<PAGE> 1
Page 1 of 21 pages
U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD
ENDED JUNE 30, 1999
-------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
ACT FOR THE TRANSITION PERIOD FROM TO
------------ -----------
Commission file number: 0-27980
-------
Potters Financial Corporation
-----------------------------
(Exact name of small business issuer
as specified in its charter)
Ohio 34-1817924
- ------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
519 Broadway, East Liverpool, Ohio 43920
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code (330) 385-0770
--------------
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 for the past 90 days.
Yes X No
--------- ---------
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date.
Common Shares, no par value Outstanding at July 31, 1999
981,183 Common Shares
Transitional Small Business Disclosure Format (check one):
Yes No X
--------- ---------
<PAGE> 2
FORM 10-QSB
QUARTER ENDED JUNE 30, 1999
Part I - Financial Information
Item 1. Financial Statements
Interim financial information required by Regulation 210.10-01 of
Regulation S-X is included in this Form 10-QSB as referenced below:
<TABLE>
<CAPTION>
Page
Number (s)
----------
<S> <C>
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Comprehensive Income 5
Consolidated Statements of Changes in Shareholders' Equity 5
Consolidated Statements of Cash Flows 6-7
Notes to Consolidated Financial Statements 8-12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13-19
Part II - Other Information
Item 1. Legal Proceedings 19
Item 2. Change in Securities and Use of Proceeds 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of
Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
2.
<PAGE> 3
<TABLE>
POTTERS FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
- ---------------------------------------------------------------------------------
<CAPTION>
June 30, December 31,
1999 1998
---- ----
<S> <C> <C>
ASSETS
Cash and due from financial institutions $ 4,007 $ 5,612
Interest-bearing deposits 900 792
Federal funds sold 689 5,463
-------- --------
Cash and cash equivalents 5,596 11,867
Securities available for sale 22,378 23,714
Federal Home Loan Bank stock 1,143 991
Loans, net 105,758 94,911
Premises and equipment, net 2,020 1,646
Other assets 2,126 1,345
-------- --------
Total assets $139,021 $134,474
======== ========
LIABILITIES
Deposits $106,728 $104,644
Federal Home Loan Bank advances 20,516 17,247
Accrued expenses and other liabilities 1,129 1,426
-------- --------
Total liabilities 128,373 123,317
SHAREHOLDERS' EQUITY
Common shares, no par value
Authorized: 2,000,000 shares;
Issued: 1,116,528 shares in 1999 and 1998
Paid-in capital 5,418 5,218
Retained earnings 7,427 8,233
Accumulated other comprehensive income (394) (41)
Unearned compensation on
recognition and retention plan shares (74) (74)
Treasury stock, at cost: 135,345 shares
in 1999 and 90,092 in 1998 (1,729) (2,179)
-------- --------
Total shareholders' equity 10,648 11,157
-------- --------
Total liabilities and shareholders' equity $139,021 $134,474
======== ========
- ---------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
3.
<PAGE> 4
<TABLE>
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------- -----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans, including fees $2,134 $1,712 $4,074 $3,391
Securities 371 455 721 946
Federal funds sold and other 25 88 93 141
------ ------ ------ ------
2,530 2,255 4,888 4,478
INTEREST EXPENSE
Deposits 1,033 1,065 2,008 2,138
Federal Home Loan Bank advances 267 170 488 332
------ ------ ------ ------
1,300 1,235 2,496 2,470
------ ------ ------ ------
NET INTEREST INCOME 1,230 1,020 2,392 2,008
Provision for loan losses (75)
------ ------ ------ ------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 1,230 1,020 2,467 2,008
NONINTEREST INCOME
Loan and security gains 19 16 32 38
Gain on sale of other assets 64 64
Other noninterest income 106 99 202 184
------ ------ ------ ------
125 179 234 286
------ ------ ------ ------
NONINTEREST EXPENSE
Compensation and benefits 423 368 820 743
Occupancy and equipment 122 96 224 186
Other noninterest expense 337 331 661 626
------ ------ ------ ------
882 795 1,705 1,555
------ ------ ------ ------
INCOME BEFORE INCOME TAX 473 404 996 739
Income tax expense 164 138 343 251
------ ------ ------ ------
NET INCOME $ 309 $ 266 $ 653 $ 488
====== ====== ====== ======
Earnings per common share
Basic $ 0.32 $ 0.26 $ 0.67 $ 0.47
====== ====== ====== ======
Diluted $ 0.31 $ 0.25 $ 0.65 $ 0.45
====== ====== ====== ======
- ---------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
4.
<PAGE> 5
<TABLE>
POTTERS FINANCIAL CORPORATION
(Unaudited)
(Dollars in thousands)
- --------------------------------------------------------------------------------------
<CAPTION>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET INCOME $ 309 $266 $ 653 $488
Other comprehensive income (net of tax):
Change in unrealized loss on securities
available for sale arising during the period (260) 8 (352) 10
Reclassification adjustment for accumulated
(gains)/losses included in net income (1)
----- ---- ----- ----
Total other comprehensive income (260) 8 (353) 10
----- ---- ----- ----
COMPREHENSIVE INCOME $ 49 $274 $ 300 $498
===== ==== ===== ====
- --------------------------------------------------------------------------------------
<CAPTION>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
1999 1998
---- ----
<S> <C> <C>
BALANCE - JANUARY 1 $11,157 $11,006
Net income for the six months ended June 30 653 488
Issuance of common shares for the exercise
of stock options (220 in 1999 and 3,520 in 1998) 1 24
Tax benefit arising from recognition and
retention plan shares 24
Purchase of treasury shares (41,377 in 1999
and 25,200 in 1998) (693) (487)
Cash dividends declared ($.15 per share in 1999
and $.10 per share in 1998) (141) (107)
Change in unrealized loss on
securities available for sale (353) 10
------- -------
BALANCE - JUNE 30 $10,648 $10,934
======= =======
- --------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
5.
<PAGE> 6
<TABLE>
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
- -------------------------------------------------------------------------------------
<CAPTION>
Six months ended
June 30,
-----------------------
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 653 $ 488
Adjustments to reconcile net income to net
cash from operating activities
Depreciation and amortization 148 111
Provision for loan losses (75)
Net amortization of securities 52 26
Net realized gain on:
Sales of securities (1) (11)
Sales of loans (31) (27)
Sales of other assets (64)
Stock dividend on FHLB stock (36) (32)
Loans originated for sale (6,471) (2,484)
Proceeds from sales of loans held for sale 5,154 1,756
Compensation expense related to
recognition and retention plan 25
Net change in other assets and liabilities (859) (308)
-------- --------
Net cash from operating activities (1,441) (545)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Maturities, repayments and calls 6,268 500
Purchases (5,518)
Activity in held-to-maturity securities:
Maturities, repayments and calls 5,031
Purchase of FHLB stock (116) (65)
Loan originations and payments, net 6,803 5,424
Loan purchases (16,267) (14,122)
Proceeds from sale of other assets 100
Additions to property and equipment (481) (46)
-------- --------
Net cash from investing activities (9,311) (3,178)
-------- --------
- -------------------------------------------------------------------------------------
</TABLE>
(Continued)
6.
<PAGE> 7
<TABLE>
POTTERS FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(Dollars in thousands)
- ---------------------------------------------------------------------------------
<CAPTION>
Six months ended
June 30,
----------------------
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 2,084 1,421
Proceeds from FHLB advances 5,279 8,200
Repayments of FHLB advances (2,010) (3,632)
Other financing activities (39) (126)
Repurchase of common stock (693) (487)
Proceeds from exercise of stock options 1 24
Cash dividends paid (141) (107)
------- -------
Net cash from financing activities 4,481 5,293
------- -------
Net change in cash and cash equivalents (6,271) 1,570
Cash and cash equivalents at beginning of period 11,867 3,816
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,596 $ 5,386
======= =======
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 2,486 $ 2,492
Income taxes 552 260
- ---------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
7.
<PAGE> 8
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include Potters Financial Corporation
(PFC) and its wholly-owned subsidiary, Potters Bank, both headquartered in East
Liverpool, Ohio. Significant intercompany transactions and balances have been
eliminated in consolidation. These interim financial statements are prepared
without audit and reflect all adjustments which, in the opinion of management,
are necessary to present fairly the consolidated financial position of PFC at
June 30, 1999, and its statements of income, comprehensive income and cash flows
for the periods presented. All such adjustments are normal and recurring in
nature. The accompanying consolidated financial statements do not purport to
contain all the necessary financial disclosures required by generally accepted
accounting principles that might otherwise be necessary in the circumstances and
should be read in conjunction with the consolidated financial statements of PFC
and notes thereto included in the 1998 Annual Report.
A new accounting standard 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. All banking operations are
considered by management to be aggregated in one reportable operating segment of
banking.
Comprehensive income is reported for all periods. Other comprehensive income
includes the change in unrealized gains and losses on securities available for
sale.
The American Institute of Certified Public Accountants issued Statement of
Position (SOP) No. 98-5, "Start-up Costs", which is effective for years
beginning after December 15, 1998. Under SOP 98-5, applicable start-up,
preoperating and organization costs, which had been capitalized under prior
accounting principles, are now to be expensed as part of current operations. SOP
98-5 requires all such costs previously capitalized as of December 31, 1998 be
written off as of January 1, 1999 as a cumulative effect of a change in
accounting principle. The adoption of this statement did not materially impact
the financial statements.
The Board of Directors declared a 10% stock dividend that was paid from treasury
shares in March 1999, reducing retained earnings by $1.3 million.
Basic earnings per share (EPS) is computed by dividing net income by the
weighted average number of common shares outstanding during the year. Diluted
EPS includes the potential dilution resulting from the issuance of common shares
upon stock option exercises. All references to common shares, earnings and
dividends per share have been restated to reflect all stock dividends and stock
splits. Following is a summary of shares used in computing EPS:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- --------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average common shares
outstanding for basic EPS 965,186 1,035,980 968,784 1,044,507
Add: Dilutive effects of assumed
exercises of stock options 38,422 36,049 29,282 36,062
--------- --------- --------- ---------
Average shares and dilutive potential
common shares 1,003,608 1,072,029 998,066 1,080,569
========= ========= ========= =========
</TABLE>
The provision for income taxes is based upon the effective tax rate expected to
be applicable for the entire year.
- --------------------------------------------------------------------------------
8.
<PAGE> 9
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 2 - SECURITIES AVAILABLE FOR SALE
Securities available for sale were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
June 30, 1999
- -------------
U.S. government and
federal agencies $ 8,496 $(379) $ 8,117
States and municipalities 166 $17 183
Other 351 4 355
Agency issued mortgage-
backed 13,865 16 (256) 13,625
------- --- ----- -------
22,878 37 (635) 22,280
Equity securities 97 1 98
------- --- ----- -------
$22,975 $38 $(635) $22,378
======= === ===== =======
December 31, 1998
- -----------------
U.S. government and
federal agencies $ 5,999 $ 6 $ (8) $ 5,997
States and municipalities 166 22 (1) 187
Other 463 4 467
Agency issued mortgage-
backed 17,072 51 (134) 16,989
------- --- ----- -------
23,700 83 (143) 23,640
Equity securities 75 (1) 74
------- --- ----- -------
$23,775 $83 $(144) $23,714
======= === ===== =======
</TABLE>
Contractual maturities of debt securities available for sale at June 30, 1999
were as follows. Securities not due at a single maturity date, primarily
mortgage-backed securities, are shown separately. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
---- ----------
(Dollars in thousands)
<S> <C> <C>
Due in one year or less $ 3 $ 3
Due after one year through five years 3,122 3,068
Due after five years through ten years 2,543 2,419
Due after ten years 3,345 3,165
Agency issued mortgage-
backed securities 13,865 13,625
------- -------
$22,878 $22,280
======= =======
</TABLE>
- --------------------------------------------------------------------------------
9.
<PAGE> 10
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 2 - SECURITIES AVAILABLE FOR SALE (Continued)
Available-for-sale securities totaling $3.0 million were called during 1999,
resulting in a gain of $1,000.
The carrying value of securities pledged as collateral for public funds amounted
to $12.9 million at June 30, 1999.
NOTE 3 - LOANS RECEIVABLE
Loans receivable were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---- ----
(Dollars in thousands)
<S> <C> <C>
Real estate loans
One-to-four family residences $ 72,770 $76,543
Loans held for sale 584 797
Nonresidential property 9,780 8,350
Multifamily and other 1,863 2,010
-------- -------
84,997 87,700
-------- -------
Consumer and other loans
Home equity loans (1) 13,370 5,746
Purchased second mortgage loans 6,027
Secured, unsecured consumer
loans and lines of credit 2,093 2,102
Commercial business loans 358 654
Other 1,735 1,726
-------- -------
23,583 10,228
-------- -------
Total loan principal balances 108,580 97,928
Undisbursed loan funds (1,443) (1,167)
Premiums on purchased loans,
unearned interest and net
deferred loan (fees) costs 744 361
Allowance for loan losses (2,123) (2,211)
-------- -------
$105,758 $94,911
======== =======
</TABLE>
- --------------------
(1) Includes $7.0 million of first mortgage home equity loans from various parts
of the country purchased from a bank in Indiana.
Activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
Six months ended
June 30,
-----------------------
1999 1998
---- ----
(Dollars in thousands)
<S> <C> <C>
Beginning balance $2,211 $2,143
Provision for loan losses (75)
Recoveries 19 87
Charge-offs (32) (26)
------ ------
Ending balance $2,123 $2,204
====== ======
</TABLE>
- --------------------------------------------------------------------------------
10.
<PAGE> 11
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 3 - LOANS RECEIVABLE (Continued)
Nonaccrual and renegotiated loans totaled $256,000 and $224,000 at June 30, 1999
and December 31, 1998, respectively. Potters is not committed to lend additional
funds to debtors whose loans have been modified. Impaired loans were not
material at any date or during any period presented.
NOTE 4 - FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank (FHLB) advances were as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---- ----
(Dollars in thousands)
<S> <C> <C>
Maturities February 1999 through September 2008,
fixed rate, from 4.66% to 6.50%, averaging 5.44% $17,247
Maturities September 1999 through September 2008,
fixed rate, from 4.66% to 6.50%, averaging 5.35% $20,516
------- -------
$20,516 $17,247
======= =======
</TABLE>
FHLB advances are payable at maturity, with prepayment penalties. At June 30,
1999, advances totaling $11.5 million were convertible fixed-rate advances
which, at the FHLB's option, can be converted to the London Interbank Offering
Rate on a quarterly basis after the first year. If the FHLB exercises its
option, the advances may be repaid in whole or in part on any of the quarterly
repricing dates without prepayment penalty. Advances are collateralized by all
shares of FHLB stock and by 100% of the qualified real estate loan portfolio.
As of June 30, 1999, scheduled maturities of advances were as follows:
<TABLE>
<CAPTION>
Maturities
----------
(Dollars in thousand)
<S> <C>
Due in one year or less $ 1,516
Due after one year through two years 3,500
Due after two years through three years 4,000
After five years 11,500
-------
$20,516
=======
</TABLE>
NOTE 5 - STOCK OPTIONS
A summary of activity relating to stock options during the periods listed was as
follows:
<TABLE>
<CAPTION>
Six months ended Six months ended
June 30, 1999 June 30, 1998
--------------------- ---------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ ----- ------ -----
<S> <C> <C> <C> <C>
Outstanding - January 1 51,907 $ 5.46 57,077 $5.60
Granted 30,000 13.06
Exercised (220) 4.55 (3,520) 6.74
------ ------
Outstanding - June 30 81,687 8.25 53,557 5.52
====== ======
</TABLE>
- --------------------------------------------------------------------------------
11.
<PAGE> 12
POTTERS FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Loss Contingencies: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. Management does not believe there now are such matters that will have
a material effect on the financial statements.
Loan Commitments: Some financial instruments, such as loan commitments, credit
lines, letters of credit and overdraft protection are issued to meet customer
financing needs. These are agreements to provide credit or to support the credit
of others, as long as conditions established in the contract are met, and
usually have expiration dates. Commitments may expire without being used.
Off-balance sheet risk of credit loss exists up to the face amount of these
instruments, although material losses are not anticipated. The same credit
policies used to make commitments are also used for loans, including obtaining
collateral at exercise of the commitment.
Financial instruments with off-balance sheet risk at June 30, 1999 were as
follows:
<TABLE>
<CAPTION>
Fixed Variable
Rate Rate
---- ----
(Dollars in thousands)
<S> <C> <C>
Commitments to make loans
(at market rates) $430 $ 294
Unused lines of credit and
letters of credit 6,483
</TABLE>
Commitments to make loans are generally made for periods of 60 days or less. The
fixed-rate loan commitments have interest rates ranging from 7.125% to 7.875%,
with maturities ranging from 15 to 30 years.
NOTE 7 - CONCENTRATIONS OF CREDIT RISK
Current local loan origination 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. The
Boardman loan production office focuses on originating loans in Mahoning and
Trumball counties in northeastern Ohio, while the Mentor loan production office
will focus its originations in Geauga and Lake counties in northern Ohio. At
June 30, 1999, the loan portfolio included approximately $28.1 million of
purchased residential real estate loans, $13.8 million located in northwestern
Ohio, $4.0 million in southwestern Ohio and $10.3 million located in Hilton
Head, South Carolina. The loan portfolio also included $7.0 million of first
mortgage home equity loans and $6.0 million of second mortgage loans from
various parts of the country, purchased from a bank in Indiana. Two
nonconforming real estate loan programs, which charge a slightly higher interest
rate on single family residential mortgage loans, are available to persons who
are considered slightly higher credit risks. Such loans totaled $6.8 million at
June 30, 1999. Of the $6.8 million, $1.1 million were purchased real estate
loans from southwestern Ohio also reported above.
- --------------------------------------------------------------------------------
12.
<PAGE> 13
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
In the following pages, management presents an analysis of the financial
condition of Potters Financial Corporation (PFC) and its wholly-owned
subsidiary, Potters Bank, as of June 30, 1999 and December 31, 1998, and its
results of operations for the three and six months ended June 30, 1999 and 1998.
In addition to the historical information, the following discussion contains
forward-looking statements that involve risks and uncertainties, including
regulatory policy changes, interest rate fluctuations, loan demand and other
risks. Economic circumstances, operations and actual strategies and results in
future time periods may differ materially from those currently expected. 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 Potters Bank's general market area. Such forward-looking statements
represent PFC's judgment as of the current date. PFC disclaims, however, any
intent or obligation to update such forward-looking statements. See Exhibit 99,
attached hereto, 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:
Results of Operations - Statements regarding efforts to attract lower
costing deposit products and increase the number of relationships with
customers.
Management's statements regarding the amount and adequacy of the allowance
for loan losses and future loan loss provisions.
Statements regarding the strategic focus and long-term goals of Potters
Bank.
Financial Condition - Statements regarding the strategic focus and
long-term goals of Potters Bank.
Management's statements regarding its plan for loan growth and its belief
that loan production offices will enable Potters Bank to become less
reliant on loan purchases to grow the loan portfolio.
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.
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. Because the activities of PFC have
been limited primarily to holding the shares of Potters Bank, the following
discussion essentially concerns the operations of Potters Bank.
13.
<PAGE> 14
RESULTS OF OPERATIONS
PFC recorded net income of $309,000 for the three months ended June 30, 1999, or
$.31 per diluted share, compared to $266,000, or $.25 per diluted share, for the
same three months in 1998. The annualized return on average assets rose to .89%
for the second quarter of 1999, from .85% during the comparable period in 1998,
while the annualized return on average shareholders' equity increased to 11.44%
from 9.63%. The 16.2% increase in second quarter 1999 net income compared to the
second quarter of 1998 was primarily due to a 20.6% increase in net interest
income, offset by higher noninterest expenses. Excluding a nonrecurring net gain
after tax of $42,000, or $.04 per diluted share, on the sale of a parking lot
during the second quarter of 1998, net income increased $85,000, or $.10 per
diluted share, during the second quarter of 1999, a 37.9% increase.
Net income for the six months ended June 30, 1999 was $653,000, a $165,000, or
33.8% increase, over net income of $488,000 for the first half of 1998. A 19.1%
increase in net interest income was somewhat offset by a 9.6% increase in
noninterest expense. Basic and diluted earnings per share were $.67 and $.65 for
the six months ended June 30, 1999, compared to $.47 and $.45 for the comparable
period in 1998. Annualized returns on average assets of .97% and .78% were
realized for the six months ended June 30, 1999 and 1998, while annualized
returns on average shareholders' equity were 11.99% and 8.68%.
Nonrecurring events in both years produced approximately $75,000 before tax, or
$50,000 after tax, of additional income. During the first half of 1998, $75,000
in nonrecurring gains resulted from securities and other asset sales, while
during 1999, a negative provision for loan losses of $75,000 was recorded to
remove excess allowances resulting primarily from the payoff of a $540,000 loan
on a Colorado property. Therefore, the improvement in net income during 1999
resulted primarily from the basic operations of the bank.
Interest income increased $275,000, or 12.2%, during the second quarter of 1999,
primarily from a 24.6% increase in loan interest income. During the first half
of 1999, interest income increased $410,000, or 9.2%, as loan interest income
grew $683,000, offset by a 23.8% decline in securities income. Interest expense
increased $65,000, or 5.3%, during the second quarter of 1999 over 1998 and
increased $26,000, or 1.1%, for the first half of 1999 over 1998, with lower
deposit costs offset by an increase in the use of Federal Home Loan Bank
advances. Net interest income increased $210,000 during the second quarter of
1999 and $384,000 on a year-to-date basis compared to the same time periods in
1998.
The asset yield increased marginally during 1999, primarily from increased loan
levels, including the purchase of higher-yielding second mortgage loans, offset
by lower yields on loans and reductions in the securities portfolio resulting
from calls and repayments. Deposit and FHLB advance balances increased, while
the cost of funds declined to 4.10% during the first six months of 1999,
compared to 4.43% for the same time period in 1998. As a result, the interest
rate spread increased during 1999, to 3.52%, from 3.15% during the first half of
1998. The strategic plan calls for continued efforts to attract lower costing
deposit products and increase the number of relationships with customers
although there can be no assurances that such efforts will be successful.
Excluding a $64,000 gain on the sale of a parking lot during the second quarter
of 1998, second quarter 1999 noninterest income increased $10,000, or 8.7%, over
the second quarter of 1998, and increased $12,000, or 5.4%, during the first
half of 1999 compared to the same period during 1998. Securities gains declined,
from $11,000 during 1998 to $1,000 during 1999, while during 1999, gains on loan
sales increased $5,000, or 16.9%, service charges on deposits increased $12,000,
or 12.0%, and other noninterest income, such as ATM and check card fees,
increased $8,000, or 9.7%, over the first half of 1998.
14.
<PAGE> 15
During the second quarter of 1999, Potters Bank introduced a new financial
investment service at OneSource Financial Center. Located at its downtown East
Liverpool Office, it provides tax-deferred annuities, tax-exempt investment
trusts, mutual funds and life insurance products through Compulife Agency, Inc.
and Compulife Investor Services, Inc. The addition of this service is part of a
strategic initiative to provide customers with a wide array of financial
services and enhance the development of total customer relationships.
Noninterest expense increased $87,000, or 10.9%, during the three months ended
June 30, 1999 over 1998 and increased $150,000, or 9.6%, for the first half of
1999 compared to 1998. Salary and benefits increased primarily from grants of
shares from the recognition and retention plan, staffing the Mentor loan
production office and performance-based incentive compensation, offset by higher
loan deferral costs. Occupancy and equipment expenses increased $26,000, or
27.1%, during the second quarter of 1999 compared to 1998, and increased
$38,000, or 20.4%, during the first half of 1999 compared to 1998. Increases
were caused primarily by rent from the Boardman and Mentor loan production
offices, office building depreciation from corporate office renovation and
improvements, increased utilities costs and depreciation of new technology and
maintenance of equipment and systems. Other noninterest expenses increased
$6,000 during the second quarter of 1999 over 1998, and increased $35,000 during
the first half of 1999 over 1998. Higher expenses resulted primarily from higher
data processing and communication costs related to the new telephone banking
system and the loan production offices. Increases also occurred in check and
ATM/check card processing volumes consistent with planned growth in these
products and services. Included in 1999 noninterest expense was $12,500,
excluding production and mailing costs for customer awareness materials, in
costs associated with year 2000 (Y2K) readiness, described later in this
discussion. Offsetting these increases were decreases in franchise tax,
organization costs relating the formation of the holding company and continuing
cost control.
ALLOWANCE AND PROVISION FOR LOAN LOSSES
The allowance for loan losses at June 30, 1999 was $2.1 million, representing a
decrease of $81,000, from $2.2 million at December 31, 1998. The decrease was
primarily due to the negative provision of $75,000 relating to the Colorado loan
payoff and $19,000 in recoveries, offset by charge-offs of $32,000, primarily in
consumer loans. During the first half of 1998, recoveries of $87,000 resulted
primarily from payments from the bankruptcy Trustee relating to the Bennett
Funding Group equipment lease credits, while charge-offs totaled $26,000.
Nonperforming loans of $256,000 at June 30, 1999 represented an increase of
$32,000 from nonperforming loans of $224,000 at December 31, 1998, but a
decrease of $151,000 from nonperforming loans of $407,000 at June 30, 1998. The
allowance for loan losses represented 829.3% of nonperforming loans at June 30,
1999, compared to 987.1% at December 31, 1998 and 541.5% at June 30, 1998. No
loans were designated impaired at June 30, 1999, 1998 and December 31, 1998. Due
to the current level of unallocated allowances, no provision for loan losses is
planned for the remainder of 1999, 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.
FINANCIAL CONDITION
PFC's assets grew, to $139.0 million at June 30, 1999 from $134.5 million at
December 31, 1998, an increase of $4.5 million, or 3.4%. Funds from calls and
sales of securities and loan repayments, received late in 1998 and included in
year-end cash and cash equivalents, were deployed into loans and securities
during the first half of 1999. Therefore, cash and cash equivalents decreased
significantly, by $6.3 million from year-end 1998. The interest rate
15.
<PAGE> 16
environment and competition produced significant repayments of both loans and
securities, especially earlier in the year. These cash inflows, plus deposit
inflows and increased FHLB borrowing during 1999, funded internal loan
originations and loan purchases to continue planned loan growth.
Securities available for sale decreased $1.3 million, to $22.4 million at June
30, 1999, compared to $23.7 million at December 31, 1998. Securities totaling
$3.0 million were called during the first six months of 1999, resulting in a
gain of $1,000, and repayments on mortgage-backed securities totaled $3.1
million. Securities totaling $5.5 million were purchased during 1999, to replace
called securities and provide continuing liquidity for the bank. 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, net of
tax, increased from $41,000 at year-end 1998 to $394,000 at June 30, 1999,
primarily due to increases in the market rate of interest in the latter part of
the second quarter of 1999, compared to PFC's portfolio yields.
Net loans increased from $94.9 million at December 31, 1998, to $105.8 million
at June 30, 1999, an increase of $10.8 million, or 11.4%. Loan purchases
totaling $16.3 million were made during 1999, $7.4 million of which were first
mortgage home equity loans and $6.0 million of which were second mortgage loans,
both purchased from a bank in Indiana. Loans totaling $6.5 million were
originated for sale during 1999, and $5.2 million were sold, generating gains of
$31,000. Loans originated for sale are 15-year and 30-year fixed-rate real
estate loans, and are sold in accordance with interest rate risk management
policies. The Boardman loan production office continues to contribute to local
loan originations. Another loan production office opened in Mentor, Ohio, a
suburb of Cleveland, in May 1999. The Boardman and Mentor areas are growing,
with new residential construction and business expansion. The strategic plan
calls for utilization of loan production offices to become less reliant on loan
purchases to grow the portfolio, although there can be no assurance the demand
for loans will continue in surrounding local areas or the loan production
offices will successfully penetrate the Boardman or Mentor markets.
Two nonconforming real estate loan programs, which charge slightly higher
interest rates on single family residential real estate loans to persons who are
considered slightly higher credit risks, totaled $6.8 million at June 30, 1999.
Such loans involve greater underwriting and default risk than conforming real
estate loans. The increased risk is somewhat mitigated by charging a higher
interest rate than on conforming loans and adherence to regulatory limitations
on the total of such loans and regulatory reporting requirements to the Board of
Directors. Such loans are also specifically identified and addressed in
management's ongoing review of the allowance for loan losses and a larger
percentage of the allowance is allocated to the nonconforming products than to
conforming real estate loans.
Total deposits increased $2.1 million during 1999, to $106.7 million at June 30,
1999. Inflows occurred primarily in certificates of deposit and the Treasury
Index savings account tied to the 90-day Treasury bill. The Asset and Liability
Management Committee continues to focus on strategies for reduced interest rate
risk and responsible deposit management. Such strategies include setting
competitive rates on selected certificates of deposit with maturity dates
exceeding one year and utilizing tiered interest rates based on amount of
deposit.
FHLB advances totaled $20.5 million at June 30, 1999, compared to $17.2 million
at December 31, 1998. Advances have been used to partially finance loan growth
during 1999 and to meet liquidity needs.
Shareholders' equity decreased $509,000 during the first six months of 1999 due
primarily to the repurchase of 41,377 common shares for a total of $693,000, an
increase in the unrealized loss on securities available for sale of $353,000 and
the payment of $141,000, or $.15 per share, in
16.
<PAGE> 17
dividends, offset by $653,000 in net income. A 10% stock dividend was also paid
from treasury shares during the first quarter of 1999, which reduced retained
earnings by $1.3 million.
LIQUIDITY AND CAPITAL RESOURCES
Normal, recurring sources of funds are primarily customer deposits, securities
available for sale, maturities, loan repayments and other funds provided by
operations. Potters Bank has the ability to borrow from the FHLB when needed as
a secondary source of liquidity.
The most significant components of cash flows from operating activities during
the first half of 1999 included sales of loans held for sale totaling $5.2
million and originations of $6.5 million. Significant investing activities
during the same time period were loan purchases of $16.3 million, purchases of
available-for-sale securities of $5.5 million, offset by repayments, calls and
maturities of $6.2 million in securities available for sale and a net decrease
in loans of $6.8 million. Operating activities during the first half of 1998
included originations of loans held for sale of $2.5 million and $1.8 million of
sales of such loans. Investing activities during the first half of 1998 included
loan purchases of $14.1 million, offset by repayments, calls and maturities of
securities held to maturity of $5.0 million and a net decrease of $5.4 million
in portfolio loans.
Financing activities during the six months ended June 30, 1999 included proceeds
from FHLB advances of $5.3 million, somewhat offset by repayments of FHLB
advances of $2.0 million and deposit inflows of $2.1 million. In addition, PFC
purchased 41,377 treasury shares for a total of $693,000 during 1999. Deposit
inflows of $1.4 million occurred during the first half of 1998, while FHLB
advance activity included proceeds of $8.2 million.
Potters Bank's average regulatory liquidity ratio for June 1999 was 13.27%. At
June 30, 1999, Potters Bank had commitments to originate loans of $724,000 and
unused lines of credit totaling $6.5 million.
The following table details the minimum capital requirements set forth by
regulation for all federally insured savings institutions and Potters Bank's
capital levels as of June 30, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
Tangible Core Risk-based
Capital Capital Capital
--------------- ---------------- ----------------
Amount % Amount % Amount %
------ - ------ - ------ -
<S> <C> <C> <C> <C> <C> <C>
Regulatory capital -
computed $10,708 7.70% $10,708 7.70% $11,700 14.96%
Minimum capital
requirement 2,086 1.50 5,562 4.00* 6,257 8.00
------- ---- ------- ---- ------- -----
Regulatory capital -
excess $ 8,622 6.20% $ 5,146 3.70% $ 5,443 6.96%
======= ==== ======= ==== ======= =====
</TABLE>
- --------------------
*Savings associations that meet certain requirements may be permitted to
maintain minimum core capital of 3.00%.
YEAR 2000 READINESS DISCLOSURE
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
17.
<PAGE> 18
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, operations depend almost entirely on
computer systems. The Board of Directors and management also recognize the risks
the year 2000 poses to all businesses utilizing computer or embedded chip
technology. A "Y2K Committee" (the Committee) was formed to address the problems
associated with the year 2000. In 1997, the Committee conducted a comprehensive
review of all operations which will be impacted by Y2K. Because Potters Bank
does not use proprietary software or hardware, it depends primarily on outside
vendors for its data processing operations and software. The Committee
identified the vendors most critical to operations, but has contacted all
vendors to ensure that the issue is being addressed, and to receive periodic
updates. The Committee developed a detailed plan to monitor the progress of
vendors in modifying their software, if necessary, and a testing plan to ensure
that all vendors appropriately test their software modifications. Detailed
testing of each critical software program has been completed by participating in
proxy testing through the vendor or performing on-site testing and independently
verifying results.
The Committee developed a contingency plan for all systems which identifies
alternatives if existing vendors show a lack of commitment or ability to make
their systems Y2K compliant. The contingency plan provides for contracting with
alternative identified vendors if existing vendors do not meet their established
deadlines for completion of tasks with respect to making their operations Y2K
compliant. At the present time, all communications with both critical and
noncritical vendors report appropriate progress, and there is no reason for
management to believe that systems or software will fail to be Y2K compliant.
The Committee has completed its business resumption contingency plan that
includes courses of action that will be taken should a system or vendor fail in
the year 2000 despite its apparent readiness in 1999. All core business
functions were identified and alternative methods of accomplishing such tasks
developed. The business resumption contingency plan primarily calls for the
manual processing of transactions. The Committee is currently training
appropriate employees in these manual processes. A liquidity plan was developed
and revised and will continue to be updated throughout 1999 to properly address
cash needs at the end of 1999 and the beginning of 2000. The business resumption
contingency plan and the liquidity plan were approved by the Board of Directors,
who receive monthly progress updates on the Y2K project.
An assessment of the risk posed by all commercial borrowers with loans in excess
of $100,000 was performed and communication has been established through letters
and questionnaires and, in some cases, personal contact. Contingency plans for
borrowers not adequately addressing Y2K compliance may include declaring the
loan immediately due.
A customer awareness program has been developed and implemented in order to keep
customers informed of progress in addressing Y2K issues. A customer newsletter
was mailed to all account holders in October 1998 and again in late February
1999, and an FDIC pamphlet and brochures detailing Potters Bank's progress are
available in the branch locations and on Potters Bank's website. Periodic
statement stuffers, additional newsletters and lobby brochures, website updates
and shareholder communications will be used throughout 1999 in addition to a Y2K
customer information line on which customers can leave a message for follow-up
by Committee members. The Committee developed a survey of cash needs which will
be sent as a statement stuffer and will be maintained in the branches to assess
customer opinions on the need for additional cash towards the end of 1999 and to
aid in planning cash levels.
Excluding a considerable amount of employee time, expenses incurred since the
beginning of the Y2K project totaled approximately $32,000 as of June 30, 1999.
However, no assurance can be given at this time that significant expense will
not be incurred in future periods. In the event that replacement computer
systems, programs and equipment are required, or substantial expense
18.
<PAGE> 19
must be incurred to make current systems, programs and equipment Y2K compliant,
or outside vendors pass on expenses of becoming Y2K compliant, net income and
financial condition could be adversely affected. Moreover, to the extent
employees must spend time ensuring that vendors are adequately preparing for
Y2K, those employees will not be focusing all of their time and energies toward
achieving other goals set by management.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Shareholders of Potters Financial Corporation was
held on April 22, 1999. The matters presented to the Security Holders and the
votes cast were as follows:
1) Election of Directors of Potters Financial Corporation
William L. Miller 749,659 FOR
2,300 WITHHELD
Edward L. Baumgardner 749,659 FOR
2,300 WITHHELD
Wm. Gaylord Billingsley 749,659 FOR
2,300 WITHHELD
Suzanne B. Fitzgerald 749,659 FOR
2,300 WITHHELD
2) Ratification of Crowe, Chizek and Company LLP as Auditors
747,509 FOR
2,350 AGAINST
2,100 ABSTAIN
Item 5. Other Information.
None.
19.
<PAGE> 20
Item 6. Exhibits and Reports on Form 8-K.
A. Exhibits
<TABLE>
<S> <C>
Exhibit 3.1 Articles of Incorporation of Potters Incorporated by reference to the
Financial Corporation Form 8-A filed with the SEC on
March 4, 1996 (the "8-A").
Exhibit 3.2 Code of Regulations of Potters Incorporated by reference to the 8-A.
Financial Corporation
Exhibit 11 Statement re: computation of Included herewith.
per share earnings
Exhibit 27 Financial Data Schedule for the Included herewith.
quarter ended June 30, 1999
Exhibit 99 Safe Harbor Under the Private Included herewith.
Securities Litigation Reform Act of 1995
</TABLE>
B. Reports on Form 8-K - none.
20.
<PAGE> 21
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
POTTERS FINANCIAL CORPORATION
Date: August 2, 1999 By: /s/ Edward L. Baumgardner
---------------------------------------
Edward L. Baumgardner
Duly Authorized Representative,
President and Chief Executive Officer
By: /s/ Anne S. Myers
---------------------------------------
Anne S. Myers
Principal Financial Officer and
Principal Accounting Officer
21.
<PAGE> 1
POTTERS FINANCIAL CORPORATION
EXHIBIT 11
<TABLE>
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
<CAPTION>
Quarter ended Six months ended
June 30, June 30,
------------------------- -----------------------
1999 1998(1) 1999 1998(1)
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income for basic and diluted $ 309,000 $ 266,000 $653,000 $ 488,000
========== ========== ======== ==========
Average basic shares outstanding 965,186 1,035,980 968,784 1,044,507
Add: Effect of stock options 38,422 36,049 29,282 36,062
---------- ---------- -------- ----------
Average diluted shares outstanding 1,003,608 1,072,029 998,066 1,080,569
========== ========== ======== ==========
Basic earnings per common share $ 0.32 $ 0.26 $ 0.67 $ 0.47
========== ========== ======== ==========
Diluted earnings per common share $ 0.31 $ 0.25 $ 0.65 $ 0.45
========== ========== ======== ==========
</TABLE>
(1) Restated to reflect the 10% stock dividend effective March 1999.
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0001010476
<NAME> POTTERS FINANCIAL CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 4,007
<INT-BEARING-DEPOSITS> 900
<FED-FUNDS-SOLD> 689
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 22,378
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 107,881
<ALLOWANCE> 2,123
<TOTAL-ASSETS> 139,021
<DEPOSITS> 106,728
<SHORT-TERM> 1,516
<LIABILITIES-OTHER> 1,129
<LONG-TERM> 19,000
0
0
<COMMON> 5,418
<OTHER-SE> 5,230
<TOTAL-LIABILITIES-AND-EQUITY> 139,021
<INTEREST-LOAN> 4,074
<INTEREST-INVEST> 721
<INTEREST-OTHER> 93
<INTEREST-TOTAL> 4,888
<INTEREST-DEPOSIT> 2,008
<INTEREST-EXPENSE> 2,496
<INTEREST-INCOME-NET> 2,392
<LOAN-LOSSES> (75)
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 1,705
<INCOME-PRETAX> 996
<INCOME-PRE-EXTRAORDINARY> 996
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 653
<EPS-BASIC> 0.67
<EPS-DILUTED> 0.65
<YIELD-ACTUAL> 3.70
<LOANS-NON> 256
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 226
<ALLOWANCE-OPEN> 2,211
<CHARGE-OFFS> 32
<RECOVERIES> 19
<ALLOWANCE-CLOSE> 2,123
<ALLOWANCE-DOMESTIC> 1,157
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 966
</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-QSB for the quarter ended June 30, 1999 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
- ----------------------------------------------------
Potters Bank 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 Potters Bank 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. Construction loans may also be negatively
affected by such economic conditions, particularly
<PAGE> 2
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
- -----------
Potters Bank 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, Potters Bank 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 Potters Bank 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 Potters Bank's Earnings
- ----------------------------------------------------------------------------
Potters Bank 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 Potters Bank 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, Potters Bank
may have to convert to a different financial institution charter or might be
regulated under federal law as a bank. If Potters Bank 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 restrictive holding company requirements, including
activity limits and capital requirements similar to those imposed on Potters
Bank. Potters Financial Corporation cannot predict the impact of the conversion
of Potters Bank to, or regulation of Potters Bank as, a bank until any
legislation requiring such change is enacted.
2
