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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[ X ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the Fiscal Year Ended December 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from __________ to __________
Commission file number: 0-27980
POTTERS FINANCIAL CORPORATION
-----------------------------
(Name of small business issuer in its charter)
OHIO 34-1817924
- -------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
519 Broadway, East Liverpool, Ohio 43920
----------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (330) 385-0770
--------------
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
----
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Shares, no par value
---------------------------
(Title of Class)
Check whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 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 of the past 90
days. Yes_X__ No____.
Check if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-B contained in this form, and no disclosure
will 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-KSB or any amendment to this Form 10-KSB. [ ]
The issuer's revenues for the fiscal year ended December 31, 1997,
totaled $8,939,000.
Based upon information regarding the last sales price provided
by The Nasdaq Stock Market, the aggregate market value of the voting stock held
by non-affiliates of the Registrant on February 27, 1998, was $14,770,847.
As of February 27, 1998, 976,436 of the
issuer's common shares were issued and outstanding.
Index to Exhibits is on page 36
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DOCUMENTS INCORPORATED BY REFERENCE
The following sections of the definitive Proxy Statement for the 1998
Annual Meeting of Shareholders of Potters Financial Corporation (the "Proxy
Statement") are incorporated by reference into Part III of this Form 10-KSB:
1. PROPOSAL ONE - ELECTION OF DIRECTORS;
2. EXECUTIVE OFFICERS;
3. Compensation of Directors and Executive Officers;
4. Voting Securities and Ownership of Certain Beneficial Owners and
Management; and
5. Section 16(a) Beneficial Ownership Reporting Compliance.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Potters Financial Corporation ("PFC") is a unitary savings and loan holding
company incorporated under the laws of the State of Ohio. PFC is the sole
shareholder of The Potters Savings and Loan Company ("Potters" or the
"Company"), a savings and loan association incorporated in 1889 under the laws
of the State of Ohio. On March 11, 1996, PFC acquired all of the common shares
of Potters in a holding company reorganization. Both entities are headquartered
at 519 Broadway in East Liverpool, Ohio.
PFC's activities have been limited primarily to holding the common shares of
Potters. Consequently, the following discussion focuses primarily on the
business of Potters.
As a savings and loan holding company, PFC is subject to regulation, supervision
and examination by the Office of Thrift Supervision of the United States
Department of the Treasury (the "OTS"). As a savings and loan association
incorporated under the laws of the State of Ohio, Potters is subject to
regulation, supervision and examination by the OTS, the Federal Deposit
Insurance Corporation (the "FDIC") and the Ohio Division of Financial
Institutions of the Ohio Department of Commerce. Deposits in Potters are insured
up to applicable limits by the FDIC. Potters is also a member of the Federal
Home Loan Bank ("FHLB") of Cincinnati.
Congress is considering the elimination of the federal thrift charter and
separate federal regulation of thrifts. Pursuant to such legislation, Congress
may eliminate the OTS and Potters may be regulated under federal law as a bank
or may be required to change its charter. Such change in regulation or charter
would likely change the range of activities in which Potters may engage and
would probably subject Potters to more regulation by the FDIC. In addition, PFC
may become subject to more restrictive holding company requirements, including
activity limits and capital requirements. PFC cannot predict when or whether
Congress may actually pass such legislation or whether such legislation will
actually change the regulation and permissible activities of PFC. Although such
legislation may change the activities in which PFC may engage, it is not
anticipated that its current activities will be materially affected by those
activity limits.
Potters provides financial products and services to the East Liverpool, Ohio
area through its three branch offices. Potters completed its conversion from a
state chartered mutual savings and loan association to a state chartered stock
savings and loan association (the "Conversion")
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on December 30, 1993. Potters is principally engaged in the business of
originating real estate loans secured by first mortgages for the purchase,
construction or improvement of one-to-four family residences and accepting
demand, savings and time deposits. Potters also originates loans secured by
multifamily and nonresidential real estate, home equity lines of credit and
various types of commercial and consumer loans. In addition to originating
loans, Potters also purchases one-to-four family real estate loans within the
State of Ohio and invests in U.S. Government and agency obligations,
mortgage-backed securities, interest-bearing deposits in other financial
institutions and other securities. See "Lending Activities". Funds for lending
and other investment activities are obtained primarily from deposits, loan and
security repayments, sales of securities available for sale and FHLB advances.
At December 31, 1997, Potters employed a total of 45 individuals and had 38
full-time employees.
Potters' income is derived primarily from interest and fees earned in connection
with its lending activities, and its principal expenses are interest paid on
deposits and borrowings and operating expenses. The primary component of its net
income is its net interest income, which is the difference between interest
income from loans and securities and interest expense on deposits and
borrowings. The interest income and interest expense of Potters change as the
interest rates on mortgages, securities and other assets and on deposits and
other liabilities change. Interest rates may change because of general economic
conditions, the policies of various regulatory authorities and other factors
beyond Potters' control. The interest rates on specific assets and liabilities
of Potters will change or "reprice" in accordance with the contractual terms of
the asset or liability instrument and in accordance with customer reaction to
general economic trends. In a rising interest rate environment, loans tend to
prepay slowly and new loans at higher rates increase slowly, while interest paid
on deposits increases rapidly because the terms to maturity of deposits tend to
be shorter than the terms to maturity or prepayment of loans. Such differences
in the adjustment of interest rates on assets and liabilities may negatively
affect Potters' income. Moreover, rising interest rates tend to decrease loan
demand in general, negatively affecting Potters' income. Potters originates
adjustable-rate real estate loans ("ARMs") and purchases one-to-four family ARMs
in order to reduce the gap between the effective maturities of its assets and
liabilities. However, such efforts to reduce this gap may not be successful if
the interest rate environment changes consumer demand for ARMs. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Asset/Liability Management" in Item 6. Management's Discussion and
Analysis or Plan of Operation.
In addition to the historical financial information included herein, the
disclosures contain forward-looking statements that involve risks and
uncertainties. Economic circumstances, PFC's operations and its actual results
could differ significantly from those discussed in these forward-looking
statements. Some of the factors that could cause or contribute to such
differences are discussed herein but also include changes in the economy and
interest rates in the nation and PFC's general market area. See Exhibit 99,
"Safe Harbor Under the Private Securities Litigation Reform Act of 1995," which
is incorporated herein by reference.
Without limiting the foregoing, some of the forward-looking statements included
herein are the statements under the following headings and regarding the
following matters:
1. Lending Activities - General - Statements regarding management's
supposition that the success of local revitalization efforts may generate
more economic growth and construction and have a positive effect on the
operations of Potters.
2. Management's plan for continued loan growth and its belief that regional
loan demand and the ability to purchase loans within the State of Ohio will
continue.
3. Management will continue to utilize FHLB advances as one of the sources to
fund loan growth.
4. Management's statements regarding the amount and adequacy of the allowance
for loan losses and its belief that no additional provisions will be
required during 1998.
5. Statements regarding the strategic focus and long-term goals of Potters.
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6. Management's belief that Potters' liquidity and capital position are
adequate to fund its outstanding short- and long-term needs.
7. Management's expectation that Potters has sufficient cash flow and
borrowing capacity to fund all outstanding commitments and maintain desired
levels of liquidity.
8. Management's expectation that Year 2000 issues will be resolved in a
satisfactory manner and will not pose significant operational problems when
the year 2000 arrives.
9. Management's expectation that the bad debt reserve recapture legislation
will not impact the future income of Potters.
10. Management's belief that a substantial percentage of certificates of
deposit at Potters maturing in 1998 will renew with Potters at maturity.
MARKET AREA
Headquartered in East Liverpool, Ohio, PFC, through Potters, conducts business
from three branch offices, located in the City of East Liverpool and the nearby
neighborhoods of Glenmoor and Calcutta. Potters' primary market area consists of
the City of East Liverpool, Ohio, and the contiguous areas of Columbiana and
Jefferson Counties, Ohio, and Hancock County, West Virginia. Loans are also
originated in Trumbull and Mahoning Counties, Ohio through an originator
employed by the Company.
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SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
The following table sets forth certain information concerning the financial
condition, earnings and other data regarding PFC at the dates and for the
periods indicated (1):
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION
DATA:
Total amount of:
Assets $122,637 $114,172 $114,242 $110,910 $114,088
Cash and cash equivalents 3,816 4,585 11,230 3,038 10,413
Securities available for sale 5,474 10,878 10,952 10,766 --
Securities held to maturity (2) 28,017 32,735 38,821 43,937 52,782
Loans receivable, net 82,093 62,450 49,889 50,078 47,392
Deposits 100,094 97,283 98,697 99,968 101,300
Foreclosed real estate
and real estate
held for investment -- -- 85 -- 804
Shareholders' equity
substantially restricted 11,006 10,576 11,189 9,793 9,937
</TABLE>
- ----------
(1) Information prior to 1996 is that of Potters.
(2) Securities held to maturity include the Company's investment in stock in the
FHLB.
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS:
Interest income $8,558 $8,206 $8,065 $7,586 $7,985
Interest expense 4,671 4,529 4,271 3,943 4,566
------ ------ ------ ------ ------
Net interest income 3,887 3,677 3,794 3,643 3,419
Provision for loan losses (485) 249 245 377 235
------ ------ ------ ------ ------
Net interest income after
provision for loan losses 4,372 3,428 3,549 3,266 3,184
Noninterest income:
Gain (loss) on sales of loans
and securities (78) -- 12 13 (82)
Other noninterest income 459 267 245 254 280
------ ------ ------ ------ ------
Total noninterest income 381 267 257 267 198
Total noninterest expense 2,927 3,688 2,977 2,868 3,238
------ ------ ------ ------ ------
Income before income taxes 1,826 7 829 665 144
Income tax expense (benefit) 629 68 -- -- (6)
------ ------ ------ ------ ------
Income (loss) before
cumulative change in
accounting for income taxes 1,197 (61) 829 665 150
Cumulative effect of change
in accounting for income taxes -- -- -- -- 225
------- ------ ------ ------ ------
Net income (loss) $ 1,197 $ (61) $ 829 $ 665 $ 375
======= ====== ====== ====== ======
</TABLE>
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SELECTED FINANCIAL RATIOS
AND OTHER DATA (1):
<TABLE>
<CAPTION>
At or for the year ended December 31,
-----------------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- -------
<S> <C> <C> <C> <C> <C>
Performance ratios:
Return (loss) on assets
(ratio of net income (loss)
to average total assets) 1.00% (0.05)% 0.74% 0.59% 0.34%
Interest rate spread
information:
Average during period 3.19 3.05 3.28 3.18 3.37
End of period 3.37 3.58 2.97 3.50 2.96
Net interest margin (ratio of
net interest income to average
interest-earning assets) 3.43 3.30 3.55 3.41 3.31
Ratio of operating expense
to average total assets 2.45 3.15 2.65 2.55 2.90
Return (loss) on equity
(ratio of net income (loss)
to average equity) 10.72 (0.57) 7.88 6.74 7.17
Dividend payout ratio (ratio of
dividends declared per share to
net income per share) 14.23 (208.33) 13.46 15.87 --
Asset quality ratios:
Nonperforming assets
to total assets at end
of period 0.17 1.51 2.21 2.37 3.38
Allowance for loan losses
to nonperforming loans 1,035.27 152.20 91.88 75.67 54.21
Allowance for loan losses
to total loans 2.54 4.04 4.30 3.77 3.97
Capital ratios:
Shareholders' equity to total
assets at end of period 8.97 9.26 9.79 8.83 8.71
Average shareholders' equity
to average assets 9.34 9.27 9.36 8.78 4.68
Ratio of average interest-
earning assets to average
interest-bearing liabilities 105.60% 105.96% 105.97% 105.31% 98.59%
Number of full-service offices 3 4 4 5 5
</TABLE>
- ----------
(1) Information prior to 1996 is that of Potters.
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LENDING ACTIVITIES
GENERAL. Potters' lending activity is concentrated in the origination of
conventional real estate loans secured by one-to-four family homes located in
Potters' primary market area. Loans to individuals to finance the construction
of their primary residence and real estate loans on multifamily properties
containing five units or more and on commercial properties are also offered by
Potters. Potters makes special real estate loans for targeted groups and home
buyers recommended by the Community Action Agency of Columbiana County. Potters
does not originate loans insured by the Federal Housing Authority or loans
guaranteed by the Veterans Administration. In addition to real estate lending,
Potters originates commercial loans and consumer loans, including home equity
lines of credit, automobile loans, loans secured by deposit accounts and
unsecured loans. At December 31, 1997, Potters' loan portfolio included
approximately $27.1 million, or 32.2% of total loans, of one-to-four family real
estate loans purchased from other Ohio financial institutions, $23.5 million on
properties located in northwestern Ohio and $3.6 million on properties in
southwestern Ohio.
The economic environment of the East Liverpool, Ohio area has remained stable
over the last few years with some inflow of new business. Area efforts continue
in the revitalization of East Liverpool, and several new retail and service
sector businesses have opened their doors within the city limits in the recent
past, but no significant business or residential construction has taken place.
However, to the extent revitalization efforts are successful, the local economy
should gradually improve in the future, which may generate more economic growth
and construction and have a positive effect on the operations of Potters. No
assurances can be given that such efforts will be successful or that local,
regional or national economic factors will not significantly change in the near
future.
LOAN PORTFOLIO COMPOSITION. The following table presents certain information in
respect of the composition of Potters' loan portfolio at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------
1997 1996
---- ----
Percent Percent
of total of total
Amount loans Amount loans
------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Type of loan and security:
Secured by real estate (1):
One-to-four family residences $66,718 79.15% $49,086 75.00%
Loans held for sale 106 .12
Multifamily residential (over 4 units) 1,537 1.82 2,034 3.11
Nonresidential property 6,211 7.37 5,897 9.01
------- ---- ------- ----
Total real estate loans 74,572 88.46 57,017 87.12
Consumer and other loans:
Home equity loans 5,224 6.20 3,859 5.90
Secured, unsecured consumer
loans and lines of credit 2,064 2.45 1,815 2.77
Commercial business 862 1.02 894 1.37
Other 1,575 1.87 1,860 2.84
------- ---- ------- ----
Total consumer and other loans 9,725 11.54 8,428 12.88
------- ----- ------- -----
Total loans 84,297 100.00% 65,445 100.00%
====== ======
Less:
Loans in process (340) (466)
Net deferred loan fees, unearned
interest and unamortized
discounts and premiums 279 101
Allowance for loan losses (2,143) (2,630)
------- -------
Total loans receivable, net $82,093 $62,450
======= =======
</TABLE>
- ----------
(1) Includes construction loans secured by various types of real estate. The
amount of construction loans is not material.
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LOAN MATURITY SCHEDULE. The following table sets forth certain information at
December 31, 1997 regarding the net dollar amount of loans maturing in Potters'
portfolio, based on contractual terms to maturity. Demand loans, loans having no
stated schedule of repayments and no stated maturity and overdrafts are reported
as due in one year or less.
<TABLE>
<CAPTION>
Real Estate Consumer and Other Total
---------------------------------------------------------------------- ------------------ -----
One-to-four family (1) Nonresidential Multifamily
---------------------- -------------- -----------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ---- ------ ---- ------ ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Due during
years ending
December 31,
1998 $ 297 8.49% $1,316 8.96% $ -- -- $1,729 8.93% $ 3,342 8.90%
1999 through
2002 1,293 8.80 778 10.86 146 7.87% 1,823 12.57 4,040 10.86
2003 and
following 65,234 7.86 4,117 9.25 1,391 8.88 6,173 10.08 76,915 8.13
------- ------ ------ ------ ------
$66,824 $6,211 $1,537 $9,725 $84,297
======= ====== ====== ====== =======
</TABLE>
- ----------
(1) Includes Construction Loans and Loans Held for Sale
The total amount of loans due after December 31, 1998 which have predetermined
interest rates is $30.4 million, while the total amount of loans due after such
date which have floating or adjustable rates is $50.6 million.
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The next table sets forth the composition of Potters' loan portfolio by
type of security and by predetermined interest rates and floating or adjustable
interest rates at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------
1997 1996
--------------------- ---------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Fixed-rate loans:
Real estate (1):
One-to-four family $28,743 34.10% $27,120 41.44%
Multifamily (over 4 units) 523 0.62 452 0.69
Nonresidential 169 0.20 243 0.37
------- ------ ------- ------
Total real estate loans 29,435 34.92 27,815 42.50
Consumer and other loans 3,443 4.08 3,045 4.65
------- ------ ------- ------
Total fixed-rate loans 32,878 39.00 30,860 47.15
Adjustable-rate loans:
Real estate (1):
One-to-four family 38,081 45.18 21,966 33.56
Multifamily (over 4 units) 1,014 1.20 1,582 2.42
Nonresidential 6,042 7.17 5,654 8.64
------- ------ ------- ------
Total real estate loans 45,137 53.55 29,202 44.62
Consumer and other loans 6,282 7.45 5,383 8.23
------- ------ ------- ------
Total adjustable-rate loans 51,419 61.00 34,585 52.85
------- ------ ------- ------
Total loans receivable 84,297 100.00% 65,445 100.00%
====== ======
Less:
Loans in process (340) (466)
Deferred fees, discounts
and premiums 279 101
Allowance for loan losses (2,143) (2,630)
------- -------
Total loans receivable, net $82,093 $62,450
======= =======
</TABLE>
- ----------
(1) Includes construction loans secured by various types of real estate. The
amount of construction loans is not material.
LOANS SECURED BY ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE. The lending
activity of Potters is concentrated in the origination of permanent conventional
real estate loans secured by one-to-four family residences, primarily
single-family residences, located within Potters' primary market area and the
purchase of real estate loans, primarily ARMs, within the State of Ohio. Potters
also originates loans to individuals to finance the construction of their
primary residences. Each loan is secured by a mortgage on the underlying real
estate and improvements thereon, if any. At December 31, 1997, Potters'
one-to-four family residential real estate loan portfolio was approximately
$66.8 million, or 79.3% of total gross loans.
During 1997, Potters purchased one-to-four family real estate loans to
supplement local loan originations. Loan purchases totaled $20.5 million during
1997 and consisted of $20.0 million of ARMs and $520,000 of fixed-rate real
estate loans. Included in the ARM purchases during 1997 were $5.1 million in
five years/one year ARMS which reprice each year after the initial five-year
adjustment period.
OTS regulations limit the amount which Potters may lend in relationship to the
appraised value of the real estate and improvements at the time of loan
origination. In accordance with such regulations, Potters makes fixed-rate loans
on one-to-four family residences up to 95% of the value of the real estate and
improvements (the "Loan-to-Value Ratio" or "LTV"). The principal amount of any
loan which
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exceeds an 80% LTV at the time of origination is usually covered by private
mortgage insurance at the expense of the borrower.
As of December 31, 1997, approximately 43.0% of Potters' loans secured by
one-to-four family residences bore interest at a fixed rate. Fixed-rate loans
are offered by Potters for terms of up to 30 years. The majority of 30-year
fixed-rate loans are sold on a servicing released basis in the secondary
mortgage market. Potters is in the process of acquiring approval to sell such
loans to the Federal Home Loan Mortgage Corporation ("FHLMC"), which will enable
the Company to retain the servicing on the loans.
ARMs are offered by Potters for terms of up to 30 years. Potters originates
one-year, three-year and five-year ARMs, with interest rate adjustments tied to
U.S. Treasury issues adjusted to constant maturities. For a limited time during
1996, a seven-year ARM product was offered. Interest rate adjustments on
pre-1995 real estate loans are tied to an index of the FHLB. The maximum
allowable adjustment at each repricing date is from 1.5% to 2.0% for ARMs, with
a maximum adjustment on all products of 6% over the term of the loan. The
initial interest rate quoted on ARMs is often lower than the fully-indexed rate
to make adjustable-rate products more appealing to the Company's customers. The
initial rate on three-year and five-year ARMs is typically higher than the
initial rate on a one-year ARM to compensate for the reduced interest rate
sensitivity. At December 31, 1997, $38.1 million, or 57.0%, of one-to-four
family real estate loans bore adjustable rates.
During 1997, Potters offered two nonconforming real estate loan programs. Such
loans involve greater underwriting and default risk than conforming real estate
loans. The increased risk is somewhat mitigated by a higher interest rate than
on conforming loans and the market value of the underlying real estate. At
December 31, 1997, such nonconforming real estate loans totaled $2.5 million, of
which none were more than 30 days delinquent.
Potters makes construction loans to individuals for the construction and
permanent financing of their primary residences. Such loans are offered with
both fixed and adjustable rates for terms of up to 20 years. During the first
year, while the residence is being constructed, the borrower is required to pay
only interest. Thereafter, the loans amortize over the remaining term.
Construction loans generally involve greater underwriting and default risks than
do loans secured by mortgages on existing properties due to the advance of loan
funds and the inherent uncertainties in estimating construction costs and loan
value prior to the completion of the project. In the event a default on a
construction loan occurs and foreclosure follows, Potters would have to take
control of the project and attempt either to arrange for completion of
construction or dispose of the unfinished project. The increased risks inherent
in construction lending are not significant to Potters because construction
loans, in the aggregate, comprise less than 1% of Potters' loan portfolio.
Potters also originates loans secured by land to be used in the eventual
construction of a borrowers' primary residence. Such loans are offered with
fixed and adjustable interest rates for terms of up to 5 years and a maximum LTV
of 75%. Although land loans are subject to greater risks than residential real
estate loans, Potters attempts to mitigate such risks by basing the lending
decision on an evaluation of the past performance and credit history of the
borrower and on the market value of the underlying real estate.
LOANS SECURED BY MULTIFAMILY RESIDENTIAL REAL ESTATE. In addition to loans on
one-to-four family properties, Potters offers loans secured by multifamily
properties containing over four units. Multifamily loans are usually offered for
terms of up to 15 years and a maximum LTV of 75%. Such loans are currently
offered with adjustable interest rates tied to the composite prime rate of 75%
of the 30 largest U.S. banks, as reported in The Wall Street Journal (the "Prime
Rate").
Multifamily lending is generally considered to involve a higher degree of risk
than one-to-four family residential lending because the borrower typically
depends upon income generated by the apartment project to cover operating
expenses and debt service. The profitability of a project can be affected by
economic conditions, government policies and other factors beyond the control of
the borrower. Potters
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attempts to reduce the risk associated with multifamily lending by evaluating
the creditworthiness of the borrower and the projected income from the project
and by obtaining personal guarantees on loans made to corporations and
partnerships. Potters requires that borrowers submit rent rolls and that all
borrowers submit financial statements annually to enable Potters to monitor the
loan.
At December 31, 1997, loans secured by multifamily properties totaled
approximately $1.5 million, or 1.8% of total loans. Of such loans, none were
delinquent at December 31, 1997.
LOANS SECURED BY NONRESIDENTIAL REAL ESTATE. At December 31, 1997, approximately
$6.2 million, or 7.4% of Potters' total loans, were secured by nonresidential
real estate properties, $2.1 million of which are located in the State of
Colorado. The majority of such loans have adjustable rates with terms of up to
15 years and amortize over a period of up to 30 years. Among the properties
securing nonresidential real estate loans in Colorado are office buildings,
retail centers, restaurants, warehouses and special purpose properties. Other
nonresidential real estate loans are secured by properties consisting of office
buildings, residential development and special purpose properties in Ohio. All
nonresidential real estate loans currently originated by Potters bear adjustable
interest rates tied to the Prime Rate and are fully amortizing with terms of up
to 15 years.
Although loans secured by nonresidential real estate typically have higher
interest rates and shorter terms to maturity than one-to-four family residential
real estate loans, nonresidential real estate lending is generally considered to
involve a higher degree of risk than residential lending due to the relatively
larger loan amounts and the effects of general economic conditions on the
successful operation of income-producing properties. Potters has endeavored to
reduce such risk by evaluating the credit history and past performance of the
borrower, the location of the real estate, the quality of the borrower, the
quality and characteristics of the income stream generated by the property and
appraisals supporting the property's valuation. At December 31, 1997, no
nonresidential loans were more than 30 days delinquent or considered impaired.
See "Delinquent Loans, Nonperforming Assets and Classified Assets."
Federal regulations limit the amount of nonresidential real estate loans which
an association may make to 400% of its total capital. At December 31, 1997,
Potters' nonresidential real estate loans totaled 63.9% of its total capital.
CONSUMER LOANS. Potters offers a wide range of secured and unsecured consumer
loans to area borrowers. Secured loans include home equity lines of credit,
those made to depositors on the security of their deposit accounts and
automobile loans. Secured and unsecured personal loans to homeowners and
nonhomeowners, a homeowner loan program, a partially secured real estate loan
program, an unsecured home improvement loan program and an unsecured check
overdraft line of credit are available to accommodate the credit needs of the
Company's primary market area. Consumer loans, other than home equity lines of
credit, are made primarily at fixed rates of interest and for varying terms
based on the type of loan.
At December 31, 1997, Potters had approximately $8.9 million, or 10.5% of total
loans, invested in consumer loans.
Home equity lines of credit are secured by a first or second mortgage on the
borrowers' principal residence. Home equity lines of credit have a five- or
ten-year draw-down period followed by a corresponding five- or ten-year
repayment period and bear variable rates of interest. During 1997, Potters
offered several home equity loan promotions with a low introductory interest
rate which reverted to a margin over the Prime Rate after a limited period of
time. Potters offered a home equity product for a limited time during 1996 in
which the interest rate was fixed for the first five years, followed by a
variable-rate five-year repayment period.
Consumer loans, particularly consumer loans which are unsecured or are secured
by assets such as automobiles or mobile homes, which depreciate at a faster rate
than real estate, may entail greater risk than do residential real estate loans.
Repossessed collateral for a defaulted consumer loan may not
11
<PAGE> 12
provide an adequate source of repayment of the outstanding loan balance. The
risk of default on consumer loans increases during periods of recession, high
unemployment and other adverse economic conditions. Of such loans, $510,000 were
delinquent at December 31, 1997.
COMMERCIAL LOANS. At December 31, 1997, Potters' loan portfolio included
approximately $862,000 in commercial loans and lines of credit. All such loans
have been made to businesses in the local area. The maximum amount of principal
which Potters was committed to advance under such loans was $883,000 at December
31, 1997. The loans are secured by equipment, receivables or vehicles and are
indexed to the Prime Rate.
A $365,000 investment in equipment lease credits with Bennett Funding was repaid
during 1997 from a settlement by Potters' Board of Directors and the bankruptcy
Trustee. For more information on the resolution of the Bennett Funding lease
credits, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations; and -Allowance and Provision for
Loan Losses" in Item 6. Management's Discussion and Analysis or Plan of
Operation.
Commercial loans have a high degree of risk because the primary source of
repayment is the borrower's income. The collateral pledged to Potters to secure
such loans, if any, is typically non-real estate collateral for which there may
be no established market. Potters attempts to limit the risk of loss on
commercial loans by limiting the number and aggregate dollar amount of such
loans. Of such loans, none were delinquent at December 31, 1997.
LOAN SOLICITATION AND PROCESSING. Loan originations are developed from a number
of sources, including continuing business with depositors, other borrowers, real
estate brokers and developers, solicitations by Potters' lending staff,
advertising and walk-in customers.
Certain risks are involved in granting loans, primarily related to the
borrowers' ability and willingness to repay the loan. Before a real estate loan
is extended, such risks are assessed through a review of the borrowers' credit
report, verification of employment and other documentation. An appraisal of the
fair market value of the collateral used to secure the loan is prepared by a fee
appraiser approved by the Board of Directors. The application for a loan is then
reviewed in accordance with Potters' underwriting guidelines and approved or
denied. A tiered structure of credit authority levels based on loan amount has
been granted to loan officers and two members of senior management with respect
to loan approval. Specific loans exceeding lending authority levels are taken to
the Executive Committee of the Board of Directors which is comprised of three
Board members. Any nonresidential real estate or commercial loan must be
reviewed and approved or rejected by the President and Chief Executive Officer,
the Senior Lending Officer or the full Board of Directors.
If a real estate loan application is approved, either a title guaranty or an
attorney's opinion of title is obtained on the real estate which will secure the
mortgage loan. Borrowers are required to carry satisfactory fire and casualty
insurance and flood insurance, if applicable, and to name Potters as an insured
mortgagee.
The procedure for approval of construction loans is the same as for residential
real estate loans, except that an appraiser evaluates the building plans,
construction specifications and estimates of construction costs. Potters also
evaluates the feasibility of the proposed construction project and the
experience and record of the builder.
Consumer loans are underwritten on the basis of the borrower's credit history
and an analysis of the borrower's income and expenses, ability to repay the loan
and the value of the collateral, if any. Potters may waive the verification of
employment requirement for certain existing customers.
LOANS TO ONE BORROWER. Federal regulations limit the amount of loans which an
association can make to any one borrower. Under current OTS regulations, the
aggregate amount of loans which Potters may make to any one borrower (including
related entities), with certain exceptions, is limited in general to 15% of
Potters' unimpaired capital and unimpaired surplus. See "REGULATION - OTS
Regulations--
12
<PAGE> 13
Lending Limits." Based on such limits, Potters was permitted to lend
approximately $1.5 million to any one borrower at December 31, 1997. Potters had
no outstanding loans in excess of such limits at December 31, 1997. Potters has
not made any loans in excess of such limits since the limits were imposed.
LOAN ORIGINATION AND OTHER FEES. Potters realizes loan origination fee and other
fee income from its lending activities and also realizes income from late
payment charges, application fees and fees for other miscellaneous services.
Loan origination and other fees are a volatile source of income, varying with
the volume of lending, loan repayments and general economic conditions. All
nonrefundable loan origination fees and certain direct loan origination costs
are deferred and recognized in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 91 as an adjustment to yield over the life of the related
loan.
DELINQUENT LOANS, NONPERFORMING ASSETS AND CLASSIFIED ASSETS. A loan is
considered delinquent when a borrower fails to make a contractual payment on the
loan within 10 days of the payment due date and does not cure the delinquency
promptly. Potters' normal collection procedures involve contact with the
borrower in an effort to bring the loan to a current status. When loan payments
have not been made by the tenth day, late notices are sent. If payment is not
received by the thirtieth day, second notices and telephone calls are made to
the borrower. Each loan bears a late payment penalty which is assessed as soon
as such loan is more than ten days delinquent. The late penalty for ARMs and
consumer loans is 5% of the payment due. For fixed-rate loans, the late penalty
increases the fixed annual interest rate by 1% until the delinquency is cured.
Although collection procedures usually cure delinquencies in a timely manner,
Potters institutes additional measures to remedy the default if the delinquency
exceeds the 30- and 60- day categories. When any loan is delinquent 90 days,
Potters ceases to accrue interest. At that time, previously accrued but unpaid
interest is deducted from interest income.
When a loan secured by real estate becomes delinquent more than 90 days, Potters
initiates foreclosure action or the acceptance from the mortgagor of a voluntary
deed to the property in lieu of foreclosure. If a foreclosure action is
instituted and the loan is not reinstated, paid in full or refinanced, the
property is sold at a judicial sale and usually purchased by Potters. An
appraisal of the security is conducted when foreclosed real estate is acquired.
If the appraisal indicates that the value of the collateral is less than the
carrying value of the loan, a valuation allowance is established for such loan.
When a consumer loan secured by an automobile or other collateral becomes more
than 90 days past due, an estimate is made of the value of the collateral. If
the estimate of value indicates that the value of the collateral is less than
the carrying value of the loan, a specific allowance for loss is established.
The following table reflects the amount of loans in a delinquent status as of
December 31, 1997:
Percent of
Number Amount total loans
------ ------ -----------
(Dollars in thousands)
Loans delinquent for:
30-59 days 73 $1,236 1.47%
60-89 days 23 303 .36
90 days and over 35 207 .24
------ ----
$1,746 2.07%
====== ====
SFAS Nos. 114, "Accounting by Creditors for Impairment of a Loan" and 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures," require recognition of loan impairment. Potters had no impaired
loans at December 31, 1997. See Notes 1 and 3 to the Consolidated Financial
Statements in Item 7. Financial Statements for information on Potters' impaired
loans.
13
<PAGE> 14
Nonperforming assets include nonaccrual loans, accruing loans which are
delinquent 90 days or more, restructured loans, real estate acquired by
foreclosure or by deed-in-lieu thereof and repossessed assets. For a discussion
of nonperforming loans, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Allowance and Provision for Loan Losses"
in Item 6. Management's Discussion and Analysis or Plan of Operation.
For the year ended December 31, 1997, gross interest income which would have
been recorded had the nonaccruing and restructured loans been current in
accordance with their original terms amounts to $23,000. The amount that was
included in interest income on such loans was $13,000 for the year ended
December 31, 1997.
Real estate acquired by Potters as a result of foreclosure proceedings is
classified as foreclosed real estate until it is sold. When property is so
acquired, it is recorded by Potters at the estimated fair value of the real
estate at the date of acquisition and any write-down resulting therefrom is
charged to the allowance for loan losses. Interest accrual, if any, ceases no
later than the date of acquisition of the real estate, and all costs incurred
from such date in maintaining the property are expensed. Costs relating to the
development and improvement of the property are capitalized to the extent they
are realizable. Subsequent to acquisition, the property is carried at the lower
of the initial balance or estimated fair value less selling costs.
OTS regulations require that each thrift institution classify its own assets on
a regular basis. Problem assets are classified as "substandard," "doubtful" or
"loss". "Substandard" assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. "Doubtful" assets have
the same weaknesses as "substandard" assets, with the additional characteristics
that (i) the weaknesses make collection or liquidation in full on the basis of
currently existing facts, conditions and values questionable and (ii) there is a
high possibility of loss. An asset classified "loss" is considered uncollectible
and of such little value that its continuance as an asset of the institution is
not warranted. The regulations also contain a "special mention" category,
consisting of assets which do not currently expose an institution to a
sufficient degree of risk to warrant classification but which possess credit
deficiencies or potential weaknesses deserving management's close attention.
The aggregate amounts of Potters' classified assets at the dates indicated were
as follows:
At December 31,
-------------------
1997 1996
---- ----
(Dollars in thousands)
Classified assets:
Substandard $209 $ 755
Doubtful 974
Loss
---- ------
Total classified assets $209 $1,729
==== ======
Federal examiners are authorized to classify an association's assets. If an
association does not agree with an examiner's classification of an asset, it may
appeal this determination to the Regional Director of the OTS. Potters had no
material disagreements with the examiners regarding the classification of assets
at the time of the last examination.
OTS regulations require that Potters establish prudent general allowances for
loan losses for any loan classified as substandard or doubtful. If an asset, or
portion thereof, is classified as loss, the association must either establish
specific allowances for losses in the amount of 100% of the portion of the asset
classified loss, or charge-off such amount. For a discussion of Potters' loan
review and classification process, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Allowance and Provision for
Loan Losses" in Item 6. Management's Discussion and Analysis or Plan of
Operation. A limited amount of general allowances may be included for purposes
of calculating total risk-based capital.
14
<PAGE> 15
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Allowance and Provision for Loan Losses" in Item 6. Management's
Discussion and Analysis or Plan of Operation for a discussion of potential
problem assets at December 31, 1997. Potters had no nonperforming or potential
problem other interest-earning assets at such date other than those discussed
above and in Item 6.
ALLOWANCE FOR LOAN LOSSES. Senior management, with oversight by the Board,
reviews on a monthly basis the allowance for loan losses as it relates to a
number of relevant factors, including but not limited to, trends in the level of
nonperforming assets and classified loans, current and anticipated economic
conditions in the primary lending area, past loss experience and probable losses
arising from specific problem assets. To a lesser extent, management also
considers loan concentrations to single borrowers and changes in the composition
of the loan portfolio. While management believes that it uses the best
information available to determine the allowance for loan losses, unforeseen
market conditions could result in adjustments, and net earnings could be
significantly affected if circumstances differ substantially from the
assumptions used in making the final determination.
The following table sets forth an analysis of Potters' allowance for losses on
loans for the periods indicated:
1997 1996
---- ----
(Dollars in thousands)
Balance at beginning of period $ 2,630 $ 2,240
Loans charged-off:
Residential real estate loans (3) (15)
Nonresidential real estate loans (15) (100)
Consumer and other loans (58) (423)
--------- --------
Total charge-offs (76) (538)
Recoveries:
Residential real estate loans 5 3
Nonresidential real estate loans 60 675
Consumer and other loans 9 1
--------- --------
Total recoveries 74 679
--------- --------
Net (charge-offs) recoveries (2) 141
Provision for loan losses (485) 249
--------- --------
Balance at end of period $ 2,143 $ 2,630
========= ========
Ratio of net (charge-offs) recoveries
to average loans (0.003)% 0.27%
The following table sets forth the allocation of Potters' allowance for loan
losses at the dates indicated:
<TABLE>
<CAPTION>
1997 1996
---- ----
Percent of Percent of
loans in each loans in each
category to category to
Amount total loans Amount total loans
------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
One-to-four family real estate loans $ 179 79.27% $ 136 75.00%
Nonresidential real estate loans 237 7.37 1,204 9.01
Consumer and other loans 296 13.36 45 15.99
Unallocated 1,431 1,245
------ ------ ------ -----
Total $2,143 100.00% $2,630 100.00%
====== ====== ====== ======
</TABLE>
15
<PAGE> 16
Potters' allowance for loan losses at December 31, 1997 represented 1,035.3% of
nonperforming loans. Because the loan loss allowance is based on estimates, it
is monitored monthly and adjusted as necessary to provide an adequate allowance.
MORTGAGE-BACKED SECURITIES. Potters invests in mortgage-backed securities,
including Government National Mortgage Association ("GNMA"), FHLMC and Federal
National Mortgage Association ("FNMA") pass-through certificates. The purchase
of such certificates entitles the holder to receive a portion of the cash flows
from an identified pool of mortgages. GNMA, FHLMC and FNMA securities are each
guaranteed by their respective agencies as to principal and interest.
At December 31, 1997, mortgage-backed securities totaled approximately $20.5
million. All of Potters' mortgage-backed securities at December 31, 1997, were
designated as being held to maturity. In accordance with SFAS No. 115, those
mortgage-backed securities designated as being held to maturity are carried on
Potters' balance sheet at amortized cost. The market value of mortgage-backed
securities held to maturity at December 31, 1997 was $20.5 million.
The OTS has deemed certain collateralized mortgage obligations and other
mortgage derivative products to be "high-risk." Potters has no such investments
or other derivative products deemed "high risk".
Because mortgage-backed securities have a lower yield relative to current loan
market rates, retention of such investments could adversely affect Potters'
earnings, particularly in a rising interest rate environment. Potters has
purchased adjustable-rate mortgage-backed securities as part of its effort to
reduce its interest rate risk. In a period of declining interest rates, Potters
is subject to prepayment risk on such adjustable-rate mortgage-backed
securities. Potters attempts to mitigate this prepayment risk by purchasing
mortgage-backed securities at or near par. If interest rates rise in general,
the interest rates on the loans backing the mortgage-backed securities will also
adjust upward, subject to the interest rate caps in the underlying
adjustable-rate mortgage loans. However, Potters is still subject to interest
rate risk on such securities if interest rates rise faster than the 1% to 2%
maximum annual interest rate adjustments on the underlying loans.
At December 31, 1997, $7.1 million, or 34.5%, of mortgage-backed securities had
adjustable rates. Although adjustable-rate securities generally have a lower
yield at the time of origination than fixed-rate securities, the interest rate
risk associated with adjustable-rate securities is lower. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Asset/Liability Management" in Item 6. Management's Discussion and Analysis or
Plan of Operation. The following table sets forth certain information regarding
Potters' investment in mortgage-backed securities at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
---------------
1997 1996
---- ----
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---- ----- ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage-backed securities
held to maturity $20,492 $20,427 $24,018 $23,735
======= ======= ======= =======
</TABLE>
16
<PAGE> 17
The combined amortized cost of mortgage-backed securities designated as held to
maturity at December 31, 1997, by contractual terms to maturity are shown below.
Actual maturities will differ from contractual maturities because borrowers
generally may prepay obligations without prepayment penalties.
At December 31, 1997
--------------------
Weighted
Amortized Average
Cost Yield
---- -----
(Dollars in thousands)
Due within one year
Due after one year through three years $ 1,457 6.41%
Due after three years through five years
Due after five years through ten years 729 6.12
Due after ten years 18,306 6.65
-------- ----
Total $ 20,492 6.60%
======== ====
INVESTMENT ACTIVITIES
OTS regulations require that Potters maintain a minimum amount of liquid assets,
which may be invested in U.S. Treasury obligations, securities of various
federal agencies, certificates of deposit at insured banks, bankers' acceptances
and federal funds. Potters is also permitted to make investments in certain
commercial paper, corporate debt securities rated in one of the four highest
rating categories by one or more nationally recognized statistical rating
organizations, and mutual funds, as well as other investments permitted by
federal regulations. From January 1, 1997, through December 31, 1997, Potters
has maintained liquid assets on a monthly average basis in an amount between
10.1% and 13.9% of total assets. See "REGULATION."
No security or group of securities, with the exception of securities issued by
the U.S. government or its agencies, exceeded 10% of Potters' equity at December
31, 1997.
The following table sets forth the composition of Potters' investment portfolio
at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------
1997 1996
---- ----
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---- ----- ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. Treasury and U.S.
Government agencies $ 5,499 $ 5,474 $ 9,988 $ 9,853
Mutual funds 1,034 1,025
--------- -------- --------- ---------
$ 5,499 $ 5,474 $ 11,022 $ 10,878
========= ======== ========= =========
Securities held to maturity:
U.S. Treasury and U.S.
Government agencies $ 5,866 $ 5,863 $ 6,854 $ 6,787
Obligations of states and
political subdivisions 168 181 175 182
Other securities 632 645 866 872
--------- -------- --------- ---------
$ 6,666 $ 6,689 $ 7,895 $ 7,841
========= ======== ========= =========
</TABLE>
17
<PAGE> 18
The maturities of debt securities are indicated in the following table:
<TABLE>
<CAPTION>
At December 31, 1997
------------------------------------------------------------------
Total debt securities
Estimated
Less than 1 to 5 5 to 10 Over Amortized Fair
1 year years years 10 years Cost Value
------ ----- ----- -------- ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale (1):
U.S. Treasury and U.S
Government agencies $4,476 $ 998 $5,499 $5,474
------ ------ ------ ------
$4,476 $ 998 $5,499 $5,474
====== ====== ====== ======
Weighted average yield (3) 5.74% 6.45% 5.88%
Securities held to maturity (2):
U.S. Treasury and U.S.
Government agencies $4,128 $1,738 $5,866 $5,863
Obligations of states and
political subdivisions 3 $ 69 96 168 181
Other securities $ 632 632 645
------ ------ ------ ----- ------ ------
$4,131 $ 69 $1,834 $ 632 $6,666 $6,689
====== ====== ====== ===== ====== ======
Weighted average yield (3) 5.43% 8.18% 6.67% 6.81% 5.93%
</TABLE>
- ----------
(1) Amounts reflected for maturities of securities available for sale are based
on the estimated fair value while the yield is based on amortized cost.
(2) Amounts reflected for maturities of securities held to maturity are based on
amortized cost.
(3) Since Potters has minimal investments in nontaxable obligations, yields are
not stated on a taxable equivalent basis.
DEPOSITS AND BORROWINGS
GENERAL. Deposits have traditionally been the primary source of Potters' funds
for use in lending and other investment activities. In addition to deposits,
Potters derives funds from interest payments and principal repayments on loans
and securities and income on earning assets. Loan payments are a relatively
stable source of funds, while deposit inflows and outflows fluctuate more in
response to general interest rates and money market conditions. Potters also
borrows funds from the FHLB.
DEPOSITS. Deposits are attracted principally from within Potters' primary market
area through the offering of a broad selection of deposit instruments, including
NOW and demand accounts, money market deposit accounts, regular passbook savings
accounts, statement savings accounts, a statement savings account indexed to the
90-day U.S. Treasury bill, holiday club accounts, term certificate accounts and
Individual Retirement Accounts. Interest rates paid, maturity terms, service
fees and withdrawal penalties for the various types of accounts are established
periodically by the management of Potters based on liquidity requirements,
growth goals and local and national interest rates. Potters had no brokered
deposits at December 31, 1997. The amount of deposits from outside Potters'
primary market area is not significant.
At December 31, 1997, Potters' certificates of deposit totaled $51.5 million, or
51.5% of total deposits. Of such amount, approximately $27.2 million in
certificates of deposit mature within one year. Based on past experience and
Potters' prevailing pricing strategies, management believes that a substantial
18
<PAGE> 19
percentage of such certificates will renew with Potters at maturity. If there is
a significant deviation from historical experience, Potters can utilize
borrowings from the FHLB as an alternative to this source of funds.
The following table sets forth the dollar amount of deposits in the various
types of deposit programs offered by Potters at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------
1997 1996
---- ----
Percent Percent
of total of total
Amount deposits Amount deposits
------ -------- ------ --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Transaction accounts:
Demand, NOW, and Super NOW
accounts (1) $ 12,678 12.7% $13,509 13.9%
Savings and club accounts (2) 33,955 33.9 34,345 35.3
Money market deposit
accounts (3) 1,955 1.9 1,978 2.0
--------- --- ------- ---
Total transaction accounts 48,588 48.5 49,832 51.2
Certificates of deposit (4) 51,506 51.5 47,451 48.8
--------- ---- ------- ----
Total deposits $100,094 100.0% $97,283 100.0%
======== ===== ======= =====
</TABLE>
- ----------
(1) Potters' weighted average interest rate paid on demand, NOW and Super NOW
accounts fluctuates with the general movement of interest rates. At December 31,
1997, the weighted average rate on such accounts was 2.05%.
(2) The weighted average rate on savings and club accounts was 3.11% at December
31, 1997.
(3) Potters' weighted average interest paid on money market accounts fluctuates
with the general movement of interest rates. At December 31, 1997, the weighted
average rate on such accounts was 3.04%.
(4) The weighted average rate on certificates of deposit at December 31, 1997
was 5.73%.
See Item 6. Management's Discussion and Analysis or Plan of Operation for
information relating to the average balance and the average rates paid on
various deposit products for the past three years.
19
<PAGE> 20
The following table presents the amount of Potters' certificates of deposit of
$100,000 or more and other certificates of deposit by the time remaining until
maturity as of December 31, 1997:
<TABLE>
<CAPTION>
Maturity
------------------------------------------------------------
3 months Over 3 to Over 6 to Over 12
or less 6 months 12 months months Total
------- --------- --------- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit
less than $100,000 $ 6,704 $6,914 $7,514 $21,572 $42,704
Certificates of deposit
$100,000 or more 1,208 345 800 2,615 4,968
Public funds (1) 2,108 1,538 103 85 3,834
------- ------ ------ ------- -------
Total certificates
of deposit $10,020 $8,797 $8,417 $24,272 $51,506
======= ====== ====== ======= =======
</TABLE>
- ----------
(1) Includes deposits from governmental and other public entities.
BORROWINGS. The FHLB System functions as a central reserve bank providing credit
for its member institutions and certain other financial institutions. See
"REGULATION - Federal Home Loan Banks." As a member in good standing of the FHLB
of Cincinnati, Potters is authorized to apply for advances from the FHLB of
Cincinnati, provided certain standards of creditworthiness have been met. Under
current regulations, an association must meet certain qualifications to be
eligible for FHLB advances. The extent to which an association is eligible for
such advances will depend upon whether it meets the Qualified Thrift Lender Test
(the "QTL Test"). See "REGULATION - OTS Regulations -- Qualified Thrift Lender
Test." If an association meets the QTL Test, it will be eligible for 100% of the
advances it would otherwise be eligible to receive. If an association does not
meet the QTL Test, it will be eligible for such advances only to the extent it
holds specified QTL Test assets. At December 31, 1997, Potters was in compliance
with the QTL Test. During 1997, a total of $16.1 million was received in FHLB
advances, $11.1 million of which were repaid. At December 31, 1997, FHLB
advances totaled $10.0 million, which included $750,000 of advances received in
conjunction with the Company's participation in an Affordable Housing Program
conducted through the FHLB and the State of Ohio. During 1997, FHLB advances
were used primarily to finance loan originations and purchases.
Additional disclosures regarding short-term borrowings are not required because
the average balance of such borrowings during 1997 did not exceed 30 percent of
shareholders' equity at the end of the year.
The average amounts of FHLB advances outstanding during the last three years and
the weighted average interest rate thereon are detailed in Item 6. Management's
Discussion and Analysis or Plan of Operation.
SUBSIDIARY ACTIVITIES
Potters has one wholly-owned subsidiary, Potters Financial Services Corporation,
which owns a parking lot in East Liverpool with a net book value of $34,000.
COMPETITION
Potters competes for deposits with other savings associations, commercial banks
and credit unions and with the issuers of commercial paper and other securities,
such as shares in money market mutual funds. The primary factors in competing
for deposits are interest rates and convenience of office location. In making
loans, Potters competes with other savings associations, savings banks,
commercial banks, consumer finance companies, credit unions, leasing companies
and other lenders. Potters competes for loan originations primarily through the
interest rates and loan fees it charges and through the efficiency
20
<PAGE> 21
and quality of services it provides to borrowers. Competition is intense and is
affected by, among other things, the general availability of lendable funds,
general and local economic conditions, current interest rate levels and other
factors which are not readily predictable. Proposed expansion in the permissible
activities of bank holding companies and decreases in the deposit insurance
assessment rates for banks versus those for savings associations may increase
this competition.
The number and size of financial institutions competing with Potters is likely
to increase as a result of changes in federal statutes and regulations
eliminating various restrictions on interstate and inter-industry branching and
acquisitions. Such increased competition may have an adverse effect upon
Potters.
REGULATION
GENERAL
As a savings and loan association incorporated under the laws of Ohio, Potters
is subject to regulation, examination and oversight by the Superintendent of the
Ohio Division of Financial Institutions of the Ohio Department of Commerce (the
"Ohio Superintendent"). Because Potters' deposits are insured by the FDIC,
Potters also is subject to regulation and examination by the OTS and to
regulatory oversight by the FDIC. Potters must file periodic reports with the
Ohio Superintendent and the OTS concerning its activities and financial
condition. Examinations are conducted periodically by federal and state
regulators to determine whether Potters is in compliance with various regulatory
requirements and is operating in a safe and sound manner. Because it accepts
federally insured deposits and offers transaction accounts, Potters is also
subject to certain regulations issued by the Board of Governors of the Federal
Reserve System ("FRB"). Potters is a member of the FHLB of Cincinnati.
PFC is an Ohio corporation and is subject to regulation, examination and
oversight by the OTS as the holding company of Potters and is required to submit
periodic reports to the OTS.
Congress is considering legislation to eliminate the federal savings and loan
charter and the separate federal regulation of savings and loan associations.
Pursuant to such legislation, Congress may eliminate the OTS and Potters may be
regulated under federal law as a bank or may be required to change its charter.
Such change in regulation or charter would likely change the range of activities
in which Potters may engage and would probably subject Potters to more
regulation by the FDIC. In addition, PFC might become subject to a different
form of holding company regulation which may limit the activities in which PFC
may engage and subject PFC to other additional regulatory requirements,
including separate capital requirements. PFC cannot predict when or whether
Congress may actually pass legislation regarding PFC's and Potters' regulatory
requirements or charter. Although such legislation may change the activities in
which either PFC and Potters may engage, it is not anticipated that the current
activities of either PFC or Potters will be materially affected by those
activity limits.
DIVISION REGULATION
The Ohio Superintendent is responsible for the regulation and supervision of
Ohio savings and loan associations in accordance with the laws of the State of
Ohio and imposes assessments on Ohio associations based on the association's
asset size to cover the cost of supervision and examination. Ohio law prescribes
the permissible investments and activities of Ohio savings and loan
associations, including the types of lending that such associations may engage
in and the investments in real estate, subsidiaries and corporate or government
securities that such associations may make. The ability of Ohio associations to
engage in these state-authorized investments is subject to oversight and
approval by the FDIC, if such investments or activities are not permissible for
a federally chartered savings association. See "FDIC Regulations --
State-Chartered Association Activities." The Ohio Superintendent must approve
most mergers or acquisitions involving a change of control of Ohio savings and
loan associations. The Ohio Superintendent may initiate certain supervisory
measures or formal enforcement actions against Ohio associations. Ultimately, if
the grounds provided by law exist, the Ohio Superintendent may place an Ohio
association in conservatorship or receivership.
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In addition to being governed by the laws of Ohio specifically governing savings
and loan associations, Potters is also governed by Ohio corporate law, to the
extent such law does not conflict with the laws specifically governing savings
and loan associations.
OTS REGULATIONS
GENERAL. The OTS is an office in the Department of the Treasury and is
responsible for the regulation and supervision of all savings associations, the
deposits of which are insured by the FDIC in the Savings Association Insurance
Fund ("SAIF"), and of all federally chartered savings institutions. The OTS
issues regulations governing the operation of savings associations, regularly
examines such associations and imposes assessments on savings associations based
on their asset size to cover the cost of general supervision and examination.
The OTS also may initiate enforcement actions against savings associations and
certain persons affiliated with them for violations of laws or regulations or
for engaging in unsafe or unsound practices. If the grounds provided by law
exist, the OTS may appoint a conservator or receiver for a savings association.
Savings associations are subject to regulatory oversight under various consumer
protection and fair lending laws. These laws govern, among other things,
truth-in-lending disclosure, equal credit opportunity, fair credit reporting and
community reinvestment. Failure to abide by federal laws and regulations
governing community reinvestment could limit the ability of a state-chartered
savings association to open a new branch or engage in a merger transaction.
Community reinvestment regulations will evaluate how well and to what extent an
institution lends and invests in its designated service area, with particular
emphasis on low-to-moderate income communities and borrowers in such areas.
Potters has received a "satisfactory" examination rating under those
regulations.
REGULATORY CAPITAL REQUIREMENTS. Potters is required by OTS regulations to meet
certain minimum capital requirements. The following table sets forth the amount
and percentage level of regulatory capital of Potters at December 31, 1997, and
the amount by which it exceeds minimum requirements. Tangible and core capital
are reflected as a percentage of adjusted total assets. Total (or risk-based)
capital, which consists of core and supplementary capital, is reflected as a
percentage of risk-weighted assets.
At December 31, 1997
--------------------
Amount Percent
------ -------
(Dollars in
thousands)
Tangible capital to adjusted total assets $ 9,722 7.93%
Requirement 1,839 1.50
--------- ----
Excess $ 7,883 6.43%
========= ====
Core capital to adjusted total assets $ 9,722 7.93%
Requirement 3,677 3.00
--------- ----
Excess $ 6,045 4.93%
========= ====
Total capital to risk-weighted assets $ 10,498 17.28%
Requirement 4,859 8.00
--------- ----
Excess $ 5,639 9.28%
========= ====
For additional information concerning the regulatory capital of Potters at
December 31, 1997, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" in Item
6. Management's Discussion and Analysis or Plan of Operation.
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Current capital requirements call for tangible capital of 1.5% of adjusted total
assets, core capital of 3% of adjusted total assets, and risk-based capital of
8% of risk-weighted assets. In determining risk-weighted assets, each asset is
weighted at a percentage level ranging from 0% to 100% depending on its relative
risk. The OTS has proposed to amend the core capital requirement so that only
those associations with the highest examination rating and acceptable levels of
risk will be permitted to maintain only 3% core capital. All other associations
will be required to maintain core capital of 4% to 5%, depending on the
association's examination rating and overall risk. Potters does not anticipate
that it will be adversely affected if the core capital requirement regulation is
amended as proposed.
The OTS has adopted an interest rate risk component to the risk-based capital
requirement, though the implementation of that component has been delayed.
Pursuant to that requirement, a savings association would have to measure the
effect of an immediate 200 basis point change in interest rates on the value of
their portfolios, as determined under the methodology established by the OTS. If
the measured interest rate risk is above the level deemed normal under the
regulation, the association will be required to deduct one-half of that excess
exposure from its total capital when determining its risk-based capital ratio.
The interest rate risk component for any quarter will be based on this
calculation as of the end of the third preceding quarter. In general,
associations with less than $300 million in assets and a risk-based capital
ratio of greater than 12% will not be subject to this requirement. Potters
currently qualifies for this exception. Pending implementation of the interest
rate risk component, the OTS may adjust the risk-based capital requirement on an
individualized basis to take into account risks due to concentrations of credit
and non-traditional activities.
The OTS has adopted regulations governing prompt corrective action to resolve
the problems of capital deficient and otherwise troubled savings associations.
At each successively lower defined capital category, an institution is subject
to more restrictive and numerous mandatory or discretionary regulatory actions
or limits, and the OTS has less flexibility in determining how to resolve the
problems of the institution. In addition, the OTS can downgrade an association's
designation notwithstanding its capital level, based on less than satisfactory
examination ratings in areas other than capital or, after notice and an
opportunity for hearing, if the institution is deemed to be in an unsafe or
unsound condition or to be engaging in an unsafe or unsound practice. Each
undercapitalized association must submit a capital restoration plan to the OTS
within 45 days after it becomes undercapitalized. Such institution will be
subject to increased monitoring and asset growth restrictions and will be
required to obtain prior approval for acquisitions, branching and engaging in
new lines of business. A critically undercapitalized institution must be placed
in conservatorship or receivership within 90 days after reaching such
capitalization level, except under limited circumstances. Potters' capital at
December 31, 1997, met the standards for the highest defined capital level, a
well-capitalized association.
Federal law prohibits an insured institution from making a capital distribution
to anyone or paying management fees to any person having control of the
institution if, after such distribution or payment, the institution would be
undercapitalized. In addition, each company controlling an undercapitalized
institution must guarantee that the institution will comply with the terms of an
OTS-approved capital plan until the institution has been adequately capitalized
on an average during each of four consecutive calendar quarters and must provide
adequate assurances of performance. The aggregate liability pursuant to such
guarantee is limited to the lesser of (a) an amount equal to 5% of the
institution's total assets at the time the institution became undercapitalized
or (b) the amount which is necessary to bring the institution into compliance
with all capital standards applicable to such institution at the time the
institution fails to comply with its capital restoration plan.
LIQUIDITY. OTS regulations require that savings associations maintain an average
daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances and specified U.S. government, state or federal agency obligations)
equal to a monthly average of not less than 4% of its net withdrawable savings
deposits plus borrowings payable in one year or less. Monetary penalties may be
imposed upon member institutions failing to meet liquidity requirements. The
eligible liquidity of Potters, as computed under current regulations, for
December 1997, was approximately $12.1 million, or 11.4%.
QUALIFIED THRIFT LENDER TEST. Savings associations are required to meet the QTL
test. Prior to September 30, 1996, there was only one QTL test which required
savings associations to maintain a
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specified level of investments in assets that are designated as qualifying
thrift investments ("QTI"), which are generally related to domestic residential
real estate and manufactured housing and include credit card, student and small
business loans, stock issued by any FHLB, the FHLMC or the FNMA. Under this test
65% of an institution's "portfolio assets" (total assets less goodwill and other
intangibles, property used to conduct business and 20% of liquid assets) must
consist of QTI on a monthly average basis in 9 out of every 12 months. Congress
created a second QTL test, effective September 30, 1996, pursuant to which a
savings association may also meet the QTL test under the Internal Revenue Code
of 1986, as amended (the "Code"), for thrift institution status. According to
the test under the Code, at least 60% of the institution's assets (on a tax
basis) must consist of specified assets (generally loans secured by residential
real estate or deposits, educational loans, cash and certain governmental
obligations). The OTS may grant exceptions to the QTL test under certain
circumstances. If a savings association fails to meet the QTL test, the
association and its holding company become subject to certain operating and
regulatory restrictions. A savings association that fails to meet the QTL test
will not be eligible for new FHLB advances. At December 31, 1997, Potters met
the QTL test.
LENDING LIMITS. OTS regulations impose a lending limit on the aggregate amount
that a savings association can lend to one borrower (the "Lending Limit") to an
amount equal to 15% of the association's total capital for risk-based capital
purposes plus any loan reserves not already included in total capital (the
"Lending Limit Capital"). A savings association may loan to one borrower an
additional amount not to exceed 10% of the association's Lending Limit Capital,
if the additional amount is fully secured by certain forms of "readily
marketable collateral." Real estate is not considered "readily marketable
collateral." In applying this Lending Limit, loans to certain related or
affiliated borrowers are aggregated. An exception to this Lending Limit permits
loans of any type to one borrower of up to $500,000. In addition, the OTS, under
certain circumstances, may permit exceptions to the Lending Limit on a
case-by-case basis.
Based on the 15% Lending Limit, Potters was able to lend approximately $1.5
million to one borrower at December 31, 1997. Potters had no outstanding loans
in excess of such limit at December 31, 1997.
TRANSACTIONS WITH INSIDERS AND AFFILIATES. Loans to executive officers,
directors and principal shareholders and their related interests must conform to
the lending limits and the total of such loans cannot exceed the association's
Unimpaired Capital. Most loans to directors, executive officers and principal
shareholders must be approved in advance by a majority of the "disinterested"
members of the board of directors of the association with any "interested"
director not participating. All loans to directors, executive officers and
principal shareholders must be made on terms substantially the same as offered
in comparable transactions to the general public, or as offered to all employees
in a company-wide benefit program, and loans to executive officers are subject
to additional limitations. Potters was in compliance with such restrictions at
December 31, 1997.
All transactions between savings associations and their affiliates must comply
with Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings
association is any company or entity that controls, is controlled by or is under
common control with the savings association. PFC is an affiliate of Potters.
Generally, Section 23A and 23B of the FRA (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, (ii) limit the aggregate of all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and
(iii) require that all such transactions be on terms substantially the same, or
at least as favorable to the institution, as those provided in transactions with
a non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and other similar types of
transactions. In addition to the limits in Sections 23A and 23B, a savings
association may not make any loan or other extension of credit to an affiliate
unless the affiliate is engaged only in activities permissible for a bank
holding company and may not purchase or invest in securities of any affiliate
except shares of a subsidiary. Potters was in compliance with these requirements
and restrictions at December 31, 1997.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS imposes various restrictions or
requirements on the ability of associations to make capital distributions,
including dividend payments. An association is prohibited
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from declaring or paying dividends or from repurchasing any of its stock if, as
a result, the net worth of the association would be reduced below the amount
required to be maintained for the liquidation account established in connection
with its mutual to stock conversion. OTS regulations also establish a system
limiting capital distributions according to ratings of associations based on
their capital level and supervisory condition.
The first rating category is Tier 1, consisting of associations that, before and
after the proposed distribution, meet their fully phased-in capital
requirements. Associations in this category may make capital distributions
during any calendar year equal to the greater of 100% of net income, current
year-to-date, plus 50% of the amount by which the lesser of the association's
tangible, core or risk-based capital exceeds its fully phased-in capital
requirement for such capital component, as measured at the beginning of the
calendar year, or the amount authorized for a Tier 2 association. A Tier 1
association deemed to be in need of more than normal supervision by the OTS may
be downgraded to a Tier 2 or Tier 3 association. Potters meets the requirements
for a Tier 1 association and has not been notified of any need for more than
normal supervision. The second category, Tier 2, consists of associations that
before and after the proposed distribution meet their current minimum, but not
fully phased-in, capital requirements. Associations in this category may make
capital distributions of up to 75% of net income over the most recent four
quarters. Tier 3 associations do not meet current minimum capital requirements
and must obtain OTS approval of any capital distribution. Tier 2 associations
that propose to make a capital distribution in excess of the noted safe harbor
level must also obtain OTS approval. Tier 2 associations proposing to make a
capital distribution within the safe harbor provisions and Tier 1 associations
proposing to make any capital distribution need only submit written notice to
the OTS 30 days prior to such distribution.
In January 1998, the OTS issued a proposal to amend the capital distributions
limits. Under that proposal, an association with a holding company would still
be required to provide a notice or an application to the OTS, although under
limited circumstances, a savings association without a holding company could
make a capital distribution without notice to the OTS. Except under limited
circumstances and with OTS approval, no capital distributions would be permitted
if it caused the association to become undercapitalized.
HOLDING COMPANY REGULATION. PFC is a savings and loan holding company within the
meaning of the Home Owners' Loan Act (the "HOLA"). As such, PFC is registered
with the OTS and is subject to OTS regulations, examination, supervision and
reporting requirements. Congress is considering legislation that may require
that PFC become a bank holding company regulated by the FRB. Bank holding
companies with more than $150 million in assets are subject to capital
requirements similar to those imposed on Potters and have more extensive
interstate acquisition authority than savings and loan holding companies. Bank
holding companies are subject to more restrictive activity and investment limits
than savings and loan holding companies. No assurances can be given that such
legislation will be enacted, and PFC cannot be certain of the legislation's
impact on its operations until it is enacted.
The HOLA generally prohibits a savings and loan holding company from controlling
any other savings association or savings and loan holding company, without prior
approval of the OTS, or from acquiring or retaining more than 5% of the voting
shares of a savings association or holding company thereof, which is not a
subsidiary. Under certain circumstances, a savings and loan holding company is
permitted to acquire, with the approval of the OTS, up to 15% of the previously
unissued voting shares of an undercapitalized savings association for cash
without such savings association being deemed to be controlled by the holding
company. Except with the prior approval of the OTS, no director or officer of a
savings and loan holding company or person owning or controlling by proxy or
otherwise more than 25% of such company's stock may also acquire control of any
savings institution, other than a subsidiary institution, or any other savings
and loan holding company.
PFC is a unitary savings and loan holding company. There are generally no
restrictions on the activities of unitary savings and loan holding companies and
such companies are the only financial institution holding companies which may
engage in commercial activities and expanded securities and insurance
activities. The broad latitude to engage in activities under current law can be
restricted, if the OTS determines that there is reasonable cause to believe that
the continuation by a savings and loan holding
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company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary savings association. The OTS may impose
such restrictions as deemed necessary to address such risk, including limiting
(i) payment of dividends by the savings association, (ii) transactions between
the savings association and its affiliates, and (iii) any activities of the
savings association that might create a serious risk that the liabilities of the
holding company and its affiliates may be imposed on the savings association.
Notwithstanding the foregoing rules as to permissible business activities of a
unitary savings and loan holding company, if the savings association subsidiary
of a holding company fails to meet the QTL Test, then such unitary holding
company would become subject to the activities restrictions applicable to
multiple holding companies. At December 31, 1997, Potters met the QTL Test.
If PFC were to acquire control of another savings institution, other than
through a merger or other business combination with Potters, PFC would become a
multiple savings and loan holding company. Unless the acquisition is an
emergency thrift acquisition and each subsidiary savings association meets the
QTL Test, the activities of PFC and any of its subsidiaries (other than Potters
or other subsidiary savings associations) would thereafter be subject to
activity restrictions. The HOLA provides that, among other things, no multiple
savings and loan holding company or subsidiary thereof that is not a savings
institution shall commence or continue for a limited period of time after
becoming a multiple savings and loan holding company or subsidiary thereof, any
business activity other than (i) furnishing or performing management services
for a subsidiary savings institution, (ii) conducting an insurance agency or
escrow business, (iii) holding, managing or liquidating assets owned by or
acquired from a subsidiary savings institution, (iv) holding or managing
properties used or occupied by a subsidiary savings institution, (v) acting as
trustee under deeds of trust, (vi) those activities previously directly
authorized by federal regulation as of March 5, 1987, to be engaged in by
multiple holding companies, or (vii) those activities authorized by the FRB as
permissible for bank holding companies, unless the OTS by regulation prohibits
or limits such activities for savings and loan holding companies. Those
activities described in (vii) above must also be approved by the OTS prior to
being engaged in by a multiple holding company.
The OTS may approve acquisitions resulting in the formation of a multiple
savings and loan holding company that controls savings associations in more than
one state, only if the multiple savings and loan holding company involved
controls a savings association that operated a home or branch office in the
state of the association to be acquired as of March 5, 1987, or if the laws of
the state in which the institution to be acquired is located specifically permit
institutions to be acquired by state-chartered institutions or savings and loan
holding companies located in the state where the acquiring entity is located (or
by a holding company that controls such state-chartered savings institutions).
As under prior law, the OTS may approve an acquisition resulting in a multiple
savings and loan holding company controlling savings associations in more than
one state in the case of certain emergency thrift acquisitions.
FEDERAL DEPOSIT INSURANCE CORPORATION
DEPOSIT INSURANCE AND ASSESSMENTS. The FDIC is an independent federal agency
that insures the deposits, up to prescribed statutory limits, of federally
insured banks and thrifts and safeguards the safety and soundness of the banking
and thrift industries. The FDIC administers two separate insurance funds, the
Bank Insurance Fund ("BIF") for commercial banks and state savings banks and the
SAIF for savings associations. The FDIC is required to maintain designated
levels of reserves in each fund. Prior to October 1, 1996, the reserves of the
SAIF were below the level required by law, because a significant portion of the
assessments paid into the fund have been and are being used to pay the cost of
prior thrift failures, while the reserves of the BIF met the level required by
law in May 1995.
Potters is a member of the SAIF and its deposit accounts are insured by the
FDIC, up to the prescribed limits. The FDIC has examination authority over all
insured depository institutions, including Potters, and has authority to
initiate enforcement actions against federally insured savings associations, if
the FDIC does not believe the OTS has taken appropriate action to safeguard
safety and soundness and the deposit insurance fund.
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The FDIC is authorized to establish separate annual assessment rates for deposit
insurance each for members of the BIF and the SAIF. The FDIC may increase
assessment rates for either fund if necessary to restore the fund's ratio of
reserves to insured deposits to its target level within a reasonable time and
may decrease such rates if such target level has been met. The FDIC has
established a risk-based assessment system for both SAIF and BIF members. Under
this system, assessments vary based on the risk the institution poses to its
deposit insurance fund. The risk level is determined based on the institution's
capital level and the FDIC's level of supervisory concern about the institution.
Because of the differing reserve levels of the funds, deposit insurance
assessments paid by healthy savings associations were reduced significantly
below the level paid by healthy savings associations effective in mid-1995.
Federal legislation, which was effective September 30, 1996, provided for the
recapitalization of the SAIF by means of a special assessment of $.657 per $100
of SAIF deposits held at March 31, 1995, in order to increase SAIF reserves to
the level required by law. Certain banks holding SAIF deposits were required to
pay the same special assessment on 80% of deposits at March 31, 1995. In
addition, the cost of prior thrift failures will be shared by both the SAIF and
the BIF. As a result of such cost sharing, BIF assessments for healthy banks in
1998 are $.013 per $100 in deposits and SAIF assessments for healthy
institutions in 1998 are $.064 per $100 in deposits.
Potters had $97.9 million in deposits at March 31, 1995. Potters paid a special
assessment of $643,000 on November 27, 1996, which was recorded as of September
30, 1996. This assessment is tax-deductible, and reduced net income by $424,000
for the year ended December 31, 1996.
STATE-CHARTERED ASSOCIATION ACTIVITIES. The ability of state-chartered
associations to engage in any state-authorized activities or make any
state-authorized investments is limited if such activity is conducted or
investment is made in a manner different than that permitted for, or subject to
different terms and conditions than those imposed on, federally chartered
savings associations. Engaging as a principal in any such activity or investment
not permissible for a federal association is subject to approval by the FDIC.
Such approval will not be granted unless certain capital requirements are met
and there is not a significant risk to the FDIC insurance fund. All of Potters'
activities and investments at December 31, 1997, were permissible for a federal
association.
FRB RESERVE REQUIREMENTS. FRB regulations currently require savings associations
to maintain reserves of 3% of net transaction accounts (primarily NOW accounts)
up to $47.8 million of such accounts (subject to an exemption of up to $4.7
million), and of 10% of net transaction accounts in excess of $47.8 million. At
December 31, 1997, Potters was in compliance with this reserve requirement.
FEDERAL HOME LOAN BANKS
The FHLBs provide credit to their members in the form of advances. Potters is a
member of the FHLB of Cincinnati and must maintain an investment in the capital
stock of the FHLB of Cincinnati in an amount equal to the greater of 1% of the
aggregate outstanding principal amount of Potters' residential real estate
loans, home purchase contracts and similar obligations at the beginning of each
year, or 5% of its advances from the FHLB. Potters is in compliance with this
requirement with an investment in FHLB of Cincinnati stock having a book value
of $859,000 at December 31, 1997.
Upon the origination or renewal of a loan or advance, the FHLB of Cincinnati is
required by law to obtain and maintain a security interest in collateral in one
or more of the following categories: fully disbursed, whole first mortgage loans
on improved residential property or securities representing a whole interest in
such loans; securities issued, insured or guaranteed by the U.S. government or
an agency thereof; deposits in any FHLB; or other real estate related collateral
(up to 30% of the member association's capital) acceptable to the applicable
FHLB, if such collateral has a readily ascertainable value and the FHLB can
perfect its security interest in the collateral.
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Each FHLB is required to establish standards of community investment or service
that its members must maintain for continued access to long-term advances from
the FHLBs. The standards take into account a member's performance under the
Community Reinvestment Act and its record of lending to first-time home buyers.
All long-term advances by each FHLB must be made only to provide funds for
residential housing finance.
TAXATION
FEDERAL TAXATION
PFC and Potters are both subject to the federal tax laws and regulations which
apply to corporations in general. In addition to the regular income tax, PFC and
Potters may be subject to an alternative minimum tax. An alternative minimum tax
is imposed at a minimum tax rate of 20% on "alternative minimum taxable income"
(which is the sum of a corporation's regular taxable income, with certain
adjustments, and tax preference items), less any available exemption. Such tax
preference items include interest on certain tax-exempt bonds issued after
August 7, 1986. In addition, 75% of the amount by which a corporation's
"adjusted current earnings" exceeds its alternative minimum taxable income
computed without regard to this preference item and prior to reduction by net
operating losses, is included in alternative minimum taxable income. Net
operating losses can offset no more than 90% of alternative minimum taxable
income. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax. Payments of alternative minimum tax may be
used as credits against regular tax liabilities in future years. Although the
Taxpayer Relief Act of 1997 repealed the alternative minimum tax for certain
"small corporations" for tax years beginning after December 31, 1997, PFC does
not qualify as a small corporation exempt from the alternative minimum tax.
Prior to the enactment of the Small Business Jobs Protection Act (the "Small
Business Act"), which was signed into law on August 21, 1996, certain thrift
institutions, such as Potters, were allowed deductions for bad debts under
methods more favorable than those granted to other taxpayers. Qualified thrift
institutions could compute deductions for bad debts using either the specific
charge off method of Section 166 of the Internal Revenue Code (the "Code") or
one of the two reserve methods of Section 593 of the Code.
Under Section 593, a thrift institution annually could elect to deduct bad debts
under either (i) the "percentage of taxable income" method applicable only to
thrift institutions, or (ii) the "experience" method that also was available to
small banks. Under the "percentage of taxable income" method, a thrift
institution generally was allowed a deduction for an addition to its bad debt
reserve equal to 8% of its taxable income (determined without regard to this
deduction and with additional adjustments). Under the experience method, a
thrift institution was generally allowed a deduction for an addition to its bad
debt reserve equal to the greater of (i) an amount based on its actual average
experience for losses in the current and five preceding taxable years, or (ii)
an amount necessary to restore the reserve to its balance as of the close of the
base year. A thrift institution could elect annually to compute its allowable
addition to bad debt reserves for qualifying loans either under the experience
method or the percentage of taxable income method. For tax year 1995, Potters
used the percentage of taxable income method because such method provided a
higher bad debt deduction than the experience method. For tax years 1990 through
1994, Potters used the experience method.
The Small Business Act eliminated the percentage of taxable income reserve
method of accounting for bad debts by thrift institutions, effective for taxable
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 are
required to use only the specific charge off method.
A thrift institution required to change its method of computing reserves for bad
debt will treat such change as a change in the method of accounting, initiated
by the taxpayer and having been made with the consent of the Secretary of the
Treasury. Section 481(a) of the Code requires certain amounts to be recaptured
with respect to such change. Generally, the amounts to be recaptured will be
determined
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solely with respect to the "applicable excess reserves" of the taxpayer. The
amount of the applicable excess reserves will be taken into account ratably over
a six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement described below. In the case
of a thrift institution that is treated as a large bank, the amount of the
institution's applicable excess reserves generally is the excess of (i) the
balances of its reserve for losses on qualifying real property loans (generally
loans secured by improved real estate) and its reserve for losses on
nonqualifying loans (all other types of loans) as of the close of its last
taxable year beginning before January 1, 1996, over (ii) the balances of such
reserves as of the close of its last taxable year beginning before January 1,
1988 (i.e., the "pre-1988 reserves"). In the case of a thrift institution that
is treated as a small bank, like Potters, the amount of the institution's
applicable excess reserves generally is the excess of (i) the balances of its
reserve for losses on qualifying real property loans and its reserve for losses
on nonqualifying loans as of the close of its last taxable year beginning before
January 1, 1996, over (ii) the greater of the balance of (a) its pre-1988
reserves or (b) what the thrift's reserves would have been at the close of its
last year beginning before January 1, 1996, had the thrift always used the
experience method.
For taxable years that begin after December 31, 1995, and before January 1,
1998, if a thrift meets the residential loan requirement for a tax year, the
recapture of the applicable excess reserves otherwise required to be taken into
account as a Code Section 481(a) adjustment for the year will be suspended. A
thrift meets the residential loan requirement if, for the tax year, the
principal amount of residential loans made by the thrift during the year is not
less than its base amount. The "base amount" generally is the average of the
principal amounts of the residential loans made by the thrift during the six
most recent tax years beginning before January 1, 1996. A residential loan is a
loan as described in Section 7701(a)(19)(C)(v) (generally a loan secured by
residential or church property and certain mobile homes), but only to the extent
that the loan is made to the owner of the property.
The balance of the pre-1988 reserves is subject to the provisions of Section
593(e), as modified by the Small Business Act, which require recapture in the
case of certain excessive distributions to shareholders. The pre-1988 reserves
may not be utilized for payment of cash dividends or other distributions to a
shareholder (including distributions in dissolution or liquidation) or for any
other purpose (except to absorb bad debt losses). Distribution of a cash
dividend by a thrift institution to a shareholder is treated as made: first, out
of the institution's post-1951 accumulated earnings and profits; second, out of
the pre-1988 reserves; and third, out of such other accounts as may be proper.
To the extent a distribution by Potters to the Company is deemed paid out of its
pre-1988 reserves under these rules, the pre-1988 reserves would be reduced and
Potters' gross income for tax purposes would be increased by the amount which,
when reduced by the income tax, if any, attributable to the inclusion of such
amount in its gross income, equals the amount deemed paid out of the pre-1988
reserves. As of December 31, 1997, Potters' pre-1988 reserves for tax purposes
totaled approximately $2.5 million. Potters believes it had approximately $1.4
million of accumulated earnings and profits for tax purposes as of December 31,
1997, which would be available for dividend distributions, provided regulatory
restrictions applicable to the payment of dividends are met. No representation
can be made as to whether Potters will have current or accumulated earnings and
profits in subsequent years.
The tax returns of Potters have been audited or closed without audit through
fiscal year 1993. In the opinion of management, any examination of open returns
would not result in a deficiency which could have a material adverse effect on
the financial condition of Potters.
OHIO TAXATION
PFC is subject to the Ohio corporation franchise tax, which, as applied to PFC,
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.
A special litter tax is also applicable to all corporations, including PFC,
subject to the Ohio corporation franchise tax other than "financial
institutions". If the franchise tax is paid on the net income basis, the
29
<PAGE> 30
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.
Ohio corporation franchise tax law is scheduled to change markedly as a
consequence of legislative reforms enacted July 1, 1997. Tax liability, however,
continues to be measured by both net income and net worth. In general, tax
liability will be the greater of (i) 5.1% on the first $50,000 of computed Ohio
taxable income and 8.5% of computed Ohio taxable income in excess of $50,000 or
(ii) 0.40% of taxable net worth. Under these alternative measures of computing
tax liability, the states to which total net income and total net worth will be
apportioned or allocated will continue to be determined by complex formulas, but
the formulas change. The minimum tax will still be $50 per year and maximum tax
liability as measured by net worth will be limited to $150,000 per year. The
special litter taxes remain in effect. Various other changes in the tax law may
affect PFC.
Potters 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 Potters' apportioned book net
worth determined in accordance with generally accepted accounting principles,
less any statutory deductions. This rate of tax is scheduled to decrease in each
of the years 1999 and 2000. As a "financial institution," Potters is not subject
to any tax based upon net income or net profits imposed by the State of Ohio.
30
<PAGE> 31
ITEM 2. PROPERTIES
The following table sets forth certain information at December 31,
1997, regarding the properties on which the main office and each branch office
of Potters is located:
<TABLE>
<CAPTION>
Owned Date acquired Net
Location or leased or leased book value
-------- --------- --------- ----------
<S> <C> <C> <C>
CORPORATE OFFICE:
519 Broadway (2) January 8, 1903
East Liverpool, Ohio 43920 Owned May 2, 1978 $105,000
BRANCH OFFICES:
530 Broadway
East Liverpool, Ohio 43920 Owned June 18, 1982 600,000
46635 Y&O Road
Glenmoor, Ohio 43920 Owned June 3, 1975 184,000
15575 State Rte. 170
Calcutta, Ohio 43920 (3) Leased February 1, 1983 204,000
</TABLE>
- ----------
(1) At December 31, 1997, Potters' office premises and equipment had a total
net book value of $1.7 million.
(2) Includes two parcels.
(3) The lease agreement with one of the directors of Potters expires on January
31, 2008, subject to five five-year renewal periods at Potters' option.
ITEM 3. LEGAL PROCEEDINGS.
Potters is not presently involved in any legal proceedings of a material nature.
From time to time, Potters is a party to legal proceedings incidental to its
business to enforce its security interest in collateral pledged to secure loans
made by Potters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the quarter ended December 31, 1997, there were no submissions of matters
to the shareholders of PFC.
31
<PAGE> 32
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
COMMON SHARES
As of February 27, 1998, 976,436 common shares of PFC were outstanding and held
by approximately 311 shareholders. Prices for PFC's common shares are quoted on
The Nasdaq SmallCap Market ("Nasdaq") under the symbol "PTRS". Five brokerage
firms currently serve as market makers for PFC's common shares: The Ohio
Company, Howe Barnes Investments, Inc., Herzog, Heine, Geduld, Inc., F.J.
Morrissey & Co., Inc. and Tucker Anthony Incorporated. All share and per share
data disclosures have been restated to reflect the two-for-one stock split in
the form of a stock dividend effective December 1, 1997.
PRICE RANGE OF COMMON SHARES
The table below shows the range of high and low sales prices for the common
shares of PFC as quoted by Nasdaq. Such prices do not represent actual
transactions and do not include retail markups, markdowns or commissions. Also
shown are dividends per share declared during each quarter presented. See Note
16 of the consolidated financial statements for a discussion of dividend
restrictions.
<TABLE>
<CAPTION>
1997 1996
---- ----
Dividends Dividends
Quarter Ended High Low Per Share High Low Per Share
---- --- ---------- ---- --- ---------
<S> <C> <C> <C> <C> <C> <C>
March 31 $10.375 $ 9.375 $ 0.035 $ 9.25 $8.50 $ --
June 30 11.00 9.50 0.045 8.875 8.00 0.06
September 30 14.125 10.50 0.045 8.125 7.75 0.03
December 31 21.75 13.00 0.05 10.00 7.875 0.035
</TABLE>
The income of PFC consists of dividends that may periodically be declared and
paid by the Board of Directors of Potters on the common shares of Potters held
by PFC and earnings on the other investments held by PFC. In addition to certain
federal income tax considerations, OTS regulations impose limitations on the
payment of dividends and other capital distributions by savings associations.
Under OTS regulations applicable to converted savings associations, Potters is
not permitted to pay a cash dividend on its common shares if the regulatory
capital of Potters would, as a result of the payment of such dividend, be
reduced below the amount required for the liquidation account (which was
established for the purpose of granting a limited priority claim on the assets
of Potters, in the event of a complete liquidation, to those members of Potters
before the conversion of Potters from the mutual form of ownership to the stock
form of ownership who maintain a savings account at Potters after the
conversion) or applicable regulatory capital requirements prescribed by the OTS.
OTS regulations applicable to all savings associations provide that a savings
association that immediately prior to, and on a pro forma basis after giving
effect to, a proposed capital distribution (including a dividend) has total
capital (as defined by OTS regulations) that is equal to or greater than the
amount of its capital requirements is generally permitted without OTS approval
(but subsequent to 30 days' prior notice to the OTS) to make capital
distributions, including dividends, during a calendar year in an amount not to
exceed the greater of (1) 100% of its net earnings to date during the calendar
year, plus an amount equal to one-half the amount by which its total capital to
assets ratio exceeded its required capital to assets ratio at the beginning of
the calendar year, or (2) 75% of its net earnings for the most recent
four-quarter period. Savings associations with total capital in excess of the
capital requirements that have been notified by the OTS that they are in need of
more than normal supervision will be subject to restrictions on dividends. A
savings association that fails to meet current minimum capital requirements is
prohibited from making any capital distributions without prior approval of the
OTS. Potters currently meets all of its regulatory capital requirements and,
unless the OTS determines that Potters is an institution requiring more than
normal supervisions, Potters may pay dividends in accordance with the foregoing
provisions of the OTS regulations.
32
<PAGE> 33
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
POTTERS FINANCIAL CORPORATION
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1997
GENERAL
Potters Financial Corporation ("PFC"), the holding company for The Potters
Savings and Loan Company ("Potters"), recorded net income of $1.2 million for
the year ended December 31, 1997, compared to a loss of $61,000 for the year
ended December 31, 1996. Basic earnings per share for 1997 were $1.24, while
diluted earnings per share were $1.21, both significant increases over the basic
and diluted loss of $.06 per share during 1996. Returns on average assets and
average shareholders' equity were 1.00% and 10.72%, respectively, for 1997,
compared to (.05%) and (.57%), respectively, for 1996. The one-time assessment
relating to the recapitalization of the Savings Association Insurance Fund
("SAIF") reduced 1996 after tax earnings by $424,000, or $.42 per basic share,
and affected the earnings of all financial institutions with SAIF-insured funds.
Potters continued to pursue its strategic priorities during 1997, focusing on
its longer-term goals of increasing interest income and the interest rate
spread. Cash inflows from loan and security repayments, maturities and calls in
the securities portfolios, sales of securities available for sale, Federal Home
Loan Bank ("FHLB") advances and deposit inflows funded significant loan growth
during 1997. Loans receivable increased $19.6 million, or 31.5%, from $62.5
million at December 31, 1996 to $82.1 million at December 31, 1997, resulting in
an increase in the ratio of loans to deposits, from 64.2% at December 31, 1996
to 82.0% at December 31, 1997. The securities portfolios declined by $10.2
million, or 23.7%, during 1997, as funds were shifted from securities yielding
6.32% during 1996 and 6.21% during 1997, to loans, which yielded 8.57% during
1996 and 8.31% during 1997. The result was a $210,000, or 5.7%, increase in net
interest income during 1997 compared to 1996 and an increase in the net interest
spread, from 3.05% for the year ended December 31, 1996 to 3.19% for the year
ended December 31, 1997.
PFC demonstrated its continuing commitment to its shareholders through a variety
of shareholder enhancement programs during 1997. Cash dividends increased from
$.125 per common share during 1996 to $.175 during 1997, representing a 40%
increase, and a two-for-one stock split in the form of a stock dividend was paid
on December 1, 1997. In addition, PFC's share repurchase program resulted in the
purchase of 85,312 common shares at a cost of $963,000, or an average of $11.29
per share. Shareholders also saw a 100% increase in the market price of PFC
common shares (as adjusted for the stock split), from $10.00 per share at
December 31, 1996, to $20.00 per share at December 31, 1997.
The following discussion and financial information are presented to provide
shareholders with a more comprehensive review of the financial position and
operating results than could be obtained from an examination of the financial
statements alone. The review should be read in conjunction with the consolidated
financial statements and accompanying notes.
In the following pages, management presents an analysis of PFC's financial
condition as of December 31, 1997, and the results of operations for fiscal
1997, as compared to prior years. In addition to this historical information,
the following discussion contains forward-looking statements that involve risks
and uncertainties. Economic circumstances, PFC's operations and PFC's actual
results could differ significantly from those discussed in the forward-looking
statements. Some of the factors that could cause or contribute to such
differences are discussed herein but also include changes in the economy and
interest rates in the nation and in PFC's general market area.
33
<PAGE> 34
Without limiting the foregoing, some of the forward-looking statements included
herein are the statements under the following headings and regarding the
following matters:
1. Net Interest Income - Management's plan for continued loan growth
and its belief that regional loan demand and the ability to
purchase loans within the State of Ohio will continue.
Management will continue to utilize FHLB advances as one of the
sources to fund loan growth.
2. Allowance and Provision for Loan Losses - Management's statements
regarding the amount and adequacy of the allowance for loan losses
and its belief that no additional provisions will be required
during 1998.
3. Financial Condition - Statements regarding the strategic focus and
long-term goals of Potters.
4. Liquidity and Capital Resources - Management's belief that
Potters' liquidity and capital position are adequate to fund its
outstanding short- and long-term needs.
Management's expectation that Potters has sufficient cash flow and
borrowing capacity to fund all outstanding commitments and
maintain desired levels of liquidity.
5. Year 2000 - Management's expectation that Year 2000 issues will be
resolved in a satisfactory manner and will not pose significant
operational problems when the year 2000 arrives.
6. Bad Debt Reserve Recapture - Management's expectation that the bad
debt reserve recapture legislation will not impact the future
income of Potters.
RESULTS OF OPERATIONS
NET INCOME
PFC recorded net income of $1.2 million for the year ended December 31, 1997,
compared to a net loss of $61,000 for 1996, and net income of $829,000 for 1995.
Basic earnings per share for 1997 were $1.24, while diluted earnings per share
were $1.21 for the same period, both significant increases over the basic and
diluted loss of $.06 per share during 1996. Basic and diluted earnings per share
for 1995 were $.80 and $.79, respectively. Operating results are primarily
affected by the general state of the economy, the interest rate environment,
fiscal, monetary and regulatory policies of government agencies and the
composition of PFC's assets and liabilities. The principal source of earnings is
net interest income, which represents the amount by which income generated on
interest-earning assets, including loans and securities, exceeds expense
incurred on interest-bearing liabilities, such as deposits and borrowings. Net
income is also impacted by provisions for losses, fee and other noninterest
income and noninterest expense.
The improvement in net income during 1997 compared to 1996 was due primarily to
an increase of $210,000, or 5.7%, in net interest income, negative loan loss
provisions of $485,000 recorded due to the payoff and sale of two nonperforming
loans, a $114,000, or 42.7%, increase in noninterest income and a $761,000, or
20.6%, decrease in noninterest expense. A large part of the decline in
noninterest expense during 1997 compared to 1996 was attributable to the
one-time Federal Deposit Insurance Corporation ("FDIC") assessment included in
1996 noninterest expense. Also depressing 1996 earnings was a $249,000 loan loss
provision primarily resulting from the write-down of the Bennett Funding Group
equipment lease credits by $377,000 upon learning of its bankruptcy filing and
the related investigation by the Securities and Exchange Commission.
34
<PAGE> 35
The decline in net income during 1996 compared to 1995 was primarily the result
of the FDIC assessment and lower net interest income during 1996, combined with
the resumption of recording income tax expense due to the elimination of the
valuation allowance against deferred tax assets in 1995.
YIELDS EARNED AND RATES PAID
PFC's net interest income consists of the difference between income generated on
loans and securities and interest expense on deposits and borrowings. Net
interest income is primarily affected by volumes, interest rates and the
composition of interest-earning assets and interest-bearing liabilities.
The following table sets forth the weighted average yields on Potters'
interest-earning assets, the weighted average interest rates on interest-bearing
liabilities and the interest rate spread between the weighted average yields and
rates at the dates indicated. Nonaccruing loans have been included in the table
as having a yield of zero.
<TABLE>
<CAPTION>
At December 31,
------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Weighted average yield on:
Loans receivable 8.49% 8.91% 9.15%
Securities (1) 6.14 6.39 5.84
Other interest-earning assets 6.64 6.70 5.50
Combined weighted average yield
on interest-earning assets 7.87 7.87 7.36
Weighted average rate paid on:
Certificates of deposit 5.73 5.67 5.81
Savings deposits 3.11 3.02 3.05
NOW accounts 2.04 2.07 2.25
Money market accounts 3.04 2.99 2.86
FHLB advances 6.31 6.51 6.29
Combined weighted average
rate paid on interest-
bearing liabilities 4.50 4.29 4.39
Interest rate spread 3.37 3.58 2.97
</TABLE>
- ---------------
(1) Includes FHLB Stock
The following table sets forth certain information relating to PFC's average
balance sheet and reflects the average yield on interest-earning assets and the
average cost of interest-bearing liabilities for the periods presented. Average
balances are derived from average daily balances for all periods presented, and
include nonaccruing loans in the loan portfolio, net of the allowance for loan
losses. Average balances of securities available for sale are based on the
carrying value while the yield is based on the amortized cost.
35
<PAGE> 36
<TABLE>
<CAPTION>
Years ended December 31,
(Dollars in thousands) ------------------------
1997
Average Interest Average
Outstanding Earned/ Yield/ Outstanding
Balance Paid Rate Balance
------- ---- ---- -------
<S> <C> <C> <C> <C>
Interest-earnings assets:
Loans receivable (1) $ 72,495 $ 6,027 8.31% $ 52,880
Securities (2) 39,549 2,465 6.21 55,055
Other 1,195 66 5.49 3,409
--------- ------- ----------
Total interest-earning assets 113,239 8,558 7.55 111,344
Noninterest-earning assets:
Cash and cash equivalents 2,789 2,350
Premises and equipment 1,739 1,700
Other nonearning assets 1,758 1,790
--------- ----------
Total assets $ 119,525 $ 117,184
========= ==========
Interest-bearing liabilities:
Certificates of deposit $ 49,723 2,816 5.66 $ 48,665
Savings and club accounts 34,452 1,031 2.99 35,389
Demand, NOW and Super NOW
accounts 12,891 263 2.04 12,671
Money market accounts 2,064 62 3.02 2,512
Borrowings 8,102 499 6.16 5,843
--------- ------- ----------
Total interest-bearing liabilities 107,232 4,671 4.36 105,080
-------
Noninterest-bearing liabilities:
Other liabilities 1,133 1,239
Shareholders' equity 11,160 10,865
--------- ----------
Total liabilities and equity $ 119,525 $ 117,184
========= ==========
Net interest income $ 3,887
=========
Interest rate spread 3.19%
=====
Net interest-earning assets $ 6,007 $ 6,264
========= ==========
Net yield on average interest-
earning assets 3.43%
=====
Ratio of average interest-earning
assets to average interest-
bearing liabilities 105.60% 105.96%
====== ======
</TABLE>
<TABLE>
<CAPTION>
(Dollars in thousands) ---------------Years ended December 31,-----------------
------------------------
1996 1995
Interest Average Interest
Earned/ Yield/ Outstanding Earned/ Yield/
Paid Rate Balance Paid Rate
---- ---- ------- ---- ----
<S> <C> <C> <C> <C> <C>
Interest-earnings assets:
Loans receivable (1) $ 4,534 8.57% $ 49,945 $ 4,441 8.89%
Securities (2) 3,491 6.32 53,530 3,436 6.36
Other 181 5.32 3,341 188 5.63
------- ----------- ---------
Total interest-earning assets 8,206 7.36 106,816 8,065 7.52
Noninterest-earning assets:
Cash and cash equivalents 2,319
Premises and equipment 1,404
Other nonearning assets 1,772
----------
Total assets $ 112,311
==========
Interest-bearing liabilities:
Certificates of deposit 2,769 5.69 $ 48,995 2,743 5.60
Savings and club accounts 1,075 3.04 35,450 1,077 3.04
Demand, NOW and Super NOW accounts 267 2.10 11,844 260 2.20
Money market accounts 78 3.09 2,743 76 2.77
Borrowings 340 5.83 1,765 115 6.52
-------- ---------- ---------
Total interest-bearing liabilities 4,529 4.31 100,797 4,271 4.24
-------- ---------
Noninterest-bearing liabilities:
Other liabilities 998
Shareholders' equity 10,516
----------
Total liabilities and equity $ 112,311
==========
Net interest income $ 3,677 $ 3,794
======== ========
Interest rate spread 3.05% 3.28%
===== =====
Net interest-earning assets $ 6,019
==========
Net yield on average interest-
earning assets 3.30% 3.55%
===== =====
Ratio of average interest-earning
assets to average interest-
bearing liabilities 105.97%
======
</TABLE>
- ----------
(1) Net of deferred loan fees, loan premiums and discounts, loans in process and
allowance for loan losses.
(2) Includes FHLB Stock.
36
<PAGE> 37
The following table presents the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities. For each category, information is provided on
changes attributable to changes in volume and changes in rate. For purposes of
this table, changes attributable to both rate and volume which cannot be
segregated have been allocated proportionately based on the absolute value of
the change due to volume and the change due to rate.
<TABLE>
<CAPTION>
1996 vs. 1995 1996 vs. 1995
------------- -------------
Increase Increase
(decrease) (decrease)
due to due to
------ ------
(Dollars in thousands)
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable $ 1,635 $ (142) $ 1,493 $ 255 $ (162) $ 93
Securities (966) (60) (1,026) 79 (24) 55
Other (121) 6 (115) 4 (11) (7)
------- ------ ------- ------ ------ --------
Total interest-earning assets $ 548 $ (196) 352 $ 338 $ (197) 141
======= ====== ====== ======
Interest-bearing liabilities:
Certificates of deposit $ 60 $ (13) 47 $ (18) $ 44 26
Savings deposits (28) (16) (44) (2) (2)
Demand, NOW and Super NOW
accounts 4 (8) (4) 18 (11) 7
Money market accounts (14) (2) (16) (7) 9 2
Borrowed funds 139 20 159 238 (13) 225
------- ------ ------- ------ ------ ------
Total interest-bearing liabilities $ 161 $ (19) 142 $ 229 $ 29 258
======= ====== ------- ====== ====== ------
Net interest income $ 210 $ (117)
======= ======
</TABLE>
NET INTEREST INCOME
Net interest income increased $210,000, or 5.7%, during 1997 compared to 1996,
due primarily to loan growth and a shift of assets from securities to loans.
Funds from loan and security repayments, sales of securities available for sale,
deposit inflows and FHLB advances were used to originate and purchase
residential real estate loans. Average loans increased $19.6 million, or 37.1%,
to $72.5 million during 1997, while the average balance of securities decreased
$15.5 million, or 28.2%. Despite the fact that the yield on loans declined from
8.57% to 8.31% during 1997, more assets were comprised of loans receivable
instead of securities yielding 6.21% and 6.32%, respectively, during 1997 and
1996. This shift in assets caused an increase in the overall earning asset yield
from 7.36% during 1996 to 7.55% during 1997. The cost of funds increased from
4.31% during 1996 to 4.36% during 1997, due primarily to an increase in
certificates of deposit relative to other types of deposits and the increased
use of FHLB advances to finance loan purchases. FHLB advances and certificates
of deposit generally bear higher interest rates than other types of deposits.
The increase in the asset yield outpaced the increase in the cost of funds which
resulted in a widening of the net interest spread from 3.05% for the year ended
December 31, 1996 to 3.19% for the year ended December 31, 1997. The interest
rate margin also increased, from 3.30% during 1996 to 3.43% during 1997.
Net interest income decreased $117,000, or 3.1%, during 1996 compared to 1995,
due primarily to the increased use of FHLB advances in 1996 to finance loan
purchases and a short-term growth strategy discussed in "Financial Condition".
Also contributing was a decline in the average yield on interest-earning assets,
offset by increasing average balances of loans and securities.
Interest on loans receivable of $6.0 million for the twelve months ended
December 31, 1997 represented an increase of $1.5 million, or 32.9%, over $4.5
million during 1996. Interest on loans receivable totaled $4.4 million during
1995. The increases in loan interest income were primarily attributable to
growth of over $19.6 million, or 31.4%, in the loan portfolio during 1997, and
$12.6 million, or 25.2%, during 1996,
37
<PAGE> 38
resulting primarily from purchases of loans in both years. One-to-four family
real estate loans grew 48.7% during 1996 and 35.9% during 1997. Home equity
lines of credit increased 16.4% during 1996, to $3.9 million at December 31,
1996, and 35.4% during 1997, to $5.2 million at December 31, 1997. Offsetting
such increases were declines in the average yield earned on loans during 1996
and 1997, and continuing strong local competition for loans which tends to
depress new loan interest rates as multiple entities compete for the same loans.
Potters' strategic plan calls for continued loan growth, although there can be
no assurance that the demand for loans will continue in surrounding local areas
or that Potters will continue to be successful in purchasing loans in other
areas of Ohio. Loan demand is affected by, among other things, regional and
national economic conditions and the prevailing interest rate environment.
Payoffs on nonresidential real estate loans located in Colorado of $2.0 million
during 1997 and $3.4 million in 1996, with weighted average yields of 9.74% in
1997 and 8.32% in 1996, negatively affected the yield on loans, but were
consistent with management's strategy of reducing credit risk from out-of-state
loans.
Interest and dividends on securities and FHLB stock of $2.5 million for the year
ended December 31, 1997 represented a decline of $1.0 million, or 29.4%, from
the $3.5 million during 1996 as PFC continued its strategic objective of
increasing the asset yield through the shift of assets from securities to loans.
Both the available-for sale and held-to-maturity securities portfolios have
declined during 1997, by 49.7% and 14.9%, respectively. Proceeds from sales of
available-for-sale securities totaling $5.5 million, along with repayments,
maturities and calls of securities were used to fund loan growth. Average
balances of securities declined $15.5 million during 1997, while the average
yield declined from 6.32% during 1996 to 6.21% during 1997.
Securities income totaled $3.5 million for 1996 compared to $3.4 million for
1995. The $55,000 increase during 1996 compared to 1995 resulted primarily from
purchases of agency securities available for sale during 1996 which increased
the average balance by $1.5 million. The purchase of $10.0 million of such
securities was part of a short-term leveraged growth strategy employed and
terminated during 1996. The yield on securities decreased to 6.32% during 1996
from 6.36% during 1995.
Interest on short-term investments declined $115,000 during 1997, to $66,000,
from $181,000 during 1996. The average yield on such investments increased
however, from 5.32% for 1996 to 5.49% for 1997. Interest on short-term
investments declined $7,000 during 1996 compared to 1995. The average balance of
short-term investments increased marginally during 1996 while the average yield
decreased from 5.63% during 1995 to 5.32% during 1996.
Interest expense on deposits remained stable at $4.2 million in each of the last
three years. Inflows have occurred in certificates of deposit during 1997 while
both certificates of deposit and demand and NOW accounts increased during 1996.
The average rate on deposits increased marginally, from 4.20% during 1995 to
4.22% during 1996, and then declined slightly to 4.21% during 1997. The
competition for deposits from financial institutions and a wide array of
alternative deposit investments continues to impact the availability and cost of
funds and will continue to do so in the future. In late 1997, Potters developed
a new statement savings account which is indexed to and floats each week with
the 90-day U.S. Treasury bill. The introduction of this account is an attempt to
retain some funds which might otherwise be lost to brokerage firm money market
accounts. At December 31, 1997, the balance in such accounts totaled $949,000.
The Company introduced a tiered interest rate pricing structure on certificates
and selected checking and statement savings products during 1995 in order to
reduce the impact of paying higher deposit rates and continued the pricing
strategy during 1996 and 1997.
Interest on FHLB advances of $499,000 during 1997 represented a $159,000
increase over 1996, due primarily to an increase of $2.3 million in the average
balance of advances and an increase in the average rate, from 5.83% during 1996
to 6.16% during 1997. Several FHLB advances obtained during 1997 were used to
fund loan purchases. The maturities of such advances were matched to selected
securities maturing within the next three years. Management expects to continue
to utilize FHLB advances to fund loan growth. Interest on borrowings increased
$225,000, to $340,000 for 1996, compared to $115,000 during 1995. The increase
during 1996 compared to 1995 was due primarily to a $4.1 million increase in the
average balance of FHLB advances which were used to fund loan purchases and a
short-term growth strategy employed during the year. Somewhat offsetting the
increased expense due to volume was a decline in the average rate on FHLB
advances to 5.83% during 1996 from 6.52% during 1995.
38
<PAGE> 39
ALLOWANCE AND PROVISION FOR LOAN LOSSES
In January 1997, a $756,000 nonperforming loan located in Colorado was repaid
and in June 1997, a $341,000 nonperforming Colorado loan was sold at a loss of
$60,000. Through the removal of the allowances specifically allocated to the
loans, the portion of the allowance for loan losses not allocated to any
specific loan or group of loans increased by over $485,000. Both of the loans
were included in restructured loans at December 31, 1996, but were current under
the terms of the renegotiated contracts and were, therefore, not included in
impaired loan disclosures. In addition to management's ongoing review of all
loans with respect to the adequacy of the allowance for loan losses, a periodic
analysis of the percentages allocated to various types of real estate, consumer
and commercial loans is conducted. Because of the decline in nonperforming loans
and the change in the risk profile of Potters' loan portfolio, and primarily
because of the payoff and sale of two nonperforming Colorado nonresidential real
estate loans, a negative provision for loan losses of $485,000 was recorded
during 1997 to remove excess allowances for loan losses. The negative provision
and the loss on the loan sale had a $281,000, or $.29 per basic share, after-tax
positive effect on 1997 earnings.
The provision for loan losses was $249,000 during 1996, compared to $245,000
during 1995. The marginally higher provision during 1996 compared to 1995
related to the extension of credit by Potters for an investment in equipment
leases with the Bennett Funding Group, a Syracuse, New York leasing corporation,
and Bennett Leasing Corporation, a related entity. Potters learned late in the
first quarter of 1996 that the Securities and Exchange Commission had commenced
proceedings against the Bennett Funding Group, charging fraud in connection with
the sale of equipment leases. On March 29, 1996, the Bennett Funding Group filed
for protection from creditors under Chapter 11 of the federal bankruptcy laws.
Potters charged-off $377,000 of the $754,000 equipment lease credits and
recorded an additional provision for loan losses of $188,500 in the first
quarter of 1996. Potters ceased the accrual of interest on the remaining
investment in March 1996. At December 31, 1996, the Bennett Funding Group
equipment lease credits totaled $365,000 and were included in nonperforming and
impaired loans.
The Court ruled that the manner in which the Bennett Funding Group equipment
lease credits were documented and recorded was sufficient to perfect Potters'
position as a secured creditor. In January 1997, the bankruptcy Trustee extended
various settlement options to all financial institutions involved in the case.
Because of the legal expenses involved in continuing with litigation and the
expected length of the case, Potters' Board of Directors decided to accept one
of the settlement options. In November 1997 Potters received $381,000, which
represented the initial payment under the terms of the settlement agreement. The
first payment eliminated the remaining balance of Potters' lease credits, which
were included in nonperforming loans, and resulted in a recovery of
approximately $12,000 of the amount previously charged-off. Additional payments
totaling $29,000 were received in November and December 1997 and recorded as
recoveries of the amount previously charged-off, as will any subsequent payments
received from the Trustee under the terms of the settlement agreement. There can
be no assurance at this time that further payments will be received.
The allowance for loan losses at December 31, 1997 was $2.1 million,
representing a decline of $487,000 from $2.6 million at December 31, 1996, due
primarily to the negative provisions of $485,000 during 1997. Loan charge-offs
during 1997 totaled $76,000, with recoveries of $74,000. No loan loss provision
is planned for 1998, although no assurances can be given that provisions will
not be made during that time if circumstances change, such as increases in the
loan portfolio, changes in the economy or increases in nonperforming loans.
Potters experienced improvement in asset quality during 1996 and 1995 despite
the addition of the Bennett Funding Group equipment lease credits to
nonperforming loans in 1996. Balances of nonperforming loans declined while the
allowance for loan losses increased. The allowance for loan losses increased
$390,000, or 17.4%, during 1996 due to provisions of $249,000 and net recoveries
of $141,000. Charge-offs of $538,000 related primarily to the Bennett Funding
Group equipment leases and payoff discounts offered to two Colorado
nonresidential borrowers. Recoveries of $679,000 were recorded during 1996,
$647,000 of which involved the payoff of Colorado property loans which had
previously been written down. The allowance increased $277,000, or 14.1%, during
1995 due to provisions of $245,000 and net recoveries of $32,000.
39
<PAGE> 40
The following table sets forth the amounts and categories of Potters'
nonperforming assets. Nonperforming assets consist of nonaccrual loans, accruing
loans which are delinquent 90 days or more, restructured loans, real estate
acquired by foreclosure or deed-in-lieu thereof and repossessed assets. Loans
are placed on nonaccrual status when the collection of principal and/or interest
becomes doubtful. Foreclosed assets include assets acquired in settlement of
loans.
<TABLE>
<CAPTION>
December 31,
------------
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Nonaccrual loans $ 207 $ 627 $ 372
Restructured loans 1,101 2,066
--------- ------- ---------
Total nonperforming loans 207 1,728 2,438
Foreclosed and repossessed assets 85
Total nonperforming assets $ 207 1,728 $ 2,523
========= ======== =========
Total assets $ 122,637 $ 114,172 $ 114,242
Total nonperforming assets as
a percent of total assets .17% 1.51% 2.21%
Allowance for loan losses $ 2,143 $ 2,630 $ 2,240
Allowance as a percentage of
nonperforming loans 1,035.27% 152.20 91.88%
</TABLE>
Nonperforming loans of $207,000 at December 31, 1997 represented a decrease of
$1.5 million, or 88.0%, from nonperforming loans of $1.7 million at December 31,
1996. The overall level of nonperforming loans has declined $2.2 million, or
91.5%, over the last three years as Potters has reduced its risk from
out-of-state nonresidential real estate loans primarily through charge-offs,
discounted payoffs and sales of loans located in Colorado. Except for the
addition of the Bennett Funding Group lease credits to nonaccrual loans during
1996, nonaccrual and restructured loans have decreased in each of the last three
years, and nonperforming loans as a percentage of assets has declined from 2.21%
at December 31, 1995, to 1.51% at December 31, 1996 and to .17% at December 31,
1997. The allowance for loan losses exceeded $2.0 million at December 31, 1995,
1996 and 1997, and has increased steadily as a percentage of nonperforming loans
at each year end.
Nonaccrual loans include impaired loans. A loan is considered impaired when it
is probable that all principal and interest will not be collected according to
the terms of the loan contract. With the settlement of the Bennett Funding Group
matter, there were no impaired loans at December 31, 1997. At December 31, 1996,
impaired loans totaled $365,000 and consisted solely of the Bennett Funding
Group lease credits. The $193,000 impaired loan reported at December 31, 1995
was paid off during 1996.
Restructured loans are those which have been renegotiated at concessionary terms
as a result of the borrowers' troubled financial condition. At year end 1995,
restructured loans were comprised of four nonresidential real estate loans
located in the State of Colorado. During 1996, one of the loans was repaid and
another was removed from the restructured category due to the collateral value,
interest rate and the history of repayment on the loan. As a result,
restructured loans declined $965,000 during 1996 and totaled $1.1 million at
December 31, 1996. As of December 31, 1996, both of the remaining restructured
loans had reverted back to the terms and conditions of the original loan
contract and were performing as agreed. At December 31, 1997, there were no
restructured loans.
Potters maintains an allowance for loan losses in an amount which, in
management's judgment, is adequate to absorb reasonably foreseeable future
losses inherent in the loan portfolio. The allowance is available to absorb
credit losses from any loans, including nonperforming loans, and a portion of
the allowance is allocated to each major loan type. Management determines the
adequacy of the allowance for credit losses by reviewing the changes in the
financial condition or operating results of borrowers, economic conditions and
business trends. While management utilizes its best judgment and information
40
<PAGE> 41
available, the ultimate adequacy of the allowance is dependent upon a variety of
factors, including the performance of Potters' loan portfolio, generally
prevailing economic conditions, changes in real estate values and interest rates
and regulatory requirements. There can be no assurance that the allowance for
loan losses will be adequate to cover future losses. The provision for loan
losses is the amount periodically charged to earnings and added to the allowance
for loan losses. The amount of the provision is based on management's regular
review of the loan portfolio considering such factors as historical loss
experience, the amount of nonperforming and delinquent loans, changes in the
size and composition of the loan portfolio, and specific borrower considerations
such as the ability of the borrower to repay the loan and the estimated value of
the underlying collateral. See Note 3 to Consolidated Financial Statements for
activity with respect to the allowance for loan losses.
Potters has identified a $233,000 real estate loan at December 31, 1997, which
does not meet the criteria of nonperforming loans but where information about
credit or other problems creates doubts as to the ultimate collectibility of the
loan. The loan included in the above figure is current as to contractually
required payments but information exists regarding possible credit or other
problems of the borrowers which causes management concerns as to the ability of
such borrowers to comply with the present loan repayment terms.
NONINTEREST INCOME
Noninterest income of $381,000 for the year ended December 31, 1997 increased
$114,000, or 42.7%, over 1996 noninterest income of $267,000. Several
nonrecurring items affected noninterest income during 1997, some of which
enhanced earnings. The property housing Potters' East End Office, which ceased
operations on March 31, 1997, and a residential property adjacent to another of
Potters' offices were sold during the second quarter of 1997, generating gains
of $53,000. A deferred gain on the sale of land of $56,000 was recognized during
1997 when the land contract relating to the sale was repaid during the third
quarter. Such gains had a $73,000, or $.08 per basic share, after-tax positive
effect on 1997 earnings. Also included in noninterest income during 1997 was a
$60,000 loss on the sale of a nonperforming loan and losses totaling $22,000 on
the sale of securities available for sale. Service charges on deposits and other
noninterest income increased $61,000, or 21.3%, during 1997 primarily from
increased service charges on deposit accounts, the addition of an off-site
automated teller machine ("ATM") and the introduction of fee-based products,
including a VISA Check Card program.
Noninterest income increased $10,000, to $267,000 during 1996. As a result of an
analysis of the existing fee structure on deposit and loan products and the
implementation of several changes, deposit account fee income and other income
increased 10.9% and 21.6%, respectively, during 1996 compared to 1995. Somewhat
offsetting the increase in 1996 was a net loss of $22,000 on foreclosed real
estate operations due primarily to the payment of real estate taxes on
foreclosed real estate which was sold during the year at a gain of $55,000. Also
included in 1996 noninterest income were gains and losses on sales of loans and
securities netting to zero during the year compared to $12,000 of gains on such
sales during 1995.
NONINTEREST EXPENSE
Noninterest expense decreased $761,000, or 20.6%, for the fiscal year ended
December 31, 1997, compared to the prior year. The primary reason for the
decrease in noninterest expense in 1997 was the recognition in 1996 of a
one-time special deposit insurance assessment of approximately $643,000 in
September 1996 as a result of legislation enacted to recapitalize the SAIF of
the FDIC. The legislation imposed a one-time assessment on virtually all
SAIF-insured institutions equal to $.657 per $100 of SAIF-insured deposits
maintained by those institutions as of March 31, 1995.
The SAIF recapitalization plan instituted a partial sharing of the cost of prior
thrift failures by both SAIF-insured institutions and commercial banks, whose
deposits are insured by the Bank Insurance Fund ("BIF"). The cost sharing
consists of the payment of interest on obligations issued by a federally
chartered corporation to provide financing ("FICO") for resolving the thrift
crisis of the 1980s. Effective January 1, 1997, BIF assessments for healthy
banks were increased to $.013 per $100 in deposits and SAIF assessments for
healthy savings associations were reduced to $.064 per $100 in deposits. Another
provision of the legislation stipulated that deposit insurance assessments for
SAIF-insured institutions may never be reduced below the level for healthy BIF
institutions. The assessment on SAIF-insured
41
<PAGE> 42
institutions is expected to be reduced to $.024 per $100 in deposits no later
than January 1, 2000, at which time BIF-insured institutions will share fully in
the cost of prior thrift failures. Depending upon the level of BIF and SAIF
deposits, such assessments will continue until the FICO bonds mature in 2017.
The recapitalization plan also provides for the merger of the SAIF and the BIF
effective January 1, 1999, assuming there are no savings associations under
federal law. Under separate proposed legislation, Congress is considering the
elimination of the federal thrift charter and the separate federal regulation of
thrifts. Pursuant to such legislation, Congress may eliminate the Office of
Thrift Supervision ("OTS") and Potters may be regulated under federal law as a
bank or may be required to change its charter. Such change in regulation or
charter would likely change the range of activities in which Potters may engage
and would probably subject Potters to more regulation by the FDIC. In addition,
PFC may become subject to more restrictive holding company requirements,
including activity limits and capital requirements. PFC cannot predict when or
whether Congress may actually pass legislation regarding PFC's or Potters'
regulatory requirements or charter.
Excluding the one-time SAIF assessment, noninterest expense decreased $118,000,
or 3.9%, for the fiscal year ended December 31, 1997 compared to the comparable
period in 1996. Due to the recapitalization of the SAIF, Potters' annual deposit
insurance premium assessment was reduced by approximately $168,000 during 1997
compared to 1996. Compensation and benefits expense decreased $17,000, while
other noninterest expense remained constant during 1997 compared to the prior
fiscal year. Included in 1997 noninterest expense was a net gain on the sale of
foreclosed and repossessed property of $50,000, compared to a net gain of
$39,000 during 1996. Occupancy and equipment expense increased $18,000 due to
continued investments in new technological capabilities and office improvements.
Professional fees increased significantly during 1997 due to legal fees
associated with the settlement of the Bennett Funding Group lease credits and
Potters' decision to outsource part of its internal audit and compliance
functions.
As part of management's ongoing process to contain costs, branch operations at
Potters' East End Office were terminated on March 31, 1997. An ATM was installed
in an East End supermarket in order to utilize technology to accommodate more
customers in the East End. Consistent with PFC's strategy to expand and
diversify its loan portfolio, management added needed technical expertise to its
loan support operations in 1997 and continued its focus on employee training and
development throughout the organization.
Noninterest expense increased $711,000, to $3.7 million during 1996 compared to
$3.0 million during 1995. The primary reason for the increase during 1996
compared to 1995 was the one-time SAIF assessment discussed above. Office
occupancy and equipment expense increased $26,000 during 1996 due to increased
depreciation expense from the new loan and deposit operations equipment and new
personal computer software installed in late 1995 and mid-1996, respectively,
and increased expenses for maintenance of and improvements to Potters' offices.
Other noninterest expense increased $123,000 as Potters worked toward its
strategic commitments to invest in employee training and development, plus new
product development. Also increasing during 1996 compared to 1995 were
advertising expense, franchise tax and data processing costs. Compensation and
benefits expense decreased $28,000 during 1996 due primarily to larger deferrals
of compensation costs related to increased loan originations during 1996,
somewhat offset by normal salary adjustments.
The Board of Directors of Potters approved ceasing the accumulation of future
benefits to participants in Potters' defined benefit pension plan during 1995
and approved a resolution terminating the plan during 1996. Such actions
resulted in a net loss of $74,000 on the curtailment of the plan included in
1995 noninterest expense and $67,000 included in 1996 noninterest expense from
the termination decision. The settlement of vested plan benefits will occur upon
receipt of a determination letter from the Commissioner of the Internal Revenue
Service approving the plan termination.
INCOME TAXES
Income tax expense during 1997 of $629,000 increased $561,000 over 1996 income
tax expense due primarily to the increase in net income in 1997 over 1996.
Income tax expense during 1996 was $68,000, resulting primarily from the early
termination of a life insurance policy during the year. The absence of a tax
provision in 1995 on income before tax of $829,000 resulted primarily from the
42
<PAGE> 43
reduction during 1995 of the valuation allowance against deferred tax assets.
The valuation allowance was reduced as the assets became more likely to be
realized as the Company established a history of generating taxable income. As a
result of the elimination of the valuation allowance as of December 31, 1995,
Potters began to recognize income tax expense in 1996.
Legislation enacted in 1996 requires the recapture, over time, of a portion of
the bad debt reserve previously deducted by Potters for income tax reporting
purposes. Since deferred taxes have been recorded on those bad debt reserves,
this recapture will not affect net income.
FINANCIAL CONDITION
Potters' total assets increased $8.5 million, or 7.4%, during 1997 to $122.6
million at December 31, 1997, from $114.2 million at December 31, 1996. During
1997, Potters continued to execute its strategic plan through balance sheet
restructure, focusing on its longer-term goals of increasing interest income and
the interest rate spread. Cash inflows from loan and security repayments,
maturities and calls in the securities portfolios, sales of securities available
for sale, FHLB advances and deposit inflows funded significant loan growth
during 1997.
Cash and cash equivalents decreased $769,000, from $4.6 million at December 31,
1996 to $3.8 million at December 31, 1997. Decreases consisted of lower balances
in various bank accounts.
Securities available for sale decreased $5.4 million, or 49.7%, from $10.9
million at December 31, 1996 to $5.5 million at December 31, 1997. Sales of $5.5
million in securities available for sale resulted in losses of $22,000 during
1997. Proceeds from securities sales in 1997 were used to shift assets from
lower-yielding securities to higher-yielding loans, funding loan originations
and purchases. Securities designated as available for sale are carried at their
fair values, with resulting unrealized gains or losses added to or deducted from
shareholders' equity, net of tax. The unrealized loss on securities available
for sale decreased from $144,000 at year-end 1996 to $25,000 at year-end 1997
due to a decline in interest rates during 1997. The equity component,
representing unrealized losses, net of tax, on securities available for sale
decreased from $94,000 at December 31, 1996, to $17,000 at December 31, 1997.
At December 31, 1997, the held-to-maturity securities portfolio totaled $27.2
million, a decrease of $4.8 million, or 14.9%, from $31.9 million at December
31, 1996. Held-to-maturity securities at December 31, 1997 consisted of $20.5
million of mortgage-backed securities and $6.6 million of other securities,
primarily U.S. Government agency securities. The $4.7 million reduction in the
portfolio during 1997 was due primarily to calls of two agency securities
totaling $1.0 million and securities repayments. Such reduction contributed to
funding loan growth.
Net loans receivable increased $19.6 million, from $62.5 million at December 31,
1996, to $82.1 million at December 31, 1997. Loan purchases and local loan
originations during 1997 resulted in a net increase of $17.6 million, or 35.9%,
in one-to-four family real estate loans. Loan purchases totaled $20.5 million
and consisted of $20.0 million of adjustable-rate real estate loans and $520,000
of fixed-rate real estate loans. The adjustable-rate features of the majority of
the loan purchases continued management's asset/liability strategy of
controlling the Company's exposure to interest rate risk. Real estate loans
secured by nonresidential property increased $314,000 during 1997 despite the
reduction of $2.0 million of nonresidential real estate loans located in
Colorado through repayments and the sale of one nonperforming loan. Consumer and
other loans increased $1.3 million, or 15.4%, during 1997, primarily from
increased home equity lines of credit and other consumer loans, somewhat offset
by the settlement of the Bennett Funding Group lease credits and the continued
paydown of the mobile home loan portfolio. Increased loan originations and
purchases were part of the Company's focus on its strategic goals, and resulted
in an increase in the ratio of loans to deposits from 64.2% at December 31,
1996, to 82.0% at December 31, 1997. Potters has developed a 30-year fixed-rate
real estate product for origination, most of which will be sold in the secondary
mortgage market. In late 1997, $276,000 of such loans were sold on a servicing
released basis, resulting in a gain of $4,000. The Asset/Liability Management
Committee ("ALCO") decided to assume a limited amount of increased interest rate
risk by purchasing up to $7.5 million in fixed-rate and/or longer-term
adjustable-rate residential real estate loans in order to enhance the yield on
interest-earning assets. Five-year adjustable-rate loans totaling $5.1
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<PAGE> 44
million were purchased during the fourth quarter of 1997. The
five-years/one-year adjustable-rate loans reprice each year after the initial
five-year adjustment period.
Total deposits increased $2.8 million, or 2.9%, from $97.3 million at December
31, 1996, to $100.1 million at December 31, 1997. Net inflows of $4.0 million
occurred in certificates of deposit during 1997. Potters competitively priced
selected certificates of deposit with maturities exceeding one year in an
attempt to attract new funds. Strong competition for certificates of deposit in
the local area continued to affect the cost of funds, although a tiered pricing
system on the basis of amount of deposit introduced in 1995 has somewhat
mitigated the effect of rising deposit costs. The ALCO continues to focus on
strategies for reduced interest rate risk and responsible deposit management.
In accordance with its asset/liability policy, Potters does not match the
highest rates offered on deposits by competitors. The Company continues to
emphasize deposits from retail sources and had no brokered deposit accounts at
December 31, 1997.
Potters funded the change in its asset mix during 1997 with loan and security
maturities, calls and repayments, sales of securities available for sale,
deposit inflows and FHLB advances. At December 31, 1997, FHLB advances totaled
$10.0 million, compared to $5.1 million at December 31, 1996. Advances totaling
$16.1 million received during 1997 contributed to financing loan growth and were
used in liquidity management. The maturities of several advances used to fund
loan purchases were matched to selected securities maturing within the next
three years. Advance repayments totaled $11.1 million during the year.
Shareholders' equity increased $430,000 during 1997 due primarily to net income
of $1.2 million and the issuance of 34,888 common shares upon the exercise of
stock options, which contributed $174,000 to the increase in shareholders'
equity. Other increases in shareholders' equity consisted of a $77,000 decrease
in the unrealized loss, net of income tax, on securities available for sale, a
$13,000 increase from The Potters Savings and Loan Company Recognition and
Retention Plan ("RRP") shares earned during 1997 and a $105,000 tax benefit
arising from stock option and RRP shares. Offsetting such increases in
shareholders' equity were the purchase of 85,312 outstanding shares for $963,000
and dividends paid of $174,000, or $.175 per share.
ASSET/LIABILITY MANAGEMENT
Asset/liability management is the process by which a company manages its
exposure to changes in interest rates. The Company's goal in managing interest
rate sensitivity is to maintain an appropriate balance between interest
sensitive assets and liabilities in order to minimize the impact of volatility
in market interest rates. The process is carried out through weekly meetings of
the ALCO. The ALCO utilizes the net portfolio value ("NPV") approach and
simulation modeling to aid in making decisions relating to pricing and the
relative mix of interest rate sensitive assets and liabilities.
NPV is the difference between the present value of expected cash flows from
assets, and the present value of expected cash flows from liabilities and
off-balance sheet contracts under various interest rate scenarios. OTS
regulations define a normal level of interest rate risk, based on a 200 basis
point change (100 basis points equals 1%) in interest rates, as a decrease in
the NPV of no more than two percent of the present value of its assets.
Presented below, as of September 30, 1997 and December 31, 1996, is an analysis
of Potters' interest rate risk as measured by changes in NPV for instantaneous
and sustained parallel shifts in the yield curve in 100 basis point increments
up and down 400 basis points and compared to current policy limits of the Board
of Directors. As illustrated in the table, NPV is more sensitive to rising rates
than declining rates. In a rising rate environment, fixed-rate loans decline in
market value because of the rise in rate and slowing prepayments. The Company
does not experience a rise in market value for such loans in a declining rate
environment because borrowers will prepay at relatively faster rates. OTS
assumptions are used in calculating the amounts in this table.
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<PAGE> 45
<TABLE>
<CAPTION>
At September 30, 1997 (1) At December 31, 1996
Change in ------------------------- --------------------------
Interest Rate Board Limit $ change % change $ change % change
(Basis Points) % Change in NPV in NPV in NPV in NPV
- -------------- -------- ------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
+400 (40)% $ (3,988) (29)% $ (3,979) (30)%
+300 (30) (2,694) (19) (2,787) (21)
+200 (20) (1,519) (11) (1,667) (13)
+100 (10) (569) (4) (702) (5)
0 0 0 0 0 0
-100 (10) 74 1 381 3
-200 (20) 238 2 695 5
-300 (30) 603 4 1,132 9
-400 (40) 1,386 10 1,898 14
</TABLE>
- ----------
(1) Information from the OTS Interest Rate Risk Report as of December 31, 1997
is not yet available.
At September 30, 1997, Potters' base case NPV ratio was 11.06% compared to
11.17% at December 31, 1996. After an assumed 200 basis point increase in
interest rates, the September 30, 1997 NPV ratio was 10.10% compared to 10.01%
at December 31, 1996. Potters' pre- and post-shock NPVs remained relatively
consistent at December 31, 1996 and September 30, 1997, despite the shift in
assets from securities to loans during the time period. The sensitivity measure
or change in the NPV ratio declined from a negative 116 basis points at December
31, 1996, to a negative 97 basis points at September 30, 1997. The Company's
change in NPV as a percentage of the present value of its assets decreased from
1.41% at December 31, 1996 to 1.21% at September 30, 1997. The percentage change
in NPV under all scenarios was well within the Board-imposed limits and the OTS
normal level of interest rate risk at both period ends.
Potters' interest rate risk exposure during 1997 was impacted primarily by the
interest rate environment and by the origination and purchase of adjustable-rate
loans funded by liabilities with maturities in excess of one year. Interest
rates declined during 1997, but the yield curve became flatter, reducing the
difference between short- and long-term interest rates. As Potters continues to
implement its strategic plan and restructure its balance sheet to achieve a
higher return on its assets, its sensitivity to interest rate risk may increase
as well.
The ALCO also utilizes an internal model using assumptions from the OTS Interest
Rate Risk Reports to simulate the impact of significant purchases or strategies.
Such analyses are performed and reviewed by ALCO prior to effecting
transactions.
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the NPV approach. Certain assets and liabilities with similar
characteristics may react in different degrees to changes in market interest
rates. In addition, the interest rates on certain assets and liabilities may
fluctuate in advance, or lag behind, changes in market interest rates. A change
in interest rates can also invalidate the prepayment and other assumptions used
in NPV calculations.
OTS regulations specifying an interest rate risk component to the calculation of
risk-based capital required financial institutions exceeding the normal interest
rate exposure as defined by the OTS to take a deduction from the total capital
available to meet the risk-based capital requirement. The effective date of this
regulation has been indefinitely delayed. If and when the regulation is enacted,
Potters' asset and risk-based capital levels make the OTS regulation not
applicable to the Company.
Net interest income is analyzed under various interest rate scenarios using
simulation modeling and limits set for maximum allowable percentage changes in
net interest income under each scenario. The Board of Directors approves and
monitors the Company's compliance with its interest rate risk management policy
on a quarterly basis.
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<PAGE> 46
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the ability of Potters to generate sufficient cash to fund
current loan demand, meet deposit withdrawals and pay operating expenses.
Liquidity is influenced by financial market conditions, fluctuations in interest
rates, general economic conditions and regulatory requirements. Potters' liquid
assets, primarily represented by cash equivalents and interest-bearing deposits
in other financial institutions, are a result of operating, investing and
financing activities. These activities are summarized below for the years ended
December 31, 1997 and 1996:
Years ended December 31,
------------------------
1997 1996
---- ----
(Dollars in thousands)
Net income (loss) $ 1,197 $ (61)
Adjustments to reconcile net income
to net cash from operating activities 488 602
-------- --------
Net cash from operating activities 1,685 541
Net cash from investing activities (9,081) (6,946)
Net cash from financing activities 6,627 (240)
-------- --------
Net change in cash and cash equivalents (769) (6,645)
Cash and cash equivalents at the
beginning of the year 4,585 11,230
-------- --------
Cash and cash equivalents at the end of
the year $ 3,816 $ 4,585
======== ========
The adjustments to reconcile net income to net cash from operating activities
consists mainly of the provision for losses, depreciation and amortization and
changes in accrued income and expense. Significant components of cash flows from
investment activities during 1997 were $20.5 million of loan purchases, sales of
securities available for sale of $5.5 million and repayments and calls on
securities held to maturity of $4.7 million. During 1996, investment activities
included $23.9 million of purchases, $13.2 million in sales and calls and
maturities totaling $10.6 million of securities available for sale. In addition,
during 1996, there were $13.7 million in real estate loan purchases and
repayments, calls and maturities of securities held to maturity of $7.1 million.
Financing activity during 1997 included net deposit inflows of $2.8 million
compared to net outflows in deposits of $1.4 million during 1996. During 1997,
proceeds from FHLB advances totaled $16.1 million, with $11.1 million of
repayments. Proceeds from FHLB advances received during 1996 totaled $15.6
million while repayments of such advances totaled $13.5 million.
Potters' normal, recurring sources of funds are primarily customer deposits,
investment securities available for sale, maturities, calls and repayments of
securities held to maturity, loan repayments and other funds provided by
operations. Potters has the ability to borrow from the FHLB when needed as a
secondary source of liquidity. Potters maintains investments in liquid assets
based upon management's assessment of the need for funds, expected deposit
flows, the yields available on short-term liquid assets and the objectives of
Potters' asset/liability management program. Potters is required under federal
regulation to maintain an average daily balance of liquid assets (generally
including cash, deposits in other financial institutions, and qualifying U.S.
government securities) at a minimum of 4% of the sum of its average daily
balance of net withdrawable deposit accounts and borrowings payable in one year
or less. During December 1997, Potters' average regulatory liquidity ratio was
11.4%. At December 31, 1997, Potters had commitments to originate loans and
unused credit lines totaling $5.0 million. Management considers Potters'
liquidity and capital reserves sufficient to fund its outstanding short- and
long-term needs on a timely basis. Potters has sufficient cash flow and
borrowing capacity to fund all outstanding commitments and to maintain desired
levels of liquidity.
At December 31, 1997, Potters' capital was in excess of all capital requirements
set forth by regulation for all federally insured savings institutions. Note 16
of the consolidated financial statements sets forth information with respect to
Potters' regulatory capital and the corresponding regulatory capital
requirements applicable to thrift institutions.
46
<PAGE> 47
FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company disclosed the estimated fair values and related carrying values of
its financial instruments at December 31, 1997 and 1996 in Note 17 of the
consolidated financial statements. The difference between the carrying values
and the estimated fair values of the Company's financial instruments is
primarily a function of the interest rate environment and the characteristics of
the financial instruments.
The estimated fair value of loans receivable represented 100.3% and 98.9% of the
carrying values at December 31, 1997 and 1996, respectively, while the fair
value of securities represented 99.9% and 99.2% of the carrying values at the
same dates. At December 31, 1997 and 1996, the estimated fair value of deposits
was 99.8% and 100.1%, respectively, of its carrying value.
YEAR 2000
As the year 2000 approaches, many computer operations will be impacted by major
system failures or miscalculations if programs are not adapted to accommodate a
four-digit year. In the past, when computer storage capacity was limited and
expensive, many programs were written using two digits rather than four to
define a year. When the year 2000 arrives, computer programs that run
time-sensitive software may identify a date using "00" as the year 1900 rather
than the year 2000.
As with all financial institutions, Potters' operations depend almost entirely
on computer systems. Potters has formed a "Year 2000 Committee" (the
"Committee") to address the problems associated with the year 2000. The
Committee has conducted a comprehensive review of all operations which will be
impacted by the year 2000. Because Potters primarily uses outside vendors in its
computerized operations, the Committee has been in close contact with all
vendors to ensure that the problem is being addressed. The Committee is in the
process of developing a detailed plan to monitor the progress of vendors in
modifying their software and to perform detailed testing of each software
program by Potters' employees to ensure that all operational systems will
accommodate the year 2000. The Committee will develop a contingency plan for all
major systems which will provide alternatives if existing vendors show a lack of
commitment to or progress in modifying systems to be year 2000 compliant. The
Committee is also addressing credit risk considerations arising from the year
2000 by contacting all major commercial borrowers to inform them of the problems
associated with the year 2000 and ensure that they are addressing such problems.
Management and the Board of Directors are committed to ensuring continuing
operations in the year 2000 and the Board of Directors is periodically informed
of the progress of the Committee. PFC and Potters believe that, with
modifications to existing software and the replacement of some software, the
year 2000 issues will not pose significant operational problems. However, if
such modifications and software purchases are not completely in a timely manner,
the year 2000 problem may have a negative impact on the operations and income of
PFC and Potters.
Potters has not yet identified any specific expenses that are reasonably likely
to be incurred by Potters in connection with year 2000 issues, but no assurance
can be given at this time that significant expense will not be incurred in
future periods. In the event that Potters is ultimately required to purchase
replacement computer systems, programs and equipment, or substantial expense
must be incurred to make Potters' current systems, programs and equipment year
2000 compliant, or Potters' vendors pass on to Potters their expenses of
becoming year 2000 compliant, Potters' net income and financial condition could
be adversely affected. Moreover, to the extent Potters' employees must spend
time ensuring that vendors are adequately preparing for year 2000, those
employees will not be focusing all of their time and energies toward achieving
other goals set by the management of Potters.
BAD DEBT RESERVE RECAPTURE
On August 20, 1996, President Clinton signed into law the Small Business Jobs
Protection Act of 1996. The law eliminates the percent-of-taxable-income method
for computing additions to the tax bad debt reserves for all thrifts for tax
years beginning after December 31, 1995. The new rules also require that thrift
institutions recapture all or a portion of their tax bad debt reserves added
since their base year (the last taxable year beginning before January 1, 1988).
Because Potters has average total assets of less than $500 million, it is
considered a small bank and is permitted to maintain the greater of the reserves
47
<PAGE> 48
for bad debts as of the base year or the 1995 reserve balance for bad debts
allowable under the experience method. Any excess of the 1995 reserve balances
over the greater of the reserve balances must be recaptured into income ratably
over six years, although a two-year delay is permitted for institutions meeting
a residential mortgage loan origination test. This recapture is not material for
Potters, because it has used the experience method of calculating its bad debt
deductions in recent years, which is the same method used by banks. In 1995,
1996 and 1997, Potters' bad debt deduction was based on a percentage of taxable
income, for which a deferred tax liability has been recognized. As a result, the
recapture of the bad debt reserve will not impact future net income.
Prospectively, small institutions such as Potters will use the experience method
for deducting bad debts for tax purposes. The unrecaptured base year reserves
will not be subject to recapture as long as the institution continues to carry
on the business of banking. Likewise, if an institution is acquired via a merger
by another financial institution, no recapture of base year reserves will result
as long as the acquiring institution continues with the business of banking.
However, if an institution ceases to qualify as a bank or converts to a credit
union, the base year reserves must be recaptured in accordance with previous
law.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles ("GAAP"), which require
the measurement of financial position and results of operations primarily in
terms of historical dollars without considering changes in the relative
purchasing power of money over time because of inflation.
Unlike most industrial companies, virtually all of the assets and liabilities of
Potters are monetary in nature. As a result, interest rates have a more
significant impact on Potters' performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as the prices of goods and services.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 130, "Reporting Comprehensive Income," establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. SFAS No. 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. It does not require a specific format for the
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement.
SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for earlier periods
provided for comparative purposes is required.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," changes the way public business enterprises report information
about operating segments in annual financial statements and requires that those
enterprises report selected information about reportable segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. SFAS No. 131 uses a "management approach" to disclose financial and
descriptive information about an enterprise's reportable operating segments
which is based on reporting information the way the management organizes the
segments within the enterprise for making operating decisions and assessing
performance. For many enterprises, the management approach will likely result in
more segments being reported. In addition, the Statement requires significantly
more information to be disclosed for each reportable segment than is presently
being reported in annual financial statements. The Statement also requires that
selected information be reported in interim financial statements. SFAS No. 131
is effective for financial statements for periods beginning after December 15,
1997.
48
<PAGE> 49
ITEM 7. FINANCIAL STATEMENTS.
POTTERS FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
1997 1996
---- ----
<S> <C> <C>
ASSETS
Cash and due from banks $ 3,348 $ 4,376
Interest-bearing deposits with Federal Home Loan Bank 459 51
Federal funds sold and cash management account 9 158
--------- ---------
Cash and cash equivalents 3,816 4,585
Securities available for sale,
at estimated fair value 5,474 10,878
Securities held to maturity (estimated
fair value: December 31, 1997 - $27,116;
December 31, 1996 - $31,576) 27,158 31,913
Federal Home Loan Bank stock 859 822
Loans receivable, net 82,093 62,450
Accrued interest receivable 829 778
Premises and equipment, net 1,742 1,738
Other assets 666 1,008
--------- ---------
Total assets $ 122,637 $ 114,172
========= =========
LIABILITIES
Deposits $ 100,094 $ 97,283
Federal Home Loan Bank advances 9,993 5,085
Accrued expenses and other liabilities 1,544 1,228
--------- ---------
Total liabilities 111,631 103,596
SHAREHOLDERS' EQUITY
Common shares, no par value
Authorized: 2,000,000 shares
Issued: 1,111,828 shares in 1997 and
1,076,940 shares in 1996
Paid-in capital 5,159 4,880
Treasury shares at cost: 138,592
in 1997 and 53,280 in 1996 (1,399) (436)
Unearned compensation on
recognition and retention plan (87) (100)
Unrealized loss on securities
available for sale, net of tax (17) (94)
Retained earnings, substantially restricted 7,350 6,326
--------- ---------
Total shareholders' equity 11,006 10,576
--------- ---------
Total liabilities and shareholders' equity $ 122,637 $ 114,172
========= =========
- -------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
49
<PAGE> 50
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three years ended December 31, 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 6,027 $ 4,534 $ 4,441
Securities 2,465 3,491 3,436
Other interest income 66 181 188
------- ------- -------
Total interest income 8,558 8,206 8,065
INTEREST EXPENSE
Interest on deposits 4,172 4,189 4,156
Other interest expense 499 340 115
------- ------- -------
Total interest expense 4,671 4,529 4,271
------- ------- -------
NET INTEREST INCOME 3,887 3,677 3,794
Provision for loan losses (485) 249 245
------- ------- -------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 4,372 3,428 3,549
Noninterest income 381 267 257
Noninterest expense 2,927 3,688 2,977
------- ------- -------
INCOME BEFORE INCOME TAX 1,826 7 829
Income tax 629 68
------- ------- -------
NET INCOME (LOSS) $ 1,197 $ (61) $ 829
======= ======= =======
Earnings (loss) per common share
Basic $ 1.24 $ (0.06) $ 0.80
======= ======= =======
Diluted $ 1.21 $ (0.06) $ 0.79
======= ======= =======
- ------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
50
<PAGE> 51
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the three years ended December 31, 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Recognition
Common Paid-in Treasury and
Shares Capital shares Retention Plan
------ ------- ------ --------------
<S> <C> <C> <C> <C>
BALANCE - JANUARY 1, 1995 $ 530 $4,253 $(140)
Net income for the year ended December 31, 1995
Issuance of 6,000 common shares for the
exercise of stock options 3 27
Cash dividends declared ($.105 per common share)
Recognition and retention plan shares earned 22
Change in unrealized loss on securities
available for sale
----- ------ -----
BALANCE - DECEMBER 31, 1995 533 4,280 (118)
Net loss for the year ended December 31, 1996
Holding company formation (533) 533
Issuance of 11,322 common shares for the exercise
of stock options 57
Purchase of 53,280 treasury shares $ (436)
Cash dividends declared ($.125 per common share)
Recognition and retention plan shares earned 18
Tax benefit arising from stock option and
recognition and retention plan shares 10
Change in unrealized loss on securities
available for sale
----- ------ ------- -----
BALANCE - DECEMBER 31, 1996 0 4,880 (436) (100)
Net income for the year ended December 31, 1997
Issuance of 34,888 common shares for the exercise
of stock options 174
Purchase of 85,312 treasury shares (963)
Cash dividends declared ($.175 per common share)
Recognition and retention plan shares earned 13
Tax benefit arising from stock option and
and recognition and retention plan shares 105
Change in unrealized loss on securities
available for sale
----- ------ ------- -----
BALANCE - DECEMBER 31, 1997 $ 0 $5,159 $(1,399) $ (87)
===== ====== ======= =====
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Unrealized gain
(loss) on securities Retained
available for sale earnings Total
------------------ -------- -----
<S> <C> <C> <C>
BALANCE - JANUARY 1, 1995 $(649) $5,799 $ 9,793
Net income for the year ended December 31, 1995 829 829
Issuance of 6,000 common shares for the
exercise of stock options 30
Cash dividends declared ($.105 per common share) (111) (111)
Recognition and retention plan shares earned 22
Change in unrealized loss on securities
available for sale 626 626
----- ------ ------
BALANCE - DECEMBER 31, 1995 (23) 6,517 11,189
Net loss for the year ended December 31, 1996 (61) (61)
Holding company formation
Issuance of 11,322 common shares for the exercise
of stock options 57
Purchase of 53,280 treasury shares (436)
Cash dividends declared ($.125 per common share) (130) (130)
Recognition and retention plan shares earned 18
Tax benefit arising from stock option and
recognition and retention plan shares 10
Change in unrealized loss on securities
available for sale (71) (71)
----- ------ ------
BALANCE - DECEMBER 31, 1996 (94) 6,326 10,576
Net income for the year ended December 31, 1997 1,197 1,197
Issuance of 34,888 common shares for the exercise
of stock options 174
Purchase of 85,312 treasury shares (963)
Cash dividends declared ($.175 per common share) (173) (173)
Recognition and retention plan shares earned 13
Tax benefit arising from stock option and
and recognition and retention plan shares 105
Change in unrealized loss on securities
available for sale 77 77
----- ------ -------
BALANCE - DECEMBER 31, 1997 $ (17) $7,350 $11,006
===== ====== =======
- ------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
51
<PAGE> 52
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three years ended December 31, 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,197 $ (61) $ 829
Adjustments to reconcile net income to net
cash from operating activities
Depreciation and amortization 211 154 130
Provision for losses (485) 249 245
Net investment amortization 44 61 96
Net (gain) loss on:
Sale of securities 22 1 (3)
Sale of loans 56 (1) (9)
Sale of foreclosed real estate and
repossessed assets (50) (39) 2
Sale of other assets (111) (2)
Stock dividend on FHLB stock (60) (51) (48)
Change in
Deferred taxes (69) (16) (243)
Other assets and liabilities 930 246 19
------- ------- ------
Net cash from operating activities 1,685 541 1,018
------- ------- ------
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing balances with banks 100
Securities available for sale
Proceeds from sales 5,515 13,225 3,385
Proceeds from calls and maturities 10,596 2,250
Purchases (23,856) (4,328)
Securities held to maturity
Proceeds from repayments, calls and maturities 4,707 7,120 7,664
Purchases (984) (3,253)
Purchase of FHLB stock (62) (16)
Redemption of FHLB stock 23 24
Net (increase) decrease in loans 570 329 (1,757)
Loans purchased (20,497) (13,678)
Proceeds from sale of loans held for sale 560 513 1,618
Proceeds from sale of foreclosed real estate
and repossessed assets 50 155 40
Proceeds from sale of premises 192
Property and equipment expenditures (201) (304) (323)
------- ------- ------
Net cash from investing activities (9,081) (6,946) 5,404
------- ------- ------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
52
<PAGE> 53
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
For the three years ended December 31, 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 2,811 (1,414) (1,271)
Proceeds from FHLB advances 16,050 15,580 4,100
Repayments of FHLB advances (11,142) (13,513) (1,082)
Net change in official checks (178) (413) 88
Net increase in advances from
borrowers for taxes and insurance 48 29 16
Purchase of treasury shares (963) (436)
Issuance of common shares for
exercise of stock options 174 57 30
Cash dividends paid (173) (130) (111)
--------- --------- ---------
Net cash from financing activities 6,627 (240) 1,770
--------- --------- ---------
Net change in cash and cash equivalents (769) (6,645) 8,192
Cash and cash equivalents at beginning of year 4,585 11,230 3,038
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,816 $ 4,585 $ 11,230
========= ========= =========
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 4,633 $ 4,519 $ 4,256
Income taxes 125 116 258
Noncash transactions
Transfer from loans to foreclosed real estate and
repossessed assets 23 97
Transfer from investment securities available for sale
to investment securities held to maturity 1,000
Transfer from investment securities held to maturity
to investment securities available for sale 1,501
Recognition and retention plan shares earned 13 18 22
Sale of land financed by the Company 130
- --------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
53
<PAGE> 54
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business: Potters Financial Corporation ("PFC" or the
"Corporation") is a unitary savings and loan holding company headquartered in
East Liverpool, Ohio. PFC is the sole shareholder of The Potters Savings and
Loan Company ("Potters" or the "Company"), also headquartered in East Liverpool,
Ohio. On March 11, 1996, PFC was formed through an internal reorganization in
which each shareholder of Potters received one common share of PFC for each
common share of Potters owned. In an internal reorganization, the historical
carrying amounts of assets and liabilities are carried forward.
Potters provides financial products and services through its three banking
centers, one located in East Liverpool, Ohio, one located in Glenmoor, Ohio and
the other located in Calcutta, Ohio. Potters' primary market area consists of
the City of East Liverpool, Ohio, and the contiguous areas of Columbiana and
Jefferson Counties, Ohio and Hancock County, West Virginia. Potters is
principally engaged in the business of originating real estate loans secured by
first mortgages for the purchase, construction or improvement of one-to-four
family residences and accepting demand, savings and time deposits. Potters also
originates loans secured by multifamily and nonresidential real estate, home
equity lines of credit and various types of commercial and consumer loans. In
addition to originating loans, Potters also purchases one-to-four family real
estate loans within the State of Ohio and invests in U.S. government and agency
obligations, mortgage-backed securities, interest-bearing deposits in other
financial institutions and other securities. The primary source of income for
the Company is interest on loans and securities.
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of PFC and Potters. All significant intercompany
transactions and balances have been eliminated in consolidation.
Securities: Potters classifies debt and marketable equity securities as held to
maturity, trading or available for sale. Securities held to maturity are those
that management has the positive intent and ability to hold to maturity, and are
carried at amortized cost. Securities classified as available for sale are those
that may be sold before maturity, and are carried at fair value with unrealized
gains and losses included as a separate component of shareholders' equity, net
of tax. Securities classified as trading are those which are held for short
periods of time and are carried at fair value with unrealized gains and losses
reflected in earnings. The Company held no trading securities during any period
presented. Realized gains or losses on dispositions are based on net proceeds
and the adjusted carrying amount of securities sold, using the specific
identification method. Income on securities consists of interest on such
securities, adjusted for amortization and accretion of purchased premiums and
discounts using the level yield method.
Loans Held for Sale: Real estate loans originated and intended for sale in the
secondary mortgage market are carried at the lower of cost or market in the
aggregate. Net unrealized losses are recognized in a valuation allowance by
charges to income.
Allowance for Loan Losses: Because some loans may not be repaid in full, an
allowance for losses on loans is maintained. Increases to the allowance are
recorded by a provision for loan losses charged to expense. Estimating the risk
of the loss and the amount of loss on any loan is necessarily subjective.
Accordingly, the allowance is maintained by management at a level considered
adequate to cover losses that are currently anticipated based on past loss
experience, general economic conditions, information about specific borrower
situations including their financial position and collateral values, and other
factors and estimates which are subject to change over time. While management
may periodically allocate portions of the allowance for specific problem loan
situations, the whole allowance is available for any loan charge-offs that
occur. A loan is charged-off against the allowance by management when deemed
uncollectible, although collection efforts continue and future recoveries may
occur.
- --------------------------------------------------------------------------------
(Continued)
54
<PAGE> 55
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
A loan is considered impaired when it is anticipated that all principal and
interest amounts will not be collected according to the terms of the loan
contract. Carrying values of impaired loans are reduced to the present value of
expected future cash flows, discounted using the loan's effective interest rate,
or at the fair value of collateral if the loan is collateral dependent. A
portion of the allowance for loan losses is allocated to such loans.
Carrying values of impaired loans are periodically adjusted to reflect cash
payments, revised estimates of future cash flows and increases in the present
value of expected cash flows due to the passage of time. Interest payments on
performing impaired loans are reported as interest income on a cash basis. All
other cash payments are recorded as reductions in the carrying value, while
increases or decreases due to changes in estimates of future payments and due to
the passage of time are reported as an increase or decrease in the provision for
loan losses.
Smaller-balance loans with similar characteristics are evaluated for impairment
in the aggregate. Such loans include residential real estate loans secured by
first mortgages on one-to-four family residences, residential construction
loans, and automobile, home equity and second mortgage loans. Commercial loans
and real estate loans secured by other properties are evaluated individually for
impairment. The Company's loan review system includes periodic analysis of
borrower operating results and financial condition. A loan is evaluated for
impairment when any delay or shortfall in payments occurs or when operating
results indicate cash flows are inadequate to meet debt service requirements.
Loans are generally moved to nonaccrual status when 90 days or more past due.
Such delinquent loans are often also considered impaired. Impaired loans, or
portions thereof, are charged off when deemed uncollectible.
Loan Origination Fees and Costs: Loan origination fees and direct loan
origination costs are deferred and recognized over the contractual life of the
loans as a yield adjustment, using the level yield method. The net amount
deferred is reported in the Consolidated Balance Sheets as part of loans.
Interest Income on Loans: Interest on loans is accrued over the term of the
loans based upon the principal outstanding. The accrual of interest is
discontinued when serious doubt exists as to the collectibility of the loan,
generally no later than when the loan becomes 90 days past due.
Mortgage Servicing Rights: Effective January 1, 1996, Statement of Financial
Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage Servicing
Rights," was adopted. This statement requires companies that engage in mortgage
banking activities to recognize as separate assets rights to service mortgage
loans for others. The adoption of SFAS No. 122 did not impact 1996 or 1997
consolidated financial statements because servicing rights were not retained on
any loans sold during either year.
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities," was adopted in 1997. It revised the accounting
for transfers of financial assets, such as loans and securities, and for
distinguishing between sales and secured borrowings. It was originally effective
for some transactions in 1997 and others in 1998. SFAS No. 127, "Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125" was issued in
December 1996. SFAS No. 127 defers, for one year, the effective date of
provisions relating to securities lending, repurchase agreements and other
similar transactions. The remaining portions of SFAS No. 125 continued to be
effective January 1, 1997. SFAS No. 125 did not have a material impact on the
consolidated financial statements.
- --------------------------------------------------------------------------------
(Continued)
55
<PAGE> 56
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Foreclosed Real Estate: Real estate acquired through foreclosure or
deed-in-lieu-of-foreclosure is recorded at fair value less estimated costs to
sell. Upon foreclosure, the asset is transferred from loans to foreclosed real
estate at fair value, with any reduction in the carrying value reflected as a
loan loss. Estimated costs to sell are recorded through a valuation account with
a corresponding charge to income. Any subsequent reduction in the property's
value is recorded in the valuation account with a corresponding charge to
income. Costs of holding such real estate are expensed as incurred and gains or
losses are recorded upon the sale of the property in the Consolidated Statements
of Operations.
Premises and Equipment: Land is stated at cost. Buildings, furniture, fixtures
and equipment are stated at cost less accumulated depreciation. Depreciation is
computed based on the straight-line method over the estimated useful lives of
the respective properties and equipment. Premises and equipment are reviewed for
impairment when events indicate the carrying value may not be recoverable.
Maintenance and repairs are charged to expense as incurred and improvements are
capitalized.
Income Taxes: Deferred income taxes are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates to differences
between the carrying amounts for financial statement reporting purposes and the
tax basis of existing assets and liabilities. Income tax expense includes the
current year income tax due or refundable and the change in deferred tax assets
and liabilities. If the collectibility of deferred tax assets is in doubt, a
valuation allowance is established to reduce such assets to the amount expected
to be realized.
Statement of Cash Flows: For purposes of this statement, cash and cash
equivalents include cash on hand, due from banks, interest-bearing deposits with
the Federal Home Loan Bank, federal funds sold and cash management accounts. Net
cash flows are reported for customer loan and deposit accounts, as well as
deposits made with other financial institutions.
Earnings per common share: Earnings per common share is computed under the
provisions of SFAS No. 128, "Earnings Per Share," which was adopted
retroactively in the fourth quarter of 1997. SFAS No. 128 requires dual
presentation of basic earnings per share ("EPS") and diluted EPS for entities
with complex capital structures. Basic EPS includes no dilution and is computed
by dividing earnings for the year available to common shareholders by the
weighted average common shares outstanding during the year. Diluted EPS reflects
the potential dilution of securities that could share in earnings such as stock
options, warrants or other common stock equivalents. All prior period EPS
calculations have been restated to conform with the new methods. As PFC has not
had significant dilution from stock options, the new calculation method was not
materially different from EPS data previously reported.
The weighted average number of shares outstanding for the calculation of basic
earnings per common share was 962,600 in 1997, 1,016,540 in 1996 and 1,034,594
in 1995. Dilution in PFC's EPS is caused by outstanding stock options. The
weighted average number of shares outstanding for the calculation of diluted
earnings per share was 988,018 in 1997, 1,032,346 in 1996 and 1,047,404 in 1995.
On November 4, 1997, the Board of Directors declared a two-for-one stock split
in the form of a 100% stock dividend. All references to common shares and
earnings and dividends per share have been restated to reflect the stock split.
Financial Statement Presentation: Certain items in the 1995 and 1996 financial
statements have been reclassified to correspond with the 1997 presentation.
- --------------------------------------------------------------------------------
(Continued)
56
<PAGE> 57
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Capital Disclosures: SFAS No. 129, "Disclosures of Information about Capital
Structure," effective for PFC in 1997, consolidated existing accounting guidance
relating to disclosures about a company's capital structure. Public companies
generally have always been required to make disclosures now required by SFAS No.
129 and, therefore, the revised disclosures had no material impact on PFC upon
adoption.
Use of Estimates in Preparation of Financial Statements: Management must make
estimates and assumptions in preparing financial statements that affect the
amount reported therein and the disclosures provided. Such estimates and
assumptions may change in the future and future results could differ.
Areas involving the use of management's estimates and assumptions include, but
are not limited to, the allowance for loan losses, the realization of deferred
tax assets, fair values of certain securities, the determination and carrying
value of impaired loans, the carrying value of loans held for sale, the carrying
value of foreclosed real estate, the accrued liability for deferred
compensation, recognition and measurement of loss contingencies and depreciation
of premises and equipment.
NOTE 2 - SECURITIES
At December 31, 1997, the amortized cost and estimated fair value of securities
are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars in thousands)
Securities available for sale:
<S> <C> <C> <C> <C> <C>
U.S. Treasury and U.S.
Government agencies $ 5,499 $ (25) $ 5,474
======= ====== =======
Securities held to maturity:
U.S. Treasury and U.S.
Government agencies $ 5,866 $ 12 $ (15) $ 5,863
Obligations of states and
political subdivisions 168 13 181
Other securities 632 13 645
Agency issued mortgage-
backed securities 20,492 119 (184) 20,427
------- ---- ------ ------
$27,158 $157 $(199) $27,116
======= ==== ====== =======
</TABLE>
The amortized cost and estimated fair value of debt securities at December 31,
1997, 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.
- --------------------------------------------------------------------------------
(Continued)
57
<PAGE> 58
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 2 - SECURITIES (Continued)
<TABLE>
<CAPTION>
Available for Sale Held to Maturity
--------------------------- ---------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Due in one year or less $ 4,131 $ 4,131
Due after one year through five years $ 4,499 $ 4,476 69 70
Due after five years through ten years 1,000 998 1,834 1,850
Due after ten years 632 638
Agency issued mortgage-
backed securities 20,492 20,427
----------- ----------- ----------- -----------
$ 5,499 $ 5,474 $ 27,158 $ 27,116
=========== =========== =========== ===========
</TABLE>
Available-for-sale securities totaling $5.5 million were sold during 1997,
resulting in gross gains of $1,000 and gross losses of $23,000.
As of December 31, 1997 and 1996, securities totaling $4.5 million and
$2.0 million, respectively, were pledged to collateralize public funds
deposited in Potters.
The amortized cost and estimated fair value of securities are as follows at
December 31, 1996:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. Treasury and U.S.
Government agencies $ 9,988 $ (135) $ 9,853
Mutual funds 1,034 (9) 1,025
----------- ----------- -----------
$ 11,022 $ (144) $ 10,878
=========== =========== ===========
Securities held to maturity:
U.S. Treasury and U.S.
Government agencies $ 6,854 $ 7 $ (74) $ 6,787
Obligations of states and
political subdivisions 175 7 182
Other securities 866 6 872
Agency issued mortgage-
backed securities 24,018 82 (365) 23,735
----------- ----------- ----------- -----------
$ 31,913 $ 102 $ (439) $ 31,576
=========== =========== =========== ===========
</TABLE>
Proceeds from sales of securities available for sale during 1996 totaled $13.2
million and resulted in gross gains of $23,000 and gross losses of $24,000.
Sales proceeds in 1995 totaled $3.4 million and resulted in $3,000 of gross
gains.
- --------------------------------------------------------------------------------
(Continued)
58
<PAGE> 59
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 3 - LOANS RECEIVABLE
Loans receivable are summarized below at December 31:
1997 1996
---- ----
(Dollars in thousands)
Real estate mortgage loans
One-to-four family residences $ 66,718 $ 49,086
Loans held for sale 106
Nonresidential property 6,211 5,897
Multifamily and other 1,537 2,034
----------- -----------
74,572 57,017
Consumer and other loans
Home equity loans 5,224 3,859
Secured, unsecured consumer
loans and lines of credit 2,064 1,815
Commercial business loans 862 894
Other 1,575 1,860
----------- -----------
9,725 8,428
----------- -----------
Total loan principal balances 84,297 65,445
Loans in process (340) (466)
Unearned interest (10) (23)
Premiums on purchased loans 295 147
Net deferred loan fees (6) (23)
Allowance for loan losses (2,143) (2,630)
----------- -----------
$ 82,093 $ 62,450
=========== ===========
Activity in the allowance for loan losses is as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 2,630 $ 2,240 $ 1,963
Provision for loan losses (485) 249 245
Recoveries 74 679 70
Charge-offs (76) (538) (38)
-------- --------- ---------
Balance at end of year $ 2,143 $ 2,630 $ 2,240
======== ========= =========
</TABLE>
Nonaccrual and renegotiated loans totaled $207,000 and $1,728,000 at December
31, 1997 and 1996, respectively. Interest income that would have been recorded
on such loans under their original terms totaled approximately $23,000 and
$204,000 for the years ended December 31, 1997 and 1996, respectively. The
amounts included in interest income for such loans totaled approximately $13,000
during 1997 and $151,000 during 1996. The Company is not committed to lend
additional funds to debtors whose loans have been modified.
- --------------------------------------------------------------------------------
(Continued)
59
<PAGE> 60
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 3 - LOANS RECEIVABLE (Continued)
Information regarding impaired loans is as follows for the years ended December
31:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Average investment in impaired loans $ 307 $ 403
======== =========
Interest income recognized on impaired loans
including interest income recognized on a cash basis $ 0 $ 23
======== =========
Interest income recognized on impaired loans
on a cash basis $ 0 $ 23
======== =========
</TABLE>
Information regarding impaired loans, which are included in nonaccrual and
renegotiated loans disclosed above, at December 31, is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Balance of impaired loans $ 0 $ 365
Less portion for which no allowance for
loan losses is allocated 0 (365)
-------- ---------
Portion of impaired loan balance for which an
allowance for loan losses is allocated $ 0 $ 0
======== =========
Portion of allowance for loan losses allocated
to the impaired loan balance $ 0 $ 0
======== =========
</TABLE>
The Company has granted loans to certain of its executive officers and directors
and their related business interests. A summary of activity during 1997 on
related party loans aggregating $60,000 or more to any one related party is as
follows:
1997
----
(Dollars in thousands)
Balance at beginning of year $ 423
New loans and advances 505
Repayments (20)
Other changes (307)
--------
Balance at end of year $ 601
========
Other changes include loans reportable in one period and not reportable in the
other period.
NOTE 4 - ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consists of the following at December 31:
1997 1996
---- ----
(Dollars in thousands)
Loans $ 507 $ 329
Securities 191 308
Mortgage-backed securities 131 141
-------- --------
$ 829 $ 778
======== ========
- --------------------------------------------------------------------------------
(Continued)
60
<PAGE> 61
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 5 - PREMISES AND EQUIPMENT
Premises and equipment consists of the following at December 31:
1997 1996
---- ----
(Dollars in thousands)
Land $ 177 $ 190
Buildings and improvements 2,490 2,440
Furniture and equipment 1,520 1,403
-------- --------
Total cost 4,187 4,033
Accumulated depreciation 2,445 2,295
-------- --------
$ 1,742 $ 1,738
======== =========
NOTE 6 - DEPOSITS
Deposits are summarized as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Demand, NOW, and Super NOW
accounts, including noninterest
bearing deposits: December 31,
1997 - $657; December 31,
1996 - $556 $ 12,678 12.7% $ 13,509 13.9%
Savings and club accounts 33,955 33.9 34,345 35.3
Money market demand accounts 1,955 1.9 1,978 2.0
Certificates of deposit 51,506 51.5 47,451 48.8
----------- ---- ----------- ----
$ 100,094 100.0% $ 97,283 100.0%
=========== ===== =========== =====
</TABLE>
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was approximately $8,802,000 and $4,278,000 at December 31, 1997 and
1996, respectively.
At December 31, 1997, scheduled maturities of certificates of deposit are as
follows:
Maturities
(Dollars in thousands)
1998 $ 27,234
1999 12,672
2000 8,094
2001 2,496
2002 and thereafter 1,010
-----------
$ 51,506
- --------------------------------------------------------------------------------
(Continued)
61
<PAGE> 62
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank advances as of December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Variable-rate advances with monthly interest payments:
5.90% advance due April 29, 1998 $ 1,300
Fixed-rate advances with monthly interest payments:
5.80% advance due May 28, 1997 $ 3,830
5.67% advance due November 27, 1998 750 750
6.30% advance due June 24, 1998 2,000
6.50% advance due June 26, 1999 2,700
6.50% advance due June 27, 2000 1,500
6.50% advance due October 17, 2000 1,500
Fixed-rate advances with monthly principal and interest payments:
6.05% advance due August 14, 1998 133 333
5.85% advance due September 1, 1999 110 172
---------- ----------
$ 9,993 $ 5,085
========== ==========
</TABLE>
FHLB advances obtained through the Community Investment Program are amortizing
loans requiring monthly principal payments. As of December 31, 1997, the
aggregate future minimum annual principal payments on FHLB advances are
$4,245,000 in 1998, $2,748,000 in 1999 and $3,000,000 in 2000. As of December
31, 1997, the Company was approved to borrow a total of $5.5 million in cash
management advances. FHLB advances are collateralized by all shares of FHLB
stock owned by Potters and by 100% of the Company's qualified real estate loan
portfolio.
NOTE 8 - EMPLOYEE BENEFITS PLANS
A 401(k) plan, adopted during 1996, covers substantially all employees. Eligible
employees may contribute up to 15% of their compensation subject to a maximum
statutory limitation. The Company may make a partial matching of employee
contributions up to 3% of compensation and a discretionary contribution to all
participating employees. During 1996 and 1997, the Company contributed up to 3%
of a participant's compensation in a matching contribution and a discretionary
contribution to all qualified participants of 3% of employee compensation.
During 1997, the Company also contributed an additional profit sharing
contribution of 3% of employee compensation to the 401(k) plan. Employee
contributions are vested at all times. The Company's matching cash contribution
and related expense included in compensation and employee benefits was
approximately $62,000 in 1997 and $36,000 during 1996. PFC common shares are
available as an investing option within the 401(k) plan to all participants. The
401(k) plan purchased 264 common shares for participants during 1996 and 1,282
shares during 1997.
In December 1996, the Company's Board of Directors approved a resolution
terminating the Company's defined benefit pension plan. In October 1995, the
Board of Directors approved ceasing the accumulation of future benefits to plan
participants. As a result of these actions, a termination loss of $67,000 was
included in 1996 noninterest expense and a curtailment loss of $74,000 was
included in 1995 noninterest expense. The settlement of vested plan benefits
will occur upon receipt of a determination letter from the Commissioner of the
Internal Revenue Service approving the plan termination. Participants may choose
a lump sum payment, the purchase of a nontransferrable deferred annuity contract
or a transfer to the 401(k) plan discussed above.
- --------------------------------------------------------------------------------
(Continued)
62
<PAGE> 63
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 8 - EMPLOYEE BENEFITS PLANS (Continued)
The pension plan was a qualified, noncontributory defined benefit retirement
plan covering substantially all of its qualified employees. Benefits were based
on each employee's years of service up to a maximum of 44 years, and the average
of the highest five consecutive annual salaries of the ten years prior to
retirement. Benefits were reduced by a specified percentage of the employee's
social security benefit. An employee became fully vested upon completion of 5
years of qualifying service. It was the policy of the Company to fund the
maximum amount that could be deducted for federal income tax purposes using a
different actuarial cost method and different assumptions from those used for
financial reporting. Net periodic pension expense was $(11,000) in 1996 and
$63,000 in 1995.
NOTE 9 - STOCK OPTION PLAN
The Stock Option Plan, under which options to purchase the common shares of PFC
are granted to certain directors, officers and other key employees of Potters,
is administered by a committee of directors of PFC who select recipients and
establish awards pursuant to the Plan. The option exercise price is determined
by the Stock Option Committee at the time of grant but the purchase price must
be at least equal to the market price of the stock at the date of grant. All
options have a term of 10 years from the date of the grant.
A summary of stock options activity and related information is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
Average Average
Exercise Exercise
Options Price Options Price
------- ----- ------- -----
<S> <C> <C> <C> <C>
Outstanding - beginning
of year 85,776 $ 5.56 94,298 $5.43
Granted 2,000 17.00 2,800 7.75
Forfeited (1,000) 10.00
Exercised (34,888) 5.00 (11,322) 5.00
------- -------
Outstanding - end of year 51,888 6.16 85,776 5.56
======= =======
Weighted average fair value
of options granted during
the year $5.26 $2.37
===== =====
</TABLE>
All options outstanding at December 31, 1997 and 1996 are exercisable. Options
available for grants totaled 84 shares at December 31, 1997.
SFAS No. 123 "Accounting for Stock-Based Compensation," effective for the
Company in 1996, encourages the use of a fair value-based method to account for
stock-based compensation plans such as the Stock Option Plan. As allowed by SFAS
No. 123, however, the Company has elected to continue to follow prior guidance,
under which no compensation expense is recognized because the exercise price of
employee stock options equals the market price of the underlying stock on the
date of grant.
- --------------------------------------------------------------------------------
(Continued)
63
<PAGE> 64
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 9 - STOCK OPTION PLAN (Continued)
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123 as if the Company had accounted for its stock options under the
fair value method of that Statement. The fair value for options granted in 1996
and 1997 and the related pro forma effect on net income and earnings per share
was not material.
NOTE 10 - RECOGNITION AND RETENTION PLAN
In connection with the conversion of Potters from the mutual to stock form of
ownership (the "Conversion"), the Board of Directors adopted a Recognition and
Retention Plan ("RRP") as a means of providing directors and certain key
employees with an ownership interest in Potters, and now in PFC, in a manner
designed to reward and retain these individuals. One-fifth of the shares awarded
to each individual are earned and vested on each of the first five anniversaries
of the effective date of the RRP, which was December 30, 1993.
The Company contributed $162,000 to the RRP for the purpose of purchasing common
shares. On December 30, 1993, the RRP purchased 25,470 shares of common stock at
$5.00 per share. An additional 6,270 shares were purchased on January 7, 1994 at
$5.50 per common share. RRP expense totaled $2,000, $7,000 and $28,000 for 1997,
1996 and 1995, respectively.
NOTE 11 - EMPLOYEE STOCK OWNERSHIP PLAN
An Employee Stock Ownership Plan ("ESOP") benefits substantially all of Potters'
employees. Contributions to the ESOP are made at the Company's discretion and
the Plan is administered by a committee of directors of PFC. The Trustees vote
all shares owned by the ESOP, except in certain matters involving mergers and
other changes in corporate structure, when shares are voted by employees. ESOP
expense consists of the Company's contribution to the ESOP. ESOP shares are
included in weighted average shares outstanding for purposes of calculating
earnings per common share. Dividends on ESOP shares are recorded as a reduction
of retained earnings. Upon termination of employment, each participant may
choose to receive distributions in shares or cash. The ESOP contribution totaled
$45,000, $27,000 and $40,000 for 1997, 1996 and 1995, respectively, and is
reflected in compensation and benefits expense. At year-end 1997 and 1996, the
ESOP owned 9,400 and 6,800 shares of PFC common stock, respectively, all of
which shares are to be allocated to employee accounts. At year-end 1997, the
estimated fair value of shares subject to the cash distribution option, based on
the last sales price quoted in 1997 on the Nasdaq SmallCap Market, totaled
approximately $188,000. All share and per share data disclosures have been
restated to reflect the stock split in the form of a stock dividend effective
December 1, 1997.
NOTE 12 - INCOME TAXES
An analysis of the provision for income tax is as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Current $ 366 $ 137 $ 243
Deferred 263 (69) (16)
Change in valuation allowance (227)
$ 629 $ 68 $ 0
========= ======== ========
</TABLE>
- --------------------------------------------------------------------------------
(Continued
64
<PAGE> 65
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 12 - INCOME TAXES (Continued)
The components of the deferred tax assets and liabilities consist of the
following at December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Items giving rise to deferred tax assets:
Allowance for loan losses $ 603 $ 785
Depreciation 33 57
Capital loss carryforward 38 55
Unrealized loss on securities available for sale 9 50
Other 12 38
----------- -----------
695 985
----------- -----------
Items giving rise to deferred tax liabilities:
FHLB stock dividends (167) (152)
Other (9) (10)
----------- -----------
(176) (162)
----------- -----------
Net deferred tax asset $ 519 $ 823
=========== ===========
</TABLE>
Taxes paid in the current and prior years are adequate to warrant recording the
full deferred tax asset without a valuation allowance.
No deferred tax liability is recognized for tax bad debt reserves arising before
December 31, 1987 for qualified thrift lenders unless it is apparent that the
difference will reverse in the foreseeable future. The Company's tax bad debt
reserves that arose prior to December 31, 1987 were approximately $2,480,000.
Unrecognized deferred taxes on these reserves totaled $843,000 at December 31,
1997.
The provision for income tax differs from amounts computed by using the
statutory federal income tax rate. The reconciled difference between the
financial statement provision and amounts computed by using the statutory rate
of 34% is as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Income tax computed at the statutory rate $ 621 $ 2 $ 282
Tax effect of
Tax exempt income (4) (5) (5)
Change in valuation allowance (227)
Other 12 71 (50)
----------- ----------- -----------
$ 629 $ 68 $ 0
=========== =========== ===========
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
65
<PAGE> 66
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 13 - COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements. These include the Company being
a defendant in certain claims and legal actions arising in the ordinary course
of business. In the opinion of management, after consultation with legal
counsel, the ultimate disposition of these matters is not expected to have a
material adverse effect on the consolidated financial position of the Company.
Lease Commitments: As of December 31, 1997, the Company is obligated to a
corporation owned by a director of the Company under an operating lease for
land. Net rent expense under this lease, included in occupancy and equipment
expense, was approximately $34,000 in 1997, 1996 and 1995. The lease term ends
on January 31, 2008, and the Company has the option of renewing the lease for up
to five successive five-year periods beyond that date. Total future lease
commitments are not material.
Loan Commitments: As of December 31, 1997, the Company had commitments to make
loans (at market rates) and unused lines of credit approximating $4,973,000, of
which $91,000 carry fixed rates, ranging from 7.50% to 8.00%, and $4,882,000
carry adjustable rates. At December 31, 1996, the Company's loan commitments and
unused lines of credit totaled approximately $4,201,000, of which $155,000
carried fixed rates, ranging from 7.75% to 9.50%, and $4,046,000 carried
adjustable rates. Since loan commitments may expire without being used, the
amounts do not necessarily represent future cash commitments.
The exposure to credit loss in the event of nonperformance by the other party to
the financial instrument for commitments to make loans and lines and letters of
credit is represented by the contractual amount of those instruments. The
Company follows the same credit policy to make such commitments as is followed
for those loans recorded in the financial statements. In management's opinion,
these commitments represent normal banking transactions and no material losses
are expected to result therefrom. Collateral obtained upon exercise of the
commitments is determined using management's credit evaluations of the borrower
and is primarily real estate.
Cash Reserve Requirements: The Company is required to have approximately
$419,000 of cash on hand or on deposit with the Federal Reserve Bank to meet
regulatory reserve requirements at December 31, 1997. Such balances do not earn
interest.
Liquidation Account: In conjunction with Potters' conversion from a mutual
thrift to a stock thrift, a liquidation account of $4,748,000 was established,
which was equal to Potters' total net worth as of the date of the latest balance
sheet appearing in the final prospectus for its stock offering. The liquidation
account will be maintained for the benefit of eligible depositors who continue
to maintain their accounts at the Company after the conversion. The liquidation
account will be reduced annually to the extent that eligible depositors have
reduced their qualifying deposits. Subsequent increases will not restore an
eligible account holder's interest in the liquidation account. In the event of a
complete liquidation, each eligible depositor will be entitled to receive a
distribution from the liquidation account in an amount proportionate to the
current adjusted qualifying balance for accounts then held.
- --------------------------------------------------------------------------------
(Continued)
66
<PAGE> 67
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 14 - NONINTEREST INCOME AND EXPENSE
Noninterest income and expense amounts include the following major categories
for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Noninterest income
Security gains (losses), net $ (22) $ (1) $ 3
Gain (loss) on sale of loans (56) 1 9
Gain on sale of other assets 111 2
Service charges on deposits 188 152 137
Income (expense) on real
estate operations, net (22) (3)
Other 160 135 111
-------- --------- ---------
Total $ 381 $ 267 $ 257
======== ========= =========
1997 1996 1995
---- ---- ----
Noninterest expense
Compensation and benefits $ 1,343 $ 1,360 $ 1,388
Occupancy and equipment 378 360 334
Deposit insurance premiums 63 874 257
Data processing expense 159 164 151
Legal, professional and
consulting fees 251 182 145
Loss (gain) on foreclosed
and repossessed property (50) (39) 2
Other 784 787 700
-------- --------- ---------
Total $ 2,927 $ 3,688 $ 2,977
======== ========= =========
</TABLE>
On September 30, 1996, legislation was passed to recapitalize the Savings
Association Insurance Fund ("SAIF"). As a result, all savings and loan
institutions paid a one-time assessment of $.657 per $100 in deposits held as of
March 31, 1995. Consequently, the Company recognized a $643,000 expense included
in 1996 "Deposit insurance premiums" above.
NOTE 15 - CONCENTRATIONS OF CREDIT RISK
Most of the Company's current business activities are with customers located
within the immediate lending area which includes portions of Columbiana and
Jefferson Counties in northeastern Ohio and northern Hancock County in West
Virginia. At December 31, 1997, Potters' loan portfolio included approximately
$27.1 million of purchased one-to-four family real estate loans, $23.5 million
on properties located in northwestern Ohio and $3.6 million on properties in
southwestern Ohio. As of December 31, 1997, the Company's loan portfolio also
included approximately $2.1 million in nonresidential real estate loans secured
by property located in the State of Colorado.
- --------------------------------------------------------------------------------
(Continued)
67
<PAGE> 68
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 16 - REGULATORY MATTERS
Potters is subject to regulatory capital requirements administered by federal
regulatory agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities and certain
off-balance-sheet items calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
regulators about components, risk weightings and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including
well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
<TABLE>
<CAPTION>
Capital to risk-
weighted assets
----------------- Core capital to
Total Core adjusted total assets
----- ---- ---------------------
<S> <C> <C> <C>
Well-capitalized 10% 6% 5%
Adequately capitalized 8% 4% 4%
Undercapitalized 6% 3% 3%
</TABLE>
At year end 1997, actual capital levels and minimum required levels were:
<TABLE>
<CAPTION>
Minimum Required
Minimum Required to be Well-Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Total capital to risk-
weighted assets $ 10,498 17.3% $ 4,859 8.0% $ 6,074 10.0%
Core capital to risk-
weighted assets 9,722 16.0 2,430 4.0 3,645 6.0
Core capital to
adjusted total assets 9,722 7.9 3,677 3.0 6,128 5.0
Tangible capital to
adjusted total assets 9,722 7.9 1,839 1.5 N/A
</TABLE>
Potters was categorized as well-capitalized at year end 1997, and management is
not aware of any subsequent matters that would cause this categorization to
change.
The income of PFC consists of dividends that may periodically be declared and
paid by the Board of Directors of Potters on the common shares of Potters held
by PFC and earnings on the other investments held by PFC. In addition to certain
federal income tax considerations, OTS regulations impose limitations on the
payment of dividends and other capital distributions by savings associations.
- --------------------------------------------------------------------------------
(Continued)
68
<PAGE> 69
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 16 - REGULATORY MATTERS (Continued)
Under OTS regulations applicable to converted savings associations, Potters is
not permitted to pay a cash dividend on its common shares if the regulatory
capital of Potters would, as a result of the payment of such dividend, be
reduced below the amount required for the liquidation account (which was
established for the purpose of granting a limited priority claim on the assets
of Potters, in the event of a complete liquidation, to those members of Potters
before the conversion of Potters from the mutual form of ownership to the stock
form of ownership who maintain a savings account at Potters after the
conversion) or applicable regulatory capital requirements prescribed by the OTS.
OTS regulations applicable to all savings associations provide that a savings
association that immediately prior to, and on a pro forma basis after giving
effect to, a proposed capital distribution (including a dividend) has total
capital (as defined by OTS regulations) that is equal to or greater than the
amount of its capital requirements is generally permitted without OTS approval
(but subsequent to 30 days' prior notice to the OTS) to make capital
distributions, including dividends, during a calendar year in an amount not to
exceed the greater of (1) 100% of its net earnings to date during the calendar
year, plus an amount equal to one-half the amount by which its total capital to
assets ratio exceeded its required capital to assets ratio at the beginning of
the calendar year, or (2) 75% of its net earnings for the most recent
four-quarter period. Savings associations with total capital in excess of the
capital requirements that have been notified by the OTS that they are in need of
more than normal supervision will be subject to restrictions on dividends. A
savings association that fails to meet current minimum capital requirements is
prohibited from making any capital distributions without prior approval of the
OTS. Potters currently meets all of its regulatory capital requirements and,
unless the OTS determines that Potters is an institution requiring more than
normal supervisions, Potters may pay dividends in accordance with the foregoing
provisions of the OTS regulations.
NOTE 17 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table shows carrying values and the related estimated fair values
of financial instruments at December 31. Items which are not financial
instruments are not included.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
----------------- -----------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
----- ---------- ----- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 3,816 $ 3,816 $ 4,585 $ 4,585
Securities available for sale 5,474 5,474 10,878 10,878
Securities held to maturity 27,158 27,116 31,913 31,576
Loans receivable, net 82,093 82,352 62,450 61,755
FHLB stock 859 859 822 822
Accrued interest receivable 829 829 778 778
----------- ----------- ---------- -----------
Total financial assets $ 120,229 $ 120,446 $ 111,426 $ 110,394
=========== =========== ========== ===========
Financial liabilities:
Deposits $ (100,094) $ (99,931) $ (97,283) $ (97,398)
FHLB advances (9,993) (9,949) (5,085) (5,085)
Accrued interest payable (90) (90) (52) (52)
----------- ----------- ----------- -----------
Total financial liabilities $ (110,177) $ (109,970) $ (102,420) $( 102,535)
=========== =========== ========== ===========
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
69
<PAGE> 70
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 17 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate such
value:
Cash and cash equivalents and interest-bearing deposits: For such short-term
instruments, the carrying amount approximates fair value.
Securities: The fair values of securities are based on quoted market prices or
dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar instruments. For FHLB stock,
the carrying amount approximates fair value.
Loans, net: For certain similar categories of variable rate loans, the
outstanding balance at the reporting date approximates fair value. The fair
value of other types of loans is estimated by discounting 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 at December 31,
1997 and 1996. The fair value of unrecorded commitments was not material at
December 31, 1997 or 1996.
Accrued interest receivable and payable: For such short-term receivables and
payables, the carrying amount approximates fair value.
Deposits and FHLB advances: The fair value of demand deposits, savings accounts
and certain money market deposits is the amount payable on demand at December
31, 1997 and 1996. The fair value of fixed maturity certificates of deposit and
FHLB advances is estimated using the rates offered at December 31, 1997 and 1996
for deposits of similar remaining maturities.
While the estimates used in determining the fair value of financial assets and
liabilities are based on management's judgment of the appropriate valuation
factors, there is no assurance that, were the Company to have liquidated such
items, the estimated fair values would necessarily have been realized. The
estimated fair values should not be considered to apply at subsequent dates.
Other assets and liabilities that are not defined as financial instruments are
not included in the above disclosures. Such assets and liabilities would
include, among others, property and equipment, financing leases and the
intangible value of the Company's customer base and profit potential.
NOTE 18 - CONDENSED PARENT-ONLY FINANCIAL STATEMENTS
Balance Sheets for PFC as of December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 64 $ 66
Investment in subsidiary 9,705 9,446
Loan receivable from subsidiary 1,270 1,000
Other assets 71 66
--------- ---------
Total assets $ 11,110 $ 10,578
========= =========
LIABILITIES
Other liabilities $ 104 $ 2
SHAREHOLDERS' EQUITY
Total shareholders' equity 11,006 10,576
--------- ---------
Total liabilities and shareholders' equity $ 11,110 $ 10,578
========= =========
</TABLE>
- --------------------------------------------------------------------------------
(Continued)
70
<PAGE> 71
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
NOTE 18 - CONDENSED PARENT ONLY FINANCIAL STATEMENTS (Continued)
Statements of Operations for PFC for the year ended December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
INCOME
Dividends from subsidiary $ 1,168 $ 1,650
Interest income 32 8
--------- ---------
1,200 1,658
EXPENSE
Other operating expense 82 22
--------- ---------
INCOME BEFORE INCOME TAXES AND EQUITY
IN SUBSIDIARY EARNINGS 1,118 1,636
Income tax benefit (15) (3)
--------- ---------
INCOME BEFORE EQUITY IN
SUBSIDIARY EARNINGS 1,133 1,639
Equity in undistributed
subsidiary earnings 64 (1,700)
--------- ---------
NET INCOME (LOSS) $ 1,197 $ (61)
========= =========
</TABLE>
Statements of Cash Flows for PFC for the year ended December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,197 $ (61)
Adjustments to reconcile net income to
net cash from operating activities
Equity in undistributed income of subsidiary (64)
Distributions in excess of subsidiary earnings 1,700
Change in other assets and other liabilities 97 (64)
--------- ---------
Net cash from operating activities 1,230 1,575
CASH FLOWS FROM INVESTING ACTIVITIES
Loans to subsidiary, net of principal repayments (270) (1,000)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury shares (963) (436)
Proceeds from exercise of stock options 174 57
Cash dividends paid (173) (130)
--------- ---------
Net cash from financing activities (962) (509)
--------- ---------
Net change in cash and cash equivalents (2) 66
Cash and cash equivalents at beginning of year 66
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 64 $ 66
========= =========
</TABLE>
- --------------------------------------------------------------------------------
71
<PAGE> 72
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Potters Financial Corporation
East Liverpool, Ohio
We have audited the accompanying consolidated balance sheets of Potters
Financial Corporation as of December 31, 1997 and 1996, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Corporation'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 consolidated financial position of Potters
Financial Corporation as of December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ CROWE, CHIZEK AND COMPANY LLP
Crowe, Chizek and Company LLP
Columbus, Ohio
February 6, 1998
72
<PAGE> 73
ITEM 8. CHANGE IN ACCOUNTANTS.
No changes in or disagreements with the independent accountants have occurred.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information contained in the Proxy Statement under the captions "PROPOSAL
ONE - ELECTION OF DIRECTORS," "EXECUTIVE OFFICERS" and "Section 16(a) Beneficial
Ownership Reporting Compliance" is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information contained in the Proxy Statement under the caption "Compensation
of Directors and Executive Officers" is incorporated herein by reference.
ITEM 11. OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information contained in the Proxy Statement under the caption "Voting
Securities and Ownership of Certain Beneficial Owners and Management" is
incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Not Applicable.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Item 3. Amended Articles of Incorporation and Code
of Regulations
Item 10. Material contracts
Item 11. Statement re: computation of per share
earnings
Item 20. Proxy Statement for the 1998 Annual
Meeting of Shareholders
Item 21. Subsidiaries of Registrant
Item 23. Consent of Independent Accountants
Item 27. Financial Data Schedule
Item 99. Safe Harbor Under the Private Securities
Litigation Reform Act of 1995
(b) No current report on Form 8-K was filed by PFC during the
fourth quarter of 1997.
73
<PAGE> 74
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Potters Financial Corporation
By /s/ EDWARD L. BAUMGARDNER
--------------------------
Edward L. Baumgardner
President, Chief Executive Officer
and Director
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
By /s/ W. GAYLORD BILLINGSLEY By /s/ ARTHUR T. DOAK
--------------------------- -------------------
W. Gaylord Billingsley Arthur T. Doak
Director Director
Date: March 13, 1998 Date: March 13, 1998
By /s/ WILLIAM L. MILLER By /s/ TIMOTHY M. O'HARA
---------------------- ----------------------
William L. Miller Timothy M. O'Hara
Director Director
Date: March 13, 1998 Date: March 13, 1998
By /s/ PETER D. VISNIC By /s/ SUZANNE B. FITZGERALD
-------------------- --------------------------
Peter D. Visnic Suzanne B. Fitzgerald
Director Director
Date: March 13, 1998 Date: March 13, 1998
By /s/ ANNE S. MYERS
------------------
Anne S. Myers
Vice President, Secretary,
Chief Operating/Financial Officer
Date: March 13, 1998
- --------------------------------------------------------------------------------
74
<PAGE> 75
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE NUMBER
- ------ ----------- -----------
<S> <C> <C>
3.1 Articles of Incorporation of Potters Financial Incorporated by reference to the
Corporation Form 8-A filed with the Securities
and Exchange Commission (the
"SEC") on March 4, 1996 (the "8-A").
3.2 Code of Regulations of Potters Financial Corporation Incorporated by reference to the 8-A.
10.1 The Potters Savings and Loan Company Incorporated by reference to the
Stock Option Plan Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1995
(the "1995 10-KSB"), Exhibit 10.1.
10.2 The Potters Savings and Loan Company Incorporated by reference to the
Recognition and Retention Plan and 1995 10-KSB, Exhibit 10.2.
Trust Agreement
10.3 Deferred Compensation Agreement dated Incorporated by reference to the
November 1, 1972, by and between The 1995 10-KSB, Exhibit 10.3.
Potters Savings and Loan Company and
Alwyn C. Purinton, Jr.
10.4 Lease dated February 1, 1983, by and Incorporated by reference to the
between Billingsley, Incorporated and The 1995 10-KSB, Exhibit 10.5.
Potters Savings and Loan Company
10.5 Employment Contract with Edward L. Baumgardner Incorporated by reference to the
Annual Report on Form 10-KSB
for the fiscal year ended
December 31, 1996 (the "1996 10-KSB"),
Exhibit 10.5.
10.6 Employment Contract with Albert E. Sampson Incorporated by reference to the
1996 10-KSB, Exhibit 10.6.
10.7 Employment Contract with Anne S. Myers Incorporated by reference to the
Quarterly Report on Form 10-QSB
for the quarter ended June 30, 1997,
Exhibit 10.
10.8 Potters Financial Corporation 1998 Stock Incorporated by reference to the
Option and Incentive Plan definitive Proxy Statement for the
1998 Annual Meeting of Shareholders.
11 Statement re: computation of earnings per share See Note 1 to the consolidated
financial statements included
herewith.
</TABLE>
75
<PAGE> 76
<TABLE>
<CAPTION>
<S> <C> <C>
20 Proxy Statement for the 1998 Annual Incorporated by reference to the
Meeting of Shareholders definitive Proxy Statement for the
1998 Annual Meeting of Shareholders
to be filed.
21 Subsidiaries of Registrant Incorporated by reference to the 1995
10-KSB, Exhibit 21.
23 Consent of Independent Accountants Included herewith.
27 Financial Data Schedule Included herewith.
99 Safe Harbor Under the Private Securities Included herewith.
Litigation Reform Act of 1995
</TABLE>
- --------------------------------------------------------------------------------
76
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectuses
constituting part of the Registration Statements on Forms S-8 filed on or about
September 4, 1996 and May 29, 1997 of Potters Financial Corporation of our
report dated February 6, 1998 related to the consolidated balance sheets of
Potters Financial Corporation as of December 31, 1997 and 1996 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ending December 31, 1997, which report is
included in this Form 10-KSB.
/s/ CROWE, CHIZEK AND COMPANY LLP
---------------------------------
Crowe, Chizek and Company LLP
Columbus, Ohio
March 12, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0001010476
<NAME> POTTERS FINANCIAL CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,348
<INT-BEARING-DEPOSITS> 459
<FED-FUNDS-SOLD> 9
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 5,474
<INVESTMENTS-CARRYING> 27,158
<INVESTMENTS-MARKET> 27,116
<LOANS> 84,236
<ALLOWANCE> 2,143
<TOTAL-ASSETS> 122,637
<DEPOSITS> 100,094
<SHORT-TERM> 4,245
<LIABILITIES-OTHER> 1,544
<LONG-TERM> 5,748
0
0
<COMMON> 5,159
<OTHER-SE> 5,847
<TOTAL-LIABILITIES-AND-EQUITY> 122,637
<INTEREST-LOAN> 6,027
<INTEREST-INVEST> 2,465
<INTEREST-OTHER> 66
<INTEREST-TOTAL> 8,558
<INTEREST-DEPOSIT> 4,172
<INTEREST-EXPENSE> 4,671
<INTEREST-INCOME-NET> 3,887
<LOAN-LOSSES> (485)
<SECURITIES-GAINS> (22)
<EXPENSE-OTHER> 2,927
<INCOME-PRETAX> 1,826
<INCOME-PRE-EXTRAORDINARY> 1,826
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,197
<EPS-PRIMARY> 1.24
<EPS-DILUTED> 1.21
<YIELD-ACTUAL> 3.43
<LOANS-NON> 207
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 233
<ALLOWANCE-OPEN> 2,630
<CHARGE-OFFS> 76
<RECOVERIES> 74
<ALLOWANCE-CLOSE> 2,143
<ALLOWANCE-DOMESTIC> 2,143
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,431
</TABLE>
<PAGE> 1
Exhibit 99
----------
SAFE HARBOR UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
----------------------------------------------------------------------
The Private Securities Litigation Reform Act of 1995 (the "Act") provides a
"safe harbor" for forward-looking statements to encourage companies to provide
prospective information about their companies, so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement. Potters Financial
Corporation desires to take advantage of the "safe harbor" provisions of the
Act. Certain information, particularly information regarding future economic
performance and finances and plans and objectives of management, contained or
incorporated by reference in Potters Financial Corporation's Report on Form
10-KSB for the fiscal year ended December 31, 1997 is forward-looking. In some
cases, information regarding certain important factors that could cause actual
results of operations or outcomes of other events to differ materially from any
such forward-looking statement appear together with such statement. In addition,
forward-looking statements are subject to other risks and uncertainties
affecting the financial institutions industry, including, but not limited to,
the following:
Interest Rate Risk
- ------------------
Potters Financial Corporation's operating results are dependent to a significant
degree on its net interest income, which is the difference between interest
income from loans and investments and interest expense on deposits and
borrowings. The interest income and interest expense of Potters Financial
Corporation change as the interest rates on mortgages, securities and other
assets and on deposits and other liabilities change. Interest rates may change
because of general economic conditions, the policies of various regulatory
authorities and other factors beyond Potters Financial Corporation's control.
The interest rates on specific assets and liabilities of Potters Financial
Corporation will change or "reprice" in accordance with the contractual terms of
the asset or liability instrument and in accordance with customer reaction to
general economic trends. In a rising interest rate environment, loans tend to
prepay slowly and new loans at higher rates increase slowly, while interest paid
on deposits increases rapidly because the terms to maturity of deposits tend to
be shorter than the terms to maturity or prepayment of loans. Such differences
in the adjustment of interest rates on assets and liabilities may negatively
affect Potters Financial Corporation income. Moreover, rising interest rates
tend to decrease loan demand in general, negatively affecting Potters Financial
Corporation income.
Possible Inadequacy of the Allowance for Loan Losses
- ----------------------------------------------------
The Potters Savings and Loan Company maintains an allowance for loan losses
based upon a number of relevant factors, including, but not limited to, trends
in the level of nonperforming assets and classified loans, current and
anticipated economic conditions in the primary lending area, past loss
experience, possible losses arising from specific problem assets and changes in
the composition of the loan portfolio. While the Board of Directors of The
Potters Savings and Loan Company believes that it uses the best information
available to determine the allowance for loan losses, unforeseen market
conditions could result in material adjustments, and net earnings could be
significantly adversely affected if circumstances differ substantially from the
assumptions used in making the final determination.
Loans not secured by one-to-four family residential real estate are generally
considered to involve greater risk of loss than loans secured by one-to-four
family residential real estate due, in part, to the effects of general economic
conditions. The repayment of multifamily residential and nonresidential real
estate loans generally depends upon the cash flow from the operation of the
property, which may be negatively affected by national and local economic
conditions that cause leases not to be renewed or that negatively affect the
operations of a commercial borrower.
<PAGE> 2
Construction loans may also be negatively affected by such economic conditions,
particularly loans made to developers who do not have a buyer for a property
before the loan is made. The risk of default on consumer loans increases
during periods of recession, high unemployment and other adverse economic
conditions. When consumers have trouble paying their bills, they are more
likely to pay mortgage loans than consumer loans, and the collateral securing
such loans, if any, may decrease in value more rapidly than the outstanding
balance of the loan.
Competition
- -----------
The Potters Savings and Loan Company competes for deposits with other savings
associations, commercial banks and credit unions and issuers of commercial paper
and other securities, such as shares in money market mutual funds. The primary
factors in competing for deposits are interest rates and convenience of office
location. In making loans, The Potters Savings and Loan Company competes with
other savings associations, commercial banks, consumer finance companies, credit
unions, leasing companies, mortgage companies and other lenders. Competition is
affected by, among other things, the general availability of lendable funds,
general and local economic conditions, current interest rate levels and other
factors which are not readily predictable. The size of financial institutions
competing with The Potters Savings and Loan Company is likely to increase as a
result of changes in statutes and regulations eliminating various restrictions
on interstate and inter-industry branching and acquisitions. Such increased
competition may have an adverse effect upon Potters Financial Corporation.
Legislation and Regulation that may Adversely Affect The Potters Savings and
- ----------------------------------------------------------------------------
Loan Company's Earnings
- -----------------------
The Potters Savings and Loan Company is subject to extensive regulation by the
Office of Thrift Supervision (the "OTS") and the Federal Deposit Insurance
Corporation (the "FDIC") and is periodically examined by such regulatory
agencies to test compliance with various regulatory requirements. As a savings
and loan holding company, Potters Financial Corporation is also subject to
regulation and examination by the OTS. Such supervision and regulation of The
Potters Savings and Loan Company and Potters Financial Corporation are intended
primarily for the protection of depositors and not for the maximization of
shareholder value and may affect the ability of the company to engage in various
business activities. The assessments, filing fees and other costs associated
with reports, examinations and other regulatory matters are significant and may
have an adverse effect on Potters Financial Corporation's net earnings.
The FDIC is authorized to establish separate annual assessment rates for deposit
insurance of members of the Bank Insurance fund (the "BIF") and the Savings
Association Insurance Fund (the "SAIF"). The FDIC may increase assessment rates
for either fund if necessary to restore the fund's ratio of reserves to insured
deposits to the target level within a reasonable time and may decrease such
rates if such target level has been met. The FDIC has established a risk-based
assessment system for both SAIF and BIF members. Under such system, assessments
may vary depending on the risk the institution poses to its deposit insurance
fund. Such risk level is determined by reference to the institution's capital
level and the FDIC's level of supervisory concern about the institution.
Congress enacted a plan to recapitalize the SAIF in 1996. The recapitalization
plan also provides for the merger of the SAIF and BIF effective January 1, 1999,
assuming there are no savings associations under federal law. Congress is
considering legislation to eliminate the federal thrift charter and the separate
federal regulation of savings and loan associations. As a result, The Potters
Savings and Loan Company may have to convert to a different financial
institution charter or might be regulated under federal law as a bank. If The
Potters Savings and Loan Company becomes a bank or is regulated as a bank, it
would become subject to the more restrictive activity limitations imposed on
national banks. Moreover, Potters Financial Corporation might become subject to
more
<PAGE> 3
restrictive holding company requirements, including activity limits and capital
requirements similar to those imposed on The Potters Savings and Loan Company.
Potters Financial Corporation cannot predict the impact of the conversion of The
Potters Savings and Loan Company to, or regulation of The Potters Savings and
Loan Company as, a bank until any legislation requiring such change is enacted.
