U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD
ENDED September 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________ TO __________
Commission file number - 33-53596
EXCHANGE BANCSHARES, INC.
________________________
(Exact name of small business issuer as specified in its charter)
OHIO 34-1721453
_______________________________ ________________
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
237 Main Street
P.O.Box 177, Luckey, Ohio 43443
_________________________________ _______
(Address of principal executive offices) (Zip Code)
(419) 833-3401
________________
(Issuer's telephone number)
N/A
_______
(Former name, former address and former fiscal year, if
changed since last report)
Check whether the issuer (1) 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 . . .
___
As of October 30, 1998, 517,963 shares of Common Stock of the Registrant were
outstanding. There were no preferred shares outstanding.
<PAGE> EXCHANGE BANCSHARES, INC.
LUCKEY, OHIO
FORM 10-QSB
INDEX
==========================================================================
Page Number
PART I FINANCIAL INFORMATION
Item. 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets -- 3
September 30, 1998, and December 31, 1997
Condensed consolidated statements of income
and comprehensive income -- Three and nine months 4
ended September 30, 1998 and 1997
Condensed consolidated statements of cash flow-- 5
Nine months ended September 30, 1998 and 1997
Notes to condensed consolidated financial 6
statements -- September 30, 1998, 1997 and December 31, 1997
Item 2. Management's Discussion and Analysis of Financial 12
Condition and Results of Operations
PART II OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
<PAGE>
<TABLE>
<CAPTION>
EXCHANGE BANCSHARES, INC.
Luckey, Ohio
CONSOLIDATED BALANCE SHEETS
================================================================================
(Dollars in thousands)
(Unaudited)
September 30, December 31,
1998 1997
____ ____
<S> <C> <C>
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions $ 2,900 $ 2,224
Interest-bearing demand deposits in banks 25 42
Federal funds sold 6,511 3,926
__________ _________
Total cash and cash equivalents 9,436 6,192
Investment securities:
Securities being held-to-maturity 16,516 2,406
(Fair value of $1,377 in 1998 and $2,405 in 1997)
Securities available-for-sale, at fair value 1,243 16,362
__________ __________
Total investment securities 17,759 18,768
Loans 62,137 46,872
Allowance for loan losses (1,513) (624)
__________ __________
Net loans 60,624 46,248
Premises and equipment, net 3,903 844
Accrued interest receivable 834 625
Federal income taxes - current 7 0
Deferred income taxes 288 10
Goodwill 39 0
Other assets 248 108
___________ __________
Total assets $ 93,138 $ 72,795
=========== ==========
Liabilities
Deposits
Non-interest-bearing $ 9,080 $ 6,371
Now & MMDA accounts 14,611 9,756
Savings passbook accounts 15,929 14,591
Time deposits of $100,000 or more 7,823 5,091
Other interest-bearing 36,290 28,119
___________ __________
Total deposits 83,733 63,928
Borrowed funds 175 198
Accrued interest payable 176 149
Accrued federal income taxes 0 28
Other liabilities 105 49
___________ __________
Total liabilities 84,189 64,352
----------- ----------
Shareholders' Equity
Preferred shares ($25.00 par value) 750 shares
authorized, no shares issued 0 0
Common shares ($ 5.00 par value) 750,000 shares authorized;
524,510 shares issued 2,622 2,622
Additional paid-in capital 3,758 3,745
Retained earnings 2,536 2,127
Treasury stock at cost, 6,547 and 8,961 shares (93) (126)
Accumulated other comprehensive income 126 75
___________ __________
Total shareholders' equity 8,949 8,443
___________ __________
Total liabilities and shareholders' equity $ 93,138 $ 72,795
=========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
EXCHANGE BANCSHARES, INC.
Luckey, Ohio
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Dollars in thousands, except per share data)
(Unaudited) (Unaudited)
3 Months Ended 9 Months Ended
September 30, September 30,
1998 1997 1998 1997
____ ____ ____ ____
<S> <C> <C> <C> <C>
Interest and dividend income
Interest and fees on loans $1,456 $1,050 $3,719 $3,065
Interest on investment securities:
Taxable 252 280 740 857
Exempt from federal income tax 9 16 30 49
Dividend income 12 3 20 8
Interest on federal funds sold 90 55 249 119
Interest on deposits with banks 0 0 1 0
_____ _____ _____ _____
Total interest income 1,819 1,404 4,759 4,098
Interest expense
Interest on interest-bearing checking accounts 114 85 259 228
Interest on savings deposits 119 97 323 292
Interest on time deposit 601 430 1,531 1,220
Interest on FHLB advances 1 3 8 4
Interest on federal funds purchased and securities sold
under agreement 0 0 1 0
_____ _____ _____ _____
Total interest expense 835 615 2,122 1,744
_____ _____ _____ _____
Net interest income 984 789 2,637 2,354
Provision for loan losses 0 0 0 0
_____ _____ _____ _____
Net interest income after provision for loan loss 984 789 2,637 2,354
Non-interest income
Service charges on deposit accounts 81 49 211 145
Gain (loss) on sale of other assets 0 (1) 0 1
Other income 12 32 46 93
_____ _____ _____ _____
Total noninterest income 93 80 257 239
Non-interest expense
Salaries and employee benefits 359 268 941 811
Net occupancy expense 73 37 152 110
Equipment expense 72 38 160 108
FDIC deposit insurance assessment 4 2 8 5
State and other taxes 29 21 92 79
Goodwill amortization 1 0 1 0
Other expense 363 169 846 565
_____ _____ _____ _____
Total non-interest expense 901 535 2,200 1,678
_____ _____ _____ _____
Income before income taxes 176 334 694 915
Federal income tax expense 32 105 187 283
_____ _____ _____ _____
Net income 144 229 507 632
Other comprehensive income 54 15 51 12
_____ _____ _____ _____
Total comprehensive income $198 $244 $558 $644
===== ===== ===== =====
Per common share data:
Basic net income $0.23 $0.45 $0.98 $1.23
Diluted net income 0.23 0.45 0.98 1.23
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
<TABLE>
<CAPTION>
EXCHANGE BANCSHARES, INC.
Luckey, Ohio
CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
(Dollars in thousands)
(Unaudited) (Unaudited)
9 Months Ended 9 Months Ended
September 30, September 30,
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 507 $ 632
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 140 90
Provision for loan losses 0 0
Deferred income taxes (305) (3)
Net loss on sale of other assets 0 (1)
Amortization/Accretion - net 61 82
Changes in operating assets and liabilities:
Increase in accrued income receivable (209) (147)
(Increase) decrease in other assets (178) 22
Increase in accrued interest payable 27 24
Increase in other liabilities 56 31
Decrease in taxes payable (35) (35)
_____ _____
Total adjustments (443) 63
_____ _____
Net cash provided by operations 64 695
Cash flows from investing activities:
Purchase of held-to-maturity securities 0 0
Purchase of available-for-sale securities (3,772) (4,241)
Payments on maturities on held-to-maturity securities 1,142 541
Proceeds from maturities on available-for-sale securities 3,655 4,500
Net increase in loans (14,661) (3,822)
Capital purchases (3,199) (54)
Proceeds from sale of other real estate 0 22
Proceeds from sale of loans 286 0
Proceeds from sale of other assets 0 1
_____ _____
Net cash used in investing activities (16,549) (3,053)
Cash flows from financing activities:
Net increase in deposits 19,804 3,803
Increase (decrease) in short-term borrowings (23) 199
Sale of treasury stock 46 22
Purchase of treasury stock 0 (43)
Dividends paid (98) (93)
______ _____
Net cash provided by financing activities 19,729 3,888
______ _____
Net increase (decrease) in cash and cash equivalents 3,244 1,530
Cash and cash equivalents at beginning of period 6,192 4,694
_____ _____
Cash and cash equivalents at end of period $9,436 $6,224
===== =====
Supplemental information:
Cash paid for:
Interest $2,095 $1,721
Net income taxes 527 321
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
<PAGE>
EXCHANGE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998, 1997 and December 31, 1997
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
In the opinion of Management, the accompanying unaudited consolidated
financial statements contain all adjustments necessary for a fair presentation
of Exchange Bancshares, Inc.'s ("Company") financial condition as of September
30, 1998, and December 31, 1997, and the results of operations for the three
and nine months ended September 30, 1998 and 1997, and the cash flows for the
nine months ended September 30, 1998 and 1997. Certain information and note
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to
the rules and regulations of the Securities and Exchange Commission. It is
suggested that these consolidated financial statements be read in conjunction
with the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-KSB. The results of operations for the
three and nine months ended September 30, 1998, are not necessarily indicative
of the results which may be expected for the entire fiscal year.
NOTE 2. ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is summarized as follows:
(Dollars in thousands)
Nine months ended Year ended
September 30, December 31,
1998 1997
Balance beginning of period $ 624 $508
Balance acquired bank 962 0
Provision for loan losses 0 0
Charge-offs (86) (69)
Recoveries 13 185
_____ ____
Balance, end of period $1,513 $624
===== ===
NOTE 3. ADVANCES FROM FEDERAL HOME LOAN BANK
Borrowings at September 30, 1998, consisted of one long-term advance totaling
$175,000 and from the Federal Home Loan Bank of Cincinnati ("FHLB"). The
advance is collateralized by all shares of FHLB stock owned by The Exchange
Bank, Luckey, Ohio, ("Bank") and by the Bank's qualified mortgage loan
portfolio.
<PAGE>
Scheduled maturity of the advance from the FHLB is as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
At September 30, 1998 At December 31, 1997
Range of Weighted- Range of Weighted
interest average interest average
Amount rates interest rate Amount rates interest rate
______ _____ _____________ ______ _____ _____________
<S> <C> <C> <C> <C> <C> <C>
After five years $175 6.85% 6.85% $198 6.85% 6.85%
</TABLE>
The aggregate minimum future annual principal payments on borrowings are
$3,000 in 1998, $5,000 in 1999, $6,000 in 2000, $6,000 in 2001, and $155,000
after 2001.
NOTE 4. REGULATORY CAPITAL
The following table illustrates the compliance by the Bank with currently
applicable regulatory capital requirements at September 30, 1998.
<TABLE>
<CAPTION>
(Dollars in thousands)
Categorized as "Well
Capitalized" Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
______ _________________ _________________
Amount Ratio Amount Ratio Amount Ratio
______ _____ ______ _____ ______ _____
<S> <C> <C> <C> <C> <C> <C>
Total Risk-based Capital
(to Risk-Weighted Assets) $9,384 16.18% $4,640 8.0% $5,799 10.0%
Tier I Capital
(to Risk-Weighted Assets) 8,649 14.91% N/A N/A 3,480 6.0%
Tier I Capital
(to Total Assets) 8,649 9.85% 3,311 4.0% 4,549 5.0%
Tier I Capital
(to Total Assets) 8,649 9.85% 2,729 3.0% N/A N/A
</TABLE>
NOTE 5. EARNINGS PER SHARE
Earnings per share ("EPS") is computed in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which
was adopted by the Company as of December 31, 1997. Common stock equivalents
would include shares held by the company's Employee Stock Ownership Plan
("ESOP") that are committed
<PAGE>
for release, shares awarded but not released under the company's Recognition
Plan ("RRP"), and stock options granted under the company's Stock Option Plan
("SOP"). Currently the Company has no such plans in existence.
Following is a reconciliation of the numerators and denominators of the basic
and diluted EPS calculations.
For the Quarter Ended September 30, 1998
____________________________________________
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income available to
common shareholders $144,197 517,963 $0.28
Effect of dilutive securities:
None 0 0 0
________ _______ _____
Diluted EPS
Income available to
common shareholders +
assumed conversions $144,197 517,963 $0.28
======== ======= =====
For the Quarter Ended September 30, 1997
__________________________________________
Income Shares Per Share
(Numerator) (Denominator) Amount
Basic EPS
Income available to
common shareholders $229,572 513,654 $0.45
Effect of dilutive securities:
None 0 0 0
________ _______ _____
Diluted EPS
Income available to
common shareholders +
assumed conversions 229,572 513,654 $0.45
======= ======= =====
For the Nine Months Ended September 30, 1998
____________________________________________
Income Shares Per Share
(Numerator) (Denominator) Amount
___________ ____________ ______
Basic EPS
Income available to
common shareholders $507,069 515,854 $0.98
Effect of dilutive securities:
None 0 0 0
________ _______ _____
Diluted EPS
Income available to
common shareholders +
assumed conversions $507,069 515,854 $0.98
======== ======= =====
<PAGE>
For the Nine Months Ended September 30, 1997
____________________________________________
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Income available to
common shareholders $632,290 513,274 $1.23
Effect of dilutive securities:
None 0 0 0
-------- -------- ------
Diluted EPS
Income available to
common shareholders +
assumed conversions 632,290 513,274 $1.23
======== ======= =====
NOTE 6. COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, "Reporting Comprehensive Income", effective
January 1, 1998, which establishes standards for reporting comprehensive
income and its components (revenues, expenses, gains and losses). Components
of comprehensive income are net income and all other non-owner changes in
equity. SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement
of financial position. Reclassification of financial statements for earlier
periods provided for comparative purposes is required.
The Company has chosen to disclose comprehensive income. Components of
comprehensive income are displayed net of income taxes. The following table
sets forth the related tax effects allocated to each element of comprehensive
income for the three and six months ended September 30, 1998 and 1997:
(Dollars in thousands)
Three months ended September 30, 1998
____________________________________
Tax
Before-Tax (Expense) Net-of-Tax
Amount or Benefit Amount
------ ---------- ------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during period $85 $(31) $54
Less: reclassification adjustment
for (gains) losses realized in
net income 0 0 0
-- -- --
Net unrealized gains (losses) 85 (31) 54
-- -- --
Other comprehensive income $85 $(31) $54
=== ===== ===
<PAGE>
(Dollars in thousands)
Three months ended September 30, 1997
_____________________________________
Tax
Before-Tax (Expense) Net-of-Tax
Amount or Benefit Amount
------ ---------- ------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during period $22 $(7) $15
Less: reclassification adjustment
for (gains) losses realized in
net income 0 0 0
-- -- --
Net unrealized gains (losses) 22 (7) 15
-- -- --
Other comprehensive income $22 $(7) $15
=== ==== ===
(Dollars in thousands)
Nine months ended September 30, 1998
______________________________________
Before-Tax (Expense) Net-of-Tax
Amount or benefit Amount
------ ---------- ------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during period $78 $(27) $51
Less: reclassification adjustment
for (gains) losses realized in
net income 0 0 0
-- -- --
Net unrealized gains (losses) 78 (27) 51
-- -- --
Other comprehensive income $78 $(27) $51
== == ==
(Dollars in thousands)
Nine months ended September 30, 1997
Tax
Before-Tax (Expense) Net-of-Tax
Amount or Benefit Amount
------ ---------- ------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during period $19 $(7) $12
Less: reclassification adjustment
for (gains) losses realized in
net income 0 0 0
-- -- --
Net unrealized gains (losses) 19 (7) 12
-- -- --
Other comprehensive income $19 $(7) $12
== == ==
<PAGE>
The following table sets forth the components of accumulated other
comprehensive income for the three and nine months ended September 30, 1998
and 1997:
<TABLE>
<CAPTION>
(Dollars in thousands)
Three months ended Nine months ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Beginning balance $72 $45 $75 $60
Unrealized gains (losses) on securities, net 54 15 51 0
-- -- -- --
Ending balance $126 $60 $126 $60
==== === ==== ===
</TABLE>
NOTE 7. RECLASSIFICATIONS
Certain amounts in the prior period's financial statements have been
reclassified to be consistent with the current period's presentation. The
reclassifications have no effect on net income.
<PAGE>
EXCHANGE BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
=============================================================================
Safe Harbor Clause
This report contains certain "forward-looking statements." The Company
desires to take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 and is including this statement for
the express purpose of availing itself of the protection of such safe harbor
with respect to all such forward-looking statements. These forward-looking
statements, which are included in Management's Discussion and Analysis,
describe future plans or strategies and include the Company's expectations of
future financial results. The words "believe," "expect," "anticipate,"
"estimate," "project," and similar expressions identify forward-looking
statements. The Company's ability to predict results or the effect of future
plans or strategies is inherently uncertain. Factors which could affect
actual results include interest rate trends, the general economic climate in
the Company's market area and the country as a whole, loan delinquency rates,
and changes in federal and state regulations. These factors should be
considered in evaluating the forward-looking statements, and undue reliance
should not be placed on such statements.
General
The Company is a bank holding company whose activities are primarily
limited to holding the stock of The Exchange Bank, Luckey, Ohio, ("Bank").
The Bank conducts a general banking business in northwest Ohio which consists
of attracting deposits from the general public and applying those funds to the
origination of loans for residential, consumer and non-residential purposes.
The Bank's profitability is significantly dependent on net interest income
which is the difference between interest income generated from
interest-earning assets (i.e., loans and investments) and the interest expense
paid on interest-bearing liabilities (i.e., customer deposits and borrowed
funds). Net interest income is affected by the relative amount of
interest-earning assets and interest-bearing liabilities and interest received
or paid on these balances. The level of interest rates paid or rece of
management control.
Earnings per common share were computed by dividing net income by the
weighted-average number of shares outstanding for the three- and nine-month
periods ended September 30, 1998.
The consolidated financial information presented herein has been prepared
in accordance with generally accepted accounting principles ("GAAP") and
general accounting practices within the financial services industry. In
preparing consolidated financial statements in accordance with GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues
and expenses during the reporting period. Actual results could differ from
such estimates.
The Company is subject to regulation by the Board of Governors of the
Federal Reserve System which limits the activities in which the Company and
the Bank may engage. The Bank is supervised by the State of Ohio, Division of
Financial Institutions and its deposits are insured up to applicable limits
under the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance
Corporation ("FDIC"). The Bank is a member of the Federal Reserve System and
is subject to its supervision. The Company and the Bank must file with the
U.S. Securities and Exchange Commission, the Federal Reserve Board and Ohio
Division of Financial Institutions the prescribed periodic reports containing
full and accurate statements of its affairs.
<PAGE>
The Bank conducts its business through its five offices located in Wood
and Lucas Counties, Ohio. The primary market area of the Bank is Wood, Lucas
and contiguous counties in northwest Ohio.
Recently Issued Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 redefines how operating segments are determined
and requires disclosure of certain financial and descriptive information about
the Company's operating segments. This statement supercedes SFAS No. 14,
"Financial Reporting for Segments of Business Enterprises." The new standard
becomes effective for years beginning after December 15, 1997, and requires
that comparative information from earlier periods be restated to conform to
the requirements of this standard. The adoption of this statement is not
material to the Company.
Acquisition or Disposition of Assets
On June 11, 1998, the Company entered into a definitive agreement with
Towne Bancorp, Inc., an Ohio corporation located in Perrysburg, Ohio ("Towne
Bancorp"), and Towne Bank, a wholly-owned subsidiary of Towne Bancorp,
pursuant to which the Company agreed to purchase 1,000,000 shares of original
issue common stock of Towne Bank for an aggregated purchase price of
$2,000,000 ("Agreement"). On June 19, 1998, the parties entered into a Merger
Agreement whereby Towne Bank would merge with and into The Exchange Bank, the
wholly-owned subsidiary bank of the Company, with The Exchange Bank being the
surviving bank in the merger ("Merger"). Cash consideration for the Merger
was paid to Towne Bancorp in exchange for the remaining common stock of Towne
Bank held by Towne Bancorp. The cash consideration paid to Towne Bancorp
pursuant to the Merger Agreement consisted of $1.5 million to be adjusted
upward or downward on a dollar for dollar basis based upon the amount of
capital in Towne Bank's capital account that was greater than or less than
$1,000,000 at the Closing of the transaction, with a minimum purchase price of
$1,000,000. The actual cash consideration paid to Towne Bancorp at the
Closing was $1,100,560 of which 25% was held back by the Company in an escrow
account for a period of six months from Closing against which the Company may
collect for any breaches of the representations, warranties and covenants
given by Towne Bancorp and Towne Bank in the Agreement. The transactions
contemplated by both the Agreement and by the Merger were consummated on June
19, 1998.
Concurrently, on June 18, 1998, the Bank purchased the two parcels of
real estate that contained the main office and the one branch of Towne Bank in
Perrysburg and Sylvania, Ohio, respectively. Exchange Bancshares, Inc. and
Ms. Carol Haas entered into a real estate purchase agreement on May 19, 1998,
whereby the Company or its subsidiary would purchase the two parcels for
$2,550,000, contingent upon the consummation of the transactions contemplated
by the Agreement and the Merger Agreement. The purchase was closed into
escrow on June 18, 1998, and the funds were released on June 19, 1998 upon the
consummation of the Agreement and Merger Agreement.
The Exchange Bank is an Ohio state-chartered bank which, prior to the
transaction described herein, operated from its main office in Luckey, Ohio
and through two branches located in Holland and Walbridge, Ohio.
Year 2000 Readiness
As with other organizations, the data processing programs used by the
Company were originally designed to recognize calendar years by their last two
digits. Calculations performed using the truncated fields may not work
properly with dates beyond 1999. Correct processing of date orientated
information is critical to the operation of all financial institutions.
Failure of these processes could severely hinder the ability to continue
operations and provide customer service. Because of the critical nature of
the issue, the Company established a committee early in 1997 to address "Year
2000" issues. Data processing for the Company is provided by a third party
service bureau. The service bureau has stated that all their processing is or
will be Year 2000 ready. The Company's subsidiary has been selected to be a
"proxy" bank and will be one of the user institutions where the service bureau
will be testing applications in December 1998.
<PAGE>
The federal regulatory agencies that regulate the Company and Bank have
instituted mandatory interagency guidelines establishing Year 2000 standards
for safety and soundness in order to ensure Year 2000 compliance by financial
institutions. The federal banking regulatory agencies are overseeing this
effort and are examining financial institutions periodically to track their
Year 2000 complicance progress. The Company and Bank are working to satisfy the
proscribed guidelines but there can be no assurance that all interim milestones
will be met. However, management believes that the Company and Bank will be
substantially compliant with Year 2000 guidelines.
Critical data processing applications, in addition to those provided by
the service bureau, have been identified. These include applications such as
electronic processing through the Federal Reserve Bank and ATM processing.
Testing procedures for these applications are in the process of development.
Contingency plans are also being developed by each operating department. The
contingency plans address actions to be taken to continue operations in the
event of system failure due to areas that cannot be tested in advance, such as
power and telephone service, which are vital to business continuation.
All personal computers ("PCs") and related software throughout the
Company have been inventoried and tested for Year 2000 capabilities. The
Company is using two testing methods for PC certification of Year 2000
compatibility. PCs must pass both tests to be considered ready for Year
2000. Those PCs identified as non-Year 2000 compatible will be modified or
replaced . The Company believes that the Year 2000 issue will not pose
significant operational problems and is not anticipated to be material to its
financial position or results of operation in any given year. As of September
30, 1998, the Company estimates that total Year 2000 implementation costs will
not exceed $110,000 and are expected to be expensed over the next 15 months,
impacting fiscal years ending December 31, 1998 and 1999. This estimate is
based on information available at September 30, 1998, and may be revised as
additional information and actual costs become available.
The following discussion under the captions "Changes in Financial
Condition" and "Results of Operations", make reference to the acquisition of
the "bank" or the "two office locations" which have had a significant effect
on the Company's operations during the second and third quarters of fiscal
1998. The following discussion, i.e. comparisons and comments, are intended
to assist the reader in understanding the operating results of the Company for
the periods presented.
Changes in Financial Condition
At September 30, 1998, the consolidated assets of the Company totaled
$93.1 million, an increase of $20.3 million, or 27.95%, from $72.8 million at
December 31, 1997. The acquisition and merger of Towne Bank accounted for
approximately $17.0 million of the increase. The remainder of the asset
increase was in the loan portfolio which was supported by an increase of
approximately $4.1 increase in deposits.
Net loans receivable increased by $14.4 million, or 31.08%, to $60.6
million at September 30, 1998, compared to $46.2 million at December 31,
1997. The increase was primarily as a result of the previously mentioned bank
acquisition, $11.8 million, and in the real estate and commercial loan
portfolios where the new loan demand continued to exceed loan repayments.
Investment securities decreased a net of $1.0 million, or 5.38%, from
$18.8 million at December 31, 1997, to $17.8 million at September 30, 1998.
The decrease was primarily the result of scheduled maturities of short-term
investment being rolled into higher earning real estate and commercial loan
production as a part of the Company's strategy to expand their loan product
base.
Funds received from the deposit increases and the investment decreases
were temporally invested in federal funds which increased $2.6 million, or
65.84%, from $3.9 million at December 31, 1997, to $6.5 million at September
30, 1998.
<PAGE>
Deposit liabilities increased $4.1 million in addition to the $15.7
million related to the bank merger. This is an increase of $19.8 million,
30.98%, from $63.9 million at December 31, 1997, to $83.7 million at September
30, 1998. Management attributes the increase to the maintaining of
competitive rates in our market area. Interest credited on accounts also
contributed to the increase.
Total shareholders' equity increased $506,000, or 5.99%, from $8.4
million at December 31, 1997, to $8.9 million at September 30, 1998. This
increase was primarily the result of $507,000 in earnings for the first nine
months in fiscal 1998, and a $35,000 decrease in common shares held as
treasury stock being offset by $98,000 in cash dividend payments. Additional
shares were sold through the Dividend Reinvestment Plan (the "DRIP") which
accounted for a $36,000 capital increase.
The Bank's liquidity, primarily represented by cash and cash equivalents,
is a result of its operating, investing and financing activities. Principal
sources of funds are deposits, loan and mortgage-backed security repayments,
maturities of securities and other funds provided by operations. The Bank
also has the ability to borrow from the FHLB. While scheduled loan repayments
and maturing investments are relatively predictable, deposit flows and early
loan and mortgage-backed security prepayments are more influenced by interest
rates, general economic conditions and competition. The Bank maintains
investments in liquid assets based upon management's assessment of (i) the
need for funds, (ii) expected deposit flows, (iii) the yields available on
short-term liquid assets and (iv) the objectives of the asset/liability
management program. In the ordinary course of business, part of such liquid
investments portfolio is composed of deposits at correspondent banks.
Although the amount on deposit at such banks often exceeds the $100,000 limit
covered by FDIC insurance, the Bank monitors the capital of such institutions
to ensure that such deposits do not expose the Bank to undue risk of loss.
The Asset/Liability Management Committee of the Bank is responsible for
liquidity management. This committee, which is comprised of various managers,
has an Asset/Liability Policy that covers all assets and liabilities, as well
as off-balance sheet items that are potential sources and uses of liquidity.
The Bank's liquidity management objective is to maintain the ability to meet
commitments to fund loans and to purchase securities, as well as to repay
deposits and other liabilities in accordance with their terms. The Bank's
overall approach to liquidity management is to ensure that sources of
liquidity are sufficient in amounts and diversity to accommodate changes in
loan demand and deposit fluctuations without a material adverse impact on net
income. The Committee monitors the Bank's liquidity needs on an ongoing
basis. Currently the Bank has several sources available for both short- and
long-term liquidity needs. These include, but are not restricted to advances
from the FHLB, Federal Funds and borrowings from the Federal Reserve Bank and
other correspondent banking arrangements.
The Bank is subject to various regulatory capital requirements
administered by its primary federal regulator, the Federal Reserve Bank
("FRB"). Failure to meet minimum capital requirements can initiate certain
mandatory, and possible additional discretionary actions by regulators that,
if undertaken, could have a material affect on the Company and the
consolidated financial statements. Under the regulatory capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of
the Bank's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Bank's capital amounts
and classification under the prompt corrective action guidelines are also
subject to qualitative judgements by the regulators about components, risk
weightings, and other factors.
Qualitative measures established by the regulation to ensure capital
adequacy requires the Bank to maintain minimum amounts and ratios of: total
risk-based capital and Tier I capital to risk-weighted assets (as defined by
the regulations), and Tier I capital to average assets (as defined).
Management believes, as of September 30, 1998, that the Bank meets all of the
capital adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from the FDIC, the
Bank was categorized as well capitalized under the regulatory framework for
prompt corrective action. To remain categorized as well capitalized, the Bank
will have to maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as disclosed in Note 4 - Regulatory Capital. There are no
conditions or events since the most recent notification that management
believes have changed the Bank's prompt corrective action category.
At September 30, 1998, Exchange Bancshares had no material commitments
for capital expenditures.
<PAGE>
Results of Operations
Comparison of Three Months Ended September 30, 1998 and 1997
General. Net income decreased for the three months ended September 30,
1998, to $144,000, as compared to the three months ended September 30, 1997,
$229,000, a decrease of $85,000. This decrease was primarily attributed to
the increases in the various operating expenses, a number of which are
directly related to the acquisition of Towne Bank. These are discussed in
greater detail under the captions "Non-Interest Income" and "Non-Interest
Expense".
Interest Income. Average earning assets have continued to increase
during the third quarter of 1998 which has contributed to an increase in
interest income of $415,000, or 29.56%, for the three months ended September
30, 1998 compared to 1997. The increase was attributed to the additional loan
income of $406,000 resulting from an increase in loans receivable, $35,000
increase in federal funds sold and $9,000 increase in dividend income which
was offset by a decrease of $33,000 in investment income primarily as a result
of the maturities and repayments.
Interest Expense. Interest expense on deposit liabilities increased
$220,000 for the three months ended September 30, 1998, as compared to the
same period in 1997. Total deposits increased by approximately $4.1 million
(exclusive of the deposit liabilities assumed in conjunction with the bank
acquisition) comparing September 30, 1998 to 1997, the average interest paid
on interest-bearing deposits increased by 31 basis points from 4.38% for the
three months ended September 30, 1997, to 4.69% for the same period ended
September 30, 1998. The FHLB advance outstanding during the three-month
period ended September 30, 1998, resulted in a decrease in interest expense to
$1,000 in 1998 compared to $3,000 for the same period ended September 30,
1997.
Provision for Loan Losses. There were no provisions for loan losses and
there were net charge-offs of $43,000 during the three months ended September
30, 1998, compared to no provisions and net charge-offs of $14,000 during the
three months ended September 30, 1997. The absence of a provision was based
upon the results of the ongoing loan reviews and composition of the loan
portfolio, primarily loans secured by one-to four-family residential
properties and other forms of collateral, which are considered to have less
risk, as well as the reserves associated with the recent bank acquisition.
Non-Interest Income. Non-interest income increased $13,000, or 16.25%,
to $93,000 for the three months ended September 30, 1998, from $80,000 for the
three months ended September 30, 1997. Service charges on deposit accounts
increased $32,000 while other income (primarily miscellaneous fee income)
decreased by $20,000.
Non-Interest Expense. Non-interest expense increased $366,000, or
68.41%, to $901,000 for the three months ended September 30, 1998, from
$535,000 in the comparable period in 1997. Of this increase, $91,000 was
attributable to an increase in compensation and benefit expense in 1998,
reflecting normal salary and benefit adjustments as well as additional
staffing associated with the addition of two branch office locations. The
normal legal, accounting and examination expenses remained relatively constant
with the remainder of the general expenses increasing slightly over the levels
experienced during the same three month period in 1997. The significant
increase in other expense, $194,000, was primarily a result of the additional
expenses incurred as a result of the due diligence efforts, legal and
accounting fees, and the data system conversions associated with the recent
bank acquisition.
Income Taxes. The provision for income taxes decreased $73,000 for the
three months ended September 30, 1998, compared with the prior year, primarily
as a result of lower taxable income for the quarter.
Comparison of Nine Months Ended September 30, 1998 and 1997
General. Net income decreased $125,000, or 19.78%, for the nine months
ended September 30, 1998, $507,000, as compared to the nine months ended
September 30, 1997, $632,000. This decrease was primarily attributed to an
increase in non-interest expense being off-set by an increases in net interest
income and non-interest income.
Interest Income. The increase in average earning assets contributed to
an increase in interest income of $661,000, or 16.13%, for the nine months
<PAGE>
ended September 30, 1998 compared to 1997. The increase was attributed to the
additional loan income of $654,000 resulting from an increase in loans
receivable and $130,000 increase in federal funds sold which was offset by a
decrease of $123,000 in interest income in the investment categories.
Interest Expense. Interest expense on deposit liabilities increased
$378,000 for the nine months ended September 30, 1998, as compared to the same
period in 1997. Total deposits increased significantly in 1998 compared to
1997, the average interest paid on interest-bearing deposits increased by 23
basis points from 4.23% for the nine months ended September 30, 1997, to 4.46%
for the same period ended September 30, 1998. The FHLB advance outstanding
during the nine-month period ended September 30, 1998, resulted in an increase
in interest expense to $8,000 in 1998 compared to $4,000 interest expense for
the same period ended September 30, 1997.
Provision for Loan Losses. There were no provisions for loan losses and
there were net charge-offs of $73,000 during the nine months ended September
30, 1998, compared to no provisions and net recoveries of $127,000 during the
nine months ended September 30, 1997. The absence of a provision was based
upon the results of the ongoing loan reviews and composition of the loan
portfolio, primarily loans secured by one-to four-family residential
properties and other forms of collateral, which are considered to have less
risk, as well as the reserves associated with the recent bank acquisition.
Non-Interest Income. Non-interest income increased $18,000, or 7.53%, to
$257,000 for the nine months ended September 30, 1998, from $239,000 for the
nine months ended September 30, 1997. The increase was primarily attributable
to a $66,000 increase in service charges on deposit accounts being off-set by
a decrease in other income of $47,000 and a $1,000 loss recognized on the sale
of other assets in the nine months ended September 30, 1997.
Non-Interest Expense. Non-interest expense increased $522,000, or
31.11%, to $2.2 million for the nine months ended September 30, 1998, from
$1.7 million in the comparable period in 1997. Of this increase, $130,000 was
attributable to an increase in compensation and benefit expense in 1998,
reflecting normal salary benefit adjustments and additional staffing as a
result of the bank acquisition . Normal legal, accounting and examination
expenses remained relatively constant with the remainder of the general
expenses increasing over the levels experienced during the first three
quarters of 1997. The significant increase in other expense, $281,000, was
primarily a result of the additional expenses incurred as a result of the due
diligence efforts, legal and accounting fees, and the data system conversions
associated with the recent bank acquisition.
Income Taxes. The provision for income taxes decreased $96,000 for the
nine months ended September 30, 1998, compared with the prior year, primarily
as a result of lower taxable income for the period.
<PAGE>
EXCHANGE BANCSHARES, INC.
PART II - OTHER INFORMATION
===========================================================================
ITEM 1 - LEGAL PROCEEDINGS
In June 1998, The exchange Bank merged with Town Bank in Perrysburg,
Ohio. As a result of this merger, The Exchange Bank succeeded to all of the
outstanding rights and obligations of Towne Bank. One of these obligations
arose out of an Agreement dated April 4, 1996 between Towne Bancorp, Inc.,
Towne Bank and Norman J. Rood, a former director and officer of Towne Bancorp,
Inc. and Towne Bank (the "Agreement"). One of the terms of the Agreement
provided that Towne Bancorp, Inc. and Towne Bank would defend and indemnify
Mr. Rood, if he was ever involved in a lawsuit resulting from actions taken
while he served as an officer or director of the Bancorp or Bank. In 1998,
Mr. Rood was named in two class action lawsuits brought by certain of the
shareholders of Towne Bancorp, Inc., styled (1) Joseph Gomez and Read Backus,
et al. vs. Town Bancorp, Inc. et al.-- United States District Court, Northern
District of Ohio, Western Division, Case No. 3:98CV7436, and (22) Anne Stahl
Crowlety, Trustee, et al. V. Huntington Trust Co., N.A., et al. - United
States District Court, Northern District of Ohio, Western Division, Case
No.3:98CV7575. Mr. Rood has hired legal counsel and has made the demand that
Towne Bancorp, Inc. and The Exchange Bank indemnify him under the Agreement
for expenses and attorneys fees as provided for in the Agreement, Mr. Rood's
attorneys have agreed to provide The Exchange Bank with regular status reports
regarding the litigation and have estimated that the total expenses of the
defense could exceed $75,000. In the event The Exchange Bank would be liable
for the full expenses associated with Mr. Rood's defense, The Exchange Bank
would look to Towne Bancorp, Inc. and Towne Bank's directors and officers
insurance policy for contribution. There is no assurance, however, that Towne
Bancorp, Inc. will have the funds to make the appropriate contribution or that
the insurer will pay on the claim.
ITEM 2 - CHANGES IN SECURITIES
Not Applicable
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
<PAGE>
ITEM 5 - OTHER INFORMATION
The Securities and Exchange Commission has recently amended Rule 14a-4 to
provide that with respect to a shareholder proposal to be presented at an
annual shareholders' meeting other than pursuant to Rule 14a-8 (i.e., which is
not to be included in the registrant's proxy statement), the registrant's
management may exercise discretionary voting authority under proxies solicited
by it for the meeting, without mention of the proposal in the proxy materials,
if it receives notice of the proposed non-Rule 14a-8 shareholder action less
than 45 days prior to the calendar date its proxy materials were mailed for
the prior year's annual meeting.
As this new provision applies to the Company, in the event notice of a
non-Rule 14a-8 shareholder proposal to be presented at the Company's 1999
Annual Meeting of Shareholders is received by the Company after March 1, 1999,
the Company will be permitted to exercise discretionary voting authority under
proxies solicited by it with respect to the 1999 Annual Meeting
ITEM 6 -EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibit 27: Financial Data Schedule
b. Report on Form 8-K was filed during the quarter ended
September 30, 1998.
<PAGE>
SIGNATURES
In accordance with 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.
EXCHANGE BANCSHARES, INC.
Date /s/ November 11, 1998 /s/ Marion Layman
--------------------- ----------------------------------------
Marion Layman
Chairman, President, and Chief Executive
Officer
Date /s/ November 11, 1998 /s/ Marion Layman
--------------------- ------------------------------------------
Marion Layman
Principal Accounting and Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
The schedule contains summary financial information extracted from the
Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997, and
the related Consolidated Statements of Income and Consolidated Income for the
three and nine months ended September 30, 1998 and 1997, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<CIK> 0000720912
<NAME> EXCHANGE BANCSHARES, INC.
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
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<CASH> 2,900
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2,622
0
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