risk.
Banking regulators continue to indicate their desire to raise capital
requirements applicable to banking organizations beyond their current levels.
Management is unable to predict whether and when higher capital requirements
would be imposed and, if so, to what levels and on what schedule.
DIVIDEND LIMITATIONS. The FDIC has authority to use its enforcement powers
to prohibit a savings bank from paying dividends if, in its opinion, the payment
of dividends would constitute an unsafe or unsound practice. Under Ohio law, the
Company and the Bank are prohibited from paying a dividend which would result in
insolvency. Ohio law requires the Bank to obtain Division approval before
payment
25
<PAGE> 28
of dividends in excess of net profits for the current and two prior fiscal
years, with certain adjustments. Federal law prohibits the payment of dividends
by a bank that will result in the bank failing to meet applicable capital
requirements on a pro forma basis. Additionally, the Bank, as a subsidiary of a
savings and loan holding company, will be required to provide the OTS with 30
days prior written notice before declaring any dividend. The Bank's Plan of
Conversion also restricts the Bank's payment of dividends in the event the
dividend would impair the liquidation account established in connection with the
Conversion.
STANDARDS FOR SAFETY AND SOUNDNESS. Federal law requires each federal
banking agency to prescribe for depository institutions under its jurisdiction
standards relating to, among other things, internal controls; information
systems and audit systems; loan documentation; credit underwriting; interest
rate risk exposure; asset growth; compensation, fees and benefits; and such
other operational and managerial standards as the agency deems appropriate. The
federal banking agencies adopted final regulations and Interagency Guidelines
Prescribing Standards for Safety and Soundness (the "Guidelines") to implement
these safety and soundness standards. The Guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired. The Guidelines address internal controls and information systems;
internal audit system; credit underwriting; loan documentation; interest rate
risk exposure; asset growth; asset quality; earnings and compensation; fees and
benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final
regulation establishes deadlines for the submission and review of such safety
and soundness compliance plans.
LIQUIDITY. FDIC policy requires that savings banks maintain an average
daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances and specified United States government, state or federal agency
obligations) in an amount which it deems adequate to protect the safety and
soundness of the savings bank. The FDIC currently has no specific level which is
required.
PROMPT CORRECTIVE REGULATORY ACTION
Federal law requires, among other things, that federal bank regulatory
authorities take "prompt corrective action" with respect to banks that do not
meet minimum capital requirements. For these purposes, the law establishes five
capital tiers: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized. At December 31,
1996, the Bank was categorized as "well capitalized."
The FDIC has adopted regulations to implement the prompt corrective action
legislation. Among other things, the regulations define the relevant capital
measures for the five capital categories. An institution is deemed to be "well
capitalized" if it has a total risk-based capital ratio of 10% or greater, a
Tier I risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or
greater, and is not subject to a regulatory order, agreement or directive to
meet and maintain a specific capital level for any capital measure. An
institution is deemed to be "adequately capitalized" if it has a total
risk-based capital ratio of 8% or greater, a Tier I risk-based capital ratio of
4% or greater, and generally a leverage ratio of 4% or greater. An institution
is deemed to be "undercapitalized" if it has a total risk-based capital ratio of
less than 8%, a Tier I risk-based capital ratio of less than 4%, or generally a
leverage ratio of less than 4%. An institution is deemed to be "significantly
undercapitalized" if it has a total risk-based capital ratio of less than 6%, a
Tier I risk-based capital ratio of less than 3%, or a leverage ratio of less
than 3%. An
26
<PAGE> 29
institution is deemed to be "critically undercapitalized" if it has a ratio of
tangible equity (as defined in the regulations) to total assets that is equal to
or less than 2%.
"Undercapitalized" banks are subject to growth, capital distribution
(including dividend) and other limitations and are required to submit a capital
restoration plan. A bank's compliance with such plan is required to be
guaranteed by any company that controls the undercapitalized institutions. If an
"undercapitalized" bank fails to submit an acceptable plan, it is treated as if
it is "significantly undercapitalized." "Significantly undercapitalized" banks
are subject to one or more of a number of additional restrictions, including an
order by the FDIC to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and cease receipt of deposits
from correspondent banks or dismiss directors or officers, and restrictions on
interest rates paid on deposits, compensation of executive officers and capital
distributions by the parent holding company. "Critically undercapitalized"
institutions also may not, beginning 60 days after becoming "critically
undercapitalized," make any payment of principal or interest on certain
subordinated debt or extend credit for a highly leveraged transaction or enter
into any material transaction outside the ordinary course of business. In
addition, "critically undercapitalized" institutions are subject to appointment
of a receiver or conservator. Generally, subject to a narrow exception, the
appointment of a receiver or conservator is required for a "critically
undercapitalized" institution within 270 days after it obtains such status.
TRANSACTIONS WITH AFFILIATES
Under current federal law, transactions between depository institutions
and their affiliates are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings bank is any company or entity that controls, is
controlled by, or is under common control with the savings bank. In a holding
company context, at a minimum, the parent holding company of a savings bank and
any companies which are controlled by such parent holding company are affiliates
of the savings bank. Generally, Section 23A limits the extent to which the
savings bank or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such savings bank's capital stock and
surplus, and contains an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus. The term
"covered transaction" includes the making of loans or other extensions of credit
to an affiliate; the purchase of assets from an affiliate, the purchase of, or
an investment in, the securities of an affiliate; the acceptance of securities
of an affiliate as collateral for a loan or extension of credit to any person;
or issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate. Section 23A also establishes specific collateral requirements for
loans or extensions of credit to, or guarantees, acceptances on letters of
credit issued on behalf of an affiliate. Section 23B requires that covered
transactions and a broad list of other specified transactions be on terms
substantially the same, or no less favorable, to the savings bank or its
subsidiary as similar transactions with nonaffiliates.
Further, Section 22(h) of the Federal Reserve Act restricts a savings bank
with respect to loans to directors, executive officers, and principal
stockholders. Under Section 22(h), loans to directors, executive officers and
stockholders who control, directly or indirectly, 10% or more of voting
securities of a savings bank, and certain related interests of any of the
foregoing, may not exceed, together with all other outstanding loans to such
persons and affiliated entities, the savings bank's total capital and surplus.
Institutions of less than $100 million in deposits may increase this limit to up
to two times capital and surplus under certain conditions. Section 22(h) also
prohibits loans above amounts prescribed by the appropriate federal banking
agency to directors, executive officers, and shareholders who control more than
10% of a savings bank, and their respective affiliates, unless such loan is
approved in advance by
27
<PAGE> 30
a majority of the board of directors of the savings bank. Any "interested"
director may not participate in the voting. The loan amount (which includes all
other outstanding loans to such person) as to which such prior board of director
approval is required, is the greater of $25,000 or 5% of capital and surplus or
any loans over $500,000. Further, pursuant to Section 22(h), loans to directors,
executive officers, and principal shareholders must be made on terms
substantially the same as offered in comparable transactions to other persons.
Section 22(g) of the Federal Reserve Act places additional limitations on loans
to executive officers.
INSURANCE OF DEPOSIT ACCOUNTS
Deposits of the Bank are presently insured by the SAIF. Both the SAIF and
the Bank Insurance Fund ("BIF") (the deposit insurance fund that covers most
commercial bank deposits), are statutorily required to be recapitalized to a
1.25% of insured reserve deposits ratio. Until recently, members of the SAIF and
BIF were paying average deposit insurance premiums of between 24 and 25 basis
points. The BIF met the required reserve in 1995, whereas the SAIF was not
expected to meet or exceed the required level until 2002 at the earliest. This
situation was primarily due to the statutory requirement that SAIF members make
payments on bonds issued in the late 1980s by the Financing Corporation ("FICO")
to recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately
adopted a new assessment rate schedule of from 0 to 27 basis points under which
92% of BIF members paid an annual premium of only $2,000. With respect to SAIF
member institutions, the FDIC adopted a final rule retaining the previously
existing assessment rate schedule applicable to SAIF member institutions of 23
to 31 basis points. As long as the premium differential continued, it may have
had adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members, such as the Bank were placed at a substantial competitive disadvantage
to BIF members with respect to pricing of loans and deposits and the ability to
achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the "Funds Act") which, among other things, imposed a special
one-time assessment on SAIF member institutions, including the Bank, to
recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a special
assessment of 65.7 basis points on SAIF assessable deposits held as of March 31,
1995, payable November 27, 1996 (the "SAIF Special Assessment"). The SAIF
Special Assessment was recognized by the Bank as an expense in the quarter ended
September 30, 1996 and is generally tax deductible. The SAIF Special Assessment
recorded by the Bank amounted to $225,000 on a pre-tax basis and $148,000 on an
after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits will
be assessed for FICO payment of 1.3 basis points, while SAIF deposits will pay
6.48 basis points. Full pro rata sharing of the FICO payments between BIF and
SAIF members will occur on the earlier of January 1, 2000 or the date the BIF
and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be
merged on January 1, 1999, provided no savings associations remain as of that
time.
As a result of the Funds Act, the FDIC recently voted to effectively lower
SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range
comparable to that of BIF members. SAIF members will also continue to make the
FICO payments described above. The FDIC also lowered the SAIF assessment
schedule for the fourth quarter of 1996 to 18 to 27 basis points. Management
cannot predict
28
<PAGE> 31
the level of FDIC insurance assessments on an on-going basis, whether the
savings association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
The Bank's assessment rate for fiscal 1996 was 23 basis points and the
premium paid for this period was $58,000. A significant increase in SAIF
insurance premiums would likely have an adverse effect on the operating expenses
and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operation or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
Division. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
THRIFT RECHARTERING LEGISLATION
The Funds Act provides that the BIF and SAIF will merge on January 1, 1999
if there are no more savings associations as of that date. That legislation also
requires that the Department of Treasury submit a report to Congress by March
31, 1997 that makes recommendations regarding a common financial institutions
charter, including whether the separate charters for thrifts and banks should be
abolished. Various proposals to eliminate the federal thrift charter, create a
uniform financial institutions charter and abolish the OTS have been introduced
in Congress. The bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date (January 1,
1998 in one bill, June 30, 1998 in the other) or they would automatically become
national banks. State chartered thrifts would become subject to the same federal
regulation as applies to state commercial banks. Holding companies for savings
institutions would become subject to the same regulation as holding companies
that control commercial banks, with a limited grandfather provision for unitary
savings and loan holding company activities. The Bank is unable to predict
whether such legislation would be enacted, the extent to which the legislation
would restrict or disrupt its operations or whether the BIF and SAIF funds will
eventually merge.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require depository institutions to
maintain non-interest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally require that reserves be maintained against aggregate
transaction accounts as follows: for that portion of transaction accounts
aggregating $52.0 million or less (subject to adjustment by the Federal Reserve
Board) the reserve requirement is 3%; and for accounts greater than $52.0
million, the reserve requirement is $1.6 million plus 10% (subject to adjustment
by the Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $52.0 million. The first $4.3 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. Because required reserves must be maintained in
the form of either vault cash, a non-interest-bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets. FHLB System members are also authorized to borrow from the Federal
Reserve "discount window," but Federal Reserve Board regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve
Bank.
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<PAGE> 32
HOLDING COMPANY REGULATION
The Company is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As a unitary savings and loan holding company,
the Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that the Bank continues to
be a qualified thrift lender ("QTL") for purposes of the federal regulations.
Upon any non- supervisory acquisition by the Company of another savings
institution or savings bank that meets the QTL test and is deemed to be a
savings institution by the OTS, the Company would become a multiple savings and
loan holding company (if the acquired institution is held as a separate
subsidiary) and would be subject to extensive limitations on the types of
business activities in which it could engage. The HOLA limits the activities of
a multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"), subject to
the prior approval of the OTS, and certain activities authorized by OTS
regulation.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a nonsubsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result in
a multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Bank report their income on a calendar year
basis using the accrual method of accounting, and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the past
five years. For its 1996 taxable year, the Bank is subject to a maximum federal
income tax rate of 34%.
BAD DEBT RESERVES. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on
30
<PAGE> 33
qualifying real property loans (generally secured by interests in real property
improved or to be improved) under (i) the Percentage of Taxable Income Method
(the "PTI Method") or (ii) the Experience Method. The reserve for nonqualifying
loans was computed using the Experience Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (I.E.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. Thrift institutions that would be treated as
small banks are allowed to utilize the Experience Method applicable to such
institutions, while thrift institutions that are treated as large banks (those
generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing reserves
for bad debts will treat such change as a change in method of accounting,
initiated by the taxpayer, and having been made with the consent of the IRS. Any
Section 481(a) adjustment required to be taken into income with respect to such
change generally will be taken into income ratably over a six-taxable year
period, beginning with the first taxable year beginning after 1995, subject to
the residential loan requirement.
Under the residential loan requirement provision, the recapture required
by the 1996 Act will be suspended for each of two successive taxable years,
beginning with the Bank's current taxable year, in which the Bank originates a
minimum of certain residential loans based upon the average of the principal
amounts of such loans made by the Bank during its six taxable years preceding
its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank is
permitted to make additions to its tax bad debt reserves. In addition, the Bank
is required to pay over a six year period the excess of the balance of its tax
bad debt reserves as of December 31, 1995 over the balance of such reserves as
of December 31, 1987. As a result of such recapture, the Bank will incur
additional tax payments of approximately $82,000 which is generally expected to
be taken into income beginning in 1998 over a six year period.
DISTRIBUTIONS. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if the Bank makes a non-dividend distribution
to the Company, approximately one and one-half times the amount of such
distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
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<PAGE> 34
CORPORATE ALTERNATIVE MINIMUM TAX. The Internal Revenue Code of 1986, as
amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI (with certain modifications) over $2.0 million is imposed
on corporations, including the Bank, whether or not an Alternative Minimum Tax
("AMT") is paid. The Bank does not expect to be subject to the AMT, but may be
subject to the environmental tax liability.
DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
SAIF RECAPITALIZATION ASSESSMENT. The Funds Act levied a 65.7-cent fee on
every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize the SAIF under this
legislation is deductible under Section 162 of the Code in the year of payment.
OHIO TAXATION
The Company is subject to the Ohio corporation franchise tax, which, as
applied to the Company, is a tax measured by both net earnings and net worth.
The rate of tax is the greater of (i) 5.1% on the first $50,000 of computed Ohio
taxable income and 8.9% of computed Ohio taxable income in excess of $50,000 or
(ii) 0.582% times taxable net worth.
In computing its tax under the net worth method, the Company may exclude
100% of its investment in the capital stock of the Bank after the Conversion, as
reflected on the balance sheet of the Company, in computing its taxable net
worth as long as it owns at least 25% of the issued and outstanding capital
stock of the Bank. The calculation of the exclusion from net worth is based on
the ratio of the excludable investment (net of any appreciation or goodwill
included in such investment) to total assets multiplied by the net value of the
stock. As a holding company, the Company may be entitled to various other
deductions in computing taxable net worth that are not generally available to
operating companies.
A special litter tax is also applicable to all corporations, including the
Company, subject to the Ohio corporation franchise tax other than "financial
institutions." If the franchise tax is paid on the net income basis, the litter
tax is equal to .11% of the first $50,000 of computed Ohio taxable income and
.22% of computed Ohio taxable income in excess of $50,000. If the franchise tax
is paid on the net worth basis, the litter tax is equal to .014% times taxable
net worth.
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<PAGE> 35
The Bank is a "financial institution" for State of Ohio tax purposes. As
such, it is subject to the Ohio corporate franchise tax on "financial
institutions," which is imposed annually at a rate of 1.5% of the Bank's book
net worth determined in accordance with GAAP. As a "financial institution," the
Bank is not subject to any tax based upon net income or net profits imposed by
the State of Ohio.
IMPACT OF NEW ACCOUNTING STANDARDS
The following does not constitute a comprehensive summary of all material
changes or developments affecting the manner in which the Company keeps its
books and records and performs its financial accounting responsibilities. It is
intended only as a summary of some of the recent pronouncements made by the FASB
which are of particular interest to financial institutions.
In May 1995, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 122, "Accounting for Mortgage
Servicing Rights." This statement requires that a mortgage banking enterprise
recognize as separate assets rights to service mortgage loans for others,
however those servicing rights are acquired. A mortgage banking enterprise that
acquires mortgage servicing rights through either the purchase or origination of
mortgage loans and sells or securitizes those loans with servicing rights
retained would allocate the total cost of the mortgage loans to the mortgage
servicing rights and the loans based on their relative fair value. Statement No.
122 is effective for fiscal years beginning after December 15, 1995. There was
no impact from the adoption of this standard in 1996.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This statement establishes accounting and reporting standards for
stock-based employee compensation plans including stock options The statement
defines a "fair value based method" for employee stock options and encourages
all entities to adopt that method for such options. However, it allows an entity
to continue to measure compensation cost for those plans using the "intrinsic
value based method" of accounting prescribed by APB Opinion No. 25. Entities
electing to remain with the accounting in Opinion 25 must make proforma
disclosures of net income and earnings per share, as if the fair value method of
accounting defined in this statement had been applied. There was no impact from
the adoption of this standard since the Company does not have any stock options.
In June 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" which
established accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. The standards are based on
a consistent application of a financial components approach that focuses on
control. Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. SFAS No. 125 supersedes SFAS No.
122. SFAS No. 125 is effective for transactions occurring after December 31,
1996. Management is currently assessing the impact of this standard.
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<PAGE> 36
ADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.
- ------------------------------------------------------
The following table sets forth certain information regarding the executive
officers of the Company and the Bank who are not also directors.
<TABLE>
<CAPTION>
Age at Position with the Company and Bank
Name 12/31/96 and Past Five Years Experience
- ---- -------- ------------------------------------
<S> <C> <C>
Michael P. Cooper 39 Chief Financial Officer and Treasurer of the Company and the
Bank. Prior to joining the Company in 1997, Mr. Cooper was
Comptroller of a property management/personnel service and
dental insurer. From 1987-1994, Mr. Cooper was Chief Financial
Officer of Guardian Savings Bank.
Diane P. Irwin 41 Vice President and Chief Operating Officer of the Company and
the Bank.
</TABLE>
ITEM 2. PROPERTIES.
- -------------------
The Company and the Bank are located and conduct their business at the
Bank's office located at 5255 Beech Street, St. Bernard, Ohio. The Company
believes that the Bank's current facilities are adequate to meet the present and
immediately foreseeable needs of the Bank and the Company. In prior years, the
Bank has not been required to pay rent for the office that the Bank has operated
from. In 1995, the lessor negotiated for lease payments through December 31,
1999 totalling $105,000. The lease payments will be lower in the first years and
increase in later years to cover the total amount of the lease. There are no
renewal options, and the Bank may need to renegotiate at the end of the term.
The following table sets forth certain information relating to the Bank's
office.
<TABLE>
<CAPTION>
ORIGINAL NET BOOK VALUE
DATE OF PROPERTY OR
LEASED LEASED DATE OF LEASEHOLD
OR OR LEASE IMPROVEMENTS AT
LOCATION OWNED ACQUIRED EXPIRATION DECEMBER 31, 1996
- --------------------------- ------ -------- ---------- ----------------
<S> <C> <C> <C> <C>
5255 Beech Street
St. Bernard, Ohio 45217... Leased 1995 2000 $264,000
</TABLE>
In addition, at December 31, 1996 the Bank had a capitalized lease
obligation related to 3 of its ATMs. See Note 6 to the Notes to Financial
Statements appearing elsewhere in this Form 10-K. At December 31, 1996, the Bank
had a total of 3 ATMs. The Bank is currently in the process of renegotiating the
agreements it has with Procter & Gamble relating to the ATMs located at Procter
& Gamble facilities. The Bank expects that as the agreements are renegotiated,
it will either reduce the costs borne by the Bank related to the continuing
operation of the ATMs or eliminate them.
For further information related to the Bank's properties, see Note 4 to
the Notes to the Financial Statements included in the Company's 1996 Annual
Report to Stockholders.
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<PAGE> 37
ITEM 3. LEGAL PROCEEDINGS.
- --------------------------
Neither the Company nor its subsidiaries are involved in any pending legal
proceedings, other than routine legal matters occurring in the ordinary course
of business, which in the aggregate involve amounts which are believed by
management to be immaterial to the consolidated financial condition or results
of operations of the Company. See Note 15 to the Notes to the Financial
Statements included elsewhere herein for more information regarding a settled
claim related to an employment matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
- ------------------------------------------------------------------------------
Information relating to the market for Registrant's common equity and
related stockholder matters appears in the Registrant's 1996 Annual Report to
Stockholders on the back inside cover. On December 31, 1996, the Company had 235
registered shareholders.
ITEM 6. SELECTED FINANCIAL DATA.
- --------------------------------
The above-captioned information appears under "Selected Consolidated
Financial and Other Data of the Company" in the Registrant's 1996 Annual Report
to Stockholders on pages 2 and 3 and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS.
- -------------
The above-captioned information appears under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Registrant's
1996 Annual Report to Stockholders on pages 4 through 13 and is incorporated
herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
- ----------------------------------------------------
The Consolidated Financial Statements of Lenox Bancorp, Inc. and its
subsidiary, together with the report thereon by Clark, Schaefer, Hackett & Co.
appear in the Registrant's 1996 Annual Report to Stockholders on pages 14
through 44 and are incorporated herein by reference.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
- --------------------------------------------------------------------------------
DISCLOSURE.
- ----------
None.
35
<PAGE> 38
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- ------------------------------------------------------------
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on April 23, 1997,
on pages 4 through 7. Information concerning Executive Officers who are not
directors is contained in Part I of this report pursuant to paragraph (b) of
Item 401 of Regulation S-K in reliance on Instruction G.
ITEM 11. EXECUTIVE COMPENSATION.
- --------------------------------
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on April 23, 1997, on pages 8 through
12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
- ------------------------------------------------------------------------
The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Registrant's
Proxy Statement for the Annual Meeting of Stockholders to be held on April 23,
1997, on pages 3 and 4, and 5 through 7.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
- --------------------------------------------------------
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on April 23, 1997, on page 12.
36
<PAGE> 39
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
- -------------------------------------------------------------------------
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company are incorporated by
reference to the following indicated pages of the 1996 Annual Report to
Stockholders.
PAGE
----
Independent Auditors' Report................................ 14
Consolidated Balance Sheets
as of December 31, 1996 and 1995............................ 15-16
Consolidated Statement of Income
for the Three Years Ended December 31, 1996................. 17
Consolidated Statement of Changes in
Stockholders' Equity for Three Years Ended
December 31, 1996........................................... 18
Consolidated Statement of Cash Flows for
the Three Years Ended December 31, 1996..................... 19-20
Notes to Consolidated Financial Statements.................. 21-44
37
<PAGE> 40
The remaining information appearing in the 1996 Annual Report to Stockholders is
not deemed to be filed as part of this report, except as expressly provided
herein.
(2) All schedules are omitted because they are not required or applicable, or
the required information is shown in the consolidated financial statements
or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Amended Articles of Incorporation of Lenox Bancorp, Inc.*
3.2 Code of Regulations of Lenox Bancorp, Inc.*
4.0 Stock Certificate of Lenox Bancorp, Inc.*
10.1 Form of Employment Agreement between the Company and
Virginia M. Porowski*
10.2 Form of Employment Agreement between the Bank and Virginia
M. Porowski*
10.3 Lenox Bancorp, Inc. Incentive Plan**
13.0 1996 Annual Report to Stockholders (filed herewith)
21.0 Subsidiary information is incorporated herein by reference
to "Item 1 - General"
27.0 Financial Data Schedule (filed herewith)
(b) Reports on Form 8-K
None
- -----------------------------
* Incorporated herein by reference to the Exhibits to Form S-1, Registration
Statement, and Pre-Effective Amendment No. 1, filed on August 25, 1995 and
March 8, 1996, respectively, Registration No. 33-96248.
** Incorporated herein by reference to the Proxy Statement for the 1997
Annual Meeting of Stockholders filed herewith.
38
<PAGE> 41
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
LENOX BANCORP, INC.
By: /s/ Virginia M. Porowski
----------------------------------
Virginia M. Porowski
DATED: March 28, 1997 President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated.
Name Title Date
---- ----- ----
/s/ Virginia M. Porowski President, Chief Executive March 28, 1997
- --------------------------- Officer and Director
Virginia M. Porowski (Principal Executive Officer)
/s/ Michael P. Cooper Chief Financial Officer and March 28, 1997
- --------------------------- Treasurer (Principal Financial
Michael P. Cooper and Accounting Officer)
/s/ Richard O. Plunk Chair of the Board March 28, 1997
- ---------------------------
Richard O. Plunk
/s/ Wyvette D. Jordan Vice Chair of the Board March 28, 1997
- ---------------------------
Wyvette D. Jordan
/s/ Gail R. Behymer Director March 28, 1997
- ---------------------------
Gail R. Behymer
/s/ Richard C. Harmeyer Director and Secretary March 28, 1997
- ---------------------------
Richard C. Harmeyer
/s/ Robert R. Keller Director March 28, 1997
- ---------------------------
Robert R. Keller
/s/ William P. Riekert, Jr. Director and Assistant Secretary March 28, 1997
- ---------------------------
William P. Riekert, Jr.
<PAGE> 42
/s/ Henry E. Brown Director March 28, 1997
- ---------------------------
Henry E. Brown
/s/ Curtis L. Jackson Director March 28, 1997
- ---------------------------
Curtis L. Jackson
/s/ Reba St. Clair Director March 28, 1997
- ---------------------------
Reba St. Clair
<PAGE> 1
1996 ANNUAL REPORT TO STOCKHOLDERS
EXHIBIT 13.0
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF THE COMPANY
The selected financial and other data of the Company set forth below is
derived in part from, and should be read in conjunction with, the Financial
Statements of the Company and Notes thereto presented elsewhere in this Annual
Report.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets $47,074 $43,149 $39,891 $42,162 $42,314
Total liabilities 39,805 39,301 36,152 38,531 39,027
Loans, net(1) 37,495 33,384 31,605 28,204 28,796
Mortgage-backed securities(2) 1,148 1,083 787 5,582 6,319
Cash and cash equivalents 1,115 1,249 1,979 3,228 2,457
Investments(2)(3) 6,687 6,639 5,026 4,681 4,440
Deposits 32,551 33,669 35,526 38,120 38,744
Borrowings 7,012 5,343 447 259 85
Stockholders' equity(4) 7,270 3,848 3,739 3,631 3,286
<CAPTION>
Fiscal Year Ended December 31,
------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
(In thousands)
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Interest income $3,336 $2,981 $2,726 $3,169 $3,500
Interest expense 1,946 1,848 1,604 1,827 2,230
------- ------- ------- ------- -------
Net interest income 1,390 1,133 1,122 1,342 1,270
Provision (credit) for
loan losses -- (2) -- 6 4
------- ------- ------- ------- -------
Net interest income after
provision for loan losses 1,390 1,135 1,122 1,336 1,266
Non-interest income 153 102 70 144 97
Non-interest expense 1,276 1,198 1,046 969 893
------- ------- ------- ------- -------
Income before income taxes 267 39 146 511 470
Income taxes 81 10 38 166 146
------- ------- ------- ------- -------
Net income $ 186 $ 29 $ 108 $ 345 $ 324
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
(continued on next page)
2
<PAGE>
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
--------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL RATIOS AND OTHER
DATA:
PERFORMANCE RATIOS(5):
Return on average assets .41% .07% .27% .83% .77%
Return on average equity 3.34 .77 2.91 9.95 10.35
Average equity to average assets 12.17 9.11 9.13 8.30 7.45
Equity to total assets at year end 15.44 8.92 9.37 8.61 7.77
Average interest rate spread(6) 2.72 2.49 2.53 2.92 2.69
Net interest margin(7) 3.15 2.82 2.85 3.28 3.09
Average interest-earning assets
to average interest-bearing
liabilities 109.84 107.19 107.73 108.23 107.31
Non-interest expense to
average assets 2.79 2.88 2.57 2.32 2.13
REGULATORY CAPITAL RATIOS(5):
Tier I leverage 11.7 8.9 9.5 8.8 7.8
Total capital to
risk-weighted capital 24.1 17.7 19.6 20.0 17.9
ASSET QUALITY RATIOS(5):
Non-performing assets as a percent
of total assets(8) .23 .21 .23 .26 .35
Non-performing loans as a percent
of gross loans(8)(9) .29 .27 .29 .39 .51
Allowance for loan losses as a
percent of gross loans(9) .15 .18 .21 .23 .20
Allowance for loan losses as a
percent of non-performing loans(8) 53.21 66.87 71.17 59.86 38.39
</TABLE>
- ------------------------------------
(1) The allowance for loan losses at December 31, 1996, 1995, 1994, 1993 and
1992 was (in thousands) $58, $60, $66, $66 and $57, respectively.
(2) The Bank's investments and mortgage-related securities are classified as
"available for sale" at December 31, 1995. The Bank adopted Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" on January 1, 1994. See
Footnote 1 to the Financial Statements of the Company.
(3) Includes FHLB stock and certificates of deposit.
(4) Consists solely of retained earnings at December 31, 1995, 1994, 1993 and
1992.
(5) Asset Quality Ratios and Regulatory Capital Ratios are end of year ratios.
With the exception of end of year ratios, all ratios are based on average
monthly balances.
(6) The interest rate spread represents the difference between the
weighted-average yield on interest-earning assets and the weighted-average
cost of interest-bearing liabilities.
(7) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(8) Non-performing assets consist of loans 90 days or more overdue and not
accruing interest.
(9) Gross loans include loans, less loans in process, allowance for loan losses
and deferred loan origination fees.
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company does not transact any material business other than through its
wholly-owned subsidiary, the Bank. The Bank's results of operations are
dependent primarily on net interest income, which is the difference between the
interest income earned on its interest-earning assets, such as loans and
investments, and the interest expense on its interest-bearing liabilities, such
as deposits and borrowings. The Bank also generates non-interest income such as
service fee income. The Bank's general, administrative and other expenses
primarily consist of employee compensation, occupancy and equipment expenses,
federal deposit insurance premiums, franchise taxes and other operating
expenses. The Bank's results of operations are also significantly affected by
general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory agencies. The
Bank exceeded all of its regulatory capital requirements at December 31, 1996.
Management Strategy
In the past, the Bank's net interest income has been adversely affected by
changes in interest rates largely because of the composition of its loan
portfolio. In 1992 and 1993, the Bank began experiencing a significant amount
of prepayments in its loan portfolio as a result of the declining interest rate
environment. Many of the Bank's loans were refinanced into new ARM loans
offered by the Bank which carried initial rates that were below market rates.
Additionally, in the past, the Bank had originated ARM loans tied to a lagging
market index, some of which had interest rate margins as low as 50 basis points
above the lagging market index. Further, some of the ARM loans have annual
interest rate caps of 1% or less. As a result, by 1994, when interest rates
began to rise, the Bank had approximately $5.0 million of 3-year ARM loans that
had been originated at low rates and had not yet repriced and $9.0 million of
ARM loans that were tied to a lagging index, many of which were repricing
downward in accordance with the lagging market index, even though the Bank's
cost of funds was increasing. The composition of the Bank's loan portfolio,
coupled with the majority of the Bank's deposits having maturities of one year
or less, made the Bank vulnerable to increases in interest rates and adversely
affected earnings. The Bank has significantly changed its lending policies and
has taken other action to improve its profitability including emphasizing the
origination of one- to four-family residential mortgage loans, increasing
non-interest income and reducing non-interest expense. The Bank's current
strategic plan is to enhance its long-term profitability, reduce the level of
interest rate risk and improve market share.
Interest Rate Sensitivity Analysis
The matching of the repricing characteristics of assets and liabilities may
be analyzed by examining the extent to which such assets and liabilities are
"interest rate sensitive" and by monitoring an institution's interest rate
sensitivity "gap." An asset or liability is said to be interest rate sensitive
within a specific time period if it matures or re-prices within that time
period. The interest rate sensitivity gap is defined as the difference between
the amount of interest-earning assets anticipated, based upon certain
assumptions, to mature or re-price within a specific time period and the amount
of interest-bearing liabilities anticipated, based upon certain assumptions, to
mature or re-price within that time period. A gap is considered positive when
the amount of interest rate sensitive assets exceeds the amount of interest rate
sensitive liabilities maturing or re-pricing within a specific time frame. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets maturing or
re-pricing within that same time frame. Accordingly, in a rising interest rate
environment, an institution with a negative gap would not be in as favorable a
position, as compared to an institution with a positive gap, to invest in higher
yielding assets. This may result in the yield on its assets increasing at a
slower pace than the increase in the cost of its interest-bearing liabilities.
During a period of falling interest rates, an institution with a negative gap
would tend to have its assets repricing at a slower rate than its
interest-bearing liabilities, which, consequently, may result in its net
interest income growing at a faster rate then an institution with a positive
gap.
4
<PAGE>
The Bank maintains a high level of short-term certificates of deposit.
These accounts typically react more quickly to changes in market interest rates
than the Bank's investments in mortgage-backed and related securities and
mortgage loans because of the shorter maturity and re-pricing characteristics of
deposits. As a result, generally, sharp increases in interest rates may
adversely affect earnings while decreases in interest rates may beneficially
affect earnings.
In managing its interest rate risk the Bank makes every effort to provide
a more equal match between the maturity of its liabilities and the maturity
or repricing of its investments. In monitoring this process the Bank
regularly conducts a comprehensive analysis of the interest rate risk profile
and inherent profitability of the Bank's balance sheet. The Bank utilizes a
discounted cash flow analysis arriving at a mark-to-market comparison of
assets and liabilities to book values and in calculating the net present
value of the Bank's equity position. The primary focus is on managing market
value and total return. In addition, but to a much lesser degree, the Bank
will review its asset-liability gap position as an indication of how it is
faring on matching its asset/liability maturity-repricing profile.
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1996, that are
expected to reprice or mature in each of the future time periods shown, based
on certain assumptions. Except as stated below, the assets and liabilities
shown that reprice or mature during a particular period were determined in
accordance with the earlier of term to repricing or the contractual terms of
the asset or liability. All mortgage-backed securities, and mortgages
secured by one- to four-family residences are assumed to prepay at a constant
prepayment rate of 14%, which was chosen based upon a consensus of prepayment
rates that apply to various weighted average coupons over various weighted
average maturities and which are published by the larger brokerage houses who
deal in mortgage-backed and related securities. Line of credit reprice
monthly, and consumer loans are based on amortized balance. Additionally,
all variable rate deposit accounts, which include statement savings and NOW
accounts assume a 10% decay rate with the remainder due in the tenth year for
all periods. The liability assumptions for variable rate deposit accounts
were derived partly from industry methodology standards of valuing core
deposits and a blend of the Bank's own historical experience. Management
believes that all of the above assumptions are reasonable.
Certain shortcomings are inherent in the method of analysis presented in
the following table. For example, although certain assets and liabilities
may have similar maturities or periods to repricing, they may react in
different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Additionally, certain assets, such as ARM
loans, have features which restrict changes in interest rates on a short-term
basis and over the life of the asset. Further, in the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the table. Finally, the
ability of many borrowers to service their ARM loans may decrease in the
event of an interest rate increase.
As shown by the table below, increases in interest rates will result in
net decreases in the Bank's net portfolio value, while decreases in interest
rates will result in smaller net increases in the Bank's net portfolio value.
5
<PAGE>
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1996, based on the
information and assumptions set forth in the notes below.
<TABLE>
<CAPTION>
At December 31, 1996
---------------------------------------------------------------------------
Three Four One to Three to Five to More
Months Months to Three Five Ten Than
or Less One Year Years Years Years Ten Years Total
--------- ----------- -------- ---------- ------- ---------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest bearing deposits $ 526 $ -- $ -- $ -- $ -- $ -- $ 526
Investments -- -- -- -- 2,956 3,569 6,525
Mortgage-backed securities 41 116 258 191 287 255 1,148
Loans receivable, net 1,723 3,544 9,978 5,794 8,715 7,741 37,495
------- ------- -------- ------- -------- ------- -------
Total interest-earning assets $2,290 $3,860 $10,236 $5,985 $11,958 $11,565 $45,694
------- ------- -------- ------- -------- ------- -------
------- ------- -------- ------- -------- ------- -------
Interest-bearing liabilities:
Certificate accounts $2,281 $ 8,935 $ 7,331 $3,323 $ -- $ -- $21,870
Money market savings accounts 78 228 408 458 1,949 -- 3,121
Passbook accounts 130 380 891 722 3,075 -- 5,198
NOW accounts 59 173 405 328 1,397 -- 2,362
FHLB advances 2,275 3,295 1,173 60 49 155 7,007
Capitalized lease obligations 5 -- -- -- -- -- 5
------- ------- -------- ------- -------- ------- -------
Total $4,828 $13,011 $10,208 $4,891 $6,470 $ 155 $39,563
------- ------- -------- ------- -------- ------- -------
------- ------- -------- ------- -------- ------- -------
Interest-rate sensitivity gap $(2,538) $(9,351) $28 $1,094 $5,488 $11,410 $ 6,131
------- ------- -------- ------- -------- ------- -------
------- ------- -------- ------- -------- ------- -------
Cumulative interest rate sensitivity gap $(2,538) $(11,889) $(11,861) $(10,767) $(5,279) $6,131 $ 6,131
------- ------- -------- ------- -------- ------- -------
------- ------- -------- ------- -------- ------- -------
Cumulative interest rate sensitivity gap
as a percentage of total assets (5.39)% (25.26)% (25.20)% (22.87)% (11.21)% 13.02% 13.02%
------- ------- -------- ------- -------- ------- -------
------- ------- -------- ------- -------- ------- -------
Cumulative interest rate sensitivity gap
as a percent of total liability (6.38)% (29.87)% (29.80)% (27.05)% (13.26)% 15.40% 15.40%
------- ------- -------- ------- -------- ------- -------
------- ------- -------- ------- -------- ------- -------
</TABLE>
6
<PAGE>
Average Balance Sheet
The following tables set forth certain information relating to the Bank
at December 31, 1996 and for the years ended December 31, 1996, 1995 and
1994. The yields and costs are derived by dividing income or expense by the
average balance of assets or liabilities, respectively, for the periods shown
except where noted otherwise. Average balances are derived from average
month-end balances. Management does not believe that the use of average
monthly balances instead of average daily balances has caused a material
difference in the information presented. The yields and costs include fees
which are considered adjustments to yields.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------
At December 31,
1996 1996 1995 1994
--------------- -------------------------- -------------------------- -------------------------
Average Average Average
Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- ---- -------- -------- ----- -------- -------- ------ -------- -------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Interest bearing deposits $ 735 5.80% $ 489 $ 25 5.11% $ 473 $ 24 5.07% $ 2,256 $ 82 3.63%
Investments 6,687 7.28 7,049 521 7.39 6,601 452 6.83 4,401 240 5.45
Mortgage-backed securities 1,148 7.92 1,125 80 7.11 827 66 7.98 3,574 274 7.67
Loans receivable, net 37,495 7.69 35,449 2,710 7.64 32,279 2,438 7.56 29,142 2,130 7.31
------- ---- ------- ----- ----- ------ ----- ---- ------ ------ -----
Total interest-earning assets 46,065 7.61 44,112 3,336 7.56 40,180 2,980 7.42 39,373 2,726 6.92
Non-interest-earning assets 1,009 1,623 1,413 1,302
-------- ------- ------- -------
Total assets $47,074 $45,735 $41,593 $40,675
-------- ------- ------- -------
-------- ------- ------- -------
Liabilities and Equity:
Interest-bearing liabilities:
Deposits $32,551 4.82% $34,224 $1,603 4.68% $34,259 $1,649 4.81% $36,100 $1,577 4.37%
FHLB advances 7,007 5.73 5,924 342 5.77 3,199 197 6.16 398 23 5.78
Capitalized lease obligations 5 7.50 13 1 7.69 26 2 7.69 51 4 7.84
------- ---- ------- ----- ----- ------ ----- ---- ------ ------ -----
Total interest-bearing
liabilities 39,563 4.98 40,161 1,946 4.84 37,484 1,848 4.93 36,549 1,604 4.39
Non-interest-bearing liabilities 258 6 319 412
-------- ------- ------- -------
Total liabilities 39,821 40,167 37,803 $36,961
Retained earnings 7,253 5,568 3,790 3,714
-------- ------- ------- -------
Total liabilities and
retained earnings $47,074 $45,735 $41,593 $40,675
-------- ------- ------- -------
-------- ------- ------- -------
Net interest income/interest
rate spread 2.63% $1,390 2.72% $1,132 2.49% $1,122 2.53%
----- ------ ----- ------ ----- ------ -----
----- ------ ----- ------ ----- ------ -----
Net interest-earning assets $6,502 $3,951 $2,696 $2,824
------ ------ ------- ------
------ ------ ------- ------
Net interest margin 3.15% 2.82% 2.85%
----- ----- -----
----- ----- -----
Ratio of interest-earning
assets to interest-bearing
liabilities 116.43% 109.84% 107.19% 107.73%
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
7
<PAGE>
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates
and changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Bank's interest income and interest expense during
the periods indicated. Information is provided in each category with respect to
(i) changes attributable to changes in volume (changes in volume multiplied by
prior rate), (ii) changes attributable to changes in rate (changes in rate
multiplied by prior volume), and (iii) the net change. The changes attributable
to the combined impact of volume and rate have been allocated proportionately to
the changes due to volume and the changes due to rate.
<TABLE>
<CAPTION>
Year Ended December 31, 1996 Year Ended December 31, 1995
Compared To Compared To
Year Ended December 31, 1995 Year Ended December 31, 1994
------------------------------ ----------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------- ------------------
Volume Rate Net Volume Rate Net
-------- ------ ---- -------- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest earning deposits $ 1 $ -- $ 1 $ (81) $ 23 $ (58)
Investments 32 37 69 140 71 211
Mortgage-backed securities 20 (6) 14 (219) 11 (208)
Loans receivable, net 242 30 272 35 74 309
------ ------ ------ ------ ------ ------
Total interest income 295 61 356 75 179 254
Interest-bearing liabilities:
Deposits (2) (44) (46) (83) 155 72
FHLB advances 156 (11) 145 172 2 174
Capitalized lease obligations (1) -- (1) (2) -- (2)
------ ------ ------ ------ ------ ------
Total interest expense 153 (55) 98 87 157 244
------ ------ ------ ------ ------ ------
Net change in net interest income $142 $116 $258 $(12) $ 22 $ 10
------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------
</TABLE>
8
<PAGE>
Comparison of Financial Condition at December 31, 1996 and December 31, 1995.
Total assets increased $3.9 million, or 9.1%, to $47.1 million at December
31, 1996 from $43.1 million at December 31, 1995. The increase is primarily
attributable to an increase in loans. Loans increased $4.1 million, or 12.3% to
$37.5 million at December 31, 1996 from $33.3 million at December 31, 1995.
Cash and cash equivalents decreased $234,000, or 18.8% to $1.1 million at
December 31, 1996 from $1.25 million at December 31, 1995. Investment
securities remained substantially the same at December 31, 1996 and 1995. The
source of funds used to increase the balance of loans outstanding were the $3.4
million net proceeds from the stock conversion and increase in borrowings from
the Federal Home Loan Bank, offset by a decrease in deposits.
Advances from the Federal Home Loan Bank increased $1.7 million, or 31.5%
to $7.0 million at December 31, 1996 from $5.3 million at December 31, 1995.
Most of the advances are short-term advances with maturities of less than one
year.
Deposits decreased $1.1 million, or 3.3% to $32.6 million at December 31,
1996 from $33.7 million at December 31, 1995. The decrease is due to
competitive market conditions for deposits in the Bank's local market.
Stockholders' equity increased $3.4 million, or 89% to $7.3 million at
December 31, 1996 from $3.9 million at December 31, 1995. The increase was
caused by the $3.4 million net proceeds from the stock conversion and net income
of $186,000 for the year offset by a decrease in the unrealized gain on
available for sale securities of $149,000 net of income taxes.
Comparison of Operating Results for the Year Ended December 31, 1996 and
December 31, 1995.
General. The Bank's net income for the year ended December 31, 1996,
increased by $157,000 or 549% to $186,000 as compared to $29,000 for the year
ended December 31, 1995, primarily due to an increase in net interest income of
$257,000 to $3.3 million from $3.0 million for fiscal 1995 and an increase in
non-interest income of $51,000 to $154,000 from $102,000 for the fiscal 1995,
offset by an increase in general administrative expenses of $78,000 to $1.3
million for fiscal 1996 from $1.2 million for fiscal 1995, which was due to the
one time SAIF assessment and increase in provision for income taxes of $71,000
to $81,000 for fiscal 1996 from $10,000 for fiscal 1995.
Interest Income. Interest income for the year ended December 31, 1996 was
$3.34 million compared to $2.98 million for the year ended December 31, 1995, an
increase of approximately $355,000 or 12%. The increase in interest income was
primarily due to an increase in the average interest earning assets from $40.2
million for the year ended December 31, 1995 to $44.1 million for the year ended
December 31, 1996. The increase in average interest earnings assets was
primarily in loans receivable as average loans outstanding increased to $35.5
million for the year ended December 31, 1996 from $32.3 million for the year
ended December 31, 1995. The Bank has continued to emphasize the origination of
one to four family loans during 1996 and the proceeds from the stock conversion
were used primarily for loan originations. The Bank also experienced an
increase in the average yield on interest earning assets as the rate increased
to 7.56% for the year ended December 31, 1996 from 7.42% for the year ended
December 31, 1995. The average balance of mortgage backed securities,
investments, and other interest earning assets in total increased $762,000 to
$8.7 million for the year ended December 31, 1996 from $7.9 million for the year
ended December 31, 1995. The increase in other interest earning assets was due
to borrowings from the FHLB to fund the growth.
Interest Expense. Interest expense increased $98,000 or 5.3% from $1.8
million for the year ended December 31, 1995 to $1.9 million for the year ended
December 31, 1996. Average interest bearing liabilities increased $2.7 million
to $40.2 million for the year ended December 31, 1996 from $37.5 million for the
year ended December 31, 1995. This increase in interest bearing liabilities was
used to fund the asset growth. The Bank has continued to fund loan demand with
the use of borrowings from the FHLB. The majority of these borrowings are
short-term loans with terms of less than one year. The Bank continues to
believe that short term borrowings are less costly than raising rates on deposit
accounts in the current competitive deposit market. The average balance of
deposits for the year ended December 31, 1996 has remained relatively stable and
was $34.22 million for the year ended December 31, 1996 compared to $34.26 for
the year ended December 31, 1995. The Bank has increased its average borrowings
from the FHLB to $5.9 million for the year ended December 31, 1996 from $3.2
million for the year ended December 31, 1995. The Bank has experienced a
reduction in its average
9
<PAGE>
interest rate paid on interest bearing liabilities to 4.84% for the year
ended December 31, 1996 from 4.93% for the year ended December 31, 1995, as
the rates on borrowings and deposits have decreased during the year ended
December 31, 1996 as compared to December 31, 1995.
Provision for Loan Losses. The Bank had no provision for loan losses for
the year ended December 31, 1996 as compared to a credit of $2,000 for the
year ended December 31, 1995. The Bank closely monitors its mortgage and
consumer loan portfolios and maintains the allowance for loan losses through
the provision for loan losses, at a level which the Bank believes to be
adequate based on an evaluation of the collectibility of loans, prior loan
loss experience and general economic conditions. While management uses the
best information available to establish the allowance for loan losses, future
adjustments to the allowance may be necessary due to economic, operating,
regulatory and other conditions that may be beyond the Bank's control. The
Bank has seen a slight increase in non-performing loans as of December 31,
1996 to $109,000 at December 31, 1996 from $89,000 at December 31, 1995.
Other Income. Other income increased $51,000 or 50%, to $153,000 for the
year ended December 31, 1996 from $102,000 for the year ended December 31,
1995. The increase was due primarily to gain on sale of investments of
$26,000 and gain on sale of real estate owned of $12,000 for the year ended
December 31, 1996, with no corresponding amounts for the year ended December
31, 1995.
General, Administrative and Other Expenses. General, administrative and
other expenses increased $78,000 or 6.5% to $1.3 million for the year ended
December 31, 1996 from $1.2 million for the year ended December 31, 1995.
The increase in general, administrative and other expenses was due to the
special assessment relating to the recapitalization of the SAIF fund during
the third quarter of 1996. The Bank's assessment was $225,000. Excluding
this charge the Bank reduced general, administrative and other expenses by
approximately $147,000 to $1.05 million for the year ended December 31, 1996.
The reduction was due primarily a reduction in other operating expenses of
$102,000 from $428,000 for the year ended December 31, 1995 to $326,000 for
the year ended December 31, 1996, as the Bank did not have expenses relating
to a lawsuit which was settled in 1995. The Bank also experienced a
reduction in its occupancy and equipment expense of $48,000 as the Bank
benefited from changing to a new provider of data processing services.
Income Tax Expense. Income tax expense increased $71,000 to $81,000 for the
year ended December 31, 1996 from $10,000 for the year ended December 31, 1995.
The increase in income taxes is due to the increase in the net income before
taxes from $38,000 to $267,000 for the years ended December 31, 1995 and 1996
respectively. The effective tax rates for the years ended December 31, 1996 and
1995 were 30% and 26%, respectively.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1995 AND
DECEMBER 31, 1994.
General. The Bank's net income for the year ended December 31, 1995,
decreased by $79,000, or 73%, compared to the year ended December 31, 1994,
primarily due to general, administrative and other expenses increasing
$153,000. Interest expense for the year ended December 31, 1995 was $1.85
million compared to $1.60 million for the year ended December 31, 1994,
primarily as a result of the Bank's increased FHLB advances which were used
to finance purchases of United States government agency securities, increased
mortgage lending and to replace deposit runoff resulting from increased
competition for deposits. At December 31, 1995, the investment portfolio of
the Bank was $6.1 million compared to $4.2 million for the period ended
December 31, 1994, a 46.3% increase. The Bank also experienced a decrease in
deposits due to increased competition from other savings institutions and
other financial investments such as stock mutual funds. At December 31,
1995, the Bank had $33.7 million in deposits, a decrease of 5.2%, when
compared to $35.5 million at December 31, 1994.
Interest Income. Interest income for the year ended December 31, 1995 was
$2.98 million compared to $2.72 million for the year ended December 31, 1994,
an increase of approximately $255,000 or 9.4%. The increase in interest income
was primarily due to an increase in the Bank's yield on average interest-earning
assets, which for the year ending December 31, 1995 was 7.42% compared to 6.92%
for the year ending December 31, 1994. In addition, the Bank experienced a
significant increase in the Bank's loans receivable and a corresponding increase
in interest income. The average balance of loans receivable at December 31,
1995 was $32.3 million compared to $29.1 million at December 31, 1994, an
increase of $3.2 million or 11.0%. Interest income from loans receivable
increased $308,000 for the year ending December 31, 1995, to
10
<PAGE>
$2.44 million, compared to $2.13 million for the year ended December 31,
1994, a 14.5% increase. Interest from investments, mortgage-backed
securities and interest-bearing deposits decreased $54,000, or 9.1%, to
$542,000 for the year ended December 31, 1995, compared with $596,000 for the
year ended December 31, 1994.
Interest Expense. Interest expense increased by $244,000, or 15.21%, from
$1.60 million for the year ended December 31, 1994 to $1.85 million for the year
ended December 31, 1995. The increase resulted primarily from an increase on
the average rate paid on interest-bearing liabilities of 54 basis points, from
4.39% to 4.93% for the respective periods, which was primarily due, among other
factors, to the Federal Reserve Board's increase in short-term rates throughout
calendar year 1994. Interest expense on deposit accounts increased $72,000, or
4.6%, from $1.58 million for the year ended December 31, 1994 to $1.65 million
for the year ended December 31, 1995. Additionally, the Bank's interest
expense on advances from the FHLB increased by $174,000 from $23,000 for the
year ended December 31, 1994, to $197,000 for the year ended December 31, 1995.
The Bank generally has relied upon a combination of deposits, borrowed funds and
retained earnings to fund loan originations and other assets. However, in
recent years, as the Bank's deposit base has declined, largely reflecting the
competition for deposits in the Bank's market area and customers' interest in
seeking higher yielding investments for their funds, the Bank has begun to rely
upon FHLB advances as a source of funds as well. The FHLB advances are
currently comprised primarily of fixed rate, term advances with terms generally
of less than one year. In the future the Bank may decide to attempt to attract
deposits by raising the interest rates offered by the Bank; however, currently
the Bank believes that using short-term FHLB advances is less costly than
raising rates offered on its deposit accounts.
Provision for loan losses. The provision for loan losses decreased
$2,000 for the year ended December 31, 1995 from no provision during the year
ended December 31, 1994. As a result, the allowance for loan losses at
December 31, 1995, totalled $60,000. The Bank closely monitors its mortgage
and consumer loan portfolios and maintains the allowance for loan losses
through the provision for loan losses, at a level which the Bank believes to
be adequate based on an evaluation of the collectibility of loans, prior loan
loss experience and general economic conditions. While management uses the
best information available to establish the allowance for loan losses, future
adjustments to the allowances may be necessary due to economic, operating,
regulatory and other conditions that may be beyond the Bank's control. The
decreased provision for the year ended December 31, 1995 reflects
management's evaluation of the risks inherent in its loan portfolio. Total
nonperforming loans decreased from $93,000, or .29% of gross loans, at
December 31, 1994 to $89,000, or .27% of gross loans, at December 31, 1995.
As a result of the $4,000 decrease in nonperforming loans from December 31,
1994 to December 31, 1995 and the $2,000 decrease in the provision for loan
losses, the ratio of allowance for loan losses to nonperforming loans
remained at approximately 67% at December 31, 1995.
Other Income. Other income increased $32,000 or 45.7% from $70,000 for the
year ended December 31, 1994 to $102,000 for the year ended December 31, 1995.
The increase was primarily due to an increase in service fee income of $18,000
or 21.4% from $84,000 for the year ended December 31, 1995 to $102,000 for the
year ended December 31, 1995. In addition, for the year ended December 31, 1994
the Bank recorded a loss of $14,000 on the sale of a mortgage-backed mutual fund
while no losses were recorded on the sale of securities for the year ended
December 31, 1995.
General and Administrative Expense. General and administrative expense
increased $153,000, or 14%, from $1.04 million for the year ended December 31,
1994 to $1.20 million for the year ended December 31, 1995, primarily due to
increases in salaries and other employee benefits and other administrative
expenses of $115,000, or 15%, from $740,000 for the year ended December 31, 1994
to $855,000 for the year ended December 31, 1995. The increases in salary
expense primarily were due to the Bank's hiring of a Chief Financial
Officer/Treasurer and a Mortgage Loan Originator. The increase in other
operating expense for the year ended December 31, 1995 as compared to the year
ended December 31, 1994 was due to the Bank's increase in expense and attorney's
fees for a lawsuit brought against the Bank that was settled in 1995, which
totalled $104,000. In addition, general and administrative expense increased
due to lease payments the Bank agreed to pay Procter & Gamble. Such payments
increase general and administrative expense by approximately $21,000 per year.
In addition, in an effort to reduce costs the Bank switched data processing
providers and eliminated four of the Bank's ten ATMs in 1995.
Income Tax Expense. Income tax expense decreased by $28,000, or 73%, from
$38,000 for the
11
<PAGE>
year ended December 31, 1994 to $10,000 for the year ended December 31, 1995.
The decrease was due to a decrease of pre-tax earnings of $107,000, or 73%
from $146,000 for the year ended December 31, 1994 to $39,000 for the year
ended December 31, 1995. The effective tax rates for the years ended
December 31, 1994 and 1995 were 26% and 26%, respectively.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, principal and
interest payments on loans and FHLB advances. While maturities and scheduled
amortization of loans are predictable sources of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates,
economic conditions, and competition. Due to the declining interest rate
environment in 1992 and 1993 and management's determination not to
aggressively price its deposit products, the Bank experienced a decline in
its level of deposits. The FDIC requires savings banks to maintain a level
of investments in specified types of liquid assets sufficient to protect and
ensure the safety and soundness of the savings bank. The Bank will maintain
a minimum level of liquidity, as defined by the FDIC, such that the total of
cash and marketable investment securities divided by total deposits and
short-term liabilities will exceed 15%. The Bank's liquidity ratios were
21.6%, 25% and 28% at December 31, 1996, 1995 and 1994, respectively.
The primary investment activity of the Company is the origination of one-
to four-family mortgage loans and consumer loans, and the purchase of
investments. During the years ended December 31, 1996, 1995 and 1994, the Bank
originated mortgage loans in the amounts of $9.3 million, $6.2 million and $8.5
million, respectively, and consumer loans in the amount of $1.3 million, $2.1
million and $2.1 million, respectively.
The FDIC has adopted risk-based capital ratio guidelines to which the Bank
is subject. The guidelines establish a systematic analytical framework that
makes regulatory capital requirements more sensitive to differences in risk
profiles among banking organizations. Risk-based capital ratios are determined
by allocating assets and specified off-balance sheet commitments to four
risk-weighted categories, with higher levels of capital being required for the
categories perceived as representing greater risk.
These guidelines divide a bank's capital into two tiers. The first tier
("Tier 1") includes common equity, certain non-cumulative perpetual preferred
stock (excluding auction rate issues), retained earnings and minority interests
in equity accounts of consolidated subsidiaries, less goodwill and certain other
intangible assets (except mortgage servicing rights and purchased credit card
relationships, subject to certain limitations). Supplementary ("Tier II")
capital includes, among other items, cumulative perpetual and long-term
limited-life preferred stock, mandatory convertible securities, certain hybrid
capital instruments, term subordinated debts and the allowance for loan and
lease losses, subject to certain limitations, less required deductions. Banks
are required to maintain a total risk-based capital ratio of 8%, of which 4%
must be Tier I capital. The FDIC may, however, set higher capital requirements
when a bank's particular circumstances warrant. Banks experiencing or
anticipating significant growth are expected to maintain a Tier I leverage
ratio, including tangible capital positions, well above the minimum levels.
In addition, the FDIC established guidelines prescribing a minimum Tier I
leverage ratio (Tier I capital to adjusted total assets as specified in the
guidelines). These guidelines provide for a minimum Tier I leverage ratio of 3%
for banks that meet certain specified criteria, provided that they have the
highest regulatory rating and are not experiencing or anticipating significant
growth. All other banks are required to maintain a Tier I leverage ratio of 3%
plus an additional cushion of at least 100 to 200 basis points. At December 31,
1996, the Bank maintained a leverage ratio of 24.1% and total capital to risk
weighted assets ratio of 11.7%. See Note 9 to the Financial Statements
appearing elsewhere in this Annual Report
The Bank's most liquid assets are cash and short-term investments. The
levels of these assets are dependent on the Bank's operating, financing, lending
and investing activities during any given period. At December 31, 1996, cash
and short-term investments totaled $1.3 million.
At December 31, 1996 the Bank had outstanding loan commitments (including
undisbursed loan proceeds) of $701,000. The Bank anticipates that it will have
sufficient funds available to meet its current loan origination commitments.
Certificates of deposit which are scheduled to mature in one year or less from
December 31, 1996, totaled $11.2 million.
12
<PAGE>
Impact of Inflation And Changing Prices
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with GAAP, which require the measurement of
financial position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of the
Company's operations. Unlike industrial companies, nearly all of the assets and
liabilities of the Company are monetary in nature. As a result, interest rates
have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
13
<PAGE>
[LOGO of Clark, Schaefer, Hackett & Co.]
Independent Auditors' Report
The Board of Directors
Lenox Bancorp Inc.:
We have audited the accompanying consolidated balance sheets of Lenox
Bancorp Inc. (formerly Lenox Savings Bank) as of December 31, 1996 and 1995,
and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Bancorp's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Lenox
Bancorp Inc. (Lenox Savings Bank) as of December 31, 1996 and 1995, and the
results of its operations and its cash flows each of the three years in the
period ended December 31, 1996 in conformity with generally accepted
accounting principles.
/s/ Clark, Schaefer, Hackett & Co.
Cincinnati, Ohio
January 24, 1997
14
<PAGE>
LENOX BANCORP, INC.
Consolidated Balance Sheets
December 31, 1996 and 1995
Assets
----------
<TABLE>
<CAPTION>
December 31,
-----------------------------
1996 1995
---------- ----------
<S> <C> <C>
Cash and due from banks (including federal
funds of $364,337, and $97,105 at
December 31, 1996 and 1995) $ 1,114,879 1,249,318
Certificates of deposit 162,280 151,874
Investment securities - available for
sale, at fair value (amortized cost
of $6,192,698 and $6,021,760 at
December 31, 1996 and 1995) 6,088,737 6,080,487
Mortgage-backed securities - available
for sale, at fair value (amortized
cost of $1,148,411 and $1,023,745 at
December 31, 1996 and 1995) 1,148,411 1,082,553
Loan receivable, net 37,495,377 33,383,757
Accrued interest receivable:
Loans 148,392 123,606
Mortgage-backed securities 7,572 7,409
Investments and certificates of deposit 129,606 103,540
Property and equipment, net 263,651 287,727
Federal Home Loan Bank stock - at cost 436,000 406,900
Prepaid federal income tax - 19,000
Prepaid expenses and other assets 79,450 252,820
---------- ----------
$ 47,074,355 43,148,991
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to financial statements.
15
<PAGE>
Liabilities and Retained Earnings
<TABLE>
<CAPTION>
December 31,
-----------------------------
1996 1995
---------- ----------
<S> <C> <C>
Deposits $ 32,551,255 33,668,938
Advances from Federal Home Loan Bank 7,006,703 5,327,482
Capitalized lease obligations 4,867 16,262
Advance payments by borrowers for taxes
and insurance 93,643 94,765
Accrued expenses 52,440 87,390
Accrued federal income taxes 44,000 -
Deferred federal income taxes 51,650 106,024
------------ -----------
39,804,558 39,300,861
Commitments - -
Stockholders' equity
Common stock-authorized 2,000,000 shares
$1 par value, 425,677 issued and
outstanding at December 31, 1996 425,677 -
Additional paid in capital 3,285,086 -
Retained earnings - substantially restricted 3,953,726 3,767,619
Less unearned ESOP shares (326,080) -
Unrealized gain (loss) on available for sale
securities net of income taxes. (68,612) 80,511
-------------- ----------
7,269,797 3,848,130
-------------- ----------
$ 47,074,355 43,148,991
-------------- ----------
-------------- ----------
</TABLE>
See accompanying notes to financial statements.
16
<PAGE>
LENOX BANCORP, INC.
Consolidated Statements of Income
Three Years Ended December 31, 1996
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Interest and dividend income:
Loans $ 2,710,337 2,438,277 2,130,280
Mortgage-backed securities 79,968 66,438 274,160
Investments and interest bearing deposits 516,614 449,180 296,571
Federal Home Loan Bank 29,235 26,593 24,641
------------- ---------- ---------
3,336,154 2,980,488 2,725,652
------------- ---------- ---------
Interest expense:
Deposits 1,603,571 1,649,038 1,576,980
Borrowed money and capitalized leases 342,828 199,076 27,264
------------- ---------- ---------
1,946,399 1,848,114 1,604,244
------------- ---------- ---------
Interest income before provision for
loan losses 1,389,755 1,132,374 1,121,408
Provision (credit) for loan losses - (2,000) -
------------- ---------- ---------
Net interest income after provision
for loan losses 1,389,755 1,134,374 1,121,408
------------- ---------- ---------
Other income:
Service fee and other income 115,343 102,356 84,343
Gain on sale of real estate owned 12,295 - -
Gain (loss) on sale of investments 25,917 - (14,251)
------------- ---------- ---------
153,555 102,356 70,092
------------- ---------- ---------
General, administrative and other expenses:
Compensation and employee benefits 448,229 427,028 407,307
Occupancy and equipment 166,833 215,345 170,598
Federal deposit insurance premiums 282,673 79,773 85,678
Franchise taxes 52,221 48,045 48,516
Other operating expenses 326,247 427,995 333,295
------------- ---------- ---------
1,276,203 1,198,186 1,045,394
------------- ---------- ---------
Income before provision for
income taxes 267,107 38,544 146,106
Provision for income taxes 81,000 9,860 38,337
------------- ---------- ---------
Net income $ 186,107 28,684 107,769
------------- ---------- ---------
------------- ---------- ---------
Earnings per share $ 0.13 N/A N/A
------------- ---------- ---------
------------- ---------- ---------
</TABLE>
See accompanying notes to financial statements.
17
<PAGE>
LENOX BANCORP, INC.
Consolidated Statement of Changes in Stockholders' Equity
Three Years Ended December 31, 1996
<TABLE>
<CAPTION>
Unrealized
Gain (loss)
Additional Unearned on Available
Common Paid in Retained ESOP for Sale
Stock Capital Earnings Shares Securities Total
-------- ----------- ---------- ---------- ------------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 $ 3,631,166 3,631,166
Net income for the year ended
December 31, 1994 - - 107,769 - - 107,769
-------- --------- --------- -------- -------- ---------
Balance at December 31, 1994 - - 3,738,935 - - 3,738,935
Net income for the year ended
December 31, 1995 28,684 28,684
Net unrealized gain on available-
for-sale securities net of tax
of $37,024, upon transfer of
securities at December 31, 1995 - - - - 80,511 80,511
-------- --------- --------- -------- -------- ---------
Balance at December 31, 1995 - - 3,767,619 - 80,511 3,848,130
Reorganization to a stock company
with the issuance of common
stock 425,677 3,282,519 (340,540) 3,367,656
Net income for the year ended
December 31, 1996 186,107 186,107
Decrease in unrealized gain (loss) on
available-for-sale securities net of
tax of $72,374 (149,123) (149,123)
ESOP shares committed to be
allocated at average market price - 2,567 - 14,460 - 17,027
-------- --------- --------- -------- -------- ---------
Balance at December 31, 1996 $425,677 3,285,086 3,953,726 (326,080) (68,612) 7,269,797
-------- --------- --------- -------- -------- ---------
-------- --------- --------- -------- -------- ---------
</TABLE>
See accompanying notes to financial statements.
18
<PAGE>
LENOX BANCORP, INC.
Consolidated Statements of Cash Flows
Three Years Ended December 31, 1996
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Cash flows from operating activities:
Interest and dividends received $ 3,239,825 2,872,709 2,659,380
Interest paid (1,937,876) (1,848,114) (1,604,244)
Loan origination fees received 27,841 10,176 56,288
Other fees 108,856 99,596 84,343
Cash paid to suppliers and employees (1,306,003) (1,326,502) (1,038,184)
Income taxes (paid) refunded - 24,140 (38,977)
-------------- ----------- ----------
Net cash provided (used) by operating activities 132,643 (167,995) 118,606
-------------- ----------- ----------
Cash flows from investing activities:
Property and equipment additions (28,183) (89,691) (17,116)
Proceeds from sale of equipment 11,500 16,750 -
Purchase of mortgage-backed securities
held to maturity - (350,219) -
Purchase of mortgage-backed securities -
available for sale (953,053) - -
Repayments of mortgage-backed securities 221,316 112,406 347,018
Proceeds from sale of mortgage-backed securities-
available for sale 636,303 - 4,156,466
Purchase of certificates of deposit (10,406) (151,874) -
Redemption of certificates of deposit - 488,347 762,186
Loan disbursements (10,578,760) (8,297,193) (10,673,000)
Loans purchased (884,168) - -
Loan principal repayments 7,313,477 6,536,363 7,292,623
Purchase of investments - held to maturity - (6,326,298) (3,861,612)
Purchase of investment securities - available for sale (6,886,789) - -
Maturity of investment securities - held to maturity - 4,460,000 -
Maturity of investments - available for sale 1,820,000 - -
Proceeds from sale of investments - available for sale 4,893,785 - 3,050,233
Proceeds from sale of real estate acquired through
foreclosure 52,204 - -
-------------- ----------- ----------
Net cash provided (used) by investing activities (4,392,774) (3,601,409) 1,056,798
-------------- ----------- ----------
Cash flows from financing activities:
Net decrease in deposits (1,117,683) (1,857,011) (2,594,216)
Borrowings from Federal Home Loan Bank 2,075,000 4,950,000 235,800
Repayment of Federal Home Loan Bank loan (395,779) (24,041) (18,361)
Payments on capitalized lease obligations (11,395) (28,862) (47,677)
Proceed from sale of stock upon conversion 3,575,549 - -
----------------- ------------ -------------
Net cash provided (used) by financing activities 4,125,692 3,040,086 (2,424,454)
----------------- ------------ -------------
Decrease in cash and cash equivalents (134,439) (729,318) (1,249,050)
Cash and due from banks at beginning of period 1,249,318 1,978,636 3,227,686
----------------- ------------ -------------
Cash and due from banks at end of period $ 1,114,879 1,249,318 1,978,636
----------------- ------------ -------------
----------------- ------------ -------------
</TABLE>
See accompanying notes to financial statements.
19
<PAGE>
LENOX BANCORP, INC.
Consolidated Statements of Cash Flows
Three Years Ended December 31, 1996
Reconciliation of Net Income to Net Cash
Provided by Operating Activities
--------------------------------
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Net income $ 186,107 28,684 107,769
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 45,097 59,421 71,345
Credit for losses on loans - (2,000) -
Amortization of deferred loan fees (14,963) (13,438) (10,415)
Deferred loan origination fees (costs) 13,784 (2,756) (10,210)
Federal Home Loan Bank stock dividends (29,100) (26,400) (20,900)
Loss (gain) on sale of investment and
mortgage-backed securities (25,917) - 14,251
Gain on sale of equipment (6,487) (2,760) -
Gain on sale of real estate acquired
through foreclosure (12,295) - -
Effect of change in operating assets and
liabilities:
Accrued interest receivable (51,015) (70,179) (38,207)
Prepaid expenses and other assets (15,523) (210,181) (22,819)
Advances by borrowers for taxes
and insurance (1,122) 14,345 13,108
Accrued expenses (17,923) 49,069 (5,616)
Accrued federal income tax 44,000 - -
Deferred federal income tax 18,000 8,200 20,300
------------ ----------- -----------
Net cash provided (used) by
operating activities 132,643 (167,995) 118,606
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
- -----------------------------------------------------------------------
Capitalized lease obligation of $17,883 was incurred when the Company entered
into a lease for automated teller equipment for the year ended
December 31, 1994.
Investment and mortgage-backed securities with a carrying value of $7,045,505
were transferred to the available for sale classification at
December 31, 1995.
Loans with a carrying value of $39,010 were transferred to real estate
acquired through foreclosure during 1996.
See accompanying notes to financial statements.
20
<PAGE>
Notes to Financial Statements
1. Organization and Summary of Significant Accounting Policies:
---------------------------------------------------------
The following describes the organization and the significant accounting
policies followed in the preparation of these financial statements. Certain
amounts in the financial statements have been reclassified from previously
issued financial statements to conform to the presentation included herein.
Nature of operations and principles of consolidation
----------------------------------------------------
Lenox Bancorp Inc. (the Bancorp) is a holding company formed in 1995
in conjunction with the conversion of Lenox Savings Bank from a mutual
savings bank to a stock savings bank in July 1996. The conversion
culminated in the Corporation's issuance of 425,677 shares. The
Bancorp's financial statements include the accounts of its wholly-owned
subsidiary, Lenox Savings Bank. All significant intercompany
transactions have been eliminated.
Lenox Savings Bank is a state chartered savings bank and a member of
the Federal Home Loan Bank system (FHLB) and subject to regulation by
the Federal Deposit Insurance Corporation (FDIC) and the State of Ohio.
As a member of the FHLB system, Lenox Savings Bank maintains a required
investment in capital stock of the Federal Home Loan Bank of
Cincinnati.
Savings accounts are insured by the Savings Association Insurance
Fund (SAIF), a division of the Federal Deposit Insurance Corporation
(FDIC), within certain limitations. Semi-annual premiums are required
by the SAIF for the insurance of such savings accounts.
Use of estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and that affect the reported amounts
of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Areas where management's estimates
and assumptions are more susceptible to change in the near term include
the allowance for loan losses and the fair value of certain securities.
21
<PAGE>
Cash and due from banks
-----------------------
For the purpose of presentation in the statements of cash flows, the
Company considers all highly liquid debt instruments with original
maturity when purchased of three months or less to be cash equivalents.
Cash and cash equivalents are defined as those amounts included in the
balance sheets caption cash and due from banks.
The Company maintains their cash deposit accounts at financial
institutions where the balance at times may exceed federally insured
limits.
Investment and mortgage-backed securities
-----------------------------------------
The Company adopted Statement of Financial Accounting Standards No.
115, Accounting for Certain Investments in Debt and Equity Securities,
as of January 1, 1994. Statement No. 115 requires the classification of
investments in debt and equity securities into three categories; held
to maturity, trading, and available for sale. Debt securities that the
Company has the positive intent and ability to hold to maturity are
classified as held to maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally
for the purpose of selling in the near-term are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings. The Company has no trading securities. Debt and
equity securities not classified as either held to maturity securities
or trading securities are classified as available for sale securities
and reported at fair value, with unrealized gains or losses excluded
from earnings and reported as a separate component of equity, net of
deferred taxes.
The Company designates investment securities and mortgage-backed
securities as held to maturity or available for sale upon acquisition.
Gains or losses on the sales of investment securities and mortgage-
backed securities available for sale are determined on the specific
identification method. Premiums and discounts on investment securities
and mortgage-backed securities are amortized or accredited using the
interest method over the expected lives of the related securities.
22
<PAGE>
In November 1995, the Financial Accounting Standards Board issued a
Special Report "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities".
The guide provided technical interpretations and guidance relating
to the adoption of SFAS No. 115, issued in May 1993. This guide allows
an enterprise to reassess the appropriateness of the classifications
of all securities held at that time and account for any resulting
reclassifications at fair value in accordance with SFAS No. 115.
Those one-time reassessments should occur no later than December 31,
1995. Management reclassified its entire portfolio of investments
and mortgage-backed securities from "held to maturity" to "available
for sale" at December 31, 1995, in accordance with the guide, to
reflect their intention as to the classification of the securities.
Loans receivable
----------------
Loans receivable that management has the intent and ability to hold
for the foreseeable future or until maturity or payoff are reported
at their outstanding unpaid principal balances reduced by any charge
offs or specific valuation accounts and net of any deferred fees or
costs on originated loans, or unamortized premiums or discounts on
purchased loans. At December 31, 1996 the entire portfolio of loans
was held for investment.
Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield of the
related loan.
The allowance for loan and real estate losses is increased by
charges to income and decreased by charge offs (net of recoveries).
Management's periodic evaluation of the adequacy of the allowance is
based on the Company's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of any underlying
collateral, and current economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such
agencies may require the Company to recognize additions to the
allowance based on judgments different from those of management.
Although management uses the best information available to make
these estimates, future adjustments to the allowances may be necessary
in the near term due to economic, operating, regulatory and other
conditions that may be beyond the Company's control. However, the
amount of the change that is reasonably possible cannot be estimated.
23
<PAGE>
The accrual of interest on impaired loans is discontinued when, in
management opinion, the borrower may be unable to meet payments as
they become due. When interest accrual is discontinued, all unpaid
accrued interest is reversed. Interest income is subsequently
recognized only to the extent cash payments are received.
In May 1993, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 114, "Accounting
by Creditors for Impairment of a Loan". This standard amends
Statement No. 5 to clarify that a creditor should evaluate the
collectibility of both contractual interest and contractual
principal on all loans when assessing the need for a loss accrual.
In October, 1994, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 118. "Accounting by
Creditors for Impairment of a Loan - Income Recognition and
Disclosure", which amends Statement No. 114 to allow a creditor to
use existing methods for recognizing interest income on impaired
loans.
For impairment recognized in accordance with SFAS No. 114, the
entire change in present value of expected cash flows is reported as
bad debt expense in the same manner in which impairment initially was
recognized or as a reduction in the amount of bad debt expense that
otherwise would be reported. Interest on impaired loans is reported
on the cash basis. Impaired loans are loans that are considered to
be permanently impaired in relation to principal or interest based
on the original contract. Impaired loans would be charged off in the
same manner as all loans subject to charge off. For the years ended
December 31, 1996 and 1995 the Company had no loans that were
impaired as described in the pronouncement and therefore no interest
income was recognized or received on impaired loans.
Foreclosed real estate
----------------------
Real estate properties acquired through, or in lieu of, loan
foreclosure are to be sold and are initially recorded at fair value
at the date of foreclosure establishing a new cost basis. After
foreclosure, valuations are periodically performed by management
and the real estate is carried at the lower of carrying amount or
fair value less cost to sell. Revenue and expenses from operations
and changes in the valuation allowance are included in loss on
foreclosed real estate.
24
<PAGE>
Property and equipment
- -----------------------
Furniture and equipment, and leasehold improvements are carried at cost, less
accumulated depreciation and amortization computed by straight-line and
accelerated methods over the estimated useful lives of the respective assets.
Income taxes
- ------------
Deferred tax assets and liabilities represent the tax effects of the
temporary differences in the basis of certain assets and liabilities for tax
and financial statement purposes, calculated at currently effective tax
rates, of future deductible or taxable amounts attributable to events that
have been recognized on a cumulative basis in the financial statements.
The Company's principal temporary differences between pretax financial income
and taxable income result from different methods of accounting for deferred
loan origination fees and costs, Federal Home Loan Bank stock dividends, the
general loan loss allowance and the post-1987 percentage of earnings bad debt
deduction. For certain assets acquired after December 31, 1980, a temporary
difference is also recognized for depreciation utilizing accelerated methods
for Federal income tax purposes.
Concentration of customers
- --------------------------
The Company grants real estate and consumer loans to, and accepts deposits
from customers who are primarily employees of The Procter & Gamble Company
located in the Metropolitan Cincinnati area.
Fair values of financial instruments
- -------------------------------------
The following methods and assumptions were used by the Company in estimating
fair values of financial instruments as disclosed herein:
Cash and short-term instruments. The carrying amounts of cash and
short-term instruments approximate their fair value.
25
<PAGE>
Available-for-sale and held-to-maturity securities. Fair values for
securities excluding restricted equity securities, are based on
quoted market prices. The carrying values of restricted equity
securities approximate fair values.
Loans receivable. For variable-rate loans that reprice frequently
and have no significant change in credit risk, fair values are based
on carrying values. Fair values for certain mortgage loans (for
example, one-to-four family residential), credit-card loans, and
other consumer loans were estimated by discounting the future cash
flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining
maturities.
Deposit liabilities. The fair values disclosed for demand deposits,
NOW and money market accounts are, by definition, equal to the
amount payable on demand at the reporting date (that is, their
carrying amounts). Fair values for fixed-rate CDs are estimated
using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
FHLB advances. The fair values of FHLB advances are estimated using
discounted cash flow analyses based on the Company's current
incremental borrowing rates for similar types of borrowing
arrangements
Accrued interest. The carrying amounts of accrued interest
approximate their fair values.
Off balance sheet instruments
- -----------------------------
In the ordinary course of business the Company has entered into off balance
sheet financial instruments consisting of commitments to extend credit and
commitments under line of credit loans. Such financial instruments are
recorded in the financial statements when they are funded or related fees are
incurred or received.
26
<PAGE>
Recent accounting pronouncements
- --------------------------------
In May 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 122, "Accounting for Mortgage Servicing
Rights". This statement requires that a mortgage banking enterprise recognize
as separate assets rights to service mortgage loans for others, however those
servicing rights are acquired. A mortgage banking enterprise that acquires
mortgage servicing rights through either the purchase or origination of
mortgage loans and sells or securitizes those loans with servicing rights
retained would allocate the total cost of the mortgage loans to the mortgage
servicing rights and the loans based on their relative fair value. Statement
No. 122 is effective for fiscal years beginning after December 15, 1995.
There was no impact from the adoption of this standard in 1996.
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting No. 123, "Accounting for Stock-Based Compensation". This
statement establishes accounting and reporting standards for stock-based
employee compensation plans including stock options. The statement defines a
"fair value based method" for employee stock options and encourages all
entities to adopt that method for such options. However, it allows an entity
to continue to measure compensation cost for those plans using the "intrinsic
value based method" of accounting prescribed by APB Opinion No. 25. Entities
electing to remain with the accounting in Opinion 25 must make proforma
disclosures of net income and earnings per share, as if the fair value method
of accounting defined in this statement had been applied. There was no impact
from the adoption of this standard since the Company does not have any stock
options.
In June 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" which
established accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. The standards are based
on a consistent application of a financial components approach that focuses
on control. Under that approach, after a transfer of financial assets, an
entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has
been surrendered, and derecognizes liabilities when extinguished. SFAS No. 125
provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. SFAS No.
125 supercedes No. 122. SFAS No. 125 is effective for transactions occurring
after December 31, 1996. Management is currently assessing the impact of this
standard.
27
<PAGE>
Earnings per share
- ------------------
Earnings per share for the year ended December 31, 1996 is based on the
Company's net income for the six months that it was operational divided by
392,346 weighted average shares outstanding. Weighted-average shares
outstanding do not include unallocated shares purchased by the Employee Stock
Ownership Plan (ESOP). Disclosure of earnings per share for 1995 and 1994 are
not applicable, as the Company completed its conversion from mutual to stock
form in July 1996.
Reclassifications
- ------------------
Certain reclassifications were made to the prior year financial statements to
conform the current year's presentation.
2. Investment and Mortgage-Backed Securities:
------------------------------------------
The amortized cost and estimated fair values of investment and
mortgage-backed securities are as follows:
<TABLE>
<CAPTION>
December 31, 1996
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------- ---------
<S> <C> <C> <C> <C>
U.S. Government
and agencies
securities $6,192,698 1,742 105,703 6,088,737
Mortgage-backed
securities 1,148,411 -- -- 1,148,411
------------- ------------- -------------- -----------
$7,341,109 1,742 105,703 7,237,148
------------- ------------- -------------- -----------
------------- ------------- -------------- -----------
<CAPTION>
December 31, 1995
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------- ---------
<S> <C> <C> <C> <C>
U.S. Government
and agencies
securities $5,567,157 64,146 6,820 5,624,483
Corporate notes 454,603 1,401 -- 456,004
Mortgage-backed
securities 1,023,745 58,808 -- 1,082,553
------------ ------------ ------------- ---------
$7,045,505 124,355 6,820 7,163,040
------------ ------------ ------------- ---------
------------ ------------ ------------- ---------
</TABLE>
28
<PAGE>
The Company has mortgage-backed securities with a carrying value of
$1,148,411 as of December 31, 1996. The amortized cost of these securities
approximates fair value and there were no significant gross unrealized gains
or losses on any individual mortgage-backed security.
The amortized cost and estimated market values of investment and
mortgage-backed securities at December 31, 1996 and 1995 by contractual
maturity are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
--------------------- -------------------
Estimated Estimated
Market Market
Cost Value Cost Value
---- --------- ---- ---------
<S> <C> <C> <C> <C>
Due in one year or less $ -- -- 704,603 705,927
Due in one to five years -- -- 1,450,000 1,446,342
Due in five to ten years 2,994,462 2,955,645 3,867,157 3,928,218
Due in over ten years 3,198,236 3,133,092 -- --
Mortgage-backed securities 1,148,411 1,148,411 1,023,745 1,082,553
---------- ---------- --------- ---------
$7,341,109 7,237,148 7,045,505 7,163,040
---------- ---------- --------- ---------
---------- ---------- --------- ---------
</TABLE>
The amortized cost and market values of investment securities by call date
at December 31, 1996 are as follows:
<TABLE>
<CAPTION>
Amortized Market
Cost Value
--------- ------
<S> <C> <C>
Callable in one year or less $4,349,813 4,273,020
Callable in one to three years 1,444,564 1,416,905
Callable in three to five years 398,321 398,812
---------- ---------
$6,192,698 6,088,737
---------- ---------
---------- ---------
</TABLE>
Proceeds and resulting gains and losses realized from sale of investments
and mortgage-backed securities for years ended December 31, 1996, 1995, and
1994 were as follows:
29
<PAGE>
Net
Realized
Gross Gross Gross Gain
Proceeds Gains Losses (Loss)
-------- ----- ------ ---------
Year ended December 31, 1996 $5,530,089 37,294 11,377 25,917
Year ended December 31, 1995 -- -- -- --
Year ended December 31, 1994 $7,206,699 279,282 293,533 (14,251)
As discussed in Note 1, the Company adopted Statement No. 115 as of January
1, 1994, and investment securities were classified based on the Company's
current intent. The impact of adopting the new standard resulted in an
increase in the carrying value of investments by $324,254 to reflect the
unrealized holding gain at January 1, 1994 for securities classified as
available for sale. Additionally, stockholders' equity was increased by
$214,000 to reflect the unrealized holding gain as a separate component of
stockholders' equity, net of taxes of $110,254. Statement No. 115 had no
impact on earnings for the year ended December 31, 1994.
Management reclassified all investment and mortgage-backed securities to
available for sale at December 31, 1995.
3. Loans Receivable:
Loans receivable are summarized as follows:
1996 1995
---- ----
Mortgage loans secured by one to
four family residences $34,832,212 30,685,593
Home equity line of credit 412,248 --
Consumer 2,293,457 2,796,487
Unsecured consumer line of credit 91,090 --
Passbook loans 13,784 20,995
----------- ----------
37,642,791 33,503,075
----------- ----------
Less:
Loans in process 47,574 16,020
Allowance for loan loss 57,770 60,050
Deferred loan fees 42,070 43,248
----------- ----------
147,414 119,318
----------- ----------
$37,495,377 33,383,757
----------- ----------
----------- ----------
30
<PAGE>
At December 31, 1996 and 1995, adjustable rate loans approximated
$17,247,000 and $18,041,000.
Activity in the allowance for loan losses are as follows:
Year Ended December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
Beginning balance $60,050 66,259 65,959
Provision (credit) for
loan losses -- (2,000) --
Charge off of loans (4,330) (5,411) (1,178)
Recoveries of prior
charge-offs 2,050 1,202 1,478
------- ------ ------
$57,770 60,050 66,259
------- ------ ------
------- ------ ------
The Company grants first mortgage and other loans to customers who are
primarily Procter and Gamble employees located in the Metropolitan
Cincinnati area. Accordingly, a substantial portion of its debtors'
ability to honor their contracts is dependent on continued employment at
Procter and Gamble as well as the health of the local economy and market.
Loans to officers and directors totaled approximately $575,451 and
$570,413 as of December 31, 1996 and 1995, respectively. An analysis of
loan activity for the years ended December 31, 1996 and 1995 follows:
1996 1995
---- ----
Outstanding balance, beginning $570,413 625,512
New loans issued 109,600 215,200
Repayments (104,562) (164,759)
Retirement of director -- (105,810)
-------- --------
Outstanding balance, ending $575,451 570,143
-------- --------
-------- --------
4. Property and Equipment:
-----------------------
Property and equipment at December 31, 1996 and 1995 are summarized by
major classification as follows:
31
<PAGE>
1996 1995
---- ----
Furniture and equipment $251,535 274,327
Leasehold improvements 240,595 240,595
-------- -------
492,130 514,922
Accumulated depreciation 228,479 227,195
-------- -------
$263,651 287,727
-------- -------
-------- -------
In 1993, the Company constructed an addition with a cost of $126,938 to
the building that it is currently leasing. The Company has an agreement
with the lessor that if the lease is terminated, the Company will receive
from the lessor a set dollar amount based on a ten year declining
schedule. The building addition at the end of the lease becomes the
property of the lessor.
Effective July 1, 1995, the Company entered into a five-year lease with
Procter and Gamble for its facilities. Rent expense for the year ended
December 31, 1996 and 1995 was $22,975 and $11,488. Future minimum lease
payments on the lease at December 31, 1996 are as follows:
1997 $21,396
1998 28,528
1999 35,660
-------
$85,584
-------
-------
The Company may exercise a five year renewal option on the lease, only
upon the approval of the lessor. The Company's continued use of its
facilities beyond the lease term is dependent upon the decisions of the
Procter and Gamble Company. The Company previously leased its facilities
on a year to year basis from the Procter and Gamble Company at a nominal
annual amount.
In June 1995, the Company entered into a sub-lease agreement with an
entity providing financial services to individuals. The lease agreement
provides for variable lease payments based on the operating results of the
lessee. The lease runs through June 1998. During 1996 and 1995 sub-lease
income recognized by the Company was $1,034 and $8,661.
32
<PAGE>
5. Deposits
--------
Deposit amounts are summarized as follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
-------------------- --------------------
Weighted Weighted
Average Average
Balance Rate Balance Rate
---------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Statement savings $ 5,138,815 2.61% 5,621,541 2.59%
NOW and money market accounts 5,482,621 2.76 5,520,279 2.70
Other 59,445 2.38 61,267 2.38
----------- ----------
10,680,881 11,203,087
----------- ----------
Certificates:
Three months 116,032 4.66 74,469 4.53
Six months 1,006,950 5.24 1,607,453 5.22
Nine months 2,413,416 5.63 352,930 5.55
One year 3,909,170 5.41 4,801,439 5.81
Fifteen months 187,971 5.56 231,089 5.76
Eighteen months 1,663,240 5.65 1,600,686 5.86
Two years 2,981,025 5.80 3,510,224 5.72
Three years 668,694 5.68 1,172,863 5.47
Four years 569,318 6.35 562,653 5.90
Five years 8,354,558 6.28 8,552,045 6.44
----------- ---- ---------- ------
21,870,374 5.86 22,465,851 5.97
----------- ---- ---------- ------
$32,551,255 4.82% 33,668,938 4.87%
----------- ---- ---------- -----
----------- ---- ---------- -----
</TABLE>
Scheduled maturities of certificate accounts are as follows:
1996 1995
---- ----
Within one year $11,215,597 11,136,932
1-2 years 3,962,691 4,080,282
2-3 years 3,368,042 2,100,229
Over 3 years 3,324,044 5,148,408
----------- ----------
$21,870,374 22,465,851
----------- ----------
----------- ----------
33
<PAGE>
Interest expense on deposits is summarized as follows:
December 31,
------------
1996 1995 1994
---- ---- -----
Statement savings $ 128,376 155,368 169,418
NOW and Money Market 143,361 127,125 160,953
Certificates of Deposit 1,331,834 1,366,545 1,246,609
---------- ---------- ----------
$1,603,571 1,649,038 1,576,980
---------- ---------- ----------
---------- ---------- ----------
The aggregate amount of certificates of deposit in denominations of
$100,000 or more was $3,568,326 and $4,020,576 at December 31, 1996 and
1995.
6. Capitalized Lease Obligations:
------------------------------
The Company leases automated teller machines under capital leases. The
leases contain a bargain purchase option at the end of the lease. The
leased assets are included in furniture and fixtures at $48,691 and
$94,736 less accumulated depreciation of $41,111 and $73,162 at December
31, 1996 and 1995 respectively.
Future minimum lease payments required under the leases for 1997 is $5,024
with the present value of minimum lease payments totaling $4,866.
7. Federal Home Loan Bank Advances:
The Company has advances from the Federal Home Loan Bank. These advances
range in maturity from ninety days to 15 years with interest rates of
between 5.55% and 6.25%. Future maturities on the advances from the
Federal Home Loan Bank are as follows:
1997 $5,570,498
1998 930,072
1999 243,097
2000 28,743
2001 30,474
Subsequent years 203,819
---------
$7,006,703
---------
---------
The advances are collateralized by a blanket pledge of residential mortgage
loans held by the Company. The Company has also pledged its Federal Home
Loan Bank stock and mortgage notes with unpaid principal balances of
approximately $10.5 million for future advances.
34
<PAGE>
8. Income Taxes:
------------
The Company had qualified under provisions of the Internal Revenue Code,
which permitted the Company to deduct from taxable income an allowance
for bad debts based on a percentage of taxable income before such
deduction. The Tax Reform Act of 1969 gradually reduced this deduction
to 40% for years beginning in 1979. The Tax Reform Act of 1986 reduced
this deduction to 8% beginning in 1988.
A bill repealing the thrift bad debt reserve has been signed into law and
is effective for taxable years beginning after December 31, 1995. All
savings banks and thrifts will be required to account for tax reserves for
bad debts in the same manner as banks. Such entities with assets less than
$500 million will be required to maintain a moving average experience based
reserve and no longer will be able to calculate a reserve based on a
percentage of taxable income.
Tax reserves accumulated after 1987 will automatically be subject to
recapture. The recapture will occur in equal amounts over six years
beginning in 1997 and can be deferred up to two years, depending on the
level of loans originated.
As a result of the tax law change, the Company is expected to ultimately
recapture approximately $82,000 of tax reserves accumulated after 1987,
resulting in addition tax payments of $25,000. The recapture of these
reserves will not result in any significant income statement effect to the
Company. Pre-1988 tax reserves will not have to be recaptured unless the
thrift or successor institution liquidates, redeems shares or pays a
dividend in excess of earnings and profits.
Appropriated and unappropriated retained income at December 31, 1996
included earnings of approximately $1,096,000 representing such bad debt
deductions for which no provision for federal income taxes has been made.
In the future, if the Company does not meet the federal income tax
requirements necessary to permit it to deduct an allowance for bad debts,
the Company will be subject to federal income tax at the then current
corporate rate.
35
<PAGE>
An analysis of the provision for federal income taxes is as follows:
Years Ended December 31,
------------------------
1996 1995 1994
------- ----- ------
Current $63,000 1,660 18,037
Deferred 18,000 8,200 20,300
------- ----- ------
$81,000 9,860 38,337
------- ----- ------
------- ----- ------
At December 31, 1996 and 1995, the deferred components of the Company's
income tax liabilities, as included in the statements of financial
condition are summarized as follows:
1996 1995
---- ----
Deferred tax liabilities:
FHLB stock dividends $82,300 73,200
Bad debt reserve 7,000 5,700
Net unrealized gains on available
for sale securities - 37,024
Depreciation 9,000 7,400
------- -------
Gross deferred tax liabilities 98,300 123,324
------- -------
Deferred tax assets:
Deferred loan fees 8,800 (14,600)
Other 2,500 (2,700)
Net unrealized losses on available
for sale securities 35,350 -
------- -------
Gross deferred tax assets 46,650 (17,300)
------- -------
Valuation allowance - -
------- -------
Net deferred tax liability $51,650 106,024
------- -------
------- -------
36
<PAGE>
The Company's income tax expense differed from the statutory federal rate of
34% as follows:
Years Ended December 31,
1996 1995 1994
---- ---- ----
Tax expense at statutory rate $90,816 13,105 49,676
Sur - tax exemption (6,678) (5,970) (9,445)
Other (3,138) 2,725 (1,894)
------ ------ ------
$81,000 9,860 38,337
------ ------ ------
------ ------ ------
Effective tax rate 30.3% 25.6% 26.2%
---- ---- ----
---- ---- ----
9. Capital Requirements:
---------------------
The Savings Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken,
could have a direct material effect on the Savings Bank financial
statements. The regulations require the Savings Bank to meet specific
capital adequacy guidelines that involve quantitative measures of the
Savings Bank liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Savings Bank capital
classification is also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Savings Bank to maintain minimum amounts and ratios
(set forth in the table below) of Tier I capital (as defined in the
regulations) to total average assets (as defined), and minimum ratios of
Tier I and total capital (as defined) to risk-weighted assets (as defined).
To be considered adequately capitalized (as defined) under the regulatory
framework for prompt corrective action, the Savings Bank must maintain
minimum Tier I leverage and Tier II risk-based, ratios as set forth in the
table. The Savings Bank's actual capital amounts and ratios are also
presented in the table.
December 31, 1996
-------------------------------------------------------------
Required Actual Required
Amount Amount Excess Rate Rate
------ -------- ------ ------ --------
Tier I $ 5,498,000 1,872,000 3,626,000 11.7 4.0
Tier II 5,556,000 1,845,000 3,711,000 24.1 8.0
December 31, 1995
-------------------------------------------------------------
Required Actual Required
Amount Amount Excess Rate Rate
------ -------- ------ ------ --------
Tier I $ 3,768,000 1,726,000 2,042,000 8.8 4.0
Tier II 3,828,000 1,726,000 2,102,000 17.8 8.0
37
<PAGE>
10. Corporate Reorganization and Conversion to Stock Form:
-------------------------------------------------------
On July 6, 1995, the Savings Bank's Board of Directors adopted an overall
plan of conversion and reorganization (the Plan) whereby the Savings Bank
would convert to the stock form of ownership, followed by the issuance of
all of the Savings Bank's outstanding common stock to a newly formed
holding company, Lenox Bancorp, Inc. (the Company).
On July 17, 1996, the Savings Bank completed its conversion to the stock
form of ownership and issued all of the Savings Bank's outstanding common
shares to the Company.
In conneciton with the conversion, the Company sold 425,677 shares to
depositors of the Savings Bank at a price of $10.00 per share which, after
consideration of offering expenses totaling $548,574 and shares purchased by
employee benefit plans, resulted in net cash proceeds of $3.37 million.
At the time of the conversion in July 1996, the Company established a
liquidation account in an amount of $3,767,619, which is equal to the
Company's regulatory capital at December 31, 1995. The liquidation account
will be maintained for the benefit of eligible savings account holders who
maintain their savings account in the Company after conversion.
In the event of a complete liquidation (and only in such event), each
eligible savings account holder will be entitled to receive a liquidation
distribution from the liquidation account in the amount of the then current
adjusted balance of savings accounts held before any liquidation
distribution may be made with respect to capital stock. Except for the
repurchase of stock and payment of dividends by the Company, the existence
of the liquidation account will not restrict the use or application of
such related earnings.
The Company may not declare or pay a cash dividend on, or repurchase any
of, its capital stock if the effect thereof would cause the regulatory
capital of the Company to be reduced below either the amount required
for the liquidation account or the regulatory capital requirements imposed
by the FDIC.
38
<PAGE>
11. Retirement Plans:
-----------------
In 1992, the Company implemented a 401-K savings plan which covers
substantially all employees. The employees may elect to make contributions
pursuant to a salary reduction agreement upon meeting age and length of
service requirements. The Company annually determines the contribution based
on the percentage of the employees plan compensation or employee pay
contributed to the Plan. The Company matched the employee contribution to
the plan up to 5% of employee compensation. Total contributions by the
Company and the years ended Decmeber 31, 1996 and 1995 and 1994 were
$9,400, $6,803, and $8,852 respectively.
Concurrent with the conversion from the mutual savings bank form to the
stock holding company form of organization, in July 1996, the Company
established an Employee Stock Ownership Plan (ESOP) which provides
retirement benefits for substantially all employees who have completed
one year of service and have attained age 21. The ESOP initially acquired
34,054 shares of common stock in the conversion offering. The funds used
by the ESOP to purchase the stock were provided by a loan from the Bancorp
which will be repaid by contributions to the ESOP by the company in the
future. Management intends to allocate these shares to eligible employees'
accounts over the next seven years. Expense for shares committed to be
allocated during 1996 was $17,027. Shares have been committed to be
allocated as of December 31, 1996 of 1,446. Remaining unearned shares at
December 31, 1996 was 32,608.
The Company was a member of The Financial Institution Retirement Fund, a
multi-employer defined benefit pension plan, for its employees. The Fund is
administered by the U.S. League of Savings Institutions which also
determines the required pension plan contribution. The pension expense for
the years ended December 31, 1995 and 1994 was $8,416 and $4,208. The
Company's policy is to fund pension cost accrued. This plan was terminated
at June 30, 1995.
12. Other Expenses
--------------
Included in other operating expenses are the following expenses which
exceed 1% of interest income and other income:
1996 1995 1994
---- ---- ----
Legal and litigation $ 28,589 121,651 32,560
Other professional fees 51,899 35,687 35,775
ATM expense 40,765 51,273 56,695
NOW account servicing 27,245 30,242 19,156
Payroll taxes 31,280 32,112 27,735
Postage and telephone 31,415 30,108 32,236
39
<PAGE>
13. Fair Value of Financial Instruments:
------------------------------------
The estimated fair values of the Company's financial instruments at
December 31, 1996 and 1995 were as follows:
1996 1995
--------------------- ------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ----- -------- ------
Financial assets:
Cash and certificates of
deposit $1,277,159 1,277,159 1,401,192 1,401,192
Investment and mortgage-
backed securities 7,237,148 7,237,148 7,163,040 7,163,040
Loans receivable, net 37,495,377 37,439,000 33,383,757 34,476,000
Accrued interest receivable 285,570 285,570 234,555 234,555
Financial liabilities:
Deposits:
Demand accounts 10,680,881 10,680,881 11,203,087 11,203,087
Certificates 21,870,374 21,876,000 22,465,851 22,688,000
FHLB advances 7,006,703 7,006,703 5,327,482 5,353,000
40
<PAGE>
14. Summarized Financial Information of the Parent Company:
-------------------------------------------------------
The following condensed financial statements summarize the financial
position of Lenox Bancorp, Inc. as of December 31, 1996, and the results
of its operations for the year then ended.
LENOX BANCORP, INC.
Statement of Financial Condition
Assets:
Cash $1,497,814
Investment in Lenox Savings Bank 1,889,351
----------
$3,387,165
----------
----------
Liabilities and stockholders' equity:
Liabilities:
Accounts payable and accrued expenses 2,526
Stockholders' equity:
Common stock 425,677
Additional paid in capital 3,282,519
Retained earnings 2,523
Less unearned ESOP shares (326,080)
----------
3,384,639
----------
$3,387,165
----------
----------
Statement of Income
Interest income $ 23,755
Professional fees (20,606)
Income taxes (626)
--------
Net income $ 2,523
--------
--------
41
<PAGE>
15. Commitment and Contingencies:
-----------------------------
The Company was named in a lawsuit related to an age discrimination
matter seeking unspecified damages. An agreement to settle the lawsuit in
February 1996 was reached by mutual agreement of the parties. All costs
associated with the settlement were accrued in the financial statements at
December 31, 1995.
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of their
customers including commitments to extend credit. Such commitments involve,
to varying degrees, elements of credit and interest-rate risk in excess of
the amount recognized in the statement of financial condition. The
contract or notional amounts of the commitments reflect the extent of the
Company's involvement in such financial instruments.
The Company's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend
credit is represented by the contractual notional amount of those
instruments. The Company uses the same credit policies in making
commitments and conditional obligations as those utilized for on-balance-
sheet instruments.
The following schedule lists commitments and off-balance-sheet items
at December 31, 1996 and 1995.
Loan Unused
Commitments Lines of Credit
----------- ---------------
1996 $700,800 526,262
1995 245,600 -
In the opinion of management, the loan commitments equaled or exceeded
prevalent market interest rates as of December 31, 1996, and all
commitments will be funded via cash flow from operations and existing
excess liquidity. Of the total loan commitments, at December 31, 1996,
$500,800 was fixed rate residential loans. Management expects no losses
as a result of these transactions.
42
<PAGE>
16. SAIF Special Assessment:
------------------------
The deposits of the Company are presently insured by the SAIF, which
together with the BIF, are the two insurance funds administered by the
FDIC. On November 8, 1995, the FDIC revised the premium schedule for
BIF-insured banks to provide a range of .00% to .31% of deposits (as
compared to the current range of .23% to .31% of deposits for SAIF-
insured institutions) due to the BIF achieving its statutory reserve
ratio. As a result, BIF members generally would pay substantially
lower premiums than SAIF members. It was previously anticipated that the
SAIF will not be adequately recapitalized until 2002, absent a substantial
increase in premium rates or the imposition of special assessments or
other significant developments.
On September 30, 1996, the President signed an omnibus appropriations
package which included the recapitalization of the Savings Association
Insurance Fund (SAIF). All SAIF members were required to pay a one-time
assessment of 65.7 cents per $100 in deposits held on March 31, 1995. The
Company's special assessment was approximately $225,000. The assessment
was charged against earnings during the 1996 year. Beginning January 1,
1997, SAIF members will be assessed a premium of 6.4 cents per $100 of
deposits to cover the FICO obligation plus a regular insurance premium.
At the present time the regular insurance premium which applies to the
Company is the minimum. Other provisions of the appropriations package
require the Treasury Department to provide Congress, by March 31, 1997,
with a report on merging of the bank and thrift charters and merging
the SAIF and Bank Insurance Fund (BIF) by January 1, 1999, provided that
the bank and thrift charters have been merged by that date. It also
required BIF and SAIF members to begin sharing the FICO obligation on a
pro-rata basis at the earlier of January 1, 2000, or when the BIF and SAIF
funds are merged.
43
<PAGE>
17. Selected Quarterly Financial Data (unaudited):
----------------------------------------------
Summarized quarterly financial information for the quarters after the
conversion is as follows:
Quarter Ended Quarter Ended
September 30, 1996 December 31, 1996
------------------ -----------------
Interest income $ 844 907
Interest expense 487 487
------ ----
Net interest income 357 420
Other income 29 44
Other expenses 477 308
------ ----
Income (loss) before
provision for income taxes (91) 156
Provision (credit) for income taxes (38) 51
------ ----
Net income (loss) $ (53) 105
------ ----
------ ----
Earnings (loss) per share $(0.14) 0.27
------ ----
------ ----
44
<PAGE>
Stock Price Information
Lenox Bancorp, Inc.'s common stock trades over the counter through the
National Daily Quotation Service "Pink Sheet" published by the National Daily
Quotation Bureau, Inc. under the symbol: LNXC. The table below shows the
reported high and low sales prices of the common stock during the periods
indicated in fiscal 1996. The common stock began trading on July 18, 1996.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
High Low
- ----------------------------------------------------------------------------
<S> <C> <C>
Fourth Quarter, 1996 $14.00 $10.50
Third Quarter, 1996 $11.75 $ 9.88
- ----------------------------------------------------------------------------
</TABLE>
Lenox Bancorp, Inc. had approximately 235 shareholders at December 31, 1996
based upon shareholders of record and an estimate of shares held in nominee
names.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
This schedule contains summary information extracted from the Form 10-K and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<CIK> 0001000050
<NAME> LENOX BANCORP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 751
<INT-BEARING-DEPOSITS> 162
<FED-FUNDS-SOLD> 364
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7,237
<INVESTMENTS-CARRYING> 436
<INVESTMENTS-MARKET> 436
<LOANS> 37,495
<ALLOWANCE> 58
<TOTAL-ASSETS> 47,074
<DEPOSITS> 32,551
<SHORT-TERM> 5,570
<LIABILITIES-OTHER> 247
<LONG-TERM> 1,436
0
0
<COMMON> 426
<OTHER-SE> 6,844
<TOTAL-LIABILITIES-AND-EQUITY> 47,074
<INTEREST-LOAN> 2,710
<INTEREST-INVEST> 546
<INTEREST-OTHER> 80
<INTEREST-TOTAL> 3,336
<INTEREST-DEPOSIT> 1,604
<INTEREST-EXPENSE> 1,946
<INTEREST-INCOME-NET> 1,390
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 26
<EXPENSE-OTHER> 1,276
<INCOME-PRETAX> 267
<INCOME-PRE-EXTRAORDINARY> 267
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 186
<EPS-PRIMARY> .13
<EPS-DILUTED> .13
<YIELD-ACTUAL> 2.72
<LOANS-NON> 109
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 60
<CHARGE-OFFS> 4
<RECOVERIES> 2
<ALLOWANCE-CLOSE> 58
<ALLOWANCE-DOMESTIC> 58
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 58
</TABLE>
