<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
(MARK ONE)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
---------------------- ----------------------
COMMISSION FILE NUMBER 0-13882
FIRST WESTERN BANCORP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
PENNSYLVANIA 25-1461570
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 EAST WASHINGTON STREET, NEW CASTLE, PENNSYLVANIA 16101
(Address of principal executive offices) (Zip Code)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (724) 652-8550
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $5 PER SHARE
------------------
Title of each class
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 __
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
The aggregate market value of Common Stock, par value $5 per share, held by
non-affiliates (based upon the closing sale price on the Nasdaq Stock Market on
March 11, 1999), was approximately $361,880,000.
As of March 11, 1999, there were 11,156,229 shares of Common Stock, par
value $5 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: None
<PAGE> 2
The undersigned Registrant hereby amends and restates in its entirety Part II,
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations of its Annual Report on Form 10-K for the year ended December 31,
1998, originally filed with the Commission on March 15, 1999.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is management's discussion and analysis of the financial
condition and results of operations of First Western for the years ended
December 31, 1998, 1997 and 1996. The discussion should be read in conjunction
with the consolidated financial statements and notes thereto and the summary
financial information included elsewhere in this annual report on Form 10-K. All
per share amounts have been restated for the effect of a three-for-two stock
split effected in the form of a 50% stock dividend declared on July 15, 1997 and
distributed on August 15, 1997.
Certain information in "Management's Discussion and Analysis" and other
statements contained in this report which are not historical facts may be
forward-looking statements that involve risks and uncertainties. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. Factors
that could cause future results to vary from current expectations include, but
are not limited to, the following: changes in economic conditions (both
generally and more specifically in the markets in which First Western operates);
changes in interest rates, deposit flows, loan demand, real estate values and
competition; changes in accounting principles, policies or guidelines and in
government legislation and regulation (which change from time to time and over
which First Western has no control); other factors affecting First Western's
operations, markets, products and services, including but not limited to, year
2000 compliance issues; and other risks detailed in this Form 10-K and in First
Western's other Securities and Exchange Commission filings.
RECENT DEVELOPMENTS
On December 13, 1998, First Western's Board of Directors approved a
definitive agreement pursuant to which First Western will be merged with and
into Sky Financial Group, Inc. ("Sky Financial"). Under the terms of the
agreement, First Western's shareholders will receive 1.211 shares of Sky
Financial common stock for each share of First Western common stock in a
transaction intended to be a tax-free exchange. The merger is intended to be
accounted for as a pooling-of-interests. In connection with this agreement,
First Western has issued an option to Sky Financial to purchase up to 19.9% of
outstanding shares of First Western, at an exercise price of $28.50 per share,
which is exercisable only upon the occurrence of certain events. The merger is
subject to shareholder and regulatory approval and is expected to be completed
during the third quarter of 1999.
OVERVIEW
First Western's net income for 1998 was $17.9 million, decreasing 11.6%
from $20.3 million for 1997, primarily due to lower gains on loan sales and a
$1.5 million restructuring charge recorded in 1998. Diluted earnings per share
decreased 10.7% from $1.77 for 1997 to $1.58 for 1998. The key performance
highlights for 1998 were:
-- First Western continued to grow its retail delivery system with the
acquisition of 16 branches from PNC Bank in June 1998. Most of these
branches were located within First Western's core banking markets.
First Western sold four of the branches which were not located within
its core market. In addition, First Western sold its three branches in
Lake County, Ohio since they were not located in an area of growth for
First Western. The result of these transactions was the growth of
First Western's deposit base and market share within First Western's
existing markets along with the elimination of some outlying branches
where First Western did not have significant market share.
-- First Western completed an internal evaluation of its operations and
staffing ("Profit Improvement Initiative") which resulted in the
elimination of approximately 70 positions during the fourth quarter of
1998. First Western recognized a $1.5 million restructuring charge
during 1998 which represents the severance benefits paid to the
affected employees.
-- In September 1998, First Western Trust Services Company was merged
into First Western Bank, N.A., eliminating the separate trust company
charter.
1
<PAGE> 3
PERFORMANCE SUMMARY
First Western's net income was $17.9 million for 1998, decreasing $2.4
million, or 11.6%, from $20.3 million for 1997, with this decrease primarily due
to a $3.5 million decrease in net gains on loan sales along with the $1.5
million restructuring charge. During 1997, First Western completed the sale of
its credit card portfolio which resulted in most of the $5.9 million of gains on
loan sales recorded during 1997. The gains on loan sales recognized during 1998
consisted primarily of gains on the sales of mortgage loans. The acquisition of
the 16 PNC Bank branches did not have a significant impact on First Western's
net income for this first partial year, however, these branches did have an
impact on the components of the income statement resulting in increases in net
interest income and service charges on deposit accounts along with increases in
operating expenses and the amortization of intangible assets expense. The
profitability of the branches acquired from PNC Bank is dependent upon First
Western combining branches that are located close to existing First Western
branches, most of which were combined during the fourth quarter of 1998, along
with the redeployment of the funds acquired with these branches from securities
into higher yielding loans. Diluted earnings per share were $1.58 for 1998,
decreasing 10.7% from $1.77 for 1997, based on diluted weighted average shares
outstanding of 11,369,000 and 11,446,000 in 1998 and 1997, respectively. The
decrease in weighted average shares outstanding from 1997 to 1998 was due to the
purchase of treasury shares.
First Western's net income was $20.3 million for 1997, increasing $3.2
million, or 18.4%, from $17.1 million for 1996, with this increase primarily due
to a $4.0 million decrease in Federal Deposit Insurance Corporation ("FDIC")
insurance expense and a $3.5 million decrease in the provision for loan losses.
First Western also realized net gains of $608,000 during 1997 from the sale of
two small branch offices and a gain of $267,000 from the sale of First Western's
credit card merchant transaction processing business. Partially offsetting these
increases in income was the $2.3 million minority interest expense on the trust
preferred securities that were issued in February 1997. Diluted earnings per
share were $1.77 for 1997, increasing 20.4% from $1.47 for 1996, based on
diluted average shares outstanding of 11,446,000 and 11,669,000 in 1997 and
1996, respectively.
The following table presents First Western's net income, earnings per
share, return on average assets and return on average equity for the last three
years:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (in thousands)..................... $17,923 $20,282 $17,127
======= ======= =======
Diluted earnings per share.................... $ 1.58 $ 1.77 $ 1.47
======= ======= =======
Return on average assets...................... 0.90% 1.19% 1.02%
======= ======= =======
Return on average equity...................... 12.37% 15.40% 14.06%
======= ======= =======
</TABLE>
First Western's return on average assets decreased from 1.19% for 1997 to
0.90% for 1998 due to the decrease in net gains from loan sales, the $1.5
million restructuring charge and also due to the acquisition of the PNC Bank
branches which added approximately $200 million to First Western's average
assets without adding significantly to First Western's net income in this first
partial year of operation. First Western's return on average assets increased
from 1.02% in 1996 to 1.19% in 1997, primarily due to the decrease in the
provision for loan losses and a decrease in FDIC insurance expense.
First Western's return on average equity decreased from 15.40% in 1997 to
12.37% in 1998 due to a decrease in net income combined with a $13.2 million
increase in average equity. The significant increase in assets, especially
intangible assets, resulting from the acquisition of the PNC Bank branches
necessitated that First Western increase its capital which resulted in the
curtailment of a share repurchase program. First Western's return on average
equity increased from 14.06% in 1996 to 15.40% in 1997 due to the 18.4% increase
in net income.
NET INTEREST INCOME
Net interest income represents the amount by which interest income on
earning assets, including securities and loans, exceeds interest paid on
interest-bearing liabilities, including deposits and other borrowed
2
<PAGE> 4
funds. Net interest income is the principal source of a financial institution's
earnings. Interest rate fluctuations as well as changes in the amounts and types
of earning assets and interest-bearing liabilities combine to affect net
interest income. Tax-exempt securities and loans carry pre-tax yields lower than
comparable taxable assets. Therefore, it is more meaningful to analyze net
interest income on a tax-equivalent basis. The tax-equivalent adjustment is
based on the federal corporate income tax rate of 35%. The following table shows
the increases over the last three years in actual and tax-equivalent net
interest income:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net interest income, actual................... $62,100 $59,704 $58,269
Tax-equivalent adjustment..................... 2,544 2,616 2,668
------- ------- -------
Net tax-equivalent interest income............ $64,644 $62,320 $60,937
======= ======= =======
Increase in actual net interest income........ $ 2,396 $ 1,435 $ 3,309
======= ======= =======
Percentage increase........................... 4.0% 2.5% 6.0%
======= ======= =======
Increase in tax-equivalent interest income.... $ 2,324 $ 1,383 $ 3,439
======= ======= =======
Percentage increase........................... 3.7% 2.3% 6.0%
======= ======= =======
</TABLE>
First Western's tax-equivalent net interest income increased $2.3 million
or 3.7% from 1997 to 1998 due to a $219 million or 13.4% increase in average
earning assets, primarily as a result of the acquisition of the PNC Bank
branches which was partially offset by a decline in First Western's net interest
margin from 3.80% in 1997 to 3.48% in 1998. The growth in average earning assets
from 1997 to 1998 was due to a $269 million or 84.8% increase in average
securities available for sale along with a $24.5 million or 2.3% increase in
average loans. The increase in average securities available for sale and
investment securities was primarily due to First Western investing the excess
funds provided by the acquisition of the PNC Bank branches. This increase in
average assets was funded by a $151 million increase in interest-bearing
deposits and a $91 million increase in borrowed funds.
First Western's tax-equivalent net interest income increased $1.4 million,
or 2.3%, from 1996 to 1997 due to a $27.8 million, or 1.7%, increase in average
earning assets, with the net interest margin increasing from 3.78% in 1996 to
3.80% in 1997. The growth in average earning assets from 1996 to 1997 was due to
a $69.8 million, or 28.3%, increase in average securities available for sale,
partially offset by a $29.5 million, or 2.7%,decrease in average loans and a
$26.5 million, or 9.3%, decrease in average investment securities. Average loans
decreased from 1996 to 1997 due to First Western selling its $48 million credit
card loan portfolio during the fourth quarter of 1996 and the first quarter of
1997, and also due to the first-quarter 1997 sale of approximately $100 million
of residential mortgage loans. The increase in average earning assets was funded
by a $25 million trust preferred securities offering in February 1997, along
with a $9.9 million increase in average equity and a $9.5 million increase in
average deposits. First Western's average borrowed funds decreased $26.6
million, or 7.1%, during 1997 compared with 1996 due to the funds provided by
the loan sales and the increase in average deposits and other funding sources.
The net interest margin or net interest income expressed as a percentage of
average earning assets was 3.48% in 1998 compared with 3.80% in 1997. The
decrease in First Western's net interest margin was due to a 27 basis point
decrease in First Western's yield on earning assets along with a decrease in net
funds provided by noninterest bearing sources. These decreases in the net
interest margin were partially offset by a nine basis point decrease in First
Western's cost of funds. The decline in the yield on earning assets was due to a
decrease in loan yields caused by falling interest rates throughout 1998 along
with an increase in the portion of earning assets invested in securities which
have lower yields than loans. During 1998, securities comprised 42% of First
Western's average earning assets compared with 35% for 1997 with this increase
due to First Western investing the excess funds provided by the PNC Bank
branches. The increase in intangible assets resulting from the premium paid for
the PNC Bank branches contributed to a net decrease in First Western's funding
from noninterest-bearing sources. These "free funds" decreased from 14% of First
Western's average earning assets for 1997 to 11% for 1998 which also contributed
to the decline in First Western's net interest margin from 1997 to 1998. The
purchase of bank-owned life insurance ("BOLI") also reduced First Western's net
3
<PAGE> 5
interest margin since the earnings on BOLI are included in other income while
the cost of funding BOLI is included in interest expense.
The net interest margin was 3.80% in 1997, compared with 3.78% in 1996. The
improvement in First Western's net interest margin was due to an increase in net
funds provided by noninterest-bearing sources, primarily as a result of the
issuance of the trust preferred securities. The payments made to the holders of
the trust preferred securities are included in other expense as minority
interest expense. First Western's yield on earning assets decreased three basis
points primarily due to the sale of the credit card portfolio, which had a
higher yield than other loan types. First Western's cost of funds increased
seven basis points primarily due to an eight basis point increase in the cost of
interest-bearing deposits, with this increase partially offset by a decrease in
the portion of funding provided by wholesale borrowed funds, which have a higher
cost than deposits. See "Market Risk" for a further discussion of the impact of
interest rate changes on First Western's financial performance.
To provide a more in-depth analysis of net interest income, the following
average balance sheets and net interest income analysis detail the contribution
of earning assets to overall net interest income and the impact of cost of
funds. The rate/volume analysis shows the portions of the net change in interest
income due to changes in volume or rate. Average yields are calculated using
tax-equivalent interest income. The changes in interest due to both rate and
volume in the rate/volume analysis table have been allocated to changes due to
rate and volume in proportion to the absolute amounts of changes in each. Since
changes in interest income and expense are independently calculated, the totals
for the volume and rate columns are not the sum of the individual lines.
4
<PAGE> 6
AVERAGE BALANCE SHEETS/NET INTEREST INCOME ANALYSIS (1)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------------------- -----------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE BALANCE INTEREST YIELD/RATE
------- -------- ---------- ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits with
other banks.................. $ 2,006 $ 95 4.74% $ 5,535 $ 260 4.70%
---------- -------- ---- ---------- -------- ----
Federal funds sold............. 321 18 5.43 10,362 554 5.35
---------- -------- ---- ---------- -------- ----
Securities available for
sale......................... 585,857 38,346 6.55 316,955 21,946 6.92
---------- -------- ---- ---------- -------- ----
Investment securities, held to
maturity..................... 196,102 12,865 6.56 256,688 16,969 6.61
---------- -------- ---- ---------- -------- ----
Loans(net)(2).................. 1,074,905 90,953 8.46 1,050,382 90,210 8.59
---------- -------- ---- ---------- -------- ----
Total interest-earning
assets..................... 1,859,191 142,277 7.65 1,639,922 129,939 7.92
---------- -------- ---- ---------- -------- ----
Noninterest-earning assets:
Cash and due from banks........ 36,538 30,139
Premises and equipment......... 22,315 20,034
Intangible assets.............. 35,584 7,340
Other assets................... 52,556 19,948
Allowance for loan losses...... (18,407) (17,257)
---------- ----------
Total assets................. $1,987,777 $1,700,126
========== ==========
Interest-bearing sources:
Deposits:
Interest-bearing demand
deposits................... $ 48,402 1,120 2.31 $ 39,954 890 2.23
Savings deposits............. 178,501 4,361 2.44 160,147 3,538 2.21
Money market deposits........ 239,418 5,637 2.35 183,402 4,224 2.30
Time deposits................ 754,044 41,627 5.52 685,979 38,812 5.66
---------- -------- ---- ---------- -------- ----
Total deposits............... 1,220,365 52,745 4.32 1,069,482 47,464 4.44
---------- -------- ---- ---------- -------- ----
Federal funds purchased and
other short-term
borrowings................... 87,194 4,927 5.65 53,226 3,136 5.89
---------- -------- ---- ---------- -------- ----
Repurchase agreements and
secured lines of credit...... 179,505 10,270 5.72 141,569 8,110 5.73
---------- -------- ---- ---------- -------- ----
Advances from the Federal Home
Loan Bank.................... 157,657 8,744 5.55 147,729 8,526 5.77
---------- -------- ---- ---------- -------- ----
Long-term debt................. 14,022 947 6.75 5,230 383 7.32
---------- -------- ---- ---------- -------- ----
Total interest-bearing
sources.................... 1,658,743 77,633 4.68 1,417,236 67,619 4.77
---------- -------- ---- ---------- -------- ----
Noninterest-bearing sources:
Demand deposits................ 121,013 94,514
Other liabilities.............. 39,244 35,445
Trust preferred securities..... 23,855 21,187
Shareholders' equity........... 144,922 131,744
---------- ----------
Total liabilities and
shareholders' equity....... $1,987,777 $1,700,126
========== ==========
Net interest rate
spread(3).................... 2.97% 3.15%
---- ----
Net interest income............ $ 64,644 $ 62,320
======== ========
Net yield on earning assets
(Net interest margin)(4)..... 3.48% 3.80%
==== ====
<CAPTION>
DECEMBER 31, 1996
-----------------------------------
AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE
------- -------- ----------
<S> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits with
other banks.................. $ 1,348 $ 61 4.53%
---------- -------- ----
Federal funds sold............. 595 34 5.71
---------- -------- ----
Securities available for
sale......................... 247,116 16,868 6.83
---------- -------- ----
Investment securities, held to
maturity..................... 283,141 18,435 6.51
---------- -------- ----
Loans(net)(2).................. 1,079,881 92,753 8.59
---------- -------- ----
Total interest-earning
assets..................... 1,612,081 128,151 7.95
---------- -------- ----
Noninterest-earning assets:
Cash and due from banks........ 33,616
Premises and equipment......... 18,865
Intangible assets.............. 7,369
Other assets................... 17,949
Allowance for loan losses...... (15,148)
----------
Total assets................. $1,674,732
==========
Interest-bearing sources:
Deposits:
Interest-bearing demand
deposits................... $ 97,088 1,362 1.40
Savings deposits............. 170,480 3,801 2.23
Money market deposits........ 114,499 3,255 2.84
Time deposits................ 674,522 37,693 5.59
---------- -------- ----
Total deposits............... 1,056,589 46,111 4.36
---------- -------- ----
Federal funds purchased and
other short-term
borrowings................... 55,731 3,096 5.56
---------- -------- ----
Repurchase agreements and
secured lines of credit...... 194,006 10,898 5.62
---------- -------- ----
Advances from the Federal Home
Loan Bank.................... 117,721 6,620 5.62
---------- -------- ----
Long-term debt................. 6,904 489 7.08
---------- -------- ----
Total interest-bearing
sources.................... 1,430,951 67,214 4.70
---------- -------- ----
Noninterest-bearing sources:
Demand deposits................ 97,891
Other liabilities.............. 24,089
Trust preferred securities..... --
Shareholders' equity........... 121,801
----------
Total liabilities and
shareholders' equity....... $1,674,732
==========
Net interest rate
spread(3).................... 3.25%
----
Net interest income............ $ 60,937
========
Net yield on earning assets
(Net interest margin)(4)..... 3.78%
====
</TABLE>
- ---------------
(1) In order to make pre-tax income and resultant yields comparable to
taxable-equivalent loans and investments, a tax-equivalent adjustment is
made equally to interest income and income tax expense with no effect on
after-tax income. The tax-equivalent adjustment has been computed using a
federal income tax rate of 35% and has increased interest income by $2.5
million, $2.6 million and $2.7 million for the years ended December 31,
1998, 1997 and 1996, respectively.
(2) Loan fees net of related origination costs are accreted over the average
lives of the related loans and are considered adjustments to interest
income. These net fees (costs) aggregated $(9,000), $48,000 and $421,000 for
the years ended December 31, 1998, 1997 and 1996, respectively. For the
purpose of calculating loan yields, average loan balances include nonaccrual
loans with no related interest income.
(3) Represents the difference between the yield on earning assets and the cost
of funds.
(4) Represents tax-equivalent net interest income divided by average
interest-earning assets.
5
<PAGE> 7
RATE/VOLUME ANALYSIS (1)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
--------------------------- --------------------------
CHANGE FROM 1997 IN CHANGE FROM 1996 IN
INTEREST INCOME INTEREST INCOME
OR EXPENSE DUE TO OR EXPENSE DUE TO
--------------------------- --------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits with other
banks.............................. $ (167) $ 2 $ (165) $ 197 $ 2 $ 199
------- ------- ------- ------- ------ -------
Federal funds sold.................... (562) 26 (536) 522 (2) 520
------- ------- ------- ------- ------ -------
Securities available for sale......... 17,662 (1,262) 16,400 4,833 245 5,078
------- ------- ------- ------- ------ -------
Investment securities, held to
maturity........................... (3,976) (128) (4,104) (1,745) 279 (1,466)
------- ------- ------- ------- ------ -------
Loans (net) (2)....................... 2,087 (1,344) 743 (2,533) (10) (2,543)
------- ------- ------- ------- ------ -------
Total interest income.............. 16,901 (4,563) 12,338 2,207 (419) 1,788
------- ------- ------- ------- ------ -------
Interest-bearing sources:
Deposits:
Interest-bearing demand deposits... 194 36 230 (1,038) 566 (472)
Savings deposits................... 427 396 823 (228) (35) (263)
Money market deposits.............. 1,317 96 1,413 1,676 (707) 969
Time deposits...................... 3,776 (961) 2,815 645 474 1,119
------- ------- ------- ------- ------ -------
Total deposits..................... 6,548 (1,267) 5,281 567 786 1,353
------- ------- ------- ------- ------ -------
Federal funds purchased and other
short-term borrowings................. 1,924 (133) 1,791 (143) 183 40
------- ------- ------- ------- ------ -------
Repurchase agreements and secured lines
of credit............................. 2,170 (10) 2,160 (3,000) 212 (2,788)
------- ------- ------- ------- ------ -------
Advances from the Federal Home Loan
Bank.................................. 559 (341) 218 1,728 178 1,906
------- ------- ------- ------- ------ -------
Long-term debt.......................... 596 (32) 564 (123) 17 (106)
------- ------- ------- ------- ------ -------
Total interest expense............. 11,325 (1,311) 10,014 (648) 1,053 405
------- ------- ------- ------- ------ -------
Net interest income................ $ 7,900 $(5,576) $ 2,324 $ 1,057 $ 326 $ 1,383
======= ======= ======= ======= ====== =======
</TABLE>
- ---------------
(1) In order to make pre-tax income and resultant yields comparable to
tax-equivalent loans and investments, a tax-equivalent adjustment is made
equally to interest income and to income tax expense with no effect on
after-tax income. The tax-equivalent adjustment has been computed using a
federal income tax rate of 35% and has increased interest income by $2.5
million, $2.6 million and $2.7 million for the years ended December 31,
1998, 1997 and 1996, respectively.
(2) Loan fees net of related origination costs are accreted over the average
lives of the related loans and are considered adjustments to interest
income. These net fees (costs) aggregated $(9,000), $48,000 and $421,000 for
the years ended December 31, 1998, 1997 and 1996, respectively. For the
purpose of calculating loan yields, average loan balances include nonaccrual
loans with no related interest income.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $4.0 million in 1998, compared with $4.8
million in 1997 and $8.3 million in 1996. The $3.5 million decrease in the
provision for loan losses from 1996 to 1997 reflects a $3.6 million decrease in
net charge-offs and an improvement in First Western's nonperforming loans during
1997. Net charge-offs in 1998 were $3.8 million, or 0.35%, of average loans,
compared with $2.8 million, or 0.27%, in 1997 and $6.4 million, or 0.59%, in
1996. Most of the loans charged off by First Western for the past three years
were loans that were originated through automobile dealers. Management
attributes the high
6
<PAGE> 8
indirect automobile loan charge-offs during 1996 to an aggressive expansion of
First Western's automobile loan program into new market areas. First Western
responded to the increase in consumer loan charge-offs by investing in
technology to improve both the underwriting and collection operations.
Additionally, First Western also introduced credit scoring for loan
applications, tiered pricing based on risk and collateral, and increased the
number of employees handling collections and recoveries. Installment loan net
charge-offs also increased during 1996 due to an $880,000, or 115.7%, increase
in credit card loan charge-offs. Most of the increase in credit card charge-offs
was due to First Western charging-off any past-due credit card accounts that
were not sold in the December 1996 transaction.
First Western's net charge-offs by loan type and changes in the allowance
for loan losses for each of the past five years were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Allowance for loan losses at beginning of
period..................................... $18,077 $16,054 $14,148 $12,943 $11,102
Charge-offs:
Commercial, financial and agricultural
loans................................... 44 4 72 44 123
Real estate construction loans............. -- -- -- -- --
Real estate mortgage loans................. 187 141 26 18 206
Installment loans.......................... 4,377 3,776 6,958 3,005 2,149
------- ------- ------- ------- -------
Total charge-offs....................... 4,608 3,921 7,056 3,067 2,478
------- ------- ------- ------- -------
Recoveries:
Commercial, financial and agricultural
loans................................... 23 38 73 88 390
Real estate construction loans............. -- -- -- -- --
Real estate mortgage loans................. 141 172 69 30 125
Installment loans.......................... 664 898 532 172 154
------- ------- ------- ------- -------
Total recoveries........................ 828 1,108 674 290 669
------- ------- ------- ------- -------
Net charge-offs.............................. 3,780 2,813 6,382 2,777 1,809
------- ------- ------- ------- -------
Provision for loan losses.................... 4,000 4,836 8,288 3,982 3,650
------- ------- ------- ------- -------
Allowance for loan losses at end of period... $18,297 $18,077 $16,054 $14,148 $12,943
======= ======= ======= ======= =======
Ratio of net charge-offs to average loans.... 0.35% 0.27% 0.59% 0.27% 0.20%
======= ======= ======= ======= =======
</TABLE>
The provision for loan losses less net charge-offs added $220,000 to the
allowance for loan losses, which increased to $18.3 million at year-end 1998.
See "Financial Condition -- Loan Quality" for further discussion.
OTHER INCOME
First Western's other income was $17.2 million in both 1997 and 1998.
During 1998, First Western experienced increases in service charges on deposit
accounts, income from bank-owned life insurance, trust fees and gains on branch
sales with these increases offset by decreases in gains on loan sales and loan
servicing income. Other income increased $1.5 million, or 9.7% from 1996 to
1997, due to increased gains on loan sales and gains from the sales of branches
and the sale of First Western's credit card merchant transaction processing
program, with these increases partially offset by a $1.5 million decrease in
credit card program fees and a $708,000 decrease in net securities gains.
Trust fees increased $514,000 or 22.3% from 1997 to 1998 primarily due to
an increase in trust fees on personal trust accounts and employee benefit
accounts. Trust fees increased $291,000, or 14.5%, from $2.0 million in 1996 to
$2.3 million in 1997 due to a $131,000 increase in estate fees, with the
remaining increase resulting from an increase in trust assets managed by First
Western.
Service charges on deposit accounts increased $1.1 million or 26.2% from
$4.2 million for 1997 to $5.3 million for 1998. The branches acquired from PNC
Bank in June 1998 contributed $620,000 of this increase with the remaining
increase due to First Western increasing its service charges beginning in March
1998. Service charges on deposit accounts increased $484,000, or 13.1%, in 1997
compared with 1996
7
<PAGE> 9
due to a $427,000 increase in service charges on interest-bearing demand
accounts and an increase in insufficient funds and returned check service
charges. First Western had been promoting its "Active Lifestyles" account, which
resulted in this increase in service charges on interest-bearing demand
accounts.
First Western realized gains on loan sales of $2.3 million during 1998
resulting from the sale of residential mortgage loans in a bulk sale during the
first quarter of 1998 along with the sale of First Western's monthly production
of conforming residential mortgage loans. First Western realized net gains on
loan sales of $5.9 million during 1997 primarily as a result of the sale of the
remaining portion of the credit card portfolio during the first quarter of 1997.
First Western's net gains on loan sales were $4.6 million in 1996, primarily due
to the gain realized on the partial sale of the credit card portfolio, partially
offset by a $2.9 million loss on the sale of $100 million of residential
mortgage loans, with this mortgage loan sale settling during the first quarter
of 1997. During the fourth quarter of 1996, First Western sold approximately
two-thirds of its credit card portfolio with a principal balance of $30.4
million, realizing a gain of approximately $7.2 million, net of certain costs
incurred by First Western in connection with the credit card sale.
During the fourth quarter of 1997, First Western purchased $25 million of
bank-owned life insurance. The increase in the cash surrender value of BOLI,
$1.4 million in 1998, is included in other income.
Other operating income increased $830,000 from 1997 to 1998 due to a
$463,000 increase in gains recognized on the sale of branch offices, a $393,000
increase in fees earned on check card transactions and automated teller machine
transactions, a $207,000 increase in insurance commissions and a $165,000
increase in fees earned on the sales of mutual funds and annuities with these
increases offset by a $622,000 decrease in loan servicing income due to the
completion of the sale of the credit card portfolio in 1997 and also due to a
$199,000 decrease in credit card program fees. Other operating income increased
$154,000 from 1996 to 1997, primarily due to gains of $608,000 realized on the
sale of two branch offices, a $408,000 increase in loan servicing income as a
result of First Western servicing the credit card loans and mortgage loans that
were sold until the servicing could be transferred to the purchasers, and a
$267,000 gain realized on the sale of the credit card merchant transaction
processing program with these increases partially offset by a $1.5 million
decrease in credit card processing fees.
OTHER EXPENSES
Other Expenses increased $7.6 million or 17.8% from $43.0 million for 1997
to $50.6 million for 1998 with the expenses of the branches acquired from PNC
Bank accounting for $4.5 million of this increase and the restructuring charge
accounting for $1.5 million. Other expenses increased $731,000, or 1.7%, from
$42.3 million in 1996 to $43.0 million in 1997 due to a $2.3 million increase in
minority interest expense, along with increases in salaries and employee
benefits expense, higher marketing expense and increased professional fees, with
these increases partially offset by a $4.0 million decrease in FDIC insurance
expense.
First Western's salaries and employee benefits expense increased a combined
$2.2 million or 11.1% from 1997 to 1998 with the PNC branches accounting for
$955,000 of the increase. The remaining increase of $1.2 million was due to
normal salary and wage increases and increased medical insurance expense. During
the fourth quarter of 1998, First Western eliminated approximately 70 positions
as part of its Profit Improvement Initiative. The objective of this program was
to reduce operating expenses by $3.5 million to $4.5 million annually with the
largest part of the cost savings coming from decreased salary and benefits
expense. The cost of the severance benefits for the terminated employees of $1.5
million was recorded during the fourth quarter of 1998 as a restructuring
charge. First Western's salaries and employee benefits expense increased a
combined $1.2 million, or 6.8%, from $18.5 million in 1996 to $19.7 million in
1997 primarily due to normal salary and wage increases along with increased
personnel. First Western had 618 full-time equivalent employees at December 31,
1998, compared with 635 and 625 at December 31, 1997 and 1996, respectively.
Expenses related to operating First Western's branches and other
facilities, including all equipment, occupancy and depreciation charges,
increased $923,000 from 1997 to 1998 with the branches acquired from PNC Bank
accounting for $517,000 of this increase. The remaining increase in occupancy
and equipment expense from 1997 to 1998 was due to the full-year operation of
the facilities that were opened during the second half of 1997. First Western's
occupancy and equipment expense increased $391,000 from $5.1 million
8
<PAGE> 10
in 1996 to $5.5 million in 1997, primarily as a result of First Western opening
two additional supermarket branches and a new loan processing center during
1997.
First Western's amortization of intangible assets expense increased from
$1.1 million in 1997 to $3.3 million in 1998 due to the premium paid for the
branches that were acquired from PNC Bank along with the full year impact of the
acquisition of the Chicora, Pennsylvania branch in 1997. First Western recorded
an intangible asset of $59 million in June 1998 related to the branches acquired
from PNC Bank with this intangible asset being amortized over a 12 year period
on a straight-line basis. First Western's amortization of intangible assets
expense should increase in 1999 due to the full year impact of the branches
acquired from PNC Bank with this increase partially offset by a reduction in
intangible assets in the first quarter of 1999 as a result of the sale of four
of the branches that were acquired from PNC Bank.
First Western's supplies expense increased $470,000 from $1.6 million for
1997 to $2.1 million in 1998 due to the supplies necessary to convert the PNC
Bank branches to First Western's data processing systems. The expenses related
to the PNC Bank branches consisted of the costs to produce and mail brochures to
the former PNC Bank customers to explain First Western's products and services,
the cost to replace the former PNC Bank customers' checks and various expenses
to add these branches to the First Western data processing system.
First Western's marketing expense decreased $664,000 from 1997 to 1998 due
to First Western sharply curtailing its marketing expenditures during the second
half of 1998. First Western's marketing expenditures also decreased from 1997 to
1998 due to First Western beginning a corporate image campaign during the fourth
quarter of 1997 with most of the production costs to develop the campaign being
incurred during the fourth quarter of 1997. Marketing expense increased
$820,000, or 67.9%, from $1.2 million in 1996 to $2.0 million in 1997, primarily
due to First Western beginning the corporate image campaign.
First Western's professional fees increased $529,000 from 1996 to 1997 due
to increased legal and consulting expense related to the merger of First Western
Bank, F.S.B. into First Western Bank, N.A., along with the start-up of First
Western's insurance business.
First Western's data processing services expense increased $307,000 or
19.9% from 1997 to 1998 primarily due to an increase in First Western's cost for
processing automated teller machine transactions. First Western's outside data
processing expense decreased $288,000, or 15.7%, from $1.8 million in 1996 to
$1.5 million in 1997 primarily due to the sale of the credit card portfolio in
late 1996 and early 1997. First Western used a third-party servicer for
processing credit card transactions.
In February 1997, First Western completed the private placement of $25
million of trust preferred capital securities issued by First Western's Delaware
trust subsidiary, First Western Capital Trust I. The distributions payable on
the securities, which totaled $2.5 million for 1998 and $2.3 million for 1997,
have been recorded as minority interest expense.
First Western's federal deposit insurance expense decreased $4.0 million,
or 91.5%, from $4.4 million in 1996 to $376,000 in 1997 due to a $3.3 million
special assessment that was paid during 1996 and also due to a reduction in
insurance rates in late 1996. The one-time special assessment of thrift deposits
was done in order to recapitalize the Savings Association Fund of the Federal
Deposit Insurance Corporation.
Other operating expenses increased $796,000 or 11.5% from 1997 to 1998
primarily due to a $450,000 increase in Pennsylvania bank shares tax expense.
This increase in Pennsylvania bank shares tax expense was a result of the merger
of First Western's former thrift subsidiary into the Banking Subsidiary in
September 1997. As a thrift, First Western Bank, F.S.B. formerly paid state
income taxes instead of shares tax. Other operating expenses decreased $302,000,
or 4.2%, from $7.2 million in 1996 to $6.9 million in 1997 due to a $651,000
decrease in credit card program expenses, with this decrease partially offset by
a $139,000 increase in fees paid to a third-party provider of services in
connection with First Western's "Active Lifestyles" account and a $111,000
increase in software maintenance expense.
9
<PAGE> 11
INCOME TAXES
First Western's income tax expense was $6.8 million in 1998, decreasing
$2.0 million, or 23.2%, from $8.8 million in 1997. The decrease in First
Western's income tax expense was due to a decrease in pre-tax earnings along
with the elimination of the state income taxes paid by First Western's former
thrift subsidiary. First Western's income tax expense increased $2.5 million or
39.9% from 1996 to 1997 due to a 24.2% increase in pre-tax earnings and also due
to a reduction in First Western's income tax expense in 1996 as a result of a
settlement reached with the Internal Revenue Service during 1996 concerning an
audit of prior years' tax returns. Excluding the impact of the settlement
reached with the Internal Revenue Service during 1996, First Western's effective
tax rate was 27.4% in 1998, compared with 30.3% in 1997 and 29.0% in 1996. The
decrease in First Western's effective tax rate from 1997 to 1998 was due to
First Western having a decreased level of fully-taxable income as compared with
pre-tax earnings as a result of the decrease in gains on loan sales along with
the increase in tax-exempt income as a result of the BOLI purchased in late
1997, and also due to the elimination of the state income tax on the former
thrift subsidiary.
YEAR 2000 CONSIDERATIONS
First Western has reviewed its mission critical systems to determine its
readiness for the year 2000. The mission critical systems identified by First
Western include: the mainframe computer hardware and operating system, the item
capture system, the core banking software applications and the trust department
accounting system.
First Western performs its own data processing for most bank operations
using an IBM AS/400 computer and the OS/400 operating system. First Western has
completed testing on its AS/400 computer and OS/400 operating system and has
determined that they will process year 2000 dates correctly.
First Western processes its own checks for collection from other financial
institutions ("item capture"). The hardware and software used to perform First
Western's item capture have been tested for year 2000 compliance and certain
minor modifications were required. These modifications were made and tested
during the fourth quarter of 1998 with no additional modifications necessary.
First Western uses the Fiserve CBS software for its core banking systems
such as loan and deposit processing. First Western's core banking system
software provider has provided First Western with year 2000 compliant software.
Installation of this software was completed during the fourth quarter of 1998.
First Western has received reports from other financial institutions that use
this software that it has passed their year 2000 testing. First Western tested
its version of this software during the fourth quarter of 1998 and has
determined that it will process year 2000 dates correctly.
First Western's trust department uses an outside vendor for data
processing. The trust department will be changing data processing vendors during
the second quarter of 1999, therefore, First Western has not tested the year
2000 readiness of its current trust data processing provider. The trust data
processing provider that First Western will be changing to in 1999 has certified
its year 2000 compliance.
Although First Western believes that its mission critical systems will be
year 2000 compliant, any undetected flaws could result in a business
interruption that could have a material adverse effect on First Western's
financial condition or results of operations.
First Western has prepared a remediation contingency plan to be followed if
any of its mission critical systems cannot be updated to achieve year 2000
compliance. As of December 31, 1998, progress in correcting the mission critical
systems was sufficient that none of the actions in the contingency plan have
been triggered. First Western is in the process of preparing a year 2000
business recovery plan to address potential failures of automated information
systems; intermittent and isolated failures in public infrastructure (electric,
telephone, water, gas, etc.) and liquidity concerns due to public demand for
cash.
First Western is currently in the process of testing its non-mission
critical systems for year 2000 compliance. Any systems that are found to be
non-compliant will be replaced.
First Western has reviewed its non-information technology ("non-IT")
systems and has not found any significant year 2000 problems. Most of the non-IT
year 2000 problems discovered by First Western consisted
10
<PAGE> 12
of non-compliant security systems and automated teller machines. This
non-compliant equipment has either already been replaced or will be replaced
before the year 2000. The estimated cost of replacing the non-compliant
equipment is less than $100,000.
First Western has contacted all of its significant commercial loan
customers to alert them to the importance of being prepared for year 2000 issues
and to determine the state of their year 2000 readiness. If a loan customer
suffers a business interruption as a result of a year 2000 problem it could
result in a loss for First Western which could be material. First Western is not
aware of any of its loan customers having a significant year 2000 compliance
problem. However, there is no assurance that these customers will not have year
2000 related business interruptions that may have a material adverse effect on
First Western's financial condition or results of operations.
First Western has contacted all of its material vendors and correspondent
banks to determine their year 2000 readiness. First Western has not been
notified by any third party vendor or correspondent bank of a year 2000
compliance problem. However, there is still a risk that a provider of services
to First Western, such as telecommunications or electricity, may suffer a
business interruption which, may in turn, result in a business interruption for
First Western that may have a material adverse effect on First Western's
financial condition or results of operations.
As of December 31, 1998, First Western has incurred cumulative year 2000
compliance costs of approximately $391,000, of which $16,000 was for outside
consultants to test First Western's mission critical systems and the remaining
$375,000 represented the salaries and benefit costs of First Western's employees
working on year 2000 issues. For the past 12 months, approximately one-half of
First Western's computer programming and systems personnel have been working on
year 2000 testing and remediation. First Western estimates that the remaining
year 2000 testing will result in additional expenditures of approximately
$383,000 over the next 12 months with this amount consisting primarily of the
salaries and benefits of First Western's employees. Since the amount expended by
First Western for year 2000 compliance consisted primarily of the salaries and
benefits of existing First Western employees, First Western has not experienced
a significant increase in other operating expenses as a result of year 2000
remediation efforts. Most of the corrections to First Western's year 2000
problems were incorporated into regularly scheduled software and hardware
upgrades, therefore there were not significant expenditures above First
Western's regular software and hardware costs. First Western did not postpone
any specific projects as a result of dedicating certain employees to year 2000
concerns. However, it is impossible to measure what these employees could have
accomplished if they had not been dedicated to year 2000 concerns.
IMPACT OF INFLATION
The effects of inflation on the local economy and on First Western's
operating results have been relatively modest for the past several years. Since
substantially all of First Western's assets and liabilities are monetary in
nature, such as cash, investments, loans and deposits, their values are less
sensitive to the effects of inflation than to changing interest rates, which do
not necessarily change in accordance with inflation rates. First Western tries
to control the impact of interest rate fluctuations by managing the relationship
between its interest rate sensitive assets and liabilities. See "Market Risk"
for further discussion.
FINANCIAL CONDITION
First Western's total assets increased $483.3 million, or 27.7%, from
$1.744 billion at December 31, 1997 to $2.227 billion at December 31, 1998, with
most of this increase due to an increase in securities available for sale funded
by increased deposits. Average total assets increased $287.7 million, or 16.9%,
from $1.700 billion for 1997 to $1.988 billion for 1998, with most of this
increase occurring in the portfolio of securities available for sale.
LOAN PORTFOLIO
Loans and loans held for sale increased $60.5 million during 1998 with this
increase in loans primarily due to an increase in commercial loans along with
the acquisition of $74 million of consumer and commercial loans from PNC Bank
with these increases partially offset by the sale of approximately $92 million
of
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<PAGE> 13
residential mortgage loans during the first quarter of 1998. The loans acquired
from PNC Bank consisted of $54 million of consumer installment loans, $10
million of home equity loans, $6 million of commercial mortgage loans and $4
million of commercial loans. During 1998, First Western emphasized its lending
program for commercial and industrial customers resulting in commercial time and
demand loans increasing $36.2 million or 34.3% and automobile floorplan loans
growing $11.0 million or 35.4%. First Western decreased its residential mortgage
loan portfolio during 1998 by selling conforming residential mortgage loans when
they are originated and also by bulk residential mortgage loan sales. Partially
offsetting the sales of residential mortgage loans has been the growth of
consumer second mortgage loans which increased by $50.6 million during 1998. In
the table below, consumer second mortgage loans are classified as one-to-four
family residential mortgage loans.
During the fourth quarter of 1998, First Western sold most of its mortgage
servicing rights at a small loss. Prior to the sale, First Western serviced
approximately $214 million of residential mortgage loans for other investors.
First Western decided to sell its servicing portfolio because First Western's
management believed that selling residential mortgage loans with their servicing
will be more profitable than selling the loans and retaining the servicing.
Included in the $383.4 million of one-to-four family residential mortgage
loans at December 31, 1998 are approximately $44.5 million of purchased mortgage
loans serviced by others. These purchased loans are secured by real estate
outside of First Western's primary market areas with no significant
concentrations in any state or region.
The portfolio of loans held for sale at December 31, 1998 consisted of
residential mortgage loans with a carrying value of $15.5 million and an
estimated market value of $15.7 million. The following table shows the
composition of First Western's portfolio of loans and loans held for sale for
the last five years (in thousands):
12
<PAGE> 14
COMPOSITION OF LOAN PORTFOLIO
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Amounts of Loans by Type:
Commercial, financial and
agricultural:
Automobile floorplan loans...... $ 41,995 $ 31,013 $ 26,668 $ 26,775 $ 25,229
Loans to municipalities......... 3,643 6,140 11,446 13,893 10,307
Other commercial loans.......... 141,492 105,323 83,645 79,491 63,662
---------- ---------- ---------- ---------- --------
Subtotal..................... 187,130 142,476 121,759 120,159 99,198
---------- ---------- ---------- ---------- --------
Real estate construction.......... 11,239 14,450 16,289 24,501 18,721
---------- ---------- ---------- ---------- --------
Real estate mortgage:
1-4 family residential.......... 383,429 385,702 433,813 357,004 370,582
Multi-family residential........ 25,902 29,331 37,173 35,088 30,923
Home equity..................... 72,008 56,811 49,653 41,417 37,129
Commercial and other............ 183,987 172,559 159,470 141,667 127,176
---------- ---------- ---------- ---------- --------
Subtotal..................... 665,326 644,403 680,109 575,176 565,810
---------- ---------- ---------- ---------- --------
Installment:
Credit cards.................... -- -- 17,328 45,226 39,412
Installment and other........... 282,986 284,874 278,940 262,554 255,421
---------- ---------- ---------- ---------- --------
Subtotal..................... 282,986 284,874 296,268 307,780 294,833
---------- ---------- ---------- ---------- --------
Total........................ $1,146,681 $1,086,203 $1,114,425 $1,027,616 $978,562
========== ========== ========== ========== ========
Percent of Loans by Type:
Commercial, financial and
agricultural:
Automobile floorplan loans...... 3.7% 2.8% 2.4% 2.6% 2.6%
Loans to municipalities......... 0.3 0.6 1.0 1.4 1.1
Other commercial loans.......... 12.3 9.7 7.5 7.7 6.5
---------- ---------- ---------- ---------- --------
Subtotal..................... 16.3 13.1 10.9 11.7 10.2
---------- ---------- ---------- ---------- --------
Real estate construction.......... 1.0 1.4 1.5 2.4 1.9
---------- ---------- ---------- ---------- --------
Real estate mortgage:
1-4 family residential.......... 33.4 35.5 38.9 34.8 37.8
Multi-family residential........ 2.3 2.7 3.3 3.4 3.2
Home equity..................... 6.3 5.2 4.5 4.0 3.8
Commercial and other............ 16.0 15.9 14.3 13.8 13.0
---------- ---------- ---------- ---------- --------
Subtotal..................... 58.0 59.3 61.0 56.0 57.8
---------- ---------- ---------- ---------- --------
Installment:
Credit cards.................... -- -- 1.6 4.4 4.0
Installment and other........... 24.7 26.2 25.0 25.5 26.1
---------- ---------- ---------- ---------- --------
Subtotal..................... 24.7 26.2 26.6 29.9 30.1
---------- ---------- ---------- ---------- --------
Total........................ 100.0% 100.0% 100.0% 100.0% 100.0%
========== ========== ========== ========== ========
</TABLE>
LOAN QUALITY
First Western has several policies and procedures in place to assist in
maintaining and monitoring the overall quality of its loan portfolio. First
Western has established underwriting guidelines to be followed by its banking
subsidiary. In addition, a formal, ongoing loan review program (discussed
below), which concentrates principally on commercial credits, has been
established to help monitor the loan portfolio of the banking subsidiary. First
Western also regularly monitors its delinquency and nonperforming levels for any
negative or adverse trends and particularly monitors credits which have total
exposure of $1.5 million or more. However,
13
<PAGE> 15
there can be no assurance that First Western's loan portfolio will not become
subject to increasing pressures from deteriorating borrower credit due to
general economic conditions.
First Western's delinquent loans, nonaccrual loans and nonperforming assets
consisted of the following for the last five years (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Loans delinquent and still accruing interest:
Loans past due 30 to 89 days............ $ 6,419 $ 8,703 $ 8,080 $10,420 $ 7,370
Loans past due 90 days or more.......... 2,879 2,466 1,427 2,648 1,870
------- ------- ------- ------- -------
Total loan delinquencies................ $ 9,298 $11,169 $ 9,507 $13,068 $ 9,240
======= ======= ======= ======= =======
Nonaccrual loans............................. $ 1,928 $ 2,634 $ 5,147 $ 4,959 $ 2,875
Other real estate owned...................... 617 382 471 165 1,185
------- ------- ------- ------- -------
Total nonperforming assets.............. $ 2,545 $ 3,016 $ 5,618 $ 5,124 $ 4,060
======= ======= ======= ======= =======
Total nonperforming assets and loans
past due 90 days or more.............. $ 5,424 $ 5,482 $ 7,045 $ 7,772 $ 5,930
======= ======= ======= ======= =======
Nonaccrual loans to total loans.............. 0.17% 0.24% 0.46% 0.48% 0.29%
Nonperforming assets to total loans and other
real estate owned.......................... 0.22% 0.28% 0.50% 0.50% 0.41%
Nonperforming assets to total assets......... 0.11% 0.17% 0.33% 0.32% 0.28%
Nonperforming assets and loans past due 90
days or more to total assets............... 0.24% 0.31% 0.42% 0.48% 0.41%
Nonaccrual loans and loans past due 90 days
or more to total loans..................... 0.42% 0.47% 0.59% 0.74% 0.48%
Allowance for loan losses to nonaccrual
loans...................................... 949.01% 686.33% 311.91% 285.31% 450.16%
Allowance for loan losses to loans past due
90 days or more and nonaccrual loans....... 380.61% 354.43% 244.20% 185.98% 272.78%
Allowance for loan losses to total loans..... 1.60% 1.66% 1.44% 1.38% 1.32%
</TABLE>
First Western's total delinquencies decreased $1.9 million, or 16.8%, from
$11.2 million at December 31, 1997 to $9.3 million at December 31, 1998, with
this decrease primarily due to a $1.2 million decrease in delinquent commercial
mortgage loans and a $420,000 decrease in delinquent commercial loans. First
Western's nonaccrual loans decreased $706,000 during 1998 due to the pay-off of
several commercial loans that were on nonaccrual status. First Western's
coverage ratio of the allowance for loan losses to nonaccrual loans increased
from 686% at December 31, 1997 to 949% at December 31, 1998, due to the 26.8%
decrease in nonaccrual loans during 1998.
Commercial and mortgage loans are placed on nonaccrual status when, in the
opinion of management, collection of principal or interest is doubtful and the
loan is not both well secured and in the process of collection. Installment
loans are generally charged off between 90 and 120 days past due or when deemed
uncollectible in the opinion of management. Cash payments received while a loan
is classified as nonaccrual are recorded as a reduction to principal as long as
doubt exists as to collection.
First Western maintains a loan review program to evaluate the credit risk
in its commercial loan portfolio for substantially all commercial loans and
commercial real estate loans greater than $200,000. Through the loan review
process, First Western maintains a classified account list which, along with the
nonperforming and delinquency lists of loans, helps management assess the
overall quality of the loan portfolio and the adequacy of the allowance for loan
losses. Loans classified as "substandard" are those loans with clear and defined
weaknesses, such as highly leveraged positions, unfavorable financial ratios,
uncertain repayment sources or poor financial condition, which may jeopardize
recoverability of the debt. Loans classified as "doubtful" are those loans which
have characteristics similar to the substandard accounts but with an increased
risk that a loss may occur, or at least a portion of the loan may require a
charge-off if liquidated at present. First Western reviews these loans in
assessing the adequacy of the allowance for loan losses.
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<PAGE> 16
Substandard loans include some loans that are delinquent or on nonaccrual
status. As of December 31, 1998, substandard and doubtful loans, including
unfunded commitments, totaled $5.5 million.
In addition to its classified account list and delinquency list of loans,
First Western maintains a separate list of "Other Loans Especially Mentioned"
("OLEM"), which further aids First Western in monitoring its loan portfolio.
These OLEM loans do not have all the characteristics of a classified loan
(substandard or doubtful), but do show potentially weak elements as compared
with those of a satisfactory credit. First Western reviews these loans in
assessing the adequacy of the allowance for loan losses. Substantially all of
the loans on the OLEM list as of December 31, 1998 are current and paying in
accordance with loan terms. As of December 31, 1998, OLEM list loans, including
unfunded commitments, totaled $8.2 million.
First Western maintains an allowance for possible loan losses to absorb losses
inherent in the loan portfolio. The allowance is based on a quarterly assessment
of the probable estimated losses inherent in the loan portfolio. First Western's
methodology for assessing the appropriateness of the allowance for loan losses
consists of several key elements which include:
o specific allowances for identified problem loans and portfolio segments,
o formula allowances, and
o an unallocated reserve
First Western establishes specific reserves for potential problem loans as
determined by its loan review program described above. The specific reserves on
these loans are determined in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan,"
and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures" taking into account the credit's current operating
status, pledged collateral and plans of action for resolving any deficiencies.
The specific reserves are usually only considered for First Western's commercial
loan portfolio.
First Western maintains formula reserves for all loans not considered by the
specific reserve method. The loans that have been assigned specific reserves are
excluded from the calculation of the formula reserves. First Western's formula
reserves are calculated for each pool of homogeneous loans. First Western
establishes formula reserves based on a loan's risk rating according to First
Western's loan review program, delinquency status and historical charge-off
experience by loan type. The loss factors used in determining the formula
reserves for substandard, doubtful and OLEM credits are based on management's
judgment of inherent losses from these classifications of loans. First Western
establishes formula reserves based on a loan's delinquency status based on a
credit's loan type and delinquency aging. The loss factors applied by loan type
and delinquency aging are based on management's judgment of inherent losses from
these delinquency categories. First Western also establishes formula based
reserves for all loan types based on the historical charge-off percentages for
each loan type as calculated by pool of homogeneous loans. The historical
charge-off percentage used by First Western is based on the greater of First
Western's one year or three year historical charge-off averages for each
homogeneous loan pool.
These formula reserves are based on First Western's historical charge-off
experience. If current charge-off levels deviate from First Western's historical
charge-off levels this deviation will be reflected in First Western's ongoing
formula reserves and will adjust the allowance for loan losses accordingly.
First Western maintains an unallocated reserve which takes the following factors
into consideration:
o Concentrations of credit
o Delinquency and nonaccrual trends
o Local and national economic conditions
o Changes in lending and collection practices
15
<PAGE> 17
o Trends in volume and terms of loans
o Other external factors that could affect the ability of First Western's
customers to repay their obligations
Executive management reviews these factors quarterly. If any of these factors
affect a specifically identified problem credit or portfolio segment as of the
evaluation date, management's estimate of the effect of this condition may be
reflected as a specific allowance applicable to this credit or portfolio
segment. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date,
management's evaluation of the probable loss concerning this condition is
reflected in the unallocated allowance.
The composition of First Western's allowance for loan losses was as follows at
December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------
1998 1997
------- -------
<S> <C> <C>
Specific reserves.......... $ 1,343 $ 1,777
Formula reserves........... 7,355 6,436
Unallocated reserves....... 9,599 9,864
------- -------
Total...................... $18,297 $18,077
======= =======
</TABLE>
First Western's specific reserves decreased $434,000 or 24.4% from December 31,
1997 to December 31, 1998 primarily due to the improvement in the financial
status of a commercial loan customer along with the foreclosure on a substandard
commercial real estate loan which was then classified as other real estate
owned.
The formula reserve portion of First Western's allowance for loan losses
increased $920,000 or 14.3% primarily due to an increase in average loans
outstanding along with increases in First Western's historic loan charge-off
ratios, particularly in consumer loans.
The unallocated reserve portion of First Western's allowance for loan losses
decreased $266,000 or 3.3% during 1998 due to First Western decreasing its
reserve for concentrations of credit with this decrease partially offset by an
increase in the reserve for changes in lending and collection practices. The
decrease in the reserve related to concentrations of credit reflected a decrease
in First Western's exposure to commercial real estate loans, particularly loans
secured by hotels and motels. The increase in the reserve relating to changes in
lending and collection practices was in response to the rising delinquency level
of First Western's indirect loan portfolio.
At December 31, 1998, First Western's average annual net charge-offs for the
past five years were $3.5 million, compared with $3.4 million at December 31,
1997. These net charge-offs represented 5.2 years of losses based on the level
of the allowance for loan losses at December 31, 1998 and 5.3 years based on the
level of the allowance for loan losses at December 31, 1997. Historical net
charge-offs are not necessarily indicative of the amount of net charge-offs that
First Western will realize in the future.
16
<PAGE> 18
First Western believes that the allowance for loan losses of $18.3 million
at December 31, 1998 is adequate to cover losses inherent in the portfolio as of
such date. However, there can be no assurance that First Western will not
sustain losses in future periods, which could be substantial in relation to the
size of the allowance at December 31, 1998.
INVESTMENT SECURITIES AND SECURITIES AVAILABLE FOR SALE
On December 1, 1998, First Western transferred all of its securities that
were classified as held to maturity to available for sale. At the time of the
transfer, these securities had an amortized cost of $193.0 million and a market
value of $193.9 million. This transfer was made in order to give First Western's
management more flexibility in managing the total investment securities
portfolio. In addition, because of the growth of the available for sale
portfolio during 1998 resulting from the investment of the funds from the PNC
Bank branches and a leverage strategy implemented by First Western, as of
December 1, 1998, approximately 78% of First Western's securities were already
classified as available for sale and management did not believe that it was
strategically important to maintain the held to maturity portfolio.
First Western's portfolio of securities that were classified as available
for sale or held to maturity increased a combined $311.4 million or 55.9% during
1998 primarily due to the investment of the funds provided by the purchase of
the PNC Bank branches along with the implementation of a $102 million leverage
strategy in July 1998. The leverage strategy involved the purchase of U.S.
government agency securities which were funded with repurchase agreements.
At December 31, 1998, the market value of First Western's portfolio of
securities available for sale was $868.7 million, which was $8.4 million or 1.0%
greater than the amortized cost of these securities of $860.3 million. At
December 31, 1997, First Western's combined portfolios of securities held to
maturity and securities available for sale had a market value of $557.8 million,
$8.8 million or 1.6% greater than the amortized cost of these securities of
$549.0 million.
17
<PAGE> 19
The following table presents the contractual maturities of securities
available for sale and their weighted average yields as of December 31, 1998, on
a tax-equivalent basis using a 35% federal income tax rate. The maturity
distribution of mortgage-backed securities is based on the weighted average
lives of these securities.
<TABLE>
<CAPTION>
AFTER AFTER
1 BUT 5 BUT WEIGHTED
WITHIN WITHIN WITHIN AFTER AVERAGE
1 YEAR 5 YEARS 10 YEARS 10 YEARS TOTAL YIELD
------ ------- -------- -------- ----- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities......... $ 7,421 $ -- $ -- $ -- $ 7,421 6.03%
U.S. Government agencies and
corporations................... 168,569 37,342 -- -- 205,911 6.17%
Mortgage-backed securities....... 1,898 334,678 114,958 46,849 498,383 7.35%
States and political
subdivisions................... 17,576 54,837 11,703 280 84,396 7.38%
Other securities, including
corporate bonds and notes...... 1,160 778 2,071 68,579 72,588 6.45%
-------- -------- -------- -------- -------- ----
Total....................... $196,624 $427,635 $128,732 $115,708 $868,699 6.99%
======== ======== ======== ======== ======== ====
Weighted average yield........... 6.22% 7.41% 7.09% 6.63% 6.99%
======== ======== ======== ======== ========
</TABLE>
BANK-OWNED LIFE INSURANCE
In December 1997, First Western purchased $25 million of life insurance on
the officers of First Western with First Western as the beneficiary. The
increase in the cash surrender value of the insurance policies is recorded as
other income. The increase in the cash surrender value and death benefits paid
to First Western are currently not included in taxable income.
DEPOSITS
First Western's total deposits increased $296.4 million, or 24.9%, during
1998, primarily due to the purchase of the PNC Bank branches with this increase
partially offset by the sale of First Western's three branches in Lake County,
Ohio. The PNC Bank branches had approximately $384 million of deposits and the
Lake County branches had approximately $47 million of deposits.
First Western primarily relies on its retail deposit base to fund its
credit needs. Deposits provided 67.5% of First Western's funding during 1998,
based on average balances of deposits and total assets. First Western's total
average deposits during 1998 were $1.341 billion, increasing 15.2% from $1.164
billion in 1997.
<TABLE>
<CAPTION>
DEPOSIT SUMMARY
DECEMBER 31,
------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------ ------------------ ------------------ ------------------ ------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Noninterest-bearing
demand deposits....... $ 142,162 9.5% $ 100,653 8.5% $ 93,163 8.1% $ 102,864 8.7% $ 97,242 9.4%
Interest-bearing demand
deposits.............. 54,668 3.7 38,539 3.2 53,946 4.7 110,703 9.4 101,659 9.9
Money market deposits... 272,339 18.3 229,046 19.2 163,602 14.2 98,605 8.4 113,914 11.1
Savings deposits........ 207,305 13.9 156,317 13.1 165,930 14.4 172,837 14.7 168,039 16.3
Time deposits less than
$100,000.............. 712,459 47.9 575,676 48.3 585,465 51.0 625,865 53.1 498,566 48.4
Time deposits of
$100,000 or more...... 99,823 6.7 92,108 7.7 86,797 7.6 66,809 5.7 49,989 4.9
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total deposits...... $1,488,756 100.0% $1,192,339 100.0% $1,148,903 100.0% $1,177,683 100.0% $1,029,409 100.0%
========== ===== ========== ===== ========== ===== ========== ===== ========== =====
</TABLE>
BORROWED FUNDS
First Western's Bank Subsidiary uses various funding sources other than
deposits to provide the funds necessary for the loan and securities portfolios.
First Western's total borrowed funds increased $102.6 million,
18
<PAGE> 20
or 28.5%, during 1998 from $359.5 million at December 31, 1997 to $462.1 million
at December 31, 1998, primarily as a result of the leverage strategy that was
implemented in July 1998.
First Western's borrowings with original maturities of one year or less
include overnight advances from the Federal Home Loan Bank, repurchase
agreements, customer repurchase agreements, and federal funds purchased. First
Western's borrowings with an original maturity of one year or less and rates
paid are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
--------------- --------------- ---------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
------ ---- ------ ---- ------ ----
<S> <C> <C> <C> <C> <C> <C>
At year-end.............................. $ 67,498 5.09% $ 97,229 6.05% $138,582 5.65%
Average during year...................... 116,328 5.62% 101,678 5.70 163,117 5.59
Maximum month-end balance................ 255,115 5.62% 150,488 5.48 219,189 5.44
</TABLE>
First Western Bank, N.A. is a member of the Federal Home Loan Bank of
Pittsburgh and, as such, it has the ability to obtain advances from the FHLB. At
December 31, 1998, First Western had advances from the FHLB (original maturity
in excess of one year) of $178.4 million, with a weighted average rate of 4.97%,
compared with advances of $156.0 million at December 31, 1997. The advances from
the FHLB are secured by certain qualifying residential mortgage loans, stock in
the FHLB, investment securities and securities available for sale.
During 1998, First Western entered into a revolving credit note with an
unrelated bank. The maximum available to First Western under this line is $25
million. First Western took an initial draw from this line of $23 million and
used $3 million of the proceeds to pay-off an existing loan from another bank
and used the remaining funds to provide a capital contribution to First Western
Bank, N.A. As a result of acquisition of the PNC Bank branches, the parent
company had to make a capital contribution to First Western Bank, N.A. totaling
$37 million in order to restore First Western Bank, N.A.'s capital levels to
"well capitalized" under the regulatory framework for prompt corrective action.
MARKET RISK
As a financial institution, First Western is subject to market risk,
primarily interest rate risk. First Western does not have significant exposure
to foreign currency risk, commodity price risk or equity price risk. First
Western has an asset/liability management committee which manages the risks
associated with changing interest rates and the resulting impact on net interest
income. The management of interest rate risk at First Western is performed (i)
by analyzing the maturity and repricing relationships between interest-earning
assets and interest-bearing liabilities at a specific point in time ("GAP"); and
(ii) by using a simulation model which analyzes the effects of interest rate
changes on net interest income over specified periods of time by projecting the
performance of the mix of assets and liabilities in varied interest rate
environments.
The tables below present First Western's GAP at December 31, 1998 and 1997.
In preparing these tables, management has anticipated prepayments for
mortgage-backed securities and mortgage loans according to standard industry
prepayment assumptions in effect at year-end. Money market deposits and
interest-bearing demand accounts have been included in the under-three-months
category. Assets with daily floating rates are included in the
under-three-months category. Assets and liabilities are included in the table
based on their maturities or period of first repricing, subject to the foregoing
assumptions.
19
<PAGE> 21
INSTRUMENTS MATURING OR REPRICING
<TABLE>
<CAPTION>
UNDER THREE SIX TO ONE TO OVER
THREE TO SIX TWELVE FIVE FIVE
MONTHS MONTHS MONTHS YEARS YEARS TOTAL
------ ------ ------ ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1998:
Rate-sensitive assets:
Money market assets........... $ 2,960 $ -- $ -- $ -- $ -- $ 2,960
Securities.................... 61,269 125,935 65,175 324,316 292,004 868,699
Loans......................... 404,659 80,807 137,328 434,558 89,329 1,146,681
--------- --------- --------- --------- -------- ----------
Total.................... $ 468,888 $ 206,742 $ 202,503 $ 758,874 $381,333 $2,018,340
========= ========= ========= ========= ======== ==========
Rate-sensitive liabilities:
Deposits...................... $ 811,909 $ 161,041 $ 210,351 $ 145,490 $ 17,803 $1,346,594
Borrowed funds................ 112,498 21,200 22,500 108,400 221,100 485,698
--------- --------- --------- --------- -------- ----------
Total.................... $ 924,407 $ 182,241 $ 232,851 $ 253,890 $238,903 $1,832,292
========= ========= ========= ========= ======== ==========
Period GAP...................... $(455,519) $ 24,501 $ (30,348) $ 504,984 $142,430 $ 186,048
========= ========= ========= ========= ======== ==========
Ratio of period GAP to total
rate-sensitive assets......... (22.6)% 1.2% (1.5)% 25.0% 7.1% 9.2%
========= ========= ========= ========= ======== ==========
Cumulative GAP.................. $(455,519) $(431,018) $(461,366) $ 43,618 $186,048
========= ========= ========= ========= ========
Ratio of cumulative GAP to total
rate-sensitive assets......... (22.6)% (21.4)% (22.9)% 2.1% 9.2%
========= ========= ========= ========= ========
DECEMBER 31, 1997:
Rate-sensitive assets:
Money market assets........... $ 6,836 $ -- $ -- $ -- $ -- $ 6,836
Securities.................... 90,953 43,652 42,518 206,178 174,044 557,345
Loans......................... 327,929 74,272 121,885 417,613 144,504 1,086,203
--------- --------- --------- --------- -------- ----------
Total.................... $ 425,718 $ 117,924 $ 164,403 $ 623,791 $318,548 $1,650,384
========= ========= ========= ========= ======== ==========
Rate-sensitive liabilities:
Deposits...................... $ 556,784 $ 126,769 $ 211,443 $ 192,172 $ 4,518 $1,091,686
Borrowed funds................ 154,437 1,000 92,650 115,700 -- 363,787
--------- --------- --------- --------- -------- ----------
Total.................... $ 711,221 $ 127,769 $ 304,093 $ 307,872 $ 4,518 $1,455,473
========= ========= ========= ========= ======== ==========
Period GAP...................... $(285,503) $ (9,845) $(139,690) $ 315,919 $314,030 $ 194,911
========= ========= ========= ========= ======== ==========
Ratio of period GAP to total
rate-sensitive assets......... (17.3)% (0.6)% (8.5)% 19.2% 19.0% 11.8%
========= ========= ========= ========= ======== ==========
Cumulative GAP.................. $(285,503) $(295,348) $(435,038) $(119,119) $194,911
========= ========= ========= ========= ========
Ratio of cumulative GAP to total
rate-sensitive assets......... (17.3)% (17.9)% (26.4)% (7.2)% 11.8%
========= ========= ========= ========= ========
</TABLE>
In analyzing its GAP position, although all time periods are considered,
First Western emphasizes the next 12-month period. An institution is considered
to be liability-sensitive, or as having a negative GAP, when the amount of its
interest-bearing liabilities maturing or repricing within a given time period
exceeds the amount of its earning assets also repricing within that time period.
Conversely, an institution is considered to be asset-sensitive, or as having a
positive GAP, when the amount of its interest-bearing liabilities maturing or
repricing is less than the amount of its interest-earning assets also maturing
or repricing during the same period. Generally, in a falling interest rate
environment, a negative GAP should result in an increase in net interest income,
and in a rising interest rate environment, this negative GAP should adversely
affect net interest income. The converse would be true for a positive GAP.
However, shortcomings are inherent in a simplified GAP analysis that may
result in changes in interest rates affecting net interest income more or less
than the GAP analysis would indicate. For example, although certain assets and
liabilities may have the similar maturities or periods to repricing, they may
react in different degrees to changes in market interest rates. Furthermore,
repricing characteristics of certain assets and
20
<PAGE> 22
liabilities may vary substantially within a given time period. In the event of a
change in interest rates, prepayment and early withdrawal levels could also
deviate significantly from those assumed in calculating GAP. Also, GAP does not
permit analysis of how changes in the mix of various assets and liabilities on
growth rate assumptions impact net interest income.
Due in part to the shortcomings of GAP analysis, the asset/liability
committee of First Western believes that simulation modeling more accurately
estimates the effects of and exposure to interest rate changes.
The simulation modeling performed by First Western measures the change in
net interest income over the next 12- and 24-month periods resulting from
hypothetical market interest rate changes. The simulation model includes all
financial instruments including derivative financial instruments. First
Western's simulation model includes assumptions on balance sheet changes and
growth. Prepayments on loans and mortgage-backed securities have been estimated
in the model based on industry prepayment trends.
As of December 31, 1998, First Western's simulation modeling indicates that
with a 200 basis point increase in interest rates, First Western's net interest
income would be 0.4% and 0.6% less than if rates had not changed for the next
12- and 24-month periods, respectively; and with a 200 basis point decrease in
interest rates, net interest income would be 2.1% and 6.4% less. As of December
31, 1997, First Western's simulation modeling indicated that with a 200 basis
point increase in interest rates, First Western's net interest income would have
been 0.1% and 1.6% less than if rates had not changed for the next 12- and
24-month periods, respectively; and with a 200 basis point decrease in interest
rates, net interest income would have been 2.6% and 4.8% less. The December 31,
1998 and 1997 simulation models were prepared with the assumption that the
change in interest rates would occur over the first 12 months and remain flat
thereafter.
LIQUIDITY AND CASH FLOWS
Liquidity is the ability to provide the cash necessary to meet customer
credit needs and satisfy depositor withdrawal requirements. One source of
liquidity is cash and short-term assets, such as interest-bearing deposits in
other banks and the Federal Home Loan Bank and federal funds sold, which totaled
$49.0 million at December 31, 1998, compared with $47.8 million at December 31,
1997. Another source of liquidity is borrowing capability. First Western's
banking subsidiary has a variety of sources of short-term liquidity available to
it, including federal funds purchased from correspondent banks, sales of
securities available for sale, sales of securities under agreements to
repurchase, the Federal Reserve discount window, interbank deposits, FHLB
advances and loan participations or sales. At December 31, 1998, First Western
had $34.5 million of unused overnight credit lines available. First Western's
portfolio of securities available for sale is another source of liquidity. This
portfolio of securities of $475.6 million at December 31, 1998, excluding
pledged securities of $393.1 million, is recorded at current market value with a
corresponding adjustment to equity, net of income tax effects. Therefore, these
securities may be sold to meet liquidity needs if necessary without impacting
First Western's equity. First Western also generates liquidity from the regular
principal payments and prepayments made on its portfolio of loans and
mortgage-backed securities.
First Western's operating activities generated cash flows of $185.9 million
in 1998, compared with $157.4 million in 1997 and $56.0 million in 1996. The
primary source of operating cash flows for 1998, 1997 and 1996 was the sale of
mortgage loans and net income combined with noncash expenses, such as the
amortization of intangible assets, provision for loan losses and depreciation.
Investing activities used cash flows of $254.2 million in 1998, compared
with $152.6 million in 1997 and $171.4 million in 1996. During 1998, the growth
of the loan portfolio used net cash flows of $153.5 million, compared with
$126.0 million in 1997 and $157.8 million in 1996. Net securities activities
used $313.7 million of cash flows during 1998, primarily as a result of the
investment of the $251.2 million received from the purchase of the PNC Bank
branches. During the first quarter of 1998, First Western sold its Lake County,
Ohio branches which used cash flows of $40.9 million.
Financing activities provided cash flows of $73.4 million in 1998 compared
with $192,000 in 1997 and $112.0 million in 1996. An increase in borrowings
provided cash flows of $121.9 million in 1998, compared with using cash flows of
$31.5 million in 1997. First Western increased its borrowings during 1998 in
order to
21
<PAGE> 23
fund the leverage strategy implemented in July 1998 and also in order to provide
a capital contribution to its bank subsidiary. First Western reduced borrowings
during 1997 with the funds provided by loan sales.
SHAREHOLDERS' EQUITY AND CAPITAL RESOURCES
Shareholders' equity at December 31, 1998 was $149.0 million, increasing
$10.2 million or 7.3% from $138.8 million at December 31, 1997 primarily due to
the retention of earnings. As a result of the pending acquisition by Sky
Financial, First Western's Board of Directors changed the schedule for First
Western's quarterly dividends. Prior to the agreement with Sky Financial, First
Western paid dividends in February, May, August and November. As called for in
the merger agreement, First Western changed its quarterly dividend schedule to
match Sky Financial's schedule. Therefore, beginning in January 1999, First
Western will pay its dividends in January, April, July and October. In order to
accommodate this change in the dividend schedule, First Western's Board of
Directors declared a dividend of $0.10 in December 1998 with this dividend
payable in January 1999. The dividend was set at $0.10 instead of First
Western's regular dividend of $0.15 since it was paid one month in advance of
when it otherwise would have been paid.
First Western's ratio of shareholders' equity to total assets was 6.69% at
December 31, 1998, compared with 7.96% and 7.53% at December 31, 1997 and 1996,
respectively. The book value per share was $13.37 at December 31, 1998, compared
with $12.47 and $11.16 at December 31, 1997 and 1996, respectively.
On February 11, 1997, First Western completed the private placement of $25
million of 9.875% capital securities due February 1, 2027. Securities of this
type received approval in October 1997 from the Federal Reserve Bank to qualify
as Tier I capital, and the interest payable thereon is currently considered to
be tax-deductible.
First Western, as a bank holding company, is required to meet certain
risk-based capital and leverage requirements. The risk-based capital
requirements redefine the components of capital, categorize assets into
different risk classes, and include certain off-balance sheet items in the
calculation of the adequacy of capital. A financial institution's capital is
divided into two classes, Tier I and Tier II.
First Western's Tier I and Tier II capital consisted of the following at
December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
TIER I:
Common shareholders' equity..................... $ 149,021 $ 138,842
Non-exempt intangible assets.................... (60,389) (9,262)
Trust preferred capital securities.............. 23,877 23,837
Unrealized appreciation in securities available
for sale..................................... (5,435) (5,443)
---------- ----------
Total Tier I................................. 107,074 147,974
---------- ----------
TIER II:.......................................... 17,349 13,658
---------- ----------
Total capital................................ $ 124,423 $ 161,632
========== ==========
Risk-weighted assets.............................. $1,271,390 $1,088,249
========== ==========
Tier I capital ratio.............................. 8.42% 13.60%
========== ==========
Required Tier I capital ratio..................... 4.00% 4.00%
========== ==========
Total capital ratio............................... 9.79% 14.85%
========== ==========
Required total capital ratio...................... 8.00% 8.00%
========== ==========
</TABLE>
First Western's regulatory capital ratios decreased from December 31, 1997
to December 31, 1998 primarily as a result of the intangible assets that
resulted from the premium paid for the PNC Bank branches along with the increase
in First Western's total assets.
22
<PAGE> 24
First Western is also subject to a minimum Tier I leverage ratio based on
Tier I capital to total average assets. The required ratio for each financial
institution is determined based on the financial institution's relative
soundness. A minimum ratio of Tier I capital to total assets of 3% has been
established for top-rated financial institutions, with less highly rated
institutions or those with higher levels of risk required to maintain ratios of
100 to 200 basis points above the minimum level. First Western's Tier I leverage
ratio was 5.00% at December 31, 1998, compared with 8.73% at December 31, 1997.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
First Western Bancorp, Inc.
By /s/ Kenneth J. Romig
--------------------
Kenneth J. Romig
Chief Financial Officer
(Principal Financial Officer)
Date: May 13, 1999
23
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT PRIOR FILING OR SEQUENTIAL
NUMBER DESCRIPTION PAGE NUMBER
- ------ ----------- -----------
<C> <S> <C>
23.1 Consent of Deloitte & Touche LLP Filed Herewith
</TABLE>
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements of
First Western Bancorp, Inc. on Form S-8 (No. 33-46923) for the First Western
Bancorp, Inc. 401(k) Profit-Sharing and Stock Bonus Plan, on Forms S-8 (Nos.
33-00528 and 33-50372) for the First Western Bancorp, Inc. Incentive Stock
Option Plan for Key Employees and on Form S-3 (No. 33-40596), as amended, for
the First Western Bancorp, Inc. Dividend Reinvestment and Additional Stock
Purchase Plan of our report dated January 25, 1999, appearing in this Annual
Report on Form 10-K/A of First Western Bancorp, Inc. (to be filed on or about
May 13, 1999) for the year ended December 31, 1998.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
May 13, 1999
