UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of The Securities Exchange Act of 1934
For the quarter ended June 30, 1998
Commission File Number 0-13030
Trans Financial, Inc.
(Exact name of registrant as specified in its charter)
Kentucky 61-1048868
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
500 East Main Street, Bowling Green, Kentucky 42101
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502)793-7717
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _
The number of shares outstanding of the issuer's class of common stock on
August 10, 1998: 11,887,923 shares.
<PAGE>
Part I - Financial Information
Item 1. Financial Statements
<TABLE>
Consolidated Balance Sheets
(Unaudited)
In thousands, except share data
<CAPTION>
June 30 December 31 June 30
1998 1997 1997
Assets
<S> <C> <C> <C>
Cash and due from banks ........................ $ 85,884 $ 70,774 $ 72,131
Interest-bearing deposits with banks ........... 99 99 98
Mortgage loans held for sale ................... 238,608 118,485 81,543
Securities available for sale (amortized
cost of $258,785 as of June 30, 1998;
$276,554 as of December 31, 1997;
and $252,082 as of June 30, 1997) ........... 260,230 278,098 251,829
Loans, net of unearned income .................. 1,552,666 1,537,820 1,473,337
Less allowance for loan losses ................. 23,677 22,017 21,016
----------- ----------- -----------
Net loans ................................... 1,528,989 1,515,803 1,452,321
Premises and equipment, net .................... 40,755 37,429 36,488
Mortgage servicing rights ...................... 51,892 46,870 44,343
Other assets ................................... 48,282 47,453 41,937
=========== =========== ===========
Total assets ................................ $ 2,254,739 $ 2,115,011 $ 1,980,690
=========== =========== ===========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing ........................ $ 253,041 $ 235,695 $ 226,140
Interest bearing ............................ 1,313,674 1,338,143 1,314,609
----------- ----------- -----------
Total deposits .............................. 1,566,715 1,573,838 1,540,749
Federal funds purchased and
repurchase agreements ....................... 203,827 109,348 93,607
Other short-term borrowings .................... 95,500 70,000 45,000
Long-term debt ................................. 194,932 185,293 140,628
Other liabilities .............................. 26,641 25,755 20,812
----------- ----------- -----------
Total liabilities ........................... 2,087,615 1,964,234 1,840,796
Shareholders' equity:
Common stock, no par value. Authorized
50,000,000 shares; issued and
outstanding 11,778,545; 11,471,689;
and 11,437,962 shares, respectively ...... 22,078 21,510 21,446
Additional paid-in capital .................. 52,404 46,284 45,570
Retained earnings ........................... 93,339 83,947 75,317
Accumulated other comprehensive income ...... 813 882 (257)
Employee Stock Ownership Plan shares
purchased with debt ...................... (1,510) (1,846) (2,182)
----------- ----------- -----------
Total shareholders' equity .................. 167,124 150,777 139,894
----------- ----------- -----------
Total liabilities
and shareholders' equity .................. $ 2,254,739 $ 2,115,011 $ 1,980,690
=========== =========== ===========
See accompanying notes to consolidated financial statements
</TABLE>
<PAGE>
<TABLE>
Consolidated Statements of Income
(Unaudited)
In thousands, except per share data
<CAPTION>
2nd Qtr. Six Months
For the periods ended June 30 1998 1997 1998 1997
Interest income
<S> <C> <C> <C> <C>
Loans, including fees .................................... $ 36,317 $ 34,337 $72,103 $67,945
Securities available for sale ............................ 3,691 3,597 7,508 7,417
Mortgage loans held for sale ............................. 3,959 1,568 6,427 2,797
Interest-bearing deposits with banks ..................... 2 2 9 4
-------- -------- ------- -------
Total interest income .................................... 43,969 39,504 86,047 78,163
Interest expense
Deposits ................................................. 16,305 16,035 32,771 31,540
Federal funds purchased
and repurchase agreements .............................. 1,547 699 2,622 1,290
Long-term debt and other
borrowings ............................................. 4,462 3,056 8,669 6,319
-------- -------- ------- -------
Total interest expense ................................... 22,314 19,790 44,062 39,149
-------- -------- ------- -------
Net interest income ........................................ 21,655 19,714 41,985 39,014
Provision for loan losses ................................ 2,300 2,900 4,520 4,850
-------- -------- ------- -------
Net interest income after
provision for loan losses ................................ 19,355 16,814 37,465 34,164
Non-interest income
Service charges on deposit accounts ...................... 2,673 2,582 5,144 5,077
Mortgage banking income .................................. 5,113 2,612 9,723 5,369
Gains (losses) on sales of securities
available for sale, net ................................ (2) (88) 148 133
Trust services ........................................... 544 677 1,161 1,238
Brokerage income ......................................... 1,308 708 2,110 1,418
Other .................................................... 1,236 2,684 2,851 3,859
-------- -------- ------- -------
Total non-interest income ................................ 10,872 9,175 21,137 17,094
Non-interest expenses
Compensation and benefits ................................ 10,062 8,577 19,446 17,185
Net occupancy expense .................................... 1,164 1,156 2,324 2,306
Furniture and equipment expense .......................... 1,828 1,615 3,637 3,181
Deposit insurance ........................................ 102 106 204 209
Professional fees ........................................ 570 712 1,212 1,378
Postage, printing & supplies ............................. 1,123 867 2,187 1,847
Communications ........................................... 829 712 1,577 1,370
Other .................................................... 3,930 3,411 7,516 6,719
-------- -------- ------- -------
Total non-interest expenses .............................. 19,608 17,156 38,103 34,195
-------- -------- ------- -------
Income before income taxes ................................. 10,619 8,833 20,499 17,063
Income tax expense ......................................... 3,589 2,971 6,895 5,653
======== ======== ======= =======
Net income ................................................. $ 7,030 $ 5,862 $13,604 $11,410
======== ======== ======= =======
Diluted earnings per share ................................. $ 0.58 $ 0.50 $ 1.13 $ 0.98
======== ======== ======= =======
Basic earnings per share ................................... $ 0.60 $ 0.51 $ 1.17 $ 1.00
======== ======== ======= =======
See accompanying notes to consolidated financial statements
</TABLE>
<PAGE>
Consolidated Statements of Comprehensive Income
(Unaudited)
In thousands
For the periods ended June 30
1998 1997
Net income $13,604 $11,410
Other comprehensive income, net of tax:
Unrealized holding gains (losses) during the period
on securities available for sale ............... 104 42
Reclassification adjustments for (gains)losses
on securities included in net income ........... (173) (207)
-------- --------
Total other comprehensive income ...................... (69) (165)
======== ========
Comprehensive income .................................. $ 13,535 $ 11,245
======== ========
See accompanying notes to consolidated financial statements.
Consolidated Statements of Changes in Shareholders' Equity
(Unaudited)
In thousands
For the six months ended June 30
1998 1997
Balance January 1 $150,777 $131,316
Net income ............................ 13,604 11,410
Other comprehensive income ............ (69) (165)
Issuance of common stock .............. 6,690 946
Cash dividends declared on common stock (4,213) (3,882)
ESOP debt reduction ................... 335 269
========= =========
Balance at end of period ................ $ 167,124 $ 139,894
========= =========
See accompanying notes to consolidated financial statements.
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows
(Unaudited)
In thousands
For the six months ended June 30
<CAPTION>
1998 1997
Cash flows from operating activities:
<S> <C> <C>
Net income ....................................................... $ 13,604 $ 11,410
Adjustments to reconcile net income to cash provided by operating
activities:
Provision for loan losses .................................... 4,520 4,850
Deferred tax expense(benefit) ................................ (915) (472)
Gain on sale of securities available for sale ................ (148) (133)
Gain on sale of mortgage loans held for sale ................. (5,306) (1,910)
Gain on sale of premises and equipment ....................... -- (3)
Gain on sale of branches ..................................... (430) (1,241)
Depreciation and amortization of fixed assets ................ 3,375 2,549
Amortization of intangible assets ............................ 792 647
Amortization of premium on securities and loans, net ......... 200 418
Amortization of mortgage servicing rights .................... 3,696 2,957
Decrease in accrued interest receivable .......................... 244 895
Decrease in other assets ......................................... (836) 21,169
Decrease in accrued interest payable ............................. (333) (102)
Increase(decrease) in other liabilities ......................... 1,301 (4,751)
Sale of mortgage loans held for sale ............................. 943,702 410,164
Originations of mortgage loans held for sale ..................... (1,058,519) (420,744)
----------- ---------
Net cash provided by (used in) operating activities ............ (95,053) 25,703
Cash flows from investing activities:
Proceeds from sale of securities available for sale .............. 3,640 2,604
Proceeds from prepayment and call of securities available for sale 18,477 5,245
Proceeds from maturities of securities available for sale ........ 46,876 30,670
Purchase of securities available for sale ........................ (51,277) (5,622)
Net increase in loans ............................................ (18,568) (25,560)
Net cash outflow from sale of Tennessee offices .................. (8,826) (13,789)
Proceeds from sale of mortgage servicing rights .................. 1,489 --
Purchase and origination of mortgage servicing rights ............ (10,207) (6,488)
Proceeds from sale of foreclosed assets .......................... 731 407
Purchases of premises and equipment .............................. (6,863) (2,648)
Proceeds from disposal of premises and equipment ................. 121 232
----------- ---------
Net cash used in investing activities .......................... (24,407) (14,949)
Cash flows from financing activities:
Net increase (decrease) in deposits .............................. 2,140 (22,463)
Net increase in federal funds purchased
and repurchase agreements ...................................... 94,479 21,728
Net increase(decrease) in short-term borrowings .................. 25,500 (10,000)
Proceeds from issuance of long-term debt ......................... 10,000 --
Repayment of long-term debt ...................................... (26) (6)
Proceeds from issuance of common stock ........................... 6,690 946
Dividends paid ................................................... (4,213) (3,882)
----------- ---------
Net cash provided by (used in) financing activities ............ 134,570 (13,677)
----------- ---------
Net increase (decrease ) in cash and cash equivalents ............ 15,110 (2,923)
Cash and cash equivalents at beginning of year ................... 70,774 75,054
----------- ---------
Cash and cash equivalents at end of period ....................... $ 85,884 $ 72,131
=========== =========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
The accounting and reporting policies of Trans Financial, Inc. and its
subsidiaries (the company) conform to generally accepted accounting principles
and general practices within the banking industry. The consolidated financial
statements includethe accounts of Trans Financial, Inc. and its wholly-owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated in consolidation. A description of other significant accounting
policies is presented in the 1997 annual report on Form 10-K.
In the opinion of management, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have been
reflected in the accompanying unaudited financial statements. Results of interim
periods are not necessarily indicative of results to be expected for the full
year.
(2) Allowance for Loan Losses
An analysis of the changes in the allowance for loan losses follows:
<TABLE>
In thousands
<CAPTION>
2nd Qtr. Six Months
For the periods ended June 30 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Balance beginning of period ................ $ 22,777 $ 19,010 $ 22,017 $ 18,065
Provision for loan losses ................ 2,300 2,900 4,520 4,850
Loans charged off ........................ (1,743) (1,141) (3,766) (2,273)
Recoveries of loans previously charged off 343 247 906 374
-------- -------- -------- --------
Net charge-offs .......................... (1,400) (894) (2,860) (1,899)
-------- -------- -------- --------
Balance at end of period ................... $ 23,677 $ 21,016 $ 23,677 $ 21,016
======== ======== ======== ========
</TABLE>
(3) Impaired Loans
The company's recorded investment in loans considered impaired in
accordance with Statement of Financial Accounting Standards No. 114, Accounting
by Creditors for Impairment of a Loan (SFAS 114), was $14,127,000 at June 30,
1998. Of that amount, $11,080,000 represents loans for which an allowance for
loan losses, in the amount of $2,486,000 has been established under SFAS 114.
Impaired loans totaled $4,694,000 at June 30, 1997, including $2,356,000 of
loans for which an allowance was established totaling $639,000.
The average recorded investment of impaired loans was $14,406,000 and
$4,476,000 for the three months ended June 30, 1998 and 1997, respectively, and
$15,133,000 and $4,456,000 for the six months ended June 30, 1998 and 1997,
respectively. Interest income recognized on impaired loans totaled $35,000 for
the three months ended June 30, 1998, and $129,000 for the six-month period
ended June 30, 1998. For the comparable periods in 1997, interest income on
impaired loans totaled $23,000 and $46,000, respectively.
(4) New Accounting and Disclosure Standards
During 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"). SFAS 130, which became effective in the first quarter of 1998, requires a
presentation of comprehensive income in a full set of general-purpose financial
statements. In addition to net income, comprehensive income includes all other
changes in shareholders' equity during the reporting period except those
resulting from investments by shareholders and distributions to shareholders. To
comply with SFAS 130, the company is presenting in this report a Consolidated
Statement of Comprehensive Income.
In June 1998, Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") was
issued by the FASB. SFAS 133 standardizes the accounting for derivative
instruments, including certain derivative instruments imbedded in other
contracts, requiring derivatives to be carried at fair value in the consolidated
balance sheet. Whether gains or losses are recognized in net income or in other
comprehensive income depends on whether the derivative instrument has been
designated as a qualifying hedge and, if so, on the reason for the hedge.
If the derivative is not designated as hedge, any gain or loss is recognized
in earnings in the period of the change in fair value. SFAS 133 must be adopted
by January 1, 2000; early adoption is permitted. The company has not determined
the impact that SFAS 133 will have on its financial statements and believes
that such determination will not be meaningful until closer to the actual date
of adoption.
(5) Pending Merger and Subsequent Event
On April 9, 1998, the company entered into an agreement and Plan of Merger
with Star Banc Corporation, based in Cincinnati, Ohio ("Star Banc"). In
accordance with the terms of the merger agreement, each share of the company's
common stock will be converted into 0.9003 share of Star Banc common stock.
During the second quarter of 1998, the Federal Reserve Board and the Office of
the Comptroller of the Currency approved the merger, and the company's
shareholders approved the merger on July 20, 1998. With no additional approvals
required, management expects the merger to be consummated on August 21, 1998.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
Trans Financial, Inc. ("the company") is a bank holding company registered
under the Bank Holding Company Act of 1956. The company has two commercial bank
subsidiaries--Trans Financial Bank, National Association ("TFB-KY"), consisting
of all of the company's banking activities in Kentucky, and Trans Financial Bank
Tennessee, National Association ("TFB-TN"), consisting of all
of the company's Tennessee banking activity. (On July 26, 1997, the company's
former thrift subsidiary--Trans Financial Bank, F.S.B.--was merged into TFB-KY,
and its Tennessee operations were sold to TFB-TN. These transactions
consolidated the company's banking operations into its current two national bank
charters.)
In addition, the company operates as subsidiaries of TFB-KY a full-service
securities broker/dealer--Trans Financial Investment Services, Inc.--and a
mortgage banking company--Trans Financial Mortgage Company ("TFMC").
During April 1997, the company sold substantially all of the deposits,
premises and equipment, and certain other assets of its Lebanon and Sparta,
Tennessee offices. These two offices represented $17 million of the company's
total deposits as of March 31, 1997. The company's Mt. Pleasant, Tennessee
office, consisting of $10 million of deposits, was sold on March 4, 1998.
On August 29, 1997, the Trans Adviser family of mutual funds ("the Funds")
was transferred to the Countrywide Family of Funds. TFB-KY had acted as
investment adviser to the Funds, which had total assets of $159 million as of
June 30, 1997. However, as a result of this transfer, TFB-KY no longer serves in
that capacity. The transfer did not have a significant impact on the company's
financial condition or results of operations.
On March 6, 1998, the company entered into an agreement to purchase $154
million in deposits and $27 million in loans from Banc One Corporation. The
acquisition includes eight offices located in Hopkins and Christian Counties in
western Kentucky. Management expects the transaction to be completed on
August 21, 1998.
On April 9, 1998, the company entered into an agreement and Plan of Merger
with Star Banc Corporation, based in Cincinnati, Ohio ("Star Banc"). In
accordance with the terms of the merger agreement, each share of the company's
common stock will be converted into 0.9003 share of Star Banc common stock.
During the second quarter of 1998, the Federal Reserve Board and the Office of
the Comptroller of the Currency approved the merger, and the company's
shareholders approved the merger on July 20, 1998. With no additional approvals
required, management expects the merger to be consummated on August 21, 1998.
The discussion that follows is intended to provide additional insight into
the company's financial condition and results of operations. This discussion
should be read in conjunction with the consolidated financial statements and
accompanying notes presented in Item 1 of Part I of this report.
Results of Operations
Overview
For the three months ended June 30, 1998, the company earned $7.0 million,
or $0.58 per diluted share, compared to $5.9 million, or $0.50 per diluted
share, for the second quarter of 1997. Results for the second quarter of 1998
produced an annualized return on average assets of 1.29% and a return on average
shareholders' equity of 17.41%, compared with 1.21% and 17.15%, respectively,
for the second quarter of 1997.
For the first half of 1998, the company recorded net income of $13.6
million, or $1.13 per diluted share, compared to $11.4 million, or $0.98 per
diluted share, in the same period of 1997. Return on average assets for the
first six months of 1998 was 1.27% and the return on average equity was 17.26%,
compared with 1.18% and 16.95%, respectively, for the first half of 1997.
Net Interest Income
Net interest income on a tax-equivalent basis totaled $21.9 million in the
second quarter of 1998, compared with $20.0 million in the comparable 1997
period--a 9% increase. For the second quarter of 1998, the net interest margin
(net interest income as a percentage of average interest-earning assets) on a
tax-equivalent basis decreased 13 basis points, from 4.50% to 4.37%, compared to
the same period in 1997. For the first six months of 1998, the net interest
margin decreased 14 basis points, from 4.47% to 4.33%, as compared to first half
1997.
Approximately $718 million of the company's loans reprice immediately with
changes in the prime rate, and another $35 million of loans reprice within three
months of a change in prime. The prime rate increased to 8.50% in late first
quarter 1997, and has remained constant since then. Since late 1997, a
significantly larger proportion of interest earning asset growth has come from
lower earning mortgage loans held for sale. Also during this time, the company's
funding costs continued to rise, as greater reliance has been placed on
wholesale funding sources, such as brokered deposits and other borrowed funds.
As a result, the company's net interest-rate spread (the difference between the
average yield on interest-earning assets and the average rate paid on
interest-bearing liabilities) decreased 19 basis points compared to second
quarter 1997, negatively impacting the net interest margin. This negative impact
was partially offset during 1998 by increased interest income due to growth in
loans and in mortgage loans held for sale.
The following tables show, for the three- and six-month periods ended June
30, 1998 and 1997, the relationship between interest income and expense and the
levels of average interest-earning assets and average interest-bearing
liabilities. The tables reflect increased volumes of commercial loans, mortgage
loans held for sale, brokered certificates of deposit and borrowed funds.
<PAGE>
<TABLE>
Average Consolidated Balance Sheets and Net Interest Analysis
For the three months ended June 30
Dollars in thousands
<CAPTION>
1998 1997
Average Average Average Average
Balance Interest Rate Balance Interest Rate
Assets:
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C>
Loans, net of unearned income $1,551,291 $36,376 * 9.41% $1,452,174 $34,412 * 9.50%
Securities 254,948 3,917 * 6.16% 253,617 3,863 * 6.11%
Mortgage loans held for sale 208,636 3,959 7.61% 80,848 1,568 7.78%
Federal funds sold
and other interest income 100 2 8.02% 164 2 4.89%
------------- ----------- -------------- -----------
Total interest-earning assets /
interest income 2,014,975 44,254 * 8.81% 1,786,803 39,845 * 8.94%
----------- -----------
Non-interest-earning assets:
Cash and due from banks 64,649 52,417
Premises and equipment 39,482 37,009
Other assets 69,207 64,861
============= ==============
Total assets $2,188,313 $1,941,090
============= ==============
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Interest-bearing demand (NOW) $61,409 $509 3.32% $35,059 $286 3.27%
Savings deposits 97,434 581 2.39% 102,276 722 2.83%
Money market accounts 273,948 2,311 3.38% 270,721 2,236 3.31%
Certificates of deposit 702,101 9,691 5.54% 708,358 9,695 5.49%
Brokered certificates of deposit 134,551 2,129 6.35% 123,363 1,925 6.26%
Individual Retirement Accounts 77,926 1,084 5.58% 82,246 1,171 5.71%
------------- ----------- -------------- -----------
Total interest-bearing deposits 1,347,369 16,305 4.85% 1,322,023 16,035 4.86%
Federal funds purchased
and repurchase agreements 115,968 1,547 5.35% 53,481 699 5.24%
Other short-term borrowings 94,807 1,341 5.67% 48,957 700 5.74%
Long-term debt 195,088 3,121 6.42% 140,786 2,356 6.71%
------------- ----------- -------------- -----------
Total borrowed funds 405,863 6,009 5.94% 243,224 3,755 6.19%
------------- ----------- -------------- -----------
Total interest-bearing liabilities /
interest expense 1,753,232 22,314 5.10% 1,565,247 19,790 5.07%
----------- -----------
Non-interest-bearing liabilities:
Non-interest-bearing deposits 247,609 215,873
Other liabilities 25,544 22,878
------------- --------------
Total liabilities 2,026,385 1,803,998
Shareholders' equity 161,928 137,092
------------- --------------
Total liabilities
and shareholders' equity $2,188,313 $1,941,090
============= ==============
Net interest-rate spread 3.71% 3.87%
Impact of non-interest bearing
sources and other changes in
balance sheet composition 0.66% 0.63%
----------- ----------
Net interest income /
margin on interest-earning assets $21,940 * 4.37% $20,055 * 4.50%
=========== =========== =========== ==========
*Includes tax-equivalent adjustment
Net interest margin is net interest income divided by average interest-earning
assets. For computational purposes, non-accrual loans are included in
interest-earning assets. Net interest rate spread is the difference between the
average rate of interest earned on interest-earning assets and the average rate
of interest expensed on interest-bearing liabilities. Average balances are based
on daily balances and average rates are based on a 365-day year.
</TABLE>
<PAGE>
<TABLE>
Average Consolidated Balance Sheets and Net Interest Analysis
For the six months ended June 30
Dollars in thousands
<CAPTION>
1998 1997
Average Average Average Average
Balance Interest Rate Balance Interest Rate
Assets:
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C>
Loans, net of unearned income $1,547,328 $72,234 * 9.41% $1,453,064 $68,101 * 9.45%
Securities 259,925 7,984 * 6.19% 262,601 7,961 * 6.11%
Mortgage loans held for sale 177,428 6,427 7.30% 75,160 2,797 7.50%
Federal funds sold
and other interest income 265 9 6.85% 131 4 6.16%
------------- ----------- -------------- -----------
Total interest-earning assets /
interest income 1,984,946 86,654 * 8.80% 1,790,956 78,863 * 8.88%
----------- -----------
Non-interest-earning assets:
Cash and due from banks 64,747 51,013
Premises and equipment 38,816 37,307
Other assets 69,768 65,214
============= ==============
Total assets $2,158,277 $1,944,490
============= ==============
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Interest-bearing demand (NOW) $63,933 $1,071 3.38% $34,474 $541 3.16%
Savings deposits 96,371 1,168 2.44% 103,205 1,409 2.75%
Money market accounts 266,930 4,478 3.38% 270,557 4,376 3.26%
Certificates of deposit 709,624 19,491 5.54% 715,698 19,273 5.43%
Brokered certificates of deposit 139,677 4,390 6.34% 116,879 3,640 6.28%
Individual Retirement Accounts 78,428 2,173 5.59% 82,822 2,301 5.60%
------------- ----------- -------------- -----------
Total interest-bearing deposits 1,354,963 32,771 4.88% 1,323,635 31,540 4.81%
Federal funds purchased
and repurchase agreements 99,647 2,622 5.31% 50,722 1,290 5.13%
Other short-term borrowings 87,627 2,500 5.75% 60,829 1,683 5.58%
Long-term debt 194,306 6,169 6.40% 140,840 4,636 6.64%
------------- ----------- -------------- -----------
Total borrowed funds 381,580 11,291 5.97% 252,391 7,609 6.08%
------------- ----------- -------------- -----------
Total interest-bearing liabilities /
interest expense 1,736,543 44,062 5.12% 1,576,026 39,149 5.01%
----------- -----------
Non-interest-bearing liabilities:
Non-interest-bearing deposits 237,232 208,855
Other liabilities 25,569 23,894
------------- --------------
Total liabilities 1,999,344 1,808,775
Shareholders' equity 158,933 135,715
------------- --------------
Total liabilities
and shareholders' equity $2,158,277 $1,944,490
============= ==============
Net interest-rate spread 3.68% 3.87%
Impact of non-interest bearing
sources and other changes in
balance sheet composition 0.65% 0.60%
----------- ----------
Net interest income /
margin on interest-earning assets $42,592 * 4.33% $39,714 * 4.47%
=========== =========== =========== ==========
*Includes tax-equivalent adjustment
Net interest margin is net interest income divided by average interest-earning
assets. For computational purposes, non-accrual loans are included in
interest-earning assets. Net interest rate spread is the difference between the
average rate of interest earned on interest-earning assets and the average rate
of interest expensed on interest-bearing liabilities. Average balances are based
on daily balances and average rates are based on a 365-day year.
</TABLE>
<PAGE>
Analysis of Changes in Net Interest Income
Shown in the following tables are changes in interest income and interest
expense resulting from changes in volumes (average balances) and changes in
interest rates for the three- and six-month periods ended June 30, 1998, as
compared to the same period in 1997.
Second Quarter 1998 vs. 1997
Increase (decrease)
in interest income and expense
In thousands due to changes in:
Volume Rate Total
Interest-earning assets:
Loans ............................ $ 2,327 $(363) $ 1,964
Securities ....................... 20 34 54
Mortgage loans held for sale ..... 2,426 (35) 2,391
Federal funds sold
and other interest income ...... (1) 1 --
------- ----- -------
Total interest-earning assets .... 4,772 (363) 4,409
Interest-bearing liabilities:
Interest-bearing demand (NOW) .... 218 5 223
Savings deposits ................. (33) (108) (141)
Money market accounts ............ 27 48 75
Certificates of deposit .......... (86) 82 (4)
Brokered certificates of deposit . 177 27 204
Other time deposits .............. (61) (26) (87)
------- ----- -------
Total interest-bearing deposits 242 28 270
Federal funds purchased
and repurchase agreements ...... 833 15 848
Other short-term borrowings ...... 649 (8) 641
Long-term debt ................... 873 (108) 765
------- ----- -------
Total borrowed funds ........... 2,355 (101) 2,254
------- ----- -------
Total interest-bearing liabilities 2,597 (73) 2,524
------- ----- -------
Increase (decrease)
in net interest income ......... $ 2,175 $(290) $ 1,885
======= ===== =======
The change in interest due to both rate and volume has been allocated to
changes in average volume and changes in average rates in proportion to the
absolute dollar amounts of the change in each.
<PAGE>
Six Months 1998 vs. 1997
Increase (decrease)
in interest income and expense
In thousands due to changes in:
Volume Rate Total
Interest-earning assets:
Loans ............................ $ 4,402 $(269) $ 4,133
Securities ....................... (82) 105 23
Mortgage loans held for sale ..... 3,706 (76) 3,630
Federal funds sold
and other interest income ...... 5 -- 5
------- ----- -------
Total interest-earning assets .... 8,031 (240) 7,791
Interest-bearing liabilities:
Interest-bearing demand (NOW) .... 491 39 530
Savings deposits ................. (89) (152) (241)
Money market accounts ............ (59) 161 102
Certificates of deposit .......... (165) 383 218
Brokered certificates of deposit . 716 34 750
Other time deposits .............. (122) (6) (128)
------- ----- -------
Total interest-bearing deposits 772 459 1,231
Federal funds purchased
and repurchase agreements ...... 1,286 46 1,332
Other short-term borrowings ...... 763 54 817
Long-term debt ................... 1,703 (170) 1,533
------- ----- -------
Total borrowed funds ........... 3,752 (70) 3,682
------- ----- -------
Total interest-bearing liabilities 4,524 389 4,913
------- ----- -------
Increase (decrease)
in net interest income ......... $ 3,507 $(629) $ 2,878
======= ===== =======
The change in interest due to both rate and volume has been allocated to
changes in average volume and changes in average rates in proportion to the
absolute dollar amounts of the change in each.
Provision for Loan Losses
The provision for loan losses was $2.3 million (0.59% of average loans on
an annualized basis, excluding mortgage loans held for sale) for the second
quarter of 1998, compared with $2.9 million (1.34% of average loans) for the
comparable period of 1997. Net loan charge-offs were $1.4 million (0.36% of
average loans) for the second quarter of 1998, compared with $0.9 million (0.25%
of average loans) for the second quarter of 1997.
For the first six months of 1998, the provision for loan losses was $4.5
million (0.58% of average loans), compared with $4.9 million (0.67% of average
loans) for the comparable period of 1997. Net loan charge-offs were $2.9 million
(0.37% of average loans) for the first half of 1998, compared with $1.9 million
(0.26% of average loans) for the first six months of 1997.
The provision for loan losses and the level of the allowance for loan
losses reflect management's evaluation of the risk in the loan portfolio.
Further discussion on loan quality and the allowance for loan losses is included
in the Asset Quality discussion later in this report.
Non-Interest Income
Non-interest income for the second quarter of 1998 increased $1.7 million,
or 18%, over the second quarter of 1997. During the second quarter of 1997 the
company recognized a $1.2 million gain on the sale of the two Tennessee offices
which were sold during the quarter. Excluding this gain, non-interest income for
the second quarter of 1998 would have increased $2.9 million, or 37% over the
second quarter of 1997.
For the first six months of 1998 non-interest income increased $4.0
million, or 24%, over the comparable period in 1997. The first quarter of 1998
included a $430 thousand gain on the sale of the Mt. Pleasant, Tennessee,
office. Excluding this gain and the $1.2 million gain in the second quarter of
1997, non-interest income for the first half of 1998 would have increased $4.9
million, or 31% over the first half of 1997.
The higher level of non-interest income in 1998 is primarily attributable
to increased mortgage loan origination and refinancing activity. During the
second quarter of 1998, mortgage banking income improved $2.2 million over the
year-earlier period, despite taking a $630 thousand provision for impairment of
the mortgage servicing rights ("MSR) asset resulting from increased mortgage
loan prepayment activity. The Surety Mortgage (Cape Coral, Florida) acquisition
and the new mortgage office in Little Rock, Arkansas, represent $1.3 million of
the increase in mortgage banking income for the second quarter. A record quarter
for brokerage income (a $600 thousand increase) also contributed to the rise in
quarterly non-interest income. Mortgage banking income (up $4.4 million) and
brokerage income (up $692 thousand) were also principally responsible for the
increase in non-interest income for the six-months ended June 30, 1998, as
compared to the first six months of 1997.
Non-Interest Expenses
Non-interest expenses increased $2.5 million, or 14%, in the second quarter
of 1998, compared to the second quarter of 1997. As a result of increased
mortgage production activities, total non-interest expense for Trans Financial
Morgage Company increased $1.5 million over the second quarter of 1997,
including $1.0 million in operating expenses associated with the new mortgage
offices in Florida and Arkansas. Higher non-mortgage retail sales and brokerage
activity, and an increased emphasis on performance-based pay led to an increase
of $373 thousand in commission and incentive expense during the quarter.
Technology-related initiatives and expansion of the convenience-store ATM
network resulted in a $330 thousand increase in non-interest expense compared
with the second quarter of 1997. The efficiency ratio (a measure of operating
expenses per dollar of income) decreased to 60.3% in the second quarter of 1998
(excluding the branch sale gains and securities gains and losses)--an
improvement over the 61.9% efficiency ratio in the second quarter of 1997.
For the six-month periods, non-interest expenses increased $3.9 million, or
11%, in 1998 as compared to the first half of 1997. Operating expenses
associated with the new Florida and Arkansas mortgage offices represent $1.4
million of the increased expenses, while mortgage and brokerage commissions and
other incentive-based pay rose $668 thousand from the first half of 1997 to the
first half of 1998. Technology expenses and ATM network expansion added another
$573 thousand, period-to-period.
Income Taxes
Income tax expense totaled $3.6 million for the second quarter of 1998,
compared with $3.0 million in the comparable 1997 period. These represent
effective tax rates of 33.8% and 33.6%, respectively. For the six months ended
June 30, 1998, the company's effective tax rate was 33.6%, compared to 33.1% in
the first half of 1997.
Balance Sheet Review
Overview
Assets at June 30, 1998 totaled $2.25 billion, compared with $2.12 billion
at December 31, 1997, and $1.98 billion a year ago. Average total assets for the
second quarter increased $247 million (13%) over the past year to $2.19 billion.
Average interest-earning assets increased $228 million to $2.01 billion.
Loans
The company experienced annualized loan growth of 2% from December 31,
1997, to June 30 1998. For the second quarter of 1998, loans decreased $4.0
million from March 31, 1998 (a 1% annualized rate). At June 30, 1998, loans net
of unearned income (excluding mortgage loans held for sale) totaled $1.55
billion, compared with $1.54 billion at December 31, 1997, and $1.47 billion a
year ago.
Total loans, net of unearned income, averaged $1.55 billion in the second
quarter of 1998, excluding mortgage loans held for sale of $209 million. For the
comparable period in 1997, loans averaged $1.45 billion, excluding the $81
million of mortgage loans held for sale.
Asset Quality
Non-performing loans, which include non-accrual loans, accruing loans past
due 90 days or more and restructured loans, totaled $28.3 million as of June 30,
1998, an increase of $3.8 million from December 31, 1997, and an increase of
$18.8 million from the end of the second quarter of 1997. The increase from a
year ago is primarily attributable to $12.8 million of loans to a coal mining
operation. The $3.7 million increase over the first quarter of 1998 is primarily
due to three loans. Two of these loans, totaling $2.4 million, are secured by
commercial real estate and the third is a $1.0 million commercial loan to the
coal mining operation. The company is closely monitoring its $23.9 million
exposure to the coal industry, which is down from $33.5 million at December 31,
1997, primarily due to several paydowns on loans. At June 30, 1998, the
company's coal exposure consisted of the non-accrual loans mentioned above as
well as an additional 102 relationships, with the next largest single credit
exposure totaling $2.5 million.
The ratio of non-performing loans to total loans (net of unearned income)
was 1.82% at June 30, 1998, compared with 1.59% at the end of 1997 and 0.64% a
year ago. Non-performing assets, which include non-performing loans, foreclosed
real estate and other foreclosed property, totaled $29.3 million as of June 30,
1998, as compared to $10.7 million at June 30, 1997. The ratio of non-performing
assets to total assets increased to 1.30% at June 30, 1998, from 0.54% a year
ago.
The following table presents information concerning non-performing assets,
including non-accrual and restructured loans.
<TABLE>
Non-performing Assets
Dollars in thousands
<CAPTION>
June 30 March 31 December 31 June 30
1998 1998 1997 1997
<S> <C> <C> <C> <C>
Non-accrual loans ............................... $22,404 $20,593 $21,803 $ 6,186
Accruing loans which are contractually
past due 90 days or more ...................... 5,331 3,403 1,991 2,611
Restructured loans .............................. 557 622 687 679
------- ------- ------- -------
Total non-performing and restructured loans ... 28,292 24,618 24,481 9,476
Foreclosed real estate .......................... 868 727 845 872
Other foreclosed property ....................... 127 258 217 354
------- ------- ------- -------
Total non-performing and restructured loans and
foreclosed property ......................... $29,287 $25,603 $25,543 $10,702
======= ======= ======= =======
Non-performing and restructured loans
as a percentage of loans, net of unearned income 1.82% 1.58% 1.59% 0.64%
Total non-performing and restructured loans and
foreclosed property as a percentage of total assets 1.30% 1.16% 1.21% 0.54%
</TABLE>
Management classifies commercial and commercial real estate loans as
non-accrual when principal or interest is past due 90 days or more and the loan
is not adequately collateralized and in the process of collection, or when, in
the opinion of management, principal or interest is not likely to be paid in
accordance with the terms of the obligation. Consumer loans are charged off
after 120 days of delinquency unless adequately secured and in the process of
collection. Non-accrual loans are not reclassified as accruing until principal
and interest payments are brought current and future payments appear reasonably
certain. Loans are categorized as restructured if the original interest rate,
repayment terms, or both were modified due to a deterioration in the financial
condition of the borrower.
Seven commercial credit relationships account for $19.7 million, or 88%, of
the company's non-accrual loans at June 30, 1998. The largest of these credits
is the $12.8 million relationship with the coal mining operation mentioned
above. The other six credits consist of $2.0 million to a motel franchisee, $1.7
million to a grocery chain, $1.4 million to a mobile home manufacturer, $0.8
million to a real estate developer, $0.6 million to a tobacco processing
company, and $0.5 million to a trucking company. Of the $2.5 million allowance
for loan losses established in accordance with Statement of Financial Accounting
Standards No. 114, Accounting by Creditors for the Impairment of a Loan, four of
these large non-accrual credits account for $2.4 million. The remaining
non-accrual loan balance consists of various commercial and consumer loans, with
no single borrower representing more than $400,000.
Foreclosed real estate at June 30, 1998, consists of several properties,
with no single property exceeding $350,000.
As of June 30, 1998, the company had $4.8 million of loans which were
not included in the past due non-accrual or restructured categories, but for
which known information about possible credit problems caused management to
have serious doubts as to the ability of the borrowers to comply with the
present loan repayment terms. Based on management's evaluation, including
current market conditions, cash flow generated and recent appraisals, no
significant losses are anticipated at this time in connection
with these loans. These loans are subject to continuing management attention and
are considered in determining the level of the allowance for loan losses.
The allowance represents an amount which, in management's judgment, will be
adequate to absorb probable losses on existing loans. The adequacy of the
allowance for loan losses is determined on an ongoing basis through analysis of
the overall size and quality of the loan portfolio, historical loan loss
experience, loan delinquency trends and current and projected economic
conditions. Additional allocations of the allowance are based on specifically
identified potential loss situations. The potential loss situations are
identified by account officers' evaluations of their own portfolios as well as
by an independent loan review function.
The allowance for loan losses is established through a provision for loan
losses charged to expense. At June 30, 1998, the allowance was $23.7 million, up
from $22.0 million at December 31, 1997, and $21.0 million at June 30, 1997. The
ratio of the allowance for loan losses to total loans (excluding mortgage loans
held for sale) at June 30, 1998, was 1.52%, compared with 1.43% at December 31,
1997, and 1.43% at June 30, 1997. The increase from June 30, 1997 reflects in
part management's review of the growth in the loan portfolio, the continuing
concentrations of credit among the company's largest credit relationships, and
anticipated general economic conditions in the company's markets.
The allowance as a percentage of non-performing loans was 84% at June 30,
1998, as compared to 90% at year-end 1997 and 222% at June 30, 1997, due to the
previously-mentioned coal mining loans, which were first classified as
non-accrual in the second half of 1997.
Management believes that the allowance for loan losses at June 30, 1998, is
adequate to absorb losses inherent in the loan portfolio as of that date. That
determination is based on the best information available to management, but
necessarily involves uncertainties and matters of judgment and, therefore,
cannot be determined with precision and could be susceptible to significant
change in the future. In addition, bank regulatory authorities, as a part of
their periodic examinations of the company's banks, may reach different
conclusions regarding the quality of the loan portfolio and the level of the
allowance, which could result in additional provisions being made in future
periods. Further discussion of the allowance for loan losses is included later
in this review in the Year 2000 Risks section.
Securities Available for Sale
Securities (all classified as available for sale) decreased from $278
million at December 31, 1997 to $260 million at June 30, 1998. A year ago,
securities totaled $252 million. Funds provided by the reduction in securities
in the first half of 1998 were utilized to fund growth in the loan portfolio.
Deposits and Borrowed Funds
Total deposits averaged $1.59 billion in the second quarter of 1998, an
increase of $57 million, or 4%, from the comparable 1997 period. Average
interest-bearing accounts increased $25 million in the second quarter of 1998,
compared to the same period in 1997, while average non-interest-bearing accounts
increased $32 million. The increase in interest-bearing accounts primarily
represents balances of NOW accounts related to a few large corporate customers.
As of June 30, 1998 and 1997, brokered certificates of deposit comprised $125
million and $130 million, respectively, of the company's deposits. These
brokered deposits have various maturities ranging from ten months to over two
years.
Long-term debt totaled $195 million at June 30, 1998 and $141 million at
June 30, 1997. In order to support growth in the loan portfolio, TFB-KY has
outstanding $55 million of notes (included in the long-term debt totals), under
a $250 million senior bank note program. These bank notes bear interest at fixed
rates of 6.48% and 7.13%. Other long-term borrowings principally represent
Federal Home Loan Bank ("FHLB") advances to TFB-KY and TFB-TN (with varying
maturity dates), which are funding residential mortgage and commercial loans.
Long-term debt also includes financing from an unaffiliated commercial bank for
the company's leveraged ESOP. Total ESOP debt was $1.5 million at June 30, 1998,
and $2.2 million at June 30, 1997.
Certain of the above brokered certificates of deposit, bank notes and FHLB
advances have been effectively converted to floating rate instruments through
the use of interest rate swap transactions. Other swap agreements are utilized
to hedge the commercial lending exposure of the company. TFB-KY pays interest at
the prime rate, and receives fixed rates from 8.60% to 9.52% under all swap
agreements. Further discussion of interest rate swaps is included later in this
review in the Asset/Liability Management and Market Risks Section.
Capital Resources and Liquidity
The company's capital ratios at June 30, 1998, December 31, 1997,
and June 30, 1997 (calculated in accordance with regulatory
guidelines) were as follows:
June 30, December 31, June 30,
1998 1997 1997
Tier 1 risk-based capital ... 8.77% 8.48% 8.36%
Regulatory minimum ..... 4.00 4.00 4.00
Well-capitalized minimum 6.00 6.00 6.00
Total risk-based capital .... 11.91 11.71 11.69
Regulatory minimum ..... 8.00 8.00 8.00
Well-capitalized minimum 10.00 10.00 10.00
Leverage ratio .............. 6.99 6.81 6.82
Regulatory minimum ..... 3.00 3.00 3.00
Well-capitalized minimum 5.00 5.00 5.00
The increase in these capital ratios in 1998 is due to the company's
increased earnings. Capital ratios of all of the company's subsidiaries are in
excess of applicable minimum regulatory capital ratio requirements at June 30,
1998.
To maintain a desired level of liquidity, the company has several sources
of funds available. The company primarily relies upon net inflows of cash from
financing activities, supplemented by net inflows of cash from operating
activities, to provide cash used in these investing activities. As is typical of
most banking companies, significant financing activities include issuance of
common stock and long-term debt, deposit gathering, and the use of short-term
borrowing facilities, such as federal funds purchased, repurchase agreements,
FHLB advances and lines of credit. The company's primary investing activities
include purchases of securities and loan originations, offset by maturities,
prepayments and sales of securities, and loan payments.
Asset/Liability Management and Market Risks
Managing interest rate risk is fundamental to the financial services
industry. The company's policies are designed to manage the inherently different
maturity and repricing characteristics of the lending and deposit-acquisition
lines of business to achieve a desired interest-sensitivity position and to
limit exposure to interest rate risk. The maturity and repricing characteristics
of the company's lending and deposit activities create a naturally
asset-sensitive structure. By using a combination of on- and off-balance-sheet
financial instruments, the company manages interest rate sensitivity while
optimizing net interest income within the constraints of prudent capital
adequacy, liquidity needs, the interest rate and economic outlook, market
opportunities and customer requirements.
The company uses an earnings simulation model to monitor and evaluate the
impact of changing interest rates on earnings. The simulation model used by the
company is designed to reflect the dynamics of all interest-earning assets,
interest-bearing liabilities and off-balance-sheet financial instruments,
combining the various factors affecting rate sensitivity into a two-year
earnings outlook. Among the factors the model utilizes are 1) rate-of-change
differentials, such as federal funds rates versus savings account rates; 2)
maturity effects, such as calls on securities; 3) rate barrier effects, such as
caps or floors on loans; 4) changes in balance sheet levels; 5) floating-rate
financial instruments that may be tied or related to prime, Treasury Notes, CD
rates or other rate indices, which do not necessarily move identically as rates
change; 6) leads and lags that occur as rates move away from current levels; and
7) the effects of prepayments on various assets, such as residential mortgages,
mortgage-backed securities and consumer loans.
The model is updated bi-monthly (or more frequently, if necessary) for
multiple interest rate scenarios, projected changes in balance sheet categories
and other relevant assumptions. In developing multiple rate scenarios, an
econometric model is employed to forecast key rates, based on the cyclical
nature and historic volatility of those rates. A stochastic view of net interest
income is derived once probabilities have been assigned to those key rates. By
forecasting a most likely rate environment, the effects on net interest income
of adjusting those rates up or down can reveal the company's approximate
interest rate risk exposure level. Several rate index and yield curve
assumptions are used in the model. As an example, the company's most likely rate
environment as of June 30, 1998, assumed the 3-month Treasury rate at 5.09%
through January, 1999, then falling to 4.58% in June, 1999.
A second interest rate sensitivity tool utilized by the company is the
quantification of market value changes for all assets and liabilities, given an
increase or decrease in interest rates. This approach provides a longer-term
view of interest rate risk, capturing all expected future cash flows. Assets and
liabilities with option characteristics are measured based on numerous interest
rate path valuations using statistical rate simulation techniques.
As of June 30, 1998, management believes the company's balance sheet was in
an asset-sensitive position, as the repricing characteristics of the balance
sheet were such that an increase in interest rates would have a positive effect
on earnings and a decrease in interest rates would have a negative effect on
earnings.
<PAGE>
The following illustrates the effects of an immediate 100- or
200-basis-point shift in market interest rates on 1) fair values of assets and
liabilities as compared to June 30, 1998 fair values, and 2) net interest income
for one year as compared to the most likely rate assumptions used in the
company's model:
<TABLE>
Market Risk Analysis
June 30, 1998 - In thousands Increase (Decrease) in Fair Value
<CAPTION>
-----------------------------------------------------
Decrease in Rates Increase in Rates
------------------------- -------------------------
Carrying Fair 200 100 100 200
Value Value b.p. b.p. b.p. b.p.
Market Risk-Sensitive Assets
<S> <C> <C> <C> <C> <C> <C>
Securities available for sale $260,230 $260,230 $11,354 $5,487 $(5,134) $(9,952)
Mortgage loans held for sale 238,608 239,135 391 196 (193) (387)
Loans, net 1,552,666 1,666,834 51,164 24,317 (21,138) (39,435)
Mortgage servicing rights
and interest rate floor contracts 52,522 54,518 (13,635) (8,357) 3,673 5,256
Interest rate swaps - (197) 5,564 2,807 (2,807) (5,638)
----------------------------------------------------- -------------------------
Total market risk-sensitive assets $2,104,026 $2,220,520 $54,838 $24,450 $(25,599) $(50,156)
% change in fair value of assets 2.47% 1.10% -1.15% -2.26%
Market Risk-Sensitive Liabilities
Transaction deposit accounts $581,543 $590,568 $(695) $(347) $347 $687
Savings accounts 98,303 91,688 (2,411) (1,220) 1,267 2,498
Certificates of deposit 886,864 910,574 (11,959) (5,975) 5,706 11,362
Short-term borrowings 299,327 295,266 (458) (229) 226 452
Long-term debt 194,932 201,378 (7,115) (3,507) 3,402 6,720
----------------------------------------------------- -------------------------
Total market risk-sensitive liabilities $2,060,969 $2,089,474 $(22,638) $(11,278) $10,948 $21,719
----------------------------------------------------- -------------------------
% change in fair value of liabilities -1.08% -0.54% 0.52% 1.04%
</TABLE>
<TABLE>
Dollars in thousands
<CAPTION>
Increase (Decrease)
Most in Interest Income and Expense
-----------------------------------------------------
Likely Decrease in Rates Increase in Rates
------------------------- -------------------------
Rate 200 100 100 200
Scenario b.p. b.p. b.p. b.p.
Projected Interest Income (annualized)
<S> <C> <C> <C> <C> <C>
Securities available for sale $15,130 $(1,974) $(987) $988 $1,975
Mortgage loans held for sale 14,193 (3,623) (1,812) 1,811 3,622
Loans, net 144,836 (15,577) (7,161) 8,130 15,301
Interest rate swaps 935 3,398 1,478 (1,823) (3,307)
--------------------------------------- --------------------
Total interest income $175,094 $(17,776) $(8,482) $9,106 $17,591
% change in interest income -10.15% -4.84% 5.20% 10.05%
Projected Interest Expense (annualized)
NOW and money market deposit accounts $11,341 $(2,594) $(1,254) $316 $622
Savings accounts 2,427 (937) (483) 330 659
Certificates of deposit 49,654 (8,569) (4,098) 4,386 8,489
Short-term borrowings 14,031 (5,094) (2,546) 2,506 5,008
Long-term debt 12,561 (439) (218) 221 439
--------------------------------------- --------------------
Total interest expense $90,014 $(17,633) $(8,599) $7,759 $15,217
--------------------------------------- --------------------
% change in interest expense -19.59% -9.55% 8.62% 16.91%
Net interest income $85,080 $(143) $117 $1,347 $2,374
% change in net interest income -0.17% 0.14% 1.58% 2.79%
</TABLE>
It should be noted that some of the assumptions made in the use of the
simulation model will inevitably not materialize and unanticipated events and
circumstances will occur; in addition, the simulation model does not take into
account any future actions which could be undertaken to reduce an adverse impact
if there were a change in interest rate expectations or in the actual level of
interest rates.
Derivative financial instruments can be a cost- and capital-efficient
method of modifying the repricing or maturity characteristics of
on-balance-sheet assets and liabilities--a necessary component of the company's
strategy for managing its overall interest rate risk. Off-balance-sheet
derivative transactions used for interest rate sensitivity management could
include interest rate swaps, forwards, floors, futures and options with indices
that directly relate to the pricing of specific assets and liabilities of the
company.
Off-balance-sheet derivatives do not expose the company to credit risk
equal to the notional amount, although the company is exposed to credit risk
equal to the aggregate of the positive fair values of the swaps, plus any
accrued interest receivable due from all counterparties. Fair values are
determined by discounting to present value the future cash flows which would
result from the difference between current market rates and the actual swap
rates.
To assist in achieving a desired level of interest rate sensitivity, the
company has entered into off-balance-sheet interest rate swap transactions which
partially neutralize the asset sensitive position which is inherent in the
balance sheet. The company pays a variable interest rate on each swap and
receives a fixed rate. In a higher interest-rate environment, the increased
contribution to net interest income from on-balance-sheet assets will
substantially offset any negative impact on net interest income from interest
rate swap transactions. Conversely, if interest rates decline, the swaps will
mitigate the company's exposure to reduced net interest income. Interest rate
swap transactions as of June 30, 1998, are as follows:
<TABLE>
Dollars in thousands
<CAPTION>
Notional Fixed Rate Floating Rate
Amount (Receiving) (Paying) Maturity
---------------- ---------------- ---------------------
<S> <C> <C> <C> <C>
30,000 8.60% 8.50% (Prime) October, 1998
25,000 8.78% 8.50% (Prime) November, 1999
25,000 8.74% 8.50% (Prime) December, 1999
40,000 8.81% 8.50% (Prime) December, 1999
50,000 9.52% 8.50% (Prime) April, 2000
50,000 8.87% 8.50% (Prime) August, 2000
40,000 8.80% 8.50% (Prime) November, 2000
40,000 8.61% 8.50% (Prime) February, 2001
--------
Total / weighted average $300,000 8.88% 8.50% April, 2000
========
</TABLE>
As shown in the table, $30 million of these interest rate swaps will mature
within twelve months. As these interest rate swaps mature, management evaluates
whether new interest rate swap transactions are appropriate, given the company's
interest rate sensitivity position at that time.
To mitigate its prepayment risk related to MSR's, the company purchases
from time to time interest rate "floor" contracts that provide for the company
to receive interest on the notional amount of the contract to the extent that
the interest rate on ten-year constant maturity U.S. Treasury Notes falls below
the contract rate. The cost of these contracts is included in with the MSR asset
in the consolidated balance sheet. Fair values can be expected to vary inversely
with market expectations for intermediate-term interest rates.
The company minimizes the credit risk in all off-balance-sheet derivative
instruments by dealing only with high quality counterparties (i.e., those which
have credit ratings of investment grade or better from one of the major rating
agencies) and each transaction is specifically approved for applicable credit
exposure. Further, the company's policy is to require all transactions be
governed by an International Swap Dealers Association Master Agreement and be
subject to bilateral collateral arrangements.
The company requires all off-balance-sheet transactions be employed solely
with respect to asset/liability management or for hedging specific transactions
or positions, rather than for speculative trading activity. Management believes
there is minimal risk that the derivatives used for rate sensitivity management
will have any significant unintended effect on the company's financial condition
or results of operations.
Year 2000 Compliance
The company is exposed to potential future losses, including litigation,
due to business interruption or errors, which could result if any of its
computer systems are not modified to ensure that dates beginning in January,
2000 are not misinterpreted by the system as January, 1900. This eventuality is
commonly referred to as the Year 2000 Problem ("Y2K"). A number of computer
systems which are affected by Y2K are utilized by the company to operate its
day-to-day business. Most of these systems use software developed by and
licensed from third party software vendors. Some of these software applications
have been customized by the company, while others have been developed
internally.
Management has established a task force to identify all instances where the
company is not currently Y2K compliant, and to take actions designed to bring
those systems into compliance before the end of 1999. The assessment phase of
this project has been completed, whereby the company has identified systems that
need modification, and the correction phase of the project has begun.
The company has been actively managing all of its third party software
vendors to obtain software corrections and warranty commitments. Management
believes that those software vendors which have been identified by the task
force as essential to the company's operations are currently on schedule to meet
the company's Y2K timetable. The company is acting upon the belief and
understanding that all federal agencies are actively managing the Y2K problems
which are inherent in the global banking and payments systems.
The correction phase was expected to be completed by the end of 1998, with
all of 1999 dedicated to the testing phase. Total cost to the company of the
correction and testing phases was projected to be approximately $500 thousand.
In light of the pending merger with Star Banc, however, the company has modified
its Y2K schedule, anticipating that its core systems will be replaced by Star
Banc's systems after the merger.
The company's credit customers are also subject to potential losses as a
result of Y2K exposure in their own computer systems as well as the computer
systems of their suppliers and customers. The company is working with those
customers that the company believes may be significantly affected to assess each
customer's Y2K exposure and the extent to which the customer has addressed the
problem. Any exposure which, in the opinion of management, is not adequately
addressed will be taken into account in assessing the loss potential, if any,
associated with that credit relationship.
- --------------------------------------------------------------------------------
This report contains forward-looking statements under the Private Securities
Litigation Reform Act of 1995 that involve risks and
uncertainties. Although the company believes that the forward-looking
statements are based upon reasonable assumptions, there can be no assurance
that the forward-looking statements will prove to be accurate. Factors that
could cause actual results to differ from the results anticipated in the
forward-looking statements include, but are not limited to: economic
conditions (both generally and more specifically in the markets in which
the company and its banks operate); competition for the company's
customers from other providers of financial services; government legislation and
regulation (which changes from time to time and
over which the company has no control); changes in interest rates (both
generally and more specifically mortgage interest rates);
material unforeseen changes in the liquidity, results of operations, or
financial condition of the company's customers; material unforeseen
complications related to addressing the Year 2000 Problem experienced by the
company, its suppliers, customers and governmental agencies; and other risks
detailed in the company's filings with the Securities and Exchange Commission,
all of which are difficult to predict and many of which are beyond the
control of the company. The company undertakes no obligation to
republish forward-looking statements to reflect events or circumstances after
the date hereof or to reflect the occurrence of unanticipated events.
- --------------------------------------------------------------------------------
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information for this item is incorporated by reference to the
Asset/Liability Management and Market Risks section of Item 2., Management's
Discussion and Analysis of Financial Condition and Results of Operations.
<PAGE>
Part II - Other Information
Item 1. Legal Proceedings
In the ordinary course of operations, the company and the banks are
defendants in various legal proceedings. In the opinion of management, there is
no proceeding pending or, to the knowledge of management, threatened, in which
an adverse decision could result in a material adverse change in the
consolidated financial condition or results of operations of the company.
Item 4. Submission of Matters to a Vote of Security Holders
A Special Meeting of Stockholders was held July 20, 1998 to vote on a
proposal to approve and adopt the Agreement and Plan of Merger, dated April 9,
1998, by and between Star Banc Corporation ("Star Banc") and the company,
pursuant to which the company will be merged with and into Star Banc. The total
number of shares of common stock outstanding as of June 14, 1998, the record
date of the Special Meeting, was 11,321,317, of which 8,667,236 shares were
represented at the meeting. The proposal was adopted by a vote of 8,586,816 in
favor of the proposal; 68,771 against; with 11,649 abstaining.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The exhibits listed on the Exhibit Index on page 21 of this Form 10-Q are
filed as a part of this report.
(b) Reports on Form 8-K
On April 15, 1998, the company filed a Form 8-K, Item 5. Other Events,
reporting that on April 9, 1998, the company entered into an Agreement
and Plan of Merger with Star Banc Corporation, pursuant to which the
company will merge with and into Star Banc, subject to shareholder and
regulatory approvals, and certain other conditions.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Trans Financial, Inc.
(Registrant)
Principal Executive Officer:
Date: August 14, 1998 /s/ Vince A. Berta
Vince A. Berta
Chairman, President and
Chief Executive Officer
Principal Financial Officer:
Date: August 14, 1998 /s/ Edward R. Matthews
Edward R. Matthews
Executive Vice President
and Chief Financial Officer
<PAGE>
Exhibits
Sequentially
Numbered Pages
2.1 Agreement and Plan of Merger with Star Banc Corporation dated April 9,
1998 is incorporated by reference to Exhibit 2.1 of the Registrant's
report on Form 10-Q for the three months ended March 31, 1998.
2.2 Stock Option Agreement with Star Banc Corporation dated April 9, 1998 is
incorporated by reference to Exhibit 2.2 of the Registrant's report on
Form 10-Q for the three months ended March 31, 1998.
10 Trans Financial, Inc. 1998 Stock Incentive Plan is incorporated by
reference to Exhibit 10 of the Registrant's report on Form 10 Q for the
three months ended March 31, 1998.*
11 Statement Regarding Computation of Per Share Earnings... ..............23
27 Financial Data Schedule (for SEC use only)
* Denotes a management contract or compensatory plan or arrangement of the
registrant required to be filed as an exhibit pursuant to Item
601(10)(iii) of Regulation S-K.
<PAGE>
<TABLE>
Exhibit 11.
Statement Regarding Computation of Per Share Earnings
In thousands, except per share amounts
<CAPTION>
2nd Qtr. Six Months
For the periods ended June 30 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Average common shares outstanding (basic) ...... 11,738 11,430 11,668 11,415
Common stock equivalents ....................... 364 267 324 258
------- ------ ------ -------
Average shares and share equivalents (diluted) 12,102 11,697 11,992 11,673
Net income (loss) ................................ $ 7,030 $ 5,862 $13,604 $11,410
Diluted earnings per share ....................... $ 0.58 $ 0.50 $ 1.13 $ 0.98
Basic earnings per share ......................... $ 0.60 $ 0.51 $ 1.17 $ 1.00
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> APR-01-1998 JAN-01-1998
<PERIOD-END> JUN-30-1998 JUN-30-1998
<CASH> 85,884 85,884
<INT-BEARING-DEPOSITS> 99 99
<FED-FUNDS-SOLD> 0 0
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 260,230 260,230
<INVESTMENTS-CARRYING> 0 0
<INVESTMENTS-MARKET> 0 0
<LOANS> 1,791,274 1,791,274
<ALLOWANCE> 23,677 23,677
<TOTAL-ASSETS> 2,254,739 2,254,739
<DEPOSITS> 1,566,715 1,566,715
<SHORT-TERM> 299,327 299,327
<LIABILITIES-OTHER> 26,641 26,641
<LONG-TERM> 194,932 194,932
0 0
0 0
<COMMON> 22,078 22,078
<OTHER-SE> 145,046 145,046
<TOTAL-LIABILITIES-AND-EQUITY> 2,254,739 2,254,739
<INTEREST-LOAN> 40,276 78,530
<INTEREST-INVEST> 3,691 7,508
<INTEREST-OTHER> 2 9
<INTEREST-TOTAL> 43,969 86,047
<INTEREST-DEPOSIT> 16,305 32,771
<INTEREST-EXPENSE> 22,314 44,062
<INTEREST-INCOME-NET> 21,655 41,985
<LOAN-LOSSES> 2,300 4,520
<SECURITIES-GAINS> (2) 148
<EXPENSE-OTHER> 19,608 38,103
<INCOME-PRETAX> 10,619 20,499
<INCOME-PRE-EXTRAORDINARY> 7,030 13,604
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 7,030 13,604
<EPS-PRIMARY> .60 1.17
<EPS-DILUTED> .58 1.13
<YIELD-ACTUAL> 4.37 4.33
<LOANS-NON> 22,404 22,404
<LOANS-PAST> 5,331 5,331
<LOANS-TROUBLED> 557 557
<LOANS-PROBLEM> 4,793 4,793
<ALLOWANCE-OPEN> 22,777 22,017
<CHARGE-OFFS> 1,743 3,766
<RECOVERIES> 343 906
<ALLOWANCE-CLOSE> 23,677 23,677
<ALLOWANCE-DOMESTIC> 23,677 23,677
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
